Credit Crisis

• Must defend against Chinese colonial expansion and get the Nigerian oil: U. S. Boosts War Role in Africa (WSJ)
• BOJ nominee Kuroda sets out aggressive policy ideas (Reuters)
• China becomes world’s top oil importer (FT)
• Baby Cured of HIV for the First Time, Researchers Say (WSJ)
• Obama to nominate Walmart's Burwell as White House budget chief (Reuters)
• Wal-Mart Anxious to Combat Amazon’s Lead in Web Vendors (BBG)
• Nasdaq executing trades at a loss (FT)
• Spending cut debate casts pall over Obama's second-term agenda (Reuters)
• Russell Indexes to Reclassify Greece as Emerging Market (BBG)
• Bond Bears Collide With Swaps Showing Low Rates (BBG)
• Buffett Deputies Leaving Billionaire in the Dust Get More Funds (BBG)
• Brazil's leftist president fights to win back business (Reuters)
• U.S. Special Forces train Syrian Rebels in Jordan (Le Figaro)
• Carlos Slim Risks Losing World’s Richest Person Title as Troubles Mount (BBG)

As we have been warning for nearly a year, the biggest threat facing China has been the fact that contrary to solemn promises, the problem of persistent, strong and very much relentless real-estate inflation has not only not been tamed but has been first and foremost on the minds of both the PBOC and the local government. After all with the entire "developed" world flooding the market every single day with countless billions in new cheap, hot money, it was inevitable that much of it would end up in the mainland Chinese real estate market. And since both the central bank and the politburo are well aware that the path from property inflation to broad price hikes, including the all critical to social stability pork and other food, is very short, it was inevitable that the issue of inflation would have to be dealt with eventually. Tonight is that "eventually", when following news from two days ago that yet another Chinese PMI indicator missed, this time the Services data which slid from 56.2 to 54.5, the government announced its most aggressive round of property curbs yet. The immediate result was that the Shanghai Stock Exchange Property Index slumped by a whopping 9.3%, the steepest drop since June 2008, and pushing it down to -11% for the year. The weakness also spread to the broader market, with the Composite closing down 3.65% the biggest drop in months, and now just barely positive, at +0.2%, year to date. We expect all 2013 gains to be promptly wiped out when tonight's risk off session resumes in earnest.

The great trade, capital flow and debt imbalances that were built up over the preceding two decades must reverse themselves. Michael Pettis notes, however, that these imbalances can continue for many years, but at some point they become unsustainable and the world must adjust by reversing those imbalances. One way or the other, in other words, the world will rebalance. But there are worse ways and better ways it can do so. Pettis adds that, any policy that does not clearly result in a reversal of the deep debt, trade and capital imbalances of the past decade is a policy that cannot be sustained. It is likely to be political considerations that determine how quickly the rebalancing processes take place and whether they do so in ways that set the stages for future growth or future stagnation. Pettis' guess is that we have ended the first stage of the global crisis, and most of the deepest problems have been identified. In 2013 we will begin to see how policymakers respond and what the future outlook is likely to be. The following 10 themes are what he will be watching this year in order to figure out where we are likely to end up.

• Obama Paints Wider Role for Government in Middle Class Revival (BBG)
• Obama to Seek a New Trade Deal With EU (WSJ)... or this is strawman why 2016 GDP will be higher
• Mobile phone sales fall for the first time since 2009 (Telegraph)
• Sequester Looms, No Deal in Sight (WSJ)
• Neither US party swallows a compromise (FT)
• Embattled Economies Cling to Euro (WSJ)
• For China, Spending Is Harder Than It Looks (WSJ)
• Bank of England's Sir Mervyn King says recovery in sight (BBC) - just a little more inflation first
• G7 fails to defuse currency tensions (FT)
• Japanese Leader Urges Firms to Boost Wages (WSJ) - so does the US one
• Fed Bank Chiefs Back Money-Fund Overhaul (WSJ), or force everyone out of MMFs and into stocks

The Truth About Facebook That No Media Outlet Or Analyst Has Bothered To Notice

From a valuation perspective, Chinese equities do not, at first glance, look to be a likely candidate for trouble. The PE ratios are either 12 or 15 times on MSCI China, depending on whether you include financials or not, and do not scream 'bubble'. And yet, China has been a source of worry for GMO over the past three years and continues to be one. China scares them because it looks like a bubble economy. Understanding these kinds of bubbles is important because they represent a situation in which standard valuation methodologies may fail. Just as financial stocks gave a false signal of cheapness before the GFC because the credit bubble pushed their earnings well above sustainable levels and masked the risks they were taking, so some valuation models may fail in the face of the credit, real estate, and general fixed asset investment boom in China, since it has gone on long enough to warp the models' estimation of what "normal" is. Of course, every credit bubble involves a widening divergence between perception and reality. China's case is not fundamentally different. In GMO's extensive discussion below, they have documented rapid credit growth against the background of a nationwide property bubble, the worst of Asian crony lending practices, and the appearance of a voracious and unstable shadow banking system. "Bad" credit booms generally end in banking crises and are followed by periods of lackluster economic growth. China appears to be heading in this direction.

In this piece, I re-examine what many economists call "financial repression" and I find it to be sorely lacking as a description of what is happening. I also look at a related concern about the loss of central bank independence. Color me skeptical.

• A Bold Dissenter at the Fed, Hoping His Doubts Are Wrong (NYT)
• China and Japan step up drone race as tension builds over disputed islands (Guardian)
• How Mario Draghi is reshaping Europe's central bank (Reuters)
• Merkel Economy Shows Neglect as Sick Man Concern Returns (BBG)
• US oil imports to fall to 25-year low (FT)
• China Loan Share at Record Low Shows Financing Risks (BBG)
• Dimon Says Some JPMorgan Execs ‘Acted Like Children’ on Loss (BBG) - children that reveleased who 'excess reserves' are truly used
• Fed injects new sell-off risk into Treasuries (FT) - really? So the Fed will stop monetizing the US deficit some time soon?
• Obama aide presses Republicans to accept more tax revenues (Reuters)
• Ex-SAC analyst named 20 alleged insider traders (FT)
• BOJ easing bets help dollar regain ground vs yen (Reuters)
• Goldman Sachs Said to Be Part of Fed-Led Foreclosure Settlement (BBG)
• Venezuela postpones inauguration for cancer-stricken Chavez (Reuters)

US Vice President Biden and Senate Minority leader McConnell brokered an agreement that was approved by the Senate that seems to avoid the full fiscal cliff.  It now is before the House of Representatives.  

While the Jan 1 deadline is passed, the more significant one, we had argued was Jan 3, when a new Congress is sworn in.  A failure by the 112th Congress to finalize the legislation would mean that process would have to begin anew with the 113th Congress. 

After what is likely to be intense though short debate, the House of Representatives can either approve the same exact bill the Senate approved, which be the quickest resolution.  It can seek to amend the bill, in which case it must return to the Senate for their approval.  The process could be cumbersome and require reconciliation and would risk the Jan 3 deadline.  Alternatively, a majority of the House could fail to ratify the Senate bill, in which case, it will be up the next Congress to claw back from the other side of the cliff.

Over the last few years, and at an increasing pace as of more recently, unions have become more and more confident of their ability to effect change and taken much more aggressive activist positions against the capitalist oppressors. The most recent examples range from California cities to Twinkies-maker Hostess Brands, and each time the stance from the unions appears to have been far more aggressive (and M.A.D. prone) than in the past. The question is why? Perhaps, as we tweeted following Hostess' liquidation:

Will the broke PBGC step in and fund Hostess' 18,000 workers suddenly vaporized pensions?

— zerohedge (@zerohedge) November 16, 2012

...It is the confidence of an all-powerful government at their back with the US Pension Benefit Guarantee Corporation, which is the backstop for private sector plans, providing cover. The problem is, as UBS explains, the PBGC has a huge deficit and is cashflow negative. This leads us to the uncomfortable expectation of further USD government support (bailout) or a more direct monetization by the Fed. PBGC could be impacted severely if a few large firms terminate their pensions. In this case, UBS expects PBGC to sell equities and buy long duration fixed income.

Presenting Dave Collum's now ubiquitous and all-encompassing annual review of markets and much, much more. From Baptists, Bankers, and Bootleggers to Capitalism, Corporate Debt, Government Corruption, and the Constitution, Dave provides a one-stop-shop summary of everything relevant this year (and how it will affect next year and beyond).

"After six years of declines, lending for so-called Helocs will rise 30 percent to $79.6 billion in 2012, the highest level since the start of the financial crisis in 2008, according to the economics research unit of Moody’s Corp. Originations next year will jump another 31 percent to $104 billion, it projected."

The recent market sell-off has not been about the re-election of President Obama but rather the repositioning of assets by professional investors in anticipation of three key events coming between now and the end of this year - the "fiscal cliff", the debt ceiling and the expiration of the Transaction Account Guarantee (TAG).  Each of these events have different impacts on the economy and the financial markets - but the one thing that they have in common is that they will all be battle grounds between a divided House and Senate.  While there has been a plethora of articles, and media coverage, about the upcoming standoff between the two parties - little has been written to cover the details of exactly what will be impacted and why it is so important to the financial markets and economy. We remain hopeful that our elected leaders will allow cooler heads to prevail and that they will begin to work towards solutions that alleviate some of the risks of economic contraction while setting forth logical plans for fiscal reform.  However, while we are hopeful of such progress, "hope" is not an investment strategy to manage portfolios by.  If we are right things are likely to get worse before a resolution is reached - but maybe that is why the "investment professionals" have already been heading for the exits.

Perhaps those sage English philosophers 'The Vapors' were on to something 32 years ago when they asked if we were "Turning Japanese" for it seems the following charts from Nomura certainly suggest the US bond market is heading in that direction. From demographics to monetary policy; from investor allocations to flows; and from bond bubbles and volatility to long-term interest-rate paths, it seems we share a lot more than a love for sushi and pachinko with our neigbours across the ocean as we seem to be chasing after many Japanese models (of asset allocation and macro-economics).

We will have much more to say on the grandiose return of CLOs in the next few days (those who were not in high school during the peak of the credit crisis, so most of today's "traders", recall these peak credit bubble contraptions quite well) but for now we just wanted to bring to our readers' attention that yet another $625 million CLO has just priced, this time from Sankaty, courtesy of Morgan Stanley. Anyone needing confirmation that the credit bubble is back with a bang, need look no further than the table below.  We look forward with amusement once the confused peanut gallery, aka CTRL-C/V majoring "financial media" (where even the somewhat more qualified are about to be "synergized" following news that the FT is pushing hard with a sale), realizes that Sankaty is Bain Capital's $20 billion credit affiliate hedge fund, especially if the election goes for Romney, and goes all aflutter googling what a CLO is and what it means for the flood surge level of liquidity in the market (but, but, Bernanke is printing it all for the children... and housing).