Today’s News September 7, 2015

• Supply and Demand Report 6 Sep, 2015

  This was a fairly quiet week in the market for the metals, with a min-rally on Thursday especially in silver which hit almost $15. By the end of the week, the price of gold was down $13 and the price of silver was up 3 cents. The action was elsewhere (e.g. equities and currencies).

  We don’t think that the price action necessarily tells us anything by itself. That’s why we look at it in the light of the basis action—the spread between spot and futures. What happened to the fundamentals of the metals this week? Read on…

  First, here is the graph of the metals’ prices.

         The Prices of Gold and Silver
  
  

  We are interested in the changing equilibrium created when some market participants
  are accumulating hoards and others are dishoarding. Of course, what makes it exciting is that speculators can (temporarily) exaggerate or fight against the trend. The speculators are often acting on rumors, technical analysis, or partial data about flows into or out of one corner of the market. That kind of information can’t tell them whether the globe, on net, is hoarding or dishoarding.

  One could point out that gold does not, on net, go into or out of anything. Yes, that is true. But it can come out of hoards and into carry trades. That is what we study. The gold basis tells us about this dynamic.

  Conventional techniques for analyzing supply and demand are inapplicable to gold and silver, because the monetary metals have such high inventories. In normal commodities,
  inventories divided by annual production (stocks to flows) can be measured in months. The world just does not keep much inventory in wheat or oil.

  With gold and silver, stocks to flows is measured in decades. Every ounce of those
  massive stockpiles is potential supply. Everyone on the planet is potential demand. At the right price, and under the right conditions. Looking at incremental changes in mine output or electronic manufacturing is not helpful to predict the future prices of the metals. For an introduction and guide to our concepts and theory, click here.

  Next, this is a graph of the gold price measured in silver, otherwise known as the gold to silver ratio. The ratio moved down this week, though it is still in what most people would call a breakout. 

  The Ratio of the Gold Price to the Silver Price
  
  

  For each metal, we will look at a graph of the basis and cobasis overlaid with the price of the dollar in terms of the respective metal. It will make it easier to provide brief commentary. The dollar will be represented in green, the basis in blue and cobasis in red.

  Here is the gold graph.

         The Gold Basis and Cobasis and the Dollar Price
  
  

  The price of the dollar rose slightly, and the scarcity (i.e. cobasis) of gold went up along with it.

  The fundamental price retreated slightly, but it’s still $120 over the market price. Gold remains on sale at a discounted price.

  Now let’s look at silver.

  The Silver Basis and Cobasis and the Dollar Price
  
  

  The price was basically flat and the cobasis fell slightly.

  The silver fundamental price remains more than 50 cents above the market price.

  It should be noted that we calculate a fundamental gold to silver ratio over 80, and the market ratio is currently 77.

   

  Monetary Metals may sponsor an event in London in early October, and another in Sydney
  in late October, to discuss economics and markets, with a focus on how to approach saving, investing, and speculating. Please let us know if you may be interested in attending either one here.

   

  © 2015 Monetary Metals

  

  

  

  

• One Thing Colombia and Canada Have in Common

  By Chris at www.CapitalistExploits.at

  Driving the back streets of Medellin a few weeks ago I found it interesting to see the various little pockets to the city. In the poor parts of town I noticed on a couple of occasions taxi drives running their vehicles on empty. I’ve seen this before in countries where there is a lack of sufficient working capital to be able to keep the tank full. Disposable income is low or non-existent…

  There are, however, pockets where we found the burgeoning middle class which give credence to the statistical numbers. Here there are delightful tree lined neighborhoods, boutique art stores, restaurants, coffee shops and Land Cruisers beginning to cramp up the streets of Medellin. Colombia has indeed a rising and growing middle class, though there still exists a large disparity in wealth.

  

  One measure used by economists to determine this ratio of rich to poor is the Gini coefficient. A Gini score of 0 would mean a perfect distribution of income and expenditure in a society and a number of 100 represents absolute inequality. This has important ramifications as often there exists a higher propensity for civil unrest as the number gets higher. Conversely the lower this number, the more equal and oftentimes stable a country. Colombia, according to the World Bank, sport a score of 53.5, though this is taken from 2012. I suspect this figure is actually lower today – it’s been falling each year since early 2000s.

  The trend appears to be going in the right direction…

  We’ve had our eye on Colombia for some time. One reason we haven’t jumped in earlier is that we’ve been cognizant that it’s a resource economy and when we first began taking notes we were already a decade into the resource bull market. Not optimum!

  Buying into a market without assessing the risks is never a good idea. As we’ve been discussing for the last 12 months or so there is an underlying trade at work: the unwinding of the USD carry trade which saw capital pour into resources. As the resource bull rolled over, capital infusions reduced and then began to reverse. We’re of the opinion that this is still in its infancy.

  The collapse of Chinese demand and the dollar bull market has already wiped something like $5 trillion of commodity driven revenues from the global system. The repercussions are only beginning to be felt. This promises to get really interesting!

  As recently discussed, Chile is a great example of the risks we’re concerned about with respect to all emerging markets.

  Chile is tied to copper much in the same way Colombia’s economy is tightly tied to oil. When the demand for copper is high then the Chilean economy and peso does well. Chile is a poster child country which saw a lot of people piling into at the top of the resource boom and as such the currency became overvalued even more than it would have if you were to play the currency by understanding copper.

  This scared us and never really made sense as all too often what we saw when we looked was foreign buying by retail investors. Retail investors for the most part are unsophisticated, act spontaneously without critical thought and fail to do their own research. This is even more true in markets outside of their own borders. When I see foreign money coming into an economy, and while this isn’t necessarily a bad omen, when that foreign money is retail investors it’s a red flag and the risk reward is rarely good.

  Case in point. I’d often see comparisons made between real estate in the US with real estate in emerging markets without considering differing credit conditions, vastly different cost structures, income levels or political climes, or even more stunningly dumb, comparisons made with agricultural land prices with those in the US on price alone. You just can’t do that!

  Yield matters, access to capital matters, and you’ll find the yields on farmland in developed countries are typically multiples of that in emerging markets. There is a reason that farmland in emerging markets often sells at a discount to developed world farmland. For example, the average dairy cow in the US has a yield 5x that of one in Mexico. Investors who fail to stop to analyse this are doomed to buy into all sorts of silly ideas and end up getting completely hosed.

  

  Colombian peso over the past 2 years…

  

  … and the South African rand during the same period

  With that in mind we have been looking at Colombia. What is of interest to us is real estate in Medellin, a city that is growing rapidly and has more infrastructure being built than any other in the country. For me the most important risk is that of the capital markets which translates into the availability of credit and this heavily influences the pricing of risk. Pricing of risk always translates itself into the currency and that is where our biggest risk and greatest potential lies.

  Let’s Go Back First and Start with the Capital Markets

  The 1970s and 80s saw some truly impressive growth in Miami. Swanky condominiums, 5 star hotels, luxury car dealerships – all of these were built on Colombian drug money. Specifically, the Medellin cartel who supplied up to 90% of the US cocaine market and 80% of the global cocaine market. The cartel was so incredibly profitable that it was bringing in more than $70M a day at its height. They were making so much money that they were spending over $2,000 per day on little rubber bands to hold the cash together, with millions of dollars which rotted and were eaten by rats.

  Miami was essentially offshore financed by Colombia. The capital flows ran all the way back to the coca fields in Colombia. While drug trafficking still exists today it’s a mere fraction of its former self. Today instead Colombia relies on commodities such as oil and coffee with the energy sector accounting for 8% of GDP and 40% of revenues in the balance of payments and about 50% of total exports. What this tells me is that much of this is financed much more by the US. Credit lines today run to NYC not the coca fields of the Medellin cartel. Funding of this nature is true of most emerging markets who enjoy immature credit markets and limited domestic capital. The risk equation is substantially different.

  During the resource bull private sector debt in emerging market corporates exploded. Historically it’s been unusual for such funding to be conducted in anything other than dollars. Now we have a perfect storm: collapsing commodity prices translating into a collapse in revenues for these corporates. As they pare back exposure they do so by buying back their dollar shorts. As the dollar strengthens they very quickly find themselves unable to pay their debts. It’s going to happen! We fully expect a massive blow up in emerging markets. I mentioned recently that Turkey and South Africa looked pretty precarious and this morning I woke to find that Turkey’s currency is going into free fall, violence has erupted on the streets and the government has begun arresting journalists. Does it spread?

  What This Means for Colombia?

  In speaking with people in Colombia I found a complacency amongst most of them. The same sort of complacency that existed in Southeast Asia even as the Asian crisis was taking hold.

  When you don’t have control over your own credit markets you’re vulnerable to global capital flows and this is where Colombia is at risk. The flip side of this is that domestic credit is still nascent. Only 72.5% of Colombians have a bank account and fewer than 3% have a mortgage. During the 2008 crisis Colombia fared very well though if you recall oil hadn’t fall out of bed quite so spectacularly so the considerations right now are somewhat different.

  The hedge fund manager in Manhattan, Tokyo or London doesn’t care much about whether or not Colombia, Chile, South Africa, etc. are sound fundamentally. His VAR (value at risk) models begin to blow out and he hits the sell button. This becomes a self reinforcing cycle. It’s quite beautiful to watch.

  The risk here, the single biggest risk, is the currency. Get it wrong and it’s incredibly easy to be wiped out. I think we’ve got at least 2-3 more years of devaluation ahead. Oil and the Colombian peso are likely to stay low for some period of time.

  At our recently concluded Seraph meet in Medellin we heard from Felipe Campos at Alianza Valores. I was really impressed with Felipe’s grounded approach and thorough research which extends beyond the narrow borders of Colombia. His presentation included this chart below which really highlights the dependence on energy that Colombia has. This will continue to be reflected in the peso.

  

  Another really fascinating chart was how closely linked the Canadian dollar is to the Colombian peso. I’d never realised how closely tied the two economies are. This also provides a means of hedging Colombian exposure in the currency markets. The COP is tough to hedge for retail guys and even when you’re hedging a $50M+ position, it’s still expensive. Hedge with the loonie?

  

  To all those Canadians who suffer under the misguided idea that Canada has a diversified economy, this above chart shows how closely tied both these economies are. The connective tissue? Oil.

  As long as oil stays low, the peso remains under pressure.

  This will pressure the economy and we expect to find some truly exceptional opportunities in a country that has so many good things going for it in the long term. The time to get your ducks in a line is well beforehand because when the opportunities start showing up two things happen:

  1. Your emotional part of your brain will tell to stay away, and
  2. You’ll have a tough time raising any capital because people will be looking at terrible headline news and will be reluctant to invest.

  We’re preparing now. If we’re wrong, we’ll know within the next couple of years and we’ll still be sitting on cash. If we’re correct, we will be buying prize assets for cents on the dollar because while we are very very long the dollar right now we’re not so naive to think that this will last forever. Like previous dollar bull markets it’ll turn around and this time it may not come back as the problems in the US financial position are unsustainable.

  – Chris  

   

  “Luck is a matter of preparation meeting opportunity.” – Lucius Annaeus Seneca

  

  

  

  

• China's "S&P" Limit Up 10%, Banks Plunge 5% As Xinhua Confirms "Stock Market Stabilized"

  Presented with little comment aside from a snarky glare as Xinhua's headline "After a roller coaster rush since July 2014, China's stock market has stabilized and risks have been released to some extent, the securities regulator said Sunday." CSI-300 was limit up 10% shortly after the open, then was hammered 5% lower. CSI Banks Index is down 5% and Shanghai Composite was not as easily manipulated and is down 0.5%!!

   

  

   

  But China Banks are geting hammered…

  

   

  Who was responsible for the magical levitation? Simple!!

  Spot The Difference!

  

   

  Welcome to the "markets"

   

  Charts: Bloomberg

  

  

  

  

  

• CyberWar & The False Comfort Of Mutually Assured Destruction

  Submitted by Jim Rickards via Bonner & Partners,

  During a recent financial war-game exercise at the Pentagon, I recommended that the SEC and New York Stock Exchange buy a warehouse in New York and equip it with copper-wire hardline phones, handheld battery-powered calculators, and other pre-Internet equipment. This facility would serve as a nondigital stock exchange with trading posts.

  The SEC would assign 30 major stocks each to the 20 largest broker-dealers, who would be designated specialists in those stocks. This would provide market making on the 600 largest stocks, covering more than 90% of all trading on a typical day.

  Orders would be phoned in on the hardwire analog phone system and put up for bids and offers by the specialists to a crowd of live brokers. This is exactly how stocks were traded until recently. Computerized and algorithmic trading would be banned as nonessential. Only real investor interest would be represented in this nondigital venue.

  In the event of a shutdown of the New York Stock Exchange by digital attack, the nondigital exchange would be activated. The U.S. would let China and Russia know this facility existed as a deterrent to a digital attack in the first place.

  If our rivals knew we had a robust nondigital Plan B, they might not bother to conduct a digital attack in the first place.

  Russia Strikes the Nasdaq

  Financial warfare attacks vary in their degree of sophistication and impact. At the low end of the spectrum is a distributed denial of service (DDoS) attack. This is done by flooding a targeted server with an overwhelming volume of message traffic so that either the server shuts down or legitimate users cannot gain access. In such attacks, the target is not actually penetrated, but it is disabled by the message traffic jam.

  The next level of sophistication is a cyberhack, in which the target, say, a bank account record file or a stock exchange order system, is actually penetrated. Once inside, the attacking cyberbrigade can either steal information, shut down the system, or plant sleeper attack viruses that can be activated at a later date.

  In 2010, the FBI and Department of Homeland Security located such an attack virus planted by Russian security services inside the Nasdaq stock market system. You have probably noticed that unexplained stock market outages and flash crashes are happening with increasing frequency. Some of these events may be self-inflicted damage by the exchanges themselves in the course of software upgrades, but others are highly suspicious and the exact causes have never been disclosed by exchange officials.

  
  A recently revealed classified map showing cyberattacks by the Chinese government against U.S. interests. Notice the concentration of attacks against technology targets in San Francisco, financial targets in New York, and military and intelligence targets in the Washington-Virginia area.

  The most dangerous attacks of all are those in which the enemy penetrates a bank or stock exchange not to disable it or steal information but to turn it into an enemy drone. Such a market drone can be used by attackers for maximum market disruption and the mass destruction of Americans’ wealth, including your stocks and savings.

  In this scenario, an attacker could penetrate the order entry system of a major stock exchange such as the New York Stock Exchange or one of the order-matching dark pools operated by major investment banks, such as the SIGMA X system controlled by Goldman Sachs. Once inside the order entry system, the attacker would place large sell orders on highly liquid stocks such as Apple or Facebook.

  Other system participants would then automatically match these orders in the mistaken belief that they were real trades. The sell orders would keep flooding the market until eventually other participants lowered their bids and began to deflect the selling pressure to other exchanges.

  An attack of this type would be launched on a day when the market was already down 3% or more, about 550 points on the Dow Jones index. Using exogenous events like that to increase the power of a planned attack is called a “force multiplier” by military strategists.

  The result could be a market decline of 20% or more in a single day, comparable to the stock market crash of October 1987 or the crash of 1929. You would not have to trade anything or be in the market during the attack; you would be wiped out based on the market decline even if you did nothing.

  The False Comfort of Mutually Assured Destruction

  Another type of highly malicious attack is to penetrate the account records system of a major bank and then systematically erase account balances in customers’ deposit accounts and 401(k)s. If the attack extended to backup databases, you or other customers might have no way of proving you ever owned the deleted accounts.

  Some analysts respond to such scenarios by saying that the U.S. has cyberwarfare attack capabilities that are just as effective as our enemies’. If Iran, China, or Russia ever launched a cyberfinancial attack on the U.S., we could retaliate.

  The threat of retaliation, they claim, would act as a deterrent and prevent the enemy attack in the first place. This is similar to the doctrine of “mutually assured destruction,” or MAD, that prevented nuclear conflict between the U.S. and Russia during the Cold War.

  This analysis is highly flawed and gives false comfort. MAD worked during the Cold War because both sides wanted to avoid existential losses. In financial warfare, the losses may be existential for the U.S., but this is not true for Russia, China, and Iran. Because they are far less developed than the U.S., their markets could be destroyed and it would have little impact on their overall economy or national security.

  Many stocks in Russia and China are owned by U.S. and European investors, so any damage would come back to haunt Western interests.

  The technological warfare capabilities may be symmetric, but the potential damage is asymmetric, so the deterrent effect on China and Russia is low. There is essentially nothing stopping Russia, Iran, or China from launching a “first strike” financial warfare attack if it serves some other national strategic purpose.

  Be Prepared

  What can you do to preserve wealth when these cyberfinancial wars break out?

  The key is to have some portion of your total assets invested in nondigital assets that cannot be hacked, wiped out or disrupted by financial warfare.

  Such assets include gold, silver, land, fine art, and private equity that is usually represented by a paper contract and does not rely on electronic-exchange trading for liquidity.

  For gold, I recommend you have a 10% allocation to physical gold if you don’t already.

  As an investor, you have enough to be concerned about just taking into account factors like inflation, deflation, Fed policy, and the overall state of the economy. Now you have another major threat looming – financial warfare, enabled by cyberattacks and force multipliers. The time to take defensive action by acquiring some nondigital assets is now.

  

  

  

  

  

• China Stocks "Death Cross", Default Risk Hits 2-Year High As Regulators Promise G-20 'Whatever It Takes' To Stabilize Market

  Even before China reopened from its 5-day holiday, regulators were pitching Chinese stocks as cheap (37.3x P/E) and less-margined (+108% YoY) and promised to "safeguard stability" in a "variety of forms" seemingly pouting cold water on The FT's recent report (and the malicious instigator of China's market crash). All of this is quite ironic, given China's chief central bankers admitted "the chinese bubble has burst." As stocks open, CSI-300 (China's S&P 500) has confirmed a 'Death Cross' which in 2008 was followed by a further 60% decline. More troubling, however, is the incessant rise in interbank rates as despite CNY530bn of liquidity injected in the last 3 weeks, overnight rates have doubled. China credit risk jumps to 2-year highs and AsiaPac stocks are generally lower at the open (as US futures dumped'n'pumped) not helped by Japanese weakness on BoJ tapering concerns. PBOC strengthened the Yuan fix for the 4th day in a row – the most since Sept 2010.

  After 3 days of stronger Yuan fixes into Wednesday of last week (before China closed), PBOC went even further – fixing Yuan 0.21% stronger, extending the streak to 4 days and 0.73% stroger – the biggest 4-day move in 5 years…

  • *CHINA SETS YUAN REFERENCE RATE AT 6.3584 AGAINST U.S. DOLLAR

  

   

  China's "S&P 500" just suffered a Death Cross (50-day moving average crossing below the 200-day moving-average)…

  

   

  It did not end well on previous occasions and we note that Shanghai Composite is likely to suffer this technical signal within the next week also.

  AsiaPac stocks are weaker…

  • *MSCI ASIA PACIFIC INDEX EXTENDS LOSS TO 1%
  • *FTSE CHINA A50 INDEX FUTURES FALL 1.1% IN SINGAPORE

  Dow Futures algorithmically extinguished all the stops above Friday's highs and below Friday's lows before tumbling back to unch…

  

  *  *  *

  However, even before tonight's weakness began…

  Speaking via the government's unofficial mouthpiece – Xinhua – China Securities Regulatory Commission promised…

  *CHINA'S ECONOMY IS STABILIZING, IMPROVING, NDRC SAYS

  *NDRC SEES CHINA ABLE TO ACHIEVE ANNUAL ECONOMIC GROWTH TARGET

   

  we want to continue to stabilize the market and prevent systemic risk as a primary task to stabilize the market – to repair market…

   

  when violent abnormal fluctuations in the market which may lead to systemic risks, the China Securities Finance Co., Ltd. will continue to play a role, safeguarding stability in a variety of forms.

  In addition, CSRC seemingly started pitching Chinese stocks as 'cheap' again noting that the P/E ration has tumbled (yeah but Shenzhen sticll 37.3x forward guesstimates) and laverage has dropped (yeah margiun debt is down CNY1 trillion but it is still up 100% YoY)…

  Cheap?

  

   

  However, most troubling of all is the doubling of overnight lending rates in the Chinese interbank market… Despite CNY 530bn in liquidity injections in the last 3 weeks alone…

  

   

  SHIFON has doubled!!!!

  

   

  Indicating Chinese banks are under massive liquidity stress… and implicitly the government too…

  • *AG BANK, BOCOM CORE CAPITAL RATIO BELOW BASEL TARGETS: SCMP
  • *MOODY'S: CHINESE BANKS WILL FACE RISING OP PRESSURE

  

   

  China is now credit riskier than Italy, Spain, and Saudi Arabia.

   

  *  *  *

  Away from China, Japanese markets are turmoiling after BOJ Tapering concerns mount…

  

   

  and not helped by Toshiba's massive accounting fraud loss…

  • *TOSHIBA POSTS 37.8B YEN FY14 NET LOSS AFTER ACCOUNTING SCANDAL

  Sending USDJPY plunging…

  

   

  Paging Mr.Kuroda…

  

   

  As everyone awaits South Korea's rate decision later this week… The carnage in Korean trade is unmistakable in the following Barclays chart:

  

  As for what this means for Korean monetary policy, no surprise here: more easing.

  We now expect the BoK to deliver a further 25bp rate cut in Q4, most likely in October. We see an outside chance of an earlier move, at the 11 September meeting, but we continue to believe that the BoK will prefer to move after the initial delivery of the fiscal supplementary spending and the US FOMC meeting on 17-18 September. Also, we now expect the first rate hike in Korea in Q3 16, rather than in late Q1 16. Moreover, with key indicators for the services economy showing a healthy post-MERS rebound, we believe the urgency to act immediately is still low. We believe the existing focus on engineering a weaker KRW bias – possibly by stockpiling essential commodities such as fuel – will remain.  

  Of course, further easing by South Korea, or even an outright devaluation, means the ball will then be in the court of Korea's trade competitors, who will then be compelled to match the Korean move with further easing (or devaluation) of their own, and so on, until one can no longer sweep the global recession under the rug. It isn't called the global race to the bottom for nothing.

   

  Charts: Bloomberg

  

  

  

  

  

• SeX WiTH AN EMaiL SeRVeR…

  

  

  

  

  

• Why The New Car Bubble's Days Are Numbered

  Having recently detailed the automakers' worst nightmare – surging new car inventories – supply; amid rapidly declining growth around the world (EM and China) – demand;

  Automakers just unleashed a massive production surge to keep the dream alive…

  

   

  With inventories at record highs (having risen for 61 straight months)…

  

   

  Which would be fine if sales were keeping up – but they are not…

  

   

  It appears the bubble in new car sales is about to be crushed by yet another unintended consequence of The Fed's lower for longer experiment.

  Edmunds.com estimates that around 28% of new vehicles this year will be leased – a near-record pace…

  

   

  Which means…

  13.4 million vehicles (leased over the past 3 years in The US) – compared with just 7 million in the three years to 2011 – are set to spark a massive surplus of high-quality used cars.

   

  Great for consumers (if there are any left who have not leased a car in the last 3 years) but crushing for automakers' margins as luxury used-care prices are tumbling just as residuals have surged.

  As The Wall Street Journal explains,

  Consumers focused on the dollar amount of their monthly payment have taken advantage of low interest rates to sometimes buy more car than they might otherwise be able to afford.

   

  But, aside from the actual cost of the vehicle, rates are only part of the equation determining monthly payments. The other is what auto makers and their financing arms think the residual value will be once a typical 36-month lease is up.

   

  Those values surged after the financial crisis.

  Now, a surfeit of off-lease vehicles is starting to depress prices, particularly for expensive vehicles.

  Three-year old, used premium luxury-car prices are down by nearly 7% from a year ago, according to Edmunds.com data. Along with Fed interest-rate increases, that would make leases less of a bargain and used cars more attractive.

   

  That new-car smell may soon involve more of a splurge.

  And if you are relying on more easing from The PBOC… it has made absolutely no difference whatsoever in the past 10 years…

  

   

  And all of this on top of the fact that the subprime auto loan market is set to collapse…

  We're gonna need a biggerer bailout… or more chemical plant explosions…

  To sum up…

  • The only way automakers are making sales is by lowering credit standards to truly mind-numbing levels and increasing residuals to make the monthly nut affordable…. that cannot last.
  • China's economic collapse has crushed forecasts for the automakers.
  • Inventories of new cars are already at record highs.
  • Inventories of luxury high-quality used cars is at record highs and prices are tumbling.
  • And July saw a massive surge in producton.
  • What comes next is simple… a production slump – just ask The Atlanta Fed.

  

  

  

  

  

• The "Great Unwind" Has Arrived

  Submitted by Doug Noland via Credit Bubble Bulletin,

  It’s my overarching thesis that the world is in the waning days of a historic multi-decade experiment in unfettered finance. As I have posited over the years, international finance has for too long been effectively operating without constraints on either the quantity or the quality of Credit issued. From the perspective of unsound finance on a globalized basis, this period has been unique. History, however, is replete with isolated episodes of booms fueled by bouts of unsound money and Credit – monetary fiascos inevitably ending in disaster. I see discomforting confirmation that the current historic global monetary fiasco’s disaster phase is now unfolding. It is within this context that readers should view recent market instability.

  It’s been 25 years of analyzing U.S. finance and the great U.S. Credit Bubble. When it comes to sustaining the Credit boom, at this point we’ve seen the most extraordinary measures along with about every trick in the book. When the banking system was left severely impaired from late-eighties excess, the Greenspan Fed surreptitiously nurtured non-bank Credit expansion. There was the unprecedented GSE boom, recklessly fomented by explicit and implied Washington backing. We’ve witnessed unprecedented growth in “Wall Street finance” – securitizations and sophisticated financial instruments and vehicles. There was the explosion in hedge funds and leveraged speculation. And, of course, there’s the tangled derivatives world that ballooned to an unfathomable hundreds of Trillions. Our central bank has championed it all.

  Importantly, the promotion of “market-based” finance dictated a subtle yet profound change in policymaking. A functioning New Age financial structure required that the Federal Reserve backstop the securities markets. And especially in a derivatives marketplace dominated by “dynamic hedging” (i.e. buying or selling securities to hedge market “insurance” written), the Fed was compelled to guarantee “liquid and continuous” markets. This changed just about everything.

  Contemporary finance is viable only so long as players can operate in highly liquid securities markets where price adjustments remain relatively contained. This is not the natural state of how markets function. The bullish premise of readily insurable/hedgeable market risks rests upon those having written protection being able to effectively off-load risk onto markets that trade freely without large price gaps/dislocations. And, sure enough, perceptions of liquid and continuous markets do create their own reality (Soros’ reflexivity). Sudden fear of market illiquidity and dislocation leads to financial crashes.

  U.S. policymaking and finance changed profoundly after the “tech” Bubble collapse. Larger market intrusions and bailouts gave way to Federal Reserve talk of “helicopter money” and the “government printing press” necessary to fight the scourge of deflation. Mortgage finance proved a powerful expedient. In hindsight, 2002 was the fateful origin of both the historic mortgage finance Bubble along with “do whatever it takes” central banking. The global policy response to the 2008 Bubble collapse unleashed Contemporary Finance’s Bubble Dynamics throughout the world – China and EM in particular.

  There are myriad serious issues associated with New Age finance and policymaking going global. The bullish consensus view holds that China and EM adoption of Western finance has been integral to these economies’ natural and beneficial advancement. Having evolved to the point of active participants in “globalization,” literally several billion individuals have the opportunity to prosper from and promote global free-market Capitalism. Such superficial analysis disregards this Credit and market cycles’ momentous developments.

  The analysis is exceptionally complex – and has been so for a while now. The confluence of sophisticated finance, esoteric leverage, the highly speculative nature of market activity and the prominent role of government market manipulation has created an extremely convoluted backdrop. Still, a root cause of current troubles can be boiled down to a more manageable issue: “Contemporary finance” and EM just don’t mix. Seductively, the two appeared almost wonderfully compatible – but that ended with the boom phase. For starters, the notion of “liquid and continuous” markets is pure fantasy when it comes to “developing” economies and financial systems. As always, “money” gushes in and rushes out of EM. Submerged in destabilizing finance, EM financial, economic and political systems become, as always, overwhelmed and dysfunctional. And as always is the case, the greater the boom the more destabilizing the bust.

  In general, reckless “money” printing has over years produced a massive pool of destabilizing global speculative finance. Simplistically, egregious monetary inflation (along with zero return on savings) ensured that there was way too much “money” chasing too few risk assets. Every successful trade attracted too much company. Successful strategies spurred a proliferation of copycats and massive inflows. Strong markets were flooded with finance. Perceived robust economies were overrun. Popular regions were completely inundated. To be sure, the post-crisis “Global Reflation Trade” amounted to history’s greatest international flow of speculative finance. Dreadfully, now comes The Unwind.

  From individual trades, to themes to strategic asset-class and regional market allocations, speculative “hot money” flows have reversed course. Global deleveraging and de-risking have commenced. The fallacy of “liquid and continuous” markets is being exposed. Faith that global central bankers have things under control has begun to wane. And for the vast majority in the markets it remains business as usual. Another buying opportunity.

  Whether on the basis of an individual trade or a popular theme, boom-time success ensured that contemporary (trend-following and performance-chasing) market dynamics spurred speculative excess and associated structural impairment. They also ensured latent Crowded Trade fragilities (notably illiquid and discontinuous “risk off” markets).

  Crowded Trade Dynamics ensure that a rush for the exits has folks getting trampled. Previous relationships break down and time-tested strategies flail. “Genius” fails. When the Crowd decides it wants out, the market turns bereft of buyers willing and able to take the other side of the trade. And the longer the previous success of a trade, theme or strategy the larger The Crowd – and the more destabilizing The Unwind. Previous performance and track records will offer little predictive value. Models (i.e. “risk parity” and VAR!) will now work to deceive and confound.

  Today, a Crowd of “money” is rushing to exit EM. The Crowd seeks to vacate a faltering Chinese Bubble. “Money” wants out of Crowded global leveraged “carry trades.” In summary, the global government finance Bubble has been pierced with profound consequences. Of course there will be aggressive policy responses. I just fear we’ve reached The Unwind phase where throwing more liquidity at the problem only exacerbates instability. Sure, the ECB and BOJ could increase QE – in the process only further stoking king dollar at the expense of faltering energy, commodities, EM and China. And the Fed could restart it program of buying U.S. securities. Bolstering U.S. markets could also come at the expense of faltering Bubbles around the globe.

  It has been amazing to witness the expansion of Credit default swap (CDS) markets to all crevices of international finance. To see China’s “shadow banking” assets balloon to $5 Trillion has been nothing short of astonishing. Then there is the explosion of largely unregulated Credit insurance throughout Chinese debt markets – and EM generally. I find it incredible that Brazil’s central bank would write $100 billion of currency swaps (offering buyers protection against devaluation). Throughout it all, there’s been an overriding certitude that policymakers will retain control. Unwavering faith in concerted QE infinity, as necessary. The fallacy of liquid and continuous markets persisted so much longer than I ever imagined.

  I feel I have a decent understanding of how the Fed and global central bankers reflated the system after the 2008 mortgage finance Bubble collapse. The Federal Reserve collapsed interest-rates to zero, while expanding its holdings (Fed Credit) about $1 Trillion. Importantly, the Fed was able to incite a mortgage refinance boom, where hundreds of billions of suspect “private-label” mortgages were transformed into (money-like) GSE-backed securities (becoming suitable for Fed purchase). The Fed backstopped the securities broker/dealer industry, the big banks and money funds. Washington backed Fannie, Freddie and the FHLB, along with major derivative players such as AIG. The Fed injected unprecedented amounts of liquidity into securities markets, more than content to devalue the dollar. Importantly, with the benefit of international reserve currency status and debt denominated almost exclusively in dollars, U.S. currency devaluation appeared relatively painless.

  These days I really struggle envisaging how global policymakers reflate after the multi-dimensional collapse of the global government finance Bubble. We’re already witness to China’s deepening struggles. Stimulus over the past year worked primarily to inflate a destabilizing stock market Bubble that has gone bust. They (again) were forced to backtrack from currency devaluation. Acute fragilities associated both with massive financial outflows and enormous amounts of foreign currency-denominated debt were too intense. Markets are skeptical of Chinese official signals that the renminbi will be held stable against the dollar. Market players instead seem to be interpreting China’s efforts to stabilize their currency as actually raising the probability for future abrupt policy measures (significant devaluation and capital controls) or perhaps a highly destabilizing uncontrolled breakdown in the peg to the U.S. dollar.

  And as China this week imposed onerous conditions on some currency derivative trading/hedging, it’s now clear that Chinese officials support contemporary market-based finance only when it assists their chosen policy course. How long will Chinese officials tolerate bleeding the nation's international reserves to allow “money” to exit China at top dollar?

  …

  I wholeheartedly agree with the statement “technical factors can push the market away from fundamentals.” Indeed, that’s been the case now for going on seven years. A confluence of unprecedented monetary inflation, interest-rate manipulation, government deficits and leveraged speculation inflated a historic divergence between securities markets Bubbles and underlying fundamentals. The global Bubble is now faltering. Risk aversion is taking hold. De-leveraging is accelerating.

  The yen jumped 2.2% this week. Japanese stocks were hit for 7%. The Brazilian real sank 7.3%. The South African rand dropped 4.2%. The Turkish lira dropped another 2.9% and the Russian ruble sank 5.0%. China sovereign CDS surged, pulling Asian CDS higher throughout. The Hang Seng China H-Financials Index sank another 7.4% this week, having now declined 39% from June highs. From my vantage point, market action points to serious unfolding financial dislocation in China. It also would appear that a large swath of the leveraged speculating community is facing some real difficulty.

  After a rough trading session and an ominous week for global markets, I was struck by Friday evening headlines. From the Wall Street Journal: “An Investor’s Field Guild to Bottom Fishing;” “Global CEOs See Emerging Markets As Rich With Opportunity.” From CNBC: “Spike in Volatility Creates ‘Traders Paradise.” And from the Financial Times: “Wall Street Waiting for Those Buy Signals;” “Time to Buy EM Stocks, History Suggests;” “Why I’m Adding Emerging Markets Exposure Despite China Wobble;” “G20 Defies Gloom to Forecast Rise in Growth.”

  There still seems little recognition of the seriousness of the unfolding global market dislocation. It’s destined to be a wrenching bear market – at best.

  

  

  

  

  

• The IMF Just Confirmed The Nightmare Scenario For Central Banks Is Now In Play

  The most important piece of news announced today was also, as usually happens, the most underreported: it had nothing to do with US jobs, with the Fed’s hiking intentions, with China, or even the ongoing “1998-style” carnage in emerging markets. Instead, it was the admission by ECB governing council member Ewald Nowotny that what we said about the ECB hitting a supply brick wall, was right. Specifically, earlier today Bloomberg quoted the Austrian central banker that the ECB asset-backed securities purchasing program “hasn’t been as successful as we’d hoped.”

  Why? “It’s simply because they are running out. There are simply too few of these structured products out there.”

  So six months later, the ECB begrudgingly admitted what we said in March 2015, in “A Complete Preview Of Q€ — And Why It Will Fail“, was correct. Namely this:

  … the ECB is monetizing over half of gross issuance (and more than twice net issuance) and a cool 12% of eurozone GDP. The latter figure there could easily rise if GDP contracts and Q€ is expanded, a scenario which should certainly not be ruled out given Europe’s fragile economic situation and expectations for the ECB to remain accommodative for the foreseeable future. In fact, the market is already talking about the likelihood that the program will be expanded/extended.

   

  … while we hate to beat a dead horse, the sheer lunacy of a bond buying program that is only constrained by the fact that there simply aren’t enough bonds to buy, cannot possibly be overstated.

   

  Among the program’s many inherent absurdities are the glaring disparity between the size of the program and the amount of net euro fixed income issuance and the more nuanced fact that the effects of previous ECB easing efforts virtually ensure that Q€ cannot succeed.

  (Actually, we said all of the above first all the way back in 2012, but that’s irrelevant.)

  So aside from the ECB officially admitting that it has become supply*constrained even with security prices at near all time highs, why is this so critical?

  Readers will recall that just yesterday we explained why “Suddenly The Bank Of Japan Has An Unexpected Problem On Its Hands” in which we quoted BofA a rates strategist who said that “now that GPIF’s selling has finished, the focus will be on who else is going to sell. Unless Japan Post Bank sells JGBs, the BOJ won’t be able to continue its monetary stimulus operations.“

  We also said this:

  “in 6-9 months, following the next major market swoon when everyone is demanding more action from the BOJ, “suddenly” pundits will have discovered the biggest glitch in the ongoing QE monetization regime, namely that the BOJ simply can not continue its current QE program, let along boost QE as many are increasingly demanding, unless it finds willing sellers, and having already bought everything the single biggest holder of JGBs, the GPIF, had to sell, the BOJ will next shakedown the Post Bank, whose sales of JPY45 trillion in JGBs are critical to keep Japan’s QQE going.

   

  The sale of that amount, however, by the second largest holder of JGBs, will only last the BOJ for the next 3 months. What next? Which other pension fund will have the massive holdings required to keep the BOJ’s going not only in 2016 but also 2017 and onward. The answer: less and less.

  Once again to be accurate, the first time we warned about the biggest nightmare on deck for the BOJ (and ECB, and Fed, and every other monetizing central bank) was back in October 2014, when we cautioned that the biggest rish was a lack of monetizable supply.

  We cited Takuji Okubo, chief economist at Japan Macro Advisors in Tokyo, who said that at the scale of its current debt monetization, the BOJ could end up owning half of the JGB market by as early as in 2018. He added that “The BOJ is basically declaring that Japan will need to fix its long-term problems by 2018, or risk becoming a failed nation.“

  

  This was our summary:

  The BOJ will not boost QE, and if anything will have no choice but to start tapering it down – just like the Fed did when its interventions created the current illiquidity in the US govt market – especially since liquidity in the Japanese government market is now non-existant and getting worse by the day. All that would take for a massive VaR shock scenario to play out in Japan is one exogenous JGB event for the market to realize just how little actual natural buyers and sellers exist.

  That said, our conclusion, which was not to “expect the media to grasp the profound implications of this analysis not only for the BOJ but for all other central banks: we expect this to be summer of 2016’s business” may have been a tad premature.

  The reason: overnight the IMF released a working paper written by Serkan Arslanalp and Dennis Botman (which was originally authored in August), which confirmed everything we said yesterday… and then some.

  Here is Bloomberg’s summary of the paper:

  The Bank of Japan may need to reduce the pace of its bond purchases in a few years due to a shortage of sellers, said economists at the International Monetary Fund.

   

  There is likely to be a “minimum” level of demand for Japanese government bonds from banks, pension funds, and insurance companies due to collateral needs, asset allocation targets, and asset-liability management requirements, said IMF economists Serkan Arslanalp and Dennis Botman.

  Here are the excerpts from the paper:

  We construct a realistic rebalancing scenario, which suggests that the BoJ may need to taper its JGB purchases in 2017 or 2018, given collateral needs of banks, asset-liability management constraints of insurers, and announced asset allocation targets of major pension funds.

   

  … there is likely to be a “minimum” level of demand for JGBs from banks, pension funds, and insurance companies due to collateral needs, asset allocation targets, and asset-liability management (ALM) requirements. As such, the sustainability of the BoJ’s current pace of JGB purchases may become an issue.

  Back to Bloomberg:

  While Governor Haruhiko Kuroda said in May that he expects no obstacles in buying government bonds, the IMF analysts join Nomura Securities Co. and BNP Paribas SA in questioning the sustainability of the unprecedented debt purchases.

  Who in turn merely joined Zero Hedge who warned about precisely this in October of last year.

  Back to the IMF paper, which notes that in Japan, where there is a limited securitization market, the only “high quality collateral” assets are JGBs, and as a result of the large scale JGB purchases by the JGB, “a supply-demand imbalance can emerge, which could limit the central bank’s ability to achieve its monetary base targets. Such limits may already be reflected in exceptionally low (and sometimes negative) yields on JGBs, amid a large negative term premium, and signs of reduced JGB market liquidity.”

  To the extent markets anticipate limits, the rise in inflation expectations could be contained, which may mitigate incentives for portfolio rebalancing and create a self-fulfilling cycle that undermines the BoJ’s objectives.

  For those surprised by the IMF’s stark warning and curious how it is possible that the BOJ could have put itself in such a position, here is the explanation:

  So far, the BoJ’s share of the government bond market is similar to those of the Federal Reserve and still below the Bank of England (BOE) at the height of their QE programs. Indeed, the BoE held close to 40 percent of the conventional gilt market at one point without causing significant market impairment. Japan is not there yet, as the BoJ held about a quarter of the market at end-2014. But, at the current pace, it will hold about 40 percent of the market by end-2016 and close to 60 percent by end-2018. In other words, beyond 2016, the BoJ’s dominant position in the government bond market will be unprecedented among major advanced economies.

  

  As we expanded yesterday, the biggest issue for the BOJ is not that it has problems buying paper, but that there are simply not enough sellers: “under QQE1, only around 5 percent of BoJ’s net JGB purchases from the market came from institutional investors. In contrast, under QQE2, close to 40 percent of net purchases have come from institutional investors between October 2014 and March 2015.”

  

   

  This is where things get back for the BOJ, because now that the BOJ is buying everything official institutions have to sell, the countdown has begun:

  given the pace of BoJ purchases under QQE2 and projected debt issuance by the government (based on April 2015 IMF WEO projections of the fiscal deficit), we estimate that Japanese investors could shed some ¥220 trillion of JGBs until end-2018 (Table 2, Figure 4). In particular, Japanese insurance companies and pension funds could reduce their government bond holdings by ¥44 trillion, while banks could sell another ¥176 trillion by end-2018, which would bring their JGB holdings down to 5 percent of total assets. At that point, the BoJ may have to taper its JGB purchases.

  

   

  Then there are the liquidity issues:

  As the BoJ ascends to being a dominant player in the JGB market, liquidity is likely to be affected, implying that economic surprises may trigger larger volatility in JGB yields with potential financial stability implications. As noted in IMF (2012), demand-supply imbalances in safe assets could lead to deteriorating collateral quality in funding markets, more short-term volatility jumps, herding, and cliff effects. In an environment of persistent low interest rates and heightened financial market uncertainty, these imbalances can raise the frequency of volatility spikes and potentially lead to large swings in asset prices.

  This, too, is precisely what we warned yesterday would be the outcome: “the BOJ will not boost QE, and if anything will have no choice but to start tapering it down – just like the Fed did when its interventions created the current illiquidity in the US govt market – especially since liquidity in the Japanese government market is now non-existant and getting worse by the day.”

  The IMF paper conveniently provides some useful trackers to observe just how bad JGB liquidity is in real-time.

  

  The IMF is quick to note that the BOJ does have a way out: it can simply shift its monetization to longer-dated paper, expand collateral availability using tthe BOJ’s Securited Lending Facility (which basically is a circular check kiting scheme, where the BOJ lends banks the securities it will then repurchase from them), or simply shift from bonds to other assets: “the authorities could expand the purchase of private assets. At the moment, Japan has a relatively limited corporate bond market (text chart). Hence, this would require jumpstarting the securitization market for mortgages and bank loans to small and medium-sized enterprises which could generate more private assets for BoJ purchases.”

  But the biggest risk is not what else the BOJ could monetize – surely the Japanese government can always create “monetizable” kitchen sinks… but what happens when the regime shifts from the current buying phase to its inverse:

  As this limit approaches and once the BoJ starts to exit, the market could move from a situation of shortage to one with excess supply. The term premium could jump depending on whether the BoJ shrinks its balance sheet and on the fiscal deficit over the medium term.

  When considering that by 2018 the BOJ market will have become the world’s most illiquid (as the BOJ will hold 60% or more of all issues), the IMF’s final warning is that “such a change in market conditions could trigger the potential for abrupt jumps in yields.”

  At that moment the BOJ will finally lose control. In other words, the long-overdue Kyle Bass scenario will finally take place in about 2-3 years, tops.

  But ignoring the endgame for Japan, and recall that BofA triangulated just this when it said that “the BOJ is basically declaring that Japan will need to fix its long-term problems by 2018, or risk becoming a failed nation“, what’s worse for Abe is that the countdown until his program loses all credibility has begun.

  What happens then? As BNP wrote in an August 28-dated report, “Once foreign investors lose faith in Abenomics, foreign outflows are likely to trigger a Japanese equities meltdown similar to the one observed during 2007-09.”

  And from there, the contagion will spread to the entire world, whose central banks incidentally, will be faced with precisely the same question: who will be responsible for the next round of monetization and desperately kicking the can one more time.

  But before we get to the QE endgame, we first need to get the interim point: the one where first the markets and then the media realizes that the BOJ – the one central banks whose bank monetization is keeping the world’s asset levels afloat now that the ECB has admitted it is having “problems” finding sellers – will have no choice but to taper, with all the associated downstream effects on domestic and global asset prices.

  It’s all downhill from there, and not just for Japan but all other “safe collateral” monetizing central banks, which explains the real reason the Fed is in a rush to hike: so it can at least engage in some more QE when every other central bank fails.

  But there’s no rush: remember to give the market and the media the usual 6-9 month head start to grasp the significance of all of the above.

  Source: IMF

  

  

  

  

  

• Why Hillary Can't Tell If Her Email Is Classified

  Presented with no comment…

   

  

   

  Source: Townhall.com

  

  

  

  

  

• ESPN: Cutting The Cord Or Political Turn Off?

  Submitted by Mark St.Cyr,

  The catchphrase that seems to be picking up more and more steam is “cutting the cord” when referring to those that are dropping traditional cable TV for viewing choices or alternatives by other means. The reasons why differ greatly. For some its price, or affordability. For others, its convenience with the growing numbers of alternatives. And for some; they just refuse to pay for anything in a zealot like fashion. Although each group has different reasons the outcome is the same: diminishing viewership.

  However, is “cutting the cord” really the reason for ESPN’s loss of millions viewers? Or, is that the easiest crutch of an excuse for what might really be happening? After all, media is, and always will be, the king of “inflated” numbers. So much so I garner when a CEO of any media company reads a term like “double seasonally adjusted” they smirk and think – “Rookies.”

  It’s just the way it has, is, and will be played; and everyone understands it. None more so than those within the business itself, which is why a few things struck me.

  Why wouldn’t ESPN™ (or Disney™ its parent company) go to great efforts to include or push the narrative that “cord cutting” doesn’t necessarily mean “all” that cut have tuned off? In other words: why aren’t numbers from alternative viewing sources highlighted as to show they might not be viewing there – but they are over here? Unless – they aren’t.

  And if they’re not – why not? After all, there’s probably no other content infringement policing company for copyright and other applicable ownership rights than Disney and all its subsidiaries. You aren’t going to see it for free or on alternative platforms unless they want or allow for it. Period.

  This would also imply if they allowed it (anywhere) it would be accounted for ( i.e., click views, etc.) in some manner of form from across the internet to help take the edge off. i.e., Sure we lost millions from cable, but as you can see here, they’ve just migrated over to this service/platform as an alternative. Monetizing the alternative is a work in progress. etc., etc.

  However, that seems not to be the case. The case appears – they’ve not only cut: they’ve tuned out or turned off the programming entirely. Why?

  It’s hard to say. However, if I use myself as an example, I believe I know a large part of the underlying reason:

  ESPN (like a few notable others such as NBC™) has seemingly transformed at near hyper-speed from sports reporting – to political sports reporting. The political edge now rampant throughout the shows, games, interviews, et al is overbearing, overburdening, and overdone.

  Here’s what I know from my own experience: It has become near impossible to turn on something that was originally created for pure entertainment value without now being bombarded with how the “political football” issue of the day is being addressed by the commentators, sideline crews, as well as players and coaches. e.g., I tuned in to watch a football game – not a game about how today’s “political football” is handled and won. i.e., gun control, domestic violence, civil unrest, global warming, etc., etc., on, and on.

  Important issues all. However, is there no respite today as to maybe catch a breather and just enjoy a sporting event and its minutia without having today’s “political football” and all its baggage forced down my throat by sports casters, players, and more? It would be one thing if these shows mentioned these topics when appropriate. But now? One would think they were watching a Sunday morning news show rather than a sports channel. Everyday 24/7.

  When I’ve watched it seems the reason for their existence (i.e., the game) is an inconvenience that must be tolerated till they can get back to what they believe really matters: the “political issue” of the day.

  Yes, I know I’m probably overstating. Yet, that’s how I feel today when I’ve tried to watch most ESPN programming as well as others. My immediate reaction? Many times I’ve turned off a game entirely: for continuing was akin to waiting for another comment as to cue a push of the bamboo chutes deeper.

  Personally, I grew so sick of it I now watch about a third, if that, of any sports TV I had watched previous. Again: specifically for this reason.

  If I want “political football” TV there are far more choices and views to get it from. Sports were at one time a sanctuary from the realities of everyday life. There one cared only about their team. Could throw all their passion (and distaste) behind them. Hate them one day, love them the next with no regards as to affecting society. It was a place to blow off steam, have fun, and armchair quarterback yourself into the Hall of Fame of “If I were on the field – I would have called that play and won!” all time greats.

  Today? It’s near impossible to escape and has been picking up steam. Need I say (or not say?) Washington Red____s?

  Listen, I’m not addressing whether or not you agree with what should, or should not, be done. I’m just trying to illustrate this as just one of the latest that shows in great detail just how one will not be able to escape the discussion that is purely based in the “political football” arena.

  Some sportscasters now will not say the name; even if they are the on-air live, play-by-play talent, and stumble all over themselves and their play-by-play calls trying to avoid it. Players will be asked from both the sidelines, booths, with others appearing via satellite, questioning them to defend how they can even put on the uniform for that day’s game. Insinuation, implication, and innuendo will be the “play calling” as opposed to what is transpiring on the field of actual play.

  Again, as I stated earlier: whether or not you agree or disagree with the topic, just this one is a representative of all the others. If it’s not a name change – its gun control. If it’s not that – it’s another. Everyday 24/7. The game now seems to be the filler as opposed to the “issue of the day.” Need I remind anyone of that great illustration of just how determined sportscasters are now going to force the “political football” down viewers throats than NBC™ Bob Costa’s gun control rant on Sunday Night Football™?

  Agreeing, or disagreeing with his take is irrelevant. My point is: I don’t turn to a sporting event, or, sports commentary program, to hear the opinion/opinions of today’s sportscasters view on the “political issue” of the day. I tune in to see sports. Period.

  This seems lost on ESPN and the others as of late. And if I’m a microcosm of what others are doing. What we’re not doing is cutting the cord and viewing it elsewhere. We’re actually giving a spin to the old Timothy Leary idea:

  We’re tuning out and turning off. Entirely.

  

  

  

  

  

• Dow Dip-Buyers Evident After Futures Open With Another Mini-Flash-Crash

  As Dow futures opened ahead of this evening’s China open (after being closed since Wednesday), it appears someone (or something) decided it was time to test down 100 points to Friday’s pre-ramp lows. Of course that mini-flash-crash has now been followed – since stops were run – with a 140 point ripfest, we assume gunning for the stops just above Friday’s late-day highs…

   

  

   

  Other moves of note ahead of the China open are a sizable surge in Bitcoin (looming Yuan devaluation?)

  

   

   

  Charts: Bloomberg and Bitcoinwisdom.com

  

  

  

  

  

• Three Reasons Why Saudi Arabia Flip-Flopped On Iran. And Now Supports The US "Nuclear Deal"

  Back in April, when the first outline of the Iran nuclear deal first appeared, Saudi Arabia (together with Israel) would have none of it. As the Atlantic Council summarized back then, “Saudi Arabia and Israel find themselves in the same camp as opponents of a nuclear deal with Iran, but the Sunni kingdom and Jewish state have very different reasons for their opposition. Israelis are concerned mainly with a nuclear-armed Iran, while the Saudis worry more about Iran’s growing regional influence, analysts said March 16 at the Atlantic Council…. for the Saudis … it’s been a traditional concern about Iran’s intentions in the Gulf.”

  One month later, the Saudi snub was heard around the globe when King Salman skipped a summit of Gulf Arab leaders at Camp David, which was widely interpreted as the latest embarrassment for the US president by a long-time mid-east US ally.

  And then, a few months later, just as the new Saudi KJng Salman arrived in the US for his first trip since assuming the throne in January (and rented out all 222 rooms at the Washington D.C. Four Seasons hotel), something unexpected happened: Saudi Arabia gave its blessings for the Iran deal. This is what Deutsche Welle reported on Friday:

   Saudi Foreign Minister Adel al-Jubeir said on Friday that President Barack Obama had assured the Saudi king that the deal agreed in July with Iran prevents Tehran from acquiring nuclear weapons, includes inspections of military and suspected sites and has a provision for re-imposing sanctions should Iran violate the agreement.

   

  Al-Jubeir said that under those conditions, Saudi Arabia would support the deal.

   

  “Now we have one less problem for the time being to deal with, with regards to Iran,” al-Jubeir said after a meeting between the king and Obama on Friday. “We can now focus more intensely on the nefarious activities that Iran is engaged in in the region.

  As BBC confirmed, “Saudi Arabia has said it is happy with President Obama’s assurances that the recent nuclear deal with Iran will not imperil the Gulf states. Saudi Foreign Minister Adel al-Jubeir said his country was satisfied that the deal would contribute to security and stability in the Middle East.”

  

  So what prompted the Saudis to change their mind in such a short time frame? There were three main reasons.

  First, as we reported some time ago, since the primary driver behind the Iran “deal” is not the Obama State Department but the US military-industrial complex, which is hoping for yet another regional flash point to capitalize on selling weapons into yet another war, one of the side deals cut with the Saudis to make the Iran deal more appetizing was a $1bn arms agreement, which senior US officials told the NYT would provide weapons for the Saudi military for the campaign against the jihadist group Islamic State and the Houthi rebel movement in Yemen.  The deal primarily comprised missiles for US-made F-15 fighter jets, the officials said. More importantly, it boosts US GDP at a time when the US is desperate for any incremental growth.

  Second, as Al Arabiya reported yesterday, Saudi Arabia unveiled a giant raft of investment and partnership potential opportunities in sectors including oil and gas, civil infrastructure, and banking as part of a 21st century vision of the cooperation between the two long-term allies, sources told Al Arabiya News on Saturday. The vision was presented by Saudi Deputy Crown Prince and Defense Minister Mohammad bin Salman, who also heads the kingdom’s economic and development council.

  The list of proposals includes the kingdom’s state-run oil giant Saudi Aramco rolling out new projects in refining, distribution and support over a five-year period.

   

  Mining was also mentioned as a “promising” sector, with plans to work with U.S. companies to extract vast deposits of phosphate, bauxite and silica.

   

  In the healthcare sector, Saudi authorities seeking to double the clinical capacity in the next five years are slated to work with U.S. health insurers to set in place a new national program.

   

  Foreign direct investment – which so far has been a rarity in the kingdom – is also mentioned as being among the plans, with major U.S. retailers expected to be invited to set up shop.

  Who will benefit the most from all of this? Why the US again:

  U.S. banks and finance firms are also to be invited to enter Saudi, with retail and commercial institutions mentioned by sources. American lenders are also suggested to tap in to the kingdom’s lucrative mortgage market.

   

  With the Saudi government ramping up investment in free zones, roads, and communication networks, the kingdom will soon “aim to employ and rely completely on U.S. construction companies,” sources told Al Arabiya News.

   

  The proposals were based on studies conducted by leading business and technology consultants, including Booz Allen Hamilton and BCG.

   

  On Friday, during Saudi King Salman’s visit to Washington, the king told reporters that his country must allow more opportunities for U.S. and the kingdom to do business.

  Because if the US can’t growth from within, and it the domestic US oil industry is now in shambles with mass shale defaults just over the horizon, what better place to invest money than the country whose oil production policies are among the key drivers for collapsing oil prices.

  Third, and perhaps most important, is that with oil at $50 and lower, Saudi Arabia is in dire financial straits as we have been covering extensively over the past month, leading to fear not only about the record Saudi budget deficit, but also concerns that the Saudi Riyal could be the next currency to lose its USD peg and devalue.Which means that just like US shale companies, Saudi Arabia is suddenly all too reliant on capital markets access, and the generosity of creditors to fund its record budget deficit, which is only set to rise (as we previews back in November 2014). AFP with the explanation:

  Saudi Arabia will cut spending and issue more bonds as it faces a record budget shortfall due to falling oil prices, the finance minister said on Sunday. The kingdom — the biggest Arab economy and the world’s largest oil exporter — is facing an unprecedented budget crunch after crude prices dropped by more than half in a year to below $50 a barrel.

   

  “We are working… to cut unnecessary expenditure,” Assaf told Dubai-based CNBC Arabia in Washington, where he is accompanying King Salman on a visit.

   

  He said the government would issue more conventional treasury bonds and Islamic sukuk bonds to “finance the budget deficit” — which is projected by the International Monetary Fund at a record $130 billion (117 billion euros) for this year.

   

  The kingdom has so far issued bonds worth “less than 100 billion riyals ($27 billion/24 billion euros)” to help with the shortfall, he said, without providing an exact figure. “We intend to issue more bonds and could issue sukuk for certain projects… before the end of 2015,” Assaf said.

  Recall that in addition to China and the rest of the EMs and petro-exporters, Saudi too has been burning through US reserves (i.e., mostly Treasurys): “Jadwa said that by the end of July the government had withdrawn $82 billion from its reserves, reducing the assets to $650 billion. The reserves are expected to drop to $629 billion by the end of the year, Jadwa said.” We’ll take the under.

  To summarize: in order to get the Saudis to “agree” to the Iran deal, all the US had to do is remind King Salman, that as long as oil is where it is to a big extent as a result of Saudi’s own record oil production, crushing countless US oil corporations and leading to the biggest layoffs in Texas since the financial crisis, the country will urgently need access to yield-starved US debt investors.

  If in the process, US corporations can invest in Saudi Arabia (and use the resulting assets as further collateral against which to take out even more debt), while US military corporations sell billions in weapons and ammo to the Saudi army, so much the better.

  And that is why Saudi King Salman flipflopped on short notice.

  And then, there is Donald Trump…

  I will be in Washington D.C. on Wednesday,1 P.M.,in front of the Capitol, to protest the horrible and incompetent deal being made with Iran.

  — Donald J. Trump (@realDonaldTrump) September 6, 2015

  

  

  

  

  

• 11,000 Icelanders Offer To House Syrian Refugees

  Submitted by Michaela Whitton via TheAntiMedia.org,

  The Icelandic government is reconsidering its national refugee quota after a social media campaign resulted in over 11,000 Icelanders offering up a room in their homes to refugees.

  As Europe struggles to cope with unprecedented levels of those seeking shelter, residents of the sparsely populated Nordic island country resorted to direct action to pressure their leaders.

  Iceland was recently awarded the title of “most peaceful country” in the Global Peace Index, with Syria ranking the least peaceful. With a population of 330,000 — less than many European cities — the country’s government had previously stated it could only take in 50 people this year.

  Taking matters into their own hands, over 16,000 Icelanders joined a Facebook page created on Sunday to pressurize the Icelandic government into accepting more refugees.

  In addition to offering rooms in homes, people have pledged financial support with air fares, language teaching, clothing, food, and toys, and the page has been inundated with messages of gratitude from Syrians, some of whom are writing from refugee camps.

  As a result of the outpouring of support, Icelandic Prime Minister Sigmundur David Gunnlaugsson announced that a committee is being formed to re-assess the country’s current policy.

  Founder of the Facebook group, author and professor, Bryndis Bjorgvinsdottir, said her country’s attitude was being changed by tragic news reports. “I think people have had enough of seeing news stories from the Mediterranean and refugee camps of dying people and they want something done now,” she told Iceland’s RUV television.

  Undoubtedly, thousands of people across the globe are equally horrified. Inspired by Iceland’s example, social media campaigns have sprung up and united those who are dismayed by the pitiful humanitarian response to the crisis. As distressing images and stories of the hurdles and barriers faced at every turn by those seeking sanctuary saturate the European press, similar schemes have snowballed throughout Europe.

  In Britain, more and more people are condemning the government’s shameful response to the crisis — a response particularly ironic considering most refugees are fleeing conflicts that the U.K.’s imperialist interventions have directly contributed to.

  Not prepared to sit back, groups like Citizens UK are pressuring U.K. leaders to step up to the plate. More than 250,000 Brits have signed a petition calling for Britain to take its fair share of Syrian refugees.

  Ireland’s ”Pledge a Bed” campaign was overwhelmed with thousands of offers of spare rooms within hours of its launch while hundreds of Germans have offered to share their homes on the Refugees Welcome website.

  Swiftly following suit and not to be outdone, offers of support haven’t stopped at Europe’s shores. A U.S. group called Open Homes, Open Hearts US – for Syrian refugees launched earlier this week.

  With no easy answers and no end in sight, the political firestorm will continue, as will the global outrage at the humanitarian tragedy. The only thing clear is that if the West were prepared to accept more refugees, desperate families wouldn’t be forced to rely on smugglers or to climb into perilous boats and refrigeration lorries.

  

  

  

  

  

• This Is What A Short Squeeze Looks Like

  Brent crude prices eased 0.7% to $49.61/bbl last week as Iranian sanctions relief proceeds toward fruition.  WTI crude gained nearly 2% as the 2nd largest speculative short position since 2006 in NYMEX futures and options leaves the prompt market significantly unbalanced and extremely susceptible to upside catalysts.

  

   

  The current spike in money manager short position (136 million barrels at last count) is second only to the 178 million barrel short that occurred in March of this year which caused both the initial plunge to $45/bbl as well as the subsequent rally back to the $60 level. 

  

   

  Recent history suggests that despite weak fundamentals, crude prices are more likely to rise further before falling again.

   

  h/t Alpman

  

  

  

  

  

• The Collapse Of The NY Taxi Cartel

  Submitted by Pater Tenebrarum via Acting-Man.com,

  The Market Breaks Monopolies Government has Created

  It turns out that it is not a good idea to create speculation revolving around interventionist government policies. Ever since Uber appeared on the scene, the previously coddled taxi industry is in trouble – and apparently nowhere more so than in NY City.

   

  

  In NYC, there is a special situation: in the 1930s, the city created the “taxi medallion”, artificially limiting the number of taxis allowed to work in the city. These medallions have become objects of speculation and have been thoroughly financialized.

  As Jeffrey Tucker reports, Uber has apparently busted the taxi cartel and destroyed the medallion market in the process:

  “An age-old rap against free markets is that they give rise to monopolies that use their power to exploit consumers, crush upstarts, and stifle innovation. It was this perception that led to “trust busting” a century ago, and continues to drive the monopoly-hunting policy at the Federal Trade Commission and the Justice Department.

   

  But if you look around at the real world, you find something different. The actually existing monopolies that do these bad things are created not by markets but by government policy. Think of sectors like education, mail, courts, money, or municipal taxis, and you find a reality that is the opposite of the caricature: public policy creates monopolies while markets bust them.

   

  […]

   

  In New York, we are seeing a collapse as inexorable as the fall of the Soviet Union itself. The app economy introduced competition in a surreptitious way. It invited people to sign up to drive people here and there and get paid for it. No more standing in lines on corners or being forced to split fares. You can stay in the coffee shop until you are notified that your car is there.

   

  In less than one year, we’ve seen the astonishing effects. Not only has the price of taxi medallions fallen dramatically from a peak of $1 million, it’s not even clear that there is a market remaining at all for these permits. There hasn’t been a single medallion sale in four months. They are on the verge of becoming scrap metal or collector’s items destined for eBay.”

  (emphasis added)

  In the meantime, the “medallion magnates” (people who in some cases control hundreds of medallions) and others have come crying for a government bailout. It turns out they borrowed a lot of money using the medallions as collateral – a potentially deadly mistake as has now turned out.

  Here is an interesting video by Reason TV on the topic:

  The collapse of the NY Taxi cartel

   

  Conclusion

  It is interesting that the free market has actually found a way to undermine a cartel that up until recently appeared to be completely safe. In some cities, Uber is being fought tooth and nail to protect the sinecures of the established taxi industry. It is a microcosm of the cronyism that is the rule almost everywhere these days.

  Just think about how greatly our lives would improve if all the regulations that have been designed for no other reason than to protect established businesses against competition from upstarts were rescinded.

   

  

  

  

  

  

• Presenting Five Channels Of Contagion From China's Hard Landing

  Before China’s bursting equity bubble grabbed international headlines, and before the PBoC’s subsequent devaluation of the yuan served notice to the world that things had officially gotten serious in the global currency wars, all anyone wanted to talk about when it came to China was a “hard landing.” Indeed for what seems like forever, the bogeyman hiding in every economist’s closet was a sharper-than-expected deceleration in China’s economy which, as everyone is now acutely aware, is the engine for global growth and trade. 

  Of course no one knows where China’s official output numbers actually come from. They could be some amalgamation of real data and NBS tinkering (much like what you get from the BEA in the US) or they could come straight from the imagination of Xi Jinping. There’s also a strong possibility that a lack of robust statistical controls mean China routinely understates its deflator, leading to perpetually overstated GDP growth during times of plunging commodity prices – times like now.

  But whatever the case, China’s “shock” devaluation effectively telegraphed the “real situation” (to quote the NBS). That is, policy rate cuts had failed to boost growth and the situation was in fact becoming so precarious that the PBoC was willing to loosen up on the dollar peg that had caused the yuan to appreciate by some 15% on a REER basis over the course of just 12 months, putting untold pressure on the export-driven economy.

  The message was clear: China is landing and it’s landing hard. 

  
  

  Now, the task is to determine what the channels are for contagion and on that note, we go to RBS’ Alberto Gallo who has more.

  *  *  *

  Via RBS

  The contagion from China’s economic slowdown is deep and widespread, with profound implications for both emerging and developed markets. 

  There are five main channels of contagion for credit: 

  1. Exports and revenue exposure. Economies for which China is the largest trading partner will suffer from lower demand: Brazil, Chile, Australia, Peru, Thailand and Malaysia. Specific sectors in developed markets will also be affected, especially Germany and Italy. A number of sectors in DM credit with high dependence on Chinese revenue could be vulnerable, including German carmakers (VW, Daimler, BMW), luxury goods manufacturers (LVMH), and telecoms companies. 

  2. Banking system exposure. Among countries which report to the BIS, South Korea, Australia and the UK have the largest proportion of foreign claims in China. For the UK and Australia, exposure is concentrated among a few banks, specifically HSBC, Standard Chartered and ANZ. UK banks are more exposed than Australian banks, as their loans to China represent up to 30% of their total lending, whereas loans to Asia are generally less than 5% of Australian bank lending (except for ANZ at 14%). 

  3. Commodity dependence. With China consuming nearly half of the world’s industrial metal supply, slower growth may weigh on supply-demand dynamics and directly lower commodity prices. Countries that rely on commodity exports, and specifically China’s consumption of them, are especially vulnerable. 

  4. Petrodollar demand for $-denominated fixed income asset investment. Lower commodity prices also mean oil exporters will have lower revenues and less savings to invest in $-denominated fixed income assets. The yearly flow of Petrodollars may shrink to around $280bn/year this year from $700bn in 2014, according to our estimates based on average annual oil prices and lifting costs. If we assume that 30% of oil proceeds is invested in $ fixed income, then the decline is roughly equivalent to $100bn/year in lower demand for dollar assets. This is equivalent to the increase in net supply of Treasuries or $ IG corporates YoY. 

  5. Currency depreciation and a high proportion of hard currency debt increase solvency risks for EM corporates. While EM sovereigns generally do not rely on hard-currency debt much more than in the past, EM firms have boosted their share of hard-currency debt over the past decade. The portion of $-denominated bonds from foreign firms is now a quarter of the total US IG market. Many EM firms have a large proportion of their debt in hard currency. We have previously highlighted the vulnerability of some EM firms in particular, such as Chinese real estate developers. 

  *  *  *

  Bonus: The updated China contagion flowchart 

  

  

  

  

  

  

• Presenting Five Channels Of Contagion From China's Hard Landing

  Before China’s bursting equity bubble grabbed international headlines, and before the PBoC’s subsequent devaluation of the yuan served notice to the world that things had officially gotten serious in the global currency wars, all anyone wanted to talk about when it came to China was a “hard landing.” Indeed for what seems like forever, the bogeyman hiding in every economist’s closet was a sharper-than-expected deceleration in China’s economy which, as everyone is now acutely aware, is the engine for global growth and trade. 

  Of course no one knows where China’s official output numbers actually come from. They could be some amalgamation of real data and NBS tinkering (much like what you get from the BEA in the US) or they could come straight from the imagination of Xi Jinping. There’s also a strong possibility that a lack of robust statistical controls mean China routinely understates its deflator, leading to perpetually overstated GDP growth during times of plunging commodity prices – times like now.

  But whatever the case, China’s “shock” devaluation effectively telegraphed the “real situation” (to quote the NBS). That is, policy rate cuts had failed to boost growth and the situation was in fact becoming so precarious that the PBoC was willing to loosen up on the dollar peg that had caused the yuan to appreciate by some 15% on a REER basis over the course of just 12 months, putting untold pressure on the export-driven economy.

  The message was clear: China is landing and it’s landing hard. 

  
  

  Now, the task is to determine what the channels are for contagion and on that note, we go to RBS’ Alberto Gallo who has more.

  *  *  *

  Via RBS

  The contagion from China’s economic slowdown is deep and widespread, with profound implications for both emerging and developed markets. 

  There are five main channels of contagion for credit: 

  1. Exports and revenue exposure. Economies for which China is the largest trading partner will suffer from lower demand: Brazil, Chile, Australia, Peru, Thailand and Malaysia. Specific sectors in developed markets will also be affected, especially Germany and Italy. A number of sectors in DM credit with high dependence on Chinese revenue could be vulnerable, including German carmakers (VW, Daimler, BMW), luxury goods manufacturers (LVMH), and telecoms companies. 

  2. Banking system exposure. Among countries which report to the BIS, South Korea, Australia and the UK have the largest proportion of foreign claims in China. For the UK and Australia, exposure is concentrated among a few banks, specifically HSBC, Standard Chartered and ANZ. UK banks are more exposed than Australian banks, as their loans to China represent up to 30% of their total lending, whereas loans to Asia are generally less than 5% of Australian bank lending (except for ANZ at 14%). 

  3. Commodity dependence. With China consuming nearly half of the world’s industrial metal supply, slower growth may weigh on supply-demand dynamics and directly lower commodity prices. Countries that rely on commodity exports, and specifically China’s consumption of them, are especially vulnerable. 

  4. Petrodollar demand for $-denominated fixed income asset investment. Lower commodity prices also mean oil exporters will have lower revenues and less savings to invest in $-denominated fixed income assets. The yearly flow of Petrodollars may shrink to around $280bn/year this year from $700bn in 2014, according to our estimates based on average annual oil prices and lifting costs. If we assume that 30% of oil proceeds is invested in $ fixed income, then the decline is roughly equivalent to $100bn/year in lower demand for dollar assets. This is equivalent to the increase in net supply of Treasuries or $ IG corporates YoY. 

  5. Currency depreciation and a high proportion of hard currency debt increase solvency risks for EM corporates. While EM sovereigns generally do not rely on hard-currency debt much more than in the past, EM firms have boosted their share of hard-currency debt over the past decade. The portion of $-denominated bonds from foreign firms is now a quarter of the total US IG market. Many EM firms have a large proportion of their debt in hard currency. We have previously highlighted the vulnerability of some EM firms in particular, such as Chinese real estate developers. 

  *  *  *

  Bonus: The updated China contagion flowchart 

  

  

  

  

  

  

• Europe's Biggest Bank Dares To Ask: Is The Fed Preparing For A "Controlled Demolition" Of The Market

  Why did we focus so much attention yesterday on a post in which the IMF confirmed what we had said since last October, namely that the BOJ’s days of ravenous debt monetization are coming to a tapering end as soon as 2017 (as willing sellers simply run out of product)? Simple: because in the global fiat regime, asset prices are nothing more than an indication of central bank generosity. Or, as Deutsche Bank puts it: “Ultimately in a fiat money system asset prices reflect “outside” i.e. central bank money and the extent to which it multiplied through the banking system.“

  The problem is that the BOJ and the ECB are the only two remaining central banks in a world in which Reverse QE aka “Quantitative Tightening” in China, and the Fed’s tightening in the form of an upcoming rate hike (unless the Fed loses all credibility and reverts its pro-rate hike bias), are now actively involved in reducing global liquidity. It is only a matter of time before the market starts pricing in that the Bank of Japan’s open-ended QE has begun its tapering (followed by a QE-ending) countdown, which will lead to devastating risk-asset consequences. The ECB, which is also greatly supply constrained as Ewald Nowotny admitted yesterday, will follow closely behind.

  But while we expanded on the Japanese problem to come in detail yesterday, here are some key observations on what is going on in both the US and China as of this moment – the two places which all now admit are the culprit for the recent equity selloff, and which the market has finally realized are actively soaking up global liquidity.

  Here the problem, as we initially discussed last November in “How The Petrodollar Quietly Died, And Nobody Noticed“, is that as a result of the soaring US dollar and collapse in oil prices, Petrodollar recycling has crashed, leading to an outright liquidation of FX reserves, read US Treasurys by emerging market nations. This was reinforced on August 11th when China joined the global liquidation push as a result of its devaluation announcement, a topic which we also covered far ahead of everyone else with our May report “Revealing The Identity Of The Mystery “Belgian” Buyer Of US Treasurys”, exposing Chinese dumping of US Treasurys via Belgium.

  We also hope to have made it quite clear that China’s reserve liquidation and that of the EM petro-exporters is really two sides of the same coin: in a world in which the USD is soaring as a result of Fed tightening concerns, other central banks have no choice but to liquidate FX reserve assets: this includes both EMs, and most recently, China.

  Needless to say, these key trends covered here over the past year have finally become the biggest mainstream topic, and have led to the biggest equity drop in years, including the first correction in the S&P since 2011. Elsewhere, the risk devastation is much more profound, with emerging market equity markets and currencies crashing around the globe at a pace reminiscent of the Asian 1998 crisis, while in China both the housing and credit, not to mention the stock market, bubble have all long burst.

  Before we continue, we present a brief detour from Deutsche Bank’s Dominic Konstam on precisely how it is that in the current fiat system, global central bank liquidity is fungible and until a few months ago, had led to record equity asset prices in most places around the globe. To wit:

  Let’s start from some basics. Global liquidity can be thought of as the sum of all central banks’ balance sheets (liabilities side) expressed in dollar terms. We then have the case of completely flexible exchange rates versus one of fixed exchange rates. In the event that one central bank, say the Fed, is expanding its balance sheet, they will add to global liquidity directly. If exchange rates are flexible this will also mean the dollar tends to weaken so that the value of other central banks’ liabilities in the global system goes up in dollar terms. Dollar weakness thus might contribute to a higher dollar price for dollar denominated global commodities, as an example. If exchange rates are pegged then to achieve that peg other central banks will need to expand their own balance sheets and take on dollar FX reserves on the asset side. Global liquidity is therefore increased initially by the Fed but, secondly, by further liability expansion, by the other central banks. Depending on the sensitivity of exchange rates to relative balance sheet adjustments, it is not an a priori case that the same balance sheet expansion by the Fed leads to greater or less global liquidity expansion under either exchange rate regime. Hence the mere existence of a massive build up in FX reserves shouldn’t be viewed as a massive expansion of global liquidity per se – although as we shall show later, the empirical observation is that this is a more powerful force for the “impact” of changes in global liquidity on financial assets.

  That, in broad strokes, explains how and why the Fed’s easing, or tightening, terms have such profound implications not only on every asset class, and currency pair, but on global economic output.

  Liquidity in the broadest sense tends to support growth momentum, particularly when it is in excess of current nominal growth. Positive changes in liquidity should therefore be equity bullish and bond price negative. Central bank liquidity is a large part of broad liquidity and, subject to bank multipliers, the same holds true. Both Fed tightening and China’s FX adjustment imply a tightening of liquidity conditions that, all else equal, implies a loss in output momentum.

   

  

  But while the impact on global economic growth is tangible, there is also a substantial delay before its full impact is observed. When it comes to asset prices, however, the market is far faster at discounting the disappearance of the “invisible hand”:

  Ultimately in a fiat money system asset prices reflect “outside” i.e. central bank money and the extent to which it multiplied through the banking system. The loss of reserves represents not just a direct loss of outside money but also a reduction in the multiplier. There should be no expectation that the multiplier is quickly restored through offsetting central bank operations.

  Here Deutsche Bank suggests your panic, because according to its estimates, while the US equity market may have corrected, it has a long ways to go just to catch up to the dramatic slowdown in global plus Fed reserves (that does not even take in account the reality that soon both the BOJ and the ECB will be forced by the market to taper and slow down their own liquidity injections):

  Let’s start with risk assets, proxied by global equity prices. It would appear at  first glance that the correlation is negative in that when central bank liquidity is expanding, equities are falling and vice versa. Of course this likely suggests a policy response in that central banks are typically “late” so that they react once equities are falling and then equities tend to recover. If we shift liquidity forward 6 quarters we can see that the market “leads” anticipated” additional liquidity by something similar. This is very worrying now in that it suggests that equity price appreciation could decelerate easily to -20 or even 40 percent based on near zero central bank liquidity, assuming similar multipliers to the post crisis period.

   

  

  

  Some more dire predictions from Deutsche on what will happen next to equity prices:

  If we only consider the FX and Fed components of liquidity there appears to be a tighter and more contemporaneous relationship with equity prices. The suggestion is at one level still the same, absent Fed and FX reserve expansion, equity prices look more likely to decelerate and quite sharply.

   

  The Fed’s balance sheet for example could easily be negative 5 percent this time next year, depending on how they manage the SOMA portfolio and would be associated with further FX reserve loss unless countries, including China allowed for a much weaker currency. This would be a great concern for global (central bank liquidity).

  Once again, all of this assumes a status quo for the QE out of Europe and Japan, which as we pounded the table yesterday, are both in the process of being “timed out”

  The tie out, presumably with the “leading” indicator of other central bank action is that other central banks have been instrumental in supporting equities in the past. The largest of course being the ECB and BoJ. If the Fed isn’t going doing its job, it is good to know someone is willing to do the job for them, albeit there is a “lag” before they appreciate the extent of someone else’s policy “failure”.

  Worse, as noted yesterday soon there will be nobody left to mask everyone one’s failure: the global liquidity circle jerk is coming to an end.

  What does this mean for bond yields? Well, as we explained previously, clearly the selling of TSYs by China is a clear negative for bond prices. However, what Deutsche Bank accurately notes, is that should the world undergo a dramatic plunge in risk assets, the resulting tsunami of residual liquidity will most likely end up in the long-end, sending Treasury yields lower. To wit:

  … if investors believe that liquidity is likely to continue to fall one should not sell real yields but buy them and be more worried about risk assets than anything else. This flies in the face of recent concerns that China’s potential liquidation of Treasuries for FX intervention is a Treasury negative and should drive real yields higher.… More generally the simple point is that falling reserves should be the least of worries for rates – as they have so far proven to be since late 2014 and instead, rates need to focus more on risk assets.

   

  The relationship between central bank liquidity and the byproduct of FX reserve accumulation is clearly central to risk asset performance and therefore interest rates. The simplistic error is to assume that all assets are treated equally. They are not – or at least have not been especially since the crisis. If liquidity weakens and risk assets trade badly, rates are most likely to rally not sell off. It doesn’t matter how many Treasury bills are redeemed or USD cash is liquidated from foreign central bank assets, US rates are more likely to fall than rise especially further out the curve. In some ways this really shouldn’t be that hard to appreciate. After all central bank liquidity drives broader measures of liquidity that also drives, with a lag, economic activity.

  Two points: we agree with DB that if the market were to price in collapsing “outside” money, i.e. central bank liquidity, that risk assets would crush (and far more than just the 20-40% hinted above). After all it was central bank intervention and only central bank intervention that pushed the S&P from 666 to its all time high of just above 2100.

  However, we also disagree for one simple reason: as we explained in “What Would Happen If Everyone Joins China In Dumping Treasurys“, the real question is what would everyone else do. If the other EMs join China in liquidating the combined $7.5 trillion in FX reserves (i.e., mostly US Trasurys but also those of Europe and Japan) shown below…

  

  … into an illiquid Treasury bond market where central banks already hold 30% or more of all 10 Year equivalents (the BOJ will own 60% by 2018), then it is debatable whether the mere outflow from stocks into bonds will offset the rate carnage.

  And, as we showed before, all else equal, the unwinding of the past decade’s accumulation of EM reserves, some $8 trillion, could possibly lead to a surge in yields from the current 2% back to 6% or higher.

  In other words, inductively reserve liquidation may not be a concern, but practically – when taking in account just how illiquid the global TSY market has become – said liquidation will without doubt lead to a surge in yields, if only occasionally due to illiquidity driven demand discontinuities.

  * * *

  So where does that leave us? Summarizing Deutsche Bank’s observations, they confirm everything we have said from day one, namely that the QE crusade undertaken first by the Fed in 2009 and then all central banks, has been the biggest can-kicking exercise in history, one which brought a few years of artificial calm to the market while making the wealth disparity between the poor and rich the widest it has ever been as it crushed the global middle class; now the end of QE is finally coming.

  And this is where Deutsche Bank, which understands very well that the Fed’s tightening coupled with Quantiative Tightening, would lead to nothing short of a global equity collapse (especially once the market prices in the inevitable tightening resulting from the BOJ’s taper over the coming two years), is shocked. To wit:

  This reinforces our view that the Fed is in danger of committing policy error. Not because one and done is a non issue but because the market will initially struggle to price “done” after “one”. And the Fed’s communication skills hardly lend themselves to over achievement. More likely in our view, is that one in September will lead to a December pricing and additional hikes in 2016, suggesting 2s could easily trade to 1 ¼ percent. This may well be an overshoot but it could imply another leg lower for risk assets and a sharp reflattening of the yield curve.

  But it was the conclusion to Deutsche’s stream of consciousness that is the real shocker: in it DB’s Dominic Konstam implicitly ask out loud whether what comes next for global capital markets (most equity, but probably rates as well), is nothing short of a controlled demolition. A premeditated controlled demolition, and facilitated by the Fed’s actions or rather lack thereof:

  The more sinister undercurrent is that as the relationship between negative rates has tightened with weaker liquidity since the crisis, there is a sense that policy is being priced to “fail” rather than succeed. Real rates fall when central banks back away from stimulus presumably because they “think” they have done enough and the (global) economy is on a healing trajectory. This could be viewed as a damning indictment of policy and is not unrelated to other structural factors that make policy less effective than it would be otherwise – including the self evident break in bank multipliers due to new regulations and capital requirements.

  What would happen then? Well, DB casually tosses an S&P trading a “half its value”, but more importantly, also remarks that what we have also said from day one, namely that “helicopter money” in whatever fiscal stimulus form it takes (even if it is in the purest literal one) is the only remaining outcome after a 50% crash in the S&P:

  Of course our definition of “failure” may also be a little zealous. After all why should equities always rise in value? Why should debt holders be expected to afford their debt burden? There are plenty of alternative viable equilibria with SPX half its value, longevity liabilities in default and debt deflation in abundance. In those equilibria traditional QE ceases to work and the only road back to what we think is the current desired equilibrium is via true helicopter money via fiscal stimulus where there are no independent central banks. 

  And there it is: Deutsche Bank saying, in not so many words, what Ray Dalio hinted at, namely that the Fed’s tightening would be the mechanistic precursor to a market crash and thus, QE4.

  Only Deutsche takes the answer to its rhetorical question if the Fed is preparing for a “controlled demolition” of risk assets one step forward: realizing that at this point more QE will be self-defeating, the only remaining recourse to avoid what may be another systemic catastrophe would be the one both Friedman and Bernanke hinted at many years ago: the literal paradropping of money to preserve the fiat system for just a few more days (At this point we urge rereading footnote 18 in Ben Bernanke’s “Deflation: Making Sure “It” Doesn’t Happen Here” speech)

  While we can only note that the gravity of the above admission by Europe’s largest bank can not be exaggerated – for “very serious banks” to say this, something epic must be just over the horizon – we should add: if Deutsche Bank (with its €55 trillion in derivatives) is right and if the Fed refuses to change its posture, exposure to any asset which has counterparty risk and/or whose value is a function of faith in central banks, should be effectively wound down.

  * * *

  While we have no way of knowing how this all plays out, especially if Deutsche is correct, we’ll leave readers with one of our favorite diagrams: Exter’s inverted pyramid.

  

  

  

  

  

  

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