Today’s News August 30, 2015

• Why The Great Petrodollar Unwind Could Be $2.5 Trillion Larger Than Anyone Thinks

  Last weekend, we explained why it really all comes down to the death of the petrodollar. 

  

  China’s transition to a new currency regime was supposed to represent a move towards a greater role for the market in determining the exchange rate for the yuan. That’s not exactly what happened. As BNP’s Mole Hau hilariously described it last week, “whereas the daily fix was previously used to fix the spot rate, the PBoC now seemingly fixes the spot rate to determine the daily fix, [thus] the role of the market in determining the exchange rate has, if anything, been reduced in the short term.” Of course a reduced role for the market means a greater role for the PBoC and that, in turn, means FX reserve liquidation or, more simply, the sale of US Treasurys on a massive scale. 

  The liquidation of hundreds of billions in US paper made national headlines this week, as the world suddenly became aware of what it actually means when countries begin to draw down their FX reserves. But in order to truly comprehend what’s going on here, one needs to look at China’s UST liquidation in the context of the epochal shift that began to unfold 10 months ago. When it became clear late last year that Saudi Arabia was determined to use crude prices to bankrupt US shale producers and secure other “ancillary diplomatic benefits” (think leverage over Russia), it ushered in a new era for producing nations. Suddenly, the flow of petrodollars began to dry up as prices plummeted. These were dollars that for years had been recycled into USD assets in a virtuous loop for everyone involved. The demise of that system meant that the flow of exported petrodollar capital (i.e. USD recycling) suddenly turned negative for the first time in decades, as countries like Saudi Arabia looked to their stash of FX reserves to shore up their finances in the face of plunging crude. Of course the sustained downturn in oil prices did nothing to help the commodities complex more broadly and as commodity currencies plunged, the yuan’s dollar peg meant China’s export-driven economy was becoming less and less competitive. Cue the devaluation and subsequent FX market interventions.

  In short, China’s FX management means that Beijing has joined the global USD asset liquidation party which was already gathering pace thanks to the unwind of the petrodollar system. To understand the implications, consider what BofAML said back in January:

  During the oil-boom era, oil-exporters used oil earnings to finance imports of goods and services, and channeled a portion of surplus savings into foreign assets. ‘Petrodollar’ recycling has in turn helped boost global demand, liquidity and asset prices. With the current oil price rout, external and fiscal balances of oil exporters are undermined, and the threat of lower imports and repatriation of foreign assets is cause for concern.

  
  

  Recycling of Asia-dollars might partly replace the recycling of petrodollars.  Asian sovereign wealth funds ($2.8tn) account for about 39% of total sovereign wealth funds, and will likely see their size increase at a faster clip. Sovereign wealth funds of China (CIC & SAFE), Hong Kong (HKMA), Singapore (GIC & Temasek) and Korea (KIC) rank in the Top-15 globally

  Yes, the “recycling of Asia-dollars might partly replace the recycling of petrodollars.” Unless of course a large Asian country is suddenly forced to become a seller of USD assets and on a massive scale. In that case, not only would the recycling of Asian-dollars not replace petrodollar recycling, but the “Eastern liquidation” (so to speak) would simply add fuel to the fire – and a lot of it. That’s precisely the dynamic that’s about to play out. 

  A careful reading of the above from BofA also seems to suggest is that looking strictly at official FX reserves might underestimate the potential size of the petrodollar effect. Sure enough, a quick check across sellside desks turns up a Credit Suisse note on the “secular downtrend in EM reserves” which the bank says could easily be understated by focusing on official reserves. 

  First, note the big picture trends (especially Exhibit 2):

  

  

  And further, here’s why the scope of the unwind could be materially underestimated.

  Taken into context, the year-to-date fall in EM reserves accounts for only 2% of the total stock of EM reserves. However, the change in the behavior of EM central banks from persistent buyers to now sellers of reserve assets carries important implications. Importantly, official reserves will likely underestimate the full scale of the reversal of oil exporters’ “petrodollar” accumulation.

   

  Crucially, for oil exporting nations, central bank official reserves likely underestimate the full scale of the reversal of oil exporters’ “petrodollar” accumulation. This is because a substantial part of their oil proceeds has previously been placed in sovereign wealth funds (SWFs), which are not reported as FX reserves (with the notable exception of Russia, where they are counted as FX reserves).

  • Currently, oil exporting countries hold about $1.7trn of official reserves but as much as $4.3trn in SWF assets.
  • In the 2009-2014 period, oil exporters accumulated about $0.5trn in official reserves but as much as $1.8trn of SWF assets.

  Now that the tide has turned, it is likely that not only official reserves drop but that SWF asset accumulation slows to nil or even reverses. SWF selling may be a slower process as assets tend to be less liquid, but the opportunity might still be taken to repatriate some investments, for instance to boost domestic rather than foreign infrastructure projects. 

   

  

  In other words, looking at the total amount of official reserves for oil exporters understates the potential for petrodollar draw downs by around $2.5 trillion. Now obviously, it’s unlikely that exporters will exhaust the entirety of their SWFs. Having said that, the fact that EM FX reserve accumulation turned negative for the first time in history during Q2 underscores how quickly the tide can turn and how sharp reversals can be. If one fails to at least consider the SWF angle then the effect is to underestimate the worst case scenario by $2.5 trillion, and if 2008 taught us anything, it’s that failing to understand just how bad things can get leaves everyone unprepared for the fallout in the event the situation actually does deteriorate meaningfully. 

  So that’s the big picture. In other words, the above is a discussion of the pressure on accumulated petrodollar investments and is an attempt to show that the pool of assets that could, in a pinch, be sold off to finance things like massive budget deficits (Saudi Arabia, for instance, is staring down a fiscal deficit that amounts to 20% of GDP) is likely being underestimated by those who narrowly focus on official reserves. Switching gears briefly to consider what $50 crude means for the flow of petrodollars (i.e. what’s coming in), RBS’ Alberto Gallo has the numbers:

  If petroleum prices continue in to year end at their current YtD average ($52), this would represent a 60% decline in Petrodollar generated in 2015 vs between 2011 and 2014. Assuming that 30% of gross Petrodollars generated per year are invested in financial markets, this would imply $288bn ready for investments in 2015 vs a $726bn average between 2011 and 2014. Lower purchasing power from oil-exporting countries may in turn reduce demand for $-denominated fixed income assets, including $ IG and $ HY. US IG and HY firms have issued $918bn and $220bn YtD, which in total marks a record-high vs past years. 

   

  

  

   

  And while all of this may seem complex, it’s actually quite simple: less petrodollars coming in without a commensurate reduction in what’s going out means the difference has to be made up somewhere and that somewhere is in the sale of USD reserve assets which are prone to being understated if one looks only at official FX reserves. Contrast this with the status quo which for years has been more petrodollars coming in than what’s going out (in terms of expenditures) with the balance being reinvested in USD assets.

  Simplifying even further: the virtuous circle (for the dollar and for USD assets) has not only been broken, but it’s now starting to reverse itself and the potential scope of that reversal must take into account SWF assets. 

  Where we go from here is an open question, but what’s clear from the above is that between China’s FX reserve drawdowns in defense of the yuan and the dramatic decrease in petrodollar flow, the self-feeding loop that’s sustained the dollar and propped up USD assets is now definitively broken and we are only beginning to understand the consequences. 

  

  

  

  

• Dis-Integrating America

  Submitted by Pat Buchanan via Buchanan.org,

  The Wednesday morning murders of 24-year-old Roanoke TV reporter Alison Parker and cameraman Adam Ward, 27, were a racist atrocity, a hate crime. Were they not white, they would be alive today.

  Their killer, Vester L. Flanagan II, said as much in his farewell screed. He ordered his murder weapon, he said, two days after the slaughter of nine congregants at the African-American AME church in Charleston, South Carolina.

  “What sent me over the top was the church shooting,” said Flanagan.

  To be sure, racism does not fully explain why Flanagan, fired from that same WDBJ7 station, committed this act of pure evil.

  Black and homosexual, he said he was the target of anti-gay slurs from black males and racial insults from white colleagues. He had gotten himself fired from other jobs in broadcasting. He carried a grab bag of grudges and resentments.

  Yet, in the last analysis, The Washington Post headline got it right: “Gunman’s letter frames attack as racial revenge.”

  Other news organizations downplayed the racial aspect. But had those murdered journalists been young and black, and their killer a 40-something “angry white male,” the racial motivation would have been front and center in their stories.

  Now, Black America is surely as sickened by this horror outside Roanoke as was White America by the Charleston massacre.

  But it is hard to see how and when we come together as a people. For racial crimes and race conflict have become “the story” that everyone seizes upon — since Ferguson in the summer of 2014.

  On the first anniversary of Michael Brown’s death, protesters blocked public buildings in St. Louis and St. Louis County, shut down I-70 at rush hour. In Ferguson, hoodlums rioted and looted for days.

  What justification was there for such lawlessness?

  Explained some in the press, it was to protest the failure to prosecute a white cop who had killed an “unarmed black teenager.”

  Left out of most stories was that Brown, 18, had knocked over a convenience store, throttled a clerk half his size, and was unarmed only because he failed to wrest a gun away from Officer Darren Wilson, whom a grand jury declared had acted in self-defense when he shot the charging 290-pound Brown.

  Since then, we have had the Eric Garner incident on Staten Island, where a 345-pound black man, suffering from diabetes, asthma, obesity and heart disease, died of heart failure after being wrestled to the ground by five cops, none of whom was charged.

  Came then the death of Freddie Gray in Baltimore, while in police custody.

  There, six officers have been charged. Then came the death of a 12-year-old black kid in Cleveland, who was waving a toy gun.
  As the incidents pile up, with white cops shooting black suspects, and black criminals killing white cops, the news goes viral and America divides along the lines of race and color, and between black and blue.

  Though, let it be said, the violence in Ferguson and Baltimore was child’s play compared to Watts in ’65, Detroit and Newark in ’67, and D.C. and 100 other cities after Dr. King’s assassination in 1968.

  “Can we all get along?” pleaded Rodney King, when South Central exploded in rioting, arson and looting after the L.A. cops who had beaten King were exonerated.

  Answer: Probably not.

  For what seems certain, ensuring that our racial divide widens and deepens, is that more incidents like those involving Michael Brown, Eric Garner and Freddie Gray are inevitable.

  Why so?

  First, violent crime, declining since the early 1990s, is rising again. And violent crime in black communities is many times higher than in the white communities of America.

  Collisions between black suspects and criminals and white cops are going to increase, and some of these collisions are going to involve shootings. And such shootings trigger fixed, deep-seated beliefs about cops, criminals and injustice, they also cause an instantaneous taking of sides.

  Moreover, this is the sort of “news” that instantly goes viral through the Internet, Facebook and 24-hour cable TV.

  Liberals and Democrats take sides with the black community out of solidarity and to solidify their political base, while Republicans stand with the cops, law-and-order conservatives, and the Silent Majority in Middle America.

  The race issue has even begun to split the Democrats.

  When former Maryland Governor Martin O’Malley, a card-carrying liberal, attended a conference of Netroots Nation and responded to a chant of “Black Lives Matter!” with the more inclusive, “Black Lives Matter! White Lives Matter! All Lives Matter!” he was virtually booed off the stage.

  O’Malley proceeded to apologize for including the white folks.

  To many Americans, even many who did not vote for him, the election of Barack Obama seemed to hold out the promise that our racial divide could be healed by a black president.

  Even Obama’s supporters must concede it did not happen, though we would, again, argue angrily over why.

  

  

  

  

  

• Stagnant US Economic Growth Explained (In 1 Cartoon)

  Presented with no comment…

   

  

   

  Source: Townhall.com

  

  

  

  

  

• Despite Being A 'Pet Rock', The Premium For Physical Bullion Is Exploding

  While status quo-huggers are all too happy to point out gold and silver's lack of utter exuberance amid this week's carnage, perhaps they need to re-comprehend the difference between a heavily manipulated 'paper' market and the surging demand for physical precious metals that is evident in the 20-plus percent premium – and rising – being paid for silver bullion currently…

   

  

   

  

  Chart: GoldChartsRUs.com

  "One important aspect of the physical market that is often overlooked is the premium it commands over spot price. Right before the Global Financial Crisis in 2008, the spot Silver price fell as low as USD 9 per oz., whereas the price of a 1 oz. Silver Eagle was around USD 17 on the wholesale market and even higher on the retail market! That’s a price premium of 188%!

   

  That means that if you had held 100 oz. of paper Silver, you might have had to liquidate that for USD 900 (assuming the market was not halted for trading then), whereas if you had held 100 pieces of 1 oz. Silver Eagle coins, you would have gotten at least USD 1700 for them if not more."

   

  BullionStar, The Difference in Paper and Physical Gold and Silver in times of Crisis

  h/t Jesse's Americain Cafe

  

  

  

  

  

• Ayn Rand & Murray Rothbard: Diverse Champions Of Liberty

  Submitted by Tibor R. Machan via Acting-Man.com,

  Differences and Similarities

  No one should attempt to treat Ayn Rand and Murray N. Rothbard as uncomplicated and rather similar defenders of the free society although they have more in common than many believe.  As just one example, neither was a hawk when it comes to deploying military power abroad.*  There is evidence, too, that both considered it imprudent for the US government to be entangled in international affairs, such as fighting dictators who were no threat to America.  Even their lack of enthusiasm for entering WW II could be seen as quite similar.

   

  

  Ayn Rand, famed writer and founder of the Objectivist movement

  Photo credit: Cornell Capa / Magnum

   And so far as their underlying philosophical positions are concerned, they both can be regarded as Aristotelians.  In matters of economics they were unwavering supporters of the fully free market capitalist system, although while Rand didn’t find corporations per se objectionable, arguably Rothbard had some problems with corporate commerce, especially as it manifest itself in the 20th century.  One sphere in which they took very different positions, at least at first glance, is whether government is a bona fide feature of a genuinely free country. Rand thought it is, Rothbard thought it wasn’t.  Yet the reason Rothbard opposed government was that it depended on taxation, something Rand also opposed, so even here where the difference between them appears to be quite stark, they were closer than one might think.

   

  

  Murray Rothbard, introducing his students to French economist Anne-Robert-Jacques Turgot (widely regarded as a “proto-Austrian” today)

  Photo credit: Roberto Losada Maestre

   

  When intellectuals such as Rand and Rothbard have roughly the same political-economic position, it isn’t that surprising that they and their followers would stress the difference between them instead of the similarities.  Moreover, in this case both had a similar explosive personality, with powerful likes and dislikes not just in fundamentals but also in what may legitimately be considered incidentals–music, poetry, novels, movies and so forth.

  Yet what for Rothbard might be something tangential, even incidental, to his political economic thought, for Rand could be considered more germane since Rand thought of herself–and many think of her–as a philosopher (roughly of the rank of a Herbert Spencer or Auguste Comte).  Rothbard wrote little in the sphere of metaphysics and epistemology, although he was well informed in these branches of philosophy, while Rand chimed in, quite directly, on several philosophical issues, having written what amounts to a rather nuanced long philosophical essay on epistemology and advanced ideas in metaphysics, such as on free will, causality, and the nature of universals.  Her followers, such as Nathaniel Branden, Leonard Peikoff, Tara Smith, Alan Gotthelf, James Lennox, and David Kelley, among others, have all made contributions to serious discussions in various branches of philosophy.

   

  Disagreements on Government and Market Exchanges

  The central dispute, however, between Rothbard and his followers and Rand and hers focuses, as I have already noted, on whether a free country would have a government.  The debate is moved forward in the volume edited by Roderick Long and me,  Anarchism versus Minarchism; Is Government Part of a Free County (Ashgate, 2006).

   

  

  A scene from John Carpenter’s famous documentary “They Live” – the State ultimately enforces its diktats and demands by threatening and exercising violence.

  Photo credit: John Carpenter

  Even apart from their disagreement about the justifiability of government in a bona fide free country, there is the difference between them about the subjectivity of (some) values. Rothbard holds, for example, that “’distribution’ is simply the result of the free exchange process, and since this process benefits all participants on the market and increases social utility, it follows directly that the ‘distributional’ results of the free market also increase social utility.”  The part here that shows the difference between Rothbard and Rand is where Rothbard says that the “free exchange process … benefits all participants on the market.”

  Maybe most of them benefit in such exchanges, but some do not.  Suppose someone exchanges five ounces of crack cocaine for an ounce of heroin.  Arguably, at least as Ayn Rand would very likely maintain, neither of these traders gains a benefit in this exchange, assuming that both commodities being traded are objectively harmful to the traders’ health.  Both are, then, harmed, objectively speaking, even if they believed they would benefit.

  This may be a minor matter but it isn’t, not at least if Rothbard’s idea is generalized to apply to all market exchanges.  True, from a purely economic viewpoint both parties in free exchanges tend to take it or believe that they are benefited by these.  But this belief could well be false.

  Now of course Rand would agree with Rothbard that just because people engage in trade that’s harmful to them, it doesn’t follow that anyone, least of all the government, is authorized to ban such trade or otherwise interfere with it.  Such matters as what may or may not harm free market traders from the trades they choose to engage in are supposed to be dealt with in the private sector.  Family, friends, doctors, nurses, et al., or other agents devoted to advising people what they should and should not do are the only ones who may launch peaceful educational or advisory measures to remedy the private misjudgments and misconduct of peaceful market participants.  Such an approach sees public policies such as the war on drugs as entirely unjustified even if consuming many drugs is objectively damaging to those doing so.

  In any case, the Randian view doesn’t assume that all free trade benefits those embarking on them.  Let me, however, return to the major bone of contention between Murray Rothbard and Ayn Rand, namely, whether government is (or could be) part of a free country.  Given that Rothbard believes government cannot exists without deploying the rights-violating policy of taxation, his view is understandable, but the underlying assumption that gives rise to it is questionable.

  Rand did indeed question it in her discussion of funding government in the chapter “Government Financing in a Free society” in The Virtue of Selfishness, at least by implication, when she argued that government can be financed without taxation. If she is correct, then Rothbard or his followers need to mount a different attack on the idea that the free society can have a government.  (And some have indeed made this argument, including me in, for example, my “Anarchism and Minarchism, A Rapprochement,” Journal des Economists et des Estudes Humaines, Vol. 14, No. 4 [December 2002], 569-588).

  Rand proposed that instead of taxation, which involves the rights-violating policy of confiscation of private property, a government could be funded by way of a contract fee, a lottery, or some other peaceful method.  Whether this is so cannot be addressed here but it shows that Rand and Rothbard were not very distant from each other on the issue of the justifiability of government in a free country. Perhaps the term “government” is ill advised when applied to whatever kind of law-enforcement institution would be involved in bona fide free countries. But this is not what’s crucial–a rose by any other name is still a rose and a law-enforcement, judicial or defense agency in a free society is what is at issue here, not what term is used to call it.  So, again, Rand and Rothbard seem closer than usually believed.

  Yet it’s not just about taxation for many who follow Rothbard.  Most also hold that the idea is mistaken that government–or whatever it is called–needs to serve a society occupying a continuous instead instead of Swiss cheese like region.  The idea of a disparately located country, without a continuous territory and with the possibility of all parts being accessible by law enforcers without the need of international treaties, makes sense to Rothbardians.  Not, however, to Randians, it can be argued, not unless the familiar science fiction transportation option of being “beamed up” from one area to anther (so that law enforcement can reach all those within its jurisdiction) is available.  Otherwise enforcement of the law can be easily evaded by criminals.

   

  Conclusion

  Again, this isn’t the place to resolve the dispute between Rand & her followers and Rothbard and his.  This brief discussion should, however, indicate where their differences lie.  It doesn’t at all explain, however, why the different parties to the debate tend often to be quite acrimonious toward each other.  What may explain this, though, is a simple point of psychology.  Nearly all champions of a fully free, libertarian society are also avid individualists and often tend to insist on what might be called the policy: My way or the highway!  Even when their differences don’t warrant it.

  

  

  

  

  

• Citigroup Chief Economist Thinks Only "Helicopter Money" Can Save The World Now

  Having recently explained (in great detail) why QE4 (and 5, 6 & 7) were inevitable (despite the protestations of all central planners, except for perhaps Kocharlakota – who never met an economy he didn't want to throw free money at), we found it fascinating that no lessor purveyor of the status quo's view of the world – Citigroup's chief economist Willem Buiter – that a global recession is imminent and nothing but a major blast of fiscal spending financed by outright "helicopter" money from the central banks will avert the deepening crisis. Faced with China's 'Quantitative Tightening', the economist who proclaimed "gold is a 6000-year old bubble" and cash should be banned, concludes ominously, "everybody will be adversely affected."

  China has bungled its attempt to slow the economy gently and is sliding into “imminent recession”, threatening to take the world with it over coming months, Citigroup has warned. As The Telegraph's Ambrose Evans-Pritchard reports, Willem Buiter, the bank’s chief economist, said the country needs a major blast of fiscal spending financed by outright "helicopter" money from the bank to avert a deepening crisis.

  Speaking on a panel at the Council of Foreign Relations in New York, Mr Buiter said the dollar will “go through the roof” if the US Federal Reserve lifts interest rates this year, compounding the crisis for emerging markets.

   

  "So why it matters is that the competence of the Chinese authorities as managers of the macro economy is really in question – the messing around with monetary policy, the hinting on doing things on the fiscal side through the policy banks. But I think the only thing that is likely to stop China from going into, I think, recession – which is, you know, 4 percent growth on the official data, the mendacious official data, for a year or so – is a large consumption-oriented fiscal stimulus, funded through the central government and preferably monetized by the People’s Bank of China.

   

  Well, they’re not ready for that yet. Despite, I think, the economy crying out for it, the Chinese leadership is not ready for this.

   

  So I think they will respond, but they will respond too late to avoid a recession, and which is likely to drag the global economy with it down to a global growth rate below 2 percent, which is my definition of a global recession. Not every country needs go into recession. The U.S. might well avoid it. But everybody will be adversely affected."

  Or translated from 'economist' to English – a massive helicopter drop of cash (well 1s and 0s) into the inflating hands of Chinese soon-to-be-consumers is al lthat can the world from another recession… and The Chinese leadership may need to stare into the abyss before they actually pull the trigger. Just think of the pork prices?

   

  

   

  Mr Buiter had some more to add on the idiocy of Chinese Equity markets. He said the stock market crash in Shanghai and Shenzhen…

  …is a sideshow. Consumption effects, you know, wealth effects, minor. Almost no capex in China is funded through share issue. And so it is a symbol of the policy failure rather than intrinsically economically important.

   

  China’s problems are excessive leverage in the corporate sector, in the local government sector, and the very fragile banking system, and shadow banking system. As Chen pointed out, it won’t be allowed to collapse because it is underwritten by the government, but it won’t be a source of great funding strength.

   

  There is excess capacity and a pathetically low rate of return on capital expenditure, right? Invest 50 percent of GDP and get, even in the official data, 7 percent growth. The true data is probably something closer to 4 ½ percent or less. So it is an economy that, I think, is sliding into recession.

   

  And what the stock market reminds us of, I think, especially this sequence of the government first cheerleading the stock market boom and bubble – because quite a few of the local pundits believed that this was a great way of deleveraging without paying for the corporate sector, to have a stock market bubble. And then, of course, the rather panicky and incompetent reaction in response.

   

  So, once again, why it matters is that the competence of the Chinese authorities as managers of the macro economy is really in question.

  *  *  *

  So, it seems, all of a sudden – despite the permabulls, asset-gatherers, and commission-takers saying otherwise – China matters! As Bloomberg notes, China’s deepening struggles are starting to make a bigger dent in the global economic outlook.

  “We’re seeing evidence that the slowdown is broader than expected” in China, saidMarie Diron, a London-based senior vice president at Moody’s and one of the report’s authors. “It’s long been clear that there’s a slowdown in the manufacturing and construction sector, but the service sector was more resilient. That’s still the case, but we’re seeing some signs of weakness in the labor market.”

   

  “We continue to believe that the greatest risks to our growth forecasts remain to the downside,” Schofield wrote. Actual growth is “probably even lower” because of “likely mis-measurement in China’s official data,” he wrote.

  *  *  *
  Which, is exactly what we have been saying for the last 2 years as the rolling collapse of China's ponzi becomes ever more evident (and hidden by ever more manipulation)…

  Here, for those curious, are links to previous discussions:

  • China Dumps Record $143 Billion In US Treasurys In Three Months Via Belgium
  • China's Record Dumping Of US Treasuries Leaves Goldman Speechless
  • How The Petrodollar Quietly Died And Nobody Noticed
  • Why It Really All Comes Down To The Death Of The Petrodollar
  • Devaluation Stunner: China Has Dumped $100 Billion In Treasurys In The Past Two Weeks
  • What China's Treasury Liquidation Means: $1 Trillion QE In Reverse
  • It's Official: China Confirms It Has Begun Liquidating Treasuries, Warns Washington

  And so on and so forth.

  In short, stabilizing the currency in the wake of the August 11 devaluation has precipitated the liquidation of more than $100 billion in USTs in the space of just two weeks, doubling the total sold during the first half of the year. 

  In the end, the estimated size of the RMB carry trade could mean that before it’s all over, China will liquidate as much as $1 trillion in US paper, which, as we noted on Thursday evening, would effectively negate 60% of QE3 and put somewhere in the neighborhood of 200bps worth of upward pressure on 10Y yields. 

  And don't forget, this is just China.

  …

  The potential for more China outflows is huge: set against 3.6trio of reserves (recorded as an “asset” in the international investment position data), China has around 2trillion of “non-sticky” liabilities including speculative carry trades, debt and equity inflows, deposits by and loans from foreigners that could be a source of outflows (chart 2). The bottom line is that markets may fear that QT has much more to go.

  What could turn sentiment more positive? The first is other central banks coming in to fill the gap that the PBoC is leaving. China’s QT would need to be replaced by higher QE elsewhere, with the ECB and BoJ being the most notable candidates. The alternative would be for China’s capital outflows to stop or at least slow down. Perhaps a combination of aggressive PBoC easing and more confidence in the domestic economy would be sufficient, absent a sharp devaluation of the currency to a new stable. Either way, it is hard to become very optimistic on global risk appetite until a solution is found to China’s evolving QT.

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• Guns, Drugs, & Booze: The Bipartisan Support For Prohibition

  Submitted by Andrew Syrios via The Mises Institute,

  It’s been noticed more than a few times that there aren’t many substantive differences between the Republicans and Democrats. While this is true in many ways for the parties themselves, the Left and Right certainly differ on a range of issues from welfare to abortion to gay rights.

  What they have in common — at least the mainstream varieties — is a desire to use the state to shape society in whatever way they see fit. As Andrew Napolitano put it, “We have migrated from a two-party system into a one-party system, the big-government party. There’s a democratic wing that likes taxes and wealth transfers and assaults on commercial liberties and there’s a republican wing that likes war and deficits and assaults uncivil liberties.” And both parties love prohibition, just of different things.

  Alcohol Prohibition

  There aren’t many people left who believe the prohibition of alcohol in the 1920s was a good idea. Interestingly enough, it was the progressives of the time that pushed for that. As historian William Leuchtenburg noted, “It was a movement that was embraced by progressives.” On the other side, in the words of historian Daniel Okrent, were the “… economic conservatives who … pushed so hard for repeal.”

  Prohibition turned out to be a disaster. A report from the Cato Institute found that after Prohibition passed in 1920, homicide rates increased, corruption increased, alcohol-related deaths were unchanged and after a short dip in 1921, alcohol consumption returned to what it had been before the law was passed. Furthermore, in the midst of this chaos, Al Capone and organized crime came to power. Indeed, black markets and prohibition go together like peas and carrots.

  Drug Prohibition

  In the past, it was usually the progressives who wanted to use the state to tell people what they could and could not put in their own bodies. However, something must have changed among conservatives as the Right has generally been at the vanguard of the War on Drugs (although, with plenty of help from many on the Left). In 1971, Richard Nixon decided to try prohibition all over again, but this time with cocaine, heroin, and marijuana.

  And of course, it has failed in every way imaginable.

  According to the National Institute of Drug Abuse, “Illicit drug use in America has been increasing.” In 2012, “9.2 percent of the population” had used illicit drugs in the last month “… up from 8.3 percent in 2002.” So drug use has actually gone up despite spending over a trillion dollars on this massive boondoggle.

  Meanwhile, the United States has the largest prison population in the world. Despite having only 5 percent of the world’s population, the United States has 25 percent of the world’s prison population. A large percentage of these prisonere are in prison for nothing more than non-violent drug charges.

  Some think this is counterproductive and immoral. Others, like Michael Gerson, believe that those who want to legalize drugs have “second-rate values.” First-rate values include locking drug addicts in cages. So in accordance with Gerson’s first-rate values, instead of trying to help these poor addicts rebuild their lives, the government declared war on the substances, and thereby, the addicts themselves.

  And to wage this war has required a massively invasive police state. “Victimless” crimes don’t leave many witnesses (or at least not many who want to talk about it). So the government must use more bellicose means. According to the ACLU, there are an estimated 45,000 SWAT raids every year and only about 7 percent are for hostage situations. The vast majority are for drugs. These raids sometimes end tragically. For example, David Hooks was shot twice while face down on the ground in one raid and a baby was put into a coma when a flash bang was dropped in another.

  The evidence also shows that legalization works. Glenn Greenwald notes that “Since Portugal enacted its decriminalization scheme in 2001, drug usage in many categories has actually decreased when measured in absolute terms” and Forbes points out that “drug abuse is down by half.”

  And despite some haranguing from conservatives, Colorado has done just fine since decriminalizing marijuana in 2014.

  Gun Prohibition

  While conservatives have taken some notes from the progressives of old, progressives certainly haven’t given up on the idea of molding society through prohibition. Fortunately, in the United States, most of the debate about guns has to do with regulation and not prohibition. This is not the case in many other countries. And it has also not been the case in several US cities, until Supreme Court decisions overturned the gun bans in Washington, DC and Chicago. Still, many US cities have extremely arduous gun laws on the books.

  John Lott did an extensive study and noted that,

  The odds that a typical state experiences a drop in murder or rape after a right-to-carry law is passed merely due to randomness is far less than 0.1 percent. … The average murder rate dropped in 89 percent of the states after the right-to-carry law was passed. … There was a similar decline in rape rates.

  Further, to make sure he controlled for every variable imaginable (or didn’t control for variables that would incorrectly skew the data) he ran “20,480 regressions” using every imaginable arrangement of possible criteria and concluded,

  … all the violent-crime regressions show the same direction of impact from the concealed-handgun law. The results for murder demonstrated that passing right-to-carry laws caused drops in the crime ranging from 5 to 7.5 percent.

  John Lott found twenty-six peer reviewed studies on concealed-carry laws, sixteen showed a reduction in crime and ten were inconclusive. Not one showed that crime rates increased.

  We can all mourn tragic events such as the recent mass shooting in Charleston. But what is obviously problematic about restricting civilian gun use is that only law-abiding citizens will comply, criminals will not. (Like many other such massacres, the Charleston shooting took place in a “gun free” zone.) Indeed, criminals will likely have no harder a time getting guns then they do getting drugs, which means that restricting guns just disarms potential victims. A survey by Gary Kleck made him conclude that there were approximately 2.5 million incidents of defensive gun use each year. Although that number is almost certainly way too high, defensive gun use is still relatively common. For example, during a school shooting in Oklahoma, Mikael Gross and Tracey Bridges retrieved the guns from their vehicles and stopped the shooter before he could kill anyone else.

  As stated above, while there are some in the United States who call for extreme restrictions on guns, or bans altogether, for the most part, outright prohibition is only an issue in other countries. Many will point to the higher murder rates in the United States than Britain as proof that gun prohibition stops murder (interestingly they don’t point to the property crime statistics as they are actually higher in Britain than the US).

  But there are major problems with this simplistic analysis. For example, gun ownership has been increasing rapidly in the United States while gun crime has been falling. In addition, most guns are owned by people in rural areas, then suburban, then urban. Crime rates are exactly the opposite. Further, as Thomas Sowell points out in Intellectuals and Society,

  Russia and Brazil have tougher gun control laws than the united States and much higher murder rates. Gun ownership rates in Mexico are a fraction of what they are in the United States, but Mexico’s murder rate is more than double that in the United States.

   

  Handguns are banned in Luxembourg but not in Belgium, France or Germany; yet the murder rate in Luxembourg is several times the murder rate in Belgium, France or Germany.

  And what about that lower murder rate for Britain? Well, Thomas Sowell again, “London had a much lower murder rate than New York during the years after New York State's 1911 Sullivan Law imposed very strict gun control, while anyone could buy a shotgun in London with no questions asked in the 1950s.” What matters are the trends, not simplistic and vulgar comparisons. Instead, an international study done at Harvard noted,

  To bear that burden would at the very least require showing that a large number of nations with more guns have more death and that nations that have imposed stringent gun controls have achieved substantial reductions in criminal violence (or suicide). But those correlations are not observed when a large number of nations are compared across the world.

  Finally, when it comes to gun bans, the results are predictably terrible. John Lott again, “Every place around the world that has banned guns appears to have experienced an increase in murder and violent crime rates.” This includes Washington, DC, Chicago, Britain, Ireland, and Jamaica. One British newspaper ran the darkly humorous article “Gun Crime Soaring Despite Ban.” Change the “Despite” to “Because” and you have an accurate article.

  Conclusion

  Penn Jillette has half-joked, “If you can convince the gun nuts that the potheads are ok and the potheads that the gun nuts are ok, then everyone's a libertarian.” Arguments about whether these things should be regulated and how much so would be the subject for a different article. But it’s hard to understand why many liberals think that prohibiting drugs creates black markets with drugs, but that it wouldn’t happen with guns. Does one really think that drug cartels couldn’t add guns to their list of products to push? And the same goes for conservatives in the reverse.

  It’s really quite simple; prohibition doesn’t work. Freedom does.

   

  

  

  

  

  

• What Bill Dudley's Hedge Fund Advisors Told Him About A September Rate Hike

  By now virtually every prominent financial authority or pundit has chimed in and told the Fed not to hike rates: these include the IMF, Larry Summers (who for some reason lost the fight with Yellen for the Fed chair because he was seen as “too hawkish” – oops, irony), and even China. Yet all of these are irrelevant, because when it comes to soliciting opinions, the NY Fed in general, and former Goldmanite Bill Dudley in particular, care about just one group of “advisors” – the Investor Advisory Committee on Financial Markets (a group created in July 2009 after the 2008 market crash) also known as the billionaires who run the country’s biggest hedge funds, prop desks and PE firms, including JPM, Credit Suisse, Apollo, Blackrock, Blue Mountain, Brevan Howard, Tudor, Fortress, and lo and behold, David “Balls to the Wall” Tepper.

  The next IACFM meeting is scheduled to take place in October, as such it will be too late to change the Fed’s opinion for a potential September 17 rate hike.  Which is why we have to revert to the latest advisory committee meeting which took place on June 25, just before the Greek referendum was announced and two months before the Chinese devaluation, the July FOMC minutes and subsequent market correction. It will have to do.

  This is what the “smartest people in the room” told Bill Dudley and his minions about a potential September rate hike. From the June 25, 2015 minutes:

  Domestic Developments

   

  Committee attendees discussed the outlook for the U.S. economy and their expectations for monetary policy. Overall, they noted that real economic activity has gradually improved after a lackluster first quarter. Committee attendees characterized indicators of realized inflation as improving, but subdued relative to FOMC objectives. Meanwhile, the labor market was viewed as at or near full employment.

   

  Committee attendees suggested that the FOMC is likely to increase the federal funds target range during 2015, with September cited as the most likely timing of liftoff. Some felt that financial markets are well positioned for liftoff, while others expected volatility following the first increase in the target range. Most Committee attendees suggested that the path of the policy rate would be more impactful on financial conditions than the timing of liftoff. They expected the path of monetary policy to be data dependent, but noted that they expect the FOMC to be cautious during normalization.

  A quick primer on what “discounting” means – since all the participants expected a September rate hike, and since most expected volatility “following” the rate hike, some of these “smartest people in the room” decide to frontrun the volatility (a polite way for violent selling), and sell first before everyone else did. Just in case there was still some confusion about the recent market selloff.

  But back to the advisory committee minutes, and what it said about global developments including China:

  The sharp rise in core euro area yields during the second quarter was mostly attributed to positioning dynamics, with some feeling low yield levels were too extended. Committee attendees suggested relative value considerations prompted the coordinated move in global developed market rates. Better-than-expected economic data in the euro area and, to a lesser extent, shifting expectations for the ultimate size of the ECB asset purchase program were cited as contributing factors.

   

  Committee attendees suggested that the euro area economy is improving, but that inflation indicators remain below mandate consistent levels and are likely to remain there for a considerable time. They felt that the ECB was doing its part, but fiscal and labor market policies across the region were likely to inhibit the euro area from reaching its inflation mandate in the near term. Most felt that that further euro depreciation was necessary to stimulate the economy.

   

  Committee attendees generally concluded that the Japanese economy has also improved, highlighting the strength of the labor market and the improvement in inflation indicators. A few cited concerns about the Bank of Japan’s exit strategy, given the size of their balance sheet.

   

  China was the focus of the emerging markets discussion. Committee attendees characterized the Chinese economy as slowing, with most believing GDP was running below the target level. Most concluded that recent PBOC easing measures were executed to combat the slowing economy, but noted that financial conditions were not easing much in response. Committee attendees acknowledged officials’ efforts to internationalize Chinese markets, but suggested some of those efforts may run counter to easing initiatives. Beyond China, Committee attendees did not consider emerging markets, on the whole, well prepared for liftoff by the Federal Reserve given that few countries have made structural changes necessary to absorb higher rates.

  Well, they were right: emerging markets have since been paralyzed by the biggest currency collapse since the Asian Crisis of 1998 in the aftermath of the Chinese devaluation. However, if the June minutes are to be trusted, then none of what is going on in China is a surprise to any of these smartest people in the room, which is why “Committee attendees suggested that the FOMC is likely to increase the federal funds target range during 2015, with September cited as the most likely timing of liftoff”, unless…

  What appears to have happened in the ensuing 2 months is that none of these so-called “smartest” people hedged against anything that they warned may happen. Well, actually we take that back: recall from August 14, or just two weeks ago: “Did David Tepper Just Call The Market Top” – the S&P tumbled some 10% since then.

  In fact, what has happened is that none of these “smartest people” were actually hedging anything – only Nassim Taleb was actually prepared and ready to capitalize from a market crash, and as we reported last night, his affiliated hedge fund, Mark Spitznagel’s Universa made $1 billion last Monday. As for everyone else, well, just look at the table below which including many of the “advisors” listed above:

  

  In fact, the hedge fund performance ranking above is the only thing anyone has to care about when evaluating the chance of a Fed rate hike: if and when the hedge fund losses become too unbearable, any rate hike – September, December, or whenever – will be indefinitely delayed. And that is all Bill Dudley will hear from the only group of advisors whose opinion, and offshore bank accounts, he cares about.

  

  

  

  

  

• Did Tim Cook Lie To Save Apple Stock: The "Channel Checks" Paint A Very Gloomy Picture

  Back in February 2013, Thorsten Heins, then-CEO of what was once the iconic “smartphone” brand Blackberry, publicly lied that its Hail Mary iPhone competitor, the Z10, had “record” early sales. He told CNET, that “BlackBerry nearly tripled the sales of its best performance over the first week in the U.K., while it had its best first day ever in Canada. In fact, it was more than 50 percent better than any other launch day in our history in Canada.”

  Less than one year later, and less than two years after he was hired, the ruse was up – Blackberry’s US market share has fallen from 50% to 3% in four years – and Thorsten was fired.

  Fast forward to Monday morning, when the S&P500 had just hit its first limit down in history, stocks were crashing, countless ETFs were crashing more as ETF pricing models were corrupt and broken, the QQQs were plummeting, and none other than AAPL was set to open at a price of $92 wiping out tens of billions of market cap overnight.

  It is then that AAPL CEO Tim Cook may have pulled a page straight out of Thorsten Heins’ playbook when did something nobody expected him to do – he panicked, and emailed CNBC anchor Jim Cramer to do what the AAPL CEO himself admitted the company does not do by providing mid-quarter updates, and assure the CNBC anchor that there is no need to sell AAPL stock.

  Specifically he said that:

  “I get updates on our performance in China every day, including this morning, and I can tell you that we have continued to experience strong growth for our business in China through July and August. Growth in iPhone activations has actually accelerated over the past few weeks, and we have had the best performance of the year for the App Store in China during the last 2 weeks.”

  Needless to say, this stunning intervention by Tim Cook to arrest the plunge in AAPL stock succeeded, and AAPL soared from $92 to close back over $100, a gain of nearly $60 billion in market cap, in turn dragging the entire market higher with it.

  Yet what many have found problematic is that in emailing Jim Cramer with what was clearly material, non-public information – how long did Cramer have possession of Cook’s email, who did he privately share the information with first, did Cramer trade on the information before going public with it, etc –  Cook may have breached Regulation FD.

  We wondered as much in our Monday post “Did Tim Cook Violate Regulation “Fair Disclosure” By Emailing Jim Cramer To Save AAPL Stock This Morning.” Nearly a week later, there is still no 8-K, even if grotesquely delayed, with what should clearly have been a replica of the statement made by Cook to Cramer.

  So we decided to follow up.

  What we uncovered may explain why Tim Cook did not want to publicly file his “all is well” email to Cramer: the simple reason is that Tim Cook may have simply been lying in order to halt the rout in his stock, a rout which incidentaly had little to do with concerns about AAPL’s Chinese sales and was driven by the latest HFT-facilitated marketwide flash crash as we described previously.

  Of course, accusations that Tim Cook is lying should be taken very seriously, which is why instead of relying on Thorsten Heins’ pardon, Tim Cook’s self-assessment, we went with the latest AAPL channel check out of GFK, Germany’s largest market research institute.

  For those who are unaware, GfK is almost universally accepted as the best source for end-market demand, collecting and aggregating point of sale data from servers at all major retailers, collecting real time consumer data, as well as conducting manual channel checks at smaller retailers. In short: if something is selling with an upward trajectory, GfK will know about it, with about an 80% confidence interval. And vice versa.

  Here is the latest GfK data on Apple:

  C3Q15 sell-out outlook:

  • Apple’s global ex-NA outlook worsened slightly with the additional JUL/AUG weekly data. Units are now forecast to grow +2.6% q/q (prior +3.0%). Softer early AUG trends in China were only partially offset by resilience in Dev. Asia.
  • In China, iPhone 6 demand softened in the final week of JUL, and remained at such levels in AUG weekly data (Figure 17). Apple, as a result, is expected to see more pronounced share loss in China than prior expectations, though units are still expected to grow +62% y/y.
  • In Japan, iPhone 6 improved meaningfully in AUG despite no material ASP movements. Sony’s Xperia Z4 was most impacted following its short-lived demand uptick in JUL (Figure 18).
  • Apple’s 3Q ASP is expected to decline -3.1% q/q (prior -2.5%); +6% y/y.

  US iPhone demand

  • Apple lost share m/m in final JUL data, with iPhone 6 & 6 Plus unit demand declining -14% m/m. This was worse than the -7% m/m decline seen for the 5s/5c in JUL-14 and was also weaker than GfK’s expectations.
  • Apple’s US smartphone share fell, as a result, to a level below that seen LY (Figure 20).
  • The downtick was more pronounced for iPhone 6 and drove the 6/6 Plus ratio from 4.2:1 in JUN to 3.8:1 in JUL.
  • iPhone 6/6 Plus continues to significantly outperform the 5s/5c launch to date, with units +22%, only modestly below the +24% growth seen through JUN.

  C3Q15 sell-in projection:

  • 49.4m; +4% q/q; +26% y/y (prior 50.6m, +7% q/q; +29% y/y)
  • International sell-out: 37.0m, -0.3% q/q (prior 37.2m, +0.1% q/q); +39% y/y (unchanged)
    • US sell-out: 11.4m, +4% q/q (prior 12.4m); -2% y/y (prior +7%)
    • Inventory build of 1.0m units (unchanged)
    • Shipment ASP projection: USD667, flat q/q; +10% y/y (unchanged)

  * * *

  While the above data has a roughly 2 week lag, but considering the explosion of market volatility into the past two week period, it is certain that sales , if anything, deteriorated as the Shanghai Composite went red for the year (after soaring 60% two months ago).

  So what can we make of the above data? Here are GfK’s highlights:

  1. The Q3 outlook for Apple has softend notably as a result of weaker trends not only in the US, but in China – the place where Cook assured Cramer Apple has “experienced strong growth in its business.”
  2. US unit demand declined 14% in July, far more than the -7% drop a year prior, and weaker than GfK’s own expectations. This could point to substantial weakness over the next 6-12 months for Apple, considering last year, ahead of the iPhone 6 launch, the sales decline was about half of the current decline even without a major new phone rollout imminent. This may mean that the upgrade cycle was much stronger and/or shorter until now, and is starting to fade dramatically.
  3. The data started deteriorating before the recent rout in Chinese stocks and EM currencies (which make products such as the iPhone more expensive). Keep in mind most of the future growth for Apple is expected to come from Emerging Markets and China now that the US only accounts for a third of total sales.

  So did Tim Cook lie?

  If one uses channel check data to objectively determine end demand, the answer is a resounding yes. To be sure, Cook may be telling the truth in a very narrow sense, if Apple is simply be resorting to the oldest trick in the book at this point: channel stuffing.

  The problem with channel stuffing is that it only allows you to mask the problem for 2-3 quarters at which unless there has been a dramatic improvement in the end-demand picture, it re-emerges that much more acutely: just ask AOL which was channel stuffing for months on end, only to be ultimately exposed, leading to a epic plunge in the stock price.

  So is AAPL the next AOL, and is Tim Cook the next Thorsten Heins?

  It all depends on China: if the world’s most populous nation can get its stock market, its economy and its currency under control, then this too shall pass. The problem is that if, as many increasingly suggest, China has lost control of all three. At that point anyone who thought they got a great deal when buying AAPL at $92 will have far better opportunities to dollar-cost average far, far lower.

  Oh, and to anyone still holding their breath for AAPL to file a public statement which may well contain an outright lie, you may exhale now.

  

  

  

  

  

• Greece – Now What

  Submitted by George Kintis of Alcimos

  Greece – Now What

  For those of you who like fast-forwarding to the end of the film, here it is:

  • Grexit was never on the cards. Even less so after the recent European Summit decisions and the Greek bank recap recently put in motion. This is mainly on account of the dual surpluses Greece currently runs: the current-account and primary budget ones. Even if one could push a magic button and kick Greece out the euro, there is nothing that would prevent Greece from immediately reintroducing it, Kosovo- or Montenegro-style. The only impediment would be the funding of the banking system, but this is being taken care of.
  • There has been a decoupling of a large part of the Greek economy from the sovereign issue; for example, exports of goods and services, accounting for around 30% of the Greek economy have been growing at 9% a year. Investors readily recognize this in publicly-traded assets (most Greek corporate bonds are trading well above the sovereign ceiling), but are so far oblivious to it when it comes to non-traded ones (e.g., loans, receivables, etc.). This is a “ginormous” arbitrage opportunity—one just needs to put in a bit of legwork to identify, diligence and acquire such assets. Sorry, you can’t do it off your Bloomberg terminal, or over lunch at Cecconi’s.
  • Greece does not have a functioning banking system—credit has been contracting for years, while new origination is practically non-existent. This depresses asset prices to ridiculous levels—even prices of assets which are uncorrelated to the sovereign situation, per the previous point. This reversal of this situation is likely to start in Q2 2016, post the Greek bank recap, which we expect will be coupled with a bank bail-in—and the mother of all NPL trades.

  Those of you who think that it’s the journey that teaches you a lot about your destination, read on.

  In our recent analyses in the Greek situation, we got many things right—and not just that Grexit will not take place. For example, we had predicted that Tsipras will do an about-face even before the elections, but we also warned that GGBs are not the way to play this on 24 February (unless one has inside information on political decisions). We then advised people on 24 February to stay away from anything that has to do with the public sector and the banks. On 5 April we discussed why investing in Greek banks makes little sense–and then explained why we think Greek banks will be bailed-in on 17 July.

  We also got some things wrong: the outcome of the referendum (for better or for worse, there’s a clear bias in our circle of friends towards people with a positive balance in their bank accounts) and the imposition of capital controls (which we believe to be completely illegal).

  Here’s why we were wrong in predicting that capital controls wouldn’t be imposed: our working assumption in predicting various outcomes at every step of the way of the Greek saga, is that all players are totally selfish, as well as ruthless and shameless in pursuing their own interests. We realize that the ruthlessness and shamelessness of Greek politicians knows no bounds—we’ve known quite a few of them personally for way too long to have any illusions. We assumed, however, that European politicians had a modicum of dignity; that’s where we got it all wrong.

  We did not, for example, expect that Ms. Danièle Nouy, head of the Single Supervisory Mechanism, would go on record as recently as 7 June proclaiming Greek banks “to be solvent and liquid”, but then the Euro Summit of 12 July would identify in its statement the need for the “the establishment of a buffer of EUR 10 to 25bn for the banking sector in order to address potential bank recapitalisation needs and resolution costs”. Where did these guys get that €25bn number—if not from the head of the bank supervisory mechanism? We’d never think that the ECB would cut off financing to banks it considers solvent, saying that they do not have adequate collateral. If they were solvent, how could they not have adequate collateral? Substituting ELA for deposits can have no effect on the solvency of the institution; if the institution was solvent—and therefore its deposits were safe, then the ELA which substitutes these deposits should be safe, too. Anything else is financial alchemy, of which we did not think an institution like the ECB would partake.

  Nor could we have imagined that the ECB would refuse to disclose the rationale behind its decisions to freeze Greek ELA, citing as reason that “[i]f the ELA ceiling determined by the Governing Council and the related deliberations including the names of the credit institutions receiving ELA were to become known to the public, market participants could infer from this information the liquidity situation of the credit institutions, with immediate detrimental effects on financial stability. Even if such ELA ceiling determined in a particular situation were to be disclosed ex post, such publication could have detrimental effects on the Governing Council’s opinion-building and decision-making in future similar situations.

  The ELA ceiling would be an indication of the extent of stress that the credit institutions were facing, and in particular if market participants were able to monitor the development of the ELA ceiling over time, an upward trend would be interpreted as a signal of increasing stress. Hence, publication of such information would negatively impact the banks’ ability to borrow funds from the market and thereby reinforce their liquidity problems”. This, at a time when the ceiling on Greek ELA is leaked to Reuters and Bloomberg immediately after the relevant ECB decisions, is reported on the Bank of Greece balance-sheet published on a monthly basis, while all four Greek systemic banks recently reported their ELA funding to the Athens Stock Exchange (see for example here).

  Who needs another “signal of increasing stress“, when the Euro Summit itself has adjudged “potential [Greek] bank recapitalisation needs and resolution costs [to be between]€10 to 25bn”? Of course, the irony of claiming that “publication of such information would negatively impact the banks’ ability to borrow funds from the market and thereby reinforce their liquidity problems”, when said banks have been locked out of credit markets for months, while their liquidity problems have been a direct effect of the contested ECB decisions, was lost on them. But we are digressing…

  We now know better: we are convinced that all players in the Greek drama are thoroughly unscrupulous. Once one analyses the Greek situation through this lens, it’s hard to get predictions wrong. You can only go wrong when certain players turn out to be even more ruthless than you would have imagined.

  Once one agrees that both sides (i.e., Greece and Germany) are only self-interested, the dynamics of the current Greek negotiation can be analysed within the framework of a prisoner’s dilemma. Greece does not want the structural changes (austerity and the like), while Germany wants to avoid a haircut at all costs. “Cooperation” would then entail Greece swallowing its medicine, while Germany continues to happily fork over money for as long as needed. “Defection” would mean that the Greek government only pretends to be discharging its obligations under the various memoranda, while Germany is forced to accept a haircut. Now, someone who’s even remotely familiar with game theory can easily predict how this will end: both sides will lose. But let’s follow the various steps.

  Germany, as we all know, won the Euro Summit battle: Tsipras surrendered and capitulated (in theory) to all German demands. Germany, has, therefore, “punished” Greece in the prisoner’s dilemma framework. Now we think Greece will retaliate—with the help of the IMF.

  Here is how:

  We have previously analysed the ongoing tug-of-war between Germany and the IMF (read: the US) on a possible haircut on Greek debt as part of the (supposedly) ideological conflict between “austerity” and “Keynesianism”. Germany has said, no deal without the IMF. The IMF has said, no deal without a haircut. Germany has said, no haircut under any circumstances. You can see where that leads: Greece will pass through the measures, but the creditors will find it difficult to agree between themselves on a new package. We may have a few more bridge loans (in the grand can-kicking tradition of Greek negotiations) but the music will eventually stop. Then Germany will be faced with the stark choice between:

  (a)    a Greek default, which will result in Greece going to the IMF for help, which “stand[s] ready to assist Greece if requested to do so”, which then leads to an effective subordination (read: haircut) of Germany’s bilateral loans to Greece due to the IMF preferred-creditor status; and

  (b)    a haircut on Germany’s loans to Greece, which will allow the IMF to participate in the Greek bailout.

  Germany is, therefore, free to choose between a haircut and a haircut—even Die Zeit seems to agree with this. A haircut is of course political suicide for Merkel, but the latter version can be sugared with some grand-European-vision talk, so we think she will go for this. We also claim, however, that whatever she does only affects her chances of political survival and not Greece. Here’s why:

  Despite all the talk, Greece (still) runs a healthy primary surplus (Jan-Jun 2015) and a current account surplus. The former means that if there was no deal with the lenders, the Greek government would keep on functioning; any new money lent to Greece goes back to repay existing debt. The latter means that Greece will still have the euros it needs to pay for its imports, irrespective of any agreement with the lenders. The only leverage Germany has over Greece, is through ECB financing of Greek banks. That last card has been played—we claim to the benefit of large European banks. Greeks banks will be recapitalized (read: bailed in) no matter what, and bought out by large European banks. Their funding no longer will come from the Bank of Greece, but from the parent—which also has access to the ECB. That bullet has been spent.

  Here’s where that leaves us: Greece stays in the Euro, but Greek banks are sold off, properly recapitalized at last. Here’s the back-of-an-envelope calculations behind this:

  As at June 2015, the Greek banking system had loans to the private sector of €220bn and total provisions of €41bn. There’s a 35% NPL figure being bandied around, but we have long believed the real number to be higher. How higher—God knows, but let’s assume it’s 50% (it’s probably even higher, but a good part of those NPLs may be strategic, so let’s settle at 50%). To the €41bn of existing provisions one should another €30bn (equal to 8% of total liabilities which, per article 44(5) BRRD, need to be bailed-in before the public purse can be accessed) and the €25bn which have been set aside for the Greek bank recap per the 12 July Euro Summit statement and you get to a figure of €97bn in capital available to absorb losses on an NPL book of €110bn—translating to an NPL coverage ratio of 88%.

  The big NPL trades, the ones everyone (and their mothers) has in vain been coming to Greece for since 2010, will finally arrive, probably in Q2 2016.

  As to the Greek economy: it’s doing very well, thank you, having grown at 1.6% y-o-y in Q2 2015. It will do even better, when Greece has a functioning banking system. Stay tuned.

  

  

  

  

  

• Finding Pearls Of Wisdom In The Donald’s Trumperbolic Campaign

  Authored by Ben Tanosborn,

  I’ve just received an interesting query from Mingo, a long-standing European journalist friend and expert on all-things-Afghan… someone whose acquaintanceship dates back to the early days of America’s involvement in Afghanistan.  Someone, I might add, who did prove to have in 2004 a clearer vision of what was to happen in that country than most, if not all, military experts, media gurus and politicians in the US.  My writings at that time can attest to that.

  Mingo’s question is about the perception, he claims, Europeans have on US’ current state of the 2016 presidential election, and what he’s calling “the phenomenon Trump.”  His incredulity as to the number of possible followers Trump is said to have (if accurately reflected by the polling) seems to match the incredulity by much of America’s media, or of career politicians sucking on Washington’s udder.  “How can ‘that many’ Americans take seriously an arrogant charlatan and be swept away by ridiculous and undisguised hyperbole,” is a question that not just Mingo raises, but one that many have been asking for weeks since Donald Trump decided to enter presidential politics.

  But it isn’t catchy phrases seasoned with political hyperbole that have been coming out of Donald Trump’s mouth; it’s not just exaggerations sliding out for emphasis or effect.  The short, catchy statements coming out of the leading Republican candidate are not the expected quantifiable or qualifiable exaggerations we are accustomed to hearing from the current political version of yesteryear’s traveling medicine man.  Hyperbole has been elevated to a new literary status more in line with the stature of its charismatic and billionaire originator: trumperbole.  If Trump’s $3 billion wealth can be subjectively inflated to $10 billion, why not just pump hyperbole and call it trumperbole or, in similar fashion, reclassify trump as an adjective and give it comparative and superlative forms: trumper, trumpest, anyone?  Well, these days in the US, we are seeing our celebrated and self-proclaimed potential savior, Donald Trump, as the non-politician politician proudly donning capitalist airs and shouting the trumpest trumperbole.

  Irony of ironies, however, is the amount of truth that can come out of the mouth of this political babe as he tears apart or diminishes the political persona of GOP adversaries.   Not just his party’s peer candidates but other Republican politicians as well who dare stand in the way: Jeb Bush, Lindsey Graham, John McCain, Scott Walker, Marco Rubio, Mike Huckabee, Rick Perry, Rand Paul… all have been cut to sub-Trump size, even ridiculed; while others have not been dignified with a Trump honorable mention, Ted Cruz being the exception with an interesting and secretive question mark.  Be that as it may, the entire group of Republican presidential contenders has been irremediably diminished to a sickly and unworthy flock of possible standard bearers for the GOP.

  But the Republicans are experiencing more than just the political castration of top party figures, often comically so by someone who lacks any orthodoxy or practicality which favors tradition and fights radical change.  Out of the mouth of this political babe, there have been two gems of political wisdom which are likely to hurt Republicans far more than Democrats.  Trump’s contention that politicians in Washington are being bought by special interests is no breaking news announcement, but his underlining and writing of this fact in bold letters readily does away with the mockery that ours is a democracy, or that our government is in any way, shape or form a government for the people… only for those who can pay the entry fee.  The other gem has to do with iniquity in taxation, likely to make him few friends in the gallery of speculators in hedge funds.

  Donald Trump, I could tell Mingo, is no phenomenon or wonder, only someone money has immunized and given a suit of armor under our capitalist system; a person with true elite-freedom.  Little wonder that few people in the media, or politicians, are willing to alienate him or, much less, tackle him head on when there is the prospect of a litigious wrecking ball waiting in the wings.

  It is precisely this view by many that Trump is impervious to any type of fear that makes him an attractive advocate or champion of causes which people would otherwise keep hidden within themselves.  Nativists can now show their passion thanks to Trump’s leadership; and so can racial-mongers; and white nationalist activists; and a few others.  They can all come out of the closet and feel safe.

  I could also tell Mingo something else.  The Republican Party is running the danger, if Donald Trump becomes its nominee, of having its candidate become the counterpart of George McGovern (the liberal candidate) in 1972.  For those then around, we can revisit those numbers and look at the prospect of Trump becoming Republicans’ McGovern.  [McGovern had just 37.5 percent of the popular vote and only carried Massachusetts and the District of Columbia in the Electoral College (520-17).]

  No; Trump is no phenomenon, just a figurehead for those with closeted anger trying to resist unstoppable change in the world and resent their loss of power.

  

  

  

  

  

• Lagarde: "China's Slowdown Was Predictable, Predicted"… Yes, By Everyone Except The IMF

  In what may be the funniest bit of economic humor uttered today, funnier even than the deep pontifications at Jackson Hole (where moments ago Stanley Fischer admitted that “research is needed for a better inflation indicator” which means that just months after double seasonally adjusted GDP, here comes double seasonally adjusted inflation), in an interview with Swiss newspaper Le Temps (in which among other things the fake-bronzed IMF head finally folded and said a mere debt maturity extension for Greece should suffice, ending its calls for a major debt haircut), took some time to discuss China.

  This is what she said.

  Turning to China, Lagarde said she expected the country’s economic growth rate to remain close to previous estimates even if some sort of slowdown was inevitable after its rapid expansion.

   

  China devalued its yuan currency this month after exports tumbled in July, spooking global markets worried that a main driver of growth was running out of steam.

   

  “We expect that China will have a growth rate of 6.8 percent. It may be a little less.” The IMF did not believe growth would fall to 4 or 4.5 percent, as some foresaw.

  Actually, some – such as Evercore ISI – currently foresee China’s GDP to be negative, at about -1.1%.

  

   

  But the funniest part was this: “The slowdown was predictable, predicted, unavoidable,” Lagarde was quoted as saying.”

  Well, yes, here is China’s Caijing quoting Zero Hedge some time in 2012, explaining that China has “the world’s largest credit bubble.” Incidentally, it was back in 2012 that we warned “that all platitudes of the Richard Koos aside and Paul Krugmans, who demand ever more debt, the developed world is at its debt capacity.”

  Three years later McKinsey admitted just that in one the most “shocking” pieces of economic analysis released in years, showing that global debt had risen by $57 trillion to $200 trillion since the first great financial crisis, which incidentally is why global growth is no longer possible in a world in which only incremental debt creation fuelled growth for decades.

  

   

  But going back to Lagarde’s sstatement that China’s “slowdown was predictable, predicted“, we just want to add that – yes, it was… by everyone but the IMF.

  Here is the history of the IMF’s Chinese GDP growth forecasts taken straight from its World Economic Outlook quarterly pieces. The graph, also known in Excel as “the dying hockeystick” needs no explanation.

  

  

  

  

  

  

• Mass Protests Sweep Malaysian Capital As Anger At Goldman-Backed Slush Fund Boils Over

  If we told you that thousands of protesters donning bright yellow shirts had taken to the streets to call for the ouster of a leader in an important emerging market, you’d be forgiven for thinking we were talking about Brazil, where President Dilma Rousseff is facing calls for impeachment amid allegations of fiscal book cooking and government corruption.

  But on this particular weekend, you’d be wrong.

  We’re actually talking about Malaysia, where tens of thousands of demonstrators poured into the streets of Kuala Lumpur on Saturday to call for the resignation of Prime Minister Najib Razak whose government has been accused of obstructing an investigation into how some $700 million from 1Malaysia Development Berhad mysteriously ended up in Najib’s personal bank account.

  

  1MDB was set up by Najib six years ago and has been the subject of intense scrutiny for borrowing $11 billion to fund questionable acquisitions. $6.5 billion of that debt came from three bond deals underwritten by Goldman, whose Southeast Asia chairman Tim Leissner is married to hip hop mogul Russell Simmons’ ex-wife Kimora Lee who, in turn, is good friends with Najib’s controversial wife Rosmah Manso.

  

  You really cannot make this stuff up.

  What Goldman did, apparently, is arrange for three private placements, one for $3 billion and two for $1.75 billion each back in 2013 and 2012, respectively. Goldman bought the bonds for its own book at 90 cents on the dollar with plans to sell them later at a profit (more here from FT). Somewhere in all of this, $700 million allegedly landed in Najib’s bank account and the going theory is that 1MDB is simply a slush fund. 

  So you can see why some folks are upset, especially considering Rosmah has a habit of having, how shall we say, rich people problems, like being gouged $400 for a home visit by a personal hairstylist. Here’s The New York Times with more on the protests:

  Tens of thousands of demonstrators in Malaysia defied police orders on Saturday, massing in the capital in a display of anger at the government of Prime Minister Najib Razak, who has been accused of corruption involving hundreds of millions of dollars.

   

  The demonstration in central Kuala Lumpur, which has been planned for weeks, has been declared illegal by the Malaysian police, and the government on Friday went as far as to pass a decree banning the yellow clothing worn by the antigovernment protesters.

   

  But the demonstrators, who represent a broad coalition of civic organizations in Malaysia, including prominent lawyers, asserted their right to protest on Saturday.

   

  The government has acknowledged that Mr. Najib received the money in 2013 and said it was a donation from undisclosed Arab royalty. 

   

  One group of protesters on Saturday carried the image of a giant check in the amount of 2.6 billion ringgit, with a sign that read, “You really think we are stupid?”

   

  The group organizing the protest goes by the name Bersih, which means clean in Malay.

   

  Calls for Mr. Najib to resign have come both from within his party, which is divided, and from the opposition. One junior member of Mr. Najib’s party, the United Malays National Organization, filed a lawsuit against Mr. Najib on Friday asking for details of how the money was spent.

  Of course the most prominent voice calling for Najib’s ouster is that of the former Prime Minister Mahathir Mohamad. “I don’t believe it is a donation. I don’t believe anybody would give [that much], whether an Arab, or anybody,” he says. 

  Meanwhile, Malaysia is facing a re-run of the 1997/98 financial crisis as the ringgit plunges amid broad-based pressure on emerging markets. With FX reserves now sitting under $100 billion some fear a return to capital controls (let’s just call it the “1998 option”) is just around the corner despite the protestations of central bank chief Zeti Akhtar Aziz. Here’s BofAML:

  Capital controls are not likely, but the possibility cannot be dismissed, despite <assurances from Zeti. Introducing controls will be a regressive move and a huge setback, hurting the economy and financial sector, and derailing any ambitions of becoming an international Islamic financial center. Malaysia’s reputation and credibility remain tainted by the capital controls of 1998, even after almost two decades.

   

  The ringgit has depreciated almost 13% year-to-date, the worst performing EM Asian currency. FX reserves fell to $94.5bn at mid-August, falling below the $100bn threshold and down by about $9bn in July alone. At the peak, FX reserves were $141bn in May 2013. Cover to short-term external debt is only 1x, while cover to imports stands at 5.9 months. Downside risks remain given looming Fed rate hikes, China’s RMB devaluation and the political crisis over 1MDB. Malaysia’s vulnerability is also heightened by high leverage (household, quasi-public and external) and a fragile fiscal position (heavy oil dependence, off balance sheet liabilities)

   

  The current crisis has not reached the extreme stress seen during the Asian financial crisis, when draconian capital controls were eventually introduced in September 1998. During that episode, the ringgit collapsed by about 89% from peak to trough at its worst (to 4.71 from 2.49 against the USD). The ringgit has depreciated some 26% in the current crisis. During that episode, the KLCI fell by about 79% from peak to trough (from 1,271 to 263) at its worst. The KLCI today has fallen by only about 12% from its recent peak. Nevertheless, downside risks remain given looming Fed rate hikes, China’s RMB devaluation and the political crisis.

  So in short, Malaysia is on the brink of political and financial crisis, and it looks as though the nuclear route (capital controls) may be just around the corner, which would of course only serve to alienate the country’s financial system at a time when the government looks to be on the brink of collapse. What’s particularly interesting here is the timing. Mahathir Mohamad famously clashed with George Soros during the ’98 crisis, going so far as to brand the billionaire a “moron”. Now that the country’s “founding father” is looking to oust Najib, it will be interesting to see what role he plays in shaping Malaysia’s response to the current financial crisis and on that note, we’ll leave you with a quote from Dr. Mahathir ca. 1997:

  “I know I am taking a big risk to suggest it, but I am saying that currency trading is unnecessary, unproductive and immoral. It should be stopped. It should be made illegal. We don’t need currency trading. We need to buy money only when we want to finance real trade.”

   

  

  

  
  

  

  

  

  

  

• Fischer Speaks At Jackson Hole: "Fed Should Not Wait Until 2% Inflation To Begin Tightening"

  Today’s most anticipated event at tthis year’s Jackson Hole event was the panel on “Global Inflation Dynamics”, not because there is any core inflation in the world (at least not in the way the CPI measures it), especially not now that China is finally in the deflation exporting business, but because the most important speaker at this year’s Jackson Hole, Fed vice chairman Stanley Fischer, alongside BOE’s Mark Carney, the ECB’s Constancio and the RBI’s Raguram Rajan, would comment.

  Moments ago he just did, and courtesy of Market News, here are the highlights:

  • FISCHER: SHLD NOT WAIT TIL 2% INFL TO BEGIN TIGHTENING
  • FISCHER: NEED TO ‘PROCEED CAUTIOUSLY’ IN NORMALIZING POLICY
  • FISCHER: FED FOLLOWING DEVELOPMENTS IN CHINESE ECONOMY
  • FISCHER: RATE PATH MATTERS MORE THAN TIMING OF FIRST HIKE
  • FISCHER: RISE IN DOLLAR COULD RESTRAIN GDP GROWTH IN ’16, ’17
  • FISCHER: $ MAY HOLD DOWN CORE INFL ‘QUITE NOTICEABLY’ THIS YR
  • FISCHER: NEED CAUTION IN ASSESSING INFL EXPECTATIONS AS STABLE
  • FISCHER: ‘GOOD REASON’ FOR INFL TO MOVE UP AFTER OIL/$ PASSES
  • FISCHER: CORE INFL ‘TO SOME EXTENT’ IMPACTED BY OIL PRICES
  • FISCHER: ECON SLACK IS ONE REASON CORE INFL HAS BEEN LOW
  • FISCHER: OIL PRICE IMPACT ‘OUGHT’ TO BE LARGELY ONE-OFF EVENT
  • FISCHER: LABOR MARKET ‘APPROACHING’ MAX EMPLOYMENT OBJECTIVE

  As AP notes, Fischer said there’s “good reason to believe that inflation will move higher as the forces holding down inflation dissipate further.” He says, for example, that some effects of a stronger dollar and a plunge in oil prices have already started to diminish.

  Both in his speech Saturday and in an interview Friday with CNBC, Fischer made clear that the most recent economic data and the direction of financial markets over the next two weeks would help determine whether the Fed raises rates next month.

   

  In the CNBC interview, Fischer acknowledged that before the recent market volatility, “there was a pretty strong case” for a rate hike at the Sept. 16-17 meeting, though it wasn’t conclusive. Now, the issue is hazier because the Fed needs to assess the economic impact of events in China and on Wall Street.

  More details from MNI:

  Federal Reserve Vice Chair Stanley Fischer said Saturday the U.S. central bank should not wait until it sees 2% inflation to begin tightening policy, but it should proceed cautiously in removing accommodation.

   

  “With inflation low, we can probably remove accommodation at a gradual pace,” Fischer said in remarks prepared for a panel discussion at the close of the Kansas City Fed’s annual Economic Symposium here.

   

  Yet, he added, “because monetary policy influences real activity with a substantial lag, we should not wait until inflation is back to 2% to begin tightening.”

   

  Fischer, who as a member of the board votes at every meeting of the Federal Open Market Committee, did not comment on a particular time for the first rate hike in more than nine years. He did say, “For the purpose of meeting our goals, the entire path of interest rates matters more than the particular timing of the first increase.”

   

  That path will be decided by the progress on the Fed’s price stability mandate as progress in the labor market continues and is “approaching our maximum employment objective,” Fischer said.

   

  “To ensure that these goals will continue to be met as we move ahead,” Fischer said, “we will most likely need to proceed cautiously in normalizing the stance of monetary policy.”

   

  Right now though, progress on the Fed’s inflation objective is being weighed down by a significant drop in oil prices and a stronger U.S. dollar since last year.  Fischer estimates the rise in the dollar, about 17% in nominal terms since last summer, will restrain real GDP growth through 2016 “and perhaps into 2017 as well.”  It “could plausibly be holding down core inflation quite noticeably this year,” he said.

   

  The lower oil prices could also put downward pressure on core inflation, even though this measure is designed to strip out the effects of the volatile prices.

   

  “Note that core inflation does not entirely ‘exclude’ food and energy, because changes in energy prices affect firms’ costs and so can pass into prices of non-energy items,” he said.

   

  Overall, though, Fischer sounded optimistic these factors will prove transitory. “While some effects of the rise in the dollar may be spread over time, some of the effects on inflation are likely already starting to fade,” he said.

   

  “The same is true for last year’s sharp fall in oil prices, though the further declines we have seen this summer have yet to fully show through to the consumer level,” he said.

   

  The transitory nature of these factors and “given the apparent stability of inflation expectations,” he said, “there is good reason to believe that inflation will move higher as the forces holding down inflation dissipate further.”

   

  In addition, “slack in the labor market has continued to diminish, so the downward pressure on inflation from that channel should be diminishing as well,” he said.

   

  But Fischer warned that Fed olicymakers should “be cautious in our assessment that inflation expectations are remaining stable.”

   

  One reason “is that measures of inflation compensation in the market for Treasury securities have moved down  somewhat since last summer,” he said.

   

  He added, though, “these movements can be hard to interpret, as at times they may reflect factors other than inflation expectations, such as changes in demand for the unparalleled liquidity of nominal Treasury securities.”

   

  Fischer didn’t comment much in his prepared remarks on other recent financial market volatility, except to say “At this moment, we are following developments in the Chinese economy and their actual and potential effects on other economies even more closely than usual.”

  In broad terms, this is a repeat of what he told CNBC’s Liesman yesterday, which resulted in the market getting spooked in a “not dovish enough” reaction, if only until the last 15 minute mauling of VIX, which sent the DJIA down from -110 to almost positive.

  What is clearly missing from Fischer’s speech is even the faintest grasp that China is now actively exporting deflation via active devaluation, which is a double whammy for the Fed’s “financial conditions” as it means not only will US inflation remains persistently low (the way the BLS measures it), but the ongoing selloff in TSYs will force the Fed to get involved soon, especially if ongoing selling in both TSYs and stocks wreaks more havoc with ‘risk parity” models, potentially forcing the world’s biggest hedge fund Bridgewater to delever and/or unwind some of its massive $150+ billion in positions.

  However once again, the most important question was missing: now that China is engaging in reverse QE and selling tens if not hundreds of billions in US Treasurys every month, with the US facing a $450 billion budget deficit (hence needing to issue half a trillion in debt), the Fed balance sheet contracting by over $250 billion, just how does the Fed plan on tightening if what it should instead be doing is easing, and massively at that.

  Full speech here (link):

  

  

  

  

  

• What The Yen Might Reveal

  Submitted by Jeffrey Snider via Alhambra Investment Partners,

  The moment you add the yen to any larger financial discussion it inevitably brings out passionate response. I think that is derived partially from its status as unbelievably durable; if there is one currency in the world that “deserves”, so to speak, ultimate execution it is that of the Japanese. The Bank of Japan has done more than any other central bank for far longer to kill it, but like any horror movie villain it seems immune to any reckoning or even the laws of financial sense.

  In the bigger picture, that is as much a damning indictment as a tale of orthodox resilience. It shows that monetary redistribution is nothing but a trap, an incredibly narrow and locked economic existence that can and will be permitted by any sustained apathy. It is a cautionary tale that “markets” can become comfortable with perpetual dysfunction and disaster over time; distract investors enough with monetary magic and they will apparently forget all about more basic functions like impoverishment and general, sustained degeneration.

  To the more immediate effect, the yen as related to financial markets elsewhere is always going to be tangled by the “carry trade.” The idea has become legend, as to whenever the yen moves starkly in one direction or the other the first commentary will usually “inform” of the carry trade potential. I have no doubt that it exists and even that it forms the great basis of yen involvement in so many spheres, but I think it more a means than an end.

  What was notable about Japan during the past few weeks was the yen’s strengthening. Almost in lockstep with gold, it was quite clear that fear was driving both as the “dollar” was being run. Under less pressured condition, a tightening in wholesale “dollars” would typically find both the yen and gold in the reverse; the fact that they (and the franc) had become the opposite was a telling cue.

  

  Any examination of the yen is drawn to the major devaluations, the most prominent of features in its chronology of the past few years. However, despite that seeming one-way direction there have been a couple of noteworthy exceptions. The first was (below) starting May 22, 2013, and running through the middle of June that year. Recall that May 22 was the onset of the credit crash after the first utterance of the word “taper” and that the selloff ran through to June 24, especially MBS and eurodollars. The yen, rather than continue against such a “strong dollar” instead itself appreciated jumping from a low of 103.50 to 94.30 by the end of the episode.

  

  In the past year, as the “dollar’s” various runs have become more frequent and globally involved, the yen has staged a couple of these same reversals to smaller degrees. The first was October 15, going from 109 to 106 which sounds like almost nothing except that it interrupted, prominently, right in the middle of the second major devaluation. Since that time, these counter moves in the yen have matched perfectly other “dollar” runs; one ending on December 16, 2014, as junk bonds and the corporate credit bubble was hit; one ending on January 15, 2015, when the SNB was forced to break its euro peg from “dollar” pressure, marking the first major central bank warning.

  

  You could even add another yen appreciation in early March, ending just after the March FOMC. Finally, there was the largest yen “safety” bid so far, a huge spike that began August 19 as the “dollar” system was run further toward its ultimate global liquidation point. Was that the carry trade unwinding? Most assuredly, but not for or of itself and certainly not because of factors in Japan. In other words, in these specific episodes at least, the carry trade was likely just one method of expressing broader uncertainty and then fear against US assets. To my view, that is an enormous statement itself given the rather deserved disdain for the yen.

  We knew liquidity globally was under great strain in the weeks prior to this Monday’s stock participation, but the yen, franc and gold also showed clearly that general fear was moving into that situation as well; that is, obviously, a shift and an unwelcome one given what transpired.

  

  Is it over? From these indications it may not be, at least not yet fully. Gold has been higher today (both through the AM and PM fixes) while the yen is still lingering around 121 rather than the 124-125 range prior to the PBOC’s defeat. Stocks may be more sanguine, but in the bubble age that is an almost permanent feature making them the last in line of the liquidity train to “get the message” (discounting mechanism? Not for a long time). It would be reasonable to assume then, despite the “dollar’s” more immediate pause across the financial system this week, not everything has resumed ignoring these deeper funding issues. That may, of course, dissipate next week or however long into the immediate future, but for now, having been subjected to a very serious move, the “system” doesn’t seem quite ready yet to just move on (interesting also that UST’s were bid starting yesterday afternoon until this morning; 10s were 2.20% in yield around 1 pm yesterday and falling to 2.13% before reversing yet again around 10 am).

  In many ways, you expect gold to behave in this manner even against its more nefarious “dollar” connections that have for a few years now been pulling it steadily lower – there was always a safety bid awaiting some more aggressive disruption. To see the yen and the franc participate too, and to such a heavy reversal, seems to suggest just how far into the interior of even the domestic foundation this “run” progressed. We knew it was a grave period by the very fact of knocking the PBOC so unsteady as it did, but these other moves add unconditional confirmation of what it really was.

  

  

  

  

  

• This Is What Happened The Last Time Malaysia Faced A Currency Crisis

  Earlier today, we highlighted the street protests currently underway in the Malaysian capital of Kuala Lumpur where tens of thousands of Malaysians are calling for the ouster of Prime Minister Najib Razak whose government has been accused of obstructing an investigation into how some $700 million from the Goldman-backed 1Malaysia Development Berhad mysteriously ended up in Najib’s personal bank account.

  Of course political turmoil isn’t Malaysia’s only problem. Two weeks ago, in the wake of the yuan devaluation, a $10 billion bond maturity sparked the largest one-day plunge for the ringgit in two decades, serving notice that whispers about a replay of the currency crisis that gripped the country in 1997/98 were about to become shouts.

  Sure enough, Malaysia – whose FX reserves fell under $100 billion late last month leaving it with dry powder sufficient to cover only 6 months of imports and putting its short-term external debt cover at just 1X – is now at the center of the Asia Financial Crisis 2.0 discussion and central bank head Zeti Akhtar Aziz has been at pains to reassure the market that a replay of 1998’s “draconian” crisis fighting measures is not in the cards. 

  Because it appears the situation is set to deteriorate meaningfully in the near term, and because the country’s political situation could serve to undermine already fragile confidence, we thought it an opportune time to revisit exactly what happened two decades ago. For the breakdown, we go to BofAML.

  *  *  *

  From BofAML

  Capital controls – the drastic option

  Concerns that Bank Negara Malaysia may re-introduce capital controls is resurfacing after the ringgit plunged past RM4 against the US dollar, with FX reserves dropping below the $100bn psychological threshold. The MYR has depreciated by 12% against the US dollar since the start of the year and by about 26% from its peak in August last year. BNM’s FX reserves fell to $96.7bn at end-July, falling below the $100bn threshold and down by about $9bn in July alone. At the peak, FX reserves were $141bn in May 2013.

  During [the crisis], the ringgit collapsed by about 89% from peak-to-trough at its worst (to 4.71 from 2.49 against the USD). The ringgit has depreciated some 26% in the current crisis. During that episode, the KLCI fell by about 79% from peak-to-trough (from 1,271 to 263) at its worst. The KLCI today has fallen by only about 12% from its recent peak. Nevertheless, downside risks remain given looming Fed rate hikes, China’s RMB devaluation and the political crisis. 

  

  But depletion of FX reserves is more severe this time, down $44.7bn so far from the recent peak in May 2013, versus $8.2bn during the Asian crisis episode. Capital controls enacted in 1998 allowed BNM to rebuild FX reserves quickly, rising +$13bn to $32.6bn in a year (Chart 2).

  This political crisis is probably the worst in Malaysia’s history, with no resolution in sight over the 1MDB scandal and a growing “trust deficit” with PM Najib.

  Former premier Mahathir has criticized the finding that Middle Eastern sources “donated” RM2.6bn ($700m) into the PM’s accounts as “hogwash.”

  Malaysia’s vulnerability is also heightened by higher leverage – household, quasipublic and external – than during the Asian crisis. Household debt is 86% of GDP, almost double that pre-Asian crisis (46%). External debt is 69% of GDP, much higher than the 44% in 1997. Even if half of external debt is MYR-denominated, foreign withdrawals will still pressure the ringgit and FX reserves. Public debt is 54% of GDP today versus 31% in 1997. Inclusive of government guarantees, quasi-public debt rises to 70% of GDP. This moreover do not include the potential liabilities from 1MDB, including “letters of support” to circumvent the use of guarantees. Only corporate debt is lower today, at 86% vs. 105% of GDP in 1997. Government-linked companies, pension and pilgrimage funds are also facing pressures to bail-out 1MDB by taking over its assets, including power plants and property projects. With the Prime Minister more focused on 1MDB and survival, the economy is in danger of slipping into another crisis.

  

  

  

  

  

  

• "Rough Summer" For Small Caps Set To Continue

  Small Cap stocks are in the middle of their worst summer doldrums since 2011 – and in fact for many individual stocks, worst summer since the collapse in 2008/9. While talking heads proclaim these smaller (supposedly more domestically-oriented) stocks a must-own, they have underperformed significantly as the credit cycle turns (thanks to their higher sensitivity to funding costs, among other things). Judging by this week's farce, the supposedly high-beta small caps are being BTFD'd aggressively either and perhaps that is because, since 1926, on average, September and October are the only months in which small-capitalization stocks have posted losses.

   

  Weak Summer…

  

   

  And Weak Bounce…

  

   

  And as Bloomberg reports, Fall may be no better…

  Shares of smaller U.S. companies are headed for their biggest monthly decline in almost four years, and history suggests they may not recover their losses any time soon.

   

   

  

   

  September and October are the only months in which small-capitalization stocks have posted losses on average since 1926, as the chart illustrates. The data was compiled by the University of Chicago’s Center for Research in Security Prices.

   

  …

   

  “It has been a rough summer for small caps,” Steven G. DeSanctis, an equity strategist for Bank of America Corp.’s Merrill Lynch unit, wrote two days ago in a report that cited the chart’s data.

   

  The Russell 2000 Index, whose companies have a $714 million median market value, has fallen 10 percent for August. A loss of that size would be the biggest monthly decline since September 2011. Rising stock volatility and weakness in high-yield bonds indicate a rebound may not come soon, wrote DeSanctis, who is based in New York.

  *  *  *

  Credit continues to flash red…

  

   

  A pattern we have seen before…

  

   

  Trade Accordingly…

  

  

  

  

  

• Here's Why The Markets Have Suddenly Become So Turbulent

  Submitted by Charles Hugh-Smith via PeakProsperity.com,

  When stock markets are free-falling 10+% in a matter of days, it’s natural to seek some answers to the question “why now?”

  Some are saying it was all the result of high-frequency trading (HFT), while others point to China’s modest devaluation of its currency the renminbi (a.k.a. yuan) as the trigger.

  Trying to finger the proximate cause of the mini-crash is an interesting parlor game, but does it really help us identify the trends that will shape markets going forward?

  We might do better to look for trends that will eventually drag markets up or down, regardless of HFT, currency revaluations, etc.

  Five Interconnected Trends

  At the risk of stating the obvious, let’s list the major trends that are already visible.

  1. The China Story is Over

  And I don’t mean the high growth forever fantasy tale, I mean the entire China narrative is over:

  1. That export-dependent China can seamlessly transition to a self-supporting consumer economy.
  2. That China can become a value story now that the growth story is done.
  3. That central planning will ably guide the Chinese economy through every rough patch.
  4. That corruption is being excised from the system.
  5. That the asset bubbles inflated by a quadrupling of debt from $7 trillion in 2007 to $28 trillion can all be deflated without harming the wealth effect or future debt expansion.
  6. That development-dependent local governments will effortlessly find new funding sources when land development slows.
  7. That workers displaced by declining exports and automation will quickly find high-paying employment elsewhere in the economy.

  I could go on, but you get the point: the entire Story is over.  (I explained why in a previous essay, Is China’s “Black Box” Economy About to Come Apart? )

  This is entirely predictable. Every fast-growing economy starting with near-zero debt and huge untapped reserves of cheap labor experiences an explosive rise as the low-hanging fruit is plucked and the same abrupt stall and stagnation when the low-hanging fruit has all been harvested, leaving only the unavoidable results of debt-fueled speculation: an enormous overhang of bad debt, malinvestment (a.k.a. bridges to nowhere and ghost cities) and policies that seemed brilliant in the good old days that are now yielding negative returns.

  2. The Emerging Market Story Is Also Done

  Emerging currencies and markets have soared on the back of the China Story, as China’s insatiable demand for oil, iron ore, copper, soy beans, etc. drove global demand to unparalleled heights.

  This demand pushed prices higher, which then pushed production (supply) higher, as the low cost of capital globally enabled marginal resources to be put into production with borrowed money.

  Now that China’s demand has fallen off—by some accounts, China’s GDP is actually in negative territory, despite official claims that it’s still growing at 7% annually—commodity prices have crashed, taking the emerging markets’ stock and currency markets down. (Source)

  Here is a chart of Doctor Copper, a bellwether for industrial and construction demand:

  

  Here is Brazil’s stock market, which has declined 54% in the past 12 months:

  

  These are catastrophic declines, and with China’s growth story over, there is absolutely nothing on the global horizon to push demand back up.

  3. Diminishing Returns on Additional Debt

  The simple truth is that expanding debt has fueled global growth. Though people identify China as the driver of global demand for commodities, China’s growth is debt-driven. As noted above, China quadrupled its officially tracked debt from $7 trillion in 2007 to $28 trillion as of mid-2014—an astonishing 282 percent of gross domestic product (GDP).  If we add the estimated $5 trillion of shadow-banking system debt and another year’s expansion of borrowing, China’s total debt of $35+ trillion is in excess of 300% of GDP—levels associated with doomed to default states such as Greece and Spain.

  While China has moved to open the debt spigot in recent days by lowering interest rates and reserve requirements, this doesn’t make over-indebted borrowers good credit risks or more empty high-rises productive investments.

  Borrowed money that poured into ramping up production in emerging nations is now stranded as prices have plummeted, rendering marginal production intensely unprofitable.

  In sum: greatly expanding debt boosted growth virtually everywhere after the Global Financial Meltdown of 2008-2009. That fix is a one-off: not even China can quadruple its $35+ trillion debt to $140 trillion to reignite growth.

  Here is a sobering chart of global debt growth:

  

   

  4. Limits on Deficit-Spending (Borrowed) Fiscal Stimulus

  When the global economy rolled over into recession in 2008, governments borrowed money by selling sovereign bonds to fund increased state spending.  In the U.S., federal borrowing soared to over $1 trillion per year as the government sought to replace declining private spending with public spending.

  Governments around the world have continued to run large deficits, piling up immense debts since 2008.  The global move to near-zero yields has enabled governments to support these monumental debt loads, but even at near-zero yields, the interest payments are non-trivial. These enormous sovereign debts place some limits on how much governments can borrow in the next global recession—a slowdown many think has already started.

  Here is a chart of U.S. sovereign debt, which has almost doubled since 2008:

  

  As noted on the chart: what structural inadequacies or problems did governments fix by borrowing gargantuan sums to fund state spending?  The basic answer is: none. All the same structural problems facing governments in 2008 remain untouched in 2015. These include: over-indebtedness, bad debts that haven’t been written down, insolvent banks, soaring social spending as the worker-retiree ratio slips below 2-to-1, externalized environmental damage that has yet to be remediated, and so on.

   

  5. Central Bank Stimulus (Quantitative Easing) as Social Policy Has Been Discredited

  In the wake of the Global Financial Meltdown of 2008-2009, central banks launched monetary stimulus programs aimed at pumping money into the economy via bank lending. The stated goals of these stimulus programs were 1) boost employment (i.e. lower unemployment) and 2) generate enough inflation to stave off deflation, which is generally viewed as the cause of financial depressions.

  While it can be argued that these unprecedented monetary stimulus programs achieved modest successes in terms of lowering unemployment and pushing inflation above the zero line, they also widened wealth and income inequality.

  Even as these programs made modest dents in unemployment and deflation, they pushed asset valuations to the moon—assets largely owned by the few at the top of the wealth pyramid.

  

  Here is a chart of selected developed economies’ income/wealth skew:

  

  The widespread recognition that the benefits of central bank stimulus mostly flowed to the top of the pyramid places political limits on future central bank stimulus programs.

  The 2008-09 Fixes Are No Longer Available

  In summary, the fixes for the 2008-09 recession are no longer available in the same scale or effectiveness.  Expanding debt to push up demand and investment, rising state deficit spending, massive monetary stimulus programs—all of these now face limitations. This means the central banks and states have very limited tools to reignite growth as global recession trims borrowing, investment, hiring, sales and profits.

  What Ultimately Matters: Capital Flows

  In Part 2: What Happens Next Will Be Determined By One Thing: Capital Flows, we’ll look at the one dynamic that ultimately establishes assets prices: capital flows.

  I personally don’t think the world has experienced a period in which capital preservation has become more important than capital appreciation since the last few months of 2008 and the first few months of 2009.  Other than these five months, the focus has been on speculating to obtain the highest possible yield/appreciation.

  This suggests to me that the next period of risk-off capital preservation will last a lot longer than five months, and perhaps deepen as time rewards those who adopted risk-off strategies early on.

  Click here to read Part 2 of this report (free executive summary, enrollment required for full access)

  

  

  

  

  

• The Evolution of America's Energy Supply (1776 – 2014)

  Some context for those who insist renewables will ‘solve’ everything…

   

  

  Source: Visual Capitalist

  The early settlers to North America relied on organic materials on the surface of land for the vast majority of their energy needs. Wood, brush, and other biomass fuels were burned to warm homes, and eventually to power steam engines. Small amounts of coal were found in riverbeds and other such outcrops, but only local homes in the vicinity of these deposits were able to take advantage of it for household warmth.

  During the Industrial Revolution, it was the invention of the first coal-powered, commercially practical locomotives that turned the tide. Although wood would still be used in the majority of locomotives until 1870, the transition to fossil fuels had begun.

  Coke, a product of heating certain types of coal, replaced wood charcoal as the fuel for iron blast furnaces in 1875. Thomas Edison built the first practical coal-fired electric generating station in 1882, which supplied electricity to some residents in New York City. It was just after this time in the 1910s that the United States would be the largest coal producer in the world with 750,000 miners and blasting 550 million tons of coal a year.

  The invention of the internal combustion engine and the development of new electrical technologies, including those developed by people like Thomas Edison and Nikola Tesla, were the first steps towards today’s modern power landscape. Fuels such as petroleum and natural gas became very useful, and the first mass-scale hydroelectric stations were built such as Hoover Dam, which opened in 1936.

  The discovery and advancement of nuclear technology led to the first nuclear submarine in 1954, and the first commercial nuclear power plant in the United States in Pennsylvania in 1957. In a relatively short period of time, nuclear would have a profound effect on energy supply, and it today 99 nuclear reactors account for 20% of all electricity generated in the United States.

  In more recent decades, scientists found that the current energy mix is not ideal from an environmental perspective. Advancements in renewable energy solutions such as solar, wind, and geothermal were made, helping set up a potential energy revolution. Battery technology, a key challenge for many years, has began to catch up to allow us to store larger amounts of energy when the sun isn’t shining or the wind isn’t blowing. Companies like Tesla are spending billions of dollars on battery megafactories that will have a great impact on our energy use.

  Today, the United States gets the majority of its energy from fossil fuels, though that percentage is slowly decreasing. While oil is still the primary fuel of choice for transportation, it now only generates 1% of the country’s electricity through power plants. Natural gas has also taken on a bigger role over time, because it is perceived as being cleaner than oil and coal.

  Today, in 2015, wind and solar power have generated 5% and 1% of total electricity respectively. Hydro generates 7%.

  

  

  

  

  

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