Monetization

As we pointed out about a month ago, in "While You Were Sleeping, Central Banks Flooded The World In Liquidity" as the world was focused on headlines whether or not the Fed would step up as it always does when the market is sliding, and unleash the monetary floodgates, it was not Ben Bernanke, but eveyrone else that hit CTRL+P and took the place of the Fed, of note the primary central banking peers among the Final Four - the ECB, the BOE and the BOJ. And why not: after all the hope was that since electronic money is electronic money, and can be moved from point A to point B at the push of a button, it would be used primarily to reflate stocks around the world, but mostly where the path has least resistance - the US. What was not accounted for was that money would also be used to inflate commodities such as oil - a key factor when delaying further US-based easing in an election year. However, more than even record for this time of year gas prices, there was one even more important outcome from this chain of events. As the following chart from Willem Buiter shows, in its fake attempt to show monetary restraint, the Fed has gone straight into last place in the "race to debase." Needless to say, in a world with $25+trillion in "excess" debt (debt which would need to be eliminated simply to reduce global debt/GDP to a "sustainable" 180% per BCG), last is a very bad place to be...

I know many of you are thinking “the ECB or Fed could just print money.” That answer is wrong. If the ECB chooses to do this, Germany will walk. End of story. They’ve already seen how rampant monetization works out (Weimar). And if the Fed chooses to monetize everything to hold things up, then the US Dollar collapses, inflation erupts creating civil unrest, interest rates rise killing the banks, US corporations and the US economy… all during an election year.

While it has no chance of passage, the GOP 2013 budget, details of which have been leaked by the WSJ, proposes slashing corporate and individual tax rates, collapsing the current six tax bracket system into just two tiers (10% and 25%), lowering top corporate tax rate to 25% and scrapping the anachronism that is the AMT, or Alternative Minimum Tax. Finally, the proposed plan would nearly eliminate U.S. taxes on American corporations' earnings from overseas operations: something which companies with foreign cash would be rather happy to hear. Needless to say, Democrats will promptly dead end this budget in the Senate: "The proposal, to be offered by Rep. Paul Ryan (R., Wis.), who has become the Republicans' leading figure on budget issues, has little chance of becoming law soon. While likely to be welcomed by House GOP rank-and-file members, it would be rejected by the Democratic-controlled Senate."

Ray Dalio released a study he did on deleveraging. The piece was featured prominently here at ZH. I am a fan of Dalio, but his analysis was surprising. His interpretation of the economy is, remarkably, based on a very conventional ideas and is shockingly wrong. For a guy who is known for thinking out of the box and has who has led Bridgewater to become the biggest hedge fund in the world, he has got the deleveraging process all wrong. 

Ahead of the US open, markets are exhibiting some modest risk appetite, with all major European bourses trading higher, and financials outperforming all other sectors. There has been little in the way of key data from Europe, however we have seen the Eurozone Trade Balance coming in alongside expectations in the seasonally adjusted reading. Bund futures continue to move lower in recent trade as US participants come into the market, with the 10-year German yield crossing the 2% level to the upside, trading at a level not seen since the 10th February. Bunds may also have experienced some pressure following the release of a research note from a major US bank recommending rotation trade with the selling of bonds and the buying of equities. USD/JPY is seen trading higher ahead of the US open following the overnight release of some relatively dovish BoJ minutes, with commentary suggesting further easing in Japan in the future. Taking a look at the energy complex, The IEA have commented on yesterday’s speculation concerning the use of the US’ Special Petroleum Reserve, stating that they have not received any contact regarding any emergency oil release. As such, WTI and Brent crude futures are seen higher; however they have seen some selling off in recent trade.

Last month, the world's biggest hedge fund, Bridgewater, issued a fascinating analysis of deleveraging case studies through the history of the world, grouped by final outcome (good, bad and ugly). As Dalio's analysts note: "the differences between deleveragings depend on the amounts and paces of 1) debt reduction, 2) austerity, 3) transferring wealth from the haves to the have-nots, and 4) debt  monetization. Each one of these four paths reduces debt/income ratios, but they have different effects on inflation and growth. Debt reduction (i.e., defaults and restructurings) and austerity are both deflationary and depressing while debt monetization is inflationary and stimulative. Ugly deleveragings get these out of balance while beautiful ones properly balance them. In other words, the key is in getting the mix right." Of these the most interesting one always has been that of the Weimar republic, as it certainly got the mix wrong.

With all of the Goldman and sell side hype, as well as many other sources focusing on nearly meaningless metrics failing to capture high growth cos. value, I decided to update my report to reveal usable knowledge and info.

At bottom, centralization is the foundation for the collectivist fallacy; that there is a “greater good” that must be maintained by the establishment.  This process makes the establishment indispensable in the minds of the public.  The elites in power today have chosen environmental dogma as their version of the “greater good”, because the “end of the world as we know” can be used to rationalize almost any brand of despotic behavior, from food and water rationing as a method for social conditioning, to population control or even depletion in the name of “saving the planet”.  Always beware the true motivations of any governing institution that seeks to assert itself as the purveyor of all that is “best” for the people.  Such groups are rarely if ever what they seem…

Today, without much fanfare, US debt to GDP hit 101% with the latest issuance of $32 billion in 2 Year Bonds. If the moment when this ratio went from double to triple digits is still fresh in readers minds, is because it is: total debt hit and surpassed the most recently revised Q4 GDP on January 30, or just three weeks ago. Said otherwise, it has taken the US 21 days to add a full percentage point to this most critical of debt sustainability ratios: but fear not, with just under $1 trillion in new debt issuance on deck in the next 9 months, we will be at 110% in no time. Still, this trend made us curious to see who has been buying (and selling) US debt over the past year. The results are somewhat surprising. As the chart below, which highlights some of the biggest and most notable holders of US paper, shows, in the period December 31, 2010 to December 31, 2011, there have been two very distinct shifts: those who are going all in on the ponzi, and those who are gradually shifting away from the greenback, and just as quietly, and without much fanfare of their own, reinvesting their trade surplus in something distinctly other than US paper. The latter two: China and Russia, as we have noted in the past. Yet these are more than offset by... well, we'll let the readers look at the chart and figure out it.

All the pseudo-scientific yada-yada on economic theory are just hollow bones thrown to journalists and pundits to have something to “chew” on and write about. The only thing that matters is the monetization of more and more government debt, and how to sell it to the public. Paul Krugman would argue that despite all the “quantitative easing” inflation has not really picked up. At zero percent interest rates, money has no preference – there is no opportunity cost of just “lying around” without interest. Investing money for 4 years for 0.15% return is not “riskless return” – it’s “return-less risk”. Perversely, the Fed has created a situation where raising interest rates would probably lead to inflation. It is boxed into ZIRP (zero interest rate policy) for infinity. Things will get serious once the Fed adopts a policy called N-GDP targeting. Instead of inflation, the Fed will try to “target” nominal GDP. If real GDP growth is zero, the nominal GDP growth will be made up entirely of inflation. Debt is a nominal unit, and it is supported by nominal GDP. In order to keep the ratio between GDP and debt halfway bearable, GDP must be inflated. It is a tax on everybody holding dollars, since the value of those will decline. Meanwhile, the Japanese are resorting to stealth interventions to break the Yen’s strength.    Currency wars have gone from “cold” to “hot”. The Fed’s printing of dollars is forcing other central banks to purchase them and selling their own currency in the hope of stemming their own currency’s rise. This makes them involuntary buyers of Treasury bills and bonds, making it easier for the US government to finance its deficit.

And so we are back to the same fiscal feudalism that Germany demanded, and the Greece refused weeks ago. We have been pondering the ECB bond swap 'news-story' and the market's reaction to this with incredulity. Our earlier discussion of the deal (here and here) pointed to the problems and now Peter Tchir explains how this debt swap is actually a step towards a Greek default (thanks to the removal of the CAC-encumberance within the ECB). It is also a large step towards colonization as the FT notes that the bailout terms will contain "unprecedented controls" on Athens. It is our earlier comments on the unintended consequence of this ECB action - that of explicitly subordinating all other sovereign bondholders in Europe, and that this would likely raise the very large specter of legal action by other Greek bondholders arguing the ECB has received unfair treatment - that the FT also brings to investors' attention (which is seemingly being ignored on the eve of OPEX). Whichever way you look at this - it is not good for Greece and could have significantly negative implications for the rest of the European sovereign bond market just as investors are starting to dip a toe in the cool risk water once again.

The prophetic words of Antal Fekete in his now infamous 'essay' on Gold are as relevant now (perhaps more so) as they were when he first wrote them 15 years ago - especially as the Euro-zone migrates from lossening fiat-money to quasi-money (greek pharma bonds for instance). While summarizing this must-read discussion of mainstream economic orthodoxy's mis-teachings is impractical, his initial introduction sets the stage for what is to come: "The year 1971 was a milestone in the history of money and credit. Previously, in the world's most developed countries, money (and hence credit) was tied to a positive value: the value of a well-defined quantity of a good of well-defined quality. In 1971 this tie was cut. Ever since, money has been tied not to positive but to negative values -- the value of debt instruments." After a brief, clarifying history of money, Fekete goes on to discuss the misnomers of currency depreciation, gold as wealth, the failings of kicking the can, quantitative easing, and finally in the misunderstanding of interest rates themselves - seeing them as nothing more than merely bribe-money, trying to persuade reluctant holders of irredeemable promises to hang on a while longer. Paradoxically, gold's importance is growing while its dispersal from official hoards and the mines continues apace. Dispersed gold represents latent power, far greater in scope than its nominal market value, as sound credit can be built only upon a gold base.

Regular readers of Zero Hedge know that in recent months tracking the portfolio and thoughts of one Bill Gross via the holdings of his flagship Total Return Fund (which just jumped by $6 billion in the past month and is just shy of its all time record north of $250 billion) has meant one thing and one thing only: betting on the Fed monetizing Mortgage Backed Securities or bust. Well, in January he just took it to a whole new level. The fund has now borrowed a record $88 billion, or -35% of its AUM, in cash (shows how much he thinks of the dollar) and used the proceeds (together with dumping European sovereign bonds from 18% to 11% of AUM) to bet on MBS which now stood at a whopping 50% of the entire portfolio - the highest since July 2009 when QE1 was in full force. However, in absolute dollar terms, due to the growth of the fund's AUM, the actual bet on MBS has never been bigger, and at $125 billion, represents the biggest notional bet ever made by PIMCO. Treasury holdings of just over $100 billion with an effective duration of 6.33 complete the epic bet that the fund has now put on QE3.

Had to cross post this discussion with my brother Michael Whalen from The Institutional Risk Analyst. The past articles in The IRA require a $99/yr subscription, but the most recent is free. 

Also note link to comment by Barry Ritholtz on The Big Picture re: the Facebook IPO.  Actually Goldman Sachs led the covert IPO and hype festival last year, but the folks at the SEC and FINRA were sound asleep.  

Chris

If you think the EU Crisis is over, think again. True we’ve got until March 20^th for the Greek deal to be reached, but things have already gotten to the point that Germany has essentially issued its ultimatum. Either Greece hands over fiscal sovereignty, or it defaults in a BIG way.