Europe End Game

So the EU has taken the first steps towards fiscal union. Economists, ever ignorant of actual history, are repeating a mantra that currency unions and fiscal unions must go together and if they don’t a currency union is doomed. So the stock markets are happy and the can has apparently been kicked again.

To a degree, this can kicking is significant. As long as the periphery countries engage in actual serious austerity, then it is highly likely that the ECB will monetize bonds right around significant rollover dates and actual default of the insolvent can be pushed back. And since this perma-austerity means that Europe is now going to head into a deep recession/depression, it is likely that the price manifestations of monetary inflation won’t appear. Why stock markets think this is good news is baffling. It is good news for debt markets and for the euro currency (short-term) — but not for equities.

What this can kicking does do is really change the politics. Greece is now basically irrelevant. They will agree on some default – when default is deemed to be non-contagious. Greek bonds are probably a good speculation here. They are already pricing in a large default – and the profit would arise from this taking a bit longer than people think. Once they default, Greece is again irrelevant.

Italy is now being run by ECB and Goldman Sachs. The technocrats will wear out their welcome – and, most likely, screw things up. But for now, Italy was weary of bunga-bunga Berlusconi and is glad to be rid of him. Short-term, Italian bond rollovers will be “taken care of” (read monetized to some degree) and very short-term Italian debt (less than two years) may be OK – in small doses. If/when Italy defaults; the Italian equity market is really really cheap already. The only thing it isn’t pricing in is perma-austerity and the nationalization of banks. But still – I’m in wait/watch mode.

France is now the AAA country on the chopping block. If they lose that – via having to nationalize a bank probably – then all bets are off for everything. Avoid French banks via any channel – via French equity indices, French government debt, US money market funds, companies with callable loans, etc. When the ratings agencies do move on this, things may be different. But that is for the future. French elections (April 2012) also play a big short-term role. If Sarkozy is re-elected (35% chance); then things remain the same. If the Socialists are elected (55% chance), then the whole euro negotiation stuff rolls back to square one and, best case, we get to relive Groundhog Day (all the euro can-kicking since May 2010). Worst case, the markets say “enough” – and force the crisis endgame in a disorderly way. If Marine LePen is elected (10% chance); then watch out below because everything will become disorderly fast. IOW – there is no real positive outcome here — so this election uncertainty is likely to weigh on markets until April.

Spain actually looks OK here. They really don’t have much government debt – far less than the US. They do have a serious housing bubble that hasn’t burst yet and that could be a problem for large parts of the economy. But Spain also has very large financing exposure to Latin America and that can really be a positive for many companies (including banks). I kind of like the Spanish equity markets here – if I can avoid the Spanish banks/housing stuff.

Germany is in the catbird seat for now. Or so they think. Everyone else in Europe will have to undergo serious government austerity if they want bailout/fiscal transfers from Germany. And the morons in the US seem willing to bailout the eurozone if the Germans hesitate (which is bad news for the US – but not for Germany). However, Germany has relied on exporting to the rest of the eurozone for its economic health. That is going to disappear with austerity — and fast. German companies that export to the non-eurozone seem to be the best positioned for now. But if the US does bailout the eurozone via the IMF, then the DAX is the place to be. Germany will NOT pull out of the eurozone. At least not first. Any rumors to the contrary are complete and utter BS. It won’t happen – for a host of reasons.

The fiscal union pulls the UK into the political problem. The continent despises the Anglos and the institutions of the eurozone fiscal union seem like they will be the same institutions as the broader institutions of the EU. That presents a real problem for the UK. The eurozone could easily vote for increased taxes on things that mostly affect the UK (eg Tobin tax) and use that to fund their fiscal transfers. If that happens, the UK will have to seriously consider dropping out of the EU — which will in turn ignite trade wars and protectionism a la the 1930’s.

Likewise, the US is now to a lesser degree pulled into the problem via NATO. Eurozone “austerity” means that Euro defense spending will go from anemic to nonexistent. The US already carries NATO on its back anyway but these changes would make it obvious to even the moronic in the US. Unfortunately, “moronic” is what the powers-that-be ASPIRE to in the US – and no one except Ron Paul is talking about ending NATO subsidies or ending an alliance that has ceased to serve any actual function.

In sum, I do suspect that this can-kicking does “work” in the sense that it delays/hides the sovereign debt crisis and removes it from the headlines for awhile. Markets still need to price in a serious deep perma-recession in Europe – but that is a different dynamic. I think volatility is likely to drop a bit going forward. But equity markets will not be rising from here. An ugly slow steady grind-down in the first half of 2012 is the most likely scenario IMO. If the austerity actually works – and Europeans reduce government spending/entitlements and allow for semi-free markets again; then Europe is going to be a far far far better buy at the trough than the US is. We in the US have not even begun to face those problems and our longer-term outlook is currently just as bad as Europe.

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G7 and ECB Intervention

Not a surprise.

The ECB announced on Sunday that they would buy Spanish and Italian and other periphery bonds. The hope being that Asia will help bail out European banks which hold that debt. Kick the can. Kick the can.

The G7 Finance Ministers and Central Bank Governors also met over the weekend and released a statement before the Asia open.

We are committed to addressing the tensions stemming from the current challenges on our fiscal deficits, debt and growth, and welcome the decisive actions taken in the US and Europe. The US has adopted reforms that will deliver substantial deficit reduction over the medium term. In Europe, the Euro area Summit decided on July 21 a comprehensive package to tackle the situation in Greece and other countries facing financial tensions, notably through the flexibilisation of the EFSF. Translation — FU S&P. You are all now criminals with international arrest warrants charged with peeing in the punchbowl.

No change in fundamentals warrants the recent financial tensions faced by Spain and Italy. Translation — WTF do you people think you are? We have told you what to think for decades. And now you are disobeying us?

We welcome the additional policy measures announced by Italy and Spain to strengthen fiscal discipline and underpin the recovery in economic activity and job creation. The Euro Area Leaders have stated clearly that the involvement of the private sector in Greece is an extraordinary measure due to unique circumstances that will not be applied to any other member states of the euro area. Translation — The water is safe for you private investors to buy non-Greek debt. You won’t get screwed. We promise. Scout’s honor.

We reaffirmed our shared interest in a strong and stable international financial system, and our support for market-determined exchange rates. Excess volatility and disorderly movements in exchange rates have adverse implications for economic and financial stability. Translation — We are making plans to centrally-plan currency interventions while uttering soothing words about market-determined exchange rates. When the centrally-planned intervention doesn’t work, we will blame it on the disorderly market since we told you all to behave but you aren’t listening and obeying.

Ugly Ugly

Equity markets worldwide dumped 4-8%. Commodity markets dumped. Junk bonds fell 2-3%. Investment grade and sovereign bonds rose a bit. Gold skyrocketed – and then fell (probably the beginning of margin calls). The TED spread is still low at 26 bps – but rising fast. Given zero interest rates for short-term debt – the risk of a global liquidity crunch or flash crash will rise sharply if it hits 40 bps. Still however a long way from a 2008 level liquidity crunch (100-400 bps). S&P500 VIX is at 31.6 – so now in parabolic panic mode. The swissie and the dollar were the only safe havens today – and both are now in full QE mode to debase themselves.

Technically, markets are still ugly. Oversold but no indication that any tradeable bottom has been reached. The S&P500 just hit “correction” mode today (10% off peak). European markets are in full bear market mode. I really don’t see how the massive numbers of serious problems can just be dismissed/ignored by US equity investors as part of a normal “correction”. More pain is due.

On an intermediate term basis, the technicals are as ugly as I have seen since 2008. On a short-term basis, markets are heavily oversold but zero zero indication of any buyers out there. Given the selling today, any short-term bounce is likely 3+ days away. And the risk of a crash is very high. My guess is that the markets will drop until a new globally coordinated QE to debase fiat money is hinted at. Right now, the most oversold/bearish/negative sentiment sector is industrials. That could change – but if it doesn’t and there is a bounce, that is the one that will likely bounce hardest.

Asia is now dumping. Gold is steady. Rumor is that Italy had bank runs today – so unless the ECB intervenes successfully – tomorrow – the euro experiment will end by next week.

Anyone who is using leverage or who has debt or anything is about to discover how painful that is in a deleveraging deflationary cycle.

We don’t need no steenkin safe haven

Well so much for the swissie and the yen as safe havens. The Swiss National Bank just announced their version of QE in order to halt-reverse the skyrocketing appreciation of the Swiss Franc. The Bank of Japan just announced an intervention to crush the yen. Brazil and Philippines — yeesh – safe havens?!? – just announced their versions of a currency war. Bank of New York just announced that they will charge 13 bps for all large cash deposits. The 3 mo T-bill is now yielding negative interest. Italy is now on the “bailout” list — markets all now shut down — but is too large to bail out. All markets are projectile vomiting – down multiple %.

Gold is up — big — but be very careful buying here. It is a dead bang certainty that CME will raise margins real real soon in order to wash paper longs out. Why the freak don’t they just raise margins to 100% and leave them there. The whole point of gold as an alternative currency is that it is UNLEVERAGED unlike all the other leveraged fast-money speculations out there. And that it therefore does not have to suffer from occasional deleveraging bank-based fiat currencies. Forget about gold mining stocks here — the risks of nationalization and confiscatory taxes worldwide are rising in line with the gold price. Central banks are now panic buying gold — and they will have no problem confiscating gold in the ground if they can’t get gold in the market. These stupid greedy fucks running the world are driving every single fucking economy in the world into a depression. It is time to pry their hands off the levers of power — cold dead hands if necessary.

With all the developed world sovereigns in, basically, various stages of bankruptcy; we could be nearing the Kondratieff winter credit crunch of all credit crunches. Right now, bond vigilantes are only focused on Eurozone – Italy, Spain, etc. But that could change in a nanosecond. All major nation public finances are crap and none are remotely capable of growing out of their debt load. The only thing preventing the emergence of true bond vigilantes – ie investors who are concerned with not only getting paid a reasonable rate of interest but also interested in getting their principal back — is that they have no safe “base” where they can withdraw to if necessary. Currency wars and trade wars are imminent.

Debt Ceiling Assessment

The jokers in DC have, unsurprisingly, managed to ensure that “business as usual” is safe and sound – while pretending to wear the newly fashionable hairshirt of fiscal responsibility. The actual spending cuts (as opposed to crossing items off of Santa’s wish list and calling them “cuts”) in the debt ceiling deal amount to roughly $30 billion. In exchange, the American people now have an additional $2.4 TRILLION worth of perpetual debt on our shoulders. In a year and a half, we will go through this nonsense again. This is a complete fraud. In a just society, the revolution would start now and a lot of people in DC would swing from a rope. It won’t happen. Those who are the most screwed by this deal (the young) are also the ones who have the most recent experience with an education system that is good only at inculcating propaganda about how great things are.

Even Bill Gross – the bailout-loving bond vigilante who has been AWOL for a couple decades – admits it is a fraud in his weekly update – Kings of the Wild Frontier. He does provide useful advice from a bond investors perspective:

He correctly states that there are only four options that the US government has (apart from outright default which won’t ever happen):
1. Balance the budget via growth — Won’t ever happen. The debt load itself now ensures that interest rates which accompany increased growth will strangle that growth and drive deficits deeper.

2. Unexpected inflation — Nice emphasis on unexpected. IOW – TIPS are garbage — as are any and all government stats re inflation. They will lie to the bitter end about what inflation actually is.

3. Currency depreciation — I disagree with Gross here. There is only a small and dwindling group of currencies against which the US$ can really depreciate. Solid, fiscally responsible nations that issue a fiat currency. None — NONE — of them are remotely large enough to take the necessary appreciation hit. And for all the world’s bitching and moaning about the dollar as a reserve currency, not one country has ever remotely considered taking the necessary penalty (gutting one’s manufacturing/export/surplus sector in order to become consumption/demand/deficit of last resort for the world) required to have the “privilege” of being the reserve currency. At best, the “fiscally responsible” are merely the last lemming rushing toward the cliff.

4. Financial repression — Gross only mentions negative real interest rates. He is correct that this is permanent. And this is the real tailwind that will drive gold and monetizable backwardated commodities higher (in purchasing power terms – not necessarily nominal terms). When gold yields zero – and Treasuries also yield zero; it is a no-brainer as to where one should put their money. That said — Gross is missing literally thousands of other means of financial repression and thievery. Most of which are now certain to be tried.

It is critical however to understand how DEFLATIONARY these sovereign debt defaults/jitters are. Monetizable commodities will do OK — but understand the difference between a monetizable commodity and a regular commodity.

AAA Credit

What the US debt kerfuffle is revealing is an interesting end game re true AAA debt. Even if the US successfully kicks this current can down the road, US sovereign debt can no longer be considered truly AAA safe. Which raises a serious problem for the global credit markets. If US Treasuries aren’t AAA, what bond issuer on Earth IS? And what will happen to such AAA bonds if/when the US gets formally downgraded?

As to the first question, the list is teeny. The universe can only be sovereign bonds of sovereigns who have very comfortable total debt limits and who are also comfortable with their currency skyrocketing in value relative to other fiat currency issuers who may debase their currency in order to pay off debt. And companies that are both financially strong enough to merit a AAA and are also global enough to avoid getting hammered by confiscatory taxes in those countries that may confiscate their way to a balanced budget or debt reduction. Among the sovereign issuers — Australia, Denmark, Finland, Luxembourg, Norway, Sweden, and Switzerland. Followed at the true AA+ level by Netherlands, Austria, and perhaps Canada and Germany. Chile would be AAA as well except that it has no government debt. Among corporate issuers — Johnson and Johnson and KfW (a German bank). That’s it.

AAA rated bonds — accurately rated AAA — are the core of global credit markets and credit creation. Anyone who is issuing credit to anyone needs some “riskless” asset against which they can measure/rate the risks of the credit to someone riskier. Riskless bonds also serve as the collateral/reserve for, literally, the entire global economy. The countries I’ve listed above are teeny. The US’ current AAA rating – along with the UK and the core Eurozone – have provided that credit foundation for the growth in the global economy for decades. If those sovereign bonds become less than AAA, then “globalization” itself loses its foundation.

That’s the real deflation we face. Global trade/finance becomes much riskier because it is based on less-than-AAA credit. The bubbles, crashes, panics, liquidity injections (resulting in commodity inflation), etc are merely the manifestation of that riskiness. If global trade/finance instead becomes based on a smaller pool of true AAA credit (countries above plus AU), then it will shrink dramatically. And until time passes and large economies can delever and become truly AAA again; then nothing CAN fundamentally change. It is why this sort of deflationary “cycle” can last so long – think decades.

What will happen? Globally, those AAA credits (and gold – as an asset with no liability risk attached) will rise in value. They are the “last man standing” – under any and all investable scenarios and so will attract whatever credit needs a riskless foundation. The only true “sleep at night” credit. Their value is NOT going to be merely the “price” or the “income yield” of the asset. Rather, their value is that they are the only source of riskless credit/leverage. That value will not be apparent most of the time – but when it does become apparent it will become glaringly apparent. To the degree that that pool of AAA credit is simply too small to support a global economy, then investment will overflow to riskier credit – but that will be erratic and depend on news flow and such.

For more details – read Nicolai Kondratieff, Joseph Schumpeter, Irving Fisher, Hyman Minski, Melchior Palyi, Antal Fekete. This is not mainstream economics. Then again, mainstream economics has been a colossal screw up for a few years — and everyone knows it.

On edit: After close of business today, the Chicago Mercantile Exchange issued a new set of guidelines re margin collateral. Short-term Treasuries will from now on get a “haircut” (0.5%) when used as collateral. This haircut will get larger over time. Which will in turn reduce the amount of leverage that is possible and the amount of credit that is made available. It will affect margin credit, bank credit, derivatives credit, trade finance credit, everything. This particular move is small but the direction and future moves are inevitable.

Europe is unraveling

fast and overnight it seems. This could get really ugly if bank runs start. Banks do not have to reserve their holdings of sovereign debt. One of the globalizing regulations put in by the Davos crowd over the last two decades. Akin to mandating that all AAA-rated collateralized mortgage debt be considered top-tier capital – which caused the 2008 crisis to be a global one. Do these clowns force Mr Magoo to write all their regulations or is Mr Magoo just the brightest mind in the room when they write them?

The euro dropped and dollar rose by 0.7% in a whoosh after Christine LaGarde new head of the IMF didn’t rule out anything re Greece and said “the IMF is not a cash machine”. Equity markets will drop the same %. Most commodities will drop more. Short-selling will likely be banned again soon – not that that is a wise thing to do. Get liquid – not leveraged.

I do think I know why the market rose in the tail end of June. That’s when the Fed and central banks started pumping more liquidity into the system. Gave their buddies and pals a two-week heads up to clear out positions before the SHTF and before they have to head off to the Hamptons and St Tropez for August.

One advantage of being a minnow. It doesn’t take as long to clear out positions

Sep 1, 2010

Markets rose a lot (all pretty much the same % depending on their beta) on moderate volume. Mostly within a five minute period right after the ISM report so the day was clearly news-driven. And we are now right below minor resistance.

Short-term: 3 green, 1 yellow – support here is stronger than I thought. bounce very likely
Intermediate-term: 1 green, 3 yellow – again, there is stronger support here than I thought
Stock targets: 38% swimming, 14% neutral, 48% sinking – still deteriorating but that’s not a surprise. This can lag a bit.

Watch carefully the next few days. If there is follow-thru buying, then it is possible the market has double-bounced off the July low and things could be OK. Still smells to me until next week.

ISM Report — drove the market up before it could even be read. So it was the headline that drove the market. Again that smells. Different interpretations of it
Bearish interpretation (from a bearish interpreter)
Actual report
Another interpretation
Financial mass media (WSJ) story

Overall, seems to me the economic report on the state of manufacturing was better than expected — but it says nothing about the future. Healthy markets just don’t pay that much attention to economic data because economic data is always about the past – the already known. Being surprised by the past is – well – silly. What this report does help explain is why the market has been diverging – and will likely continue. Some Main Street businesses are doing OK – and that may well continue. And those are precisely the sort of stocks that can probably be nibbled on any broader pullback here at these levels. But they ain’t gonna lift the whole boat.

Rev the Engines Helicopter Ben

The market was completely run today by the reaction to Ben Bernanke’s speech at Jackson Hole. No surprise since “the market” is now a completely rigged game run by computers. But this does provide a reason to go into the speech and the reaction in more detail.

First the market’s reaction. Everything went up by virtually identical %. Hardly the sign of any times-of-yore parsing of sentences about winners and losers. Everyone and everything will apparently win. More accurately, those who run the markets and own the country using leverage were reassured today that the Fed has their back and will not allow any change and will pump in whatever liquidity is needed. So the few remaining shorts covered (see chart) – and the market then slowly drifted up as sellers disappeared. Don’t fight the Fed. However, the bounce today did not even get any end-of-day volume. There are no buyers sitting on the sidelines here. The trend will remain down.

The speech itself:
1. The Fed could not point to a single specific part of the private sector that has a good chance of picking up the rest of the economy or being the next bubble. Which probably means there isn’t one — and the economy is in for at least one more year of recession or no growth. In that environment, the only things worth owning are a)things which provide income or b)things which aren’t in the US or c)things which are in bottleneck/shortage. And the latter are really rare (and don’t include equities of companies who issue options – even if they do sell something in bottleneck).

2. If the Fed is forced to fight deflation by monetizing debt, it will only be doing so at lower levels because currently the risks of doing that are perceived as outweighing the benefits. IOW – what the Fed actually did was guarantee an upside for T-bonds – not an upside for stocks or the economy. Therefore if cash/liquidity is needed before the economy turns around, the only options are a)cash in the mattress or b)T-bills/bonds.

3. If the Fed fails in fighting that deflation by monetizing debt, the result will be hyperinflation. Not inflation. Hyperinflation – the destruction of a currency by destroying its ability to function as a medium of exchange. In that event, the only things to own are a)food/staples; b)physical energy source (maybe); c)possession of shelter; d)a black market medium of exchange; and e)a black market means of ensuring that you retain possession of the previous four. All else will be worthless. Odds of this are still low – but not negligible. Be prepared for it – and hope it doesn’t happen is the best advice.

4. If an actual economic recovery happens; then the problem the Fed will face is how to withdraw liquidity. This would be the problem that the US faced in the 1970’s (stagflation). But this time round, the “solution” is much easier — ANY increase in interest rates will immediately kill the housing market and thus choke any economic recovery. The result is that there will be no economic growth – no “potential bottlenecks/shortages if the economy rebounds a bit”. Other countries – particularly emerging markets – may face this scenario – but not the US/Europe/Japan.

History Geek Time

OK. I like history and charts/numbers — and sometimes the two show something quite interesting.

Here is the — inflation-adjusted, total return (price + reinvested dividends) chart overlay for two time periods — post-1929 and post-2000

The same chart without an inflation adjustment

One of the saddest lessons of history is this: If we’ve been bamboozled long enough, we tend to reject any evidence of the bamboozle. We’re no longer interested in finding out the truth. The bamboozle has captured us. It is simply too painful to acknowledge — even to ourselves — that we’ve been so credulous. So the old bamboozles tend to persist as the new bamboozles rise. — Carl Sagan

There is no question that inflation is one of the best bamboozles. It was Keynes who observed —
Lenin is said to have declared that the best way to destroy the capitalist system was to debauch the currency. By a continuing process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens. By this method they not only confiscate, but they confiscate arbitrarily; and, while the process impoverishes many, it actually enriches some. The sight of this arbitrary rearrangement of riches strikes not only at security, but at confidence in the equity of the existing distribution of wealth. Those to whom the system brings windfalls, beyond their deserts and even beyond their expectations or desires, become ‘profiteers,’ who are the object of the hatred of the bourgeoisie, whom the inflationism has impoverished, not less than of the proletariat. As the inflation proceeds and the real value of the currency fluctuates wildly from month to month, all permanent relations between debtors and creditors, which form the ultimate foundation of capitalism, become so utterly disordered as to be almost meaningless; and the process of wealth-getting degenerates into a gamble and a lottery.
Lenin was certainly right. There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose.

And, surely, the entire “inflation-adjusting” process is one that can conceal/distort as much as it reveals. But even using government-created inflation data, what is revealed is the massive deterioration of our economy and the transfers (via inflation) of wealth that have occurred since the stock market bubbletop of 2000. Not 2008. 2000. Ten years. And even at this point, Keynes is probably right that only 300 people in the US actually understand what is happening to them. For the rest, merely an inchoate anger that something is badly wrong

Where Keynes is clearly either wrong or evil is that our government has been following totally Keynesian policies during that entire time. Monetary policy was for all practical purpose near-zero for most of the time. Bush and Republican Congresses spent money like drunken sailors trying to goose the economy. And Bush/Obama and Democrat congresses have spent money like drunken sailors trying to goose the economy. And we are still now in just as bad shape in real terms as we were in the Great Depression. None of it has fixed the problem. Nor has any real honest serious open public discussion of the problem even occurred yet. Just like Japan, we have already had a lost decade. We just haven’t known it.

That is the real “value” of inflation to those who benefit from it. It – combined with a bit of social welfare around the edges to dull the senses of those who should be angry as hell and a lot of divide-and-conquer to ensure that no real agenda/discussion is allowed – is more effective than opium. A population that should, IMO, be hanging the bastards from the trees by now is instead generally simply continuing to play our acceptable role in the divide-and-conquer game. Pretending that if we elect a slightly different group of bastards that the game will change in our favor. And once that no longer works, then presumably a war will be started so that we can be riled up to go out and smote some them. Divide-and-conquer on a grander scale. That is ultimately what worked in the 1929-1945 timeframe. Pearl Harbor. We did not “solve” the underlying problems then. We just floundered until a war presented the right circumstances/conditions for the problem to be coincidentally solved.

I do wish I were one of the one-in-a-million. Sometimes I think I am. And no doubt I understand economics (without being tied to supporting the existing structures that create this problem) better than the vast vast majority of people. But I know I’m not one of the one-in-a-million. This stuff stretches me to my limits – and it is beyond those limits where understanding lies.

Enough.