Friday, August 29, 2008


This is not a decrease in supply, at worst it is a re-routing to more favorable jurisdictions. Russia is not the swing producer (that honor falls to the Saudis) of oil and is prodding for weakness. The oil is transferred to other places, wherein those buyers could purchase oil at the world price and sell on to the west for modest profit.

This assumes that Russia will keep production level, which they must or risk losing market share to OPEC.

Interesting to note the combination of political, economic, and military means being used...and the attendent ends.

Russia may cut off oil flow to the West

By Ambrose Evans-Pritchard
Last Updated: 9:26pm BST 28/08/2008

Fears are mounting that Russia may restrict oil deliveries to Western
Europe over coming days, in response to the threat of EU sanctions and
Nato naval actions in the Black Sea.

Any such move would be a dramatic escalation of the Georgia crisis and
play havoc with the oil markets.

Reports have begun to circulate in Moscow that Russian oil companies
are under orders from the Kremlin to prepare for a supply cut to
Germany and Poland through the Druzhba (Friendship) pipeline. It is
believed that executives from lead-producer LUKoil have been put on
weekend alert.

"They have been told to be ready to cut off supplies as soon as
Monday," claimed a high-level business source, speaking to The Daily
Telegraph. Any move would be timed to coincide with an emergency EU
summit in Brussels, where possible sanctions against Russia are on the

Any evidence that the Kremlin is planning to use the oil weapon to
intimidate the West could inflame global energy markets. US crude
prices jumped to $119 a barrel yesterday on reports of hurricane
warnings in the Gulf of Mexico, before falling back slightly.

advertisementGlobal supplies remain tight despite the economic
downturn engulfing North America, Europe and Japan. A supply cut at
this delicate juncture could drive crude prices much higher, possibly
to record levels of $150 or even $200 a barrel.

Thursday, August 28, 2008

Once bitten...

...twice shy.

Oligarchs and ex-KGB operatives (who have grown very wealthy) run the country. They are far more likely to desire preserving their new-found riches than rebuilding the former Soviet Union.

The rest of the world understands this...

Russia fails to secure regional backing
By Stefan Wagstyl in London, Charles Clover in Moscow and Geoff Dyer in Beijing

Published: August 28 2008 10:06 | Last updated: August 28 2008 19:14

Dmitry Medvedev, Russian president, failed on Thursday to win support from China or the former Soviet republics of central Asia in his deepening dispute with the west over military action in Georgia.

At a central Asian summit in Tajikistan, Mr Medvedev was unable to persuade Hu Jintao, the Chinese president, or other regional leaders to give explicit backing to Russia’s intervention or its decision to recognise the independence of the two breakaway regions, South Ossetia and Abkhazia

Phase transition.

I am once again ignoring my self imposed "rule"*** to resist injecting metaphors into my commentaries. Indulge me.

The macro issues that I have been writing about for months now (the Chinese stock market, the U.S. Dollar, The Euro and commodities) are more or less coming to fruition. Now what?

In thermodynamics, phase transition is the process of matter changing from one form to another. International capital is now changing form from a risk-seeking, yield hogging form of liquid, to the decidedly less fluid form of a solid which seeks safety and blissful contentment.

a few thoughts:


Interest rate compression in the G8, rate increases in Emerging Market countries. Flight to safety, quality and transparent legal processes for the orderly work-out of debt convenants. The credit/liquidity hurricane touches down on the continent.

Spreads between peripheral EU countries and core countries continue to widen. Calls for synthetic inflation exportation are met with cries of unfair trade practices.

U.S. financial assets ascendent.


The Russian Bear hibernates, suitably chastened by international capital flight (due to both war and strange instances of the expropriation of foreign owned assets.)

The EU continues its decline. Does anyone here know the capital and current account between California and Washington State? The EU countries still calculate this...the participants themselves are telling Brussels "this is NOT an optimal currency area".

Long run:
There are major geopolitical risks in Latin America - a region that has far-left leanings. The deflating of the commodity boom will cause serious sovereign debt risk for Brazil, Argentina and Chile. 20 years from now, pure communism will only be found in Latin America.

China faces widespread deflation, low growth, economic stagnation, and politcal unrest.

The EU is dissolved, European realpolitik resumes after the minor speed bump of Maastricht and Lisbon.

Japan muddles along at 0%-1% growth in real terms.

The U.S. continues to be the world leader in employing physical and financial assets to produce excellent investment returns.

***My father once told me "any rule that is not a law should be distrusted"

Monday, August 25, 2008

Regulatory arbitrage...

Banks shopping around for the most advantageous jurisdiction to place impaired collateral...

Aug. 25 (Bloomberg) -- The European Central Bank will announce changes to the rules governing its money-market auctions in coming weeks to head off the risk of abuse by financial institutions, council member Yves Mersch said.

``At the margins there can still be cases where you see dangers of gaming the system,'' Mersch said in an interview on Aug. 23 in Jackson Hole, Wyoming. ``The Governing Council has been discussing the whole issue'' and has agreed on a ``certain amount'' of refinement to the existing rules, he said.

ECB officials have become increasingly concerned that banks are taking advantage of collateral rules that are broader than those used by the Federal Reserve and the Bank of England. The danger is that banks struggling to sell securities damaged by the credit-market turmoil will dump them on the ECB and become overly reliant on central-bank funds.

Friday, August 22, 2008

Stress test in action.

This article is self-explanatory. Like most news articles it is an after-the-fact explanation as Eurodollar spreads (and some EU debt repo prices) reflected this.

Bank borrowing from ECB is out of control

By Ambrose Evans-Pritchard
Last Updated: 3:06pm BST 21/08/2008

The European Central Bank has issued the clearest warning to date that it
cannot serve as a perpetual crutch for lenders caught off-guard by the
severity of the credit crunch.

Not Wellink, the Dutch central bank chief and a major figure on the ECB
council, said that banks were becoming addicted to the liquidity window in
Frankfurt and were putting the authorities in an invidious position.

"There is a limit how long you can do this. There is a point where you take
over the market," he told Het Finacieele Dagblad, the Dutch financial daily.

"If we see banks becoming very dependent on central banks, then we must push
them to tap other sources of funding," he said.

While he did not name the chief culprits, there are growing concerns about
the scale of ECB borrowing by small Spanish lenders and 'cajas' with heavy
exposed to the country's property crash. Dutch banks have also been hungry
clients at the ECB window.

One ECB source told The Daily Telegraph that over-reliance on the ECB funds
has become an increasingly bitter issue at the bank because the policy
amounts to a covert bail-out of lenders in southern Europe.

"Nobody dares pinpoint the country involved because as soon as we do it will
cause a market reaction and lead to a meltdown for the banks," said the

This "soft bail-out" is largely underwritten by German and North European
taxpayers, though it is occurring in a surreptitious way. It has become a
neuralgic issue for the increasingly tense politics of EMU.

Thursday, August 21, 2008

Labor shortages in China...

Decades from now, the Olympics will be seen as the apex in this cycle of China's development.

TOKYO (Nikkei)--Dark clouds are gathering quickly over China's economy, with concern growing over a notable drop in the number of workers migrating from rural areas to take factory jobs in cities.
The labor shortages are emerging at a time when the export-led growth model that has propelled China's rapid-fire expansion is grinding to a halt. And China has not made sufficient progress in replacing its export-driven economy with a new one that draws on domestic demand. There is a danger that Chinese society could be destabilized if the current period of high economic growth ends.
The city of Shenzhen in Guangdong Province, a special economic zone bordering Hong Kong, raised the minimum wage by 17.6% to 1,000 yuan a month in July, a margin more than double the increase in consumer prices
Home to clusters of companies assembling electronic goods and a wide range of other products, Guangdong serves as China's foremost export base, accounting for some 30% of the country's total export value. Until a few years back, factories in the province had hummed with activity, being able to tap a labor pool of rural migrant workers paid around 500 yuan a month.
Now, employers in Shenzhen and elsewhere in Guangdong are finding that capable workers are hard to come by unless they are paid double to triple the minimum wage. There have been reports of an increasing number of factories in the province closing down after being hit by stagnant exports. But the labor shortage is here to stay because "the total number of migrant workers is stuck at the same level," according to Ryo Ikebe, deputy director-general of the Japan External Trade Organization's Guangzhou office.
Wages are also rising in inland regions, although pay levels there continue to be lower than in coastal areas. Wuhan, the capital of Hubei Province, hiked the minimum wage 20% to 700 yuan, effective in August.

Monday, August 18, 2008

Expected shocks??

We need a new language for explaining what occurs in capital markets. One supposes this is more akin to the kind/type of "shock" experienced in tectonic shifts, but goodness what confusing language.

Enough on word usage. Is the below bullish or bearish for U.S. equities considering what I have been writing about on this blog for the past 6 or so months? Where do you, faithful readers, think sovereign wealth funds, large mutual funds, retirement plans, central banks, etc., etc., think market participants are going to do their investable assets? Given the relative forward looking prospects of same?

Financial Crisis Is Expected To Bring More Big Shocks
Monday August 18, 10:17 am ET

The year-old financial crisis is not only far from over but could actually get much worse, bringing more big shocks to the US economy and stock market, a host of experts said Monday.
Among the predictions: the failure of some of the country's biggest financial institutions, the collapse of 1,000 banks and a possible government bailout of mortgage giants Fannie Mae (NYSE:FNM - News) and Freddie Mac (NYSE:FRE - News).

Friday, August 15, 2008

Piling on...

For foreign readers unfamiliar with American Football, "piling on" is what often occurs after a tackle is made and overzelous defensive team-mates decide to jump on the tackler and tacklee. This creates a pile of bodies and is meant to display defensive prowess.

There is no corollary in Rugby Union (where American football got its roots) as rucks have very specific rules regarding engagement and conduct. Because of the lack of visibility, bad things happen in pile-ons. (Bad things happen in rucks as well...but everyone knows this is simply good gentlemanly fun.)

So this article is no surprise.

I have also noticed that a very famous investment bank has called for a "bottom" for the U.S./EURO exchange rate.

The ECB will be politically compromised, just like the Fed.

Wednesday, August 13, 2008

No surprise to readers here.

Dollar Optimists Return as Slowdown Spreads to Europe, Japan

By Lester Pimentel

Aug. 13 (Bloomberg) -- The dollar will appreciate against the euro, yen, pound and Swiss franc in the next six months as economies in Europe and Asia falter, a survey of Bloomberg users showed.

U.S. investors turned bullish on the greenback after incorrectly forecasting a decline last month, according to respondents in the monthly Bloomberg Professional Global Confidence Index, which questioned 2,969 users from Los Angeles to Paris to Tokyo. Participants became bearish on the franc and yen while growing more pessimistic about the British pound.

``It's not that people are more optimistic about the U.S. economy,'' said Richard Franulovich, a senior currency strategist at Westpac Banking Corp. in New York and a survey participant. ``The rest of the world is catching up with the U.S.''

Libor issues and EU bank financing

The below excerpt speaks for itself. EU banks are scrambling for short term dollar denominated financing. G12 interest rates are compressing and this bodes well for U.S. equities and the dollar going forward.

By Paul J Davies in London and Michael Mackenzie in New York

Published: August 12 2008 23:19 | Last updated: August 12 2008 23:19

Central banks in the US and Europe saw heavy demand for their first
auctions of three-month dollar funds for banks on the two continents
as they continue to battle the strains in the interbank lending

European banks bid for almost four times the $10bn available in
Tuesday's debut three-month auction.

US banks put in orders for more than twice the $25bn available in
their market and Swiss banks asked for five times the $2bn available

The strength of demand meant that the rate that banks will pay to
borrow the funds through the central bank auctions was settled at only
a tiny fraction below the prevailing interbank lending rate, leading
to fears that Libor is actually too low.

The European Central Bank, Swiss National Bank and the US Federal
Reserve announced at the end of July that they would be rearranging
the Term Auction Facility (TAF) operations to make some of the funds
available for 84 days instead of just 28 days.

Analysts and bankers said the move was aimed at reducing the still
elevated level of US dollar Libor rates at three-month maturities
relative to one-month money and ease funding pressures around the end
of quarterly reporting periods.

European banks, many of which have large exposures to US dollar assets
mainly through structured finance holdings, have struggled to find
dollar funding from short-term money markets in the wake of the credit
crunch and do not have access to a dollar deposit base.

Friday, August 08, 2008

The ECB and Trichet near capitulation

The ECB does a very quick about-face on its interest rates analysis.

Raising rates was a mistake as I have said multiple times on this blog. The ECB is staging something of a coup here. Re-prioritization of the specific ECB mandate against inflation (and inflation alone) is no small matter.

Still, no-one will complain. Between the rock of high exchange rates destroying foreign demand for European goods and the periphery PIGS falling into recession, growth and the lack thereof, is the only thing that matters.

Euro bank's hawks take a pounding

By Ambrose Evans-Pritchard
Last Updated: 10:40pm BST 07/08/2008

Collapsing growth in Germany, Italy and Spain has forced the European
Central Bank to abandon its hawkish policy stance, preparing the way for
likely rate cuts in coming months.

Jean-Claude Trichet, the ECB's president, said yesterday that the picture
had darkened over recent months and growth was now "particularly weak"
across the eurozone. "We knew that there were downside risks, and those
risks are materialising," he said after a meeting by the governing council
that left rates on hold at 4.25pc.

The comments caused the euro to plummet by almost two cents against the
dollar to $1.5310 yesterday. Traders scrambled to unwind bets on future rate

"The ECB has capitulated on the economic outlook," said Julian Callow,
Europe economist at Barclays Capital.

"They have cut out all reference to 'moderate ongoing growth' and no longer
seem sure that the economy will recover even in the fourth quarter. I detect
meaningful concern," he said.

A wriddle wrapped in a mystery inside an enigma...

Churchill was correct about Russia.

I direct all readers here to my July 10 post regarding "innovative" forms of national conflict.

Georgia and Russia edge towards war over South Ossetia

Russian jets accused of invading airspace and bombing border towns as
rebels clash with Georgian troops in breakaway region

Helen Womack in Moscow and Anil Dawar, Friday August 08
2008 09:38 BST Article history

Georgian troops have launched a full-scale bombardment of separatists
in the breakaway region of South Ossetia, raising the risk of all-out
war with Russia and other former Soviet states.

In a televised statement, the Georgian president, Mikhail Saakashvili,
said Russian aircraft had bombed several Georgian villages and other
civilian facilities. He said there were injuries and damage to the

"A full-scale aggression has been launched against Georgia," he said,
before urging Russia to immediately stop the bombing. "Georgia will
not yield its territory or renounce its freedom," he said.

Tuesday, August 05, 2008

Intellectual Bubbles...

A more philosophical meandering today...

I have noticed a slew of recent articles proclaiming the end of exotic derivatives because of a "lack of transparency".

This is a nice way of saying alot of people bought what they did not understand and trusted the analysis of people they thought knew better.

"At best, probability describes perceived uncertainty" - Glyn Holton

Throughout history, the discovery of new mathematical ideas and techniques have led to people thinking that "this time, we have it!" This Epimenidian eureka effect has such strong underpinnings in humanity's relentless drive for progress and understanding that we often believe we have found "the answer".

Computation and simulation using Bayesian algorthims is another such discovery. It is an immensely powerful technique. One can simulate a huge variety of physical systems and receive probability distributions that correlate nicely to real-world observations.

Unfortunately, human market systems do not behave like physical systems. Atoms do not have the ability to choose. Human financial market participants seek to maximize profit - and engage in Keynsian beauty contests in order to do so. CEOs observe what their competitors do in making overplus profits and promptly copy them. And now, in this new era of cheap and ubiquitous computational power, all market participants have access to algorithmic models.

And so the participants created a bubble based on mathematical understanding, or the lack thereof. The gold rush for Wall Street for new ways to model boring old cash flows using math and computer power was on.

And so, investments have been flooded obscure mathematical models that purport to properly "price" a derivative within a given set of parameters (none of which, it seemed, included the non-zero probability of zero liquidity). Ostensibly, these models have been included to help clients understand what they had bought. A sort of "intellectual warranty" on these exotic products.

Too bad there was no fine print which paraphrased Mr. Theodore Sturgeon:

"Nothing is always absolutely so"

Bubbles can be intellectual as well as physical. And are no less dangerous.

Monday, August 04, 2008

Global Trajectories...

FIFO. This accounting principle generally describes what is happening in the developed world. The U.S. has fulfilled its traditional role of slashing and burning early and often, which exacerbates the cries of doom from popular publications. Those same publications fail to consider (warning: mixed metaphors coming up) the essential and beneficial purpose forest fires provide to an ecosystem.

So if the U.S. is an occasional arsonist who unwittingly clears unproductive foliage for the benefit of future, generations of more vigorous flora, what is the Euro area? Probably some bureaucrat who is in charge of keeping a petrified forest free from change forever.

Sometimes, chaos and destruction are beneficial things. If artificially restrained, progress is impossible.

European companies braced for slowdown
By Richard Milne in London

Published: August 3 2008 17:03 | Last updated: August 3 2008 20:35

Companies across Europe have begun to cut jobs, scale back production
and reduce hiring to slash costs as they brace for a recession or
sharp economic slowdown at the end of the year.

The defensive moves are being seen in businesses ranging from
carmakers and airlines to accountants and banks.

Our strategy is to freeze the non-essential," said John Griffith
Jones, chairman of KPMG in the UK and joint-head in Europe.
"Non-essential vacancies are not being filled and we're saving on
non-essential overheads."