Budget Deficit

The Wall Street Journal recently ran a front-page article reporting that the monetary-policy “doves,” who had forecast low inflation in the United States, have gotten the better of the “hawks,” who argued that the Fed’s monthly purchases of long-term securities, or so-called quantitative easing (QE), would unleash faster price growth. The report was correct but misleading, for it failed to mention why there is so little inflation in the US today. Those who believe that inflation will remain low should look more thoroughly and think more clearly. There are plenty of good textbooks that explain what too many policymakers and financial-market participants would rather forget.

With all of the problems afflicting the world economy nowadays, inflation seems to be the least of our worries. In addressing the post-2008 economic malaise, which stems from over-indebtedness, policymakers are correct to focus on the threat of debt deflation, which can lead to depression. But dismissing inflation as “yesterday’s problem” could undermine central banks’ efforts to address today’s most pressing issues – and, ultimately, facilitate inflation’s resurgence. Understanding how the Great Inflation from the late 1960’s to the early 1980’s was tamed offers important lessons for addressing far-reaching economic problems, however different ours may be, and provides insight into the dangers that may lie ahead.

President Obama recently stopped in Phoenix to deliver his latest diatribe on how he is going to fix the economy.  Yes, that is correct, another round of "campaign speeches" that, as has been the hallmark of this Administration to date, have generally wound up mired in an abyss of a broken congressional system.  What really struck me, however, was his comprehensive plan designed to further boost the housing market. Another housing bailout program is the last thing we need. It's time to stop trying to fix what is broken by trying to cure the symptoms rather than the disease.

Confidence leads to spending; spending strengthens the economy; and economic strength buttresses confidence. It’s a circular, self-fulfilling prophesy. Confidence can also fuel market movements. Belief that the price of an asset will rise causes people to buy the asset... making its price rise. This is another way in which confidence is self-fulfilling. But, of course, as Oak Tree Capital's Howard Marks points out, the confidence that underlies economic gains and price increases only has an impact as long as it exists. Once it dies, its effect turns out to be far from permanent. As the economist Herb Stein said, "If something cannot go on forever, it will stop." This is certainly true for confidence and its influence. As far as confidence today, Marks notes significant uncertainty is one of the outstanding characteristics of today’s investing environment. It discourages optimism regarding the future and limits investors’ certainty that the future is knowable and controllable. In other words, it saps confidence. This is a major difference from conditions in the pre-crisis years. In fact, Marks warns he doesn't remember when his list of 'uncertainties' was this long...

A week that has been all about acronyms - GDP, PMIs, FOMC, ECB, BOE, ADP, ISM, DOL, the now daily record highs in the S&P and DJIA - is about to get its final and most important one: the NFP from the BLS, and specifically an expectation of a July 185K print, down from the 195K in the June, as well as an unemployment rate of 7.5% down from 7.6%. The number itself is irrelevant: anything 230 and above will be definitive proof Bernanke's policies are working, that the virtuous circle has begun and that one can rotate out of everything and into stocks; anything 150 or below will be definitive proof the Fed will be here to stay for a long time, that Bernanke and his successor will monetize everything in sight, and that one can rotate out of everything and into stocks, which by now are so disconnected from any underlying reality, one really only mentions the newsflow in passing as the upward record momentum in risk no longer reflects pretty much anything.

With all eyes fixed on GDP and unemployment data this week (and all their revised and propagandized unreality) for more hints at if (not when) the Fed will Taper; the dismal reality that few seem willing to admit is that it is when (not if) and that the announcement of a "Taper" has nothing to do with the economy. There are three key factors driving this decision: Bernanke's bubble-blowing and bond-market-breaking legacy, the political 'clean slate' his successor needs, and, most importantly, the fear that QE will be discovered for what it is - monetization. As BoJ's Kuroda admitted last night "if QE is seen as financing debt, this could lead to rise in yields." With deficits falling, the Fed's real actions will be exposed (unless QE is tapered) and as Kyle Bass has explained before, it was out of the hands of the BOJ (or The Fed) and entirely up to market psychology.

Anyone that thinks that the U.S. economy can keep going along like this is delusional.  We are in the terminal phase of an unprecedented debt spiral which has allowed us to live far, far beyond our means for the last several decades.  Unfortunately, all debt spirals eventually end, and they usually do so in a very disorderly manner. 

Without doubt, Iceland was the canary in the coalmine for the sovereign debt crisis that is unfolding across the world right now. Today, Iceland is held up as the model of recovery. 'Famous' economists like Paul Krugman praise the government for rapidly rebuilding the economy without having to resort to austerity. This morning’s headline from The Telegraph newspaper sums it up: “Iceland has taken its medicine and is off the critical list”. It turns out, most of these claims are dead wrong. Despite being so widely reported by the mainstream financial media, Iceland is not a story of model economic recovery. It’s a story of how to fool people. And for now, it’s working.

Sovereign debt is the bonds that are issued by national governments in foreign currencies with the intent to finance a country’s growth. The risk involved is determined by whether that country is a developed or a developing country, whether that country has a stable government or not and the sovereign-credit ratings that are attributed by agencies to that country’s economy.

CFTC whistleblowers, JP Morgan silver short, Andrew McGuire, Gold Leasing, Robert Rubin, Larry Summers, Gibson's paradox and that sink in your kitchen

On the even of Bastille Weekend and the 100th anniversary of the Tour de France, you know it must be bad when the French-company-owned ratings agency Fitch is forced to remove its AAA rating from France. Key drivers include Debt-to-GDP projections rising and substantially weaker economic output and forecasts. Full statement below...

When it comes to changing the "measurement" rules in the middle of the game, nobody does it quite like Japan: in the aftermath of the Fukushima nuclear explosion, when radiation was soaring (and still is with Tritium levels just hitting a record high but who cares - Goldman partners have to earn record bonuses on the back of the irradiated island) Japan's solution was simple: double the maximum safe irradiation dosage. Done and done. Now, it is time to do the same to that other just as pesky, if somewhat less lethal indicator: inflation. Reuters reports that the Japanese government plans to adopt a different measure of inflation to the central bank's.

Despite media rumors that the Portuguese foreign minister Portas, who resigned on Tuesday precipitating a complete collapse in Portugual bond prices and ushering in the latest European political crisis, has agreed to stay in the government as a Deputy PM and economy minister (nothing like some title inflation-pro-quo), things in Portugal are rapidly turning from bad to worse. To wit:

PORTUGUESE 10-YEAR BONDS DECLINE; YIELD RISES 14 BPS TO 7.60%
PORTUGUESE TWO-YEAR NOTE YIELD RISES 60 BPS TO 5.64%
PORTUGUESE 2-YEAR YIELD REACHES 5.66%, HIGHEST SINCE NOV. 20

The main reason for the collapse appears to be the near consensus developing this morning that no matter what the government does at this point, a second bailout of the small country is inevitable.

Given the US holiday, markets are likely to be thin today but there are some big news stories floating around at the moment.  If the fast and furious events from the past few days in a revolutionary Egypt bear a striking resemblance to what happened in the spring of 2011, it is because they are strikingly comparable. Only this time, following the ouster of yet another US-supported "leader" by the US-supported military, the country's CDS has normalized at a level that is roughly double where it was two years ago as the implicit backing of the US looks increasingly shaky, following what was yet another bungled foreign policy venture by the Obama administration. But for now, the people are celebrating, just as they did in 2011. One wonders what happens between now and the next coup, somewhere two years (or less) hence. For now focus merely on who controls the Suez - after all that is really all that matters for the US. The other major story of yesterday, Portugal, continues to be in limbo,

Portgual stuck with austerity even after the orthodoxy changed.  The finance minister resigned and was replaced by someone who promises continuity.  This led to the resignation of the head of the jr coalition partner leader.  Still, snap elections are not the most likely scenario.