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Strength is fading. Parity is visible. Reform is the only option. European markets are tumbling and the euro has slipped to record lows against several major currencies. The market is in reaction mode responding Spain and Greece in the headlines.

Ray Dalio's Bridgewater On The "Self Re-Inforcing Global Decline"

The world's largest hedge fund is not as sanguine about the hope that remains in the markets today. The firm's founder, Ray Dalio, who has written extensively on the good, bad, and ugly of deleveragings, sounds a rather concerned note in his latest quarterly letter to investors as the "developed world remains mired in the deleveraging phase of the long-term debt cycle" and has spread to the emerging world "through diminished capital flows which have weakened their growth rates and undermined asset prices". Between China, Europe, and the US, which he discusses in detail, he sees the lack of global private sector credit creation leaving the world's economies highly reliant on government support through monetary and fiscal stimulation. The breadth of this slowdown creates a dangerous dynamic because, given the inter-connectedness of economies and capital flows, one country's decline tends to reinforce another's, making a self-reinforcing global decline more likely and a reversal more difficult to produce. After discounting a relatively imminent return to normalcy in early 2011, markets are now pricing in a meaningful deleveraging for an extended period of time, including negative real earnings growth, negative real yields, high defaults and sustained lower levels of commodity prices. Lastly he believes the common-wisdom - that the Germans and the ECB will save the day - is misplaced.

Are Postal Workers About To Go Postal On Imminent USPS Benefits Default?

So far the beyond insolvent US Postal Service has been able to avoid outright bankruptcy simply because no major cash outflows were required by the organization. That is about to change in just under two weeks when the USPS is due to make a $5.5 billion payment for retirement accounts. The problem: the USPS does not have the money and needs a bailout. The bigger problem: the USPS needs Congressional action to authorize this latest and so far greatest USPS bailout, however with Congressional recess imminent this won't happen. So are several hundred thousand postal workers about to go postal once they realize that (earmuffs time for all those who love chanting ideological slogans, but have yet to graduate to the abacus) math matters, and every "welfare-funding" entity in the US is ten times broke over? And maybe most importantly: just how will the postal labor union vote in the upcoming election if indeed they suddenly are denied what they had been lied to for years is rightfully theirs?

The Reign In Spain May Soon Be Over

Recently two noted Spanish economists were interviewed. One was always an optimist and one was always a pessimist. The optimist droned on and on about how bad things were in Spain, the dire situation with the regional debt, the huge problems overtaking the Spanish banks and the imminent collapse of the Spanish economy. In the end he said that the situation was so bad that the Spanish people were going to have to eat manure. The pessimist was shocked by the comments of his colleague who had never heard him speak in such a manner. When it was the pessimist’s turn to speak he said that he agreed with the optimist with one exception; the manure would soon run out.

Sicily Is Greece As Italy Provides EUR400 Million 'Risk-Free' Bailout/Loan

We thought it was coming (as we wrote yesterday); we heard the rumors; but now the 'temporary liquidity problem' that faced Sicily has been resolved by... yes, you guessed it - the transfer of EUR400 million from the Italian government. Do not worry though. As one official noted "there's no default risk for Sicily, whose budget was in surplus in 2010 and 2011". Unbelievable.

"The developments in Sicily are very serious," said Prof Giuseppe Ragusa from Luiss University in Rome. "It is just the sort of negative shock we don’t want right now. Everything has to go perfectly for Italy to pull through."

UBS Issues Hyperinflation Warning For US And UK, Calls It Purely "A Fiscal Phenomenon"

From UBS: "We think that a creditor nation is less at risk of hyperinflation than a debtor nation, as a debtor nation relies not only on the confidence of domestic creditors, but also of foreign creditors. We therefore think that the hyperinflation risk to global investors is largest in the US and the UK. The more the fiscal situation deteriorates and the more central banks debase their currencies, the higher the risk of a loss of confidence in the future purchasing power of money. Indicators to watch in order to determine the risk of hyperinflation therefore pertain to the fiscal situation and monetary policy stance in high-deficit countries. Note that current government deficits and the current size of central bank balance sheets are not sufficient to indicate the sustainability of the fiscal or monetary policy stance and thus, the risk of hyperinflation. The fiscal situation can worsen without affecting the current fiscal deficit, for example when governments assume contingent liabilities of the banking system or when the economic outlook worsens unexpectedly. Similarly, the monetary policy stance can expand without affecting the size of the central bank balance sheet. This happens for example when central banks lower collateral requirements or monetary policy rates, in particular the interest rate paid on reserves deposited with the central bank. A significant deterioration of the fiscal situation or a significant expansion of the monetary policy stance in the large-deficit countries could lead us to increase the probability we assign to the risk of hyperinflation."

City Of Compton Next On The Muni Bankruptcy Deck

Because once the dominoes start, they don't stop. Stockton, Mammoth, San Bernardino and now legendary rap and LA riots nexus - the City of Compton. Fear not: the ESM, and the German population whose retirement age will have to be in the quadruple digit range to fund a broke world, has got this, too, covered. Also, only squares don't make fun of Meredith Whitney for saying municipal America is insolvent, so please do.

So Much For "Housing Has Bottomed" - Shadow Housing Inventory Resumes Upward Climb

Appropriately coming just after today's Housing Starts data, which captured MSM headlines will blast was "the highest since 2008" is the following chart from this morning's Bloomberg Brief, which shows precisely the reason why "housing has bottomed" - and it has nothing to do with organic demand rising. No, it has everything with excess inventory once again starting to pile up, which means that the imbalance in the supply and demand curves is purely a function of shadow inventory being stocked away, and that there is once again no true clearing price.

Frontrunning: July 18

  • Who Needs the Euro When You Can Pay With Deutsche Marks? (WSJ)
  • Now it's personal and ad hominem: Is German Economist Exacerbating Euro Crisis? (Spiegel)
  • Bernanke Outlines Range Of Options For Additional Easing (Bloomberg)
  • Italy's Monti says serious worry Sicily region may default (Reuters)
  • Libor ‘structurally flawed’, says Fed (FT)
  • Some Firms Opt to Bring Manufacturing Back to U.S. (WSJ)
  • ECB Signals Support for Easing Irish Debt Terms (WSJ)
  • China’s Wen Warns Of Severe Job Outlook As Growth Yet To Return (Bloomberg)
  • Hollande scraps tax breaks on overtime (WSJ)
  • China’s June Home Prices Rebound As Sentiment Improves (Bloomberg)

Pick Your Debt Poison

When it comes to estimating the biggest threat to the global financial system, by far the biggest threat and biggest unknown is the total Financial debt in the system, for the simple reason that as we have been showing for over two years, it is simply impossible to quantify just what the real level of such debt in the developed world truly is, especially when one accounts for shadow liabilities, rehypothecated collateral, derivatives, and all those other footnotes in financial statements that only become relevant when daisy-chained collateral links start collapsing following the default of one or more financial entities, and when gross becomes net. What we can, however, do is show the other three major categories of debt currently existing in the system: Government, Corporate and Household debt, as they are distributed among the "developed" countries. We also know what the tresholds are beyond which the debt becomes unstustainable. In the words of the BIS: "For government debt,  the threshold is around 85% of GDP... When corporate debt goes beyond 90% of GDP, it becomes a drag on growth. And for household debt, we report a threshold around 85% of GDP, although the impact is very imprecisely estimated."