- Why It Really All Comes Down To The Death Of The Petrodollar
Last week, in the global currency war’s latest escalation, Kazakhstan instituted a free float for the tenge. The currency immediately plunged by some 25%.
The rationale behind the move was clear enough. The plunge in crude prices along with the relative weakness of the Russian ruble had severely strained Kazakhstan, which is central Asia’s largest crude exporter. As a quick look at a chart of the tenge’s effective exchange rate makes clear, the pressure had been mounting for quite a while and when China devalued the yuan earlier this month, the outlook for trade competitiveness worsened.
What might not be as clear (on the surface anyway) is how recent events in developing economy FX markets following the devaluation of the yuan stem from a seismic shift we began discussing late last year – namely, the death of the petrodollar system which has served to underwrite decades of dollar dominance and was, until recently, a fixture of the post-war global economic order.
In short, the world seems to have underestimated how structurally important collapsing crude prices are to global finance. For years, producers funnelled their dollar proceeds into USD assets providing a perpetual source of liquidity, boosting the financial strength of the reserve currency, leading to even higher asset prices and even more USD-denominated purchases, and so forth, in a virtuous (especially if one held US-denominated assets and printed US currency) loop. That all came to an abrupt, if quiet end last year when a confluence of economic (e.g. shale production) and geopolitical (e.g. squeeze the Russians) factors led the Saudis to, as we put it, Plaxico themselves and the US.
The ensuing plunge in crude meant that suddenly, the flow of petrodollars was set to dry up and FX reserves across commodity producing countries were poised to come under increased pressure. For the first time in decades, exported petrodollar capital turned negative.
That set the stage for a prolonged downturn in emerging market currencies, and as worries about China’s economy – the engine of global growth and trade – grew, so did the pressure.
Thus when Beijing moved to devalue the yuan, it drove a stake through the heart of the EM world by simultaneously i) validating concerns about weak Chinese growth, thus guaranteeing further pressure on commodities, ii) delivering a staggering blow to the export competitiveness of multiple emerging economies, iii) depressing demand from the mainland by making imports more expensive. Thanks to the conditions that resulted from the death of the petrodollar (e.g. falling FX reserves and growing fiscal headwinds), the world’s emerging markets were in no position to defend themselves against the fallout from the yuan devaluation. Complicating matters is a looming Fed hike. Included below is a look at flows into (or, more appropriately, “out of”) EM bonds. As Barclays notes, the $2.5 billion outflow in the week to August 21 is the highest level since February of last year.
We are, to put it mildly, entering a not-so-brave new world and the shift was catalyzed by the dying petrodollar. Kazakhstan’s move to float the tenge is but the beginning and indeed Kazakh Prime Minister Karim Massimov told Bloomberg on Saturday that the world has entered “a new era” and that soon, any and all petro currency dollar pegs are set to fall like dominoes. Here’s more:
Currency pegs in crude-producing nations are set to topple as the world enters a “new era” of low oil prices, according to the prime minister of Kazakhstan, which rattled markets this week with a surprise decision to abandon control of its exchange rate.
“At the end of the day, most of the oil-producing countries will go into the free floating regime,” including Saudi Arabia and the United Arab Emirates, Karim Massimov said in an interview on Saturday in the capital, Astana. “I do not think that for the next three to five, maybe seven years, the price for commodities will come back to the level that it used to be at in 2014.”
Central Asia’s biggest energy producer cut its currency loose on Thursday, triggering a 22 percent slide in the tenge to a record low versus the dollar. The move followed China’s shock devaluation of the yuan the week before, which drove down oil prices on concern global growth will stutter and nudged nations with managed exchange rates toward competitive devaluations of their own.
More than $3.3 trillion has been erased from the value of global equities after China’s decision spurred a wave of selling across emerging markets. Brent crude touched a six year-low of $45.07 per barrel on Friday, while the Dow Jones Industrial Average entered a correction.
“After I watched what is happening on the financial market and stock market in the U.S. on Friday night, I thought that we did it at the right time,” Massimov, 50, said in his office in the government’s headquarters. The decision avoided “big speculation and pressure this weekend in Kazakhstan,” he said.
The central bank spent $28 billion this and last year to support the tenge, including $10 billion in 2015, Kazakh President Nursultan Nazarbayev said this week. After its slump on Thursday, the currency rallied 7.4 percent to close at 234.99 against the dollar a day later. The country’s dollar bonds due July 2025 climbed after the announcement, lowering the yield nine basis points to 5.74 percent in the last two days of the week.
Before the currency shift, Kazakhstan was at a competitive disadvantage to Russia, its neighbor and top trading partner along with China. The tenge had fallen by only 7.6 percent against he dollar in the 12 months up to Aug. 20, compared with a 46 percent depreciation for the ruble, while crude had plummeted 55 percent in the period.
We discussed this in great detail on Friday (with quite a bit of color on the fiscal impact for Saudi Arabia) and we’ve included a chart from Deutsche Bank which should have some explanatory and predictive value below, but the big picture takeaway is that the world is now beginning to feel the impact of the petrodollar’s quiet demise, and because this is only the beginning, we’ve included below the entire text of the petrodollar’s obituary which we penned last November .
* * *
How The Petrodollar Quietly Died And Nobody Noticed
Two years ago, in hushed tones at first, then ever louder, the financial world began discussing that which shall never be discussed in polite company – the end of the system that according to many has framed and facilitated the US Dollar’s reserve currency status: the Petrodollar, or the world in which oil export countries would recycle the dollars they received in exchange for their oil exports, by purchasing more USD-denominated assets, boosting the financial strength of the reserve currency, leading to even higher asset prices and even more USD-denominated purchases, and so forth, in a virtuous (especially if one held US-denominated assets and printed US currency) loop.
The main thrust for this shift away from the USD, if primarily in the non-mainstream media, was that with Russia and China, as well as the rest of the BRIC nations, increasingly seeking to distance themselves from the US-led, “developed world” status quo spearheaded by the IMF, global trade would increasingly take place through bilateral arrangements which bypass the (Petro)dollar entirely. And sure enough, this has certainly been taking place, as first Russia and China, together with Iran, and ever more developing nations, have transacted among each other, bypassing the USD entirely, instead engaging in bilateral trade arrangements, leading to, among other thing, such discussions as, in today’s FT, why China’s Renminbi offshore market has gone from nothing to billions in a short space of time.
And yet, few would have believed that the Petrodollar did indeed quietly die, although ironically, without much input from either Russia or China, and paradoxically, mostly as a result of the actions of none other than the Fed itself, with its strong dollar policy, and to a lesser extent Saudi Arabia too, which by glutting the world with crude, first intended to crush Putin, and subsequently, to take out the US crude cost-curve, may have Plaxico’ed both itself, and its closest Petrodollar trading partner, the US of A.
As Reuters reports, for the first time in almost two decades, energy-exporting countries are set to pull their “petrodollars” out of world markets this year, citing a study by BNP Paribas (more details below). Basically, the Petrodollar, long serving as the US leverage to encourage and facilitate USD recycling, and a steady reinvestment in US-denominated assets by the Oil exporting nations, and thus a means to steadily increase the nominal price of all USD-priced assets, just drove itself into irrelevance.
A consequence of this year’s dramatic drop in oil prices, the shift is likely to cause global market liquidity to fall, the study showed.
This decline follows years of windfalls for oil exporters such as Russia, Angola, Saudi Arabia and Nigeria. Much of that money found its way into financial markets, helping to boost asset prices and keep the cost of borrowing down, through so-called petrodollar recycling.
But no more: “this year the oil producers will effectively import capital amounting to $7.6 billion. By comparison, they exported $60 billion in 2013 and $248 billion in 2012, according to the following graphic based on BNP Paribas calculations.”
In short, the Petrodollar may not have died per se, at least not yet since the USD is still holding on to the reserve currency title if only for just a little longer, but it has managed to price itself into irrelevance, which from a USD-recycling standpoint, is essentially the same thing.
According to BNP, Petrodollar recycling peaked at $511 billion in 2006, or just about the time crude prices were preparing to go to $200, per Goldman Sachs. It is also the time when capital markets hit all time highs, only without the artificial crutches of every single central bank propping up the S&P ponzi house of cards on a daily basis. What happened after is known to all…
“At its peak, about $500 billion a year was being recycled back into financial markets. This will be the first year in a long time that energy exporters will be sucking capital out,” said David Spegel, global head of emerging market sovereign and corporate Research at BNP.
Spegel acknowledged that the net withdrawal was small. But he added: “What is interesting is they are draining rather than providing capital that is moving global liquidity. If oil prices fall further in coming years, energy producers will need more capital even if just to repay bonds.”
In other words, oil exporters are now pulling liquidity out of financial markets rather than putting money in. That could result in higher borrowing costs for governments, companies, and ultimately, consumers as money becomes scarcer.
Which is hardly great news: because in a world in which central banks are actively soaking up high-quality collateral, at a pace that is unprecedented in history, and led to the world’s allegedly most liquid bond market to suffer a 10-sigma move on October 15, the last thing the market needs is even less liquidity, and even sharper moves on ever less volume, until finally the next big sell order crushes the entire market or at least force the [NYSE|Nasdaq|BATS|Sigma X] to shut down indefinitely until further notice.
So what happens next, now that the primary USD-recycling mechanism of the past 2 decades is no longer applicable? Well, nothing good.
Here are the highlights of David Spegel’s note Energy price shock scenarios: Impact on EM ratings, funding gaps, debt, inflation and fiscal risks.
Whatever the reason, whether a function of supply, demand or political risks, oil prices plummeted in Q3 2014 and remain volatile. Theories related to the price plunge vary widely: some argue it is an additional means for Western allies in the Middle East to punish Russia. Others state it is the result of a price war between Opec and new shale oil producers. In the end, it may just reflect the traditional inverted relationship between the international value of the dollar and the price of hard-currency-based commodities (Figure 6). In any event, the impact of the energy price drop will be wide-ranging (if sustained) and will have implications for debt service costs, inflation, fiscal accounts and GDP growth.
Have you noticed a reduction of financial markets liquidity?
Outside from the domestic economic impact within EMs due to the downward oil price shock, we believe that the implications for financial market liquidity via the reduced recycling of petrodollars should not be underestimated. Because energy exporters do not fully invest their export receipts and effectively ‘save’ a considerable portion of their income, these surplus funds find their way back into bank deposits (fuelling the loan market) as well as into financial markets and other assets. This capital has helped fund debt among importers, helping to boost overall growth as well as other financial markets liquidity conditions.
Last year, capital flows from energy exporting countries (see list in Figure 12) amounted to USD812bn (Figure 3), with USD109bn taking the form of financial portfolio capital and USD177bn in the form of direct equity investment and USD527bn of other capital over half of which we estimate made its way into bank deposits (ie and therefore mostly into loan markets).
The recycling of petro-dollars has benefited financial markets liquidity conditions. However, this year, we expect that incremental liquidity typically provided by such recycled flows will be markedly reduced, estimating that direct and other capital outflows from energy exporters will have declined by USD253bn YoY. Of course, these economies also receive inward capital, so on a net basis, the additional capital provided externally is much lower. This year, we expect that net capital flows will be negative for EM, representing the first net inflow of capital (USD8bn) for the first time in eighteen years. This compares with USD60bn last year, which itself was down from USD248bn in 2012. At its peak, recycled EM petro dollars amounted to USD511bn back in 2006. The declines seen since 2006 not only reflect the changed global environment, but also the propensity of underlying exporters to begin investing the money domestically rather than save. The implications for financial markets liquidity – not to mention related downward pressure on US Treasury yields – is negative.
* * *
Even scarcer liquidity in US Capital markets aside, this is how BNP sees the inflation and growth for energy exporters:
Household consumption benefits: While we recognise that the relationship is not entirely linear, we use inflation basket weights for ‘transportation’ and ‘household & utilities’ (shown in the ‘Economic components’ section of Figure 27) as a means to address the differing demand elasticities prevalent across countries. These act as our proxy for consumption the consumption basket in order to determine the economic benefit that would result as lower energy prices improve household disposable income. This is weighted by the level of domestic consumption relative to the economy, which we also show in the ‘Economic components’ section of Figure 27.
Reduced industrial production costs: Outside the energy industry, manufacturers will benefit from falling operating costs. Agriculture will not benefit as much and services will benefit even less.
Trade gains and losses: Lost trade as a result of lower demand from oil-producing trade partners will impact both growth and the current account balance. On the other hand, better consumption from many energy-importing trade partners will provide some offset. The percentage of each country’s exports to energy producing partners represents relative to its total exports is used to determine potential lost growth and CAR due to lower demand from trade partners.
Domestic FX moves are beyond the scope of our analysis. These will be tied to the level of openness of the economy and the impact of changed demand conditions among trade partners as well as dollar effects. Neither do we address non-oil related political risks (eg sanctions) or any fiscal or monetary policy responses to oil shocks.
GDP growth
The least impacted oil producing country, from a GDP perspective, is Brazil followed by Mexico, Argentina, Tunisia and Trinidad & Tobago. The impact on fiscal accounts also appears lower for these than most other EMs.
Remarkably, the impact of lower oil for Russia’s economic growth is not as severe as might be expected. Sustained oil at USD80/bbl would see growth slow by 1.8pp to 0.6%. This compares with the worst hit economies of Angola (where growth is nearly 8pp lower at -2%), Iraq (GDP slows to -1.6% from 4.5% growth), Kazakhstan and Azerbaijan (growth falls to -0.9% from 5.8%).
For a drop to USD 80/bbl, it can be seen (in Figure 27) that, in some cases, such as the UAE, Qatar and Kuwait, the negative impact on GDP can be comfortably offset by fiscal stimulus. These economies will probably benefit from such a policy in which case our ‘model-based’ GDP growth estimate would represent the low end of the likely outcome (unless a fiscal policy response is not forthcoming).
Global growth in 2015? More like how great will the hit to GDP be if oil prices don’t rebound immediately?
On the whole, we can say that the fall in oil prices will prove negative, shaving 0.4pp from 2015 EM GDP growth. The collective current account balance will fall 0.58pp to 0.6% of GDP, while the budget deficit will deteriorate by 0.61pp to -2.9%. This probably has the worst implications for EM as an asset class in the credit world.
Energy exporters will fare worst, with growth falling by 1.9pp and their current account balances suffering negative pressure to the tune of 2.69pp of GDP. Budget balances will suffer a 1.67pp of GDP fall, despite benefits from lower subsidy costs. The impact of oil falling USD 25/bbl will be likely to put push the current account balance into deficit, with our analysis indicating a 0.3% of GDP deficit from a 2.4% surplus before. Fortunately, the benefit to inflation will be the best in EM and could help offset some of the political risks from reduced growth.
As might be expected, energy importers will benefit by 0.4pp better growth in this scenario. Their collective current account will improve by 0.6pp to 1.1% of GDP.
The regions worst hit are the Middle East, with GDP growth slowing to 0.3%, which is 3.8pp lower than when oil was averaging USD105/bbl. The regions’ fiscal accounts will also suffer most in EM, moving from a 1.7% of GDP surplus to a 1.8% deficit. Meanwhile, the CAB will drop 5.3pp, although remain in surplus at 3.9%. The CIS is the next-worst hit, from a GDP perspective, with regional growth flat-lined versus 1.91% previously. The region’s fiscal deficit will worsen from 0.7% of GDP to -1.8% and CAB shrink to 0.7% from 3% of GDP. Africa’s growth will come in 1.4pp slower at 2.8% while Latam growth will be 0.4pp slower at 2.2%. For Africa, the CAB/GDP ratio will fall by 2.4pp pushing it deep into deficit (-2.9% of GDP).
Some regions benefit, however, with Asia ex-China growing 0.45bpp faster at 5.5% and EM Europe (ex-CIS) growing 0.55pp faster at 3.9%, with the region’s CAB/GDP improving 0.69pp, although remain in deficit to the tune of -2.4% of GDP.
And so on, but to summarize, here are the key points once more:
- The stronger US dollar is having an inverse impact on dollar-denominated commodity prices, including oil. This will affect emerging market (EM) credit quality in various ways.
- The implications of reduced recycled petrodollars has significant ramifications for financial markets, loan markets and Treasury yields. In fact, EM energy exporters will post their first net drain on global capital (USD8bn) in eighteen years.
- Oil and gas exporting EMs account for 26% of total EM GDP and 21% of external bonds. For these economies, the impact will be on lost fiscal revenue, lost GDP growth and the contribution to reserves of oil and gas-related export receipts. Together, these will have a significant effect on sustainability and liquidity ratios and as a consequence are negative for dollar debt-servicing risks and credit ratings.
- Where Does The Market Go From Here?
Back in 2011, we showed the one and only correlation that has mattered to traders during the entire past 7 year period, in which capital markets lost their discounting ability and instead became policy tools micromanaged by central bankers, for an administration which equated the level of the S&P500 with policy success: that of the Fed balance sheet with everything else, and most certainly, asset and stock prices.
Then, just before the completion of QE tapering by the Fed, we showed what was also the only chart that has mattered since October, when the Fed stopped directly propping up risk assets when the Taper ended.
At the time, we quoted one of the few respectable strategists on Wall Street, DB’s Jim Reid who said that “since the Fed balance sheet was used as an aggressive policy tool post-GFC, the graph suggests that the S&P 500 is well correlated with the size of the Fed balance sheet with the former leading the latter by 3 months. Given that the Fed have recently signalled that they will likely be finishing expanding their balance sheet in October, 3 months before that was July. This is important as virtually all of the mega rally in the last 5 years has come in the Fed balance sheet expansion periods. The other periods have been more challenging for markets.”
Fast forward one year when after last week’s furious selloff in stocks, the biggest in four years… stocks are precisely where they were a year ago. Just as we expected.
In fact, on Thursday, when the S&P500 closed at 2027, we merely remarked that based on its fair Fed balance sheet value, the S&P was “almost there“, “there” being a level of just about 1970.
Almost there pic.twitter.com/UzNDDEibcB
— zerohedge (@zerohedge) August 20, 2015
What happened on Friday? Precisely that: the convergence between the Fed’s balance sheet and the stock market, which had traded “rich” to the Fed’s BS for just under a year, finally took place, and the S&P is now trading back to where it should be, based on the Fed’s $4.5 trillion in “assets.”
And so, here we are, with the S&P500 back to where it was a year ago, and where it should be based on a Fed balance sheet which amounts to 25% of US GDP.
Which should come as a surprise to nobody: after all, it is now clear to even the most discredited self-proclaimed finance gurus well maybe not all) that it has all been a function of Fed liquidity injections into stocks (and withdrawals from other asset classes such as Treasurys which tend to flash crash on a monthly basis now).
The only question, now that stocks are back to their fair excess-liquidity implied value, is what happens next?
Because since it is once again shown that the S&P is all about the balance sheet, a rate hike, which make no mistake is tightening pure and simple, will simply accelerate the already violent decline. Which may be why Janet Yellen should indeed take Suze Orman’s advice and “comment on rate increases” because suddenly the new generation of 17-year-old hedge fund managers is feeling just a little vulnerable.
Worse, the next leg up in stocks in this Pavlovian market, may well require the Fed doing precisely what we have said all along is the next inevitable step: QE4…. then 5… then 6… and so on, until finally the helicopter money finally rains.
- China Chooses Her Weapons
By Alasdair Macleod of Gold Money
China’s recent mini-devaluations had less to do with her mounting economic challenges, and more to do with a statement from the IMF on 4 August, that it was proposing to defer the decision to include the yuan in the SDR until next October
The IMF’s excuse was to avoid changes at the calendar year-end and to allow users of the SDR time to “adjust to a potential changed basket composition”. It was a poor explanation that was hardly credible, given that SDR users have already had five years to prepare; but the decision confirming the delay was finally released by the IMF in a statement on Wednesday 19th.
One cannot blame China for taking the view that these are delaying tactics designed to keep the yuan out, and if so suspicion falls squarely on the US as instigators. America has most to lose, because if the yuan is accepted in the SDR the dollar’s future hegemony will be compromised, and everyone knows it. The final decision as to whether the yuan will be included is not due to be taken until later this year, so China still has time to persuade, by any means at her disposal, all the IMF members to agree to include the yuan in the SDR as originally proposed, even if its inclusion is temporarily deferred.
China was first rejected in this quest in 2010 and since then has worked hard to address the deficiencies raised at that time by the IMF’s executive board. That is the background to China’s new currency policy and what also looks like becoming frequent updates on her gold reserves. It bears repeating that these moves had little to do with her domestic economic conditions, for the following reasons:
- To have an economic effect a substantial devaluation would be required. That is not what is happening. Furthermore devaluation as an economic solution is essentially a Keynesian proposal and it is far from clear China’s leadership embraces Keynesian economics.
- Together with Russia through the Shanghai Cooperation Organisation, China is planning an infrastructure revolution encompassing the whole of Asia, which will replicate China’s economic development post-1980, but on a grander scale. This is why “those in the know” jumped at the chance of participating in the financing opportunities through the Asian Infrastructure Investment Bank, which will be the principal financing channel.
- China’s strategy in the decades to come is to be the provider of high-end products and services to the whole of the Eurasian continent, evolving from her current status as a low-cost manufacturer for the rest of the world.
China’s leaders have a vision, and it is a mistake to think of China solely in the context of a country whose economy is on the wrong end of a credit cycle. This is of course true and is creating enormous problems, but the government plans to reallocate capital resources from legacy industries to future projects. Rightly or wrongly and unlike any western government at this point in a credit cycle, China accepts that a deflating credit bubble is a necessary consequence of a deliberate policy that supports her future plans. She is prepared to live with and manage the fall-out from declining asset valuations and business failures, facilitated by state ownership of the banks.
Instead, to understand why she is changing the yuan-dollar rate we must look at currencies from China’s perspective. China is the world’s largest manufacturing power by far, and can be said to control global trade pricing as a result. It then becomes obvious that China is not so much devaluing the yuan, but causing a dollar revaluation upwards relative to international trade prices. She is aware that the US economy is in difficulties and that the Fed is worried about the prospect of price deflation, so lower import prices are the last thing the Fed needs. Now China’s currency move begins to make sense.
The mini-devaluations were a signal to Washington and the rest of the world that if she so wishes China can dictate the global economic outlook through the foreign exchange markets. China believes, with good reason, that she is more politically and economically robust, and has a better grasp over the actions of her own citizens, than the welfare economies of the west in the event of an economic downturn. Therefore, she is pursuing her foreign exchange policy from a position of strength. And the increments that will now be added to gold reserves month by month are a signal that China believes she can destabilise the dollar through her control of the physical gold market, because it gently reminds us of an unanswered question always ducked by the US Treasury: what evidence is there of the state of the US’s gold reserves?
China would probably live with a deferral of her SDR membership for another year, if there is a definite decision in October to include her currency in the SDR basket. That being the case, China must be tempted to increase pressure on all IMF members ahead of the October meeting. The strategy therefore changes from less passivity to more aggression over both foreign exchange rates and gold ownership over the next eight weeks. We can expect China to tighten the screw if necessary.
The stakes are high, and China’s devaluation of only a few per cent has caused enough chaos in capital markets for now. But if the eventual answer is that the yuan will not be allowed to join the SDR basket, it will be in China’s interest to increase the pace of development of the new BRICS bank instead with its own version of an SDR, selling dollar reserves and underlying Treasuries to fund it. The threat that China will turn her back on the post-war financial system and the IMF would also undermine the credibility of that institution more rapidly perhaps than the dollar’s hegemony if the yuan was accepted. And if a US-controlled IMF loses its credibility, even America’s allies will desert her, just as they did to join the Asian Infrastructure Investment Bank a few months ago.
It was always going to be the US that faced a predicament from China’s growing economic power. She has chosen to bluff it out instead of gracefully accepting the winds of change, as Britain did over her empire sixty years ago. Change in the economic pecking-order is happening again whether we like it or not and China will have her way.
* * *
And, as a reminder from 2013, here again is the “US vs China Currency War For Dummies”
- Speak, That I May See Thee
My stomach rolled over when I read this post from ZeroHedge about Suze “the teeth” Orman. She tweeted out the following, indicating not only that she’s so well off that she’s just going to kick back for a year, but that she wants Yellen to “help us out” since we’ve all suffered the unspeakable calamity of stocks actually going down a few percent.
Right on the heels of this, everyone’s favorite financial clown, Jim Cramer, sycophantically acknowledged the counsel of his “good friend’ and retweeted her plea:
What struck me, thumbing through the reactions, was the sharp contrast between those who apparently support these two nincompoops and those who didn’t. The tone of the naysayers was along these lines:
So we have a plethora of intelligent, well-spoken people pushing back against these disgusting bulls who demand to suck at the government teat until the end of time. In sharp juxtaposition to this, here’s a sampling of those who applaud Suze and Jimze:
We have a smattering of bleating (“request help!”), illiteracy to a degree that I didn’t think possible (“advise” instead of “advice” and “invester’s“, which manages to not only be misspelled but also is an oaf-like way of attempting to express a plural noun), and the completely deluded notion that Janet Yellen is sitting around reading tweets from the likes of these buffoons.
I’ve said it before, and I’ll say it again: stock market bulls are welfare queens par excellance, and I suppose we should not be surprised that since they’ve been on the dole since October 2008, that they’ve become very accustomed to what is a gargantuan version of the entire nation arranging to be receiving liability checks from the federal government since actually working is just too hard.
- Clinton Madison: Tying It All Together
There is at least one hacked account that is sure to have been mysteriously deleted… You know, for personal reasons.
h/t @joshgreenman
- Productivity In America Now On Par With Agrarian Slave Economy
Submitted by Eugen Bohm-Bawerk
In the first episode we showed how the US became an unsustainable service sector based economy from the 1970s onward when service sector employment diverged from manufacturing without a corresponding boost in productivity. In the second episode we laid out the consequences that transition has had on labour in terms of lower wages and benefits. In addition, we reiterated our argument that monetary policy has become slave to the service sector as it has become linked to the much touted wealth effect (capital consumption) that is now an integral part of the American business cycle.
Now it is time to take a closer look at productivity measured in terms of GDP per capita. While this is not an entirely correct way to measure productivity, it does adhere to new classical growth model theories which posit that in a developed economy, reached steady state, the only way to increase GDP per capita is through increased total factor productivity. In plain English, growth in GDP per capita equals productivity growth. The reason we use this concept instead of more advanced productivity measures is to get a long enough time series to properly understand the underlying fundamental forces driving society forward.
In our main chart we have tried to see through all the underlying noise in the annual data by looking at a 10-year rolling average and a polynomial trend line.
In the period prior to the War of 1812 US productivity growth was lacklustre as the economy was mainly driven by agriculture and slaves (slaves have no incentive to work hard or innovate, only to work just hard enough to avoid being beaten). From 1790 to 1840 annual growth averaged only 0.7 per cent.
As the first industrial revolution started to take hold in the north-east, productivity growth rose rapidly, and even more during the second industrial revolution which propelled the US economy to become the world largest and eventually the global hegemon (see bonus chart at the end).
As a side note, it is worth noting that while the US became the world largest economy already by 1871, Britain held onto the role as a world hegemon until 1945. Applied to today’s situation in light of the fact that China is, by some measures, already the largest economy on the planet, it does not mean it will rule the seven seas anytime soon. In our view, they probably never will, but that is a story for another time.
Adjusting for the WWII anomaly (which tells us that GDP is not a good measure of a country’s prosperity) US productivity growth peaked in 1972 – incidentally the year after Nixon took the US off gold. The productivity decline witnessed ever since is unprecedented. Despite the short lived boom of the 1990s US productivity growth only average 1.2 per cent from 1975 up to today. If we isolate the last 15 years US productivity growth is on par with what an agrarian slave economy was able to achieve 200 years ago.
In addition, the last 15 years also saw an outsized contribution to GDP from finance. If we look at the US GDP by contribution from value added by industry we clearly see how finance stands out in what would otherwise have been an impressively diversified economy.
With hindsight we know that finance did more harm than good so we can conservatively deduct finance from the GDP calculations and by doing so we essentially end up with no growth per capita at all over a timespan of more than 15 years! US real GDP per capita less contribution from finance increased by an annual average of 0.3 per cent from 2000 to 2015. From 2008 the annual average has been negative 0.5 per cent!
In other words, we have seen a progressive (pun intended) weakening of the US economy from the 1970s and the reason is simple enough when we know that monetary policy broken down to its most basic is a transaction of nothing (fiat money) for something (real production of goods and services). Modern monetary policy thereby violates the most sacred principle in a market based economy; namely that production creates its own demand. Only through previous production, either your own or borrowed, can one express true purchasing power on the market place.
The central bank does not need to worry about such trivial things. They can manufacture the medium of exchange at zero cost and express purchasing power on the same level as the producer. However, consumption of real goods and services paid for with zero cost money must by definition be pure capital consumption.
Do this on a grand scale, over a long period of time, even a capital rich economy as the US will eventually be depleted. Capital per worker falls relative to competitors abroad, cost goes up and competitiveness falls (think rust-belt). Productive structures cannot be properly funded and the economy must regress to align funding with its level of specialization.
In its final stage, investment give way for speculation, and suddenly finance is the most important industry, pulling the best and brightest away from every corner of the globe, just to find more ingenious ways to maximise capital consumption.
As the slave economy got perverted by incentives not to work, so does the speculative fiat based economy, which consequently create debt serfs on a grand scale.
Bonus chart:
- Jim Chanos' Dire Prediction On China: "Whatever You Might Think, It's Worse"
“In fact, like many of us, sometimes they don’t have a clue.”
That’s from Jim Chanos, who sat down on Friday with CNBC’s Fast Money A-Team which, like the rest of the mainstream financial media punditry, can’t seem to figure why things unravelled so quickly last week.
Chanos was referring to the Chinese government and more specifically to their efforts to simultaneously manage a decelerating economy, a currency devaluation, and a bursting stock market bubble.
As we’ve said on too many occasions to count, the task is quite simply impossible, a reality which often manifests itself in contradictory policy initiatives and directives emanating from Beijing. Despite the plunge protection national team’s best efforts to channel some CNY900 billion into SHCOMP large caps, China’s stock market looks to be on the verge of an outright meltdown, and the effort to support the yuan after the devaluation is draining liquidity and tightening money markets, rendering policy rate cuts less effective even as further easing becomes more necessary with every FX intervention.
In short, the situation is, as Chanos puts it, “worse than you think,” and because it’s sometimes hard to get through to CNBC’s Halftime crew, Chanos reiterated the sentiment: “Whatever you might think, it’s worse.”
See the interview below.
- "The Seven Year Glitch" – Has The Time Come
A couple of interesting charts from State Street’s “Mr Risk” Fred Goodwin, courtetsy of Saxo’s Steen Jakobsen, both of which deal with business cycles, the first in the economy by way of the Citigroup surprise index which may have recently hit its local maximum and is now due for a substantial deterioration, in line with virtually all other high frequency economic indicators except for the job market which is kept afloat courtesy of low-quality, low paying waiters and bartender jobs (resulting in the “surprising” zero wage growth).
The second one is more suggestive: it looks at key events occuring in 7 year cycles, finds that every recent multiple of the year 2015 going back in 7 year increments brings
with it some major adverse market event, and asks: is it 2015’s turn?
- What Does The Fed Do Now? The FOMC Decision Tree
Over the past few months, numerous so-called “experts” (they know who they are) desperately tried to come up with both their own facts and their own history by saying that, far from fearing the Fed’s decision, “a rate hike would be good for stocks.” Well, as last week’s historic VIX surge, and biggest market plunge in years confirmed, that was not the case. In fact, what happened is what we summarized in 7 words late last week:
The Rate Hike Tantrum has finally arrived
— zerohedge (@zerohedge) August 20, 2015
In short: the market made it very clear that a rate hike is not welcome. Promptly other so-called “personal finance experts” joined in the demands for a bailout.
Others, such as Bank of America, were slightly more tongue-in-cheek in their “explanation” of what it would take for the Fed to panic and not only delay rate hikes but pass Go and proceed straight to QE4 (for those who missed our post on the topic, the answer is go short Glencore and Noble Group).
But back to the $64TN question: what does the Fed do? One attempt at an explanation taking into account last week’s market plunge comes from Nomura, which provides a “2015 Scenario Analysis” in which it “breaks down various monetary policy (rate hike options) and rates market implications ahead.”
This is the summary:
The minutes to the July meeting revealed that the Committee has doubts about a variety of aspects of the economic outlook, including growth, inflation, and developments abroad. Incoming data since the July FOMC meeting have not really answered those questions, all the while financial conditions have tightened materially recently. As such, we believe that the probability the FOMC will raise short-term interest rates for the first time in September has decreased materially while the probability of liftoff in December or no interest rate increase this year has increased. We now only put a 20% probability of liftoff in September (previously 35%) while we have raised the likelihood of liftoff in December to 44% (previously 40%) and liftoff after December to 36% (previously 25%).
Here are the details broken down by meeting:
The September FOMC meeting
We think there is only a 20% likelihood that the FOMC will decide to raise interest rates at its meeting in September. The minutes to the July meeting revealed that the Committee has doubts about a variety of aspects of the economic outlook, including growth, inflation, and developments abroad (see Minutes of the July FOMC Meeting, Policy Watch, 20 August 2015). Incoming data since the July FOMC meeting have not really answered those questions. Moreover, developments abroad, notably in China, have raised new questions about the outlook for the rest of the global economy. Last, as noted above, financial conditions have tightened materially.
A decision to raise interest rates at the FOMC meeting in September would probably require a combination of factors. The economic data released between now and the meeting—both real side and inflation—would have to surprise to the upside. Developments abroad and financial conditions would have to stabilize. There would have to be a strong consensus within the Committee on the need to start the interest rate adjustment sooner rather than later. This is certainly possible, but it does not seem likely.
We will get some new data between now and the September FOMC meeting (see Fig. 10). But the amount of additional information that the FOMC will have at its September meeting will be limited. An important reason why we doubt that the FOMC will raise rates in September is that there simply isn’t enough time to answer the questions that the Committee seemed to be struggling with at its meeting in July.
The December Meeting
If the FOMC does not raise rates at its meeting in September (and it stays on hold in October), the issues that will drive a decision in December are mostly the same. That is: a decision will depend on the outlook for growth and inflation, financial conditions, and developments abroad. We think there is a good likelihood (55%) that the economy will have evolved in a way that leads the FOMC to initiate liftoff in December. We think that positive fundamentals for consumers will drive stronger spending. We think that investment will recover as drilling activity in the oil gas sector stabilizes. We think that housing activity will continue to grow at a healthy pace. We think that growth in China will remain on target and that financial conditions are likely to stabilize. We think that labor markets will continue to improve. We think that a forward-looking assessment of inflation will be more positive. The additional time between the September and December meetings will make all of these positive developments apparent.
Of course, there may not be enough progress on these measures to convince the Committee that it is time to raise short-term interest rates. Moreover, concerns about year-end issues may cause it to delay liftoff until next year.
For what it’s worth, we remain in “concerns about year-end issues” camp (clearly the Fed realizes there is nothing quite as destructive as 6 inches of snow to the Apple Sachs Industrial Average, pardon the world’s biggest economy as the past two “harsh winters” have shown), or in the worst case: a rate hike followed promptly by QE4.
Here, for those who naively still think the Fed is data-driven, here is Nomura’s full decision-tree.
- A Modern-Day Shoeshine Boy Moment
By Pater Tenebrarum of Acting Man
A Modern-Day Shoeshine Boy Moment
There is a well-known – though likely apocryphal – anecdote from the end of the roaring 20s. It involves Joseph P. Kennedy, US ambassador to the UK from the late 1930s to mid 1940s. Before he entered the civil service and politics, he had made a name (and a fortune) for himself as a businessman and investor. On Wall Street he inter alia ran the Libby-Owens-Ford stock pool with a number of Irishmen, a loose association of investors pooling their resources and dedicated to manipulating the hell out of Libby-Owens-Ford stock by deftly using insider information to their advantage.
Today he would be deemed a criminal, but at the time his activities on the stock exchange were perfectly legal and he was widely admired for being a wily operator. Rightly so, we should add.
Meet Joseph P. Kennedy, wily Wall Street operator.
Photo credit: Wide World PhotosAs the story goes, Kennedy realized several months before the crash of 1929 that he had to get out of the market. What made him realize it was this: In the winter of 1928, he decided to stop to have his shoes shined before going to his office. When the shoe-shine boy had finished, he suddenly offered Kennedy a stock tip, without having been solicited to do so: “Buy Hindenburg!”
Kennedy is said to later have told people that he sold off his stock market positions shortly thereafter, as he was thinking: “You know it is time to sell when shoeshine boys start giving you stock tips. This bull market is over.”
A member of the anonymous stock tipsters association at work
Photo credit: pa/akgA Modern-Day Equivalent
The unusual escalation in the stock market’s recent weakness (right into an options expiration – this is practically unheard of these days!) and our brief discussion of the situation yesterday (see “The Stock Market in Trouble” for details), caused us to wonder whether we could think of anything along similar lines that has happened recently.
Of course we are no Joseph Kennedy, but we are continually exposed to market-related information, including assorted spam. Keep in mind in this context that after Kennedy received his shoeshine boy warning, the market still rose for another eight months. So there is a certain lead time involved when the shoeshine boy bell rings, and given the market’s oversold state, it may actually be ripe for a bounce here.
As we also noted yesterday, the current bubble is not comparable to the mania that culminated in the year 2000. At the time, one could actually watch out for very close equivalents to the shoeshine boy, given the huge participation of retail traders in the market. Nowadays we have a “bubble of professionals”, so we must look for something slightly different. And we have found it – or rather, it actually fell into our lap yesterday, or rather, suddenly appeared in our inbox.
What we found there was this ad:
“Capture Top Momentum Opportunities! Investing in securities or asset classes with positive price momentum can potentially deliver higher returns than a traditional buy-and-hold strategy. The Horizons Managed Multi-Asset Momentum ETF (“HMA”) is the first actively managed ETF in Canada to give investors access to a globally diversified portfolio of momentum investment opportunities.”Just to make that clear, we don’t want to pick in any way on the firm offering this undoubtedly well-managed (if potentially crash-prone) product. We are quite sure countless other examples along similar lines exist, but we were certainly struck by the timing of this offer. It almost screams “shoeshine boy”.
This became even more clear when a friend shortly thereafter pointed us to the following chart published by Bloomberg :
The “momentum trade” over the past 11 months, click to enlarge.
To be sure, the associated Bloomberg article expresses a certain degree of skepticism, which could end up giving this trade another lease of life:
“Virtually nothing has worked better in this year’s thinning equity market than momentum, where you load up on stocks that have risen the most in the past two to 12 months and hope they keep going up. Sent aloft by sustained rallies in biotech and media shares, concern is mounting that the trade has gotten too popular, setting the stage for sharper swings.
[…]
With breadth narrowing before the Federal Reserve raises rates, sticking with winners has been a blueprint for success in 2015.
[…]
Individual investors have noticed. One of the largest exchange-traded funds employing the tactic, the iShares MSCI USA Momentum Index Fund, lured a record $125 million in July, boosting its total by about a fifth. It hasn’t had a single month of outflows since it started in 2013.
Owning it has paid off, too: the fund is up 8.2 percent in 2015, compared with 1.8 percent in the S&P 500. Another ETF, the Powershares DWA Momentum Portfolio, recently saw assets cross $2 billion and has returned more than 7 percent this year. Still, some of the trades contributing the success have been weakening.”
(emphasis added)
All in all we would say that it is probably not the most auspicious moment in time to offer yet another “momentum” ETF to the public – even a “multi-asset” one.
Conclusion:
In recent days, the market’s momentum darlings have suffered a bit. We cannot say with certainty if they deserve to be called “former momentum darlings” already, as there is always a chance that they will rebound shortly. Especially with us poking fun at the concept, they might decide to poke back (good thing we are wearing glasses, so they can’t poke us in the eye).
Readers are more than welcome to tell us their shoeshine boy stories, if they have any to tell. We would certainly consider publishing the best ones (mail us at info@acting-man.com, or alternatively use the comments section if you need to get it off your chest right away).
- Is This Where The Long Lost Nazi "Gold Train" Is Located
Earlier this week, two people, a Pole and a German, said they may have found the legendary, long-lost Nazi train rumored to be full of gold, gems and guns, i.e., the prize possessions of years of Third Reich plunder, that disappeared just before the end of World War Two. As BBC first reported, the train was believed to have gone missing near what is now the Polish city of Wroclaw as Soviet forces approached in 1945.
It is said, the Mail adds, that Nazis loaded all the valuables they had looted in Wroclaw, then called Breslau and part of Greater Germany, to escape the advancing Red Army. According to a local website, the train was 150m long and may have up to 300 tonnes of gold as well as unknown “hazardous materials” on board.
A law firm in south-west Poland says it has been contacted by the two men who have discovered the armored train: their demand to unveil the precise whereabout of their discovery: 10% of the value of the train’s contents. Since the contents of the train has been said to be in the billions, such an agreement would make the two discoverers rich overnight.
The two men who claim to have found the long lost gold train
According to local news websites the apparent find matched reports in local folklore of a train carrying gold and gems that went missing at the end of World War Two near the gothic Ksiaz castle, which served as the Nazi’s headquarters in the area during World War II. The claim was made to a law office in Walbrzych, 3km (2 miles) from Ksiaz castle.
Ksiaz castle, Nazi headquarters during World War II
Some of the locals are skeptical, perhaps because all previous searches for the train had so far proved fruitless: Walbrzych’s local leader Roman Szelemej said he doubted the supposed find but would monitor developments. “Lawyers, the army, the police and the fire brigade are dealing with this,” Marika Tokarska, an official at the Walbrzych district council, told Reuters.
Still this time may be different: Joanna Lamparska, a historian who focuses on the Walbrzych area, told Radio Wroclaw the train was rumored to have disappeared into a tunnel. “The area has never been excavated before and we don’t know what we might find.”
At this point the story turns bizarre, because the latest discovery – if it is indeed that – may not be genuine: according to the Mail, a group calling itself The Silesian Research Group insists that it in fact found the legendary train here over two years ago. The group claims the duo who made the news this week by filing the discovery claim with local authorities pilfered their information.
There is a second group of treasure hunters who claim to have found the train.
Andzrej Boczek, one of the members, showed MailOnline where he believes it to be hiddenOne group member, who asked not to be identified after receiving threatening phone calls from a ‘mysterious man,’ told MailOnline: ‘About two or three years ago we carried out extensive research of the area using geo-radar and magnetic readings. We came across an anomaly about 70 metres below the surface and further investigation revealed this was most likely a train.
‘It is well-known that the Nazis built a network of railway lines under the mountains.
‘And we know that in May 1945 gold and other valuables from the city of Wroclaw were being transported to Walbrzych when they disappeared between the towns of Lubiechow and Swiebodzice.’
Resting at the foot of the Sowa (Owl) mountains in woods three miles outside of the town of Walbrzeg in western Poland, is the alleged train, filled with gold, possibly diamonds and maybe even masterpieces stolen from Polish noble families and museums. Specifically, according to the researchers, the actual train is now resting somewhere under the surface of the hill shown in the photo below.
The “gold train” is said to be located under this hill
The researcher went on: ‘During the war, there used to be an SS barracks here which was heavily guarded. And just behind the railway bridge was the entrance to the tunnel. We recorded our findings and marked the location on a map as well as storing the information on computer records.”
Here the researcher’s story becomes even more bizarre: “We were and are convinced that this is where the gold train is. But, soon after our discovery, the map and data for the area went missing. At first we thought it had been mislaid, but then we heard about the findings of these two people and we realised they must have got hold of our information.”
He then added that he had been ‘warned off’ talking about the subject or investigating it further” adding that “last night I received a phone call from a mysterious man who warned me to stay away from the story and to not get involved.
“A lot of dangerous people are interested in finding this train, this could have been a warning from one of them. This man who called me knows that I know something.”
Joanna Lamparska explains that there are two main theories about the gold train. “One is that is hidden under the mountain itself. The second is that it is somewhere around Wa?brzych. Until now, no-one has ever seen documents that confirm the existence of this train.”
The story is given credence because under the local hills is a mammoth subterranean project called RIESE – German for giant – which was the construction of a honeycomb of tunnels, bunkers and underground stations begun in 1941.
Stretching from the gothic castle of Ksiaz overlooking the town of Walbrzeg they built the labyrinth deep into the surrounding mountains. The idea was to move supplies, factories and workers underground in the event of Allied bombing.
One of a series of tunnels the Nazis built in the mountain
Local explorer and treasure hunter Andrzej Boczek, who is also a member of the Silesian Research Group, guided MailOnline to the site where he says the train is buried. He said: ‘We think it is here because first of all it is between the two places were we know it disappeared. And it is just 2.37km from Ksiaz castle which was the German headquarters during the war. That’s where all treasures were taken.’
The 55-year-old, who has been searching the region for 25 years and has already found numerous artefacts, said: ‘Also, this path used to be where the path ran down to the tunnel,’ he says pointing at a dirt track leading towards the woods. “We don’t know where the entrance is as we need permission to dig. But we have carried out tests and we know something is there. During the war this place was open to the public and then it suddenly was closed by the Germans, they clearly had a secret to hide. A man who lived nearby told me he used to see strange activity at night with trains rolling in and disappearing into the tunnel.”
Two other locations identified by local media in Poland have since been rubbished by experts. One is close to the town of Walbrzych the other in the town of Walim, 17km away. Historian Mrs. Lamparska added: “These two areas are very well known and have been well-researched. The chances of the train being there are zero. It is likely that they found something, however, whether this is the gold train is a different matter.”
But while the latest rumor that the legendary train has been found may end up being a red herring once again, people in the region have woken up their Indiana Jones and are rushing into the area: the news of the possible discovery has sent people from across Germany and Poland to the area with metal detectors. Germans piling on to trains the spoils of their carpetbagging in foreign lands towards the end of the war was not a rare occurrence. And the Reichsbank in Berlin, many of its buildings and vaults shattered by intense American and British air raids, used precious Deutsche Bahn rolling stock to hide treasure in regional towns, often in the cellars of fortified post offices.
The loot was destined for a number of purposes: getaway money for high-ranking war criminals, the basis for a German resistance movement called ‘Werewolf’ intended to fight the occupiers; and to become the pension funds for generals whose vast estates bequeathed to them by a grateful Fuhrer in the east which fell into the hands of new, unforgiving owners.
That is why the story of the 590-foot long train which steamed into the tunnel long ago has fired the imagination of many. But it also comes with many caveats, as expressed by Focus magazine in Germany, which asked: ‘Is there really a train and is it mined?
Real or not, the story may be enough to provide an aspiring screenwriter enough ammo for the next Indiana Jones, or at least American, er European, Treasure sequel.
Finally, for those looking for real treasure, forget the Third Reich’s plunder, which by 1945 had been mostly spent, but focus on trains and other vehicles operated by the Bank of International Settlements: the discovery of even one such train should be enough to keep a small country funded in perpetuity.
- Making Sense Of The Sudden Market Plunge
Submitted by Chris Martenson of PeakProsperity
Making Sense Of The Sudden Market Plunge
The global deflationary wave we have been tracking since last fall is picking up steam. This is the natural and unavoidable aftereffect of a global liquidity bubble brought to you courtesy of the world’s main central banks. What goes up must come down – and that’s especially true for the world’s many poorly-constructed financial bubbles, built out of nothing more than gauzy narratives and inflated with hopium.
What this means is that the traditional summer lull in financial markets has turned August into an unusually active and interesting month. August, it appears, is the new October.
Markets are quite possibly in crash mode right now, although events are unfolding so quickly – currency spikes, equity sell offs, emerging market routs and dislocations, and commodity declines – that it’s hard to tell for sure. However, that’s usually the case right before and during big market declines.
Before you read any further, you probably should be made aware that, at Peak Prosperity, our market outlook has been one of extreme caution for several years. We never bought into so-called “recovery” because much of it was purely statistical in nature, and had to rely on heavily distorted and tortured ‘statistics’ to be believed. Okay, lies is probably a more accurate term in many cases.
Further, most of the gains in financial assets engineered by the central banks were false and destined to burstbecause they were based on bubble psychology, not actual returns.
Which bubbles you ask? There are almost too many to track. But here are the main ones:
- Corporate bond bubble
- Corporate earnings bubble
- Junk bond bubble
- Sovereign debt bubble
- Equity bubbles in various markets (US, China) and sectors (Tech, Biotech, Energy)
- Real estate bubbles, especially in the commodity exporting countries
- Central bank credibility bubble (perhaps the largest and most dangerous of them all)
What’s the one thing that binds all of these bubbles together? Central bank money printing.
Passing The Baton
Operating in collusion, the world’s major central banks passed the liquidity baton back and forth between them, first from the US to Japan, then from Japan to Europe, then back to the US, then over to Europe again where it now resides. Seemingly endless rounds of QE that didn’t always do what they were supposed to do, and plenty of things they were not intended to do.
The purpose of printing up trillions and trillions of dollars (supposedly) was to create economic growth, drive down unemployment, and stoke moderate inflation. On those fronts, the results have been dismal, horrible, and ineffective, respectively.
However, the results weren’t all dismal. Big banks reaped windfall profits while heaping record bonuses on themselves for being at the front of the Fed’s feeding trough. The über-wealthy enjoyed the largest increase in wealth gains in recorded history, and governments were able to borrow more and more money at cheaper and cheaper rates allowing them to deficit spend at extreme levels.
But all of that partying at the top is going to have huge costs for ‘the little people’ when the bill comes due. And it always comes due. Money printing is fake wealth; it causes bubbles, and when bubbles burst there’s only one question that has to be answered: Who’s going to eat the losses?
The poor populace of Greece is just now discovering that it collectively is responsible for paying for the mistakes of a small number of French and German banks, aided by the collusion of Goldman Sachs, in hiding the true state of Greek debt-to-GDP using sophisticated off-balance sheet derivative shenanigans. As a direct result, the people of Greece are in the process of losing their airports, ports, and electrical distribution and phone networks to ‘private investors’ — mainly foreigners harvesting the last cash-generating assets the Greeks have left to their names.
Broken Markets
As we’ve detailed repeatedly, our “markets” no longer resemble markets. They are so distorted, both by central bank policy and technologically-driven cheating, that they no longer really qualify as legitimate markets. Therefore we’ve taken to putting double quote marks around the word “”market”” often when we use it. That’s how bad they’ve become.
Where normal markets are a place for legitimate price discovery, todays “”markets”” are a place where computers battle each other over scraps in the blink of an eye, ‘investors’ hinge their decisions based on what the Fed might or might not do next, and rationalizations are trotted out by the media for why inexplicable market price movements make sense.
Instead, we view the “”markets”” as increasingly the playgrounds of, by and for the gigantic market-controlling firms whose technology and market information have created one of the most lopsided playing fields in our lifetimes.
Signs of these distortions abound. One completely odd chart is this one, showing that the average trading range of the Dow (ytd) was the lowest in history as of last week (before this week’s market turmoil hit). And that was despite Greece, China, QE, Japan, oil’s slump, Ukraine, Syria, Iran and all of the other ample market-disturbing news:
(Source)
Based on the above chart, you’d think that 2015 up through mid-August was the most serene year of the last 120 years. Of course, it’s been anything but serene.
The explanation for this locked-in trading range is a combination of ultra-low trading volume and the rise of the machines. There have been times recently when practically 100% of market volume was just machines playing against each other…no actual investors (i.e, humans) were involved.
As long as there was ample liquidity, then the machines were content to just play ping pong with the “”market””. Which they did, crossing the S&P 500 over the 2,100 line 13 times before the recent sell-off took hold.
But that’s not the most concerning part about having broken markets. The most concerning thing centers on the fact that things that should never, ever happen in true markets are happening in todays “”markets”” all the time.
One measure of this is how many standard deviations (std dev) an event is away from the mean. For example, if the price of a financial asset moves an average of 1% per year, with a std dev of 0.25 %, then it would be slightly unusual for it to 2%, or 3%. However it would be highly unusual if it moved as much as 6% or 7%.
Statistics tells us that something that 3 std dev movements are very unlikely, having only a 0.1% chance of happening. By the time we get to 6 std devs, the chance is so small that what we’re measuring should only happen about once every 1.3 billion years. At 7 std dev, the chance jumps up to once every 3 billion years.
Why take it to such a ridiculous level? Because those sorts of events are happening all the time in our “”markets”” now. And that should be deeply concerning to everyone, as it was to Jamie Dimon, CEO of JP Morgan:
‘Once-in-3-Billion-Year’ Jump in Bonds Was a Warning Shot, Dimon Says
Apr 8, 2015
JPMorgan Chase & Co. head Jamie Dimon said last year’s volatility in U.S. Treasuries is a “warning shot” to investors and that the next financial crisis could be exacerbated by a shortage of the securities.
The Oct. 15 gyration, when Treasury yields fluctuated by almost 0.4 percentage point, was an “unprecedented move” that would have serious consequences in a stressed environment, Dimon, the New York-based bank’s chairman and chief executive officer, said in a letter Wednesday to shareholders. Treasuries are supposed to be among the most stable securities.
Dimon, 59, cited the incident as he waded into a debate about whether bank regulations implemented after the 2008 financial crisis exacerbate price declines by limiting the ability of Wall Street banks to make markets. It’s just a matter of time until some political, economic or market event triggers another financial crisis, he said, without predicting one is imminent.
The Treasuries move was “an event that is supposed to happen only once in every 3 billion years or so,” Dimon wrote. A future crisis could be worsened because there “is a greatly reduced supply of Treasuries to go around.”
(Source)
While Mr. Dimon used the event to suggest that bank regulations were somehow to blame, that explanation is self-serving and disingenuous. He’d use any excuse to try and blame bank regulations; that’s his job, I guess.
Instead what happened was that our “”market”” structure is so distorted by computer trading algorithms, with volume so heavily distorted by their lighting-fast reflexes, that one of those ‘once in 3-billion years events’ resulted.
This simply wouldn’t have happened if humans were still the ones doing the trading, but they aren’t. All the colored jackets have been hung up at the CME, and human market makers on the floor of the NYSE are rapidly slipping away into the sunset as algorithms now run the show.
The good news about computers is that they allow our trading to be faster and cheaper, presumably with better price discovery. The bad news is that nobody really understands how the whole connected universe of them interact and that, from time to time, they go nuts.
As Mr. Dimon hinted, they have the chance of taking the next financial downturn and converting it into a certified financial meltdown
How common are these ‘billion year events’?
They happen all the time now. Here’s a short list:
(Source)
All of this leads us to conclude that the chance of a very serious, market-busting accident is not only possible, but that the probability approaches 100% over even relatively short time horizons.
The deflation we’ve been warning about is now at the door. And one of our big concerns is that we’ve got “”markets”” instead of markets, which means that something could break our financial system as we know and love it.
From the Outside In
One of our main operating models at Peak Prosperity is that when trouble starts it always begins at the edges and moves from the outside in.
This is true whether you are looking at people in a society (food banks see a spike in demand well before expensive houses decline in price), stocks in a sector (the weakest companies decline first), bonds (junk debt yields spike first), or across the globe where weaker countries get in trouble first.
What we’re seeing today is an especially fast moving set of ‘outside in’ indicators that are cropping up so fast it’s difficult to keep track of them all. Here are the biggest ones.
Currency Declines
The recent declines in emerging market (EM) currencies is a huge red flag. This combined chart of EM foreign exchange shows the escalating declines of late.
(Source)
Since last Monday, here’s the ugly truth:
Many of these countries have been using precious foreign reserves to try and stem the rapid declines of their currencies, but I fear they will all run out of ammo before the carnage is over.
What’s happening here is the reverse part of the liquidity flood that the western central banks unleashed. The virtuous part of this cycle sees investors borrow money cheaply in Europe, the US or Japan, and then park in in EM countries, usually by buying sovereign bonds, or investing in local companies (especially those making a bundle off of the commodity boom that was happening).
So on the virtuous side, a major currency was borrowed, and then used to buy whatever local EM currency was involved (which drove up the value of that currency), and then local assets were bought which either drove up the stock market or drove down bond yields (which move as in inverse to price).
The virtuous part of the cycle is loved by local businesses and politicians. Everything works great. The currency is stable to rising, bond yields are falling, stocks are rising, and everyone is generally happy.
However when the worm turns, and it always does, the back side of this cycle, the vicious part, really hurts and that’s what we’re now seeing.
The investors decide that enough is enough, and so they sell the local bonds and equities they bought, driving both down in price (so falling stock markets and rising yields), and then sell the local currency in exchange for dollars or yen or euros, whichever were borrowed in the first place.
And thus we see falling EM currencies.
To put this in context, many of the above listed currencies are now trading at levels either not seen since the Asian currency crisis of 1997, or at levels never before seen at all. The poor Mexican peso is one of the involved currencies, which has fallen by 12% just this year, and almost made it to 17 to the dollar early this morning (16.9950). Battering the peso is also the low price of oil which is absolutely on track to destroy the Mexican federal budget next year.
Stock Market Declines
In concert with the currency unwinds we are seeing deep distress in the peripheral stock markets. There are now more than 20 that are in ‘bear country’ meaning they’ve suffered declines of 20% or more from their peaks.
Here are a few select ones, with Brazil being in the worst shape:
All of these signs reinforce the idea that the great central back liquidity tsunami has reversed course and is about to create a lot of damage and suck a lot of debris out to sea.
The Commodity Rout
A lot of EM countries are commodity exporters. They sell their minerals trees and rocks to the rest of the world, by which we mean to China first and foremost.
Commodities are not just doing badly in terms of price, they are absolutely being crushed, now down some 50% over the past four years.
(Source)
Commodities tells a number of things besides the extent of EM economic happiness or pain – they tells us whether the world economy is growing or shrinking. Right now they are saying “shrinking” which is confirmed by all of the recent Chinese import, export and manufacturing data, along with the dismal results coming out of Japan (in recession), Europe and the US.
Conclusion Part I
As we’ve been warning for a long time, you cannot print your way to prosperity, you can only delay the inevitable by trading time for elevation. Now, instead of finding ourselves saddled with $155 trillion of global debt as we did in 2008, we’re entering this next crisis with $200 trillion on the books and interest rates already stuck at zero. We are 30 feet up the ladder instead of 10 and it’s a long way down.
What tools do the central banks really have left to fight the forces of deflation which are now romping across the financial landscape from the outside in?
If the computers hiccup and give us some institution smashing or market busting 8 sigma move what will the authorities do? Shut down the markets? It’s a possibility, and one for which you should be prepared.
Where are we headed with all this? Hopefully not the way of Venezuela which is now so embroiled in a hyperinflationary disaster that stores are stripped clean of basic supplies, social unrest grows, and creative street vendors are now selling empanadas wrapped in 2 bolivar notes because they are, literally, far cheaper than napkins. Cleaner? Maybe not so much. I wouldn’t want to eat off of currency.
(Source)
But make no mistake, the eventual outcome to all this is captured brilliantly in this quote by Ludwig Von Mises, the Austrian economist:
There is no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as the result of a voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved.
The credit expansion happened between 1980 and 2008, there was a warning shot which was soundly ignored by ignorant central bankers, and now we have more, not less, debt with which to contend.
Venezuela has already entered the ‘total catastrophe’ stage for its currency, but Japan will follow along, as will everyone eventually who lives in a country that finds itself unable to voluntarily abandon the sweet relief of booms enabled by credit creation.
- Deez Nuts On Top Of Hillary Clinton
On Wednesday we documented the unlikely rise of dark horse Presidential candidate “Deez Nuts” who, at last count, was polling at or near 9% in three states.
Obviously, this is a story where the punchlines write themselves, and while there’s no doubt that some of Nuts’ popularity is simply a reflection of the fact that voters in Iowa, Minnesota, and North Carolina have a sense of humor, it also says something about the state of American politics and, indirectly, about Donald Trump’s rise to the top of the polls. Here’s how we put it:
The endemic corruption, crony capitalism, rampant regulatory capture, and licentious logrolling that many voters have come to associate with the American political process has created a deep-seated desire for change and if there are two names which most certainly do not portend a break from business as usual inside the Beltway they are “Bush” and “Clinton.”
And while some were disappointed to learn that Deez Nuts is actually a 15-year-old farm boy from Iowa (apparently at least some voters were hoping to see Nuts make a real run for The White House), his popularity is still growing and it certainly seems as though the media and at least one polling company are set to see just how far Deez Nuts can run (so to speak).
Below, find a graphic which shows that search interest for Nuts is now greater than for Hillary Clinton along with the backstory from The New York Times.
From The New York Times:
The presidential candidate Deez Nuts was surging on Wednesday in a poll, albeit unscientific, in North Carolina.
Deez Nuts was also the No. 1 trending topic on Twitter.
For anyone who has fallen 24 hours behind the campaign news cycle, Deez Nuts is a registered independent, a supporter of a balanced budget and the Iran nuclear deal — and a 15-year-old farm boy from Iowa.
In registering with the Federal Election Commission last month, Deez Nuts listed an address in rural Wallingford, Iowa, that is the home of Mark and
Teresa Olson. Mr. Olson, who farms 2,000 acres of corn and soybeans, said in an interview that Deez Nuts was his son Brady, who begins his sophomore year in high school next week.
Like any surging candidate, Deez Nuts has been besieged with requests from the national news media since becoming an Internet meme, but has said he would be interviewed only by email. “School’s starting back up and I still have to sort this out,’’ he wrote to this reporter.
Asked why Deez Nuts entered the presidential race, Brady replied, “To clear the way for a future third-party movement.’’
Tom Jensen, the director of Public Policy Polling, said he added Deez Nuts to statewide survey three weeks ago because “the name makes people laugh, and it’s a long presidential election.’’
But Mr. Jensen also drew a serious conclusion from the Deez Nuts surge.
“I would say Mr. Nuts is the most ludicrous and unqualified third-party candidate you could have, but he’s still polling at 7, 8, 9 percent,’’ Mr. Jensen said. “Right now the voters don’t like either of the people leading in the two main parties, and that creates an appetite for a third-party candidate.’’
After the North Carolina results, which were picked up by television news broadcast, Mr. Jensen thought the joke had run its course. But now that Deez
Nuts is receiving a wave of publicity, the pollster is curious to see if the Deez Nuts candidacy can be lifted higher. Mr. Jensen plans to include the independent in polls in New Hampshire this weekend and in a national survey next week.
* * *
Bonus: the Deez Nuts campaign platform from the candidate’s official campaign website
Illegal Immigration
I believe that anyone who is found as an illegal immigrant in this country must be deported back to their country of origin, with the lone exception of being a minor.
Federal Budget & Government Spending
I believe that the US Government should not be allowed to spend more than it makes from tax revenue. The reason we are in a budget crisis is because the two main parties refuse to compromise on this issue. Every federal official in either Congress, President, or the Cabinet, should immediately have their salary cut in half. Once the budget is balanced, those salaries may slowly rise. If the budget returns negative, salaries go back to where they started.
Abortion & Same-Sex Marriage
I feel that as equal human beings that we should be allowed to choose how to live our lives without being discriminated by one another. At the same time however, I also understand that people believe that Christian religion outweighs government policy. But America is no longer mainly Christian. It is Christian, Jewish, Islam, Hebrew, and many others.
Foreign Policy
I support the work that John Kerry and the State Department did with the Iran nuclear deal, considering it took nearly two years to reach this point. Everyone wants a better deal, but that’s the whole point of negotiating. Look at your wants, then their wants, and meet in the middle. Now is the time being respected instead of feared by other nations. I also feel that we need to stop being a world watchdog and limit our positions in international conflicts.
Energy
I support cutting subsidies to oil companies and giving tax incentives to individuals and corporations that implement green technology and renewable energy sources into their communities. I also support giving grants to communities for the purpose of installing municipal wind turbines, hydroelectric dams, and rooftop solar panels.
Economy
I support giving corporations tax incentives for the sole purpose of creating jobs IN America TO Americans FOR Americans. This will in turn stimulate the economy and make us more self-sufficient instead of relying on products from foreign countries.
Territorial Voting Rights
I support giving citizens in our American territories voting rights. I also support giving American Samoan citizens automatic US citizenship. I would give Puerto Rico 3 electoral votes since Puerto Rico is bigger than many states. Guam, the US Virgin Islands, and the Northern Marianas all get 2 since they are smaller, but still incorporated territories. Finally, American Samoa would only get 1 since it is still considered an “unincorporated” territory. This would bring the total of electoral votes from 538 to 548. I also support giving all 5 territories plus Washington, D.C. 1 seat in the House of Representatives instead of non-voting delegates. This would bring seats in the House from 435 to 441.
- Venezuela Announces Martial Law In Border State, Dispatches 1500 Soldiers
While Venezuela’s collapse to a socialist singularity best defined by total economic devastation has been chronicled extensively here over the years…
… to the point where neither the country’s hyperinflation, nor the total collapse of its currency…
… nor its return to a barter economy, nor even the fact that it has run out of condoms, fake breasts, or beer engender much of a reaction, perhaps the only thing readers seem attuned to is when will the social implosion lead to renewed political tensions which will likely result in another violent political overthrow, one which may or may not involve the local military.
Today Venezuela took a step in that direction when its president Maduro declared a state of emergency in a border region near Colombia following an attack by smugglers in which three soldiers and a civilian were injured, resulting in 60 days of martial law in five municipalities of the state of Tachira. He also said the closure of the border, announced on Thursday, will be extended until further notice.
Petrol and food smugglers have increasingly clashed with officers. According to the BBC, Maduro said Colombian paramilitary groups regularly travel to Venezuela, generating chaos and shortages in order to destabilise the revolution.
Many are openly speculating that the official explanation is bogus, and Maduro merely wants a pretext to deploy the army first to one state in which social tensions have led to violence and death as a test, then everywhere else where anti-government sentiment is on the rise.
Maduro said an extra 1,500 soldiers had arrived to reinforce the area. “This decree provides ample power to civil and military authorities to restore peace,” he said in a broadcast on state television.
It also empowers the local army to deal with the population as it sees fit, and in general to confirm that Venezuela society is rapidly spiraling out of control.
On Wednesday, three Venezuelan army officers and a civilian were injured in riots with Colombian smugglers.
Venezuela closed its border with Colombia for the first time last year.
Colombian President Juan Manuel Santos has criticised the move. Mr Santos said ordinary people on both sides of the border, including children, would suffer the most. “If we co-operate, the only ones to lose are the criminals, but if the border is closed, there is no co-ordination and the only ones to gain are the criminals,” said Mr Santos.
Tensions run high along the porous 2,200-kilometre (1,370-mile) border.
And unless the price of oil somehow rebounds, Venezuela, whose economy is entirely dependent on oil exports, will surely see tensions migrate to the capital Caracas, where a far more violent ending is assured, as well as the country’s inevitable default. Recall as of a few weeks ago, according to the CDS market VENZ was determined to be the state most likely to default in the coming months.
Perhaps at this point the question is not whether Maduro will lose control – he will – but which US-baked banking interests will step in to wrest control of the Venezuelan oil industry from the state, and just how will this be implemented?
- Is It Time to Get into Crash Positions, Or Will The Market Just Enter A Glide Path Rather Than A Tailspin
Submitted by Charles Hugh Smith from Of Two Minds
Is It Time to Get into Crash Positions?
Maybe this flight won’t go into a tailspin; perhaps it simply runs out of fuel.With stock markets diving around the globe, a pressing question arises: is it time to get into Crash Positions?
In case you forgot how to get into Crash Positions, here’s a reminder:
After a dizzying 500+ point drop in the Dow on Friday, should we brace for impact? There are plenty of fundamental and technical reasons to view the swoon this week as the initial downturn that presages a crash landing.
But if we look at the last equivalent spike down in October 2014, we’re not so sure. Both spikes (October 2014 and August 2015) smashed through the lower Bollinger band, but the volume in last week’s plummet was nothing special compared to the 2014 swoon.
Big moves have a bit more credence if they’re accompanied by massive volume.
This leaves the door open to a sharp rebound, i.e. what followed the spike down last October.
The Put-Call Ratio (CPC) has actually exceeded the spike of October 2014, suggesting fear and panic are at higher levels now than back then. Sharp peaks in the CPC typically signal market bottoms.
But even if the market rebounds sharply, that doesn’t necessarily signal the return of higher highs. Recent lows in the CPC signaling extremes of complacency did not result in new highs; the market has been range-bound for months. This suggests the Bull is tiring–even if price pops back up.
The SPX MACD has worked its way down to the neutral line, threatening to punch through to negative territory. Bad things tend to happen when MACD stumbles below the neutral line, and that suggests the next decline might be different from the spike-down-snapback pattern of last year.
Is it time to get into Crash Positions? It never hurts to be prepared, but if the market pulls another October 2014 snapback here, the market could enter a glide path rather than a tailspin.
Keep an eye on the fuel gauges. Maybe this flight won’t go into a tailspin; perhaps it simply runs out of fuel.
- The Demands For Another Fed Bailout Have Begun
Back in August 2007, just as the quant funds had their first taste of what the upcoming collapse would look like and when the Fed for the first time realized that the subprime woes were “not contained” despite what Ben Bernanke had promised previously to Congress, financial comedy TV’s best known mascot, Jim Cramer had a meltdown on CNBC following Bear Stearns’ CFO admission that the fixed-income market turmoil was the worst in 22 years, ranting how the Fed “knows nothing” and how it should promptly bail out the financial system.
Little did Bear Stearns know that less than 9 months later it would no longer exist, but not before the same Jim Cramer proclaimed Bear Stearns was “fine” and is not in trouble when it was trading at $62/share. A week later the company was insolvent and was handed to JPM for a forced take-out at $2/share.
Fast forward 8 years when we just witnessed the biggest weekly market rout in 4 years and largest VIX surge in history, and when – like clockwork – the financial “experts” come crawling out demanding, you guessed it, another Fed bailout.
Here is Suze Orman, self-described as “America’s Most Trusted Personal Finance Expert” who, hilariously enough, in a Twitter conversation with none other than financial comedy’s prime mascot made it quite clear how she feels about the market rout:
I am taking this year off but it is hard to sit silently and watch these markets. Fed Chair Yellen help us out. Commit to no rate increases
— Suze Orman (@SuzeOrmanShow) August 21, 2015
Cramer’s prompt response was essentially a rerun of 2007:
.@SuzeOrmanShow Could not be more right. Silence the Fed heads who say all is good. IMF is dead right! https://t.co/f1BV7JfSyr
— Jim Cramer (@jimcramer) August 21, 2015
The “trusted expert” chimes in, demanding someone do something to crush the selling which “did not need to happen” – after all only buying is allowed under central planning.
@jimcramer Jim do something. This is so crazy. This did not need to happen. I know run for President.
— Suze Orman (@SuzeOrmanShow) August 21, 2015
The punchline, as usual, belongs to Cramer:
Everyone should be following my good friend @SuzeOrmanShow as she is the most commonsensical individual in finance.
— Jim Cramer (@jimcramer) August 21, 2015
So let’s get this straight: when the Fed-manipulated market keeps levitating ever higher, even as the Fed itself admits QE has failed to help the economy, America’s “most trusted personal finance expert” is delighted.
But once we have even a modest stock correction – arguably because stocks are no longer allowed to drop… ever – the same expert comes out demanding a bailout, because you see it was beyond her “expert” skills to prepare America for tthe inconceivable contingency of a market drop. And just in case her message is lost on someone, Cramer defines this same “expert” as the most commonsensical individual in finance.
Is it any wonder that with “personal finance experts” such as these, that the personal finances of America have never been worse?
- Caught On Tape: Another Huge Chemical Warehouse Explosion Rocks China
Who could have seen this coming?
Just a little over a week after a powerful explosion killed 114 and injured more than 700 in the Chinese port of Tianjin, it appears as though a second blast has occurred at a chemical warehouse, this time in China’s eastern Shandong province. A residential area is reportedly located just 1 km away.
We’ll await the details which we imagine will suggest that, as was the case in Tianjin, many more tonnes of something terribly toxic were stored than is allowed under China’s regulatory regime which apparently only applies to those who are not somehow connected to the Politburo. Indeed, The People’s Daily is reporting that the plant contained adiponitrile, which the CDC says can cause “irritation eyes, skin, respiratory system; headache, dizziness, lassitude (weakness, exhaustion), confusion, convulsions; blurred vision; dyspnea (breathing difficulty); abdominal pain, nausea, [and] vomiting.”
There are two videos shown below. As of now, there’s some confusion as to which is authentic.
BREAKING: Chemical warehouse in Shandong exploded on Sat. Firefighters are at the site now pic.twitter.com/DdZ5o3k4sk
— People’s Daily,China (@PDChina) August 22, 2015
#BREAKING Explosion occurs to a chemical plant in E China’s Shandong on Saturday evening, flames spotted at site pic.twitter.com/CG9cRwlOAM
— CCTVNEWS (@cctvnews) August 22, 2015
From BBC:
An explosion has been reported at a chemical plant in China’s eastern province of Shandong.
Large flames can be seen from the site of the blast in Zibo County. There are so far no reports of any casualties.
The People’s Daily said a warehouse at the plant exploded and firefighters are at the scene. There is a residential area about 1km from the plant.
Earlier this month blasts in the northern city of Tianjin killed at least 116 people, with hundreds hurt.
Unverified YouTube footage showed a massive explosion at the Shandong plant.
It is not yet clear if homes in the Shandong area have been damaged.
And from Reuters:
The factory produced adiponitrile, a colorless liquid that releases poisonous gases when it reacts with fire, the People’s Daily said, citing the state-run Beijing Times.
Seven fire brigades consisting of a total of 150 fire fighters and 20 fire engines were sent to the scene and fire brigades that are trained to work with fires involving chemicals are being dispatched, Xinhua said.
Windows shattered in the village where the blast occurred, state media said, and tremors reverberated within 2 kilometers (1 mile) of the site of the explosion.
- Introducing The Gigantic And Dangerous Wall Street Loophole You’ve Never Heard Of
By Mike Krieger of Liberty Blitzkrieg
Introducing the Gigantic and Dangerous Wall Street Loophole You’ve Never Heard of
This spring, traders and analysts working deep in the global swaps markets began picking up peculiar readings: Hundreds of billions of dollars of trades by U.S. banks had seemingly vanished.
The vanishing of the trades was little noted outside a circle of specialists. But the implications were big. The missing transactions reflected an effort by some of the largest U.S. banks — including Goldman Sachs, JP Morgan Chase, Citigroup, Bank of America, and Morgan Stanley — to get around new regulations on derivatives enacted in the wake of the financial crisis, say current and former financial regulators.
The trades hadn’t really disappeared. Instead, the major banks had tweaked a few key words in swaps contracts and shifted some other trades to affiliates in London, where regulations are far more lenient. Those affiliates remain largely outside the jurisdiction of U.S. regulators, thanks to a loophole in swaps rules that banks successfully won from the Commodity Futures Trading Commission in 2013.
Many of the CFTC employees who were lobbied in these meetings went on to work for banks. Between 2010 and 2013, there were 50 CFTC staffers who met with the top five U.S. banks 10 or more times. Of those 50 staffers, at least 25 now work for the big five or other top swaps-dealing banks, or for law firms and lobbyists representing these banks.
The lobbying blitz helped win a ruling from the CFTC that left U.S. banks’ overseas operations largely outside the jurisdiction of U.S. regulators. After that rule passed, U.S. banks simply shipped more trades overseas. By December of 2014, certain U.S. swaps markets had seen 95 percent of their trading volume disappear in less than two years.
– From the excellent Reuters article: U.S. Banks Moved Billions of Dollars in Trades Beyond Washington’s Reach
The following story is guaranteed to make you sick. Once again, we’re shown that following trillions in taxpayer funded bailouts and backstops, TBTF Wall Street banks immediately went ahead and focused all their attention obtaining loopholes in order to transfer risk and make billions upon billions of dollars in the financial matrix, as opposed to adding any benefit whatsoever to society.
From Reuters:
NEW YORK – This spring, traders and analysts working deep in the global swaps markets began picking up peculiar readings: Hundreds of billions of dollars of trades by U.S. banks had seemingly vanished.
“We saw strange things in the data,” said Chris Barnes, a former swaps trader now with ClarusFT, a London-based data firm.
The vanishing of the trades was little noted outside a circle of specialists. But the implications were big. The missing transactions reflected an effort by some of the largest U.S. banks — including Goldman Sachs, JP Morgan Chase, Citigroup, Bank of America, and Morgan Stanley — to get around new regulations on derivatives enacted in the wake of the financial crisis, say current and former financial regulators.
The trades hadn’t really disappeared. Instead, the major banks had tweaked a few key words in swaps contracts and shifted some other trades to affiliates in London, where regulations are far more lenient. Those affiliates remain largely outside the jurisdiction of U.S. regulators, thanks to a loophole in swaps rules that banks successfully won from the Commodity Futures Trading Commission in 2013.
For large investors, the products are an important tool to hedge risk. But in times of crisis, they can turn toxic. In 2008, some of these instruments helped topple major financial institutions, crashing the U.S. economy and leading to government bailouts.
After the crisis, Congress and regulators sought to rein in this risk, and the banks fought back. From 2010 to 2013, when the CFTC was drafting new rules, representatives of the five largest U.S. banks met with the regulator more than 300 times, according to CFTC records. Goldman Sachs attended at least 160 of those meetings.
Many of the CFTC employees who were lobbied in these meetings went on to work for banks. Between 2010 and 2013, there were 50 CFTC staffers who met with the top five U.S. banks 10 or more times. Of those 50 staffers, at least 25 now work for the big five or other top swaps-dealing banks, or for law firms and lobbyists representing these banks.
The lobbying blitz helped win a ruling from the CFTC that left U.S. banks’ overseas operations largely outside the jurisdiction of U.S. regulators. After that rule passed, U.S. banks simply shipped more trades overseas. By December of 2014, certain U.S. swaps markets had seen 95 percent of their trading volume disappear in less than two years.
While many swaps trades are now booked abroad, some people in the markets believe the risk remains firmly on U.S. shores. They say the big American banks are still on the hook for swaps they’re parking offshore with subsidiaries.
Still, the banks’ victory on the swaps loophole leaves a concentrated knot of risk at the heart of the financial system. The U.S. derivatives market has shrunk but remains large, with outstanding contracts worth $220 trillion at face value. And the top five top banks account for 92 percent of that.
In 2009, President Barack Obama tapped Gary Gensler, then 51 years old, to chair the CFTC. Liberals grumbled about Gensler’s résumé. The son of a cigarette and pinball-machine salesman in working class Baltimore, Gensler, at 30, had become the youngest banker ever to make partner at Goldman Sachs.
Among other jobs, he oversaw the bank’s derivatives trading in Asia. Later, as an undersecretary of the Treasury, Gensler helped push through the 2000 law that had banned regulation of derivatives markets.
Kenneth Raisler, a former Enron lobbyist representing JP Morgan, Citigroup, and Bank of America, argued in a letter that the CFTC should allow U.S. banks to do things overseas “even if those activities were not permissible for a U.S. bank domestically.”
“Kenneth Raisler, a former Enron lobbyist representing JP Morgan, Citigroup, and Bank of America.”
You just can’t make this stuff up. Gold Jerry, gold.
Meanwhile, Obama was hard at work as always proving himself to be a capable banker coddler in order to ensure his payday upon leaving office.
In his place, Obama nominated a long time aide to Democratic Senator Harry Reid, Mark Wetjen. Gensler and other pro-reform allies assumed that the veteran Democrat would vote with the Democrats on the commission.
Wetjen, a derivatives newcomer, was not a conventional liberal. He came with an endorsement from the U.S. Chamber of Commerce, an opponent of the Dodd-Frank Act. As his policy adviser, Wetjen hired Scott Reinhart, former in-house counsel at the structured credit products division at Lehman Brothers – the bank whose collapse in 2008 set off the financial crisis.
Rosen, the banks’ lead lawyer, discussed Wetjen often on calls with his bank clients. The newcomer, Rosen told them, was key to swinging the commission in the banks’ favor.
Banks got dramatically more face time with commissioners after Wetjen’s appointment. In 2010, Gensler had met with the top five U.S. banks 13 times, and in 2011, 10 times. That was still more than any other staffer or commissioner at the CFTC.
In the year after Wetjen’s appointment, Wetjen aide Reinhart met with the top five banks 36 times, more than anyone else at the CFTC. Wetjen himself met with the top banks second-most often, 34 times. Gensler met them less than half as frequently, as did nearly every other commissioner and staffer, according to the records.
In June, Reinhart left the CFTC to join Rosen’s practice at Cleary Gottlieb.
Gensler had little patience for the bank-friendly Wetjen, former CFTC officials say. As their disagreements sharpened, Wetjen’s pro-bank views seemed to harden, these people said.
“Mark was struggling a little with the substance,” one former CFTC official said. “Gary treated Mark like he was a moron, and then Mark refused to budge.”
“The fight over this provision was one of the biggest policy fights in all of Dodd Frank,” said Kelleher, of the think tank Better Markets. “Once the banks got that loophole, then a lot of that predatory behavior migrated overseas to wherever there was less regulation.”
Goldman had already started moving to restructure its trading operations to get around Dodd-Frank. In March 2012, it sent out a four-page letter to its derivatives clients with an unusual demand. Goldman wanted clients to sign off on giving the bank standing permission to move a client’s swaps trades to different affiliates around the world, whenever and wherever the bank saw fit.
Goldman called the letter the “Multi-entity ISDA Master Agreement.” It meant that a client might strike a derivatives deal with Goldman in New York in the morning, and that afternoon, with no disclosure, a Goldman office in London or Singapore or Hong Kong could take over the deal. With each shift, the trade could fall under different regulators.
Perhaps I should ask John Hilsenrath whether it is “anti-Semitic” to point this out.
Just in case you need a reminder of how incredibly putrid and corrupt Banana Republic America has become…
The global inter-dealer market for interest rate swaps in Euros is one of the largest derivatives markets in the world. U.S. banks’ monthly share of the market had plunged nearly 90 percent since January 2013, from over $1 trillion to $125 billion, according to ISDA.
The data were misleading. U.S. banks were still trading as vigorously as ever. But their trades, booked through London affiliates, without any credit guarantees linking them back to the U.S., were now showing up in the data as the work of European banks.
In mid 2014, the Securities Industry and Financial Markets Association, a banking lobby in Washington, circulated a private memo to its members. The memo consisted of talking points banks could use to justify the de-guaranteed contracts and shifting of trades if questioned by regulators and lawmakers.
Where have you heard about the Securities Industry and Financial Markets Association, or SIFMA, before? Recall the following from the post, Ex-NSA Chief Keith Alexander is Now Pimping Advice to Wall Street Banks for $1 Million a Month:
So what is Mr. Alexander charging for his expertise? He’s looking for $1 million per month. Yes, you read that right. That’s the rate that his firm, IronNet Cybersecurity Inc., pitched to Wall Street’s largest lobbying group the Securities Industry and Financial Markets Association (SIFMA), which ultimately negotiated it down to a mere $600,000 a month. In case you need a refresher on how much of a slimy character this guy is, I suggest you read the following posts…
What would we have done without the bailouts…
For related articles, see:
Why Obama Allowed Bailouts Without Indictments by Janet Tavakoli
Why Bailouts are Anti-American in One Minute by Max Keiser
Wall Street Moves to Put Taxpayers on the Hook for Derivatives Trades
The U.S. Department of Justice Handles Banker Criminals Like Juvenile Offenders…Literally
Why Obama Allowed Bailouts Without Indictments by Janet Tavakoli
Elizabeth Warren Confronts Eric Holder, Ben Bernanke and Mary Jo White on Bankster Immunity
Even Washington D.C. Insiders Admit Eric Holder is a Bankster Puppet
- 7 Million People Haven't Made A Single Student Loan Payment In At Least A Year
Perhaps it’s all the talk about across-the-board debt forgiveness or maybe the total amount of outstanding student debt has simply grown so large ($1.3 trillion) that even those with no conception of how much money that actually is realize that it’s simply never going to paid back so there’s no point worrying about, but whatever the case, the general level of concern regarding America’s student debt bubble doesn’t seem to be at all commensurate with the size of the problem.
And it’s not just the sheer size of the debt pile that’s worrisome. There’s also the knock-on effects, such as delayed household formation and the attendant downward pressure on the homeownership rate, and of course hyperinflation in the rental market.
Of course one reason no one is panicking – yet – is that the severity of the problem is masked by artificially suppressed delinquency rates. As we’ve documented in excruciating detail, if one excludes loans in deferment and forbearance from the numerator in the delinquency calculation, but includes those loans in the denominator then the delinquency rate will be deceptively low. In any event, as WSJ reports, even if one looks at something very simple like, say, the number of borrowers who haven’t made a payment in a year, the picture is not pretty and it’s getting worse all the time. Here’s more:
Nearly seven million Americans have gone at least a year without making a payment on their federal student loans, a staggering level of default that highlights how student debt continues to burden households despite an improving labor market.
As of July, 6.9 million Americans with student loans hadn’t sent a payment to the government in at least 360 days, quarterly data from the Education Department showed this week. That was up 6%, or 400,000 borrowers, from a year earlier.
The figures translate into about 17% of all borrowers with federal loans being severely delinquent—and that share would be even higher if borrowers currently in school were excluded. Additionally, millions of other borrowers who haven’t hit the 360-day threshold that the government defines as a default are months behind on their payments.
Each new crop of students is experiencing the same problems” with repaying, said Mark Kantrowitz, a higher-education expert and publisher of the information website Edvisors.com. “The entire situation isn’t getting better.”
The development carries big implications for borrowers, taxpayers and the economy. Economists have warned of student-debt defaults damaging borrowers’ credit standing, which would hurt their ability to borrow for things like cars and homes. That in turn would hamper the economy, which relies heavily on consumer purchases for economic activity. Delinquencies also drain government revenues, which are used to make future loans.
So what’s the solution you ask? According to the government, the answer is the income based repayment plans. Here’s The Journal again:
Education Secretary Arne Duncan said declines [in some categories of delinquencies] resulted from rising participation in income-based repayment plans, which lower borrowers’ monthly bills by tying payments to their incomes. Enrollment in the plans surged 56% over the past year among direct-loan borrowers.
The administration has urgently promoted the plans, mainly through emails to borrowers, over the past two years in an effort to stem defaults. The plans set payments as 10% or 15% of their discretionary income, defined as adjusted gross income minus 150% the federal poverty level.
The plans carry risks, though, for both borrowers and the government. Many borrowers’ payments aren’t enough to cover the interest on their debt, allowing their balances to grow and threatening to trap them under debt for years.
At the same time, the government could be left forgiving huge amounts of debt if borrowers stay in the plans. The government forgives balances after 10, 20 or 25 years of on-time payments, depending on the plan.
But aside from the fact that these plans will cost taxpayers an estimated $39 billion over the next decade – and that’s just counting those expected to enroll in plans going forward and ignoring the $200 billion or so in loans already enrolled in an IBR plan – the most absurd thing about Duncan’s claim is that, as we’ve shown, IBR programs don’t drive down delinquency rates, they just change the meaning of the term “payment”:
See how that works? If you can’t afford to pay, just tell the Department of Education and they’ll enroll you in an IBR plan where your “payments” can be $0 and you won’t be counted as delinquent.
So we suppose we should retract the statement we made above. You are correct Mr. Duncan, these plans are actually very effective at bringing down delinquencies and the method is remarkably straightforward: the government just stopped couting delinquent borrowers as delinquent.
Digest powered by RSS Digest
Saving...