Budget Deficit

By monetizing more than the entire Japanese budget deficit, the BOJ is running of out willing sellers. Without those, Japan's QE, just like that of the ECB, will grind to a halt. Better yet, this creates a vicious loop, because with every passing month, the inevitable D-Day when the BOJ has no more TSYs on the offer gets closer, which in turn will force those who bought stocks to sell in anticipation of the end of QE, and to seek the safety of bonds themsleves, in effect precipitating the next inevitable Japanese stock market crash.

Saudi Arabia is staring down a current account-fiscal account outcome that makes Brazil look favorable by comparison. With the fiscal budget deficit projected at some 20% of GDP and two proxy wars combined with the necessity of maintaining the status quo for ordinary Saudis serving to make fiscal retrenchment next to impossible, you might be wondering how high oil prices need to climb in order for the Saudis to plug the gap. Deutsche Bank has the answer.

"A cloudy fiscal policy along with unattractive economic data and oil prices continuing to decline fueled negative sentiment about the market which exaggerated fears among investors."

World oil production is about 90 million barrels a day, representing a cash flow of about nine billion dollars a day which comes down to three trillion dollars a year. With the oil price 40 to 50% lower, this flow is also cut by 40 to 50%. This amounts to 10% US GDP. Compare it with the 0.5% growth we are now missing in China, we prefer to keep our eyes on the oil price. These extreme moves can not be without consequence.

Today's most anticipated event at tthis year's Jackson Hole event was the panel on "Global Inflation Dynamics", not because there is any core inflation in the world (at least not in the way the CPI measures it), especially not now that China is finally in the deflation exporting business, but because the most important speaker at this year's Jackson Hole, Fed vice chairman Stanley Fischer, alongside BOE's Mark Carney, the ECB's Constancio and the RBI's Raguram Rajan, would comment. Moments ago he just did, and courtesy of Market News, here are the highlights.

Late last year, Saudi Arabia "Plaxico'd" itself and the petrodollar when, in an effort to "preserve market share" and bankrupt US shale producers, the kingdom endeavored to purposefully suppress crude prices. Nine months and billions in liquidated FX reserves later, Saudi Arabia is facing a budget crisis of epic proportions. 

You know what they say: when it rains it pours, especially when you’re the poster child for an epic emerging market unwind and you’re suffering through the worst inflation-growth outcome in over a decade while trying to combat dual deficits and ward off political and social upheaval.

It appears the economy is doing just well enough and the reflexive bounce in stocks showing that everything is awesome is all that Fed's vice chair Stan Fischer appeared to need to note that "we are heading [a September rate hike]direction." This has been judged as "not dovish enough" and sparked some turmoil...

• Global Stocks Struggle to Shrug Off China Fears (WSJ)
• Brief Respite Ends for European Stocks Amid Renewed Retreat (BBG)
• Stock futures rise after China injects $21.8 billion (Reuters)
• China turmoil needn't rattle BOJ, yen rise not a worry: Abe adviser (Reuters)
• Stock-Market Tumult Exposes Flaws in Modern Markets (WSJ)
• Dollar gains as stocks recover, lessens safe-haven bid for yen (Reuters)

With declining crude revenues clashing head on with the cost of simultaneously financing the state while intervening militarily in Yemen, the Saudis are looking to tap the bond market (a move which could increase debt-to-GDP by a factor of 10 by the end of next year) and some are speculating that the riyal’s dollar peg could ultimately prove unsustainable. Now, as Bloomberg reports, "Saudi Arabia is seeking to cut billions of dollars from next year’s budget because of the slump in crude prices."

Over the weeks, months, and years ahead we’ll begin to understand more about the fallout from the death of the petrodollar and nowhere is it likely to be more apparent than in Saudi Arabia where widening fiscal and current account deficits have forced the Saudis to tap the bond market to mitigate the FX drawdown that's fueling speculation about the viability of the dollar peg. As Bloomberg reports, the current situation mirrors a "very scary moment" in Saudi Arabia’s history.

Last week, in the global currency war’s latest escalation, Kazakhstan instituted a free float for the tenge causing the currency to immediately plunge by some 25%. The rationale behind the move was clear enough. What might not be as clear is how recent events in developing economy FX markets stem from a seismic shift we began discussing late last year - namely, the death of the petrodollar system which has served to underwrite decades of dollar dominance and was, until recently, a fixture of the post-war global economic order.

... and the ECB printing presses!

In simple terms, Greece from 2003-2010 was an economic boom driven by incomes, which were in turn driven by cheap debt NOT real organic growth. Thus, the collapse in GDP was yet another case of “price discovery” in which asset prices fall to economic realities…

Low oil prices and the battle against Islamic State (IS) are pushing Iraq toward a financial crisis. Only fundamental reforms, especially decentralization of power, can resolve the challenges facing Iraq today.