Stock-Market Crashes Through the Ages – Part III – Early 20th Century

Pivotfarm — Tue, 18 Jun 2013 23:54:40 +0000

The 20th century could be categorized as THE century when communications took off and we started living in each other’s pockets. Lives had been ruined by war, trouble and strife. Wealth had been redistributed beyond belief. There were no longer just a few that were making the profits, but there were growing classes of people that wanted recognition.

They might not have got it until the second half of the 20th century, but the way things unraveled in the first half meant that people were not prepared to sit back and let things go into the hands of the rich landlords and the factory owners.

Rights had been acquired and they were being demanded. Women, workers, whoever they were, everybody wanted a piece of the cake. It wasn’t until the second half of the twentieth century that dabbling and buying shares, thinking you could strike it lucky and make a million, was going to become part and parcel of most people’s lives. Maybe that’s the whole problem. People betting on investments as if that was nothing more than a couple of whippets running round the race track on a Saturday afternoon, bag of chips in one hand and a pint of ale in the other. Flat cap and everything.

The markets don’t act like that. But, we allowed people to think that they could make a quick million bucks by investing what they had hidden under the mattresses for decades. Why did they need to worry anyhow, social security had been invented, we were looking after the destitute and not locking them behind the gates of Victorian workhouses and mental asylums. There was a safety net that had been created in society by the advent of the National Health Services (1948 in the UK) that we pride ourselves for inventing or the retirement schemes that we say will make pensioners’ lives better (Dankeschön, Mr. Bismarck).

As time went on in the 19th century the number of stock-market crashes increased.

That number increased even more in the 20th century. Information was accessible. Telecommunication technology was entering our lives as a daily piece of equipment. I could start to be absent and yet present at the same time. I didn’t have to be literally somewhere physically; I could be there almost in person via the transmission of my voice or an image. It was reserved for the elite at the start, but as the century progressed, it became more and more democratized. Later in the century, it would be possible to be completely present, and yet physically absent and I would be able to do it from the comfort of my own living room. Education was becoming more and more widespread. Newspapers were being read even by those that had not been able to read in the previous century (total circulation was at over 27 million in 1920 and households had papers delivered both in the morning and in the evening). Access to information meant the learning of events almost in real-time.

Stock Markets: Interconnected

The 20th century saw an explosion in the number of stock market crashes. Here are a few of them. The ones that bit us from behind as we scrambled out of the markets sometimes to be left without a cent. One thing about it all was that the dream of the self-made man, the entrepreneur, the idea of striking it rich had really come into its own in this century! This is just the first half of the 20thcentury!

1. Panic of 1901

We entered the 20th century with a panic. The turn of the century has always been equated with great change, either good or bad. The Panic of 1901 was due to some extent to the fight for the control of the Northern Pacific Railway.

Stock Market: Edward Henry Harriman

The Northern Pacific was a transcontinental railway (1864-1970).
Edward Henry Harriman who was the Chairman of Union Pacific attempted at all costs to monopolize the railway sector.
He attempted to buy stock en masse belonging to Northern Pacific Railway to take control of the company.
The NYSE was said to look more like a football field as the panic started and prices began to fall as people started to sell in sheer panic.
The market crashed and brought down with it the majority of US railway companies (Burlington and Missouri Pacific, for example).
The only one that was left still standing was the Northern Pacific. The run on their shares by Harriman had meant that people were selling all other shares like they were going out of fashion and attempting to buy into Northern Pacific.
One company’s loss became another companies gain and Northern Pacific increased by 16.5 points.

The crash spread to other companies. It brought the country into recession and was the first stock-market crash of the 20th century.

2. Panic of 1907

The Panic of 1907, is the Bankers’ Panic. The NYSE dropped by 50%. The reasons? Lack of confidence in the market and retraction of market liquidity by NY banks. The banks had lent out too much money in an attempt to purchase the United Copper Company and this caused loss of confidence and bank runs ensued.

The US had no central bank that would act as a lender of last resort at the time. President Andrew Jackson had let the charter of the Second Bank of the United States lapse in 1836. Money supplies fluctuated only in line with agricultural cycles. Money left NY in the autumn to purchase harvests and the only thing that made that money come back was a raise in interest rates.
J.P. Morgan shored up the banks and bailed them out; otherwise there might have been an even worse situation.
There was an attempt to corner United Copper, by purchasing large quantities of the stock of the company in a bid to be able to manipulate the price of copper afterwards.
Shares rose in the beginning from $39 to $52 per share. They reached $60 before they began to collapse.
Within just a few days, they ended up at $10.

J.P. Morgan had managed to shore up the banks for a while as they were suffering from lack of liquidity, but he was unable to do so indefinitely. The bankers tried to call a press meeting to persuade the papers that they were controlling everything. Even the city of New York needed $20 million otherwise it would go bankrupt.

Morgan said “if people will keep their money in the banks, everything will be all right”.

The banks were not willing to make loans (short-term) to brokers to carry out daily trading, worried that the stock would fall even more. Prices fell as a consequence on October 24th 1907. The President of the NYSE requested that the stock exchange be closed early to halt more losses. Closing the NYSE would mean even greater loss of confidence. So, J. P. Morgan decided to call the banks to a meeting. He requested $25 million and it was raised in 10 minutes flat! Not bad, really! But, it didn’t stop the free-fall.

1907 caused the highest number of bankruptcies to that date in the US.
Production was estimated to have fallen by 11%.
Imports were down by 26%.
Even immigration dropped. The US was no longer the land of plenty (fall from 1.2 million immigrants to just ¾ of a million in one year).
Unemployment rose to over 8%, whereas it had been at under 3%.

3. Wall Street Crash 1929

Probably the most famous stock market crash of the entire history of the economy (apart from the one that we are living right now). The Wall Street Crash is also known as Black Tuesday. Since this date we have used Black days throughout our stock market crashes (Black Monday in 1987, or Black Wednesday in 1992, for example).

Just like in the period that preceded the stock-market crash of 2008, there was a time of wealth, success, making money, sandwiched in between World War I and just before World War II. The roaring twenties. Innovation, dynamism, liberation, freedom.

Motion pictures abounded, the automobile became commonplace, electricity entered the homes of the middle-classes. Culture and lifestyles changed drastically. Everything became possible. Modernity had arrived. It’s strange that the period that preceded the stock market crashes of the 21st century was also a time of great change. We had invented and democratized communications to a point where we could carry it around in our pockets. We had changed the way we accessed information and we had it at our finger tips like no other generation had had before via Internet.

Speculation became the order of the day in 1929. The world investors were on a roll and it wasn’t going to end. Money could be had and it was short-time financial gain that was important. Making money and making it fast. But, even though we might not always apply the same knowledge today, what goes up must come down.

On March 25th 1929, it began with a mini-crash. This was only an omen of what was to come.
The National City Bank tried to shore up the losses by injecting $25 million into the market, stopping is descent into hell. But, it was all temporary.
The USA was showing signs of waning economically. The steel market was on the slippery slope and construction wasn’t anything more than just sluggish. The peak had been reached.
There were already 20 million cars on the roads, for example in 1929 in the US. Automakers sold 4.5 millioncars in the US market alone in that year before the crash.
General Motors had a net profit of $248 million. But, the peak had been reached, 1929 saw a dramatic drop. It was only selling 1/3 of the cars it had been selling prior to the crash on the domestic market. It took ten years to come back to the same level of profit and the number of car sales as in the period before the crash of 1929.
Although, it has to be said, even then, it was the shareholders that counted. The shareholders got dividends every single year from GM between 1929 and 1939.

The roaring twenties had roared on from 1920 until 1929. The Dow Jones Industrial Average had been multiplied by ten. Some even said that it was a “permanently high plateau” in September 1929. Very few are able to predict what the market will do, but nobody today, at least, would suggest for a second that we are going to be on a permanent high. That lesson has been heard loud and clear. The Dow jones reached its peak at 38.17 on September 3rd 1929.

The London Stock Exchanged collapsed when a British investor (Clarence Hatry) became the most hated man in the UK when he was jailed for fraud. Hatry was a London insurance clerk that had amassed immense wealth by profiteering during WWI. He was about to merge his companies into a $40-million affair called the United Steel Companies. But, the Stock Exchange Committee discovered that he had been borrowing ($1 million) without anything to back it up.

It was on October 24th 1929 that Black Thursday occurred. The NYSE plummeted 11%. Bankers managed to stop the landslide and purchase large quantities of stock well above the market price in blue-chip companies. It halted the free-fall. But, temporarily. The NYSE closed at -6.38 points.
The newspapers managed to report the news and Monday 28th became known as Black Monday.
Black Monday saw the DJIA spiral out of control. The US market lost 12.8% as trading opened up on the NYSE. It plummeted 38.33 points and closed at 260.64.
Black Tuesday, October 29th had 16 million shares being traded. The DJIA fell 30.57 points, to just 23.07. It lost 11.7%. In three days of trading the DJIA had lost over 30%.

What went horribly wrong? Speculation and certainly the belief that things would never end. Brokers were lending 2/3 of the face value of stocks that they were purchasing and that meant that in 1929 there was more money that was on loan than the entire currency in circulation in the USA ($8.5 billion). That smacks of something familiar when we think about the sub-prime crisis. The belief that housing prices could never fall and that we would always be on an upper, lending money left, right and center.

One other thing that we learned is that our worlds were interconnected. Falls in London, Tokyo and New York happened at the speed of light in 1929. What one did the other followed suit with. Only 16% of the US population had money invested in the stock market in 1929, but it was probably those that had the companies that employed the people that worked. The knock-on effect was enormous.

But people like Joseph Schumpeter and Nikolai Kondratieff believed through their economic-cycle theories looking at the way the market reacted that the 1929 crash was just acceleration in the cycle and it enabled moving towards the next one.

Stock Market: Nikolai Kondratieff

Stock Market: Joseph Schumpeter

4. Recession 1937

Spring 1937 saw the US economy get back on its feet and the levels of economic activity were similar to pre-1929 ones. Unemployment was still relatively high, but that was nothing compared to the vertiginous heights of 1933 (25%!). In 1937 things went haywire for just over a year causing an economic recession in the US, with a knock-on effect in the rest of the world.

Unemployment was at 14.3% in 1937. It increased to19%.
Manufacturing output fell by 37%.
Spending decreased and incomes fell by 15%.
GDP fell by 11%.

Economists fail to agree on the reasons (nothing surprising) as to the economic recession of 1937. Depends where you stand. If you are a Keynesian, you will believe that federal spending cuts brought about the recession, coupled with increased taxation. If you are a Milton-Friedman man then it’s the money supply and the Federal Reserve’s tightening of it that is the instigator.

The 1937 recession was called the ‘Recession within the Depression’.

Conclusions

Some might say that the benefits of what we have gained over the past century are far better than the relatively few times that we had to wade through the nightmares on Wall Street and the Stock Market crashes that hit us full in the face at times.

Some might say that it was worth it as the market generated the wealth on which we prospered in the 20th century. But, they also resulted in depression, recessions and slumps. Recessions that brought about the rise to power of some of the worst dictators that the world had seen.

Recessions that brought about a fight for greed and a closing in upon ourselves in protectionist fear. But, the 1st half the of the century was nothing compared to the stock market crashes that were waiting in store for us once we would become really industrially connected and inter-connected. When we went global, when we reduced our barriers, when we travelled from point A to point B at supersonic speed, and when one push of a fat finger on a keyboard sent millions across the other side of the planet.

Stock markets were going to run in the second half of the 20th century at supersonic, virtual speed. We would enterthe Big-Bang world of deregulation of the financial markets, abolishing fixed commission charges. But, behind the big bang was a black hole…

What reasons do you think could explain the stock-market crashes of the 20th century?

Take a look at the Stock Market Crashes Through the Ages – Part I – 17th and 18th Centuries.

Take a look at the Stock Market Crashes Through the Ages – Part II – 19th Century.

In the next installment, we’ll take a look at the historical stock-market crashes in the 2nd half of the 20th century.

Originally Posted: Stock-Market Crashes Through the Ages – Part III – Early 20th Century

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Google Challenges Surveillance Gag Order: Squares NSA Secrecy Against First Amendment

Tyler Durden — Tue, 18 Jun 2013 23:31:44 +0000

It appears that unlike the president, whose rating is plunging in the aftermath of PRISM-gate, US corporations are not eager to double down on their privacy intrusive ways, and some are becoming increasingly concerned about what all the recent exposure may do to their bottom line. Such as Google, which earlier today became only the first company to challenge the long-standing gag order issued by the secretive Foreign Intelligence Surveillance Court (FISA), arguing that the company has a First Amendment right to speak about information it is forced to give to the government. From Google: "Greater transparency is needed, so today we have petitioned the Foreign Intelligence Surveillance Court to allow us to publish aggregate numbers of national security requests, including FISA disclosures, separately." And yes, GOOG, which once upon a time pretended its motto is "don't evil" and since transformed it to "be evil, just don't get caught", still refer to "constitutional rights" - how quaint.

From WaPo:

The legal filing, which cites the First Amendment’s guarantee of free speech, is the latest move by the California-based tech giant to protect its reputation in the aftermath of news reports about sweeping National Security Agency surveillance of Internet traffic.

Google, one of nine companies named in NSA documents as providing information to the top-secret PRISM program, has demanded that U.S. officials give it more leeway to describe the company’s relationship with the government. Google and the other companies involved have sought to reassure users that their privacy is being protected from unwarranted intrusions.

It is not as if Google is even requesting much: in the petition, filed with the FISA court in downtown Washington, Google is seeking permission to publish the total numbers of requests the court makes of the company and the numbers of user accounts they affect. The company long has made regular reports with regard to other data demands from the U.S. government and from other governments worldwide. Basically, this would at least put the FISA court's data demands on equal footing with all other judicial entities. But we can't have that now, can we, or else the terrorists win.

That information would not necessarily shed much light on PRISM, whose existence was first reported by The Washington Post and Britain’s Guardian newspaper. But initiating a high-profile legal showdown may help Google’s efforts to portray itself as aggressively resisting government surveillance.

More importantly, it will now start an arms, or rather words race, between US corporations, in which the company that does not seek to emulate the "truth-telling" overtures of others, will be seen as the one most willing to handover user privacy to a secret organization without a fight. Which to internet companies means less users, less eyeballs, less clicking lifeblood. And most importantly, less top and bottom line.

All of the technology companies involved in PRISM, including Facebook, Apple, Microsoft, Google and Yahoo, have struggled to respond to the revelations about NSA surveillance. Most have issued carefully word denials, saying that they do not permit wholesale data collection while acknowledging that they comply with legal government information requests.

So now the ball is in the administration's court which will have no choice but to reject the demand, or else find itself bombarded on all sides by enjoinders from all other internet companies. Which in turn will put Obama in an even more unpleasant place: against the companies.

Because if anything, at least until this point he could spin the ever-escalating scandal as one in which the US was collaborating with an very eager private sector. This will very soon no longer be the case.

And if the accelerating of PRISM-gate means further loss of revenues and profits for some of the biggest companies in the world as a result of Obama's resolute defense of his Dubya legacy inheritance which he has succeeded in putting on steroids, then we would most certainly open a long private sector, short Obama pair trade.

What A Correction Could Look Like

Tyler Durden — Tue, 18 Jun 2013 22:46:26 +0000

While disappointment from the FOMC's comments tomorrow may not be enough to create 'the big one', it is perhaps worth a look at the more meaningful corrections over the last 10 years in equity and credit markets for some sense of context for what is possible. So far, it is clear, especially given today's equity rally (and ongoing credit weakness) that the consensus of the equity herd are not expecting disappointment tomorrow - while credit markets are preparing for the 'flow' to slow.

Credit markets are well on their way to a 'normal' correction...

But stocks remain notably confident relative to previous corrections...

and the divergence is becoming clearer...

and continues today...

Charts: Morgan Stanley

Conquering the Indonesian (and Mongolian) Frontier

Capitalist Exploits — Tue, 18 Jun 2013 22:27:00 +0000

Originally posted at http://capitalistexploits.at/

I caught up recently with Ranjeet Sundher in Singapore to go over his latest projects and thought it would be worthwhile introducing him to you. I really like Ranjeet because he’s a nuts and bolts entrepreneur, the type of guy who is adaptive enough, smart enough and flexible enough to prosper in countries which many shy away from.

Ranjeet is the CEO of Challenger Deep Resources (TSX.V: CDE), an Indonesian coal producer. Ranjeet formerly built-up Red Hill mining before selling it to Prophecy coal in Mongolia. More on that below.

Scott met more recently with Ranjeet over in Cambodia. Enjoy!

——–

Scott: Ranjeet, you’ve a fascinating background spanning software to coal mining on the Mongolian steppe. You moved from Canada to Indonesia in 1995. What prompted this move?

Ranjeet: My background is actually in equity trading. I worked up from a phone clerk to senior trader on the Vancouver stock exchange and eventually worked on the US trading desk. The Canadian Stock Exchanges were dominated by resource companies, mostly exploration and this is where the focus of my trading was. As a hobby I began staking claims in “hot” areas and selling them to companies, my hobby then became my full time job and I moved to Indonesia, which I believed offered the most reward long-term. I formed a private mining service company that soon grew to 90 employees and we covered everything from acquisition to exploration, legal and accounting for our clients. It was an exciting time until some political uncertainty affected FDI. Then in 2001 I relocated to Singapore where my home base has been ever since.

Scott: In 2001 Mongolia creeped onto your radar. After following the story remotely via your Bloomberg terminal, you ventured to Mongolia to learn about the resource revolution about to unfold first hand. What made you finally decide to commit time and capital there? Something which you are doing to this day.

Ranjeet: I have always, even now, watched for breaking resource news and traded accordingly. In January 2001 Ivanhoe, then a junior, reported an exceptional drill result from its Turquoise Hill Copper/Gold property. I realized immediately that junior exploration companies from around the world would start to focus their attention on Mongolia. Within 2 weeks I was on a plane to UB and spent the majority of my time there, until 2 years ago.

Scott: From a previous conversation, you mentioned Mongolia was awash with opportunities… from purchasing land leases to the obvious commodities plays. How did you find trustworthy partners to help you navigate the local scene?

Ranjeet: There was some luck involved. For the first 2 weeks I could not find the right partner who understood what I needed. UB was much different then, with no expat scene and no service companies in my sector. On the last day I met the right local partner who understood exactly what I needed, we have been partners ever since.

Scott: Founded in 2003, Redhill Energy focused on Mongolia and eventually identified 200m tonnes of thermal coal at Ulaan Ovoo, near the Russian border and over 1 billion tons on the Chandgana projects in Khenti. What was the strategy for this operation? Where was your end market and how did you intend to achieve delivery with limited infrastructure in country?

Ranjeet: To be honest we were a little short-sighted with our Mongolian ambitions, we were there to build resources fast and gave little thought to how we would sell it, a massive land grab was under way. We had spent 2001 until 2003 searching for gold and copper privately, then as Redhill we continued this and added Uranium. We had lots of initial exploration success but nothing panned out on the scale we needed. We started looking at coal in 2004, at this time there was no interest. In 2005 we made our first acquisitions and the next 4 years were very busy until we sold the company.

Scott: Today it is no surprise that Mongolia is awash in coal, especially thermal. Looking at the economics of this deposit can I assume that this was high-quality coal?

Ranjeet: The Ulaan Ovoo coal was of medium quality, but at the time was probably one of the top 5 deposits in Mongolia. The economics looked good at the resource delineation stage and we had several international consulting companies sign off of on positive scoping and PFS studies as the project developed.

Scott: What were some of the hurdles you faced operating this mine, or was it a rather smooth process?

Ranjeet: The acquisition and exploration of our Mongolian coal projects were straightforward and clear, the hurdles came with the needed mine and environmental permitting. The process was not that clear and few foreign companies had done this, so we kind of learned as we went. In the end we were successful and the hurdles we faced were nothing compared to what others face in Mongolia today.

Scott: Oyu Tolgoi’s tax and royalties agreement with the Mongolian government was initially settled in 2009 which sparked the great mining rush. Was this the catalyst that transformed Mongolia from a sleepy backwater to world class mining destination?

Ranjeet: Without the Ivanhoe discovery in 2001 there would have been no mining rush and Mongolia would not be what it is today. The pioneers of our industry started arriving in Mongolia between 2002, and in 2009 the mainstream investors started to arrive. Mongolia will again have another rush to the resource sector, though in my opinion that’s a couple years away.

Scott: Your operating history in Asia has been largely coal based. What licenses besides Ulan Ovoo did Redhill own and were any of them outside the realm of coal?

Ranjeet: Redhill started out exploring for copper and fold in Mongolia as well as Uranium, we probably had some sort of deal on over 50 projects in total over the years. In late 2004 I decided to have look at the coal sector, because at that time interest did not even exist. In 2005 we acquired Ulaan Ovoo, and 2 years later made a massive coal discovery on our Chandgana coal projects in Khenti Province.

Scott: In 2010 Redhill Energy shareholders agreed to a merger with Prophecy Coal. What made this strategically attractive? Why not position yourself to have been bought out by one of the majors?

Ranjeet: This deal was simply to good to turn down. At the time of the deal Redhill was looking at a capex of $50 million to get Ulaan into production, as well our market cap was only $20 million. By the time our all share swap deal closed the Redhill market cap was around $58 million. We all had shares in Prophecy, who at the time was trading large volume and raising large amounts of capital, they later spun out the non-Mongolian assets into NKL and we received additional shares, it was a good deal for us.

Scott: Today you are focusing your time on Challenger Deep Resources, a TSX.V listed company focusing on developing high caloric coal deposits in Central Kalimantan, Indonesia. At a time when prices have plummeted, what continues to attract you to the Asian thermal coal market?

Ranjeet: In 2008 I decided I wanted to run a coal mine for cash flow, I believed in the sector’s growth potential and had a good understanding of the steps to success from my previous coal experiences. The best place in the world for this is Indonesia, so I built Challenger and my team and we started to build a small to mid-size coal producer.

Scott: Elaborate on the specifics of the thermal coal market. What does the coal mining and export environment look like in Indonesia?

Ranjeet: Indonesia is the largest exporter of thermal coal in the world, in recent years it has surpassed Australia. There is a lot of untapped potential, and in large part the government has been supportive for 40 years to foreign investment in this sector, this does not however mean that irrational thinking doesn’t comes into play from politicians from time-to-time, but it always works out.

Scott: Speaking of irrational thinking, in 2009 Indonesia created a mining law banning the export of unprocessed ores, to be enforced from 2014. The Supreme Court struck down the export ban in September of last year, though MoEMR is attempting to counter the ruling. While it seems rational to demand the creation of an upstream mining industry in-country, it has wreaked havoc on junior resource companies and scared away investment. What are your thoughts on all of this and is there the potential for the domestic coal industry to be negatively impacted?

Ranjeet: I would first like to point out that the Indonesian domestic market demand for coal is growing every year. Additional power plants are being built and domestic users are competing for the coal that’s being exported, also domestic coal sales are priced against an average of different international coal benchmarks, so margins to sell your coal domestically are competitive. For the foreseeable future coal exports will continue as they have been, I could see however some increased government royalties on exports coming into play once coal prices start to move upwards.

Scott: Your Barito licenses are the most prospective of CDE’s properties, and are expected to be producing coal in Q4. A moderate sized deposit, what are you doing to enhance your resource base? What are your other licenses showing in terms of coal quality and quantity?

Ranjeet: The Barito project comprises 2 licenses 11km from the Barito river, there are also several other licenses in this area that we find attractive. There was only one private road into this area and one jetty, Challenger has purchased all this infrastructure. This creates a mini coal hub in this area and gives us leverage and scale to grow the resources and the economics.

Challenger has reviewed over 200 projects. It is our goal to have 2 operating mines before the end of 2014 as well as 2-3 exploration stage projects. This would then provide several value drivers for our shareholders as far as a return on investment.

Scott: That’s a remarkable filtering process, 200 licenses. Clearly you have a narrow focus which I presume is based predominately around low-capex projects?

Ranjeet: Low hanging fruit… we are looking for 5 to 10 year mine life projects with a capex under $10 million and a payback within 24 months of production starting. We rely on investor money to grow and we need to have the economics be very competitive.

Scott: Thanks Ranjeet, we’ll speak in more detail soon!

——–

We expect to hear more from Ranjeet in the coming months as I’ll be catching up with him shortly. We also hope to have him speak at our next Meet Up in Southeast Asia, with details on that forthcoming.

- Chris

”How many millionaires do you know who have become wealthy by investing in savings accounts? I rest my case.” – Robert G. Allen

Greece Has One Month To Plug A €1.2 Billion Healthcare Budget Hole

Tyler Durden — Tue, 18 Jun 2013 22:16:28 +0000

Think Cyprus is the only country that will need a repeat bailout (as the FT reported earlier)? Think again. Cause heeeeere's Greece... again.... where as Kathimerini reports, a brand new, massive budget hole for €1.2 billion has just been "discovered." Only this time it is not some C-grade government service that can just be swept away: it is to fund the country's biggest healthcare provider, EOPYY. And the deadline is imminent: Greece has less than a month to plug it.

From the Greek publication:

The Health Ministry has less than a month to find ways to plug a funding gap of around 1.2 billion euros in the budget of the country’s biggest healthcare provider, EOPYY, following a meeting between representatives of the country’s creditors and Minister Andreas Lykourentzos on Monday.

“There are important issues still to be discussed, such as restructuring EOPYY and the issue of costs created by shortfalls from social security funds,” Lykourentzos said.

He added that the inspectors noted progress in curbing the costs of hospitals and in supplies, but he also said that spending on medicines still has some way to go to reach a set target of 2.44 billion euros by the end of the year from 2.8 billion in 2012.

Why are all these "funding shortfalls" coming out suddenly, two months before the German general election? Because Europe's periphery is now an expert in leverage, which is precisely why the budget holes are emerging at this moment.

Because if there is one time Angela Merkel is most vulnerable, it is right about now, and with an election to focus on, a crash in the EUR, and a repeat spike in bond yields in the European periphery, not to mention a test of the EFSF, the ESM, and of course, the non-existent OMT, is that last thing she would want on her mind. And, the insolvent thinking goes, any demands for extra cash issued now will be promptly met.

So: first Cyprus, now Greece. Who's next? Because now is the time to make demands from Mama Merkel.

Guest Post: Why We Shouldn't Trust The Fed's Inflation Target

Tyler Durden — Tue, 18 Jun 2013 21:24:49 +0000

Submitted by F.F. Wiley via Cyniconomics blog,

Awhile back, I thought it might be interesting to create one of those island economy stories to demonstrate a problem with the Fed’s policy framework. I finally got around to it over the past week, after reading an article on the same policy flaw.

My island story’s relevance won’t be clear right away, but stick with it if you’re wondering what could go wrong with monetary policy (or if you like islands). I’ll show how the Fed’s inflation target can cause policymakers to do the exact opposite of what they should be doing. And then I’ll come back to the excellent article I read last week.

Introducing Debtor and Creditor Isles

Imagine an island where basic necessities are free, thanks to an abundance of miracle plants that drop a never-ending supply of shoes, clothes, fruit, vegetables, Big Macs and more. The island has mostly two types of inhabitants – those who make Gadgets and those who build houses. Each Gadget maker produces a different type of Gadget and sells one unit per year for $100. Except for the housing sector, the economy is essentially a giant Gadget exchange.

Now imagine a second island whose inhabitants expend virtually all their efforts just to produce basic necessities. But they still save a substantial portion of their incomes. Their savings are used by the government to build a brand new city – Export City – with a factory that’s equipped to produce Gadgets.

I’ll call the first island Debtor Isle and the second Creditor Isle. Let’s see what happens once Export City’s factory is complete…

Tracking the island economies

Each year, one Creditor Isle inhabitant takes a new job at the factory and produces a perfect replica of a Gadget used on Debtor Isle. She exports the Gadget to Debtor Isle for $50 and then visits the People’s Bank of Competitive Currency Controls (PBOC³) to exchange her dollars for local currency. The PBOC³ then loans the dollars back to the inhabitants of Debtor Isle.

Back on Debtor Isle, one domestic Gadget maker is priced out of the market each year by the new Creditor Isle producer. She’s only unemployed for a short moment, though, because she designs a new Gadget. Her new Gadget is priced at $100 with an annual production run of one unit (just like the other Gadgets produced on Debtor Isle). In other words, Debtor Isle produces an unchanging number of Gadgets, but it imports and consumes one additional Gadget each year. As above, the imported Gadgets are priced at $50 apiece and buyers pay for them with loans from the PBOC³.

Debtor Isle inhabitants see three key trends in their economic indicators:

The trade deficit grows by $50 per year.
Household and external debt grow by increasing amounts – $50 of additional debt in year one, $100 in year two and so on.
The consumer price index falls (Gadgets priced at $50 gradually replace those priced at $100).

Enter the planners

Now let’s add the Far Reaching Bankers (FRB) of Debtor Isle to the story. The FRB are responsible for monetary policy and closely monitor the indicators above. In this instance, they ignore foreign trade and debt and adjust policy in response to inflation. They have an inflation target of sorts – a range of inflation rates that’s deemed acceptable – and the Gadget deflation sets alarms ringing. They reduce interest rates to virtually nothing (say, 1%) to stimulate the economy and encourage inflation.

Debtor Isle inhabitants take advantage of this cheap money and double their annual increase in borrowing, using the additional funds to buy newer and bigger houses. The money pouring into the housing sector enriches homebuilders, who then loan funds back to Gadget makers to keep the boom alive. Here are the effects on economic indicators:

The trade deficit and external debt continue to climb at the same rate, while household debt rises even faster than before.
Home prices soar.
Increasing home building costs push inflation above the FRB’s target, while Gadget prices rise slowly because producers are wary of competition from Export City.

The Far Reaching Bankers see off the deflation “scare” and declare great success. They begin to raise interest rates toward levels more typical of a buoyant economy with inflation now above target. But they show little urgency and make only tiny, gradual changes. They aren’t especially concerned about trade deficits or external and household debt. Nor are they concerned about house prices reversing their rapid climb. That could never happen according to a review of data extending back to, well, the time period immediately after the last instance of falling house prices.

The Far Reaching Bankers’ backstory

More fundamentally (digression warning!), Far Reaching Bankers are drawn from a religious sect with core beliefs such as rational agents and a general equilibrium. In a nutshell, their religion holds that rational people always force the economy toward an ideal state of equilibrium, where it then remains. Like any other religion, their faith is guided by sacred objects. The FRB’s sacred objects are abstract mathematical models, from which they take great comfort that their beliefs are valid.

Far Reaching Bankers also believe in stabilization policies, which suggest they can guide the economy even faster to its presumed equilibrium than natural forces allow. That’s where the inflation targeting comes in. They declare that if they take care of the inflation targets, while rational agents take care of the rest, Debtor Isle inhabitants can enjoy a utopian world called a Great Moderation.

A few rogue inhabitants suggest this story is all wrong. They warn of fallacies in the FRB’s religion and dangerous imbalances in the economy. But they’re branded as heretics and relegated to often derided professions such as “hedge fund manager” and “tin foil hat wearing blogger.”

Story ending and thesis

The story ends with a mountain of bad debt leading to an implosion of the imbalances in Debtor Isle’s housing and external sectors. (I’m sure the suspense was killing you.) And here’s my thesis:

The story is a rough but reasonable approximation to certain developments during the housing boom – from the Fed’s concerns about falling core inflation in 2003 to its response of slashing the Fed Funds rate to 1% to its decision to normalize policy only gradually and well after the deflation “threat” receded.
Inflation objectives were a big part of the problem, for both the Far Reaching Bankers of Debtor Isle and the Federal Reserve Board of real life. In either case, deflation that was imported from abroad in certain sectors was merely another window on imbalances (overconsumption funded by foreign creditors, for example) that should have led to monetary restraint, not stimulus. For the Fed, the doctrine that core inflation should be kept above 1% at the lowest (later increased to 1.5%) overrode concerns about these imbalances, which received lip service at best and outright dismissals in policymakers’ worst moments.

In other words, I’m arguing that inflation targets are too narrow to play such a large policy role. What’s more, they sometimes tell you to do the exact opposite of what you should actually be doing. Disinflation in the housing boom’s early stages was closely connected to the growing external debt that helped trigger the crisis; it was like the calm that tells you to expect a storm. But thanks to their discomfort with low inflation, policymakers felt threatened by the calm and tried to stir up a breeze just as the storm was approaching.

If you agree with this thesis, then you might have been surprised when the Fed formalized an inflation target in 2012. I certainly was. But then I thought about the heuristics and biases that cloud our ability for rational decision-making. The best explanation for the Fed’s decision to formalize inflation targeting, in my opinion, gets back to the religion analogy. Real events are no match for religious fervor. As we’ve learned from studies demonstrating confirmation bias, deeply held beliefs resist contradictory evidence. History can be written in an infinite number of ways, and people generally craft it around their pre-existing positions.

The Fed’s direction since the financial crisis seems a prime example of confirmation bias. Fed researchers produced work that absolved its interest rate policies (and inflation targets) of any responsibility for the crisis. And so it is.

How else might the Debtor Isle and U.S. FRBs have viewed their housing booms?

In David Stockman’s bestseller, The Great Deformation, he describes Fed Chairman William McChesney Martin’s decision to reign in speculative excess only four months into the recovery from the 1957-58 recession. Martin increased both interest rates and stock market margin requirements. Here’s an excerpt from Stockman:

Unlike the ineffectual baby-step hikes of 25 basis points that Alan Greenspan later favored, Martin raised the discount rate by a full percentage point on each of several occasions, and also further tightened stock market margin lending.

Moreover, these moves were decisive. In one of its post-meeting statements the Fed zeroed in directly on excessive bank lending. Unlike today’s debt-besotted central bankers, the Martin-era Fed worried about too much credit growth, not too little, saying that it was “restraining inflationary credit growth in order to foster sustainable economic growth.”

Martin’s signature definition of a central banker’s job – adjusting policy when “the party gets going” by “taking the punch bowl away”– belies the Fed’s technocratic inflation targeting of today. There’s little room anymore for a broad and old fashioned assessment of speculative excess, taking account of both credit and asset markets in addition to inflation.

And it can’t be emphasized enough (I’ve emphasized it here, here and here) that there’s a close link between the Fed’s narrowing focus and the core, theoretical models that economists developed in the decades after World War II. These model builders naïvely ignored boom-bust cycles in credit and asset markets, just as the Fed disastrously eliminated the relevance of these cycles from its policy framework. Or, more precisely, policymakers reversed Martin’s maxim, spiking the punch bowl when credit and asset markets weaken but dismissing the case for action when the “party gets going”.

Recommended links

Short of conjuring up the old school policy approaches of the past, there are indicators that we can use to understand how the Fed’s inflation target might trip us up next. And this brings me to the article I mentioned at the outset. Asset manager Jake Honeycutt recently suggested one such indicator – an alternative inflation measure. He replaces the artificial “owner-occupied rent” component of the consumer price index with direct estimates of house prices (the S&P Case/Shiller Home Price Index). He concludes that the Fed should begin tightening almost immediately, although not aggressively. Here’s his article.

Also, I don’t remember when I first thought that an island economy might be an interesting way to look at inflation targeting, but it may have been when I read this post on ZeroHedge. I saved it at the time and liked it just as much on the second read as on the first over a year ago.

SEC Uses HFT Firm-Designed Tool To Find That HFT Doesn't Cause Flash Crashes

Tyler Durden — Tue, 18 Jun 2013 20:48:18 +0000

Just when one thought the SEC has hit rock bottom in stupidity, corruption and porn-addiction terms, to paraphrase the beloved Dennis Gartman, it whips out a shovel and starts digging.

Today's case in point: a report by the agency that Mary Schapiro made into Wall Street's punching bag (and whose legacy her Morgan Stanley-friendly replacement is set to perpetuate) according to which "unexplained rapid price drops in single stocks have generally been triggered by human error, not nefarious trading activity or high-speed trading algorithms gone wild, an official at the U.S. Securities and Exchange Commission said on Tuesday."

Not HFT-driven flash crashes you say? Reuters reports:

"What we are seeing is the result of sloppiness, combined with a lack of checks and balances," Greg Berman [formerly of RiskMetrics] said at a Securities Industry and Financial Markets Association conference. "In this day and age, there should be no excuse for these types of mistakes, especially considering the significant negative impact that these events have on investor confidence."

Most rapid price spikes are caused by old fashioned human mistakes, such as "fat finger" errors, where a trader may accidentally add an extra zero to an order, or by portfolio managers accidentally requesting a large order be immediately executed rather than meted out in a managed flow, Berman said.

"Contrary to public speculation, these types of events do not seem to triggered by proprietary high-speed algorithms, by robots gone wild, or by excessive order cancellations."

Oh, so like Waddell and Reed was to blame for the flash crash, not the fact that some 70% of the tape is filled with empty quotes in which one algo tries to outsmart another algo, and instead of trading blast hollow bids and asks just to game the NBBO?

But just how did the SEC come up with this startling conclusion which flies in the fact of all the factual evidence we have presented over the past 3 years?

Berman heads up a new initiative at the SEC that analyzes market data using a platform launched in January called Market Information Data Analytics System, or MIDAS, which was developed by Red Bank, New Jersey-based automated trading firm Tradeworx.

MIDAS gives the SEC access to all orders posted on the national exchanges, including modifications, cancellations and trade executions of those orders, as well as all off-exchange executions, putting the regulator on even footing with the most sophisticated high-speed trading firms.

Traditionally when a problem in the market has needed to be investigated, the SEC has gone to the exchanges, the Financial Industry Regulatory Authority, and the firm that introduced the error, to diagnose the cause. But MIDAS allows the regulator to do its own assessment as well.

And once again, the conclusion:

The SEC has found that high-frequency trading tactics have not caused or amplified the mini flash crashes it has examined, Berman said.

This is Tradeworx:

So, to summarize, the SEC which admits it was clueless in analyzing the modern, fragmented market (yet which found definitively that the culprit for the May 2010 flash crash was Waddell and Reed, and nobody else, using what technology at the time, nobody knows), uses a platform developed by High Frequency Trading firm Tradeworx... to reach a conclusion that High Frequency Trading firms are innocent of every flash crash resulting from an HFT algo gone haywire...

That sound, dear reader, is your head just going splat.

Market Echoes June 2012 FOMC As Dow Swings Most Since Oct 2011

Tyler Durden — Tue, 18 Jun 2013 20:15:51 +0000

For the sixth day in a row, the Dow managed a triple digit gain/loss - the first time since Sep/Oct 2011 - as markets appear to playing out a perfect echo of last year's June FOMC meeting with a ~3% 4-day gain in the run-up to the decision only to give it all back in the next few days. In the same way as last year, despite the rally in stocks, VIX (hedging) is rising, credit is diverging (hedging), and bonds are bid (though this appears more a Taper-off trade this time). Today's volume was among the lowest of the year (even accounting for holiday trading days) but that didn't stop the Dow ended up within a Hilsenrath headline of its all-time highs (though VIX near YTD highs, credit near YTD high spreads, and bonds close to YTD high yields). Silver, gold, and copper were hit hard today (-1.8% on the week) as WTI surged back up to $98.50; the USD retraced back to unchanged on the week (JPY -1%); Treasury yields are now up 4-5bps on the week (unch today); and while stocks looked good off the Friday surge, the last few minutes today saw them give back some of the exuberance back as hedgers turned to sellers (helped by a smash'n'grab in HYG) but all-in-all, equity investors seem very confident that Bernanke won't let them down.

Sixth day in a row of triple-digit moves...

and this is what happened at last June's FOMC... when everyone it seemed was convinced QE3 was coming (and was disappointed).

But the last couple of days' exuberance in stocks is tempered by hedging in stocks...

and credit...

The USD is unchanged on the week as EUR is rising and JPY is weakening...

WTI surged as copper, silver and gold all fell in line on the week...

Charts: Bloomberg and Capital Context

Bonus Chart: The Great Recoupling...

Chart Of The Day: When ETF Paper Beats Gold Rock

Tyler Durden — Tue, 18 Jun 2013 19:47:36 +0000

Demand for physical gold across the world continues to surge at an unprecedented pace leading India to blame its soaring current account deficit, sliding currency and even deteriorating economy on it (even if failing in its attempts to regulate demand for the yellow metal), and yet gold continues to slide. How come? One word - paper, or rather, ETF paper.

And more vividly, the combined holdings of GLD and IAU.

So, for now, paper does indeed beat rock.

Is The Credit Cycle Over?

Tyler Durden — Tue, 18 Jun 2013 19:21:31 +0000

No matter how much pushing on the market- or economic-string a central planner tries, eventually the risk-based pricing of credit (as opposed to nominal price based stocks) turns the corner from accepting rising leverage as potentially good thing for growth to worrying that cash flows are at risk from an over-generous management transfer to shareholders. The four-year bullish period of this credit cycle is nearing its historical average and leverage is near its cycle highs with near record numbers of firms raising leverage YoY suggesting the credit cycle is over.

Leverage is rising...

and pretty much every other credit metric is deteriorating...

and the credit cycle is getting long in the tooth...

It seems the only factor driving credit from not being wider based on these leverage and cycle indications is the 'flow' from the Fed. We suspect that is what has created the weakness in bonds recently (even though we note that cash bond markets have not weakened as much as CDS since managers are preferring to hedge than cover for now - since, quite bluntly, they know that if they all collaborate and don't sell then everything is fine but once one manager decides to cover instead of hedge, the small doors and large crowds will see major liquidity gaps appear in HY credit).