Sovereign Debt

Let’s be clear: financial misdeeds ruin lives. If a Madoff takes your money and uses it to pay off other investors in a ponzi scheme, you won’t be able to get it back. If a Blankfein underling issues you with misleading advice, and then bets against you (creaming himself a nice profit), you won’t be able to get it back. If a Corzine steals your money and uses it to bet on the European sovereign debt market, you might not be able to get it back. You might end up in poverty or worse. You might lose your children’s college money, your retirement money, or capital you needed for your business. You might lose your home. So shouldn’t we take a tough line against financial misdeeds? Shouldn’t tricking and stealing from investors, tricking and stealing from the public, tricking and stealing from clients carry a heavy disincentive, like death? Would a corrupt banker not think twice about their misdeeds if they knew that apprehension would mean a noose around their neck and a kicked bucket? A lot of commentators — like for example, Max Keiser — seem to think so. And in China financial crimes are treated with a gravity far beyond a cushy minimum security cell, and home visits on the weekends. Financial criminals in China are often executed.

Further confirmation of gold’s continuing but gradual renaissance as a safe haven asset was given by the IMF yesterday who warned that a “growing shortage of safe assets” poses a threat to “global financial stability.”  The IMF identified $74.4 trillion of potentially safe assets today, including gold, investment grade government and corporate debt, and covered bonds. Sovereign debt crises are reducing the number of governments that investors trust to issue "risk-free" bonds just as new financial regulations are increasing demand for safe securities from banks. Importantly, the IMF’s latest Global Financial Stability Report’s introduction finds that  "In the future there will be rising demand for safe assets, but fewer of them will be available, increasing the price for safety in global markets.” “Both the lack of political will to reshape fiscal policies at times of rising concern over debt sustainability and an overly rapid reduction of fiscal deficits limit governments’ capacity to produce assets with low credit risk.” The IMF has warned regarding illiquidity in “safe haven” markets. Gold remains one of the most liquid markets in the world and the illiquidity in bond markets would see increased safe haven demand for gold.  The IMF is warning regarding deteriorating public finances. As many governments see themselves being downgraded - safe haven bonds may become less safe.

Now that every morning the US market is once again in full on European debt issuance stress mode, it makes sense to see just when the real stress will hit the tape, or in other words, how long until the LTRO money fully runs out. Remember that the latest contraption in the European ponzi, the LTRO, took worthless collateral from European banks, and flooded them with fresh money good cash so they could use this cash to buy their own sovereign debt, and specifically to prefund the hundreds of billions in 2012 issuance net of debt maturities. So how does the math work out? Deutsche Bank summarizes the unpleasant picture.

Last week we had the Fed's hawks line up one after another telling us how no more QE would ever happen. We ignored them because they are simply the bad cops to the Fed's good cop doves. Sure enough, here comes Bernanke's right hand man, or in this case woman, hinting that one can forget everything the hawkish stance, and that ZIRP may last not until 2014 but 2015! Which, by the way, is to be expected: since ZIRP can never expire, it will always be rolled to T+3 years, as the short end will never be allowed to rise, until the Fed has enough FRNs in circulation to absorb the surge in rates without crushing the principal, as explained yesterday.

We all know that central banks and governments have been actively intervening in markets since the 2007 subprime mortgage meltdown destabilized the leveraged-debt-dependent global economy. We also know that unprecedented intervention is now the de facto institutionalized policy of central banks and governments. In some cases, the financial authorities have explicitly stated their intention to “stabilize markets” (translation: reinflate credit-driven speculative bubbles) by whatever means are necessary, while in others the interventions are performed by proxies so the policy remains implicit.  All through the waning months of 2007 and the first two quarters of 2008, the market gyrated as the Federal Reserve and other central banks issued reassurances that the subprime mortgage meltdown was “contained” and posed no threat to the global economy. The equity market turned to its standard-issue reassurance: “Don’t fight the Fed,” a maxim that elevated the Federal Reserve’s power to goose markets to godlike status. But alas, the global financial meltdown of late 2008 showed that hubris should not be confused with godlike power. Despite the “impossibility” of the market disobeying the Fed’s commands (“Away with thee, oh tides, for we are the Federal Reserve!”) and the “sure-fire” cycle of stocks always rising in an election year, global markets imploded as the usual bag of central bank and Sovereign State tricks failed in spectacular fashion.

Imagine the world economy as an armada of ships passing through a narrow and dangerous strait leading to the sea of prosperity. Navigating the channel is treacherous for to err too far to one side and your ship plunges off the waterfall of deflation but too close to the other and it burns in the hellfire of inflation. The global fleet is tethered by chains of trade and investment so if one ship veers perilously off course it pulls the others with it. Our only salvation is to hoist our economic sails and harness the winds of innovation and productivity. It is said that de-leveraging is a perilous journey and beneath these dark waters are many a sunken economy of lore. Print too little money and we cascade off the waterfall like the Great Depression of the 1930s... print too much and we burn like the Weimar Republic Germany in the 1920s... fail to harness the trade winds and we sink like Japan in the 1990s. On cold nights when the moon is full you can watch these ghost ships making their journey back to hell... they appear to warn us that our resolution to avoid one fate may damn us to the other.

Four months ago we presented what was easily the clearest and most undiluted by media propaganda clue about the future of the European experiment, when we noted that even immigrants from places such as Afghanistan and Bangladesh, using Greece as a stepping stone onward to the gateway Shengen country of Italy, no longer have the urge to pursue their European dreams, and instead return home. As Art Cashin explained, "Over the decades, immigrants from Afghanistan, Bangladesh and other poor nations would work their way to Patras. They would stay for days or weeks awaiting a chance to smuggle themselves on to a freighter headed for Italy. Once there, they could make their way north into Europe to find hope and opportunity and maybe a job. Last week his relatives told him that things were changing. The immigrants still come to their way station of Patras (hope still blooms). But now, after a couple of weeks in Greece, they are trying to hop ships going the other way. They are going back home. Life was better, or at least no worse, where they came from and they had friends and family for support back there." It appears that the immigrant boycott is spreading, only this time instead of "discretionary" immigrants, or those that have not been fully assumed by society (think "cheap labor" along America's south, such as California, Texas and Arizona), it is starting to hit the core of the cheap PIIGS labor force: the migrant workforce, and in this case the Albanian diaspora working out of Greece at a fraction of the normal cost. And as one Albanian migrant worker, so critical to keeping the Greek construction sector supplied with cheap jobs puts it, "It looks like there's no money left," he said of Greece. "It all dried up." As a result even the Greek illegal-yet-symbiotic-aliens are giving up and going back home. Yes folks: the "indicators" on the ground are telling us that it is now easier to make money in Albania than in Greece.

A lot.

The regulators have "fixed" a big problem. Actually they just created a much larger one.

Much has been made, and rightly so, of the echoing crisis that is evolving in Spanish bank and sovereign credit (and equity) markets in the last few weeks. The impact of the LTRO on the optics of Spain's problems hid the fact that things remain rather ugly under the surface still and with the fading of that cashflow and reach-around demand from the Spanish banking system, the smaller base of sovereign bond investors has shied away. Stephane Deo, of UBS, notes that while the Spanish budget is a positive step (with its labor market reforms), Spain's economy remains weak and will face a severe recession this year followed by still significant contraction next year. However, he fears the measures announced may not be enough to calm investor angst as he doubts the size of fiscal receipts numbers and the ability to half the deficits of local authorities. Furthermore, the measures will have a large impact on corporate earnings - implicitly exaggerating the dismal unemployment numbers (which is increasingly polarizing young against old) with expectations that the aggregate unemployment rate could well top 26% and youth well over 50%. This will only drag further on the housing market, which while it has suffered notably already, is expected to drop another 25% before bottoming and credit is contracting rapidly (compared to a modest rise overall in Europe). Spanish banks remain opaque in general from the perspective of the size and quality of collateral and provisioning and Deo believes they are still deep in the midst of the provisioning cycle and tough macro conditions will force restructuring and deleveraging. Spain scores 5 out of 5 on our crisis-prone indicator and markets, absent intervention, are starting to reflect that aggressively.

Let's get it all out there. America's dirty laundry that is. Our family secrets. The skeletons in the closet. The goal is to create a list of the many and numerous ways in which our country is deluding itself into believing we are the greatest, smartest, most innovative, freedom loving country that ever was. Don't get me wrong, I'm not some unpatriotic ne'er do well. I love what the Founding Fathers of our country set out to accomplish, faults and all. I love it so much, I was willing to put my life on the line for this country by serving in a US Marine Corps special forces unit for 8 years (your move armchair patriot). But we have drifted so far from the original concepts, I believe our current central planning apparatus more closely resembles the USSR than what most people think is the USA. So I'm going to kick this list off but in no way do I intend this to be exhaustive.

There are many reasons why gold is still our favorite investment – from inflation fears and sovereign debt concerns to deeper, systemic economic problems. But let's be honest: It's been rising for over 11 years now, and only the imprudent would fail to think about when the run might end. Is it time to start eyeing the exit? In a word, no. Here's why. There's one indicator that clearly signals we're still in the bull market – and further, that we can expect prices to continue to rise. That indicator is negative real interest rates.

The Deepwater Horizon incident demonstrated that most of the oil left is deep offshore or in other locations difficult to reach. Moreover, to obtain the oil remaining in currently producing reservoirs requires additional equipment and technology that comes at a higher price in both capital and energy. In this regard, the physical limitations on producing ever-increasing quantities of oil are highlighted, as well as the possibility of the peak of production occurring this decade. The economics of oil supply and demand are also briefly discussed, showing why the available supply is basically fixed in the short to medium term. Also, an alarm bell for economic recessions is raised when energy takes a disproportionate amount of total consumer expenditures. In this context, risk mitigation practices in government and business are called for. As for the former, early education of the citizenry about the risk of economic contraction is a prudent policy to minimize potential future social discord. As for the latter, all business operations should be examined with the aim of building in resilience and preparing for a scenario in which capital and energy are much more expensive than in the business-as-usual one.

When one cuts out all the noise, the only true purpose of aggressive (or not) central bank asset expansion, is to be a "buyer" of last resort of sovereign debt funding. Think of it as the source of credit money demand (and hence supply) when every other sector is deleveraging, and when a given Treasury authority needs to pump trillions in debt into the market but when nobody can afford to lever up and buy said incremental debt. Call it monetization, call it funding the deficit, call it whatever: that's what it is. And when people think of monetization, they think, first and foremost of the Chairman, who recently was caught praising the fiat system at a university named for a person who said the following prophetic line: "Paper money has had the effect... it will ever have, to ruin commerce, oppress the honest, and open the door to every species of fraud and injustice." Irony aside, when one cuts to the chase, and ignores even further noise about monetization being direct, indirect, sterilized, shadow, etc, there are just two metrics that are relevant: change in sovereign debt and change in Central Bank Assets. In this regard, of the US' $5.5 trillion in sovereign debt increase, the Fed matched Geithner for $2.0 trillion of the total, or 37%. An admirable number and certainly better than the BoE's 29%. Yet who gets the absolute top prize? Why none other than the ECB, which with $2 trillion in expansion (of which about 60% took place under Goldman apparatchik Mario Draghi in just the past 6 months) represents a whopping 63% of total Eurozone sovereign debt expansion of $3.1 trillion!