Counterparties

One year on from the "whatever it takes" speech and all appearances suggest Draghi's all-in move with the imaginary OMT 'worked. European sovereign spreads have compressed dramatically, European stock indices are near their highs, European financials are doing great. Of course, record unemployment rates, record loan delinquencies, record drops in house prices, and record deposit outflows can all be ignored because no matter what, Draghi will do "whatever it takes." Except, as JPMorgan notes, the excess cash in the Euro area banking system continues to decline reaching EUR230bn, closer to the so-called inflection point at which money market rates, i.e. EONIA and repo rates, are responding more pronouncedly to changes in the excess cash. Bank funding is becoming increasingly volatile since the 2nd LTRO repayment and the trend shows no sign of abating. We suggest Mrs. Merkel will be on the phone telling Mr. Draghi to "get back to work," - at least until September 23rd anyway.

Excessive monetary stimulus and low interest rates create financial bubbles. This is the biggest debt bubble in history. It is a potent deflationary force and central banks are forced into deploying increasingly aggressive (offsetting) inflationary forces. The avoidance of a typical deflationary resolution to this economic long (Kondratieff) wave is pushing the existing monetary system beyond the point of no return. The purchasing power of the developed world’s currencies will have to bear the brunt of the “adjustment”. Preparations for this by the BRICS nations, led by China, are advancing rapidly. The end game is an inflationary/currency crisis, dislocation across credit and derivative markets, and the transition to a new monetary system. A new “basket” currency is likely to replace the dollar as the world’s reserve currency. The “Inflationary Deflation” paradox refers to the coming rise in the price of almost everything in conventional money and simultaneous fall in terms of gold.

While the conventional way of looking at hedge fund assets has traditionally been to simply add up the assets under management to estimate gross exposure, as so often happens conventional wisdom is wrong. Because what the "traditional" approach simplistically looks at is merely a fund's equity and ignores all leverage through assorted generic and "shadow" conduits such as repo, loans, rehypothecation, "hedging" and others. Luckily, as a result of Dodd-Frank, hedge funds were required to present their full market exposure when netting leverage as per an annual SEC form known as Form PF. It is here that we learn that SAC's market exposure, something very relevant now that the firm is facing an imminent or eventual winddown, is likely orders of magnitude above what the market believes.

As Welt reported overnight, the ECB just announced a change to its collateral framework, changing the haircuts and acceptability rules for ABS and covered bonds in an attempt to boost moribund and stalled European lending. As part of its announcement, the ECB reduced haircuts applicable to ABS rated A- or higher to 10% from 16% and to 22% from 26%. The bank also cut the minimum rating for ABS subject to loan level reporting requirements to 2 "A" ratings from 2 "AAA" ratings as more and more credit in Europe sinks into the quicksand of NPL-ness. Draghi also announced he would tighten risk control measures for covered bonds and that all the announced changes would have an overall neutral effect on amount of collateral available. Will this latest Hail Mary attempt work to boost lending in Europe? Of course not: Europe's issue is not credit supply constraints but a deterioration in asset quality and an explosion in NPLs, which has lead to an acceleration in overall deleveraging at both the bank and consumer level, and which is unlikely to end any time soon and certainly not before more widespread liability liquidations a la Cyprus.

While the skeleton crew of market participants are still digesting yesterday's uber-dovish, "forward guidance" conversion by the BOE and ECB, driven in response to the Fed's increasingly tight (at least relatively) monetary policy, they now have month's biggest economic and market catalyst to look forward to. In a day which promises to be rife with illiquidity as the bulk of US market participants are within 100 feet of a sandy beach, we are about to get the number that will shape the market's mood for the next month: will the Fed's tapering planes be strengthened in response to strong NFP, or not. As Deutsche accurately points out, the curveball to throw in is that June-August numbers have tended to be seasonally weak over the whole period we have data (back 70+ years) and again over the last 10 years. Today's number is therefore going to be fascinating. A number between 150-200k is unlikely to change anyone’s opinion on the Fed whereas a number below might start to build a case for a taper delay. Above 200k and the September taper momentum will build. Such a high number (especially in a weak seasonal period) is unlikely to be great for markets but the ECB/BoE might have cushioned some of the hawkish blow for now. For the record the market is expecting 165k on payrolls and 7.5% (DB same) for unemployment. A full NFP preview post is coming shortly.

"Even though the consensus is convinced that the gold bull market has ended, we remain firmly of the opinion that the fundamental argument in favor of gold remains intact. There exists no back-test for the current financial era. Never before have such enormous monetary policy experiments taken place on a global basis.

If there ever was a need for monetary insurance, it is today."

Extreme Developed Market (DM) monetary policy (read The Fed) has floated more than just US equity boats in the last few years. Foreign non-bank investors poured $1.1 trillion into Emerging Market (EM) debt between 2010 and 2012 as free money enabled massive carry trades and rehypothecation (with emerging Europe and Latam receiving the most flows and thus most vulnerable). Supply of cheap USD beget demand of EM (yieldy) debt which created a supply pull for EM corporate debt which is now causing major indigestion as the demand has almost instantly dried up due to Bernanke's promise to take the punchbowl away. From massive dislocations in USD- versus Peso-denominated Chilean bonds to spiking money-market rates in EM funds, the impact (and abruptness) of these colossal outflows has already hit ETFs and now there are signs that the carnage is leaking back into money-market funds (and implicitly that EM credit creation will crunch hurting growth) as their reaching for yield as European stress 'abated' brings back memories of breaking-the-buck and Lehman and as Goldman notes below, potentially "poses systemic risk to the financial system."

Fractional reserve banking is unlike most other businesses. It's not just because its product is money. It's because banks can manufacture their product out of thin air. Under the bygone rules of free market capitalism, only one thing kept banks from creating an infinite amount of money, and that was fear of failure. Periodic bank failures remind depositors of the connection between risk and reward. What is not widely appreciated is that the ensuing government bailouts allowed an underlying shadow banking system to not only survive but grow even larger. To the frustration of Keynesians, and despite an unprecedented Quantitative Easing (QE) by the Federal Reserve, conventional commercial banks have broken with custom and have amassed almost $2 trillion in excess reserves they are reluctant to lend as they scramble to digest all the bad loans still on their books. So most of the money manufactured today is actually being created by the shadow banks. But shadow banks do not generally make commercial loans. Rather, they use the money they manufacture to fund proprietary trading operations in repos and derivatives. No one knows when the bubble will pop, but when it does a donnybrook is going to break out over that thin wedge of collateral whose ownership is spread across counterparties around the world, each looking for relief from their own judges, politicians, bureaucrats, and taxpayers.

The wild ride in Japan's bond market is a prelude to what will happen in other developed markets.

A week ago, when the brand new Hong Kong Mercantile Exchange suddenly shuttered after being in operation for only two years, urgently settling what little contracts were outstanding, many questions were left unanswered. Such as: how it was possible that the exchange, expected by many to become the new preferred trading venue for Asian precious metals and to steal the CME's crown, could close on such short notice. This mystery deepened further after reports that the exchange barely had seen any volume, with allegedly only a tiny 200 open contracts remaining to be settled upon shuttering. Now, the confusion surrounding the HKMex closure has taken another big step for bizarrokind following news that not only have at least four HKMex senior executive have been arrested having been found to be in possession of false bank docs for nearly half a billion in dollars, but that government itself was forced to "shore up confidence" in CY Leung, Hong Kong's 3rd Chief Executive, whose former top aide was none other Barry Cheung Chun-yuen, founder of the HKMex.

There has been a growing shift in favour of assets relative to bank deposits. This was initially encouraged by zero interest rates, but more recently there is little doubt that Cyprus’s bail-in has accelerated the trend. This helps explain why, for example, Italian 10-year bonds are on a 4% yield. The reason, doubtless reaffirmed by the Cyprus bail-in, is that investors with cash balances think over-priced sovereign debt is less risky than adding to their euro deposits. However, some of depositors’ cash balances post-Cyprus will have gone into physical gold and silver, which explains why the bullion banks operating in the futures markets and the central banks behind them are so keen to dissuade us that gold and silver is a safe haven.

Several moments ago, TSLA (hardly) surprised the world when it filed an open-ended S-3 (Shelf) statement, as many had expected it was only a matter of time before the company used the recent surge in its stock price to sell shares. Then, a few moments later, TSLA once again (hardly) surprised the world when it announced a joint $450 million convertible bond and 2.7 million share common stock offering. And because a dilution is not a dilution if the founder is participating in the common offering (buying his own equity at an unprecedented price to "anchor" it as a benchmark- sure why not - after all he is making much on all the other equity he has in the firm that he is not buying, as a result), the stock is trading up after hours.

The Chairman is about to take the lectern to discuss bank structure and competition at the SIFI conference at the Chicago Fed. His prepared remarks are likely to be a little less exciting than the Q&A where the world will be watching for the words "buy, buy, buy", "mission accomplished", or "taper". Charles Evans will be his lead out man. Finally, since Bernanke will be discussing shadow banking, or the source of some $30 trillion in shadow money always ignored by Keynesians, Monetarists and Magic Money Tree (MMT) growers, a topic we have discussed over the past three years, here is the TBAC's own summary on how Modern Money really works.

Over a year ago, we first explained what one of the key terminal problems affecting the modern financial system is: namely the increasing scarcity and disappearance of money-good assets ("safe" or otherwise) which due to the way "modern" finance is structured, where a set universe of assets forms what is known as "high-quality collateral" backstopping trillions of rehypothecated shadow liabilities all of which have negligible margin requirements (and thus provide virtually unlimited leverage) until times turn rough and there is a scramble for collateral, has become perhaps the most critical, and missing, lynchpin of financial stability. Not surprisingly, recent attempts to replenish assets (read collateral) backing shadow money, most recently via attempted Basel III regulations, failed miserably as it became clear it would be impossible to procure the just $1-$2.5 trillion in collateral needed according to regulatory requirements. The reason why this is a big problem is that as the Matt Zames-headed Treasury Borrowing Advisory Committee (TBAC) showed today as part of the appendix to the quarterly refunding presentation, total demand for "High Qualty Collateral" (HQC) would and could be as high as $11.2 trillion under stressed market conditions.

The crypto-currency Bitcoin is still merely a speck on the global monetary landscape. It is young, experimental, and for all we know, it may ultimately fail to break into the monetary mainstream. However, on a conceptual level some are willing to call it a work of genius and arguably the most exciting development in the field of money for more than 130 years. The outcome is probably binary: Either Bitcoin ultimately fails and the individual Bitcoins end up worthless. Or Bitcoin takes off and Bitcoins are worth hundreds of thousands of paper dollars, paper yen, paper euros, or paper pounds. Maybe more. Those who buy Bitcoin as a speculative investment should consider it an option on the future success of the crypto-currency. We still consider gold to be the essential self-defense asset in the ongoing paper money crisis. The brand-new crypto-currency Bitcoin has to first earn its stripes as a monetary asset by proving itself as a ‘common’ medium of exchange. That is why we view Bitcoin very differently from gold, although the attraction of both has its origin in the demise of entirely elastic, politicized state fiat money. In the meantime, the debasement of paper money continues.