Central Banks

Currency debasement of all major currencies is happening today on a scale never before seen in history. Yet there continues to be a complete lack of awareness amongst the majority in the western world as to the risks posed by our currency monetary and financial system. There continues to be a lack of knowledge and indeed often wilful ignorance regarding gold. Indeed, some comments on gold are so ignorant of the historical and academic record that they have all the hallmarks of crude anti-gold propaganda – and will be seen as such in time. Gold is a proven safe haven asset and currency. Despite much recent academic evidence and the historical record showing this and despite voluminous articles, research and evidence, (evidence succinctly summarised in the video 'Gold Bullion or Cash'), there continue to be frequent anti gold outbursts by some of the most respected and trusted people in the western financial and economic world. Such attacks on gold have come from men such as Paul Krugman, Nouriel Roubini and more recently Warren Buffett. Alan Greenspan correctly wrote in 1966 that "an almost hysterical antagonism toward the gold standard is one issue which unites statists of all persuasions”. Today, an almost hysterical antagonism towards gold bullion as a diversification and as a store of wealth alternative to fiat currencies unites beneficiaries of the current status quo – both intellectual beneficiaries and material beneficiaries. That status quo is a massively leveraged and insolvent monetary, financial and economic system. 

Belgium's total exposure to its bank bailouts: 41% of GDP. But finally there is some resistance.

2012 is proving to be the 'Year of the Central Bank'. It is an exciting celebration of all the wonderful maneuvers central banks can employ to keep the system from falling apart. Western central banks have gone into complete overdrive since last November, convening, colluding and printing their way out of the mess that is the Eurozone. The scale and frequency of their maneuvering seems to increase with every passing week, and speaks to the desperate fragility that continues to define much of the financial system today.... All of this pervasive intervention most likely explains more than 90 percent of the market's positive performance this past January. Had the G6 NOT convened on swaps, had the ECB NOT launched the LTRO programs, and had Bernanke NOT expressed a continuation of zero interest rates, one wonders where the equity indices would trade today. One also wonders if the European banking system would have made it through December. Thank goodness for "coordinated action". It does work in the short-term.... But what about the long-term? What are the unintended consequences of repeatedly juicing the system? What are the repercussions of all this money printing? We can think of a few.

While the headline-chasers will allocate cause to effect for every twitch and ditch in asset prices, JPMorgan's Michael Cembalest appears to agree with us that nothing else matters but central bank balance sheet expansion. As we discussed earlier in the week, major central banks have injected nearly $7tn into world markets since 2007 and while the obscene rise in gas prices should somewhat self-limit the print-fest, it appears not before another bubble has burst as central bankers feel safe on this path given their microscopic focus on their own inflation-measures. Whether it be asset-reflation, boosting bank capital, pulling forward consumer demand, or government-reacharound financing, Cembalest sums up: super-easy monetary policy supports markets right now, prompting his question: "Who knew that unlimited money printing would be such a clean and simple solution to the world’s problems? I would love to read a book called “Reliable Central Bank Exit Strategies”, but I don’t think it has been written yet. Enjoy the ride."

We have only one question: "If a 20% rise in global stocks required a $2 trillion expansion in aggregate assets, which also took EUR-Brent to all-time record highs and WTI to over $107 $108, where will the next 20% come from, and how will the economy fare with $150 WTI?"

“Ms. Katseli, an economist who was labor minister in the government of George Papandreou until she left in a cabinet reshuffle last June, was also upset that Greece’s lenders will have the right to seize the gold reserves in the Bank of Greece under the terms of the new deal.” The Reuters Global Gold Forum confirms that in the small print of the Greek “bailout” is a provision for the creditors to seize Greek national gold reserves. Reuters correspondents in Athens have not got confirmation that this is the case so they are, as ever, working hard to pin that down. Greece owns just some 100 tonnes of gold. According to IMF data, for some reason over the last few months Greece has bought and sold the odd 1,000 ounce lot of its gold bullion reserves. A Reuter’s correspondent notes that “these amounts are so tiny that it could well be a rounding issue, rather than holdings really rising or falling.” While many market participants would expect that Greece’s gold reserves would be on the table in the debt agreement, it is the somewhat covert and untransparent way that this is being done that is of concern to Greeks and to people who believe in the rule of law.

While the bulk of tangential themes in Albert Edwards' latest letter to clients "The Ice Age only ends when the market loses hope: there is still too much hope" is in line with what we have been discussing recently: myopic markets focused on momentum not fundamentals ("It's amazing though how the market can get itself all bulled up and becomes convinced that we are the start of a self-sustaining recovery. And funnily enough there's nothing more likely to get investors bullish than a rising market"), short-termism ("One thing you can say for the market is that it has an extremely short memory"), and that so far 2012 is a carbon copy of 2011 ("One thing you can say for the market is that it has an extremely short memory. Let us not forget that the performance of the equity market so far this year is almost exactly the same as we saw at the start of 2011 (in fact the performance has been similar for the last 5 months"), his prevailing topic is one of hope. Or rather the lack thereof, and how it has to be totally and utterly crushed before there is any hope of a true bull market. And just to make sure there is no confusion, unlike that other flip flopper, Edwards makes it all too clear that he is as bearish as ever. Which only makes sense: regardless of what the market does, which merely shows that inflation, read liquidity, is appearing in the most unexpected of places (read Edwards' colleague Grice must read piece on why CPI is the worst indicator of asset price inflation when everyone goes CTRL+P), the reality is that had it not been for another $2 trillion liquidity injection in the past 4-6 months by global central banks, the floor would have fallen out of the market, and thus the global economy. In fact, how the hell can one be bullish when the only exponential chart out there is that of global central bank assets proving beyond a doubt that every risk indicator is fake???

Back in December I penned an article about the potential for gasoline prices to rise quickly to catch up with surging oil prices.  We said then "If we look at just the nominal price data going back to 1990 we can see that there is indeed a very high correlation between oil prices and gasoline prices.   While divergences from each other do occur on occassion those divergences tend not to last for very long with gasoline usually correcting towards the price of oil."   That is precisely what has happened since the near $3 per gallon of gasoline this summer, which was an effective $60 billion tax break for consumers during the much anticipated retail shopping season, to near $3.50 a gallon today.  That 16% rise in gasoline has now effectively wiped out the entire payroll tax cut being extended into 2012. There has been a lot of media commentary as of late about the recovery in the economy.  The dangerous assumption being made here is that the recent upticks in the economic data have come primarily at the expense of inventory restocking and end of year buying of capital goods by businesses to lock in tax credits.  Extrapolating those bounces in the data well into the future can prove to be disappointing.  Yet this is exactly what the the President's current budget, which has been presented to Congress, has done.  That budget plans for 3% or stronger economic growth over the next 6 years.  This is a pretty lofty goal which considering last years growth was a paltry 1.7%.  However, in order to acheive a 3% plus growth rate the consumer is going to have to should 2.1% of that load through consumption.

Warning: Not for the faint of heart.

A riddle, wrapped in a mystery, inside an enema.

While the record corporate profit bonanza (if now declining) is still the fallback argument for any bearish allegation that the only reason why the market is up 20% in 3 months is due to $2 trillion in liquidity dumped into markets by central banks, this may be about to end quite abruptly, especially if Europe is a harbinger of things to come. As the following chart from Credit Suisse shows, the number of large companies (>500bn market cap) that lose money on an LTM basis (so not just in the quarter, and thus with a much longer lasting effect) has risen in Q4 for the first time since Q3 2009. And while in nominal terms the change is still relatively modest, the actual change in "losing companies" is a doubling from under 5% to 10%, as for the first time in years the percentage of European money losing companies matches that of the US.

Since the system itself has disconnected risk from consequence with backstops, guarantees and illusory claims of financial security, then it is has lost the essential feedback required to adapt to changing circumstances. As the risk being transferred to the system rises geometrically, the system is incapable of recognizing, measuring or assessing the risk being transferred until it is so large it overwhelms the system in a massive collapse/default. The consortium has only two ways to create the illusion of solvency when the punter's $100 million bet goes bad: borrow $100 million from credulous possessors of capital or counterfeit it on a printing press. These are precisely the strategies being pursued by central banks and states around the globe. BUt since risk remains disconnected from gain/loss, then capital and risk both remain completely mispriced. Risk is being transferred to the entire global financial system at a fantastic rate, because counterfeiting money or borrowing it on this scale to cover losses creates new self-reinforcing feedbacks of risk....At some unpredictable stick/slip point, the accumulated risk will cause the system to implode like a supernova star.

We have discussed, at length, the symbiotic (or perhaps parasitic) relationship between the banking system in Europe and the governments (read Central Banks). The LTRO has done nothing but bring them into a closer and more mutually-reinforcing chaotic relationship as we suspect many of the Italian and Spanish banks have gone all-in on the ultimate event risk trade in their government's debt. It should come as no surprise to anyone that the bulk of the Greek bailout money will flow directly to the European banking system and Credit Suisse has recently updated the bank exposure (by country) to peripheral sovereign debt that shows just how massively dependent each peripheral nation's banking system is on its own government for capital and more importantly, how the core (France and Germany) remains massively exposed (in terms of Tier 1 Capital) to the PIIGS. Retroactive (negative) salary cuts may well not be the worst of what is to come as the bankers deleveraging returns to bite them in a phoenix-like resurrection of sovereign risk on now even-more sovereign-bloated (and levered) balance sheets.

After months (it seems like years) of trying to avoid a CDS Credit Event, it looks like one is inevitable.  The Greek 5 year CDS is at least 70 bid which may be the highest ever.  The game plan seems to be that Greece will put in retroactive CAC laws.  The PSI will come in below 100%.  Greece will trigger the CAC clauses on the Greek bonds, and we will get 100% participation in all those bonds, and we will get a Credit Event.  The interesting part is that depending on what they manage to do with English law bonds, the only bonds outstanding (not in the hands of the central bank only bonds, and troika loans) will be the new bonds.  If they start CAC’ing each bond, it is possible that there will be no existing bonds outstanding left.  Settlement would be based on the new bond (yes, ISDA has a Sovereign Restructured Deliverable Obligation clause – Section 2.16 of the definitions).  With the amortization schedule in place (and not including any value attributable to the GDP strippable warrants), I get that the new bonds would trade at 30% of par with a yield of just over 13%.  I would be careful paying up for CDS here, because settlement will be against these new bonds, not existing bonds if every old bond is CAC’d.  And given the attitude out of Greece late yesterday, and harsh IMF demands, we may well see that. 

Highly paid shills for the status quo on Wall Street have recently been wheeled out to observe the fundamental ugliness of western government bonds. They are correct. This is an asset class that has managed to defy the laws of economics in becoming ever more expensive even as its supply swells. Their response has been to recommend piling into stocks instead. The logic here is not so pristine. If Napier's thesis is correct, the West faces a period of outright deflation, which will be deeply traumatic for exactly the sort of speculative stocks that have lately done so well. Admittedly, the picture is confused, and prone to all sorts of political horseplay, as observers of the long-running euro zone farce can attest. Nevertheless, when faced with a) huge underlying uncertainties; b) structurally unsound banking and government finances; and c) central banks determinedly priming the monetary pumps, we conclude that the last free lunch in investment markets remains diversification. G7 government bond markets are a waste of time (though you may end up being cattle-prodded into them regardless). But there are still investment grade sovereign markets offering positive real yields. Stock markets are partying like 1999. Which, in many cases, it probably is. We would normally advise to enjoy the party but dance near the door.

Much has been written of the dramatic drop in the Debt/GDP multiplier, or Keynesian accelerator, over the last few years that shows the marginal utility of adding more debt produces less and less growth (and in fact can become a drag). More debt to solve too much debt seems put to bed as a solution except in the surreal world of central bankers and politicians. Well, with all the hoop-la today for the 'peek' over Dow 13000 and our discussion of the nominal versus real 'value' of the Dow as central banks of the world have printed $7tn into existence in the last few years, we thought an examination of the marginal utility of central bank printing would be useful. The depressing truth is that, using Gold as a proxy for central bank ebullience, the impact of implicit devaluation (or explicit printing) by central banks is having a smaller and smaller impact on stock market (asset) prices. Since the lows in March 2009, the impact of central bank intervention on the Dow has rapidly diminished from over 20 Dow points per $1 Gold move to only 2 Dow points per $1 Gold move in the last few months. What is dramatically clear is that investors are losing 'value' even as they see their brokerage statements rise and while Gas prices will inevitably slap reality into their faces, perhaps just as the Debt/GDP multiplier signaled the Keynesian Endgame, then the Gold/Dow multiplier signals the Currency-Wars Endgame - or alternatively, Central Banks will have to go exponential in their extreme experimentation to fulfill equity-holder's hopes and dreams as they approach their event horizon.