Sunday, May 30, 2010


Summer has arrived and there is no shortage of gold bugs to usher in the hot season.

They seem to be everywhere. In popular media, in strip malls, on the street corners holding placards, and everywhere in between.

The arguments proffered by the gold bugs are simple:

1. It will protect you from inflation. It won't. Witness the Price Revolution of 1600 in response an influx of precious metals from the New World. Owning gold does not mean one is immune to inflationary pressures.

2. It serves as a store of value. True, however, there are storage costs for physical gold that dilute value over time and provide an EXPROPRIATION/THEFT risk.

3. Governments cannot be trusted. True. but this is not a reason to own gold. Refer again to the "Price Revolution" of 1600 as well as the panics of 1820, 1890, and 1910. If the End Of Timer scenarios do play out, does anyone want to hold a large supply of a relatively heavy metal that requires considerable energy to store and transport?

4. It is a safe asset. It is not, by a long shot. Gold prices are volatile, and the current FAD will subside soon enough. Milton Friedman once quipped "Nothing cures high prices like high prices". In other words, supply is popping up everywhere and the purveyors of the supply wish to keep the illusion of massive scarcity and governmental collapse at the forefront of the popular Zeitgeist for as long as it takes to clear their inventory. Is a "safe" asset one that is highly dependant on extraction activities in sub-Saharan Africa???

5. It has historical, preternatural value. True. So what? So did Salt and cow teeth at one time or another in history. Tying a sovereign currency to a commodity that is not WHOLLY dependant on production factors WITHIN its own borders completely obliterates the point of having a sovereign currency in the first place. So let us go back to a gold standard that is highly sensitive to gold production in countries thousands of miles away.

As an aside, the number one producer of gold is...China. If the United States outsources its currency advantage, I will look at emigration options, because the greatest non violent foreign policy victory in the history of mankind occurred when the U.S. went off the gold standard in 1971, and the second the U.S. relinquishes this precious advantage will harbor great danger for coming generations. That is the real danger as opposed to the hogwash regarding balanced budgets and deficit terrorists who wish to whip the country into a frenzy based on economic analysis wholly inapplicable to non-convertible sovereign issuers currency regimes.

Interesting timing...

...For this trial balloon. More circumvention and/or obviation of sovereignity. Given the current environment, it is no wonder a smallish country recently victimized by an aggressive neighbor is chosen as the herald for this proposal.

Simply imagine the reaction if the U.S. had released this proposal.

May 31 (Bloomberg) -- South Korea proposed central banks set up a permanent arrangement for foreign-currency swaps to help address the type of funding shortages that emerged during the global financial crisis.

“Broadening and institutionalization” of such measures could help establish “a global financial safety net,” Bank of Korea Governor Kim Choong Soo said in the text of a speech to be delivered today in Seoul at a conference of central bankers.

Saturday, May 29, 2010

Procyclical squeeze...

Non-sovereign currency issuers are powerless to counter-act pro-cyclical exogenously induced austerity measures.

The Friedman/Keynes false dichotomy is dead. Power, survival, and pecking orders are the issue here.

Threats of a general strike in Spain intensified this weekend
following Friday's decision by the credit agency Fitch Ratings to
downgrade the country's debt from AAA to AA+.

The latest blow to Europe's fourth-biggest economy comes just days
after a series of austerity measures scraped through the Spanish
parliament by a margin of a single vote. Designed to rein in a deficit
behind Ireland and Greece in the eurozone, the measures to passed
thanks only to a series of abstentions.

Any feelings of optimism following the ultra-close vote were quickly
dented by the bleak statement from Fitch on Friday.

But Spain's deficit is far from being its only economic headache:
unemployment, for example, stands at over 20 per cent, double the 2007

Social unease at the austerity measures, which includes a freeze on
pensions, is also on the rise.

Spain's two largest trade unions have threatened a public-sector
strike next week over the austerity measures, due to cut €15bn off the
Spanish budget, which would see a 5 per cent cut in civil service pay.

Fitch's head of Europe, Brian Coulton, said: "The process of
adjustment to a lower level of private-sector and external
indebtedness will materially reduce the rate of growth of the Spanish
economy over the medium term," he said

It could hardly have been a more cheerless message for a country that
has only just limped out of its worst recession in 50 years with a
growth rate of 0.1 per cent in the first quarter of this year.

Fitch's downgrading also comes barely a month after Standard & Poor's
had cut its own rating for Spain to AA, with only Moody's retaining an
AAA rating for the country.

Spaniards are now bracing themselves for a VAT rise of 2 per cent next
month, while the government has warned that growth will slow in 2011,
from 1.8 per cent to 1.3 per cent because of the austerity programme.


Wages rising, exports falling, imports artificially enjoined, centrally planned manufacturing benefiting a misguided mercantilist strategy.

...and the U.S. has a plausible reason to think the Chinese will appreciate the Yuan?

The biggest eye-opener for multinationals in China recently has been a
nine-day-old strike at a sprawling Honda transmission factory here in
Foshan, about 100 miles northwest of Hong Kong.

The strike, which has forced Honda to suspend production at all four
of its joint venture assembly plants in China, has shown that Chinese
authorities are willing to tolerate work stoppages at least
temporarily, even at high-tech operations on which many other
factories depend.

Chinese policy makers are trying to let wages rise to create the
foundations of an economy driven by domestic demand, without derailing
the export machine that has produced the world’s strongest economic
growth over the last three decades.

Even before the strike, manufacturers and buyers of low-cost products
were already actively seeking alternatives to China, like Vietnam and
Cambodia, said Richard Vuylsteke, the president of the American
Chamber of Commerce in Hong Kong.

“They’re looking very seriously, and we’re seeing that in apparel and
footwear,” he said. “A lot of our members are seeing appreciating

Picking sides

"South Korea is an important trading partner to us Mr. Kim, that will be all"

A non-violent solution brokered by China would be very impressive and would be evidence of a more aggressive approach to Chinese foreign policy.

I have mentioned before that invasion of North Korea by China is more than mere possibility, and now it appears they are signaling their interests...reunification next. China should attempt to absorb the penninsula and leave Japan as the major American ally in East Asia.

SEOUL — China's Premier Wen Jiabao Saturday called for talks on a
bilateral free-trade agreement with South Korea as the two countries
wrapped up a three-year joint feasibility study on the project.

"The two countries should start official talks on their free-trade
agreement in the future," Wen was quoted as saying by Yonhap news
agency at a meeting with South Korean business leaders in Seoul.

South Korea and China on Friday signed a memorandum of understanding,
agreeing to hold preliminary talks on sensitive sectors such as
agriculture before starting full-fledged negotiations on a free-trade

China has emerged as South Korea's largest trading partner, absorbing
some 24 percent of its total exports in 2009.

Wednesday, May 26, 2010


...bellum omnium contra omnes...

Full article here.

"The euro has lost 14 percent of its value against the dollar since the start of the year and is hovering near a four-year low on concerns that the mounds of government debt in a number of eurozone countries amounts to a ticking time bomb. The euro has continued to slide despite the creation of a $1 trillion reserve bailout fund and a $140 billion bailout for Greece earlier this month. The unveiling of austerity plans in Italy, Greece, Spain, Portugal, and Ireland has also done little to reassure investors.

European solidarity is in danger – though some analysts say that unity on the continent has always been achieved by hammering out differences in periods of crisis.

“We’ve seen a fiscal, an economic, and a social crisis...and a political crisis inside nations could be next," says Éloi Laurent of the French Economic Observatory in Paris. "We’ve seen it in Greece, and we already have a political crisis at the European level, which is a union in shambles."

US Treasury Secretary Timothy Geithner travels to Berlin tomorrow for consultations in the wake of a new set of German restrictions on market speculation. German Chancellor Angela Merkel yesterday announced a ban on naked short selling of certain kinds of debt. A naked short sale is when an investor promises to deliver an asset at its current market price to another investor, effectively "selling" something he doesn't own in the hope that the price will decline quickly, allowing him to cover his trade at a profit. Merkel's ban infuriated European finance chiefs for its unilateral and non-consultative nature.

Last week Merkel called the crisis the Europe’s biggest test in 50 years, which irritated France. President Nicolas Sarkozy even threatened to withdraw from the eurozone, in what was seen as a rhetorical flourish underscoring the depth of French feeling and disagreement with Berlin.

“Merkel is sabotaging [rescue efforts] in order to prove to her domestic audience that everyone should follow Germany’s economic lead,” says Mr. Laurent. “Well, every country can’t be Germany. This is a beggar-thy-neighbor policy. Merkel is saying ‘I have no interest in the Europeans, I am only interested in my own government.' "


More problems...

The Department of Homeland Security is alerting Texas authorities to be on the lookout for a suspected member of the Somalia-based Al Shabaab terrorist group who might be attempting to travel to the U.S. through Mexico, a security expert who has seen the memo tells

The warning follows an indictment unsealed this month in Texas federal court that accuses a Somali man in Texas of running a “large-scale smuggling enterprise” responsible for bringing hundreds of Somalis from Brazil through South America and eventually across the Mexican border. Many of the illegal immigrants, who court records say were given fake IDs, are alleged to have ties to other now-defunct Somalian terror organizations that have merged with active organizations like Al Shabaab, al-Barakat and Al-Ittihad Al-Islami.

In 2008, the U.S. government designated Al Shabaab a terrorist organization. Al Shabaab has said its priority is to impose Sharia, or Islamic law, on Somalia; the group has aligned itself with Al Qaeda and has made statements about its intent to harm the United States.

In recent years, American Somalis have been recruited by Al Shabaab to travel to Somalia, where they are often radicalized by more extremist or operational anti-American terror groups, which Al Shabaab supports. The recruiters coming through the Mexican border are the ones who could be the most dangerous, according to law enforcement officials.


"The spirit of the age, is in some measure a novel expression. I do not believe that it is to be met with in any work exceeding fifty years in antiquity. The idea of comparing one's own age with former ages, or with our notion of those which are yet to come, had occurred to phiosohphers, but it never before was itself the dominant idea of any age. Before men begin to think much and long on the peculiarities of their own times, they must have begun to think that those times are, or are destined to be, distinguished in a very remarkable manner from the times that preceded them"

-J.S. Mill, 1831

And so we continue to define historical cycles by the edicts of historians characterizing the age in terms of what was "discovered" instead of who held the power.

In this current epoch of globalization, harmonious world cooperation, the absence of war, instantaneous communciation, abundant food supplies, and (most importantly) breathtaking technological progress, it is natural to think the motivations of Man could be overcome with political integration.

This hubris has a long tradition in Europe, but Giambattista Vico sums up this theme nicely:

"That the world of civil society has certainly been made by men, and that its principles are therefore to be found with in the modifications of our own human mind. Whoever reflects on this cannot but marvel that the philosophers should have bent all their energies to the study of the world of nature, which, since God made it, He alone knows, and that they should have neglected the study of teh world of nations...which, since men had made, men could come to know"

-Vico, Principles of a New Science concerning Common Nature of the Nations (1725)

Tuesday, May 25, 2010

In nothing we trust...

Various measures indicating increased mistrust amongst market participants.

Counter-party risk has once again reared its ugly head and is making a mockery of all these measures designed to increase "liquidity".

Holding large cash and short-term Treasury security positions is entirely rational if you are reluctant take counter-party risk exposure.

Monday, May 24, 2010


North Korea operating from the only rule-sets it knows. It is convenient that our Secretary of State is in China at the moment discussing "economic issues and Europe".

As I have stated before, China may surprise everyone by playing "peacekeeper" in this region and either invade North Korea or negotiate an armistace.

Asian stocks and the won plunged to the lowest in 10 months after a report that North Korean leader Kim Jong Il ordered his military to prepare for combat last week. The euro weakened and commodities declined on concern Europe’s debt crisis may spread.

The MSCI Asia Pacific Index dropped 2.2 percent to 109.82 as of 12:09 p.m. in Tokyo, set for its lowest close since July 30. Standard & Poor’s 500 stock index futures lost 1.3 percent. The won plunged to a 10-month low and the nation’s stock benchmark slumped 3.4 percent. The euro fell for a second day against the yen and the dollar. Crude oil slipped below $70 a barrel in New York and copper declined for the first day in four.

Tensions on the Korean peninsula ratcheted higher as the North’s military was placed on alert last week, the North Korea Intellectuals Solidarity group reported on its website, citing a person in the communist country. The U.S. yesterday announced plans to conduct joint anti-submarine exercises with South Korea after the March 26 sinking of one of the South’s warships cost 46 lives. Spain’s financial sector “remains under pressure,” the International Monetary Fund said yesterday in urging the nation to do more to overhaul its ailing banks.


More confusion about official policy positions. China to strengthen the Yuan in the face of weakened global demand? (based mostly on the dismal growth prospects for the EU)

This is because "coordination" is breaking down. This is a crucial period for global markets and as usual, the politicians have regressed back to a REACTION FUNCTION based on measures of popular opinion as opposed to acting on contingency plans that should have been in place at the inception of the EU, when the current issues were spelled out for all to see. This flailing results in loss of confidence with predictable results.

100 years macroeconomic theory and no-one can convince the EU to cut taxes and distribute Euros on a per-capita basis in order to combat a massive debt deflation spiral.

This is because social theories only work if all participants agree with the theory, and trust other participants to obey the agreed upon rules.

Every nation for itself, and Devil take the hindmost.

May 25 (Bloomberg) -- China and the U.S. focused their first day of talks in Beijing on joint efforts to prop up the world’s economy in the face of a European sovereign-debt crisis that pushed off a showdown on the yuan’s value.

Officials “spent quite a bit of time discussing the European debt crisis,” Chinese central bank Governor Zhou Xiaochuan said at a press briefing. The nation’s currency policy is being “touched upon” at the talks, he said.

President Hu Jintao said China will move gradually and independently in altering exchange-rate policy after keeping the yuan pegged to the U.S. dollar for 22 months. Treasury Secretary Timothy F. Geithner, who has delayed a report to the U.S. Congress that could name the nation a currency manipulator, said he welcomed China’s commitment to yuan changes.

Sunday, May 23, 2010

A beautiful anecdote...

...about economic realities within the belly of the Paper Dragon. You simply cannot make this stuff up.

(from the FT)

Before his arrest on corruption charges, Wang Yi was not only a powerful financial official in the Communist party but also one of China’s most celebrated modern classical music composers.

But since his detention and arrest last year, Mr Wang’s magnum opus – a symphony called Ode to China – has been dropped as a repertoire staple of the China National Symphony Orchestra and his compositions derided by formerly adoring media commentators and critics.

Mr Wang is described now as someone who has trouble reading music, had no formal training and was reliant on ghost writers to produce what was once hailed by state media as “China’s answer to Mozart” and “music for rejuvenation of the nation”.

Official reports suggest that most of the millions of renminbi spent on tickets to see Mr Wang’s works came from businesspeople and officials hoping to curry favour with him.

The case is one example of the extraordinary influence senior party officials with few or no artistic credentials wield over the Chinese arts.

Critics say these factors are the main reason China, the world’s biggest exporter of manufactured goods, has produced relatively few cultural or artistic exports in recent years – despite a multibillion-dollar global campaign and regular exhortations from leaders to develop the “cultural industries” and “soft power” of the nation.

“The officials want China to be seen as a cultured, creative nation, but in this anti-liberal political society everything outside the direct control of the state is seen as a potential threat,” says Ai Weiwei, a well-known contemporary artist and a bold critic of Communist party rule.

“The people who control culture in China have no culture, and in this system art provides a hugely lucrative source of corruption.” Mr Ai notes that artistic works, because they are not officially included in the assets of officials, have become popular as bribes, and many officials have learnt to paint, write or compose music so they can sell their works to people who expect favours in return.

Because of the patronage and benefits officials can bequeath, their work is lauded as genius, unless they fall from grace, as in Mr Wang’s case. Two weeks ago a Beijing court handed him a death sentence suspended for two years, so he is likely to remain in prison for the rest of his life.

Mr Wang served first as vice-chairman of China’s securities regulator in charge of share issuance and fund management, and later as vice-governor of the powerful state-owned China Development Bank, which owns part of Barclays in the UK.

Although he had never studied music and had not heard a full symphony until eight years ago, Mr Wang decided to nurture his latent talent after a trip to Tibet, during which he was struck with an overwhelming urge to sing.

The Obama Doctrine...a continuing series...

(For my initial report outlining the Obama Doctrine of October, 2008, see the "PAPERS" section under the "useful links" heading on this blog)

In my previous post regarding Mr. Das and his "bullseye" understanding of the macro factors surrounding China, the following quote encapsulates and sets the trajectory for the Obama Doctrine:

China’s mercantilist strategies have important implications for other developing countries. Chinese investment in and trade with Latin America and Africa is concentrated on securing access to resources forcing these nations to specialise in commodities. This reversion to a 19th century trend may not be compatible with Latin American and African long term development and stability.

The U.S. has no choice but to enforce boundaries and ground rules for resource-hungry China and this will eventually manifest itself as the Obama Doctrine.

Friday, May 21, 2010

Your larger neighbor...

...needs an excuse to gain international good will, to say nothing of occupation or outright war's ability to distract entire populaces.

I speak of China, of course, and the economic stresses it is currently under make North Korea a low-hanging fruit. Mr. Kim had better beware.

North Korea on Thursday threatened "all-out war" if South Korea takes punitive action over the sinking of the South Korean Navy corvette Cheonan on March 26. The South Korean government in an official report the same day announced that the shipwreck was caused by a North Korean torpedo attack.

A spokesman for North Korea's powerful National Defense Commission called the findings a "fabricated farce" and offered to send an inspection group to South Korea. It threatened "drastic measures including an all-out war" if Seoul takes sanctions against it. "Such an all-out war would be a holy war to completely wipe out the base of the traitorous clique and establish a great unified nation," he said.


Depending on the surface area, a small percentage of sound waves will rebound back at the source, thus creating the illusion of a 2nd, 3rd, 4th origination of sound.

Today's decision by Germany will be regarded by posterity in a similar fashion - 2nd, 3rd, 4th attempts at reverting back to the original fidelity.

If only the world listened to the echoes of 1929. If only they help themselves and act for some ephemeral concept of "greater good" and guarantee all EU debts wholesale, and distribute billions of Euros on a per capita basis to combat deflation and silly austerity measures that pave the road to serfdom, revolt, and violence.

They cannot. THIS IS A RESCUE OF LARGE EU MONEY CENTER BANKS, NOT OF GREECE. And the die has been cast for further realpolitik. A harmony corruption.

Thursday, May 20, 2010

A more visual rendition of the previous post. This is certainly not evidence of monetary growth and, since loans create deposits, is indicative of serious weakness in the bank lending arena.

Bank Lending...

...still relatively weak. At this point, it is the most important variable for the economy. Bank "lending" has grown as money center banks have been (forced) to carry off balance sheet loans, but the kind of organic bottom-up economic growth is not there in the latest figures found here.

Kick the can...

The idea of a United and powerful Europe is more religious than realistic. This is a dangerous time as Brussel elites frantically struggle to adjust "law" on the fly in order to preserve market and economic stability. Once again, the perception and SIGNAL of "doing something" takes priority. This has been the response of EU (and American, for that matter) politicians: simply signal that "government is working hard to resolve the problem" and hope time heals all wounds (then, of course, take credit for the resultant good fortune).

We also have plentiful evidence that some nations in the EU are planning for EU break-up and acting accordingly.

It is like quicksand.

As I have said before, this can unwind very quickly. Nothing the EU has done thus far has assuaged the liquidity risk facing individual EU nations. Quite the contrary, with austerity measures and various Shylock's taking their pound of flesh, deflationary pressures are running rampant. (This begs the question of the Euro's weakness, which is at the moment facing risk aversion and diminished status it loses "reserve currency status")

Wednesday, May 19, 2010


When everything is connected, "fail-safe" is a misnomer. The following is from an article on my reading list for today:

The risk comes if the defaults burn through these member resources. In that case, Mr. Dodd is signaling that taxpayers will be called upon to help. Regulators are selling this Beltway re-engineering as a way to offset the "interconnectedness" of financial firms in the over-the-counter derivatives market. But clearinghouses are the most interconnected of all institutions—by design.

Clearinghouses do have a generally good record for trading in futures and other things, but they can and have failed. They didn't fail during the 2008 crisis, but a senior financial regulator in office at the time tells us that one or more clearinghouses might have been in distress if the feds had not rescued the commercial paper market.

Clearinghouses had traditionally held the margin they collected in cash or Treasurys, but over time some of this money was invested in instruments with a higher yield and a triple-A rating from one of the government-selected credit-rating agencies. These assets became much more difficult to sell in the fall of 2008. Regulators thought about raising the issue at the time but didn't want to add to the panic. They have since pressed clearing organizations to keep only the most liquid financial instruments.

Tuesday, May 18, 2010


Das hits the target. No link provided as I have reproduced this wonderful article in its entirety. He gets it.

China: The Future That Was?
Posted At : May 15, 2010 10:44 PM | Posted By : Satyajit Das
Related Categories: Emerging Markets
The Future That Was

China’s economic model is reminiscent of 17th century mercantilist policies. Thomas Mun, a Director of the East India Company, in England's Treasure by Foreign Trade (1664), wrote that the purpose of trade was to export more than you imported. At the same time, a country should amass foreign ‘Treasure’ that would be the basis of acquiring foreign colonies to allow control of essential natural resources. The strategy required reducing domestic consumption and imports and export of goods manufactured with imported foreign raw materials. China’s strategy coincides almost entirely with Mun’s views.

China’s mercantilist strategies have important implications for other developing countries. Chinese investment in and trade with Latin America and Africa is concentrated on securing access to resources forcing these nations to specialise in commodities. This reversion to a 19th century trend may not be compatible with Latin American and African long term development and stability.

The Chinese economic model may be unsustainable. It relies on global trade and investment (much of it export related), which together contribute a high proportion of China’s GDP. This trade entails importing foreign components that are then reassembled and then exported. Domestic consumption has been kept low. Treasure has been built up in the form of domestic savings and trade surpluses.

Recently, China announced that its $2 trillion+ treasure would be used to make foreign acquisitions to secure exclusive access to raw material. The problem is that China’s treasure is already invested in assets of dubious value and limited liquidity to finance global consumption.

Chinese Premier Wen Jiabao warned that the Chinese growth was becoming increasingly “unstable, unbalanced, uncoordinated and ultimately unsustainable”. That was two years ago! Currently, China may be aggravating the problems by massive liquidity-driven stimulus to perpetuate a failed strategy. Speaking at the meeting of the World Economic Forum in Dalian on 10 September 2009, the Chinese Premier Wen Jiabao repeated his message from two years ago without signalling any change in direction: “China’s economic rebound is unstable, unbalanced and not yet solid. We cannot and will not change the direction of our policies when the conditions aren’t appropriate.”

There is broad agreement that a key component of the GFC was the problem of global capital imbalances. A central feature was debt-funded consumption by the U.S. that allowed 5% of the global population to constitute 25% of its GDP, 15% of consumption and 48% of global current account deficit. Japan, China, Germany and the other savers funded the consumption.

Any lasting solution to the GFC requires this imbalance to be dealt with. The glib solution requires the U.S. to save more and consume less and the savers to save less and consume more. The problems in implementing the solution are considerable. Timothy Geithner’s recent discussion with Chinese officials, to assure his hosts of the safety of their investments in dollars and U.S. Treasury Bonds, reveals the dilemma.

On the one hand, America needs the Chinese to continue and increase their purchase of U.S. Government debt to finance its fiscal stimulus and bailouts. On the other hand, America needs China to cut the size of its current account surplus, boost government spending, encourage personal consumption and reduce savings. All this should also occur ideally without any major decline in the value of the dollar or U.S. Treasury bonds or the need for China to liberalise it currency and allow internationalisation of the Renminbi.

A cursory look at the respective economies also highlights the magnitude of the task. Consumption’s contribution to GDP in the U.S. is 71% while in China it is 37%. Given that the GDP of China is around $4-5 trillion versus $15 trillion for the U.S. and average income in China is around 10-15% of U.S. earnings, the difficulty of using Chinese consumption to drive the global economy becomes apparent.

During the last quarter of century, Chinese savings have risen and exports have been the engine for growth. Given that a significant portion of exports is driven ultimately by American and European buyers, lower global growth and declining consumption creates significant challenges for China.

Dealing with the global imbalance has not been a high priority in the various summits global leaders have shuttled to and from.

In March 2009 in advance of schedule G-20 meeting, the Chinese central bank proposed replacing the US dollar as the international reserve currency with a new global system controlled by the International Monetary Fund. In an essay posted on the Peoples’ Bank of China’s website, Zhou Xiaochuan, the central bank’s governor, argued that creating a reserve currency “that is disconnected from individual nations and is able to remain stable in the long run, thus removing the inherent deficiencies caused by using credit-based national currencies”. Mr. Zhou wrote: “The outbreak of the [current] crisis and its slipover to the entire world reflected the inherent vulnerabilities and systemic risks in the existing international monetary system.”

The US predictably dismissed the proposal. The Wall Street Journal argued that: “For all its faults, the dollar is attractive as a reserve currency because it is the common language of global finance and trade. In other words, its appeal is proportionate to how many other market players use it. For decades, the dollar has been a convenient medium of exchange for everyone from a central bank seeking to buy US Treasury bonds to a business exporting commodities from Latin America to Asia.” The unstated reason was the loss of the ability to finance itself in its own currency would significantly disadvantage the US.

In July 2009, at the G8 Summit in the earthquake damaged town of L'Aquila in Italy, Dai Bingguo, Chinese state councillor, was again openly critical of the dominant role of the U.S. dollar as a global reserve currency: “We should have a better system for reserve currency issuance and regulation, so that we can maintain relative stability of major reserve currencies exchange rates and promote a diversified and rational international reserve currency system,”

Western leaders expressed concerns about even raising the issue fearing that discussion of long-term currency issues could undermine the nascent recovery in markets and economies. Gordon Brown, Britain's prime minister, spoke on behalf of the West: “We don't want to give the impression that big change is around the corner and the present arrangements will be destabilised.” The West it seems was heeding Deng Xiaoping’s advice to: “Keep a cool head and maintain a low profile.”

In September 2009, the Americans and Europeans proposed an effort to tackle global economic imbalances at the G20 summit in Pittsburgh. Against a background of rising trade tensions, China’s ambassador to the U.S. Zhou Wenzhong expressed scepticism about the proposals, seeking focus instead on avoiding protectionism.

Still heavily reliant on exports, China was wary of a global push on imbalances that would focus of its large trade surplus (which reached nearly 10 per cent of GDP in 2008). Zhou pointedly blamed the crisis on “the lack of supervision and abuse of the openness of the market, very risky levels of leverage and too much speculation.” He proposed improving global financial supervision, strengthen bank capital and create global early warning systems to identify threats but resisted action to address the imbalance.

Ironically, recent modest improvements in the global economy potentially risked increasing the same imbalances that were one of the factors that caused the current financial crisis. China’s and the world’s economic future requires resolving fundamental global imbalances that lie at the heart of the GFC.

Turning Japanese

China’s problems, to a degree, mirror earlier problems of Japan, its neighbour and competitor for global influence.

Japan’s export driven model successfully generated strong growth of 10% average in the 1960s, 5% in the 1970s and 4% in the 1980s. This growth was driven by a number of factors, including an artificially low exchange Yen rate.

On 22 September 1985, Japan, the U.S., the U. K., Germany and France signed the Plaza Accord agreeing to depreciate the dollar in relation to the Japanese Yen and German Deutsche Mark by intervention in currency markets. The Accord had limited success in reducing the U.S. trade deficit or helping the American economy out of recession.

The Plaza Accord signalled Japan’s emergence as an important participant in the international monetary system and global economy. The effects on the Japanese economy were disastrous.

The stronger Yen triggered a recession in Japan’s export-dependent economy. In an effort to restart the economy, Japan pursued expansionary monetary policies that led to the Japanese asset price bubble that collapsed in 1989. Economic growth fell sharply and Japan entered an extended period of lower growth and recession, generally referred to as ‘The Lost Decade’.

In the 1990s, Japan ran massive budget deficits to finance large public works programs in a largely unsuccessful attempt to stimulate growth to end the economy’s stagnation. Only structural reforms in the late 1990’s and early 2000’s restored modest rates of growth. Japan’s public debt is now approaching 200% of Japan’s GDP.

Significant shifts in economic strategy are now necessary. Chinese President Hu Jintao recently noted: “From a long-term perspective, it is necessary to change those models of economic growth that are not sustainable and to address the underlying problems in member economies.”

China can try to continue its existing economic strategy, which looks increasingly difficult. Changing its economic model is also difficult if it means a slower rate of growth. China’s challenge will be to learn from and avoid the problems and fate of Japan.

History and cultural issues compound China’s dilemma. The 1842 Treaty of Nanking entered into at the end of the first Opium War awarded Britain war reparations, eliminated the Chinese Hong monopoly, set Chinese exports and imports at a low rate, provided British access to several Chinese ports and transferred Hong Kong to the English. The humiliation of the Treaty is deeply etched into China’s dealing with the West.

China should have heeded the warning of Kang His, emperor of China, on the British presence at Canton in 1717: “There is cause for apprehension lest in centuries or millenia to come China may be endangered by collision with the nations of the West.”

The tradeoff between economic and political liberalisation may also be problematic. As Fang Li, a renowned astro-physicist often called China’s Andrei Sakharov, remarks in dissident author Ma Jian’s novel about China “Beijing Coma”: “Without a democratic political system in place, [China’s] economy will eventually flounder. The people’s wealth will be eaten up by the corrupt institutions of this one party state.”

There is an apocryphal story about a visiting world leader drawing back the current of his hotel room to be stunned by the futuristic skyline of Shanghai’s Pudong Financial District. “How long has this being going on?” He asked. Today, the question might be: “How long can this go on?”

© 2010 Satyajit Das

Satyajit Das is a risk consultant and author of Traders, Guns & Money: Knowns and Unknowns in the Dazzling World of Derivatives - Revised Edition (2010, FT-Prentice Hall).

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The Chinese Recovery: Stepping on A Bounding Mine
Posted At : May 9, 2010 5:11 AM | Posted By : Satyajit Das
Related Categories: Emerging Markets
Fall & Rise

In 2007, unsustainable levels of debt in many economies triggered a near collapse of the global banking system that, in turn, triggered a major slowdown in growth.

The unprecedented external demand shock, with sharp decreases in consumption and investment from synchronous deep recessions in the developed world, affected the Chinese economy. The sudden and precipitous fall in exports led to a significant slow down in China’s stellar growth rates in 2008 triggering sharp declines in stock and property markets.

Job losses in export-intensive Guangdong province were in excess of 20 million migrant workers. Workers and students entering the workforce were unable to find work. Fearful of social instability, the Beijing government moved quickly to restore rapid growth.

Panicked government spending and loose monetary policies increasing available credit is currently driving China’s recovery, contributing between 75-90% of China’s growth of 10+% in 2009. In the Great Recession, Chinese exports (around 35-40% of the economy) decreased by around 20% implying that the non-export part of the economy grew strongly.

In 2009, new loans totalled around $1.5 trillion. This compares to total loans for the full 2008 year of around $600 billion. New lending peaked at a staggering 25% of China’s GDP. Once, the budget deficit is included the Chinese economic stimulus effort was around 15% of GDP.

The availability of credit fuelled rampant speculation in stocks, property and commodities. Estimates suggest that around 20-30% of new bank lending found it way into the property and stock market, driving up values. China’s recovery, in turn, underpinned the recovery in commodity prices and economies dependent on natural resources. In parliamentary testimony, Reserve Bank of Australia Assistant Governor Philip Lowe highlighted the extent to which Australia, a major trading partner of China, was reliant on Chinese demand. Lowe noted that 23% of Australia’s total exports went to China in the most recent quarter, up from 4% 10 years ago. China now also takes 80% of Australia’s iron ore exports and 20% of coal exports.

While a significant part of the importation of commodities is restocking depleted inventory, abundant and low cost bank finance combined with a deep seated fear of the long term prospects of U.S. Treasury bonds and the dollar has encouraged speculative stockpiling artificially boosting demand.

Lock & Load

Government spending and bank loans has resulted in sharp increases in fixed asset investments (over 30% up on 2008). A major component is infrastructure spending which accounts for over 70% of the Chinese government’s stimulus package. In 2009, investment accounted of over 80% of growth, approximately double the 43% average contribution over the last 10 years.

Infrastructure investment is adding to production capacity in a world with sluggish demand and major over-capacity in many industries. In the absence of sufficient domestic demand, the production may be directed into exports increasing the global supply glut and creating deflationary pressures.

Progress on shifting the emphasis to domestic consumption has been disappointing. Government incentives, in the form of rebates for purchases of high value durables such as cars and white goods, has increased consumption in the short run (up 15% on 2008). But, over the last 25 years, Chinese consumption has declined from around 50% to its current levels of 37%.

The current expansion in lending also risks creating China’s own home grown banking crisis with a rise in non-performing bank loans. The problems of bad debts from loose lending are not new. In the 1990s, similar credit expansion led to an increase in bad debts. The big state-owned Chinese banks had to be substantially recapitalised and restructured at significant cost to the State in a series of steps that ended as recently as 2004.

Chinese bank regulators are concerned that new lending is being used to finance real estate and stock market speculation rather than productive purposes. They have moved to try to reduce speculative lending but it is likely that the central bank will resolutely maintain its moderately loose monetary policy because of uncertainties in the external and domestic environment.

On 24 August 2009, Chinese Premier Wen Jiabao was reported as saying: “China will maintain its stimulative policy stance because the economy, far from being on solid footing, is facing fresh difficulties, … Beijing would ensure a sustainable flow of credit and a ‘reasonably sufficient’ provision of liquidity to support growth… ‘We must clearly see that the foundations of the recovery are not stable, not solidified and not balanced. We cannot be blindly optimistic…Therefore, we must maintain continuity and consistency in macro economic policies, and maintaining stable and quite fast economic growth remains our top priority. This means we cannot afford the slightest relaxation or wavering.’”

The centralised control structure of the Chinese economy has allowed rapid action to be taken to avert the slowdown in growth. In July 2009, Su Ning, Vice Governor of the Chinese Central Bank People’s Bank of China observed: “… ‘the mind and action’ of all financial institutions should ‘be as one’ with the government’s goal, and financial institutions should properly handle the relationship between supporting the economy’s development and preventing financial risks.” Even if execution is not in question, the appropriateness of the policy measures and the sustainability of the recovery are unclear.

Statistical Feelings

There are also concerns that Chinese statistics are unreliable and frequently manipulated by officials to meet political and personal objectives. One unexplained and nagging discrepancy is the difference between reported growth figures and electricity consumption. It is difficult to reconcile falls in electricity consumption with continued robust economic growth.

Even China’s state-controlled media has become increasingly skeptical about the accuracy of statistics. In recent polls, a high percentage of the population doubted official data.

International commentators have become concerned about the quality of the economic data. Commenting on the time taken by China’s National Bureau of Statistics (“NBS”) to compile growth data, Derek Scissors, from the Washington-based Heritage Foundation, wryly observed: “Despite starkly limited resources and a dynamic, complex economy, the state statistical bureau again needed only 15 days to survey the economic progress of 1.3 billion people.”

In response, the NBS launched a campaign - “Statistical Feelings: We have walked together – Celebrating the 60th anniversary of the founding of New China” - to increase confidence in its work. The campaign has already produced memorable slogans and poems. “I’m proud to be a brick in the statistical building of the republic.” “I can rearrange the stars in the sky because I have statistics.”

The problems extend to financial information as generally accepted accounting principles are not generally accepted in China. Writing in the 17 August 2009 New York Times, Mark Dixon, a mergers and acquisition advisor in China, expressed surprise that revenue and cost gymnastics were not included as an official event at the Beijing Olympics.

Bounding Mines

China’s $2 trillion foreign currency reserves, a large proportion denominated in dollars, is generally cited as a sign of economic strength. It may have limited value. They cannot be liquidated or mobilised without massive losses because of their sheer size. Increasingly strident Chinese rhetoric reflects rising concern about the security of these dollar investments as the U.S. issues massive amounts of debt reducing the value of Treasury bonds and the currency.

China’s Premier Wen Jiabao has expressed concern: “If anything goes wrong in the U.S. financial sector, we are anxious about the safety and security of Chinese capital…” In December 2008, Wang Qishan, a Chinee vice-premier, noted: “We hope the US side will take the necessary measures to stabilise the economy and financial markets as well as guarantee the safety of China’s assets and investments in the US.”

Yu Yindong, a former adviser to the Chinese central bank castigated the U.S. over its “reckless policies”. He asked Timothy Geithner, the U.S. Treasury Secretary to “show us some arithmetic.” At the University of Beijing, Mr. Geithner obliged indicating that the U.S. intended to reduce its budget deficit to 3% of GDP from its current level of 12% eliciting sceptical laughter from students.

China’s position is similar to that of a bank or investor with poor quality assets. China is trying to switch its reserves into real assets – commodities or resource producers where foreign countries will allow.

In the meantime, China continues to purchase more dollars and U.S. Treasury bonds to preserve the value of existing holdings in a surreal logic. On the other side, the U.S. continues to seek to preserve the status of the dollar as the sole reserve currency in order to enable the Treasury to finance America’s budget and trade deficit.

Every lender knows Keynes’ famous observation: “If I owe you a pound, I have a problem; but if I owe you a million, the problem is yours.” Almost 40 years ago, John Connally, then the U.S. Treasury Secretary, accurately identified China’s problem: “it may be our currency, but it’s your problem.”

The Chinese used to refer to dollars affectionately as mei jin, literally “American gold”. Chinese investments may not be the real thing – merely iron pyrite, fool’s gold.

China’s position is like that of an unfortunate who has stepped on a type of anti-personnel mine, known as a ‘bounding mine’. The mine does not explode when you step on it. Instead, it trips when you step off it as a small charge propels the body of the mine into the air where the explosive charge bursts and sprays fragmentation at a height of around 3 to 4 feet (1 to 1.3 metres). China, in building and investing its massive foreign exchange reserves in dollars and U.S. Treasury Bonds, has stepped onto the mine and it cannot step off without serious damage!

© 2010 Satyajit Das

Bacon on the barbie...

Spain experiencing the pain of investor shun as bids remain scarce for its latest offering...

Spain came close to its first debt auction failure on Tuesday,
highlighting the funding problems for weaker eurozone economies.

The government’s difficulties in selling €6.44bn ($7.96bn) in one-year
and 18-month bills sparked worries over its 10-year debt auction on

Madrid had planned to issue €8bn, but only just attracted that amount
of bids, with yields at record highs. This prompted debt managers to
reduce the size of the sale by €1.56bn. Normally a government bill
auction would be covered at least 1.5 times.

Steven Major, head of fixed income at HSBC, said: “The Spanish auction
was very disappointing and does not bode well for further issuance.
It’s becoming more apparent just how difficult it is for Spain, which
is a big worry so soon after the launch of the international rescue

Niall Fergusion

...rings the bell for a Euro rally. This article from the same man who recently announced the end of the U.S. I think he confuses levels with rates of change. Once pundits begin to re-state arguments found here, or here, it means the trade is getting crowded.

Even more alarming is the exposure of other EU banks to Greek debt, which totals $193 billion, according to the Bank for International Settlements. Factor in the risk of copycat crises in Portugal and Spain, and you begin to see the outlines of a disastrous Europewide banking crisis. The only way out of that will be further compromises by the ECB about the paper it accepts as collateral. Already last week it waived its rules, continuing to hold Greek bonds, despite their junk status. If this continues, there is only one way for the euro to go, and that's down.

Keep this in perspective. When the euro was launched back in January 1999, it was worth less than $1.20, and for most of its first three years it was down below parity with the dollar. So its recent slide from close to $1.60 before the global financial crisis to $1.27 last week is far from unprecedented. But the way this crisis is unfolding, further declines seem likely. It will surely be at least a year before investors wake up to the fact that the fiscal predicament of the United States is actually worse than that of the euro zone.

The difference is, of course, that the United States has a federal system, while the euro zone does not. In America, Texas automatically bails out Michigan via the redistribution of income and corporation tax receipts. What the Greek crisis has belatedly revealed is that such fiscal centralization is the necessary corollary of a monetary union.

Europe now faces a much bigger decision than whether to bail out Greece. The real choice is between becoming a fully fledged United States of Europe, or remaining little more than a modern-day Holy Roman Empire, a gimcrack hodgepodge of "variable geometry" that will sooner or later fall apart.

Monday, May 17, 2010

Foreign demand...

...for U.S. assets still massively strong. Net foreign purchases up by a large margin, and Treasury bond yields remain low in the face of healthy demand. Most pundits will ascribe this to one-off events like temporary EU volatility.

There is nothing temporary about the largest economic bloc in the world losing "reserve currency" status.

May 17 (Bloomberg) -- U.S. 10-year Treasury yields were near the lowest in more than a week amid concern European austerity measures will derail the economic recovery, increasing demand for the relative safety of government debt.

Two-year notes held near last week’s advance as a report showed New York manufacturing slowed. The dollar reached a four- year high against the euro after European Central Bank President Jean-Claude Trichet said the debt crisis may be worse than the Great Depression. European finance ministers meet in Brussels today, facing pressure to cut deficits fast enough to satisfy investors and police budgets once targets are met.

“There is no new data or fundamental news to provide much as far as the policy and economic landscape in Europe in concerned, so we are left to trade the prevailing themes of sovereign risk in Europe and the uncertainties in FX and equity markets.” said Ian Lyngen, a government bond strategist at CRT Capital Group LLC in Stamford, Connecticut. “The continuing uncertainty in Europe puts a cap on how much the Treasury market can sell off.”

The U.S. 10-year note yielded 3.45 percent as of 9:11 a.m. in New York, according to BGCantor Market Data, little changed from May 14. It dropped as far as 3.38 percent, the lowest since May 7. The 3.5 percent security maturing in May 2020 rose 1/32, or 31 cents per $1,000 face amount, to 100 14/32. The two-year note yield was little changed at 0.78 percent, after a drop of 3 basis points last week.

Setting the table...

...and providing the arena for any future conflict with China. A symbiotic relationship may be stable in the short-term with the U.S. providing security and the Chinese providing capital, low cost manufacturing, and resource extraction.

Full article here, and worth the read in the context of what I have mentioned before here, here, and here.

Three years ago it was reported that the Pentagon had already “agreed on access to air bases and ports in Africa and ‘bare-bones’ facilities maintained by local security forces in Gabon, Kenya, Mali, Morocco, Namibia, Sao Tome and Principe, Senegal, Tunisia, Uganda and Zambia.” [5] That is, in northern, eastern, western, central and southern Africa.

The U.S. has maintained its military base in Djibouti, Camp Lemonnier, since 2003, established a naval surveillance facility in Seychelles last autumn, and has access to base camps and forward sites in Kenya, Ethiopia, Morocco, Mali, Rwanda and other nations throughout the continent.

AFRICOM, as noted above, plans a central headquarters on the continent – its current headquarters remains in Stuttgart, Germany, although Djibouti’s Camp Lemonnier functions as a de facto one in Africa – with five regional satellite outposts in northern, southern, eastern, western and central Africa.

Expropriation risk...

...a continuing series.

The last sentence in this announcement from Mr. Chavez is a classic of its kind. They could not "settle with the owners", so they simply relieved the owners from the burden of ownership. So now what? We see the familiar refrain of capital, both financial and physical, fleeing to adjacent jurisdictions or perceived safe havens until some semblance of certainty with property rights can be achieved. The security and surveillance costs alone will be enough to bring Venezuela down.

CARACAS, Venezuela (AP) -- President Hugo Chavez announced Saturday the expropriation of a group of iron, aluminum and transportation companies in Venezuela's mining region.

Among the expropriated companies is Materiales Siderurgicos, or Matesi, which is the Venezuelan subsidiary of Luxembourg-based steel maker Tenaris SA.

Venezuela's socialist president said in a televised that his government was going to take over Matesi because "we couldn't reach an amicable and reasonable settlement with the owners."

Sunday, May 16, 2010

The men of Newport Beach...

...think that the EU rescue program is "backfiring".

“We think it is too risky to buy Greece and Portugal,” said the head of one of the largest US asset managers. “The chance of restructuring is too high. When there is default risk, you scale your exposure differently. There is no value. But even if there was value, our investors still don’t want us to invest.”

Ramin Toloui, a senior portfolio manager at Pimco, said the European Central Bank’s decision to buy government debt could be backfiring. Instead of encouraging private investors to keep their government debt, the programme might be leading to more sales, he said.

“The risk is that investors are using the ECB as a vehicle to exit their positions,” he said.

Read more:

Saturday, May 15, 2010

The apex of naivety...

More bloviating regarding the depth of the crisis and the proper "policy response". No-one in history has ever legislated away the NEED for countries to compete with one another, to obtain comparative advantage economically, politically, or militarily, to expand influence at home and abroad. These are the very incentives that drive the existence of sovereign nations.

I don't view national boundaries in a geographic sense. I view them as ecological barriers that restrain organic growth. Unfortunately, these are not stable.

full article here.

BERLIN (AP) -- The President of the European Central Bank was quoted Saturday as saying that he still sees Europe's economy in its deepest crisis since World War II, or even World War I.

German news weekly Der Spiegel reported that Jean-Claude Trichet said that since the beginning of the financial crisis in 2008 "we have experienced and we are experiencing really dramatic times."

Trichet was quoted as saying that there was no doubt the economy "is in its most difficult situation since World War II or perhaps even since World War I."

In an interview to be published Monday, Trichet said the recent exacerbation of the eurozone's debt crisis had provoked a market reaction similar to that at the height of the global financial crisis in 2008.

"The markets didn't function anymore, it was almost like in the wake of the Lehman (Brothers) bankruptcy in September 2008," he was quoted as saying.

Even though European leaders last weekend agreed on rescue measures including a euro750 billion ($935 billion) loan guarantee package for troubled eurozone nations, Trichet urged further action to address the crisis' underlying problems.

The ECB's president called for a "quantum leap" in control of financial and economic policy across the 16-nation currency zone, the magazine reported.

"We need improved structures, to avoid and sanction wrongdoing," Trichet was quoted as saying. "We need an effective implementation of the mutual control, we need effective sanctions for breaches of the stability and growth pact."

Friday, May 14, 2010


A wonderfully encapsulating statement regarding European scenario planning. Creating an entirely new structure of governance for a continent that has historically speaking been one of the most violent neighborhoods on the planet without any contingency preparations. What possible conclusion can an observer derive from this?

Full article here

What was conceived as a club for Europe’s strongest economies was expanded for political reasons, leaving the currency union with minimal powers to police deficit spending and no safety net for dealing with countries, like Greece, that veer toward default.

“There was no discussion of that at all, of a crisis mechanism,” said Niels Thygesen, a retired Copenhagen University economics professor who served on the 1989 group led by European Commission President Jacques Delors that mapped out the path to the euro. “It was believed that if countries adhered more or less to prudent budgetary policies, that would not or could not happen.”

Thursday, May 13, 2010

Euro funding difficulties.

A nice graph depicting the funding difficulties (Euro and otherwise) of several countries.

Wednesday, May 12, 2010

Mean Reversion...

...which direction is this more likely to go?

(graph depicts Dividend Yield for S&P 500 since 1860.)

Economic data

Business activity and capacity crawling upwards. Housing and manufacturing still flat.

Full report from the Treasury here.

What could possibly go wrong?

Cimpletely circumventing congress and providing funding to the ECB without collateral or a very iron-clad schedule of payments. I see the rational, what I find inexcusable is the process.

"U.S. Dollar-Euro Swap Agreement Dated as of May 10, 2010", Section 5 part (b):

"In the event the ECB does not pay the USD amount due under a swap transaction on the maturity date, the parties agree to roll over any shortfall into a new overnight swap transaction"

"I think at this point it should be very clear"

(The title and accompanying picture refer to events in Episode 13, Season 3 of "Mad Men", one of precious few Television shows worth watching)

Real Estate prices "correcting" in China. The cash flows that support these purchases and investments rely on export volume, which has slowed. It has been exacerbated by central planning and the inability of the CPC to adjust to changing economic decisions. Instead, China opted for the Khyber Pass strategy...simply throw more resources at the same strategy and hope it works. And so Chinese banks abandoned any semblance of prudent risk management and loaned ever greater amounts to industrial companies in the hopes that the world would wake up and import even more Chinese goods.

You see, dear reader, this is why the "alarm bells" going off in the popular press that "China has decreased Treasury purchases!, America is doomed" was always so silly. The financial press should have looked deeper: The reason China has levelled off its purchases is because it is receiving less American currency from purchases. Very few people understood how crucial American purchases were to the Chinese economy given just how thin profit margins were. "Making it up on volume" only works if you have the volume.

On the other side, Yuan is plentiful given the deluge of State-Directed Bank loans. How to put that Yuan-denominated capital to use? What assets were to be bought or built? The below article spells it out.

We've been waiting for tightening measures to hit the Beijing property market, especially after the city's real estate association itself said the situation was a bubble.

It looks like the government's clampdown is starting to bite, hard. Average Beijing transaction prices collapsed 31% month on month:

Capital Vue:

The average transaction price of commercial residential properties in Beijing for the week ended May 9 fell 1,790 yuan per square meter or 9.6 percent week-on-week to 16,898 yuan per square meter, reports The Beijing News, citing statistics released by Beijing Real Estate Information Network.


Nice editorial by Gilbert at Bloomberg:

May 12 (Bloomberg) -- One of the proudest achievements of the euro project was ensuring government borrowing costs converged at the lower levels enjoyed by Germany rather than the higher yields paid by its less fiscally disciplined neighbors.

That’s over. Done. Finished. Just as the bailout of the banking system produced a plethora of unintended consequences, so the European Union’s decision to pledge almost $1 trillion to defend the single-currency project will unleash a series of undesirable aftershocks. Here are some that are inevitable.

It’s Solvency, Stupid, Not Liquidity.

Cast your mind back to March 17, 2008. Richard Fuld, then chief executive officer of Lehman Brothers Holdings Inc., said the Federal Reserve’s decision to expand the list of firms it lent money to “takes the liquidity issue off the table.” Six months later, Lehman was dead.

Europe can’t solve the problem of too much debt by adding yet more debt. Robbing Helmut to pay Stavros is a recipe for disaster. Giving Greece a helping hand over its bond repayment humps doesn’t fix the underlying crisis -- Greece is insolvent, and some of its peers aren’t in much better shape. That’s a far bigger worry for bondholders than any short-term cash-flow issues.

The Meanness of the Mean

Moral hazard, which came to the fore as governments admitted that some institutions are too big to fail and will always get bailed out no matter how egregious their financial transgressions, now attaches to governments themselves.

Greece lived beyond its means, and got rescued by the EU. The irresistible logic is that all the debt of the euro region is now jointly and severally guaranteed -- exactly what the euro’s founders sought to avoid.

The inevitable market response should be to drive bond yields to some average level that is higher than the previously subdued bund yields, now that Germany is effectively on the hook for the debt of all its currency neighbors.

The End of AAA

A similar analysis applies to credit ratings. Germany is a AAA borrower in its own right; if you saddle it with the debt obligations of Greece, Portugal, Spain and others, its grading will have to be lower than the top level. It remains to be seen whether the rating companies, which are under almost daily regulatory threat from European governments for finally doing their job and downgrading weak borrowers, have the backbone to follow through on this logic.

Tuesday, May 11, 2010


Looks good, but...

...looking healthy on the consumer side, but still anemic in real estate markets and investment most likely to produce employment gains. I have also been getting largely anecdotal reports that bid-ask spreads in most markets are heading quickly toward convergence.

Some real positive signs, and the U.S. is clearly benefiting from Europe's difficulties.

In tin-foil hat news, I have also received reports of large trucks in Germany near large banks...the speculation being that the D-Mark will be back. This is of course silly, but it does add to Europe Schadenfreude.

Inflation in China

This should surprise no-one here.

May 11 (Bloomberg) -- China’s inflation accelerated, bank lending exceeded estimates and property prices jumped by a record, increasing pressure on the government to raise interest rates and let the currency appreciate.

Consumer prices rose 2.8 percent in April from a year earlier, the fastest pace in 18 months, and property prices jumped 12.8 percent, the statistics bureau said in statements today. New lending of 774 billion yuan ($113 billion), announced by the central bank, was more than any of 24 economists forecast.

Asian stocks fell, with the local benchmark index entering into a bear market, and oil and copper slumped on concern the government will move to cool the fastest-growing major economy. China should focus on preventing excessive increases in asset prices and liquidity after Europe’s almost $1 trillion loan package reduced the risk of another global slump, central bank adviser Li Daokui said yesterday.


The clamor concerning the eroding credibility of the ECB interesting to witness. Divorcing monetary policy from fiscal policy is difficult enough within a sovereign nation (witness the Fed's attempt to navigate through the political labyrinth with varying degrees of success).

But, as usual, expediency is the rule of the day for politicized institutions. This is especially true of the ECB, which has no institutional experience with crisis (and as I have repeatedly said, apparently had no contingency plan in place for severe market stress).

And so the perception of the ECB will be permanently tarnished as it folds. The several governments are already performing their own contingency analysis to be prepared when the Euro fails.

With more and more chatter out of Deutschland, this is a certainty.

May 11 (Bloomberg) -- There is an old saying among central bankers that credibility is earned in years of hard work, but can be lost overnight. On Sunday night, the European Central Bank may have said goodbye to its credibility when it agreed to buy the government bonds of euro nations in trouble.

This casts a dark shadow over the euro area’s 750 billion- euro ($980 billion) stability package, which was dressed to impress, and seems to have worked so far. Markets will probably advance in the near term as short positions need to be covered.

A major casualty of the emergency decisions was the ECB. With its move to prop up the failing bonds of governments in financial distress, it has allowed itself to be transformed into an agent of fiscal policy. The intention to sterilize bond purchases means, in effect, that it taxes euro-area private borrowers to support governments in difficulty. In the long run, this is likely to undermine confidence in the ECB and the euro.

Markets last week gave their thumbs down to the Greek rescue program led by the euro area and the International Monetary Fund, probably for two reasons: fears that Greece can’t implement the program, and that Greece wouldn’t return to solvency even if it did.

Here is what has scared investors (apart from the riots in Athens): Even if the IMF program were fully implemented, the Greek debt ratio is projected to rise to 150 percent of gross domestic product by 2013. Assuming an interest rate of 5 percent, Greece would pay 7.5 percent of its GDP to bondholders. With more than 80 percent of creditors being foreign by then, the country would transfer at least 6 percent of its GDP abroad.

Monday, May 10, 2010

All this...

...and Treasury yields as well as the Euro are basically flat.

This has to make Trichet very nervous. My view is that this is just the first tremor that will lead to the eventual break-up of the Euro area. Whether this is due to financial pressures, mass political unrest, something even more onerous remains to be seen.

It looks formidable...

(My apologies, dear reader, but I had to continue the Star Wars theme...indulge me)

...but the measures taken by the ECB and Euro Area countries don't address the various Euro funding needs by the PIIGS. Today's melt-up in global stock indices will be tested in the next two days as the ramifications from this "Euro-Tarp" are parsed out from the rhetoric.

Thus far, the provisions announced simply fund the peripheral governments from the core EU governments. This increases deflationary pressure (something the EU desperately needs to avoid as the presumed goal of these measures is buying time for exports to increase) as the funding pressures increase. At its core, this is swapping debt for more debt without correcting the core problems.

Meanwhile, ominously, the 10-year seems ambivalent to this. Bond markets in my experience are the "smartest guys in the room" and this does not portend well. A challenge to these EU actions seems imminent to me.

Also, notice the fissures in political rule-sets. These bail-out measures (which are expressly "verboten" in the EU treaties) must be approved by various parliaments, which is by no means guaranteed. Germany in particular appears particularly agitated as a Supreme Court challenge looms.

Again, its obvious this scenario was never contemplated, or if it was, the architects of the system counted on the fact political pressure would give them license to do whatever they wished and to work out any troublesome "details" (such as the measures being against EU treaties and against the law in the several countries). I am not sure which is more disconcerting.

Sunday, May 09, 2010

Swap Lines fully armed AND operational

The EU is throwing the kitchen sink at this, with QE, swap lines, loan guarantees, SDR requests, etc. An impressive array of financial weaponry on display. Of course "display" being the key word as this is about signaling. Sterilization of debt does not work. Japan has "sterilized" trillions of Yen in the past decade or so and still rates are no-where near what they should be if such "Qauntivative Easing" actually worked.

Violating many provisions of the various EU treaties as well as the ECB bank charter. Expediency rules the day here, and it is to my great dismay (handled in a previous post) that the Fed has agreed to re-establish swap lines with the ECB. A massive risk given the amount of turbulence in the FX markets for Euro...which, incidentally, was touted as a "reserve currency" not more than two quarters ago. NOTE that the only quantities given are with the Bank of other AMOUNTS thus far, although they will have to be disclosed.

Again, expediency rules the day here. This smacks of Cortez grounding his ships to indicate that there is no turning back or alternative to the status quo suitably rescued from disaster by socializing the risks involved.

Release Date: May 9, 2010
For release at 9:15 p.m. EDT

In response to the re-emergence of strains in U.S. dollar short-term funding markets in Europe, the Bank of Canada, the Bank of England, the European Central Bank, the Federal Reserve, and the Swiss National Bank are announcing the re-establishment of temporary U.S. dollar liquidity swap facilities. These facilities are designed to help improve liquidity conditions in U.S. dollar funding markets and to prevent the spread of strains to other markets and financial centers. The Bank of Japan will be considering similar measures soon. Central banks will continue to work together closely as needed to address pressures in funding markets.

Federal Reserve Actions
The Federal Open Market Committee has authorized temporary reciprocal currency arrangements (swap lines) with the Bank of Canada, the Bank of England, the European Central Bank (ECB), and the Swiss National Bank. The arrangements with the Bank of England, the ECB, and the Swiss National Bank will provide these central banks with the capacity to conduct tenders of U.S. dollars in their local markets at fixed rates for full allotment, similar to arrangements that had been in place previously. The arrangement with the Bank of Canada would support drawings of up to $30 billion, as was the case previously.


The elephant in the room (Germany) being very quiet during the latest round of trial ballons from the EU/ECB. This is interesting as the pressure mounts.

Latest Market Indicator

The Empire State Building.

It's lighting scheme for this weekend (May 8-9) is "European Union, E.U. Day".

I shudder to think what will happen on 5/25...Lighting in celebration of Argentina's 200 year anniverary.

EU finance ministers meet.

This is a perfect time to instill my proposal for these types of meetings. If the U.S. is serious about making these summits productive for the rest of the world, it will ship 100 cases of Bourbon and Rye American Whiskey and demand a 3 drink minimum for any meeting between 2 or more EU officials.

This is because it is clear EU members are quite happy to reap the benefits of currency union, and quite unwilling to face any reckoning that results. This is natural, and is what is expected from sovereign nations in a competitive world. Realpolitik is back. Volatility is back. Conflict is back.

In this article, the below quote is illuminating as it is too obvious. A mash-up of Lehman quotes regarding its financial position and quotes from these meetings would be an amusing exercise.

Officials hope the loan guarantees would prevent the crisis in Greece spreading to other eurozone countries with high deficits or debts as well as low economic growth, most notably Portugal, Spain and Ireland.

"Between now and Sunday night we will have a watertight line of defence," Eurogroup Chairman Jean-Claude Juncker said on Saturday.

"We have to make it clear that all eurozone countries are ready to defend each and every eurozone country, because they want to defend the eurozone as a whole," he added.

Saturday, May 08, 2010

No bail out clause?

A promise to establish a fund that promises to defend the euro. Deft.

Tightening the noose. This only makes the (in my opinion inevitable) implosion of the Euro area that much more dangerous. Imagine all the scenarios for each Euro country member during times of economic stress. Remember, the Euro is only a bit more than a decade old and experienced its first existential crisis.

The euro will likely see a rebound until the final implications are digested. This measure simply buys time.

British officials are concerned that the EU is preparing to use the sweeping Lisbon Treaty clause as the legal basis for a European bailout scheme.

Under the clause, an EU member state hit by “natural disasters or exceptional occurrences beyond its control” can receive “financial assistance” after a qualified majority vote by European leaders.

Supporters of the plan argue that “exceptional circumstances” includes market “attacks” on the euro.

”The euro’s 16 countries have already agreed it - that’s a majority," said a diplomat. "It’s a fait accompli. Those not in the euro - Britain, Poland, Sweden and other new EU members - can’t stop this."

Officials and diplomats have confirmed that Gordon Brown, the Prime Minister, was the last non-eurozone leader to be telephoned on Friday night by José Luis Rodríguez Zapatero, his Spanish oppositer number, to be warned about the EU plan.

Europe’s failure to contain Greece’s fiscal crisis last week triggered a 4.3 per cent drop in the euro and threatened to spark a global debt crisis.

Central Bank Swaps

There are rumors about concerning the Fed and the possibility that it may open foreign currency swaps with other central banks.

I have raised this issue many times on this blog, specifically here, here, and here.

AGAIN, I sound the alarm: The Fed is going to take on enormous foreign currency risk WITHOUT AUTHORIZATION FROM CONGRESS. This alone might be pause for concern, but there is also the issue of oversight on the back are the dollars from the swap agreements going to be used and what assurances concerning their use are given by the ECB? This is no mere swap between small market players where counter-party risk can be managed. We are discussing Central Banks taking massive, potentially destabilizing, risks in the name of stopping "contagion".

This will be labelled "coordination" or some equally innocuous term by Central Banks, but this is incredibly dangerous and the fact that there is no official oversight of this activity, or a hurdle that activates congressional involvement (say, 100 Billion. Anything above that requires other eyes besides the cloister of the Fed examining the deal) speaks a great deal about how powerful the Fed has become. A banks that was formed to promote economic growth and provide price stability to the United States currency now sees fit to perform global economic rescues without direct authorization from any branch of the U.S. government.

Let me make clear I have no problem actually providing this swap - if the U.S. can benefit from its position as provider of both physical security AND financial security, it will remain in the most enviable of positions. However, the process and lack of risk disclosure is worrisome.

Satire is a wonderful weapon....

...That Mr. Grayson puts to effective use.

In this video, he advocates for auditing the Fed. I agree, and the predictable response from the Eunuch class of "transparency will make us less effective in our own operations" rings hollow.

Friday, May 07, 2010


...worthy of a Keiretsu. I note the subtle use of occult imagery with amusement as well.


...likely begin to erode off the bonds at this point. A nice ride. This dovetails nicely with most of the "suggestions" I have been talking about for some time. We are entering a new set of geo-political risk inflection points. I will comment at length on my new views. We must all keep looking forward.

Consumer credit., unemployment

Weak, and note the activity by money center banks and institutions.

Full release here.

Today's unemployment will provide further guidance on Fed policy.

ADDENDUM: Unemployment comes in at 9.9%, with only 44k or so jobs added (after some statistical revision), with ghastly hourly numbers. A positive number for private employment is the silver lining.

Meanwhile, it looks as if the financial media is keeping up with the themes I have been speaking about time and time again. Rate compression,Fisherian Debt Deflation, flight to safety, similarities with Japan and the fallacy of deficit spending of SCIs being inflationary by definition, etc. Full Article here.

The combination of low inflation and high unemployment makes this economic cycle different from any since the 1940s, Kasman said. In the recoveries from the recessions of the 1970s and early 1980s, the annual rate of inflation peaked at 10.2 percent and 9.7 percent, as measured by the core personal- consumption index.

During the recoveries in the early 1960s and in 2001, inflation slowed to a pace as low as 1.1 percent and unemployment never rose above 7.1 percent.

Fed officials last week restated their intention to keep their benchmark rate low for an “extended period,” noting that consumer spending continues to be restrained by weak income growth and tight credit. The target for overnight loans among banks has been in a range of zero to 0.25 percent since December 2008.

Minutes of the Fed’s March meeting show policy makers were surprised by the pace at which price growth slowed in the first quarter.

Thursday, May 06, 2010

Hugh Hendry...

in the news again in this exchange with some technocrats and a Brookings Institute fellow.

The technocrats and intellectuals all have predictable views toward the stability of the EU: it has to be defended at all costs less the grand experiment be deemed a failure and the golden goose is killed.


...making very large moves today. Percentage changes.

The Universe...

/start metaphysical rant

I have long thought that, despite the best Doppler estimates regarding the speed of the expansion of the universe, that it will all collapse in upon itself..."again". I say "again" because I have a feeling this super-cycle-of-everything has happened many times. Perhaps there are many such experiments going on simultaneously in the Great Architect's laboratory.

Anyway, the resultant singularity will then explode in "another" bang and the multi-billion year cycle "everything". Of course, this comes from the same person who wrote a high school paper that theorized Qausars were simply the "ejection" points for Black Holes.

/end metaphysical rant

Here on planet earth, readers will note my penchant for historical corrolaries and cycles. Some are more obvious than others and are triggered by a wide variety of catalysts.

Government law and policy is a MAJOR source of these catalysts, and it is rare for Government to examine all the consequences resulting from drafting legislation. This is entirely natural for an entity that suffers no immediate consequence from their actions and the sheer complexity of the systems they create makes accountability problematic. In other words, blame the previous administration, and continue the game.

And so we have this Health Care legislation that is causing some companies to reconsider health benefits for employees. The economic costs of the penalties will be weighed against providing such coverage as the below article outlines. This in turn will cause profits to increase as health care costs are pared down.

At this point, a Value Added Tax ("VAT") will be considered as the Government finds its citizenry getting increasingly "concerned" about the cost/quality of health care insurance. A VAT will seek to redress the mistake of Health Care reform.

VATs directly benefit large conglomerates in market competition. Conglomerates have the scale and systems integration to apply the VAT without much cost. Smaller companies will have increased costs in compliance and administration.

And so, paradoxically, a possible outcome of Health Care legislation is the increased presence and power of very large companies. If we see a repeal effort for the anti-trust laws, then you know the cycle is complete.

(Fortune) -- The great mystery surrounding the historic health care bill is how the corporations that provide coverage for most Americans -- coverage they know and prize -- will react to the new law's radically different regime of subsidies, penalties, and taxes. Now, we're getting a remarkable inside look at the options AT&T, Deere, and other big companies are weighing to deal with the new legislation.

Internal documents recently reviewed by Fortune, originally requested by Congress, show what the bill's critics predicted, and what its champions dreaded: many large companies are examining a course that was heretofore unthinkable, dumping the health care coverage they provide to their workers in exchange for paying penalty fees to the government.


Trichet and the rest of the ECB continue to stammer and flail about without any real credible action. Swift, decisive action is needed and the EU/ECB/Brussels culture is diametrically opposed to such measures. It is amazing to me that, with all the technocrats in Brussels and throughout the EU, this type of scenario has not even been imagined nor a contingency plan formulated.

It is also history's accident that someone so close to the French establishment is head of the ECB and I cannot help but think Trichet will not act entirely in accordance with the collective will of the EU. France seems to know what is coming and is preparing.