Money Supply

Peripheral stock indices underperformed in early trade, with banks under considerable selling pressure amid renewed tensions in credit markets. Wave after wave of poor data from the European PMIs and the German IFOs placed shares under further pressure and talk of macro names selling EUR/USD weighed on the pair. As a result, in the fixed income space, the German 2/5 spread traded at levels not seen since December 2008. However as the session progressed, stocks staged a decent recovery, which coincided with unconfirmed market talk of an asset reallocation trade, together with talk of Asian real money accounts buying French OATs, which in turn prompted sharp tightening in FR/GE 10y bond yield spread. This also supported EUR/USD, which after coming close to making a test on the 1.2500 barrier is now trading little changed. In other news, the ONS reported that the UK economy shrank by 0.3% in the first three months of the year, more than previously thought. The downward revision was due to a bigger contraction in construction output than previously estimated. Despite this, FTSE in the cash has persisted, and is the strongest performing index in Europe today.

All you need to read.

Michael Hudson argues that Mr. Krugman is a conservative in disguise.

In an interview with Louis James, John Hathaway discusses the US's economic outlook and why he's delighted by the current bearish sentiment toward gold. "I think we're at the end of a correction that resulted from the peak last summer. It was overcooked, kind of hyperventilated hysteria over the debt-ceiling talks, the rating downgrade of the US sovereign debt, and I think basically the stocks and the metal had been working off that boiled down to what we now have is a simmer. I think we are at a position where there's not a lot of downside, and I would not be surprised by revisiting the previous highs of $1,900 and maybe even new highs over $2,000 this year."

• Inside J.P. Morgan's Blunder (WSJ) - Where we learn that Jamie Dimon did not inform his regulator, the Fed, where he is a board member of the massive JPM loss even as he was fully aware of the possible unlimited downside
• Euro Attempted Recovery Countered By Asian Sovereigns (MNI)
• Santander, BBVA Among Spanish Banks Downgraded by Moody’s (Bloomberg)
• Defiant Message From Greece (WSJ)
• G-8 Leaders to Discuss Oil Market as Iran Embargo Nears (Bloomberg)
• Spain hires Goldman Sachs to value Bankia (Reuters)
• China to exclude foreign firms in shale gas tender (Reuters)
• Fed Board Nominees Powell, Stein Win Senate Confirmation (Bloomberg)
• Defiant Message From Greece (WSJ)
• Fitch Cuts Greece as Leaders Spar Over Euro Membership (Bloomberg)
• Madrid Hails Moves by Regions to Cut Spending (WSJ)

As either taxpayers or long-term JPM investors, we should be more grateful than sorry about the JPM CIO Ina Drew.

After sell-side analysts had been begging for it, pardon, predicting it for months, the PBOC finally succumbed and joined every other bank in an attempt to reflate, even as pockets of inflation are still prevalent across the country, although the recent disappointing economic data was just too much. Overnight, the Chinese central bank announced it was cutting the Reserve Requirement Ratio by 50 bps, from 20.5% to 20.0%, effective May 18. The move is expected to free up "an estimated 400 billion yuan ($63.5 billion) for lending to head-off the risk of a sudden slowdown in the world's second-largest economy" as estimated by Reuters. "The central bank should have cut RRR after Q1 data. It has missed the best timing," Dong Xian'an, chief economist at Peking First Advisory in Beijing, told Reuters. "A cut today will have a much discounted impact. So the Chinese economy will become more vulnerable to global weakness and the slowing Chinese economy will in turn have a bigger negative impact on global recovery. Uncertainties in the global and Chinese economy are rising," he said. The irony, of course, is that the cut, by being long overdue, will simply accentuate the perception that China is on one hand seeing a crash in its housing market and a rapid contraction int he economy, while still having to scramble with high food prices (recall the near record spike in Sooy prices two weeks ago). In the end, the PBOC had hoped that it would be the Fed that would cut first and China could enjoy the "benefits" of global "growth", and the adverse effects of second hand inflation. Instead, Bernanke has delayed far too long. When he does rejoin the race to ease, that is when China will realize just how short-sighted its easing decision was. In the meantime, the world's soon to be largest source of gold demand just got a rude reminder that even more inflation is coming.

All you need to read and some more.

Highly respected economist and strategist David Rosenberg has told that Financial Times in a video interview (see below) that gold “will go to $3,000 per ounce before this cycle is over.” Markets are repeating the downturns of 2010 and 2011 and it is time to search for safety, David Rosenberg of Gluskin Sheff tells James Mackintosh, the FT Investment Editor. Rosenberg sees a “very good opportunity in gold” as it has corrected and seems to be “off the radar screen right now”. He sees gold as a currency and says the best way to value gold is in terms of money supply and “currency in circulation.” As the “volume of dollars is going up as we get more quantitative easing” he sees gold at $3,000 per ounce. Mackintosh says that Rosenberg’s view is a “pretty bearish view”. To which Rosenberg responds that it is “bullish view on gold and gold mining stocks.” Mackintosh says that it is “bearish on everything else”. Rosenberg  says that it is not about being “bullish or bearish,” it is about “stating how you view the world” and he warns that the major central banks are all going to print more money and keep real interest rates negative “as far as the eye can see.”

Mitt Romney's theory goes that by buying U.S. currency (so far they have accumulated around $3 trillion) and treasuries (around $1 trillion) on the open market, China keeps demand for the US dollar high.  They can afford to buy and hold so much US currency due to their huge trade surplus with America, and they buy US currency roughly equal to this surplus.  To keep this pile of dollars from increasing the Chinese money supply, China sterilises the dollar purchases by selling a proportionate amount of bonds to Chinese investors.  Supposedly by boosting the dollar, yuan-denominated Chinese goods look cheap to the American (and global) consumer.  What Romney is forgetting is that every nation with a fiat currency is to some degree or other a currency manipulator. That’s what fiat is all about: the ability of the state to manipulate markets through monetary policy. When Ben Bernanke engages in quantitative easing, or twisting, or any kind of monetary policy or open market operation, the Federal Reserve is engaging in currency manipulation. Every new dollar that is printed devalues every dollar out in the wild, and just as importantly all dollar-denominated debt. So just as Romney can look China in the face and accuse them of being a currency manipulator for trying to peg the yuan to the dollar, China can look at past U.S. administrations and level exactly the same claim — currency manipulation in the national interest.

All you need to read and some more.

If the greatest trick the devil ever pulled was convincing the world he didn’t exist, the greatest trick our central bank ever pulled was convincing the world we couldn’t live without it. For most of that past twenty years, that PR campaign has been centered on the Great “Moderation”, so called because it apparently represented the full embodiment of economic management – a period of unparalleled prosperity, a Golden Age of soft economic central planning. Give the central bank enough “flexibility” and it will produce unmatched economic and financial satisfaction.

Bernanke’s legacy is still to be made. But he has put the US economy in a position from which it can succeed. If Europe falls apart, it will be more difficult. If we fall of the fiscal cliff we will have our own Thelma and Louise moment. The Fed Chairman has already said he can’t save us from that shock. It’s really time for fiscal policy makers to step up. As long as they refuse it makes Bernanke’s job all the harder. And the pressure on him is intense.

Bernanke is under a lot of pressure and is given little credit for what have been remarkable achievements. Do risks remain? They sure do. But that result is yet to be decided. Meanwhile risks elsewhere are at least as pressing. Look at his successes...

Anybody watching the EUR/CHF exchange rate this year was wondering why the volatility the pair saw last year had completely left. The pair slowly fell from 1.2156 over 1.2040 at the end of Q1 to 1.2014 today. FX traders hoped on a hike of the floor from 1.20 to 1.25, as many Swiss politicians and companies requested. Banks sold masses of Long EUR/CHF certificates and options. The retail market measured in SSI (Speculative Sentiment Index) was 96% long EUR/CHF.  We saw the typical Forex web sites telling regularly their masses of followers that the protagonists of these web sites were going long EUR/CHF in the hope that the SNB is going to act. This happened at multiple critical levels, at 1.2070, 1.2050, at 1.2030 and finally at 1.2010. The small FX trader was begging for months that the SNB would finally intervene. When all these people were long EUR/CHF, who was actually short, when the exchange rate continued to fall ? We speculated that some big accounts wanted their clients to be knocked out with their EUR/CHF longs, we thought that Swiss pension funds and big investors continued to repatriate their foreign funds.  What did the SNB ? Did they support the hopes of the masses, of all these SNB rooters ? But on the back-door of all this rhetoric they did the complete opposite: The central bank was happy to get rid of their Euros at a higher price than the floor they had set in September 2011 !

While Krugman does not by any means endorse the level of centralism that Diocletian introduced, his defence of bailouts, his insistence on the planning of interest rates and inflation, and (most frighteningly) his insistence that war can be an economic stimulus (in reality, war is a capital destroyer) all put him firmly in Diocletian’s economic planning camp. So how did Diocletian’s economic program work out? Well, I think it is fair to say even without modern data that — just as Krugman desires — Diocletian’s measures boosted aggregate demand through public works and — just as Krugman desires — it introduced inflation. And certainly Rome lived for almost 150 years after Diocletian. However the long term effects of Diocletian’s economic program were dire. Have the 2008 bailouts done the same thing, cementing a new feudal aristocracy of bankers, financiers and too-big-to-fail zombies, alongside a serf class that exists to fund the excesses of the financial and corporate elite? Only time will tell.