Fail

A core piece of last week's European newsflow was that following much pushback, Angela Merkel, who understands the underlying math all too well, finally dropped her opposition to expanding the European "firewall" in the form of a combined EFSF and ESM rescue mechanisms, to bring the total "firepower" to €800 billion (ignoring for a moment that when the true dry powder of the combined vehicle is just about €500 billion net as explained here, hardly enough to rescue Spain, let alone Italy). Yet as has been explained here repeatedly, and as Merkel has figured out, this is easily the most symbolic expansion of a rescue facility ever. Because while the ECB's agreement to allow Eurobanks to abuse its €1 trillion discount window for three years (which is what the LTRO is), following the replacement of JC Trichet with a Goldman apparatchik, at least infused the system with $1.3 trillion in new fungible liquidity (and resulted in a stock market performance boost for the ages, one which is now unwinding), the 'firewall" does not represent new money, nor is a "firewall" to begin with - it is merely one massive contingent liability which will remain unfunded in perpetuity. Slowly the German media is waking up, and in an article in Der Spiegel, the authors observe that "Even a 1-Trillion Euro Firewall wouldn't be enough." And they are correct, because the size of the firewall is completely irrelevant, as explained later. All the "firewall" does is shift even more backstop responsibility on the only true AAA-country left in the Eurozone, Germany. However, the main cause of problems in Europe - a massive debt overhang which can at best be rolled over but never paid down due to the increasingly lower cash flow generation of Europe's (and America's) assets, still remains, and will do so until the debt is finally written down. However, it can't because one bank's liability is another bank's asset. And so we go back to square one, which is that the system is caught in the biggest Catch 22, as we explained back in 2009. We are glad to see that slowly but surely this damning conclusion is finally being understood by most.

BANZAI7 WARNING: BEVERAGES, INCLUDING STARBUGS, ARE NOT RECOMMENDED NEAR THIS POST

In the not quite 100 years since the founding of your institution, America has exchanged central banking for a kind of central planning and the gold standard for what I will call the Ph.D. standard. I regret the changes and will propose reforms, or, I suppose, re-reforms, as my program is very much in accord with that of the founders of this institution. Have you ever read the Federal Reserve Act? The authorizing legislation projected a body “to provide for the establishment of the Federal Reserve banks, to furnish an elastic currency, to afford means of rediscounting commercial paper and to establish a more effective supervision of banking in the United States, and for other purposes.” By now can we identify the operative phrase? Of course: “for other purposes.” As you prepare to mark the Fed’s centenary, may I urge you to reflect on just how far you have wandered from the intentions of the founders? The institution they envisioned would operate passively, through the discount window. It would not create credit but rather liquefy the existing stock of credit by turning good-quality commercial bills into cash— temporarily. This it would do according to the demands of the seasons and the cycle. The Fed would respond to the community, not try to anticipate or lead it. It would not override the price mechanism— as today’s Fed seems to do at every available opportunity—but yield to it.

Gold has been trading in a tight box around $1,660/oz today, as eurozone finance ministers meet in Copenhagen to discuss the scale of the permanent “bailout fund” set for July. Gold has been stuck in range of roughly $1,630/oz to $1,700/oz in recent weeks as risk appetite has returned after the latest European debt “solution” which saw the battered can kicked down the shortening road once again. Nothing has been solved with regard to the European debt crisis, and debt crises in Japan, the UK and the US now loom. The misguided panacea of heaping debt upon debt and shifting debt onto government balance sheets, debt monetisation and currency debasement is leading to continuing currency devaluations internationally. Despite this or maybe because of this - risk appetite returned with a vengeance as evidenced in equities internationally rising to multi-month and multi-year highs and the slight weakness in gold in March. So far in 2012, gold has performed well and is set to end the first quarter in 2012 with gains in all major currencies. Gold is 6.3% higher in US dollars, 3.2% higher in euros, 3.1% higher in pounds, 2.25% higher in Swiss francs and 12% higher in Japanese yen which fell sharply in the quarter.

 The ponzi will fail, and the economy will reset - the only question is when.

Austerity hasn’t worked for countries.  So far the austerity path has made situations worse, rather than better.  Without stimulus, economies have seen their problems compound.  So now virtually everyone is against the idea that austerity is helpful. That takes us back to spending.   Maybe it’s just me, but spending is what got us into this mess in the first place.  If spending worked so well and was so easy we wouldn’t have a sovereign debt crisis in the first place.  Virtually every country was spending, yet deficits grew and economies shrank.  Why is there any faith that spending now will work?  Are we so good at targeting specific things that will really, truly, work?  Not a chance.  Spending will ensure debt grows just as fast, make the problem even bigger in the end, but will make people slightly happier in the near term. So if austerity doesn’t work, and spending hasn’t worked, what will? PSI, or Default, or Restructuring.

For every semi-positive data point the bulls have emphasized since the market rally began, there's a counter-point that makes us question what all the fuss is about. The bulls will cite expanding US GDP in late 2011, while the bears can cite US food stamp participation reaching an all-time record of 46,514,238 in December 2011, up 227,922 participantsfrom the month before, and up 6% year-over-year. The bulls can praise February's 15.7% year-over-year increase in US auto sales, while the bears can cite Europe's 9.7% year-over-year decrease in auto sales, led by a 20.2% slump in France. The bulls can exclaim somewhat firmer housing starts in February (as if the US needs more new houses), while the bears can cite the unexpected 100bp drop in the March consumer confidence index five consecutive months of manufacturing contraction in China, and more recently, a 0.9% drop in US February existing home sales. Give us a half-baked bullish indicator and we can provide at least two bearish indicators of equal or greater significance. It has become fairly evident over the past several months that most new jobs created in the US tend to be low-paying, while the jobs lost are generally higher-paying. This seems to be confirmed by the monthly US Treasury Tax Receipts, which are lower so far this year despite the seeming improvement in unemployment. Take February 2012, for example, where the Treasury reported $103.4 billion in tax receipts, versus $110.6 billion in February 2011. BLS had unemployment running at 9% in February 2011, versus 8.3% in February 2012. Barring some major tax break we've missed, the only way these numbers balance out is if the new jobs created produce less income to tax, because they're lower paying, OR, if the unemployment numbers are wrong. The bulls won't dwell on these details, but they cannot be ignored.

Following the May 2010 flash crash, the investing public hoped that as part of its "exhaustive report", the SEC would find and hold responsible the various components of a broken market structure, be it HFTs, ETFs, stubbing and sub-pennying algorithms, and all the other knowns and unknowns we have covered over the years. Instead, in what would prove to be a move of cataclysmic stupidity (if sadly understandable - the SEC, like everyone else "in charge" is used to dealing with a gullible and simplistic public, which has no access to the real data and analysis, and whose opinion could be easily manipulated, at least until now), the regulator blamed and scapegoated it all on a Waddell and Reed trade (we wonder just what the quid pro quo was to get the asset manager to roll over and take the blame despite protestations to the contrary, at least in the beginning). The result was that the same investing public realized that market structure is so corrupt, and so robotically mutated, there is no place for the small investor in this broken market. Last week's BATS IPO fiasco merely confirmed this. And as usual, BATS (whose chairman Ratterman has just been demoted even as he stays on as CEO) decided to take the "passive voice" approach and blame it all on a faceless, emotionless, motiveless "software glitch". Just like that perfectly innocuous BSOD we have all grown to love and expect any minute. Only it wasn't. To get to the bottom of what really happened, in a world in which the SEC is far more interested in finding the latest discount internet porn stream than actually protecting the small investor, we relied on our friends from Nanex, who have time and again proven to have a far better grasp of what it is that really happens in the market than virtually anyone else. And if Nanex' interpretation of events is correct (spoiler alert - it was not a "software glitch") it takes SkyNet wars from the silver screen and to a trading terminal near you. What happened is that a malicious, 100% intentional Nasdaq algorithm purposefully brought BATS stock to a price of 0.00 within 900 millisecond of the company's break for trading! This is open SkyNet warfare.

Although not quite there yet, it will soon be time to go shopping...

While the previous two lectures have had a clear message - Central Banks good, Gold Standard bad, Stability Only Through Central Planning - today's lecture, while unequivocally net positive for the staggering power of the Fed to do what it wants, was less focused. With only one use of the words 'CDO' and 'Save'-the-world, Bernanke focused on the threat of Depression (14 times) and the world-ending 'M.A.D.-bringing' event that would have been the end of AIG (29 times!). With the word mortgage dominant (75 times) and 'Fail' bandied around 33 times, it is clear where Bernanke sees the blame and how the saving of AIG truly was a Flash Gordon moment. Nowhere is this bias better indicated than the 9 uses of the 'People' compared to the 104 uses of the word 'Bank' and should you feel that this was a 'save' by the Fed, the word 'Rescue' does not appear once during the 11,431 word diatribe.

The Fed is clearly worried about the economy. Ben Bernanke's latest speeches aren't exactly inspiring. It is as if he thinks the rosy(ier) numbers are some prank being played upon him by the gods; that soon this will all be taken away. He is right. He admits he doesn't understand why the economy is the way it is. Reality doesn't fit his theory. ("It's supposed to work, dammit!") So, what do you do when you are the head of the world's biggest printing press, and don't know what else to do? Why QE3 of course.

Every quarter the Office of the Currency Comptroller releases its report on Bank Derivative Activities, and every quarter we find that the Too Big To Fail get Too Bigger To Fail. To wit: in Q4 2011, of the total $230.8 trillion in US outstanding derivatives, the Top 5 banks (JPM, BofA, Morgan Stanley, Goldman and HSBC) accounted for 95.7% of all Derivatives. In some respects this is good news: in Q2, the Top 5 banks held 95.9% of the $250 trillion in derivatives. Unfortunately it is also bad news, because $220 trillion is more than enough for the world to collapse in a daisy chained failure of bilateral netting (which not even all the central banks in the world can offset). What is the worst news, is that the just released report indicates that in addition to everything else, we have now hit peak delusion, as banks now report to the OCC that a record high 92.2% of gross credit exposure is "bilaterally netted." While we won't spend much time on this issue now, it is safe to say that bilateral netting is the biggest lie in modern finance (read How US Banks Are Lying About Their European Exposure; Or How Bilateral Netting Ends With A Bang, Not A Whimper for an explanation of this fraud which was exposed completely in the AIG collapse). And just to put this in global perspective, according to the BIS in the first half of 2011, global derivative gross exposure increased by $107 trillion to a record $707 trillion. It will be quite interesting to get the full year report to see if this acceleration in gross exposure has increased. Because if it has, we will now know that in 2011 European banks were forced up to load up on several hundred trillion in mostly interest rate swap exposure. Which can only mean one thing: when and if central banks lose control of government bond curves, an rates start moving wider again, the global margin call will be unprecedented. Until then we can just delude ourselves that central planners have everything under control, have everything under control, have everything under control.

The enigma that is eccentricity can be unravelled by grasping of this single statement; that which you perceive is both a matter of the object of your perception (in this case; the eccentric person) and your apparatus of perception. Eccentricity, then, is as much a quirk of the popular mind as it is of a particular person. So with the assumption that you seek creativeness and intrigue — here’s how to think eccentrically, find your edge and risk little for lots.

Yesterday afternoon, Barack Obama who is currently in South Korea, briefly was within bullet range (if behind bulletproof glass) of North Korea when he stood on the edge of the DMZ separating the two feuding countries. A few minutes later he left and told the world that "Bad behaviour will not be rewarded" referring to the imminent launch of North Korea's Unha-3 rocket scheduled for a test launch in April. He added that "I will also note that every time North Korea has violated an international resolution, the Security Council resolution, it has resulted in further isolation, tightening of sanctions, stronger enforcement. I suspect that will happen this time as well." Alas, we doubt that Obama's warnings will have much of an impact and that in a few weeks NK will go ahead and hit the launch button undeterred, in the process forcing Japan to scramble its Aegis destroyers and take other countermeasures as discussed last week, in case the missile "veers of course." But just what is the trajectory? Courtesy of North Korea Tech, we now know the secret path the North Korean rocket is expected to take. All we can say is there better not be strong Westerly winds.

Last week, Bernanke's first (of four) lecture at George Washington University was entirely dedicated to attempting to discredit gold and all that sound money stands for. The propaganda machine was so transparent that it hardly merited a response: those away from the MSM know the truth (which, simply said, is the "creation" of over $100 trillion in derivatives in just the first six months of 2011 to a record $707 trillion - how does one spell stability?), while those who rely on mainstream media for the news would never see an alternative perspective - financial firms are not among the top three sources of advertising dollars for legacy media for nothing. Still, for those who feel like the Chairman's word need to be challenged, the following extensive and annotated reply by QBAMCO's Paul Brodsky makes a mockery of the Fed's full on assault on gold, and any attempts by the subservient media to defend it. To wit: "Has anyone asked why so many powerful people are going out of their way to discredit an inert rock? We think it comes down to maintaining power and control over commercial economies. After professionally watching Fed chairmen cajole, threaten, persuade and manage sentiment in the markets since 1982, we argue this latest permutation is understandable, predictable and, for those willing to bet on the Fed’s ultimate success in saving the banking system (as we are), quite exciting.... Gold is no longer being ignored and gold holders are no longer being laughed at. “The Powers That Be” seem to have begun a campaign to discredit gold."