Budget Deficit

While we have grown 'used' to hearing of protests in several European peripheral nations, South Africa has turned the anti-austerity protest amplifier to 11 in recent days. From the Lonmin massacre and subsequent wage increase to the truck-drivers' strike and Amplats firing of 12,000 workers , Reuters is reporting that South Africa's local government worker's union has now said it will join a nationwide strike amid the labor unrest in the mining sector. Demanding 'market-related salaries' this strike would bring the South African economy to its knees - at a time of rising deficit concerns. Critically, this has dramatic repercussions. Since firing people is no longer an option as "Those who are dismissed will make sure that there will be no operations operating and that will cause a massacre just like at Marikana," some companies will be forced out of business (reducing supply) or suffer significant margin compression on cost increases leaving commodity producers struggling - which will inevitably mean prices for end-users will rise (slowing end-user demand or crushing their margins). It seems the South African labor unions found the M.A.D. card.

The president is about to speak in Keene, CA, just off Bakersfield, where he will announce the establishment of the Cesar Chavez national monument. That at least is the official topic. What everyone is curious about is if Obama will bring up the topic that is on every Californian's mind today: gas prices that have never been higher.  Find out shortly if the recent gas price breakout is once again the work of evil, evil speculators, some of whom may not even have a printing press, or if the market's discounting of $1 trillion in new Treasury monetizations by the Fed, or roughly half the budget deficit through 2014 has anything to do with it. Also, certainly keep an eye on RBOB and various energy margin hike after the close. After all, Obama is not known as the margin hiker-in-chief for nothing.

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.

• No Joy on Wall Street as Biggest Banks Earn $63 Billion (Bloomberg)
• And more good news: IMF’s Blanchard Says Crisis Will Last a Decade (Reuters)
• Hobbit Returns to Find Middle Earth Has Become Expensive (Bloomberg)
• Freddie's Foreclosure Plan Hits Roadblock (WSJ)
• Who will buy the FT? Pearson CEO Scardino Will Step Down as Fallon Takes Over (BBG)
• Jeremy Lin Said to Be in Talks With Harvard on Licensing Deal (Bloomberg)
• Jon Weil tears apart the NYAG "prosecution" - Eric Schneiderman Will Have to Do Better Than This (BBG)
• Portugal Offers to Exchange Bonds as It Seeks Debt Market Access (Bloomberg)
• Is unlimited growth a thing of the past? (FT-Martin Wolf)
• European Bank Capital Results Overtaken by Tougher Global Rules (Bloomberg)
• China’s Slowdown Reverberates as ADB Cuts Forecasts (Bloomberg)
• Tokyo has no plan to extend currency swap deal with Seoul (Reuters)

Here are a few interesting tidbits to chew on...

• RBA Cuts Rate to 3.25% as Mining-Driven Growth Wanes (Reuters)
• Republicans Not Buying Bernanke’s QE3 Defense (WSJ)
• Spain ready for bailout, Germany signals "wait" (Reuters)
• EU says prop trading and investment banking should be separated from deposit taking (Reuters)
• Call for bank bonuses to be paid in debt (FT)
• Spanish Banks Need More Capital Than Tests Find, Moody’s Says (Bloomberg) ... as we explained on Friday
• "Fiscal cliff" to hit 90% of US families (FT)
• The casualties of Chesapeake's "land grab" across America (Reuters)
• U.K. Government Needs to Do More to Boost Weak Economy, BCC Says (Bloomberg)
• World Bank Sees Long Crisis Effect (WSJ)
• UBS Co-Worker Says He Used Adoboli’s Umbrella Account (Bloomberg)
• And more easing: South Korea central bank switches tack to encourage growth (Reuters)

Remember when last week Spain disclosed the terms of its 2013 Austerity budget, and everyone, literally, came out of the trunk in the ZZ Top wagon, including Olli Rehn who said Spain had done even more than Europe demanded, which led many to believe this was the basis for Spain preparing to announce its bailout request? Well, today Europe is kinda, sorta force to reevaluate said statement, and poor Mr Rehn has to self-flagellate himself in some Helsinki sauna for speaking too fast, because over the weekend Spain preannounced (the first of many) 2012 budget target misses. The Spanish government said the deficit would hit 7.4% of GDP, which misses the 6.3% target set for the year. The 6.3% number in turn, was a "loosened" goal as the original deficit target for the country set by the Commission was 5.3%. What will happen is that at some point, in late December just like in 2011, Spain will say it was only kidding and the real budget deficit will be in the double digits, or about 100% more than the preliminary announced one. But don't worry: in 2013 all shall be well: IMF, ECB, Spain and Princeton economists all over the world promise, so it must be.

A month ago, when we first presented the dwindling Spanish treasury cash position, we wrote: "once the next Spanish State Liability update is posted, we wouldn't be surprised to see this number plunge to a new post-Lehman low. Yet what is scariest is that all else equal (and it never is), at the current run rate Spain may well run out of cash by the end of the year even assuming it manages to conclude all its remaining auctions through year's end without a glitch." The August cash balance update was just released by the Banco de Espana, and there's good news, unsurprising news and bad news.

One-by-one, the highest quality collateral in the world (according to ratings that is) is disappearing. To wit, Fitch warns that a downgrade of the UK's AAA rating is increasingly likely: "weaker than expected growth and fiscal outturns in 2012 have increased pressure on the UK's 'AAA' rating, which has been on Negative Outlook since March 2012." The Negative Outlook on the UK rating reflects the very limited fiscal space, at the 'AAA' level, to absorb further adverse economic shocks in light of the UK's elevated debt levels and uncertain growth outlook. Global economic headwinds, including those emanating from the on-going eurozone crisis, have compounded the drag on UK growth from private sector deleveraging and fiscal consolidation as well as from depressed business and consumer confidence, weak investment, and constrained credit growth. But no mention of unlimited QE? Fitch expects only a weak recovery beginning in 2013 and output is not expected to surpass its 2007 pre-crisis peak until 2014.

"Hoover-esque. Spain's has unemployment near 25% and yet the govt is proposing tax increases and a raiding of social security funds in an effort to rein-in its budget deficit. (The deficit was 4.77% for the first 8 months.) The rub is whether Spain will be able to cut enough to obtain  EU support (probably) and whether there will be an eventual haircut for current debtholders (probably). Catalonia, Valencia and other regions will probably need $20B of aid, the sen. debtholders of the weak banks will be forced to take losses, and there might be some sharing of losses among all banks. An estimated decline in GDP of 1.7% (per the Economy Ministry), the IIF's recent estimate of addl bank loan losses up to EUR260B, and depositor flight hurt. From 2008 to 2011, Spain's debt jumped from EUR436B to EUR735B while its GDP declined from EUR1.09T to EUR1.07T."

As the words were spewing from the mouths of Saenz, Montoro, and Guindos - with little to no substance at all, so EURUSD started to push higher - in a hurry. In today's quiet market, the correlated-monkeys took over and US equities - thanks to weakness in the USD - and Gold and Oil spurted higher. AAPL - as the high beta proxy for all things market - surged 2% (we assume as the Spaniards will need to buy more AAPL stock to fund the shortfalls in their pension funds). The bottom-line is we have fallen for a few days and so a bounce is not unlikely but the timing and size smells very fishy and the front-running of quarter-end front-running wind-dressing front-runners remains a quagmire of circular logic to us. The bottom-line is that the media can now say the words "the market seemed to 'like' what Spain was saying - is the bottom in?" despite there being no news at all.

European riots protests are on UBS' Art Cashin's mind. Furthermore, Art notes that Spain has seen a fifth region (Castilla La Mancha) request a billion-euro-bailout (along with Catalonia's secession concerns) and Greece is hotting up. However, it is Egypt that is becoming an increasing concerning for the avuncular aristocrat of the exchange floor, as he fears the region's growing instability along with its potential need to devalue the pound may see the current 'sporadic outbursts of social unrest' spill over into more broad based protestations on the streets of Cairo.

Whether Atwater, California will join the prodigious ranks of Stockton, San Bernardino, and Mammoth Lakes to become the 4th Muni bankruptcy is up for vote on October 3rd (before a $2mm bond payment in November). As Bloomberg notes, the 28,000-strong Merced county town is suffering under the same weight of public employee costs, lost revenue, and a stagnant economy leaving it with a $3.3 million budget deficit. While some put their hope in the FB IPO, perhaps Bernanke should have mandated investment in AAPL for all these municipal comptrollers? The median income is 19% below the national average as the foreclosure crisis - which saw Atwater's median home price drop by more than half - has depleted property-tax revenues dramatically. "We just started negotiating with our unions and they are going to have to take a major cut," Mayor Joan Faul said. "We hope that once we declare a fiscal emergency, that they will realize that we are definitely in an emergency. If they want to save all the jobs, everyone is going to have to take a cut,"

Remember when we said two months ago that one way or another the market will need to tumble to enforce the chain of events that lead to Spain demanding the bailout which has long been priced in, and (especially after yesterday's violent protest) Rajoy handing in his resignation? Well, it's "another." After nearly 3 months of suspending reality, in hopes to not "rock the boat" until the US presidential election, reality has made a quick and dramatic appearance in Europe, where after a day in which the EURUSD tumbled, events overnight have finally caught up. What happened? First, ECB's Asmussen said that the central bank would not participate in any debt restructuring, confirming any and all hopes that the ECB would ever be pari passu with regular bondholders were a pipe dream. Second, Plosser in the US said additional QE probably won't boost growth which has reverberated across a globe in which the only recourse left is, well, additional QE. Finally, pictures of tens of thousands rioting unemployed young men and women in Madrid did not help. The result: Spain's 10 Year is over 20 bps wider, and back over 6%, Germany just had a €5 billion 10 Year auction for which it only got €3.95 billion in bids, which means it was technically a failure, and the second uncovered auction in one month, and finally CDS across the continent, not to mention the option value that is the Spanish IBEX which may fall 3% today, have finally realized they are priced far too much to perfection and have, as a result, blown out.