Monetization

Readers may recall that Ron Paul once surprised everyone with a seemingly very elegant proposal to bring the debt ceiling wrangle to a close. If you're all so worried about the federal deficit and the debt ceiling, so Paul asked, then why doesn't the treasury simply cancel the treasury bonds held by the Fed? After all, the Fed is a government organization as well, so it could well be argued that the government literally owes the money to itself. He even introduced a bill which if adopted, would have led to the cancellation of $1.6 trillion in federal debt held by the Fed. Of course the proposal was not really meant to be taken serious: rather, it was meant to highlight the absurdities of the modern-day monetary system. In a way, we would actually not necessarily be entirely inimical to the idea, for similar reasons Ron Paul had in mind:  it would no doubt speed up the inevitable demise of the fiat money system. Control can be lost, and it usually happens only after a considerable period of time during which their interventions appear to have no ill effects if looked at only superficially: “Thus we learn….to be ignorant of political economy is to allow ourselves to be dazzled by the immediate effect of a phenomenon."

There is no indication that the Obama administration has even considered this eventuality. Indeed, I have not heard anyone on the left refer to Bernanke or the poison of his policies at any point in the last few months.

One way or another, change is coming. 

I want to draw your attention to the fact that the Fed balance sheet is DOWN $50 billion year over year. This confirms that the Fed has in fact been engaging in mostly verbal intervention over the last year rather than actual monetary intervention.

We are now five years into the Great Fiat Money Endgame and our freedom is increasingly under attack from the state, liberty’s eternal enemy. It is true that by any realistic measure most states today are heading for bankruptcy. But it would be wrong to assume that ‘austerity’ policies must now lead to a diminishing of government influence and a shrinking of state power. The opposite is true: the state asserts itself more forcefully in the economy, and the political class feels licensed by the crisis to abandon whatever restraint it may have adhered to in the past. Ever more prices in financial markets are manipulated by the central banks, either directly or indirectly; and through legislation, regulation, and taxation the state takes more control of the employment of scarce means. An anti-wealth rhetoric is seeping back into political discourse everywhere and is setting the stage for more confiscation of wealth and income in the future. This will end badly.

Now that the ESM has been officially inaugurated, to much pomp and fanfare out of Europe this morning, many are wondering not so much where the full debt backstop funding of the instrument will come from (it is clear that in a closed-loop Ponzi system, any joint and severally liable instrument will need to get funding from its joint and severally liable members), as much as where the equity "paid-in" capital will originate, since in Europe all but the AAA-rated countries are insolvent, and current recipients of equity-level bailouts from the "core." As a reminder, as part of the ESM's synthetic structure, the 17 member countries have to fund €80 billion of paid-in capital (i.e. equity buffer) which in turn serves as a 11.4% first loss backstop for the remainder of the €620 billion callable capital (we have described the CDO-like nature of the ESM before on many occasions in the past). The irony of a country like Greece precommiting to a €19.7 billion capital call, or Spain to €83.3 billion, or Italy to €125.4 billion, is simply beyond commentary. Obviously by the time the situation gets to the point where the Greek subscription of €20 billion is the marginal European rescue cash, it will be game over. The hope is that it never gets to that point. There is, however, some capital that inevitably has to be funded, which even if nominal, may prove to be a headache for the "subscriber" countries. The payment schedule of that capital "invoicing" has been transformed from the original ESM document, and instead of 5 equal pro rata annual payments has been accelerated to a 40%, 40%, 20% schedule. And more importantly, "The first two instalments (€32 billion) will be paid in within 15 days of ESM inauguration." In other words, October 23 is the deadline by which an already cash-strapped Spain, has to pay-in the 40% of its €9.5 billion, or €3.8 billion, contribution, or else.

UPDATE: ZNGA re-opened -13%, now -16%

That foundation of social media monetization has just announced a cut to its outlook and plenty more. The stock is currently halted but its proxy FB is being sold after-hours...

• *ZYNGA SEES YR BOOKING $1.085B TO $1.100B, SAW $1.15B-$1.225B
• *ZYNGA 3Q PRELIM EST. $286.4M, SAW $300M-$305M,       :ZNGA US
• *ZYNGA SEES YR ADJ EBITDA $147M-$162M, SAW $180M-$250M :ZNGA US
• *ZYNGA 3Q PERLIM ADJ. BREAKEVEN-LOSS 1C; SAW BREAKEVEN
• *ZYNGA CITES REDUCED EXPECTATIONS FOR `THE VILLE,' OTHERS
• *ZYNGA SEES CHARGE ON INTANGIBLE ASSETS ACQUIRED ON OMGPOP

Who couldanode? Securitizing synthetic farms and paying huge premia for acquisitional growth wouldn't pay off? Is OMGPOP accepted as collateral at the ECB yet?

Just as we had suspected for months, Bernanke's attempt to herd cats and to drive retail investors into equities is now a complete and unmitigated catastrophe. According to just released ICI data, in the week ended September 26, the second full week after the announcement of QE3, retail investors pulled $5.1 billion from domestic equity funds, following a massive $4.8 billion outflow the week prior, and the most in 2 months. This is also the sixth largest weekly outflow in 2012 to date, a year in which over $100 billion has already been pulled from equity mutual funds. And since we now know that Bernanke's only motive for QE3 is to stimulate a wealth effect and to push everyone into the broken casino, where such trading farces as Kraft's flash smash today, as Knight Capital's implosion a month ago, and FaceBook's IPO, not to mention the virtually daily Flash Crash in at least one name, have killed every last shred of faith in equities, it can be safely said that QE3 has failed three short weeks after being launched. As to where the money did go: why taxable bonds of course - not even the "dumb money" is that dumb to go where the Fed tells it to, and instead merely does what the Fed does: it keeps on frontrunning the Fed's monetization of the US deficit, which is now going on for the 3rd year in a row. Eventually "this time may be different." But not yet.

Yes, you read that correctly. High ranking members of the US Federal Reserve believe that because a one time purchase of an iPad is cheaper, the increase in the daily cost of food and energy is balanced out.

Because the horse and buggy is the new normal car:

• FIAT ITALY NEW CAR SALES FALL 24% IN SEPT
• FRENCH CAR SALES FALL 18.3% IN SEPTEMBER, DOWN 13.9% THROUGH SEPTEMBER
• PORTUGUESE LIGHT VEHICLE SALES DROP 42% THROUGH SEPTEMBER

This is what happens when you don't take advantage of US, Chinese, or for that matter Global channel stuffing. It is, for now, unclear if Mario Draghi's monetization of 1-4 cylinder Fiats is forbidden by Article 123.

Ray Dalio recently described the characteristics of a “beautiful deleveraging” in which equal doses of austerity, write-downs, and inflation gradually lighten the load of impaired debt. Two things can turn beautiful inflation into ugly inflation: Wages don’t inflate along with prices and the currency depreciates as money is printed excessively. This might not matter for a nation that is a net exporter of goods and services.  But for nations that import essentials such as oil and grain, this is a catastrophe, as wages are flat while the cost of imported energy and food skyrocket.  Households have less money to spend, and servicing debt becomes increasingly burdensome. Welcome to the United States of Ugly Inflation.  Real household income (i.e., adjusted for official inflation) has declined 8% since 2007; the cost of oil, medical care and higher education has climbed; and government revenues have stagnated even as demand for government services has increased. As a result, the entire beautiful deleveraging scenario is at risk.

If there is one dominant consensus in the financial sphere, it is that the Federal Reserve's $85 billion/month bond-and-mortgage-buying "quantitative easing" will inevitably send stocks higher. The general idea is that the Fed buys the mortgage-backed securities (MBS) and Treasury bonds from the banks, which turn around and dump the cash into "risk on" assets like equities (stocks). This consensus can be summarized in the time-worn phrase, "Don't fight the Fed." This near-universal confidence in a QE-goosed stock market is reflected in the low level of volatility (the VIX) and other signs of complacency such as relatively few buyers of put options, which are viewed as "insurance" against a decline in stocks. The usual sentiment readings are bullish as well.

But what if QE fails to send stocks higher? Is such a thing even possible? Yes, it does seem "impossible" in a market as rigged and centrally managed as this one, but there are a handful of reasons why QE might not unleash a flood of cash into "risk on" assets every month from now until Doomsday

We discussed the unintended consequence of QEternity previously as we noted the massive front-running of the Fed's MBS buying program that was occurring as 30Y current coupon mortgage bond yields were tumbling. While the last week or so has seen Treasury yields reverse their rising trend, the trend of front-running the Fed has not abated. In what, quite frankly, stunned us more than Sofia Vergara's wardrobe malfunction this weekend, we note that today the spread between the 30Y FNMA CurCpn mortgage bond (at 1.66%) and 10Y US Treasuries has smashed to incredible all-time lows of around 3bps. The day before QEternity, this spread was 60bps - having been over 100bps at the start of June 2012. The previous low from July 2010 of 54bps has been obliterated as Bernanke has managed to remove one more market from the lexicon of risk (and in the meantime, PIMCO's Bill Gross has earned back his 'bond guru' title by making a killing). Can we see Mortgage yields trade inside of Treasury yields?

As we noted on several occasions in the past ten days, as a result of QE3 and its imminent transformation to QE4, which will merely be the current monetization configuration but without the sterilization of new long-term bond purchases, the Fed's balance sheet is expected to grow by over $2 trillion in the next two years. This also means that the matched liability on the Fed's balance sheet, reserves and deposits, will grow by a like amount. So far so good. However, as Bank of America points out today, there may be a small glitch: as a reminder on December 31, 2012 expires the FDIC's unlimited insurance on noninterest-bearing transaction accounts at which point it will revert back to $250,000. Currently there is about $1.6 trillion in deposits that fall under this umbrella, or essentially the entire amount in new deposit liabilities that will have to be created as a result of QEternity. The question is what those account holders will do, and how will the exit of deposits, once those holding them realize they no longer are government credit risk and instead are unsecured bank credit risk, impact the need to ramp up deposit building. One very possible consequence: negative bill rates as far as the eye can see.

We believe an unsustainable new global financial architecture that arose in response to the US and European financial crises has replaced an older, more sustainable, architecture. The old architecture was crystallized in Washington- and IMF-inspired policy responses to the numerous sovereign defaults, banking system failures, and currency collapses. Most importantly, the previous architecture recognized limits on fiscal and central bank balance sheets. The new architecture attempts to 'back', perhaps unconsciously, the entire liability side of the global financial system. This framing is consistent with a purely political—institutional stylized—fact that it is nearly impossible to penetrate the US political parties if the message is that there are limits to their power…or that their power requires great effort and sacrifice. This is why Keynesians (at least US ones) who argue there are no limits to a fiscal balance sheet are so popular with Democrats, and why monetarists (at least US ones) who argue there are no limits to a central bank balance sheet are popular with (a decreasing number of) Republicans. Party on! Again, nobody chooses hard-currency regimes – they are forced on non-credible policymakers. Let me put it more positively. If politicians want the power of fiat money, let alone the global reserve currency, they need to behave differently than they have - or the consequences for Gold are extraordinary.