Today’s News September 19, 2015

• Palo Alto Outdoes Itself

  As many of you know, the real estate market in Palo Alto has been going bananas for years, particularly recently. I’ve written about this phenomenon here, here, here, and – my favorite – here.

  I’ve lived in Palo Alto since 1991, and at the time, it was a terrible stretch for the very-young Tim to buy a house in town. In retrospect, it was one of the greatest (and few) “long’ positions of my life, since it’s worth about twelve times what I paid for it back then.

  I sure wish I could buy a put option on it, though, because we’ve got to be at some kind of zany top, given the front page headline on this morning’s Daily Post. Here ya go:

  

  So, as you can see, the (very well-compensated) new CFO at Google purchased a house in town for $30 million, a record for the city. (It’s also good news for the school district, since Ms. Porat will be shelling out about $350,000 in property tax per year in perpetuity).

  Before you think to yourself what a grand palace it must be, and on such a stunningly huge plot of acreage, let me disabuse you of this notion: this house is 4,700 square feet, and it is on a plot of land smaller than a single acre. There are two really nice neighborhoods in town: Crescent Park (which is where I live, thank you very much) and Old Palo Alto, which is where the above house is located. She’s a block away from the ghost of Steve Jobs. It’s a lovely neighbhorhood, to be sure. But……..…thirty million dollars???

  One interesting tidbit I learned about the house is that it’s been unoccupied for……….twenty years. Its owner, the billionaire John Arrillaga, bought the house in 1972 for a million bucks, and although he lived there a while, after he moved out, he just let it sit vacant. (I guess when you’re a billionaire, foregoing rent doesn’t really matter). He says he was waiting to sell it to someone “with a family”, and although I suspect over the past twenty years a few non-single people have moved into town, for some reason he chose Ms. Porat as the perfect buyer.

  Speaking of Porat, here’s a tidbit about her, too: according to her Wikipedia page, “During the financial crisis, Porat led the Morgan Stanley team advising the United States Department of the Treasury regarding Fannie Mae and Freddie Mac, and the New York Federal Reserve Bank with respect to AIG.” A dubious achievement, if you ask me, but given the fact that she is paid a salary that in the span of five months equals the above house price, whatever she’s doing, she’s doing right. All the same, this is insane.

  

  

  

  

• Deep State America

  Authored by Philip Giraldi, originally posted at The American Conservative,

  It has frequently been alleged that the modern Turkish Republic operates on two levels. It has a parliamentary democracy complete with a constitution and regular elections, but there also exists a secret government that has been referred to as the “deep state,” in Turkish “Derin Devlet.”

  The concept of “deep state” has recently become fashionable to a certain extent, particularly to explain the persistence of traditional political alignments when confronted by the recent revolutions in parts of the Middle East and Eastern Europe. For those who believe in the existence of the deep state, there are a number of institutional as well as extralegal relationships that might suggest its presence.

  Some believe that this deep state arose out of a secret NATO operation called “Gladio,” which created an infrastructure for so-called “stay behind operations” if Western Europe were to be overrun by the Soviet Union and its allies. There is a certain logic to that assumption, as a deep state has to be organized around a center of official and publicly accepted power, which means it normally includes senior officials of the police and intelligence services as well as the military. For the police and intelligence agencies, the propensity to operate in secret is a sine qua non for the deep state, as it provides cover for the maintenance of relationships that under other circumstances would be considered suspect or even illegal.

  In Turkey, the notion that there has to be an outside force restraining dissent from political norms was, until recently, even given a legal fig leaf through the Constitution of 1982, which granted to the military’s National Security Council authority to intervene in developing political situations to “protect” the state. There have, in fact, been four military coups in Turkey. But deep state goes far beyond those overt interventions. It has been claimed that deep state activities in Turkey are frequently conducted through connivance with politicians who provide cover for the activity, with corporate interests and with criminal groups who can operate across borders and help in the mundane tasks of political corruption, including drug trafficking and money laundering.

  A number of senior Turkish politicians have spoken openly of the existence of the deep state. Prime Minister Bulent Ecevit tried to learn more about the organization and, for his pains, endured an assassination attempt in 1977. Tansu Ciller eulogized “those who died for the state and those who killed for the state,” referring to the assassinations of communists and Kurds. There have been several significant exposures of Turkish deep state activities, most notably an automobile accident in 1996 in Susurluk that killed the Deputy Chief of the Istanbul Police and the leader of the Grey Wolves extreme right wing nationalist group. A member of parliament was also in the car and a fake passport was discovered, tying together a criminal group that had operated death squads with a senior security official and an elected member of the legislature. A subsequent investigation determined that the police had been using the criminals to support their operations against leftist groups and other dissidents. Deep state operatives have also been linked to assassinations of a judge, Kurds, leftists, potential state witnesses, and an Armenian journalist. They have also bombed a Kurdish bookstore and the offices of a leading newspaper.

  As all governments—sometimes for good reasons—engage in concealment of their more questionable activities, or even resort to out and out deception, one must ask how the deep state differs. While an elected government might sometimes engage in activity that is legally questionable, there is normally some plausible pretext employed to cover up or explain the act.

  But for players in the deep state, there is no accountability and no legal limit. Everything is based on self-interest, justified through an assertion of patriotism and the national interest. In Turkey, there is a belief amongst senior officials who consider themselves to be parts of the status in statu that they are guardians of the constitution and the true interests of the nation. In their own minds, they are thereby not bound by the normal rules. Engagement in criminal activity is fine as long as it is done to protect the Turkish people and to covertly address errors made by the citizenry, which can easily be led astray by political fads and charismatic leaders. When things go too far in a certain direction, the deep state steps in to correct course.

  And deep state players are to be rewarded for their patriotism. They benefit materially from the criminal activity that they engage in, including protecting Turkey’s role as a conduit for drugs heading to Europe from Central Asia, but more recently involving the movement of weapons and people to and from Syria. This has meant collaborating with groups like ISIS, enabling militants to ignore borders and sell their stolen archeological artifacts while also negotiating deals for the oil from the fields in the areas that they occupy. All the transactions include a large cut for the deep state.

  If all this sounds familiar to an American reader, it should, and given some local idiosyncrasies, it invites the question whether the United States of America has its own deep state.

  First of all, one should note that for the deep state to be effective, it must be intimately associated with the development or pre-existence of a national security state. There must also be a perception that the nation is in peril, justifying extraordinary measures undertaken by brave patriots to preserve life and property of the citizenry. Those measures are generically conservative in nature, intended to protect the status quo with the implication that change is dangerous.

  Those requirements certainly prevail in post 9/11 America, and also feed the other essential component of the deep state: that the intervening should work secretly or at least under the radar. Consider for a moment how Washington operates. There is gridlock in Congress and the legislature opposes nearly everything that the White House supports. Nevertheless, certain things happen seemingly without any discussion: Banks are bailed out and corporate interests are protected by law. Huge multi-year defense contracts are approved. Citizens are assassinated by drones, the public is routinely surveilled, people are imprisoned without be charged, military action against “rogue” regimes is authorized, and whistleblowers are punished with prison. The war crimes committed by U.S. troops and contractors on far-flung battlefields, as well as torture and rendition, are rarely investigated and punishment of any kind is rare. America, the warlike predatory capitalist, might be considered a virtual definition of deep state.

  One critic describes deep state as driven by the “Washington Consensus,” a subset of the “American exceptionalism” meme. It is plausible to consider it a post-World War II creation, the end result of the “military industrial complex” that Dwight Eisenhower warned about, but some believe its infrastructure was actually put in place through the passage of the Federal Reserve Act prior to the First World War. Several years after signing the bill, Woodrow Wilson reportedly lamented, “We have come to be one of the worst ruled, one of the most completely controlled and dominated governments in the civilized world, no longer a government by conviction and the vote of the majority, but a government by the opinion and duress of a small group of dominant men.”

  In truth America’s deep state is, not unlike Turkey’s, a hybrid creature that operates along a New York to Washington axis. Where the Turks engage in criminal activity to fund themselves, the Washington elite instead turns to banksters, lobbyists, and defense contractors, operating much more in the open and, ostensibly, legally. U.S.-style deep state includes all the obvious parties, both public and private, who benefit from the status quo: including key players in the police and intelligence agencies, the military, the treasury and justice departments, and the judiciary. It is structured to materially reward those who play along with the charade, and the glue to accomplish that ultimately comes from Wall Street. “Financial services” might well be considered the epicenter of the entire process. Even though government is needed to implement desired policies, the banksters comprise the truly essential element, capable of providing genuine rewards for compliance. As corporate interests increasingly own the media, little dissent comes from the Fourth Estate as the process plays out, while many of the proliferating Washington think tanks that provide deep state “intellectual” credibility are similarly funded by defense contractors.

  The cross fertilization that is essential to making the system work takes place through the famous revolving door whereby senior government officials enter the private sector at a high level. In some cases the door revolves a number of times, with officials leaving government before returning to an even more elevated position. Along the way, those select individuals are protected, promoted, and groomed for bigger things. And bigger things do occur that justify the considerable costs, to include bank bailouts, tax breaks, and resistance to legislation that would regulate Wall Street, political donors, and lobbyists. The senior government officials, ex-generals, and high level intelligence operatives who participate find themselves with multi-million dollar homes in which to spend their retirement years, cushioned by a tidy pile of investments.

  America’s deep state is completely corrupt: it exists to sell out the public interest, and includes both major political parties as well as government officials. Politicians like the Clintons who leave the White House “broke” and accumulate $100 million in a few years exemplify how it rewards. A bloated Pentagon churns out hundreds of unneeded flag officers who receive munificent pensions and benefits for the rest of their lives. And no one is punished, ever. Disgraced former general and CIA Director David Petraeus is now a partner at the KKR private equity firm, even though he knows nothing about financial services. More recently, former Acting CIA Director Michael Morell has become a Senior Counselor at Beacon Global Strategies. Both are being rewarded for their loyalty to the system and for providing current access to their replacements in government.

  What makes the deep state so successful? It wins no matter who is in power, by creating bipartisan-supported money pits within the system. Monetizing the completely unnecessary and hideously expensive global war on terror benefits the senior government officials, beltway industries, and financial services that feed off it. Because it is essential to keep the money flowing, the deep state persists in promoting policies that make no sense, to include the unwinnable wars currently enjoying marquee status in Iraq/Syria and Afghanistan. The deep state knows that a fearful public will buy its product and does not even have to make much of an effort to sell it.

  Of course I know that the United States of America is not Turkey. But there are lessons to be learned from its example of how a democracy can be subverted by particular interests hiding behind the mask of patriotism. Ordinary Americans frequently ask why politicians and government officials appear to be so obtuse, rarely recognizing what is actually occurring in the country. That is partly due to the fact that the political class lives in a bubble of its own creation, but it might also be because many of America’s leaders actually accept that there is an unelected, unappointed, and unaccountable presence within the system that actually manages what is taking place behind the scenes. That would be the American deep state.

  

  

  

  

  

• Never Say "Never"

  Never… is a long time.

   

  

   

  Source: Investors.com

  

  

  

  

  

• It Begins: Australia's Largest Investment Bank Just Said "Helicopter Money" Is 12-18 Months Away

  Just over two years ago, when the world was deciding who would be Bernanke Fed Chair replacement, Larry Summers or Janet Yellen (how ironic that Larry Summers did not get the nod just because a bunch of progressive economists thought he would not be dovish enough) we wrote about a different problem: with the end of QE3 upcoming and with the inevitable failure of the economy to reignite (again), we warned that there remains one option after (when not if) QE fails to stimulate growth: helicopter money.

  While QE may be ending, it certainly does not mean that the Fed is halting its effort to “boost” the economy. In fact… the end of QE may well be simply a redirection, whereby the broken monetary pathway, one which uses banks as intermediaries to stimulate inflation (supposedly a failure according to the economist mainstream), i.e., “second-round effects”, is bypassed entirely and replaced with Plan Z, aka “Helicopter Money” mentioned previously as an all too real monetary policy option by none other than Milton Friedman and one Ben Bernanke. This is also known as the nuclear option.

  Today, one day after the Fed according to some finally lost its credibility, none other than Australia’s largest investment bank, Macquarie, just made the case that helicopter money is not only coming, but has a “very high” probability of commencing its monetary paradrops over the next 12-18 months.

  Time for a policy U-turn? Back to the future: British Leyland

   

  From conventional QEs to more unorthodox policies…

   

  As discussed (here and here), we do not believe that investors are likely to benefit from acceleration in growth rates, trade or liquidity and indeed on the contrary, negative feedback loops from EMs to DMs imply that neither would be able to support global growth. Secular stagnation is the key explanatory variable (here). The deflationary pressures from overleveraging, overcapacity and technology shifts can be either allowed to work through economies or public sector needs to continue resisting via expansionary policies.

   

  Since ’08, monetary policies were doing most of the lifting with limited participation by fiscal authorities (bar China). In other words, in the absence of either private or public sectors driving higher velocity of money, it was CBs that were supplying incremental liquidity to preclude contraction of nominal GDP and avoid stronger deflationary pressures. However, marginal utility of incremental injections has been declining (witness much lower impact of recent ECB’s QE and increase in BoJ accommodation since Dec ’14).

   

  Part of the reason for monetary stimulus fading is that supply of US$ remains low. Global economy continues to reside on a de-facto US$ standard and current incremental supply is almost non-existent (depending on definition growing at +2%/-1% clip vs. average since ‘01 of ~15%). In other words, due to lack of recovery in the US velocity of money and lack of QEs, global economy is not getting enough US$ to continue leveraging.

   

  …as efficacy of conventional monetary QE is questioned

   

  At the same time efficacy of continuing with conventional QE policies is being challenged and not just by independent observes but also ‘insiders’ (such as recent SF Fed paper). As velocity of money globally continues to fall, conventional QEs have to become exponentially larger, as marginal benefit declines. If public sector is not prepared to step aside, what other measures can be introduced to support nominal GDP and avoid deflation?

   

  There are several policies that could be and probably would be considered over the next 12-18 months. If private sector lacks confidence and visibility to raise velocity of money, then (arguably) public sector could. In other words, instead of acting via bond markets and banking sector, why shouldn’t public sector bypass markets altogether and inject stimulus directly into the ‘blood stream’? Whilst it might or might not be called QE, it would have a much stronger impact and unlike the last seven years, the recovery could actually mimic a conventional business cycle and investors would soon start discussing multiplier effects and positioning in areas of greatest investment.

   

  British Leyland failed, but it might work at least for a while

   

  British Leyland (formed from nationalized British car companies in the late ’60s) destroyed its automotive industry but for a time it provided employment and investment. CBs directly monetizing Government spending and funding projects would do the same. Whilst ultimately it would lead to stagflation (UK, 70s) or deflation (China, today), it could provide strong initial boost to generate impression of recovery and sustainable business cycle. It could also significantly shift global terms of trade (to the benefit of commodity producers) and cause a period of underperformance by our ‘Quality & Stability’ portfolio and improve performance of ‘Anti-Quality’ screen. What is probability of the above policy shift? Low over next six months; very high over the longer term.

  What’s most disturbing about the above assessment is that Macquarie realizes this last ditch attempt to preserve the status quo will fail, but will – if nothing else – buy another 12-18 months.

  So is that the event horizon countdown: 1-2 years… and then?

  And just like last week’s Daiwa report broke the seal on unprecedented economic bearishness (Citi promptly made a global recession its 2016 base case) will the Macquarie report become the benchmark which the other penguins will ape as suddenly calls to bypass the banks become the norm and suddenly every “authority” on the topic, which so vehemently advocated for QE, admits it never worked from day one, and instead recommends that the only option left to save the world is the “nuclear” one?

  Which, incidentally, is precisely what we said would be the endgame on March 18, 2009 – the day the Fed announced the full-blown first QE1.

  

  

  

  

  

• Mark Spitznagel Warns: If Investors Thought August Was Scary, "They Ain't Seen Nothin' Yet"

  The man who made a billion dollars on Black Monday sums up his strategy perfectly in this excellent FOX Business clip with the money-honey, "I'm a hedge fund manager that actually hedges for his clients. This is something of an old fashioned idea in this day of just gambling on the next Fed bailout." Spitznagel, who is wholly unapologetic in his criticism of The Fed (and any central planner), unleashes eight minutes of awful truthiness on what is going on under the surface of the so-called 'market', concluding ominously, "if August was scary for people, they ain't seen nothin’ yet."

   

  Grab a beer and relax…

  Watch the latest video at video.foxbusiness.com

   

  Some key excerpts:

  On Universa's tail-risk strategy..

  "We tend to lose or draw—most of the time—these small battles or skirmished. But, ultimately, we win the wars."

  On the Great Myth of centrally planned economies..

  "Great myths die hard. And I think what we're witnessing today is the slow death of one of the great myths of human history: this idea that centrally planned command economies work, that they're even feasible, and that they can be successful.

   

  It's one of these enigmatic mythologies of the last hundred years in particular that we've been grappling with, and here we are today yet again thinking about this. Let's remember that in the last hundred years a lot of blood has been shed over this mythology. And here we are today, how did we get here again?

  On today's "all alpha is beta" hedge fund community…

  There was this notion not long ago of the Bernanke put, the Greenspan put. It was sort of a dirty thing to admit that it was part of our investment strategy. But today, it's everyone’s investment strategy."

  On "it's different this time"…

  "I think that another generation will look back and say 'how could you have made that mistake all over again? How could you have failed to understand Hayek's notion of the fatal conceit, that central planners can't do better than the dispersed knowledge and signals of free market processes?'"

  On the crazy world in which we live…

  "There's something self-fulfilling about this mythology, only in the short run.

   

  But in the long run we know that it is ultimately self-defeating. When bureaucrats mandate low interest rates it doesn't spawn long term productive investment. What it spawns is this short term gambling, punting on momentum-driven moves, on levered buybacks. This is the world we're in today."

  

  

  

  

  

• Yellen's "New" Mandate – Why We Are All Fed-Watchers Now

  Submitted by Paul Brodsky via Macro-Allocation.com,

  The Fed’s Calculus

  We have been watching the Fed professionally since 1982, when the weekly release of Money Supply was the thing. This is not meant to imply that being older than the hills gives us special insight into when the Fed will hike rates – a lack of insight we accept not necessarily because we are slow learners, but rather because the Fed is a living organism with changing mandates and incentives adopted for changing economic and market conditions.

  For example, according to the Fed’s website:

  "The Federal Reserve System and public- and private-sector analysts have long monitored the growth of the money supply because of the effects that money supply growth is believed to have on real economic activity and on the price level. Over time, the Fed has tried to achieve its macroeconomic goals of price stability, sustainable economic growth, and high employment in part by influencing the size of the money supply. In the past few decades, however, the relationship between growth in the money supply and the performance of the U.S. economy has become much weaker, and emphasis on the money supply as a guide to monetary policy has waned."

  And so, as the Fed notes, US monetary aggregates have been relegated to the bank bench of economic data. The reason behind this – the overwhelming emphasis on fractionallyreserved bank and fully-reserved shadow bank credit that eventually usurped the importance of the money stock over the last few decades (and made possible by twenty years of easy credit conditions overseen by the Fed) – is not discussed on the Fed’s website. Perception is everything in contemporary economics and the Fed is the center of perception; the medium has become the message.

  This is not gratuitous Fed bashing, but rather an observation directed at where the esteemed institution sits in the global economy and how it positions itself in the narrative. Though it must pose as an erstwhile body of best-in-class econometric modelers and policy wonks applying its findings to optimize sustainable economic demand; the Fed is, in reality, an erstwhile cabal of respected theoretical extrapolators jerry-rigging credit rates to fit a public narrative it also creates.

  The truth is more this: the Fed no longer reacts to the waxing and waning of animal spirit-led demand. In the current monetary regime it exists to create and maintain animal spirits with a secular policy centered on ever-expanding credit, but it is very aware that admitting it’s centrality would defeat its purpose.

  If there is any benefit to torturing one’s self by Fed watching for thirty-odd years, it is the knowledge that its credit and communication policies are as circular as the monetary system it oversees.  

  A New Narrative 

  The Fed did not raise its target for Fed Funds yesterday and suggested recent global economic weakness and implied potential US dollar strength were the main reasons. According to Chair Yellen: “A lot of our focus has been on risks around China, but not just China – emerging markets more generally and how they may spill over to the US.”

  We have two main observations that suggest a meaningful shift in Fed oversight and communications.

  First, by waiting and citing global economic weakness, the Fed effectively took responsibility over the exchange rate of the US Dollar – oversight traditionally managed by the Treasury Department.

   

  One does not have to go back to the eighties to know that US Dollar policy has historically been the specific domain of the US government. Ms. Yellen’s willingness to disregard any mention of “a strong-dollar policy” made famous by Robert Rubin’s Treasury implies: 1) a fundamental shift in control over the economic policy narrative put forth by the United States, and 2) the US wants to send a message to foreign monetary authorities that it will let the US dollar weaken…for now.

   

  It seems economic authorities and commercial operators in China and everywhere else now need only watch and listen to the Fed to understand US policy towards the Dollar and now know that the US will support their efforts to stabilize their economies. (More on this in later reports.)

   

  Our second observation is that Ms. Yellen’s comments yesterday make clear that the Fed is implicitly judging the health of the US economy by incorporating global factors that may directly or indirectly affect its formal domestic macroeconomic mandates of price stability, sustainable economic growth, and high employment.

   

  This had to happen eventually. US dollars are not only the domestic currency Americans use to consume, invest (and ostensibly save); they are also the world’s most dominant reserve currency used in trade and the one in which significant global debt is denominated. Ms. Yellen’s tacit admission that the USD is a consideration in the Fed’s decision to maintain zero-bound US rates a little longer does not necessarily suggest that the Fed does not believe the US economy, per se, could not absorb a rate hike.

  Taken together – unilateral authority over US dollar policy, an implied acknowledgment that the global economy could not yet withstand a stronger US dollar (but don’t mess with us!), and the US economy would suffer as a result – is the likely calculus behind last week’s Fed rate decisions.

  The implication for investors in the US and everywhere else is, to paraphrase the famous line credited to President Nixon after the 1971 USD/gold default, we are all Fed watchers now. Regardless of focus, there has never been a better time to include macroeconomic analysis in one’s investment process.

  

  

  

  

  

• Interbank Credit Risk Soars To 3 Year Highs – Is This Why Janet Folded?

  Last week we warned of the ominously rising risks evident under the surface in US financials. Following Yellen's decision to chicken-out yesterday, it appears interbank counterparty risk is even ominous-er. With bank stocks prices tumbling, catching down to credit market's concerns, the TED Spread – implicitly measuring interbank credit risk – jumped over 21% yesterday – to its highest in 3 years.

   

  Is this the real reason The Fed did not hike?

  

   

  and now financial stocks tumble back to credit reality…

  

   

  The question is – is this the tail that is wagging the Fed's dog? Given the Fed's ownership structure, any rise in the banks' cost of financing, in an era of surging counterparty risks may be the straw that break the "confidence camel's" back. Just see Nigeria.

  If so – then we have a problem – The Fed's dovish inaction is not helping alleviate any concerns.

   

  Charts: Bloomberg

  

  

  

  

  

• Austrian Economics, Monetary Freedom, & America's Economic Roller-Coaster

  Submitted by Richard Ebeling via EpicTimes.com,

  For over a decade, now, the American economy has been on an economic rollercoaster, of an economic boom between 2003 and 2008, followed by a severe economic downturn, and with a historically slow and weak recovery starting in 2009 up to the present.

  Before the dramatic stock market decline of 2008-2009, many were the political and media pundits who were sure that the “good times” could continue indefinitely, including some members of the Board of Governors of the Federal Reserve, America’s central bank.

  When the economic downturn began and then worsened, many were the critics who were sure that this proved the “failure” of capitalism in bringing such financial and real economic disruption to America and the world.

  There were resurrected long questioned or rejected theories from the Great Depression years of the 1930s that argued that only far-sighted and wise government interventions and regulations could save the country from economic catastrophe and guarantee we never suffer from a similar calamity in the future.

  The Boom-Bust Cycle Originates in Government Policy

  Not only is the capitalist system not responsible for the latest economic crisis, but all attempts to severely hamstring or regulate the market economy out of existence only succeeds in undermining the greatest engine of economic progress and prosperity known to mankind.

  The recession of 2008-2009 had its origin in years of monetary mismanagement by the Federal Reserve System and misguided economic policies emanating from Washington, D.C. For the five years between 2003 and 2008, the Federal Reserve flooded the financial markets with a huge amount of money, increasing it by 50 percent or more by some measures.

  For most of those years, key market rates of interest, when adjusted for inflation, were either zero or even negative. The banking system was awash in money to lend to all types of borrowers. To attract people to take out loans, these banks not only lowered interest rates (and therefore the cost of borrowing), they also lowered their standards for credit worthiness.

  To get the money, somehow, out the door, financial institutions found “creative” ways to bundle together mortgage loans into tradable packages that they could then pass on to other investors. It seemed to minimize the risk from issuing all those sub-prime home loans, which we viewed afterwards as the housing market’s version of high-risk junk bonds. The fears were soothed by the fact that housing prices kept climbing as home buyers pushed them higher and higher with all of that newly created Federal Reserve money.

  At the same time, government-created home-insurance agencies like Fannie Mae and Freddie Mac were guaranteeing a growing number of these wobbly mortgages, with the assurance that the “full faith and credit” of Uncle Sam stood behind them. By the time the Federal government formally took over complete control of Fannie and Freddie 2008, they were holding the guarantees for half of the $10 trillion American housing market.

  

  Easy Money and Lower Interest Rates Led to the Bust

  Low interest rates and reduced credit standards were also feeding a huge consumer-spending boom that that resulted in a 25 percent increase in consumer debt between 2003 and 2008, from $2 trillion to over $2.5 trillion. With interest rates so low, there was little incentive to save for tomorrow and big incentives to borrow and consume today. But, according to the U.S. Census Bureau, during that five-year period average real income only increased by at the most 2 percent. Peoples’ debt burdens, therefore, rose dramatically.

  The easy money and government-guaranteed house of cards all started to come tumbling down 2008, with a huge crash in the stock market that brought some indexes down 30 to 50 percent from their highs. The same people in Washington who produced this disaster then said that what was needed was more regulation to repair the very financial and housing markets their earlier actions so severely undermined.

  That included, at the time, a shotgun wedding between the U.S. government and the largest banks in America, when in October of 2008, the heads of those financial institutions were commanded to come to Washington, D.C. for a meeting with, then, Secretary of the Treasury, Henry Paulson and former Federal Reserve Chairman, Ben Bernanke.

  They were told the Federal government was injecting cash into the banking system with a purchase of $245 billion of shares of bank stocks in the financial sector. The banking CEOs present – some of who made it clear they neither needed nor wanted an infusion of government money – were basically told they would not be allowed to leave the Treasury building until they had signed on the dotted line. (The money was eventually returned to the Treasury, with bank buybacks of the shares in which the government had “invested.”)

  Opening the Monetary Spigot Again

  The Federal Reserve, in the meantime, turned on the monetary spigot, increasing the monetary base (cash and bank reserves) between 2007 and 2015 from $740 billion to around $4 trillion, brought about through a series of monetary creation policies under the general heading of “quantitative easing.”

  A variety of key interest rates, as a consequence, when adjusted for inflation, have been in the negative range most of the time for seven years. Nominal and real interest rates, therefore, cannot be considered to be telling anything truthful about the actual availability of savings in the economy and its relationship to market-based profitability of potential investments.

  Interest rates manipulation has worked similar to a price control keeping the price of a good below its market-determined and clearing level. It has undermined the motives and abilities of some people to save on the supply-side, while distorting demand-side decision-making in terms of both the types and time-horizons of possible investments to undertake, since the real scarcity and cost of borrowing for capital formation has been impossible to realistically estimate and judge in a financial market without market-based interest rates.

  Markets have been distorted, investment patterns have been given wrong and excessive directions, and labor and resources have been misdirected into various employments that will eventually be shown to be unsustainable.

  

  Low Inflation and Faulty Price Indexes

  Keynesians and other supporters of “stimulus” policies have argued that there has been no need to fear “excesses” in the economy because price inflation has been tame – running less than two percent a year practically the entire time since 2008.

  First, it needs to be remembered that this measurement of price inflation is based upon one or another type of statistical price index. This by necessity hides from view all the individual price changes that make up the statistical average, and which has seen in the last few years significant price increases in subsectors of the market.

  Second, the full impact of the massive monetary expansion has been prevented from having its full effect due to a policy gimmick that the Federal Reserve has been following since virtually the start of its quantitative easing policies. The central bank has been paying banks a rate of interest slightly above the interest rate it could earn from lending to borrowers in the private sector.

  Thus, it has been more profitable for many banks to leave large amounts of their available reserves unlent as “excess reserves” that have been totaling almost $2.8 trillion of the nearly $4 trillion that Federal Reserve as created. Having created all this additional lending potential, the Fed has been manipulating interest rates, again, this time to keep a large amount of it from coming on the market.

  Third, particularly since 2014, the world has been increasingly awash in expanding oil supplies that has resulted in dramatically lower prices for refined oil products of all types, and most visibly to the average consumer in the form of falling prices to fill up one’s car with gasoline.

  Greater supplies of useful and widely used raw materials and resources at significantly lower cost should be considered a boon to all in the economy, in making production and finished goods less expensive, and thereby raising the standards of living of all demanding such products.

  Instead, the Federal Reserve worries about “price deflation” as a drag on the economy, rather than as a market-based stimulus through supply-side plentifulness that, in the long run, reduces the scarcity and cost of desired goods and services.

  Central banks around the world have all gravitated to the idea that the “ideal” rate of price inflation that assures economic stability and sustainability is around two percent a year. Fixated on averages and aggregates, the central bankers continue to give little or no attention to the really important influence their monetary policies have on economic affairs: the distortion of the structures of relative prices, profit margins, resource uses and capital investments.

  The “Austrian” Theory of Money and the Business Cycle

  In my new book, Monetary Central Planning and the State, which will be published in October 2015 by the Future of Freedom Foundation in a eBook format available from Amazon, I explain the “Austrian” theory of money and the business cycle in contrast to both Keynesian Economics and Monetarism.

  Developed especially by Ludwig von Mises and Friedrich A. Hayek in the 20^th century, the Austrian theory uniquely demonstrates the process by which central bank-initiated monetary expansion and interest rate manipulation invariably sets the stage for both an artificial boom and an eventual, inescapable bust.

  Their theory is explained in the context of an analysis of the most severe economic downturn of the last one hundred years, the Great Depression. The crash of 1929 and the depression that followed was the outcome of Federal Reserve monetary policy in the 1920s, when the goal was price level stabilization – neither price inflation nor price deflation. But beneath the apparent stability of the statistical price level, monetary expansion and below-market rates of interest generated a mismatch between savings and investment in the American economy that finally broke in 1929 and 1930.

  But the depth and duration of the Great Depression through the greater part of the 1930s was also not due to anything inherent in the market economy. Rather than allow markets to find their new, post-boom market-clearly levels in terms of prices, wages, and resource reallocations, governments in America and Europe undertook a wide variety of massive economic interventions.

  The outcome was rising and prolonged unemployment, idle factories, unused capital and vast amounts of economic waste caused by wage and price interventions, large government budget deficits and accompanying accumulated debt, uneconomic public works projects, barriers to international trade due to economic nationalism and protectionism, and introduction of forms of government planning and control over people’s lives and market activities.

  

  Faulty and Misguided Keynesian Ideas

  Many of these rationales for “activist” monetary and fiscal policy emerged and took form under the cover of the emerging Keynesian Revolution as first presented by British economist, John Maynard Keynes. In Monetary Central Planning and the State, I also offer a detailed critique of the fundamental premises of the Keynesian approach and why its policy prescriptions in fact lead to the very boom-bust cycle the Keynesians claim to want to prevent.

  Furthermore, it is shown why it is that every essential building-block of the Keynesian edifice is based on faulty economic premises, superficial conceptions of how markets actually function, and why its end result is more government control with none of the benefit of economic stability that the Keynesians say is their goal.

  Also, in spite of Milton Friedman’s valuable contributions to an understanding of the superiority of competitive markets in general, his own version of activist monetary policy through a “rule” of monetary expansion and “automatic” fiscal stabilizers was more an “immanent criticism” within the Keynesian macroeconomic framework, rather than a fundamental alternative such as the “Austrian” economists have offered.

  Private Free Banking, Not Central Banking

  What, then, is to be done, in terms of the workings and the institutions of the monetary system? A good part of Monetary Central Planning and the State is devoted to explaining the inherent economic weaknesses and political shortcomings of all forms of central banking.

  In a nutshell, central banking suffers from many of the same problems as all other forms of central planning – the presumption that monetary central planners can ever successfully manage the monetary and banking system better than a truly competitive private banking system operating on the basis of market-chosen forms of money and media of exchange.

  It is shown how systems of private competitive banking could function if government central banking were brought to an end. This is done through a critical analysis of the proposals for a private monetary and banking system as found in the writings of Ludwig von Mises, Friedrich A. Hayek, Murray N. Rothbard, and the “modern” proponents of monetary freedom: Lawrence H. White, George Selgin, and Kevin Dowd.

  Monetary Central Planning and the State ends with a brief list of the steps that could and should be taken to begin the successful transition from central banking to a free market monetary and banking system of the future.

  If the last one hundred years has shown and demonstrated anything, it is that governments – even when in the hands of the well intentioned – have neither the knowledge, wisdom nor ability to manage the social and economic affairs of multitudes of hundreds of millions, and now billions, of people around the world. The end result has always been loss of liberty and economic misdirection and distortion.

   

  

  It is the Time for Monetary Freedom

  A hundred years of central banking in the United States since the establishment of the Federal Reserve System in 1913 has equally demonstrated the inability of monetary central planners to successfully direct the financial and banking affairs of the nation through the tools of monopoly control over the quantity of money and the resulting powerful influence on money’s value and the interest rates at which savers and borrowers interact.

  It is time for a radical denationalization of money, a privatization of the monetary and banking system through a separation of government from money and all forms of financial intermediation.

  That is the pathway to ending the cycles of booms and busts, and creating the market-based institutional framework for sustainable economic growth and betterment.

  It is time for monetary freedom to replace the out-of-date belief in government monetary central planning.

  

  

  

  

  

• "Activists" Misleading Ownership Stakes & Suspect "Positioning" Strategies

  Submitted by Dominique Dassault of GlobalSlant

  Something Is Very Wrong Here

  “Activist Investors”, the relatively new classification for corporate agitators, want you to believe that their intellectual tactics/ strategies improve both corporate governance and shareholder returns. That may be true but they also seem to be involved in another, less savory, tactic, that is, inflating their company “ownership” claims with extremely large derivatives positions as outlined in SEC disclosure filings.

  Is it legal? It seems like it but it certainly does not “smell” right. This exclusive breed of both newer and established “Activists”, unfortunately, perpetuate the idea that Wall St. is still populated with a “Den of Thieves” softly endorsed by another one of the federal government’s “asleep at the wheel” regulators…SEC chief Mary Jo White.

  **************************************************************************

  Two recently disclosed positions by “Activist” powerhouses JANA Partners and Carl Icahn will serve to illustrate this phenomenon. Of course, they are not the only firms/personas engaged in controversial positioning techniques.

  Any discussion of dicey, “Activist” trading tactics must also include Pershing Square’s Bill Ackman…he who built a very large stake in the “old” Allergan/AGN knowing, full well, that Valeant/VRX would be bidding to acquire the company. Somehow, in the SEC’s complicated and twisted legal morass, that was considered “kosher”.

  However this particular “post” will focus on JANA Partners’ place-holding in ConAgra Foods/CAG and Icahn’s footprint in Freeport McMoRan/FCX.

  **************************************************************************

  First off a little background on JANA/Icahn and their disclosure responsibilities to the SEC.

  As of June 30, 2015 [13F Filings] JANA Partners, managed by Barry Rosenstein, managed a portfolio valued at $16.8B with Icahn’s equaling $31.2B. Further, the investment track records, for both, are very good especially since the market trough in 2009 but even prior to that.

  In addition to managing capital both JANA/Icahn must also tend to an array of mandated administrative tasks including public filing disclosures with the SEC. The quarterly Form 13F, in particular, is of keen interest to many industry observers.

  Amongst other data this filing specifically reveals the fund’s portfolio composition [as of calendar quarter end]. For all to see… newly acquired positions/liquidated prior positions/existing positions trimmed or added to…punctuated by their dollar value. A true window into the portfolio…but it may be time lagged, to a maximum, by 6 Weeks/45 days.

  Moreover if any investor [including “Activist’s”] acquires 5% of the common equity outstanding [directly or indirectly], of a publicly traded company, it is required [at a minimum] to file an SEC Schedule 13D within ten days of crossing the 5% threshold.

  It is also important to note that a firm can request an exemption from disclosure if a position is currently being acquired as it could interrupt their accumulation pattern and price tolerance[s].

  This “Schedule”, once filed with the SEC, immediately becomes publicly accessible. JANA’s 13D was disclosed on June 18, 2015 [5% threshold met on June 8] while Icahn revealed his 13D on August 27, 2015 [5% threshold met on August 17]. Both filings occurred after the close of regular trading hours and adhered to the SEC’s dubious “beneficial ownership” definitions.

  **************************************************************************

  SEC’s DEFINITION OF BENEFICIAL OWNERSHIP:

  The SEC, supposedly in the business of enforcing disclosure, seems to be running afoul of its own mandate. They’ve technically refined Webster’s “Ownership” as “Beneficial Ownership”…certainly loosening/stretching the intuitive definition as follows:

  Beneficial Ownership =
  
  Direct/Stock Ownership [D/SO]
  +
  In-Direct/Derivative Ownership [I/DO]

  Despite being combined in the SEC’s “Beneficial Ownership” definition these two “ownership” sub-categories are quite different. Specifically, the typical rights accorded to D/SO i.e. voting and dividends are NOT accorded to I/DO.
  
  Derivatives simply offer a trader/investor the RIGHT to future ownership/liquidation with a “hard” set of conditions/choices [buy/sell, strike price & exercise/maturity dates]. Until/If that RIGHT is exercised the trader/investor actually does NOT own/is NOT “short” the underlying asset.

  So the 13D’s [filed by Icahn’s and JANA’s legal clans] classifying “Ownership” stakes as 88M/31M shares of FCX/CAG [suggesting approximate capital commitments of $1.1B & $1B] respectively is, in reality, such a great distance from the truth that it is almost comical [see below].

  **************************************************************************

  “OWNERSHIP” POSITIONS:

  Icahn/FCX [at time of filing]

  88M Shares Beneficially Owned
  8.46% of FCX Common Shares Outstanding

  52.011M = 5% Ownership Threshold [13D]

  3.254M Shares = Directly Owned = Stock

  80.402M Shares = In-Directly Owned = Forward Contracts
  12M Shares = In-Directly Short = Put Options [implied long position]

  4.344M Shares = *Unknown [Direct vs. Indirect?]*
  
  JANA/CAG [at time of filing]

  30.863M Shares Beneficially Owned
  7.20% of CAG Common Shares Outstanding

  21.352M = 5% Ownership Threshold [13D]

  6.732M Shares = Directly Owned = Stock

  19.032M Shares = Indirectly Owned = Call Options

  5.099M Shares = *Unknown [Direct vs. In-Direct?]*
  ___________________________________________________________

  *13D filings require disclosure of executed positions within the prior 60 days. Any “positioning” prior = no obligation to disclose.

  For JANA, since the 13F [dated 3.31.15], did not reveal any prior position in CAG [unless they were exempted…as discussed above] it is likely the “Unknown” share quantities of 5.099M shares were “acquired” between April 1 and April 19.

  Icahn’s “Unknown” share quantities are a little more complicated to track. There was no FCX position listed in the 13F dated 6.30.15 [unless they were exempted…as discussed above]. And despite the claim, in the 13D, of 80.402M shares owned through “Forward Contracts” [a very lightly regulated/regarded derivative] it was only possible to track 57.183M of those shares. Anyway I suppose if he says he owns the derivatives…then he probably does.

  Similar to the forward contracts it was only possible to track 3.254M of those shares “Directly Owned”…though the document indicates a position of 7.596M shares. Again …I suppose if he says he owns the shares…then he probably does.*
  _____________________________________________________

  Consider please, the most important point of this mathematical detail…that Icahn’s initial [direct ownership position] was, possibly, just 3.254M shares [vs. the 88M ownership stake characterized in the 13D filing].

  No matter…even if the “Unknown” classification of shares [from above] were entirely included as “Directly Owned” [as the filing “softly” indicates]…it still would equal just 21.38% of the 88M shares claimed as ownership.

  As for JANA…their direct ownership position was, possibly, just 6.732M shares [vs. the claimed 30.863M shares characterized in the 13D filing].

  And as with Icahn…even if the “Unknown” classification of shares [from above] were entirely included as “Directly Owned”…it would equate to just 38.33% of the 30.863M shares claimed as ownership.

  Another more direct way to assess this = without the large derivatives positions…the “Market Moving” 5% ownership threshold, in either case, would not have been met. Plainly not even close. [more on this point later].

  **************************************************************************

  A pundit may indicate…“You may not like the SEC’s beneficial ownership definitions but those ARE the current rules. Your “beef” is with the SEC…not Icahn/JANA. They’ve really done nothing wrong”. And I’d essentially agree…while also noting that the current SEC “ownership” definition is exceptionally misleading and distorts the “spirit” of true ownership.

  But there is much more to this than just the arcane/legal examination of securities ownership/disclosure mandates albeit important to understand.

  **************************************************************************

  Cornerstone Question #1 =

  IF THE “ACTIVISTS” TRULY WISH TO ULTIMATELY/”DIRECTLY” OWN THE STOCK [AND INFLUENCE STRATEGIC COURSE AT A TARGETED COMPANY] THEN WHY THE LOPSIDED “FRONT END” POSITIONING IN DERIVATIVES?

  1. The most obvious answer is that they are simply “trading” the 13D disclosures with the most price sensitive securities on the planet. So…a quick flip? It is possible but unlikely.

  Both JANA & Icahn have substantial records of legitimately pursuing economic/qualitative reforms at their target companies.

  2. Perhaps, then, that the stock is just not liquid enough? In the cases of both CAG & FCX that is just a ridiculous thought. And, typically, if the stock is not too liquid then neither are the derivatives underlying the security.

  Anyway, during JANA’s accumulation phase, CAG equity traded about 2M shares/$68M volume/value per/day and CAG is no small company = Enterprise Value = $26.2B comprised of approximately $18.9B [427M shares outstanding] of equity and $7.3B of Net Debt.

  And, it appears, JANA was acquiring a position since the beginning of April…not filing with the SEC until June 18th [almost three entire months]. Positioning the common equity, during this extended time period, should not have been too challenging.

  FCX was even easier to position than CAG [despite the more brief accumulation window from mid-July to mid-August]…as its liquidity was overwhelming [averaging about 30M shares/$330M traded volume/value per/day].

  Actually the stock was in a virtual free-fall [down almost 40% during that time period] and, likely, could have easily been bought in the open market without much detection many “times over”.

  And, for the record, its Enterprise Value = $31.5B comprised of approximately $12.5B [1.128B shares outstanding] of equity and $18.97B of Net Debt.

  3. Another consideration is that derivatives positions, initially, require substantially less capital than core equities positions but ultimately not…when/if exercised.

  4. And then…if the expiration/maturity months are staggered it allows for a more gradual capital commitment. I suppose so.

  Some of the above may be true but, even aggregated, are not a tremendously powerful argument for such a dislocated position in derivatives vis-a-vis the common equity.

  And if the derivatives positions, for whatever reasons, are so attractive then why even buy any stock? [a point that Icahn seems to appreciate a whole lot more than JANA although, it seems, Rosenstein shares the general sentiment]

  Now…to examine the specific positioning techniques.

  **************************************************************************

  DERIVATIVE POSITIONING TACTICS:

  Icahn:
  The positioning in FCX [July 17 – August 21] is just a dizzying array of purchased “forward contracts” and the extremely questionable strategy of selling puts [as the true intent is to directly position long]. As noted above some stock [minimal quantities] was “directly” purchased.

  Amazingly, or not, a portion of the derivatives were purchased on margin. From the filing…Part of the purchase price of such Shares was obtained through margin borrowing.

  You have to love it. Derivatives Purchased On Margin. Hey…Why Not? And this is America’s future Treasury Secretary [as in Trump]?

  Specifically, Icahn’s forward contracts and short put position offer great detail.

  First of all, the “forward contracts” were purchased on just about every day he was transacting. Secondly, the three different contract strike prices [mostly far “out of the money”] are articulated. Thirdly, the share counts [underlying the forward contracts] are noted. Finally, it is stated that the contracts are length-ily dated to mature/expire in March 2017.

  Plus, the filing indicates a closely dated maturity/expiration for the shorted put position of mid-September 2015.

  JANA:

  Rosenstein’s call option positions in CAG offer a less complex picture than Icahn [although no specific purchase dates were cited]. It appears the call options were predominantly “in the money” and closely dated to maturity [all within seven weeks after the 13D was disclosed…most much sooner.]

  However JANA, unlike Icahn, elected not to utilize margin when building their options [and equity] positions. “Such Shares are held by the investment funds managed by JANA in cash accounts and none of the funds used to purchase the Shares reported herein as beneficially owned by JANA were provided through borrowings of any nature.”

  It also ought to be noted that JANA did not sell any put options. So “cleaner” than Icahn but still a very large derivatives position ahead of a significant disclosure.

  **************************************************************************

  Cornerstone Question #2 =

  A LARGE DERIVATIVES POSITION AHEAD OF A “MATERIAL” DISCLOSURE?

  YES…but the “material” event, ironically, is not a company pronouncement about a transformative strategic initiative. The event, in these cases, is that the well regarded JANA/Icahn have simply announced 13D sized “ownership” stakes in two separate companies…with plans/attempts to increase shareholder value.

  And that they utilize the SEC’s compulsory disclosure procedures to host/act as a conduit for their specious, market moving announcements…This is just SO CUNNING & YET…SO BRILLIANT.

  **************************************************************************

  Cornerstone Question #3 =

  IF NOT “THE DERIVATIVES FLIP” THEN WHAT IS THE SPECIFIC STRATEGY?

  It is not as obvious as it seems but, still, relatively straight forward.

  In a surprising twist it appears these quasi “Masters of the Universe” are, rather than bold and daring, just tremendously risk averse….so risk averse that, despite huge capital bases to draw from, they won’t fully commit to “directly” buying a stock they’ve targeted…until, what I’ve termed, the “Angle” comes about.

  The “Angle”…the “Real Angle”, it seems, is to get the stock quickly moving in the direction of/exceed their derivative “strikes”. Of course…Right? Like any rational derivatives player they’ll certainly exercise their “right” to acquire the stock…but only when the market price exceeds their strike price[s]…deferring the uptake of any substantial capital “at risk” until there’s essentially “NO RISK”…as in an EXISTING PROFIT. And their spurious 13D disclosures are just the catalyst to help achieve that objective.

  **************************************************************************
  And so the news “hits” the wires…the inevitable price surges occur: 10.43% for CAG on June 19, 2015 and 3.04% [28.66% the day prior as the information seemed to have leaked] for FCX on August 28, 2015.

  Naturally the especially price sensitive derivatives contracts are immediately turbo charged…even though they’ll likely be exercised…as many are now massively “in the money”. The “out of the money” contracts automatically re-price much higher too…as that elusive “out of the money” feature suddenly seems almost attainable.
  **************************************************************************

  In the case of JANA this dramatic price crossover feature [market price > strike price], not surprisingly, coincided with the 13D disclosure.

  In the case of Icahn, although the 13D disclosure incrementally improved the values of his positions, the majority of the derivatives, were still “out of the money”…but, it seems, only due to their poorly selected [for now] strike price[s]. Still, certainly a good start [with some profitable “marks”]…but more work to be done.

  So collectively…somewhat shrewd…but also tremendously slippery. Who wouldn’t want to either: exercise a massively “in the money” derivatives contract or own almost any derivative on a day[s] when the underlying security increases in value by 10.43%/28.46% +.

  **************************************************************************

  They really do have it “covered”. Don’t they? In the VERY UNLIKELY/IMPROBABLE scenario of an immediate price move down, on a 13D disclosure date, their capital at risk is finite. In the LIKELY/USUAL scenario of a sharp price move higher their capital is favorably exposed in a BIG WAY.

  Almost sounds like an asymmetrical capital hedge. But despite the apt classification these positions are not intended to be hedged. They are intended to generate out-sized, positive returns because, as indicated in their 13D filings [including CAG/FCX], the targeted company’s share price is deemed “undervalued”…but, apparently, not “undervalued” enough to buy a lot of stock…just “undervalued” enough to buy a boatload of derivatives.

  Because, with a deceptively large ownership position, the true formula they both seemed to adhere to [in these two cases] goes as follows:

  1. Build a “Stock-Light”/”Derivative Heavy” Position In A Target Company.
  2. File a Schedule 13D, Threatening To Serve As A Company Change Agent, To Move The Stock Price Up.
  3. Only Commit “Majority” Capital When Your Derivatives Positions Are “In The Money”.

  **************************************************************************

  And so, in the midst of all this, just where is SEC Chief Ma-Jo? I’m sure she’s probably “nodding off”, right now, at one of those endless afternoon policy meetings but I suggest she “wake up”… “pound” a Red Bull…and start paying attention.
  
  JANA/Icahn seem to be straddling the razor’s edge of a very dangerous “accumulation” game built on both their own creativity and the ignorance[s] of the SEC. Sure…the “soft dollar-ed” compensated lawyers have it “covered”, but occasionally, they are fallible.

  Even though she still can’t determine how to “nail” those High Frequency Traders scalping for nano-pennies on just about every conceivable stock transaction [hint: start looking at Citadel] perhaps she could examine the aggressive trading/positioning disclosures practiced by some “Activist” hedge funds? It may not “smell” right to her either or, perhaps, it is more than just a foul smell?

  

  

  

  

  

• Fed Opens Negative Interest Rate Pandora's Box: What Happens Next

  As we already commented extensively, while the Fed’s dovish non-hike was a violent surprise for the market, and has led to what may be the first thoroughly unanticipated (at least by the market) policy mistake by the Federal Reserve (judging by the market), the biggest news was the very symbolic, yet all too ominous, negative interest rate forecast in the Fed’s projection materials by one FOMC member.

  

  This was the first time in Fed history that an FOMC member has on the record predicted NIRP in the US.

  Janey Yellen’s subsequent non-denial during the press conference did not exactly inspire hope that the Fed was just “joking”:

  I don’t expect that we’re going to be in a path of providing additional accommodation. But if the outlook were to change in a way that most of my colleagues and I do not expect, and we found ourselves with a weak economy that needed additional stimulus, we would look at all of our available tools. And that would be something that we would evaluate in that kind of context.

  Furthermore, when considering that virtually all of Europe is already flooded by NIRP, and earlier Bank of England’s Andy Haldane, one of the otherwise more rational members of the central bank, advocated negative rates in the UK, one can be virtually certain that unless there is a dramatic rebound in the global economy, the next step by Yellen will not be a rate hike, but easing (just as Goldman predicted) right into negative interest rate territory.

  What would NIRP in the US mean in practical terms?

  For the answer we go straight to, drumroll, the Fed itself whose New York economists discussed precisely this topic just three years ago and issued a very stark warning (which apparently the Fed itself decided to ignore), saying “If Interest Rates Go Negative . . . Or, Be Careful What You Wish For.”

  This is what the New York Fed said in August 2012:

  If Interest Rates Go Negative . . . Or, Be Careful What You Wish For

   

  One way to push short-term rates negative would be to charge interest on excess bank reserves. The interest rate paid by the Fed on excess reserves, the so-called IOER, is a benchmark for a wide variety of short-term rates, including rates on Treasury bills, commercial paper, and interbank loans. If the Fed pushes the IOER below zero, other rates are likely to follow.

   

  Without taking a position on either the merits of negative interest rates or the Fed’s statutory authority to fix the IOER below zero, this post examines some of the possible consequences. We suggest that significantly negative rates—that is, rates below -50 basis points—may spawn a variety of financial innovations, such as special-purpose banks and the use of certified bank checks in large-value transactions, and novel preferences, such as a preference for making early and/or excess payments to creditworthy counterparties and a preference for receiving payments in forms that facilitate deferred collection. Such responses should be expected in a market-based economy but may nevertheless present new problems for financial service providers (when their products and services are used in ways not previously anticipated) and for regulators (if novel private sector behavior leads to new types of systemic risk). 

   

  Cash and Cash-like Products 

   

  The usual rejoinder to a proposal for negative interest rates is that negative rates are impossible; market participants will simply choose to hold cash. But cash is not a realistic alternative for corporations and state and local governments, or for wealthy individuals. The largest denomination bill available today is the $100 bill. It would take ten thousand such bills to make $1 million. Ten thousand bills take up a lot of space, are costly to transport, and present significant security problems. Nevertheless, if rates go negative, the U.S. Treasury Department’s Bureau of Engraving and Printing will likely be called upon to print a lot more currency as individuals and small businesses substitute cash for at least some of their bank balances.

   

  If rates go negative, we should also expect to see financial innovations that emulate cash in more convenient forms. One obvious candidate is a special-purpose bank that offers conventional checking accounts (for a fee) and pledges to hold no asset other than cash (which it immobilizes in a very large vault). Checks written on accounts in a special-purpose bank would be tantamount to negotiable warehouse receipts on the bank’s cash. Special-purpose banks would probably not be viable for small accounts or if interest rates are only slightly below zero, say -25 or -50 basis points (because break-even account fees are likely to be larger), but might start to become attractive if rates go much lower.

   

  Early Payments, Excess Payments, and Deferred Collections

   

  Beyond cash and special-purpose banks, a variety of interest-avoidance strategies might emerge in connection with payments and collections. For example, a taxpayer might choose to make large excess payments on her quarterly estimated federal income tax filings, with the idea of recovering the excess payments the following April. Similarly, a credit card holder might choose to make a large advance payment and then run down his balance with subsequent expenditures, reversing the usual practice of making purchases first and payments later.

   

  We might also see some relatively simple avoidance strategies in connection with conventional payments. If I receive a check from the federal government, or some other creditworthy enterprise, I might choose to put the check in a drawer for a few months rather than deposit it in a bank (which charges interest). In fact, I might even go to my bank and withdraw funds in the form of a certified check made payable to myself, and then put that check in a drawer.

   

  Certified checks, which are liabilities of the certifying banks rather than individual depositors, might become a popular means of payment, as well as an attractive store of value, because they can be made payable to order and can be endorsed to subsequent payees. Commercial banks might find their liabilities shifting from deposits (on which they charge interest) to certified checks outstanding (where assessing interest charges could be more challenging). If bank liabilities shifted from deposits to certified checks to a significant degree, banks might be less willing to extend loans, because certified checks are likely to be less stable than deposits as a source of funding.

   

  As interest rates go more negative, market participants will have increasing incentives to make payments quickly and to receive payments in forms that can be collected slowly. This is exactly the opposite of what happened when short-term interest rates skyrocketed in the late 1970s: people then wanted to delay making payments as long as possible and to collect payments as quickly as possible. Some corporations chose to write checks on remote banks (to delay collection as long as possible), and consumers learned to cash checks quickly, even if that meant more trips to the bank, and to demand direct deposits. However, if interest rates go negative, the incentives reverse: people receiving payments will prefer checks (which can be held back from collection) to electronic transfers. Such a reversal could impose novel burdens on payment systems that have evolved in an environment of positive interest rates.

   

  Conclusion

   

  The take-away from this post is that if interest rates go negative, we may see an epochal outburst of socially unproductive—even if individually beneficial—financial innovation. Financial service providers are likely to find their products and services being used in volumes and ways not previously anticipated, and regulators may find that private sector responses to negative interest rates have spawned new risks that are not fully priced by market participants.

  Yes, the conclusion is staggering: the Fed itself previewed the complete debacle that the Fed itself is now preparing to unleash with NIRP which will lead to “an epochal outburst of socially unproductive—even if individually beneficial—financial innovation.” Not only that but the Fed, in a moment of rare lucidity, admitted that “private sector responses to negative interest rates have spawned new risks that are not fully priced by market participants.”

  Tell that to Europe, Sweden, Switzerland where NIRP already reigns supreme, and all other countries where NIRP is coming.

  But what may be missed between the lines is the Fed’s explicit observation that in a world of NIRP, cash will reign supreme, as everyone rushes to withdraw their “taxed” bank deposits and keep the funds in the form of paper cash, hidden safely somewhere where the bank has no access, and where no bank can collect an interest rate for the “privilege” of being funded with a negative rate liability.

  Furthermore, as the Fed correctly observes, “the usual rejoinder to a proposal for negative interest rates is that negative rates are impossible; market participants will simply choose to hold cash. But cash is not a realistic alternative for corporations and state and local governments, or for wealthy individuals.”

  So what is the alternative?

  The answer was hinted during Andy Haldane’s speech earlier today in which he not only urged the banning of cash but the implementation of negative rates, two concepts which, after reading the note above, should intuitively go hand in hand: as we commented “one idea, Haldane told an audience of business owners in Northern Ireland, could be to scrap cash and adopt a state-issued digital currency like Bitcoin. Although widely reviled as the currency for drug dealers and criminals, Haldane said Bitcoin’s distributed payment technology had ‘real potential’. Which may explain the Fed’s sudden fascination in the virtual currency.”

  And fascination it is. Below are some examples of recent Fed research on a topic which as recently as 2011 it held as a heretic taboo, and which the ECB considered a Ponzi scheme as recently as November 2012:

  • Chicago Fed on Bitcoin: A Primer, December 2013
  • Boston Fed on Bitcoin as Money, September 2014
  • St. Louis Fed on “Bitcoin and Beyond: The Possibilities and the Pitfalls of Virtual Currencies”, March 2014
  • Federal Reserve on Bitcoin: Technical Background and Data Analysis, October 2014
  • The Federal Reserve Bitcoin Strategy

  Last but not least:

  • Research: Federal Reserve Needs Power Over Bitcoin

  Of course it does. Why? For two simple reasons:

  • First, as noted above, cash and NIRP simply do not mix as cash provides the general population a handy way of circumventing the intentionally punitive implications of negative rates, which as a tax on all savers, would force everyone to spend savings the moment these were created. The thinking here, of course, would be that with savings immediately converted to consumption, the velocity of money would surge and boost economic growth in the process even if it was conducted under punitive rate duress.
  • Second, and even more important, is the blockchain basis of bitcoin, which is precisely why the Fed is so fascinated by it. With a perpetual and current ledger of every single transaction in the monetary domain, a digital currency such as bitcoin provides the Fed something cash never would – a constant database (or ledger) of every single transaction everywhere and any given moment.

  It is the second aspect of bitcoin that has led to such recent headlines as “Big banks consider using Bitcoin blockchain technology” and, of course, Bloomberg’s piece from September 1 in which “Blythe Masters Tells Banks the Blockchain Changes Everything.”

  Yes it does, and especially in a world in which the Fed regulates all blockchain transactions under a negative interest rate regime: quite simply, the combination of blockchain and NIRP give the Fed supreme control over all transactions.

  Simply said: bitcoin under NIRP is a Fed match made in heaven.

  There is just one small hurdle – eliminating cash as a transaction medium entirely. However, considering the US experience with confiscating monetary intermediates most recently observed with Executive Order 6102 when FDR confiscated all US gold, will the Fed allow such a little “problem” as “sequestering” available cash stand in the way of NIRP dominance? Of course not, especially if the alternative is the complete loss of central bank credibility.

  Which, in a nutshell, is what Kocherlakota’s negative interest-rate dot unleashed: a world in which the existing cash/ZIRP paradigm becomes blockchain/NIRP (and where the Fed is aware of every single transaction).

  And, before you ask, will there be substantial – and violent – opposition to the Fed’s mandatory conversion of cash to bitcoin? Of course. But that too certainly not stop the Fed, which fighting for the survival of trillions in legacy “wealth” would simply steamroll over anyone and anything courtesy of the US government’s armed backing (which has conclusively proven in recent years its function has metastasized to serve only the wealthiest corporations and Wall Street interests) to preserve such wealth, if only for a little longer.

  

  

  

  

  

• Three Reasons Why The U.S. Government Should Default On Its Debt Today

  Submitted by Doug Casey via InternationalMan.com,

  The overleveraging of the U.S. federal, state, and local governments, some corporations, and consumers is well known.

  This has long been the case, and most people are bored by the topic. If debt is a problem, it has been manageable for so long that it no longer seems like a problem. U.S. government debt has become an abstraction; it has no more meaning to the average investor than the prospect of a comet smacking into the earth in the next hundred millennia.

  Many financial commentators believe that debt doesn’t matter. We still hear ridiculous sound bites, like “We owe it to ourselves,” that trivialize the topic. Actually, some people owe it to other people. There will be big transfers of wealth depending on what happens. More exactly, since Americans don’t save anymore, that dishonest phrase about how we owe it to ourselves isn’t even true in a manner of speaking; we owe most of it to the Chinese and Japanese.

  Another chestnut is “We’ll grow out of it.” That’s impossible unless real growth is greater than the interest on the debt, which is questionable. And at this point, government deficits are likely to balloon, not contract. Even with artificially low interest rates.

  One way of putting an annual deficit of, say, $700 billion into perspective is to compare it to the value of all publicly traded stocks in the U.S., which are worth roughly $20 trillion. The current U.S. government debt of $18 trillion is rapidly approaching the stock value of all public corporations — and that’s true even with stocks at bubble-like highs. If the annual deficit continues at the $700 billion rate — in fact it is likely to accelerate — the government will borrow the equivalent of the entire equity capital base of the country, which has taken more than 200 years to accumulate, in only 29 years.

  You should keep all this in the context of the nature of debt; it can be insidious.

  The only way a society (or an individual) can grow in wealth is by producing more than it consumes; the difference is called “saving.” It creates capital, making possible future investments or future consumption. Conversely, “borrowing” involves consuming more than is produced; it’s the process of living out of capital or mortgaging future production. Saving increases one’s future standard of living; debt reduces it.

  If you were to borrow a million dollars today, you could artificially enhance your standard of living for the next decade. But, when you have to repay that money, you will sustain a very real decline in your standard of living. Even worse, since the interest clock continues ticking, the decline will be greater than the earlier gain. If you don’t repay your debt, your creditor (and possibly his creditors, and theirs in turn) will suffer a similar drop. Until that moment comes, debt can look like the key to prosperity, even though it’s more commonly the forerunner of disaster.

  Of course, debt is not in itself necessarily a bad thing. Not all debt is for consumption; it can be used to finance capital goods intended to produce further wealth. But most U.S. debt today finances consumption — home mortgages, car loans, student loans, and credit card debt, among other things.

  Government Debt

  It took the U.S. government from 1791 to 1916 (125 years) to accumulate $1 billion in debt. World War I took it to $24 billion in 1920; World War II raised it to $270 billion in 1946. Another 24 years were needed to add another $100 billion, for a total of $370 billion in 1970. The debt almost tripled in the following decade, with debt crossing the trillion-dollar mark in October 1981. Only four and half years later, the debt had doubled to $2 trillion in April 1986. Four more years added another trillion by 1990, and then, in only 34 months, it reached $4.2 trillion in February 1993. The exponential growth continued unabated. U.S. government debt stood at $18 trillion in 2015. Off-balance sheet borrowing and the buildup of massive contingent liabilities aren’t included. That may add another $50 trillion or so.

  When interest rates rise again, even to their historical average, the U.S. government will find most of its tax revenue is going just to pay interest. There will be little left over for the military and domestic transfer payments.

  When the government borrows just to pay interest, a tipping point will be reached. It will have no flexibility at all, and that will be the end of the game.

  In principle, an unsustainable amount of government debt should be a matter of concern only to the government (which is not at all the same thing as society at large) and to those who foolishly lent them money. But the government is in a position to extract tax revenues from its subjects, or to inflate the currency to keep the ball rolling. Its debt indirectly, therefore, becomes everyone’s burden.

  As I've said before, I think the U.S. government should default on not just some, but all of its debt.

  There are at least three reasons for that. First is to avoid turning future generations into serfs. Second is to punish those who have enabled the State by lending it money. Third is to make it impossible for the State to borrow in the future, at least for a while.

  The consequences of all this are grim, but the timing is hard to predict. Perhaps the government can somehow borrow amounts that no one previously thought possible. But its creditors will look for repayment. Either the creditors are going to walk away unhappy (in the case of default), or the holders of all dollars are going to be stuck with worthless paper (in the case of hyperinflation), or the taxpayers’ pockets will be looted (the longer things muddle along), or most likely a combination of all three will happen. This will not be a happy story for all but a few of us.

  

  

  

  

  

• Investors Dump Stocks For Safety Of Bonds & Bullion In Yellen's New "World Of Confusion"

  There is really only one clip for this week  – so full of chest-beating "I told you so"-ism early on, only to have hope crushed by an old granny's confusion – it's an oldie but a goodie…

   

  What did Janet Do?!!

  • Copper -3.1% – worst week in 2 months
  • WTI Crude – biggest 2-day drop in a month
  • Silver – biggest 3-day gain in 4 months (best week in 4 months)
  • Gold – biggest 3-day gain in 4 months

  • US Equities – worst 2-day drop since Sept 1st
  • VIX biggest daily jump in 2 weeks (above 50DMA for 22 days – longest period since October)
  • China Equities – down 4 of last 5 weeks, lowest close since Feb 2015
  • German Equities worst day in a month

  • 30Y Yield -15bps – biggest 2-day drop since Jan 6th 2015
  • 2Y Yield -13.7bps – biggest 2-day drop since March 2009

  Since The Fed unleashed the world of confusion…

  

   

  Gold and The Long Bond ripped 2%, S&P dipped 2%

  

   

  Futures gives us a decent view of the action in the last 48 hours (note the weakness overnight and the opening US ramp by the algos back to VWAP)..\

  

   

  At 1515ET on Quad-Witching, NYSE Broke but the market did not do what it was supposed to…

  

   

  XIV and SPY are slowly starting to converge…

  

   

  Look at the noise in VIX today (and post FOMC yesterday)…

  

   

  On the week, a mixed picture – Small Caps only ones to cling to gains…

  

   

  Some context for the moves – failed breakouit of key resistance… and a close below support

  

   

  Very ugly week for financials…

  

   

  This is not helping…

  

   

  Treasury yields have collapsed in the last 2 days (with 30Y catching down today and notably flattening the curve) closing the week modestly lower in yields…

  

   

  The US Dollar ende dthe week unchanged after being dumped yesterday and overnight but "rescued" mysteriously by a very active JPY seller (cough Kuroda cough) today…

  

   

  Which created some equity momo off the open but that failed as Europe closed…

  

   

  Commodities ended the week very mixed as The Fed's inaction sparked degrowth selling in crude and copper and PMs surged…

  

   

  Gold jumping to 3 week highs… (seems like someone knew something on Wednesday)

  

   

  Crude roundtripped all the way to unch on the week… from growth hype to no hope…

  

   

  As Oil Vol and the underlying recoupled… (hedges on the ramp lifted and forcing coinvergence)…

  

   

  Charts: Bloomberg

  Bonus Chart: S&P still 40 points rich to the Fed Balance Sheet…

  

  

  

  

  

• The Fed Is Trapped: The Naked Emperor's New "Reaction Function"

  When China transitioned to a new currency regime last month, what should have been immediately apparent to everyone, was that the Fed was, from there on out, cornered. Boxed in. Trapped. Screwed. 

  We reiterated this earlier today as the market still seems to be quite confused as to what exactly happened that caused Janet Yellen to resort to what many thought was the most unlikely option going into this week’s meeting: the “dovish hold”, or, as Deutsche Bank recently called it, the “clean relent.”  

  What follows is a recap of just how we got to this point or, in other words, an explanation of how the FOMC missed its opportunity and became trapped in the wake of China’s move to devalue the yuan. Following the recap, we present excerpts from Citi’s take on the Fed’s “new reaction function. For those familiar with the backstory and/or who have a good grasp on why it is that the Fed went the route they did, feel free to skip straight to the section from Citi and the subsequent discussion.

  *  *  *

  How did we get here?

  Despite all the ballyhooing about moving to a more market-based exchange rate, the PBoC actually did the opposite on August 11. As BNP’s Mole Hau put it “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.” Obviously, a reduced role for the market, means a greater role for the PBoC, and that of course means intervention via FX reserve drawdowns (i.e. the liquidation of US paper). Of course no one believed that China’s deval was “one and done” which meant that the pressure on the yuan increased and before you knew it, the PBoC was intervening all over the place. By mid-September, PBoC intervention had cost some $150 billion between onshore spot interventions and offshore spot and forward meddling. The problem – as everyone began to pick up on some 10 months after we announced the death of the petrodollar – is that when EMs start liquidating their reserves, it works at cross purposes with DM QE. That is, it offsets it. Once this became suddenly apparent to everyone at the end of last month, market participants simultaneously realized – to their collective horror – that the long-running slump in commodity prices and attendant pressure on commodity currencies as well as the defense of various dollar pegs meant that, as Deutsche Bank put it, the great EM reserve accumulation had actually begun to reverse itself months ago. China’s entry into the global currency wars merely kicked it into overdrive. 

  What the above implies is that the Fed, were it to have hiked on Thursday, would have been tightening into a market where the liquidation of USD assets by foreign central banks was already sapping global liquidity and exerting a tightening effect of its own. In other words, the FOMC would have been tightening into a tightening. 

  But that’s not all. When China devalued the yuan it also confirmed what the EM world had long suspected but what EM currencies, equities, and bonds had only partially priced in. Namely that China’s economy was crashing. For quite a while, the fact that Beijing hadn’t devalued even as the yuan’s dollar peg caused the RMB’s REER to appreciate by 14% in just 12 months, was viewed by some as a sign that things in China might not be all that bad. After all, if a country with an export-driven economy can withstand a double-digit currency appreciation without a competitive devaluation even as the global currency wars are being fought all around it, then the situation can’t be too dire. Put simply, the devaluation on August 11 shattered that theory and reports that China is “secretly” targeting a much larger devaluation in order to boost export growth haven’t helped. For emerging markets, this realization was devastating. Depressed demand from China had already led to a tremendous amount of pain across emerging economies and the message the devaluation sent was that China’s economy wasn’t set to rebound any time soon, meaning global demand and trade will likely remain subdued, as will commodity prices.

  That was the backdrop facing the Fed going into September’s meeting. Put simply, if the Fed hiked to maintain some semblance of credibility and to prove that it isn’t outright lying about being “data dependent” , it would have risked accelerating EM capital outflows, which would in turn prompt further FX reserve drawdowns and serve to amplify the effect of “liftoff”, in the process turning what should have been a merely “symbolic” move into something far more dangerous. Once that dynamic tipped the EM world into crisis, it would be only a matter of time before the Fed was forced to reverse course and, ultimately, to launch QE4 to offset the tightening of global liquidity it had unleashed by failing to realize that in a world operating under a massive, coordinated easing effort, the smallest policy “error” reverberates exponentially.

  And then there was of course China’s epic stock market meltdown which triggered a modern day Black Monday across global equity markets.

  

  As if that wasn’t enough to think about going into this week’s meeting, the FOMC had also to consider whether not hiking would also have the effect of accelerating EM capital outflows and triggering the very same chain of events described above. The argument for that eventuality is simply that the Fed missed its window to hike and now, the market gets more nervous and more uncertain with each passing Fed meeting and so by failing once again to rip off the band-aid, the Fed has ensured that capital will continue to flow out of EMs as the market continues to anticipate what it assumes is inevitable but which, for all the reasons laid out above, may actually be impossible. As Vanguard’s senior economist Roger Aliaga-Diaz put it: “We are concerned with the Fed’s acknowledgement of recent market volatility in its decision. The Fed runs the risk of being held captive to the markets as, paradoxically, much of that volatility is due to the anticipation and uncertainty around when the Fed will move.”

  Of course not everyone understand or took the time to consider all of this going into Thursday which is why some were confused about why it is that concerns centered around the global economy and global financial markets were sufficient to override employment gains when it came time for the Fed to make a decision. For those who are still confused, or who seek confirmation of the narrative laid out above and on numerous occasions in these pages over the past three weeks, consider the following from Citi who is out with a fresh look at the Fed’s “new reaction function.”

  *  *  *

  From Citi

  The Federal Open Market Committee (FOMC) decision to stay pat reveals a new monetary policy rule in place—one that amplifies the importance of international and financial market developments. 

  We did not believe the FOMC would take such a limited risk scenario involving China, which is not part of their baseline outlook, and delay a rate increase that arguably is warranted by domestic conditions. Indeed, we have noted that the last time international economic and market developments stopped the Fed from raising rates was in 1997-1998 when LTCM, Russia, and the Asian crisis caused disorderly markets that were global and systemic. Current volatility conditions are not at all similar to those of 1998.

  The new FOMC reaction function—one that assigns greater importance to global and international financial market developments—will require some time to assess and understand. 

  Now what? China’s growth uncertainty will not diminish quickly and the EM fallout will take time to assess. The Chinese authorities have no track record of successfully dealing with such a structural slowdown, nor a track record of not exacerbating such a well-anticipated economic weakness. Also, excess supply conditions in commodity markets depressing EM growth and US inflation likely will not dissipate quickly.

  The September FOMC meeting was a real “bunker buster” insofar as it has challenged our understanding of Federal Reserve policymaking and the inputs that matter most. There is little evidence that an emerging markets-led global slowdown would be able to generate sufficient drag to warrant delaying normalization, unless it were severe and engaged the advanced economies as well. However, this risk alone should not have delayed normalization.

  

  In light of the new Fed behavior, we tentatively have revised our forecast for the next interest rate increase to be sometime in the spring of 2016 (Figure 1). This delay would be required for market participants and the Fed to gather sufficient information to reduce the uncertainty surrounding the global growth outlook and to ease financial conditions. We believe that a gradual rate increase implied by such a cautious policy posture would bring the federal funds rate to 1 percent by end-2016, 1.5 percent by end-2017, and 2.25 percent by end-2018. 

  *  *  *

  There are a few things to note here. 

  Citi seems to have not taken seriously the idea that a Fed hike would almost certainly serve to push EM over the edge. That is, when they say that “there is little evidence that an emerging markets-led global slowdown would be able to generate sufficient drag to warrant delaying normalization, unless it were severe and engaged the advanced economies as well,” they seem to be ignoring the fact that hiking would have made just the type of slowdown they’re talking about a virtual certainty which would have then fed back into DMs causing the Fed to immediately reverse course. 

  Second, the Fed isn’t operating in a vacuum and as such, it should come as no surprise that developments in China played a prominent role in the FOMC’s decision making. That said, Citi is probably correct to say that considering Beijing’s track record of late, waiting on China to stabilize before hiking may be a fool’s errand. Similarly, the fact that, as Citi says, “excess supply conditions in commodity markets depressing EM growth and US inflation likely will not dissipate quickly,” means justifying a hike could be difficult for the foreseeable future. 

  The implications from all of this are that the world will now plunge further into the monetary Twilight Zone. That is, with the Fed on hold, the ECB may be forced to cut further, which, as we discussed on Thursday evening, means the Riksbank, and then the SNB will need to follow suit, diving further into NIRP as everyone scrambles to ensure that a foreign central bank’s double-down-dovishness doesn’t jeopardize their own domestic inflation targets.

  Needless to say, the takeaway here is that the emperors (all of them) have no clothes and this is a never ending race to the NIRP bottom. For those interested in a preview of what comes next, see here (or ask Blythe Masters).

  

  

  

  

  

• Moody's Downgrades France, Blames "Political Constraints", Sees No Material Reduction In Debt Burden

  Citing "continuing weakness in the medium-term growth outlook," Moody's has downgraded France:

  • *FRANCE CUT TO Aa2 FROM Aa1 BY MOODY'S, OUTLOOK TO STABLE

  Apearing to blame The EU's "institutional and political constraints," Moody's expects French growth to be at most 1.5% and does not expect the debt burden to be materially reduced this decade.

   

  Moody's Investors Service has today downgraded France's government bond ratings by one notch to Aa2 from Aa1. The outlook on the ratings is stable.

   

  The key interrelated drivers of today's action are:

  1. The continuing weakness in France's medium-term growth outlook, which Moody's expects will extend through the remainder of this decade; and

   

  2. The challenges that low growth, coupled with institutional and political constraints, poses for the material reduction in the government's high debt burden over the remainder of this decade.

  At the same time, France's credit worthiness remains extremely high, supporting an Aa2 rating. The country's significant strengths include: (i) a large, wealthy, and well-diversified economy with a high per capita income, (ii) favourable demographic trends as compared to other advanced economies, and (iii) a strong investor base and low financing costs. The rating and its stable outlook are also supported by the country's efforts to stabilise its public sector finances and initiatives recently deployed or announced to arrest the erosion of the economy's competitiveness.

   

  In a related rating action, Moody's has today announced its decision to downgrade the ratings of the Société de Prise de Participation de l'État (SPPE) to Aa2 from Aa1. The SPPE's short-term rating was affirmed at P-1, including its euro-denominated commercial paper programme. The outlook on the ratings is stable. The debt instruments issued by the SPPE are backed by unconditional and irrevocable guarantees from the French government.

   

  The local and foreign currency deposit ceilings and the local-currency and foreign-currency bond ceilings for France are unaffected by this rating action and remain at Aaa/P-1.

   

  RATINGS RATIONALE

   

  The main driver of Moody's decision to downgrade France's government bond rating to Aa2 is the increasing clarity, in Moody's view, that French economic growth will remain low over the medium term, and the obstacle that this will pose for any material reversal in France's elevated debt burden in the foreseeable future.

   

  The current economic recovery in France has already proven to be significantly slower — and Moody's believes that it will remain so — compared with the recoveries observed over the past few decades. In part, this is due to the erosion of competitiveness and loss of growth potential following the global financial crisis. It is becoming increasingly clear, in the rating agency's view, that these problems will continue to constrain growth long after the cyclical recovery from the crisis is completed. In Moody's opinion, France's potential annual growth rate is at most 1.5% over the medium term. France faces material economic challenges, such as a high rate of structural unemployment, relatively weak corporate profit margins, and a loss of global export market share that have their roots in long-standing rigidities in its labour and product markets.

   

  France entered the crisis with a legacy of sustained, very high levels of state expenditure and a history of recurring budget deficits that goes back four decades. A pattern that has become evident over time has been that French public sector debt, relative to GDP, essentially stabilises in good times and rises in bad. The rise in indebtedness since the onset of the crisis has been very rapid and the country's debt burden will likely peak and stabilise at around or close to 100% of GDP. Notwithstanding the magnitude of the fiscal and economic challenges that the government faces, the institutional response since the onset of the crisis has been slow and halting, essentially consisting of a series of small positive steps that have, individually and collectively, been insufficient to deal with these challenges in a timely manner. Within the context of Moody's sovereign rating methodology, a government's institutional willingness and ability to reverse the impact of shocks on the public finances is an important attribute associated with very high rating levels. While Moody's assessment of the quality of France's institutions remains very high, the rating agency does not believe that the country's institutional strength is on a par with many of the most highly rated sovereigns.

   

  Taken together, low growth and institutional and political challenges to reforms make it unlikely that we will see a material reduction in the government's high debt burden over the rest of this decade, which means that it will remain well above the debt burdens of Aa1-rated peers. The combination of structurally weaker growth, low inflation, and a more than 30 percentage point increase in the debt/GDP ratio since the onset of the global financial crisis means that the shock absorption capacity of France's balance sheet has weakened and, in Moody's view, is no longer expected to recover materially in the next three to five years.

   

  RATIONALE FOR STABLE OUTLOOK

   

  The stable outlook on France's Aa2 sovereign rating partly reflects the strengths that underpin the Aa2 rating itself–the underlying economic and fiscal strengths of the French sovereign. France is a large, wealthy and well-diversified economy that is home to a significant number of companies in high-value added sectors. Income inequality is relatively low. Relative to other advanced economies, France has a favourable demographic profile, and is not expected to see a contraction in the size of its working age population over the long term. The government's current interest burden (both as a percentage of revenues and as a percentage of GDP) does not represent a significant constraint on the public finances. Efforts are being taken to reduce the budget deficit, albeit at a materially slower pace than was envisioned as recently as the 2014 Stability Programme.

   

  The stable outlook also recognises the French government's stated desire to address some of the structural challenges to growth and the fiscal balance, which should at least protect its balance sheet from further deterioration. While the revealed preference of French institutions is to undertake incremental, gradual change, the changes we expect in these areas–for example, though a second Macron Law and a revision to the labour code–between now and national elections in 2017 should prevent a further material deterioration in French credit quality over this time horizon.

   

  WHAT COULD MOVE THE RATING UP/DOWN

   

  As reflected by the stable rating outlook, Moody's does not anticipate any movement in the rating over the next 12-18 months. However, downward pressure on the rating could arise if progress on structural macroeconomic reform were to fail to materialise as we expect. Moody's could also downgrade France's government debt rating further in the event of a reduced political commitment to fiscal consolidation or should we conclude that a material increase in debt was likely for any other reason.

   

  Conversely, Moody's would consider changing the outlook on France's rating to positive, and ultimately upgrading the rating back to Aa1 in the event of much more rapid economic growth and debt-to-GDP reduction than Moody's is currently anticipating.

   

  GDP per capita (PPP basis, US$): 40,375 (2014 Actual) (also known as Per Capita Income)

   

  Real GDP growth (% change): 0.2% (2014 Actual) (also known as GDP Growth)

   

  Inflation Rate (CPI, % change Dec/Dec): 0.1% (2014 Actual)

   

  Gen. Gov. Financial Balance/GDP: -4% (2014 Actual) (also known as Fiscal Balance)

   

  Current Account Balance/GDP: -0.9% (2014 Actual) (also known as External Balance)

   

  External debt/GDP: [not available]

   

  Level of economic development: Very High level of economic resilience

   

  Default history: No default events (on bonds or loans) have been recorded since 1983.

   

  On 15 September 2015, a rating committee was called to discuss the rating of the France, Government of. The main points raised during the discussion were: The issuer's economic fundamentals, including its economic strength, have materially decreased. The issuer's institutional strength/framework, have materially decreased. The issuer's fiscal or financial strength, including its debt profile, has materially decreased. An analysis of this issuer, relative to its peers, indicates that a repositioning of its rating would be appropriate.

  

  

  

  

  

• Weekend Reading: Fed Rate Failure

  Submitted by Lance Roberts via STA Wealth Management,

  Over the last year, I have written extensively about how despite the Fed's best intentions to raise rates, the real economic backdrop would likely impose a major impediment in doing so. However, I also suggested that with the Fed now caught in a liquidity trap, they would potentially hike rates to avoid being caught at zero during the next economic downturn. To wit:

  "Currently, there is little evidence that is supportive of higher overnight lending rates. In fact, the current environment continues to support the idea of a 'liquidity trap' that I began discussing in 2013.

   

  '…a situation described in Keynesian economics in which injections of cash into the private banking system by a central bank fail to lower interest rates and hence fail to stimulate economic growth. A liquidity trap is caused when people hoard cash because they expect an adverse event such as deflation, insufficient aggregate demand, or war.

   

  Signature characteristics of a liquidity trap are short-term interest rates that are near zero and fluctuations in the monetary base that fail to translate into fluctuations in general price levels.'

   

  Please review the chart on monetary velocity above. This is a major issue for the Federal Reserve, which remains firmly committed to a line of monetary policies that have had little effect on the real economy.

   

  While the Federal Reserve clearly should not raise rates in the current environment, there is a possibility that they will anyway – 'data be damned.'(Which is ironic for a 'data dependent Fed.')

   

  They understand that economic cycles do not last forever, and that we are closer to the next recession than not. While raising rates would likely accelerate a potential recession and a significant market correction, from the Fed's perspective if just might be the 'lesser of two evils.' Being caught at the 'zero bound' at the onset of a recession leaves few options for the Federal Reserve to stabilize an economic decline. The problem is that it already might be too late."

  The current surge in deflationary pressures is not just due to the recent fall in oil prices, but rather a global epidemic of slowing economic growth. While Janet Yellen addressed this "disinflationary" wave during her post-meeting press conference, the Fed still maintains the illusion of confidence that economic growth will return shortly.

  Unfortunately, this has been the Fed's "Unicorn" since 2011 as annual hopes of economic recovery have failed to materialize.  

  

  "The problem for the Federal Reserve is that they are still looking for that elusive economic recovery to take hold after more than five years. Unfortunately for the Fed, economic recovery cycles do not last forever, and the clock is ticking."

  This weekend’s reading list is dedicated to the views surrounding the latest Fed announcement. What are they really saying? What impact does that potentially have for the markets? And what will they do if a recession rears its head? 

  ---

  THE LIST

  1) Federal Reserve And Economy Stands Pat by Steve Forbes via Forbes

  “THE FEDERAL RESERVE'S announcement that it will continue to suppress interest rates is going to harm the economy. We won't be breaking out of the rut we're in, which is bad news for us and the rest of the world.

   

  The Federal Reserve thinks its zero-interest-rate policy stimulates the economy, but it's actually doing the opposite. It's the equivalent of bleeding an anemic patient.

   

  In a nutshell, if a product can't be properly priced, you get less of it, and you get distortions in how that market operates. Alas, our central bank remains obtusely ignorant of this basic truth.”

  Read Also: Fed Gives Economic Growth A Chance by Editorial Board via NY Times

   

  2) Central Banks Missing What They Don't Know by Jeffrey Snider via Real Clear Markets

  “It was no surprise the FOMC failed to find its own exit this week given that a few days earlier Deutsche Bank announced yet another restructuring including massive layoffs. It doesn't appear as if any of those job cuts will be applied to US operations, which seems to render this a quite curious correlation with domestic monetary policy. If you like, you can substitute Citigroup's 5% decline in FICC "revenue" this quarter, or Jefferies Group 50% collapse in fixed income losses (tied to the corporate bond bubble, no less). It's all one and the same.

   

  On the surface, the relationship between banking and the Fed seems to be just that straightforward. In very general terms, interest rate targeting is supposed to reduce the "cost" of funds for banks so that they can "earn" a greater spread to the assets they hold or will hold. If only it were as easy as economists believe.”

  Read Also: Janet Yellen Did The Right Thing by John Cassidy via The New Yorker

   

  3) Negative Rates Coming To The U.S.? by Tyler Durden via ZeroHedge

  “Of course, this should come as no surprise to our readers: just in January we wrote "Get Ready For Negative Interest Rates In The US", but for the Fed to admit this possibility just when it was widely expected to at least signal a rebound in the economy with the tiniest of rate hikes, or at worst a hawkish statement, was truly a shock.

   

  This is what she [Janet Yellen] said:

   

  'Let me be clear that negative interest rates was not something that we considered very seriously at all today. It was not one of our main policy options.'

   

  'I don't expect that we're going to be in a path of providing additional accommodation. But if the outlook were to change in a way that most of my colleagues and I do not expect, and we found ourselves with a weak economy that needed additional stimulus, we would look at all of our available tools. And that would be something that we would evaluate in that kind of context.'”

  

  Read/Watch Also: Ray Dalio Worried About Downturn by Katherine Burton via BloombergBusiness

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  4) Fed Delay's Interest Rate Lift-Off by Jon Hilsenrath via WSJ

  "The decision left uncertain for a while longer just when the Fed would raise its benchmark rate, which has been near zero since December 2008. Most of the policy makers at the meeting, 13 of 17, indicated they still expect to move this year, but that was down from the 15 who held that view in June. The central bank has two more scheduled policy meetings this year, in late October and mid-December.

   

  One reason for the shifting outlook: Officials have become a bit less optimistic about the economy's long-run growth potential. They projected the economy will grow at a rate between 1.8% and 2.2% per year in the long-run, down from their June estimate of growth of 2.0% to 2.3% in the long-run. A more lumbering economy has less capacity to bear much higher rates."

  Read Also: Fed To Economy: Party On, Not So Excellent by Brian Doherty via Reason.com

   

  5) A Roadmap For Stocks After No Rate Hike by Michael Kahn via Barron's

  "Given the volatility levels today, it is important to step back to look at the bigger picture. After all, the major trend and structure of the market provides the framework within which the short-term condition operates.

   

  For example, if the bull market is still intact, then the spin on the Fed news will be positive even if on the surface it seems it is not. And if this is a bear market, then the spin will most likely be bad. Stocks should fall further.

   

  While the bull market seems to be over, thanks to a rather convincing breakdown of the major trendline and 2015 trading range, I do not yet see enough evidence to conclude this is a major bear market (see Chart 1). I need one more price breakdown to get there."

  

  Read Also: Fed Makes Same Mistakes As It Did In 1927 by Martin Armstrong via Armstrong Economics

  ---

  Other Reading

  • Fraud, Fools And Financial Markets by Robert Shiller via Project Syndicate
  • Something's Askew In This Market by Dana Lyon via Dana Lyon's Tumblr
  • The Future And How To Survive It by Dobbs, Koller and Ramaswamy via HBR
  • It's Not Easy by Howard Marks via Oaktree Management
  • The Fed Has No Control by Dr. John Hussman via Hussman Funds

  ---

  “Nothing is more suicidal than a rational investment policy in an irrational world.” – John Maynard Keynes

  Have a great weekend.

  

  

  

  

  

• Wanna See The 'Trick' In Trickle-Down?

  Submitted by Thad Beversdorf via FirstRebuttal.com,

  In the chart below I’ve indexed real median personal income against real corporate profits (before tax w/o adjustments) to the beginning of 2009, the point at which central bankers implemented trickle down economics to rescue Americans from the largest gov/banking policy induced disaster in the history of the world.   Let’s have a look at the results of the bankers trickle down strategy….

  

  Go figure eh….  Anyone think moar QE is the answer??  We just won’t know unless we keep on trying I suppose… says Ms. Yellen and the Business Roundtable (click to see many of the very faces of those that reached their shifty little hands into the ass of the golden goose and pulled out trillions of printed dollars but left trillions in debt obligations for your grandchildren).

  Anecdotally, for those of you that rarely leave the city, I was in a small town in Indiana not too long ago.  I stopped to get a bite to eat and prefer local diners to fast food.  Problem was almost every shop in what would have been a quaint downtown was boarded up.  I asked a lady if there was still a place to get a bite to eat in town.  She pointed me to the last shop at the end of the row.  I went in, sat down, ordered some food and couldn’t help overhearing the guys talking at the table next to me.

  “I’m really hoping to get onto the second shift soon”, says one guy.  The other guy responds, “yeah me too man we (family) could really use that extra $0.75 an hour”. 

  I immediately texted some broker buddies in Chicago and New York and relayed the conversation I’d just overheard, with the caption…. “I just overheard what everyday Americans are talking about….”

  The reality is that while most folks who are reading this may find it difficult to empathize, the vast majority of Americans are scratching for any extra $0.75 an hour they can find.  At the same time CEO’s and highly paid bureaucrats continue to tout policies that have enriched themselves beyond the wildest dreams and comprehension of the average American.  Yet they promote these policies as being in the best interest of the working class.

  And although you may be comfortable with your current financial sector job it to is but a fleeting position.  Today you are fine but tomorrow you too will be scratching for whatever cash you can find. There are very few who will not be impacted by what’s already been set in motion.

  

  

  

  

  

• And The NYSE Breaks 30 Minutes Before Quad-Witching Close

  Normally when the world needs an equity market boost, a broken market suffices to slam VIX and save the world. This time not so much.. and the carnage that this will cause into quad witch is frightening…

  The Market Breaks…
  

  

   

  But it doesn’t work…

  

   

  And…

   

  It’s Quadruple Witching Day. pic.twitter.com/MSkwcAXQnA

  — Rudolf E. Havenstein (@RudyHavenstein) September 18, 2015

  

  

  

  

  

• Friday Humor: ISIS Fighter Upset At Group's Lack Of Cell Phone Charger Etiquette

  Late in July, we remarked, with some amusement, that Jihadi John, the ISIS executioner who became famous for his starring roles in slick videos depicting the beheading of Westerners, was leaving the terrorist group because he feared other members – let’s just call them “jealous jihadis” – would kill him out of envy. 

  As Jihadi John’s story makes clear, it’s not all kittens and Nutella for members of ISIS, and indeed, even among brothers-in-arms united in the global war against the “Great Satan” and its allies, not everyone gets along. 

  Well, it turns out that pettiness within ISIS isn’t confined to jealousy over another member’s rise to fame. As The Washington Post reports, a 27-year old former supermarket security guard from Britain who left to fight with ISIS in Syria and Iraq has a laundry list of complaints about his “brothers,” which include their propensity to steal shoes and the fact that they “see no issue in unplugging your mobile phone to charge their own phone.”

  Here are some excerpts from the blog of Omar Hussein:

  Here in Sh?m, the Arabs and the non-Arabs are united in one line, under one banner, defending each other’s life with their own blood. However, with the unification of tribes and cultures, there will be clashes which are inevitable. Clashes which arise due to many reasons. Some are due to the level of knowledge which people possess, and some are due to different upbringings and cultures.

   

  On [one] occasion an Indonesian brother was working on his laptop and was using it to speak to his family (or friends) back in Indonesia. After some time he went to go eat so he left his laptop open not expecting anything to happen, as no one really goes through other people’s property without permission, right? Wrong! As he was in the other room eating, an Arab brother went through his laptop and deleted all his conversations the brother was having with his family on his Messenger service. 

   

  Another common trait is that they see no issue in unplugging your mobile phone to charge their own phone. Even if it’s your own charger, they would casually take your phone off charge to charge their own phone, even if there is no real need for them to charge their phone at that current time.

   

  In the west, it is common knowledge to walk out of a room wearing the same pair of shoes that you wore while entering the room. Nay, it is common sense. However here in Sh?m, our Syrian brothers have a very peculiar philosophy whereby they believe that everyone can share each other’s footwear, irrespective of foot size. Someone who is a size 40 will casually walk out the room wearing your footwear even though you are a size 44, and strangely he may not even realise. Weird? Of course it is.

   

  During rib?t one would be eating, sleeping, and fighting alongside other Arabs. For those of you who have been to university, it’s a bit like uni-life with a group of friends all being together. No doubt this can be enjoyable, however with Arabs around it can be quite frustrating, especially when one notices their sleeping habits.

   

  In rib?t, everyone does their few hours of guarding while the others rest. During night hours, when our shift is complete, we wake up the next person about 5 minutes before his shift. However with most Syrians, you would need to wake them up a good 15 minutes before their shift. Some Syrians are such heavy sleepers that even shaking and kicking them would not wake them up.

   

  Coming from the west, we have certain rules and regulations which we abide by while on the road. These are for our own benefit to prevent accidents and henceforth, complications. In the Arab world however, there are not that many rules for the highway, and one can easily obtain a driving license without any test. Yes I know, very scary indeed!

   

  Many things which may seem illegal or irrational are quite common for Arabs to do. In the west, one is required to look into his side mirrors prior to moving lane or going to a slip road, however an Arab would hardly ever look into his mirrors, even if he is coming onto a busy motorway. Women casually walk on the roads and hardly look over their shoulder to see if a car is coming, nor do they move out the way until you are right besides them horning at them.

  The list goes on (and on, and on). We suppose the takeaway here is that if you are a Westerner and are thinking of joining ISIS, you may want to first consider how strange it would be if your friend put on your shoes and unplugged your phone to plug his in…

  

  

  

  

  

  

• Why The Fed's Credibility Is Crashing: The Market's Three Biggest Worries

  Early this week, when evaluating the likelihood of a Fed rate hike, we cited RBS’ Alberto Gallo who said the “real reason to hike is another one: preventing the debt $-denominated overhangs from building up further – the burst of which would be, in turn, even more deflationary (and the same imbalances resulting from a financial boom can also reduce productivity, as discussed by the IMF). So if the Fed’s mandate is to worry about the medium-term and to target structural issues vs today’s asset prices, the right thing to do would be to hike. This is also what the majority of institutional investors think. But the Fed won’t.”

  Why not? Because the Fed itself realizes its credibility is fading fast and as RBS also showed as per a recent survey of its clients, a whopping 63% replied that the Fed is losing credibility. In other words, it has little to lose by doing what will erode its credibility that much more.

  

  Yesterday the Fed confirmed this was the case when it once again chickened out of its first rate hike in 9 years and took the easy way out, one which however confirmed to everyone that the Fed is increasingly gambling with what precious little credibility it still has left. As a reminder, if and when the Fed loses all trust, its only recourse will be to print boxes of cash and paradrop them on the population. Pardon, boxes of paper because at that point the US reserve will be worthless.

  We are not there yet, but as RBS notes in its follow up note today, “the price action in market today is negative, suggesting  increasing worries.”

  According to Alberto Gallo, the biggest worries are the following:

  1. The first is that by keeping rates lower for even longer, the EM imbalances the Fed is worrying about will grow even larger, making it harder to exit stimulus
  2. The second is a question on the value of forward guidance, after the Fed has repeatedly called for a hike and then backed out
  3. The third is that the Fed may have limited, or no ammunition to react to the next potential shock, and that financial booms and busts may grow even larger over time

  

  Gallo’s conclusion:

  And as the IMF wrote recently in its World Economic Outlook, these booms and busts have structural – not cyclical – consequences on productivity, following misallocation of capital and human resources to leverage-heavy sectors (real estate, infrastructure), which following the bust create a drag on banks’ balance sheets and in the workforce.

   

  Our US trading desk economist Michelle Girard says the Fed has missed its window, and now expects a first hike in March 2016. Together with our rates colleagues, we expect the ECB to react with more easing, increasing lengthening its QE programme, by year-end.

   

  The world we are heading into is one of increasingly market-dependent central bank policy, and of decreasing returns for bondholders. The investor reaction function has clearly changed from QE-positive to worries about too much easing and its collateral effects.

  Back in 2009 – when we commented on the arrival of global central planning –  we warned this was coming. 6 years later, after the biggest transfer of wealth known to man with virtually no objections by those being pillaged blind, the cracks in the centrally-planned facade are finally appearing.

  Additional thoughts from Gallo in the BBG TV clip below:

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