Credit Crisis

Hedge Fund "gating", or the forced administrative limit on how much money hedge fund investors can redeem at any given moment, is one of those bad memories that most wish could remain dead and buried with the peak of the credit crisis, when virtually every hedge fund was swamped with redemption requests as impatient LPs couldn't wait to get what was left of their money back. However, the problem for hedge funds, in addition to underperforming the market substantially for a 5th year in a row, with almost all hedge funds now returning far less than the broader market (which continues to successfully defend the 1400 barrier every day) especially after October when the two biggest hedge fund darling stocks GOOG and AAPL finally reincountered gravity, is that their LPs have once again gotten restless and are now again actively seeking their money back from underperformers. Sadly, it was thus only a matter of time before the "gates" returned. As of this weekend they have.

A cyber attack does not have to be limited to a single country and its networks.  It could be used to strike multiple countries and fuel a global firestorm of systems failures.  Globalists need a macro-crisis, a world-wide catastrophe, in order to present their “global solution” to the desperate masses. This solution will invariably include more dominance for them, and less freedom for us.  A global crisis can also be used to manipulate various cultures to forget concerns of sovereignty and think in terms of one-world action.  Surely, a worldwide breakdown can only be solved if we “all work together and all think alike”, right...? Without a doubt, a cyber attack serves the interests of elitist entities and banking monstrosities like nothing else in existence.  Set off a nuke, start WWIII, turn the U.S. dollar into stagflationary dust; a cyber attack tops them all, because a cyber attack can lead to them all while maintaining deniability for the establishment.  The fact that whispers of cyber threats have turned into bullhorn blasted propaganda should concern us all.  Are we being conditioned for a cyber event in the near future?  That remains to be seen.  However, none of us should be surprised if one does occur, especially in light of the many gains involved for globalists, and all of us should be ready to dismantle and expose any lies surrounding the event before the American public is whipped into a 9/11 style frenzy yet again

"The recovery continues but it has weakened" is how the IMF sums up their 250-page compendium of rather sullen reading for most hope-and-dreamers. The esteemed establishment led by the tall, dark, and handsome know-nothing Lagarde (as evidenced by her stroppiness after being asked a question she didn't like in the Eurogroup PR) has cut global growth expectations for advanced economics from 2.0% to only 1.5%. Quite sadly, they see two forces pulling growth down in advanced economies: fiscal consolidation and a still-weak financial system; and only one main force pulling growth up is accommodative monetary policy. Central banks continue not only to maintain very low policy rates, but also to experiment with programs aimed at decreasing rates in particular markets, at helping particular categories of borrowers, or at helping financial intermediation in general. A general feeling of uncertainty weighs on global sentiment. Of note: the IMF finds that "Risks for a Serious Global Slowdown Are Alarmingly High...The probability of global growth falling below 2 percent in 2013––which would be consistent with recession in advanced economies and a serious slowdown in emerging market and developing economies––has risen to about 17 percent, up from about 4 percent in April 2012 and 10 percent (for the one-year-ahead forecast) during the very uncertain setting of the September 2011 WEO. For 2013, the GPM estimates suggest that recession probabilities are about 15 percent in the United States, above 25 percent in Japan, and above 80 percent in the euro area." And yet probably the most defining line of the entire report (that we have found so far) is the following: "Central bank capital is, in many ways, an arbitrary number." And there you have it, straight from the IMF.

Modern Portfolio Theory (MPT) is broken. That is how we interpret Niels Jensen's (Absolute Return Partners) latest missive as he draws a concerning line between the number of managers who rely sheep-like on the diversifying 'artifacts' of MPT in a new normal world of undiversifiable systemic risks. The shifts in intra- and inter-asset class correlations (both long- and short-term) have been incredible both in terms of direction change and magnitude - for example (as Nielsen notes) - In the 2000-03 bear market commodities were an excellent diversifier against equity market risk with the two asset classes being virtually uncorrelated (+0.05). Nowadays, the two are highly correlated (+0.69). This shift to a risk-on / risk-off world, fed by central bankers, makes the empirical Sharpe ratios of olde and track records of your favorite balanced-fund manager entirely useless for any investor seeking protection from not just volatility risk but ultimate risk - the permanent loss of capital.

We have in the past attempted to take on the gargantuan task of exposing the multi-trillion Chinese Shadow Banking system (not to be confused with its deposit-free, rehypothecation-full Western equivalent), most recently here. Alas, it is has consistently proven to be virtually impossible to coherently explain something as decentralized and as pervasive as an entire country's underground economy, especially when the country in question is the riddle, wrapped in a mystery, inside an enigma known as China. Today, however, courtesy of AsiaFinanceNews we get a report as close as possible to the most comprehensive overview of what may soon be (especially if rumors of tumbling Chinese municipal dominoes are correct) the most talked about subject in the financial world: China's Shadow Banking empire.

• Europe’s crisis will be followed by a more devastating one, likely beginning in Japan. (Simon Johnson)
• Porsche, Daimler Indicate Europe’s Car Crisis Spreading (Bloomberg)
• No progress in Catalonia-Madrid talks (FT)
• Hilsenrath speaks: Fed's Kocherlakota Shifts on Unemployment (WSJ) - luckily QEternity made both obsolete
• Lenders Reportedly Consider New Greek Haircut (Spiegel)
• Fed Officials Highlight Benefits of Bond-Buying (WSJ)
• ESM to Launch without Leverage Vehicle Options (WSJ)
• Japanese companies report China delays (FT)
• Borg Says Swedish Taxes Can’t Go Into Ill-Managed European Banks (Bloomberg)
• Greek Leaders Struggle With Spending Reductions (Bloomberg)
• Asian Stocks Rise as iPhone 5 Debut Boosts Tech Shares (Bloomberg)
• China government's hand seen in anti-Japan protests (LA Times)

• Obama, Romney tiptoe around housing morass as they woo voters (Reuters) ... just as ZH expected
• Poll Finds Obama in Better Shape Than Any Nominee Since Clinton (Bloomberg)
• Romney on Offense, Says Obama Can’t Help Middle Class (Bloomberg)
• Fed’s Fisher Says U.S. Inflation Expectations Rising (Bloomberg)
• Citigroup Warns Irish Investors to Plan for Losses (Bloomberg)
• Central Banks Flex Muscles (WSJ)
• China says U.S. auto trade complaint driven by election race (Reuters)
• Brussels sidesteps China trade dispute (FT)
• How misstep over trading fractions wounded ICAP's EBS (Reuters)
• Ex-CME programmer pleads guilty to trade secret theft (Reuters)
• Income squeeze will persist, says BoE (FT)
• South African miners return to work, unrest rumbles on (Reuters)

• Deposit Flight From Europe Banks Eroding Common Currency (Bloomberg)
• BOJ eases monetary policy as global slowdown bites (Reuters)
• Stalled Rally Puts Pressure on Spain (WSJ)
• Missed Chances Stoke Skepticism Over EU’s Crisis Fight (Bloomberg)
• Germany's big worry: China, not Greece (Reuters)
• Goldman names new CFO, heralding end of an era (Reuters)
• Russia Demands U.S. Agency Halt Work (WSJ)
• Fed’s Dudley Says Easing Vital to Spur Too-Slow Growth (Bloomberg)
• Romney under fire from all sides (FT)
• Poland cuts red tape to spur growth (FT)
• IMF to Put Argentina on Path to Censure Over Inflation Data (Bloomberg)

Since 2007 our analysis has suggested the likelihood of economic outcomes that most have considered unlikely: significant and ongoing monetary inflation, policy-administered currency devaluation, substantial global price inflation, and an eventual change in how the forty year old global monetary system is structured. Most observers have viewed such outlooks as tail events – highly unlikely, unworthy of serious consideration or a long way off. We remain resolute, and believe last week’s movements in Frankfurt and Washington towards perpetual quantitative easing confirmed and accelerated the validity of our outlook. With QBAMCO's view that $15,000 - $19,000 Gold is possible, timing of the catch-up phase is impossible - though they suspect last week's events may be the catalyst that begins to raise public awareness of the link between monetary inflation and price inflation.

Global financial markets are awash in hundreds of trillions of dollars worth of derivatives. By some estimates, the total amount exceeds one quadrillion. Derivatives played a central role in the 2008 credit crisis, as they had a brutal multiplying effect on the magnitude of the carnage. As a bad asset was written down, oftentimes there were derivative contracts written against it that resulted in total losses 10x greater than the initial write-down. But what exactly are derivatives? How do they work? And have we learned to treat these "weapons of mass financial destruction" (as Warren Buffet colorfully coined them) any more carefully in the aftermath of the global financial crisis? Not really, claims Janet Tavakoli, the danger behind derivatives doesn't lie in their existence, she stresses, but when abused, derivatives can create massive damages. So at the root of the "derivatives problem" is control fraud - the rampant unchecked criminal action by influential players on Wall Street.

"If you’re rich you get a bailout. If you’re poor you get a handout. And if you’re middle class you get left out." That's not a sustainable way to run the system, exclaims investment strategist Keith Fitz-Gerald. A cancer at the core of our current economy is the magical thinking, "no pain, all gain" philosophy, pursued by those running it. They are doing all they can to remove the consequences of failure from the system -- blind to failure's essential 'waste-clearing' function in a healthy free market. Without the discipline of Darwinism, the individual actors in the system make all sorts of malinvestments that would never make sense in an efficient marketplace. But since the losses from these inane pursuits are socialized, there's no incentive to stop making them. At least, up until the point where the class whose back is burdened with paying for the socialized messes finally breaks.

If you still require proof that in the short term, market action is driven by perceptions and sentiment rather than reality, here it is. It is worth quoting again what Mrs. Merkel said in Ottawa in toto:

“The European Central Bank, although it is of course independent, is completely in line with what we’ve said all along. And the results of the meeting of the central bank and their decisions, actually shows that the European Central Bank is counting on political action in the form of conditionality as the precondition for a positive development of the Euro.”

Does this sound like 'unlimited bond buying without preconditions' to anyone? No? Investors seemed to think that is what it meant. We see no painless way out for Spain, regardless of what ultimately happens. Even if the ECB were to act without conditionality or limits, it could not possibly alter the underlying solvency problems -  and this isn't going to happen anyway. So what are markets currently pricing in? Everybody seems quite certain of a happy end at the moment. The bet is that massive central bank intervention is heading our way in the near future and will boost asset prices further. This is a mindset that has very likely set up the markets for disappointment.

Russia and the southeast Asian countries are analogs for Greece, Spain, and Cyprus, with no particular association between their references within the timeline.  The timeline runs through the Russian pain; things begin to turn around after the timeline ends. This is meant to serve as a reference point: In retrospect it was clear throughout the late-90s that Russia would default on its debt and spark financial pandemonium, yet there were cheers at many of the fake-out "solution" pivot points.  The Russian issues were structural and therefore immune to halfhearted solutions--the Euro Crisis is no different.  This timeline analog serves as a guide to illustrate to what extent world leaders can delay the inevitable and just how significant "black swan event" probabilities are in times of structural crisis.  It seems that the next step in the unfolding Euro Crisis is for sovereigns to begin to default on their loan payments.  To that effect, Greece must pay its next round of bond redemptions on August 20, and over the weekend the IMF stated that they are suspending Greece's future aid tranches due to lack of reform.  August 20 might be the most important day of the entire summer and very well could turn into the credit event that breaks the camel's back.

There is a strange delayed reaction between the initial exposure of weakness in the financial system and the public’s realization of the truth, sort of like Wile E. Coyote dashing off a cliff in the cartoons only to continue running in mid-air above the abyss below.  It is a testament to the fact that beyond the math, there is an undeniable power of psychology in our economy.  The investment world naively believes it can fly, even with the weight of endless debt around its ankles, and for a very short time, that pure delirious oblivious belief sustains the markets.  Eventually, though, gravity always triumphs over fantasy…

Merkel and Weidermann’s points here are crucial. There is no way that either can OK giving German funds (ultimately Germany is the real backstop for the EFSF and ESM) without conditions. Why should Germany risk its AAA status to prop up countries that have proven to be unwilling to implement any meaningful reforms and whom actually lie openly to Germany’s face time and again?