An Analytic Framework For 2013

Tyler Durden's picture

Submitted by Martin Sibileau of A View From The Trenches blog,

In the same fashion that I proposed an analytic framework for 2012, I want to lay out today what I think will be the big themes of 2013. Their drivers were established in September 2012, and I sought to give a thorough description of them here, here and here.

An analytic framework for 2013

In one sentence, during 2013, I expect imbalances to grow. These imbalances are the US fiscal and trade deficits, the fiscal deficits of the members of the European Monetary Union (EMU) and the unemployment rate of the EMU thanks to a stronger Euro. A stronger Euro is the consequence of capital inflows driven by the elimination of jump-to-default risk in EMU sovereign debt. Below is a drawing I made to help visualize these concepts:


The drawing shows a circular dynamic playing out: The threat of the European Central Bank to purchase the debt of sovereigns (that submit to a fiscal adjustment program) eliminates the jump-to-default risk of this asset class. As explained and forecasted in September, this threat also forces a convergence in sovereign yields within the EMU, to lower levels. As long as the market perceives that the solvency of Germany is not affected, the Bund yields will not rise to that convergence level. So far, the market seems not to see that (Possunt quia posse uidentur). But the resulting appreciation of the Euro will eventually address that illusion.

This convergence, in my view, is behind the recent weakness in Treasuries. I proposed this thesis last September. However, the ongoing weakness in Treasuries does not mean I was right. In fact, I fear I may have been right for the wrong reasons. The negotiations on the US fiscal deficit and the latest announcement of the Fed with regards to debt monetization quantitative easing to infinity may also be behind this move. But until proven wrong, I will cautiously hold to my thesis.

The above factors drove capital inflows back to the European Monetary Union and strengthened the Euro. I believe this strength will last longer than many can endure. The circularity of this all resides in that the strength of the Euro will make unemployment and fiscal deficits a structural feature of the EMU, forcing the ECB to keep the threat of and eventually implementing the Open Monetary Transactions. The alternative is a social uprising and that will not be tolerated by the Euro kleptocracy.

All this -and particularly the strength of the Euro- is not sustainable. Ad infinitum, it would create a Euro so strong that the periphery would drag coreEuropein its bankruptcy. But while it lasts, the compression in sovereign yield will mask the increasing default risks in Euro corporate debt, specially the one denominated in US dollars. Both have been fuelling the rise in the value of equities globally.

The unsustainable framework rests upon the shoulders of the Federal Reserve, which thanks to the established USD swaps and unlimited Quantitative Easing, has completely coupled its balance sheet to that of the European Central Bank. In the end, as this new set of relative prices between asset classes sets in, it will be more difficult for the European Central Bank to sterilize the Open Monetary Transactions.

History provides an example of the current growth in imbalances

By now, it should be clear that the rally in equities is not the reflection of upcoming economic growth. Paraphrasing Shakespeare, economic growth “should be made of sterner stuff”.

Under the current framework, the European Central Bank can afford to engage in the purchase of sovereign debt because the Fed is indirectly financing the European private sector. The Fed does so with the backstop of USD swaps and tangible quantitative easing, which provides cheap USD funding to European banks and thus avoids a credit contraction of the sorts we began to see at the end of 2011.

This same structure was in place between the Federal Reserve and the central banks of France and England in 1927, 1928 and 1929 and, as a witness declared, (it) transformed the depression of 1929 into the Great Depression of 1931”. Something tells me that this time however it will be different. It will be worse. That little something is the determination of the new Japanese government to devalue its currency via purchases of European sovereign debt (ESM debt).

How fragile is this Entente?

Most analysts I have read/heard, focus on the political fragility of the framework. And they are right. The uncertainty over the US debt ceiling negotiations and the fact that prices today do not reflect anything else but the probability of a bid or lack thereof by a central bank makes politics relevant. Should the European Central Bank finally engage in Open Monetary Transactions, the importance of politics would be fully visible.

However, unemployment is “the” fundamental underlying factor in this story and I do not think it will fall. In the long term, financial repression, including zero-interest rate policies, simply hurt investment demand and productivity. I do not see unemployment dictating the rhythm in 2013, indirectly through defaults. Furthermore, in the meantime, the picture may look different, because “…we should not be surprised if, under zero-interest-rate policies in the developed world, we witness a growing trend in corporate leverage, with vertical integration, share buybacks and private equity funds taking public companies private…”. This is obviously supportive of risk.

No systemic meltdown in 2013?

From earlier letters, you know that I believe quasi-fiscal deficits (i.e. deficits from a central bank) are a necessary condition for a meltdown to occur, and that these usually appear when deposits begin to seriously evaporate. So far, capital is leaving main street (via leveraged share buybacks and dividends), but at the same time, it is being parked at banks in the form of deposits. The case of Wells Fargo and the temporary pause in the flight of deposits from the periphery of the European Union suggest that the process towards a meltdown, if any (and I believe there will be one) will be a long agony. Furthermore, in the short term, at the end of January, European banks, have the option to repay the money lent by the European Central Bank in the Long-Term Refinancing Operations from a year ago, on a weekly basis. I expect them to repay enough to cause more pain to those still long of gold (including me, of course).

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francis_sawyer's picture

Graphically speaking ~ We're Ayn Rand bisexual weakling 'wannabees' trying to support an edifice that's being surrounded & attacked by multiple orbiting Saturns [aka "Satan"]...


We're fucked...

Dr. Engali's picture

Those planets all have the same orbital path and that's just not going to work. Actually the gravitational pull from the center mass is not enough to hold those planets in orbit, unless of course it's a collapsed star then there is the possiblity that it could hold into the planets. But in that scenerio the planets would probably get sucked into the star.

We are going to need a little better scale on the next diagram for realism.

AynRandFan's picture

You're a svengali, herr doktor.

koder's picture

Actually im confused the sky ISNT falling this year afterall?

Cabreado's picture

Pay less attention to the weather and the calendar,

and concentrate on the trajectory.

Bring your common sense with you.

DeadFred's picture

Don't worry. It's happening this year. He's just being overly cautious because we've been waiting sooo long. Keep your powder dry and wait for stocks to bounce off the top (currently at about 1490).

OpenThePodBayDoorHAL's picture

Ok I read this and I think I understand it. Makes sense. But my God it's getting f*cking complicated. Can we please get back to actual markets? You know, where capital formation is the objective, to invest in businesses that make a product and sell it at a profit? That then provide jobs for actual people. Figuring out this monetarist BS just sucks.

ThatGuyEhler's picture

Damn, I'm long gold. I guess I'm screwed.

hooligan2009's picture

no gloating...what about that platinum hey?

W74's picture

Nah, just consider it a buying opportunity.

Dr. Engali's picture

I predict more lying, obfuscating, and printing. Oh yeah and his lordship Obummer will try to grab more power.

Dr. Engali's picture

I'm always hopeful that somebodies , or something will stop him. I don't know who though... the "loyal opposition" isn't much of an opposition.... Or very loyal.

TPTB_r_TBTF's picture

Obama will rule for 7 years.


Then Prince William will be placed onto the Throne

of the World GovT.


The Sheeple shall rejoice and proclaim his name!  They like him.  The Sheeple will embrace the World GovT.

LeisureSmith's picture

EMU...That bird don't fly.

EARLPEARL's picture

better buy physical silver....obama probably tax the hell out of gold

adr's picture

I just saw speculation that the new law Obama is going to propose tomorrow is going to limit magazines to 7 rounds and require background checks to purchase ammo.

Fuck the muslim clown again.

No mention if the law covers Nerf ammo as well.

Revolution time yet?

Dr. Engali's picture

Yeah seven rounds makes just about every clip out there illegal. What a fucker.

francis_sawyer's picture

Well ~ francis_sawyer just posted a link to the REVOLVER album... Don't say I'm not trying to do my part...

espirit's picture

Just going to work harder on the reload speed of the 1911.

AynRandFan's picture

One more than a revolver. Next we will have single action. Gonna have to fan it to fire.

q99x2's picture

Thou shalt not doubt.

All the companies should take their stock private. That's what I said years ago. Then once the banksters are in prisons they can open the exchanges again.

koder's picture

I keep telling you people....there can be no revolution till the EBT stops workin... =/

techstrategy's picture

Martin or others:

I usually follow your work quite well.  I am missing why European Banks repaying LTRO loans will hurt those long of gold in USD terms...

Frankly, the past 3 months have been a squeeze of levered gold longs.  From a fundamentals point of view (balance sheets or the total assets effectively now guaranteed by global central banks since they will not allow default in any asset class for fear of a deflationary cascade), gold should be significantly higher.   

AynRandFan's picture

Every identifiable imbalance is nullified by central bank action. You'll never hear the incoming round.

GFORCE's picture

2013 and 14 are about to be low to no growth when the fantasy ends and the hopeful predictions for GDP wash away with the tide and reveal once again, who's wearing no trunks. China will slow, Japan and maybe UK will face upticks in bonds but Spain, France etc will be in focus. Everyone will expect europe to be the catalyst but maybe not. Maybe the US. They're now joined the extend and pretend race to the bottom so a downgrade, more asian treasury dumping and poor data will finally catch up.



banshee's picture

Another well thought out and well written article....thanks