Monday, October 3, 2011

October 3 2011: Commodities and Deflation: A Response to Chris Martenson

Gustave Doré The Ninth Circle of Hell (Treachery) 1857
Illustration for Dante Alighieri’s Commedia [Divina]: Inferno

Ilargi Interview with Alex Smith of Radio Ecoshock, October 3 2011

Stoneleigh: Chris Martenson recently posted a rebuttal to the deflationist take on commodities - Commodities Look Set to Rocket Higher. In contrast, our deflationary view here at The Automatic Earth, written at the end of August, is encapsulated in Et tu, Commodities?. To recap, our position is that commodity prices are coming off the top of a major speculative episode and consequently have a very long way to fall.

That is how speculative periods always resolve themselves. We argue, however, that this does not mean commodities will be cheap, even at much lower prices than today, given that the implosion of the wider credit bubble will cause purchasing power to fall faster than price. This means affordability worsening even as prices fall.

To be clear, at TAE we define inflation and deflation as monetary phenomena - respectively an increase or a decrease in the supply of money plus credit relative to available goods and services. Mr Martenson begins his piece with:

Their argument is pretty clear cut: Because inflation is a function of available money plus credit (their definition), and because credit has fallen, deflation is what comes next.

We would point out that, according to our definition, credit contraction does not lead to deflation, it IS deflation by definition. What it leads to is falling prices, virtually across the board. 

Mr Martenson points to three conditions which he argues would have to be met for commodity prices to fall, arguing that these are "all just versions of the old supply/demand argument for commodity prices, except that our consideration also includes the important element of the Austrian economic view of demand for money".

In this view, three things have to be true:
  1. Demand for commodities has to fall below supply. After all, as long as demand exceeds supply, prices will typically rise.
  2. Money, including credit that would normally be used to buy commodities, has to shrink. That's the definition of deflation that we're analyzing here.
  3. People's preference for money has to be greater than their preference for 'things,' with commodities being very obvious 'things.' That is, faith in money has to be there or people will prefer to store their wealth elsewhere.

Regarding the first condition, Mr Martenson has this to say:

A key component of the deflation argument is that with credit shrinking, demand will drop, leaving excess market supply that resolves with lower commodity prices.”

This does not represent our position, which is based on the powerful impact of bubble psychology, rather than on supply and demand. In contrast, we would argue that for commodity price to fall a long way, and very quickly too, it is not necessary for supply to exceed demand, especially by any significant margin.

Changes in supply and demand do not typically occur rapidly, but changes in perception certainly do, and it is perception that drives markets. If the fundamentals of supply and demand were responsible for setting prices, we would not see price collapses over a matter of months, yet this is exactly what we saw in 2008. 

The dramatic move in 2008 from $147/barrel to under $35/barrel had essentially nothing to do with supply and demand, and everything to do with speculation shifting into reverse, in other words the implosion of a speculative commodity bubble.

The fact that the entire commodity complex showed essentially the same behaviour at the same time, and that financial crisis was becoming acute, strongly suggests that the fundamentals of any particular industry have little to do with prices in the short term, and that financial conditions are a major driver in their own right. 

We do expect demand to fall, and for this to have a depressive effect on oil prices further into the future, but we do not expect this to be the primary driver of price collapse in the short term. Our view is that both demand and commodity prices will fall as a direct result of financial crisis, in the form of an acute liquidity crunch, and that prices will do so far more quickly.

The real supply and demand economy responds over a much longer timeframe than financial effects. The ebb and flow of liquidity have been moving disparate markets in synchrony and we expect this to continue. See for instance the common May 2nd top in the S&P, the CRB Index and crude oil.

Speculation going into reverse should account for the majority of the downward price move we expect to see, which we anticipate will (temporarily) take prices below the 2008/2009 bottom. Since then, prices have once again been bid up on fear of shortages, as they were into the 2008 top. This is very typical for commodities.

Commodity bubbles form on the perception of imminent scarcity, which leads to additional money flooding into a sector on the grounds that future prices 'must rise', and that there are therefore profits to be made by betting on a rise. This response is accentuated where purchasing power is plentiful and leverage readily available, as during a period of credit expansion. The perception of near-term scarcity can then become a self-fulfilling prophecy. 

Acute fear of shortages gets ahead of itself, driving prices to unrealistic heights in a classic Ponzi structure that will collapse once the Greatest Fool (or most aggressive speculator) has committed himself, and there is no one left to drive the trend further in that direction. The speculative premium disappears, and then opposite dynamic asserts itself - speculation that prices will now fall, which becomes another self-fulfilling prophecy.

Speculative reversals are thus followed by a temporary undershoot, as we saw in 2008. Prices fall to well below where the fundamentals would place them - in the case of commodities perhaps to the cost of the lowest price producer. 

Mr Martenson says:

If it costs $70 - $80 to produce a new barrel of oil, the price cannot fall much below that for very long.

Production costs are very likely to fall in a deflationary environment, albeit not nearly as quickly as oil prices, meaning that many suppliers would be squeezed. The cost of the lowest prices producer could end up considerably below where it is today. Prices could temporarily undershoot even this level.

We have seen in North American natural gas markets, in the context of shale gas, that production can temporarily be maintained at unprofitable levels. We do not expect a downward price spike to extremely low levels to be maintained for long, however, because production costs falling more slowly than price will eventually drive producers out of the market, reducing the (temporary) excess of supply.

Approaching scarcity leads not to a one way trip to the moon in price terms, but to an exaggerated boom and bust dynamic, which we have seen in force since 2006. The fundamentals interact with perception, and the inevitable resulting herding behaviour, in complex, yet probabilistically predictable, ways. Movements in both directions can be large and rapid. Volatility, in response to fear and uncertainty, is the name of the game.

Markets are creatures of positive feedback, and commodities are no exception. It is not enough to understand the fundamentals. One must also understand how those fundamentals will interact with human nature at a collective level. As in quantum physics, the observer and the system are not independent. The view of prices as a function purely of supply and demand rests on the notions that markets are rational, efficient and omniscient, and that human effects are an irrelevant external factor.

We maintain that this view is a completely inaccurate description of reality. Human actions, particularly the collective actions of herding behaviour, cannot be assumed away - they must be viewed as an inherent, and indeed vital, component of the system. Human beings chase momentum, often in the absence of any real information at all. They jump en masse on to passing bandwagons on the assumption that someone must know what they are doing.

We regard markets as fundamentally irrational and driven by emotionally-grounded perception, not by reality. They exhibit an eternal tug-of-war between collective greed and fear that expresses itself in fractal patterns. This lends itself to technical analysis (based on Elliottwaves), but not of the kind mentioned by Mr Martenson in his article. Elliottwaves identify and rank different unfolding possibilities for market action. There are always many possibilities as fractals unfold at all degrees of trend simultaneously.

The highest ranked option will be the one that satisfies the greatest number of guidelines while violating no rules, but it is not always the highest probability option that plays out. What Elliottwave analysis does is to indicate higher and lower probability time periods for trend changes, and boundaries for interpreting subsequent price action in the context of different possbilities, providing advance warning of potentially significant moves. In conjunction with contrarian sentiment indicators, it is a powerful, if inherently probabilistic, tool.

Continuing on the supply and demand theme, Mr Martenson comments on the apparently insatiable demand of India and China:

What's new in this story today is the emergence of a couple of new economic powerhouses with billions of citizens as new participants at the resource table....We're seeing exactly what you would expect from a major economy expanding like crazy:  a rapidly growing, or, shall we say, exponentially increasing hunger for natural resources....Perhaps a slump in the Western economies will suddenly flood the world with enough resources to cause a commodity crash, but perhaps not....

....So on the first deflationist point that supply of commodities will soon greatly exceed demand, I have to conclude that until and unless we see China's and India's economies fall off a cliff, the impact of bringing an additional 2.5 billion consumers to the global buffet of natural resources will provide ample pressure to prevent a sustained crash in prices. Perhaps we'll experience a short-term correction, especially if the Fed is stingy with its still-unannounced QE III program, but a long-term crash seems highly unlikely.

We have said for some time that we do not expect the Fed to provide a QE3. Even if it were to attempt to do so, we are of the opinion that it would be a miserable failure. The previous rounds of quantitative easing occurred against the backdrop of a supportive rally, and rallies are kind to central authorities by making their actions appear effective. Rallies unfold on a temporary resurgence of optimism, which leads people to extend credence to their leadership.

This suspension of disbelief allows interventions to achieve apparent traction. Once this supportive psychological milieu gives way, however, and the larger down-trend is back in force, which it has been since May 2nd, optimism rapidly dissipates and disbelief reasserts itself. The actions of central authorities under such adverse conditions are very likely to appear incompetent and useless. Kicking the can further down the road under such circumstances will be exceptionally difficult.

Exponential growth, particularly in the form of a dramatic parabolic rise, as we have seen in India and China, is the hallmark of a bubble living on borrowed time. Exponential growth curves end in collapse, and those in India and China will be no exception.

In other words, it is not just western economies that are poised to experience a sharp reversal of fortunes, but the rapidly growing BRIC countries as well. They too have lived through massive credit expansions, with concommitant build up of unpayable debt, and like western countries, their bad debts are set to messily implode in credit crunch and demand crash.

They have focused on building an export economy during their expansion phase, and have benefited from a global consumption boom, but that is coming to an end. Much of the export capacity, built on bad debt, will prove to have been wasted capital as consumption collapse, and with it export markets.

As empires in the ascendancy, the difficulties of India and China are likely to be less intense and more transitory than the old imperial centres moving into decline. For this reason, their domestic demand is likely to recover far more quickly, although the death of their export markets will be an enduring factor that could yet take considerable time to overcome.

If by the time Indian and Chinese domestic demand begins to recover enough to overcome the loss of export-driven demand, global energy supply has been squeezed by low prices, we could expect a major price spike in the next few years on the continuation of the exaggerated boom and bust cycle continues. A potential future resource grab would accentuate this considerably. Prices for commodities such as oil could therefore bottom relatively early in this depression.

We at TAE are not failing to recognize in our arguments either resource limits or recent demand history in the BRIC countries. However, we are firmly of the opinion that it is primarily money rather than natural resources that we and others will find ourselves acutely short of over the next few years. Beyond that, we can expect resource limits to reassert themselves. In volatile times, different factors can become limiting at different times, and relative values can change almost overnight. The key is to anticipate these moves, which is far more challenging than merely extrapolating current trends into the future, as many analysts commonly do.

The second condition Mr Martenson cites is that money, including credit that would normally be used to buy commodities, has to shrink. His objection is that:

This explanation is especially problematic for me when it is used in an overly broad way by lumping all credit market debt into a single spot and then saying, "There. Look. It's fallen. Credit is down, and that's deflationary."....(Hey, credit has to be paid back at some point, right? So it's roughly neutral over the long haul.) 

As I pointed out previously, credit contraction is not deflationary, it IS deflation by definition. We not only regard this as inevitable, we would argue that it is already well underway. Credit began to contract in 2008 for the first time since WWII. Although it has bounced back to some extent with the rally from March 2009, it has not regained its peak. Now that the larger downward trend has resumed, we can expect credit contraction to reflect this, following a time lag for the contraction to appear in the data.

To argue that credit is neutral, since it has to be paid back at some point, is to miss an enormous impact between the begging of a credit expansion and the end of its aftermath. Credit has the effect of bringing demand forward and then crashing it thereafter. The effect may be neutral if one takes a sufficiently long term view, but that view would have to cover several decades of tremendous boom and bust. Averaging that out over such a period of time would be to miss the largest factor influencing commodity prices for a century, or indeed perhaps in history, and that seems highly counter-productive to the effort of understanding what is happening and why, and how it will play out from here.

The collapse of the Ponzi credit expansion of the last thirty years will crash the effective money supply, given that credit represents the vast majority of that money supply today. Credit represents excess claims to underlying real wealth. During the bubble expansion phase, the increase in claims to wealth greatly outstrips any growth in real wealth. The flip side of credit expansion is debt, hence during a credit expansion, debt becomes less and less well collateralized, and the real economy more and more hollowed out as a result. 

The blinding optimism characteristic of expansion keeps people from noting this fact until it is far too late to prevent a debt implosion that will proceed at least until the small amount of remaining debt is acceptably collateralized to the few remaining creditors.

The excess claims that credit represents will be largely eliminated under this scenario. Confidence and liquidity are equivalent. When confidence evaporates, as it does on the recognition of of an unpayable debt predicament, liquidity will shrink proportionately. This cannot help but reduce purchasing power. In fact, 'reduce' is a considerable understatement from the perspective of the vast majority of people.

The depression conditions that result from the bursting of a large bubble can virtually eliminate purchasing power for many, or perhaps most. Since the aftermath of a bubble is roughly proportionate to the excesses that preceded it, and this has been the largest bubble in human history, we can expect an extremely severe depression to follow.

Mr Martenson distinguishes between the effect of credit expansion and contraction on financial assets versus the effect on the consumer price index (CPI), suggesting that the two are independent, and that effects in the financial sector have little effect on the real economy: 

The trouble I have with this view is that not all credit has the same impact on demand. Some credit leads to demand that directly impacts the CPI (inflation), and some does not. When we are talking about inflation, what most people care about is the price of things they use or consume (cars, food, gasoline, health care, houses, etc.), rather than financial instruments or paper assets (stocks, bonds, derivatives, etc.)....Whether credit-default swaps (CDS), traded within and among the shadowy world of purely financially motivated entities, are trending up or down in price has almost zero impact on the price of molybdenum or corn.

It is difficult to imagine how the disappearance of access to credit, combined increased debt burden on spiking interest rates, skyrocketing unemployment, falling (and highly insecure) incomes, loss of pensions and other entitlements, loss of investment value as asset prices collapse, and loss of savings to a systemic banking crisis, all of which are typical of deflationary episodes, could possibly fail to have a dramatic impact on people's collective purchasing power. 

The tremendous potential impact on purchasing power in turn cannot help but impact upon the ability of people to convert their wants into what they can actually afford. It is not that people will no longer want commodities, or many other goods and services, but that they will not be able to afford them in anything like the previous quantity. Demand is not what one wants, but what one is ready, willing and able to pay for. For a time, supply will be geared to the previous level of demand, leaving a substantial surplus that should weigh on prices for a significant period of time. 

The odds of people being able to pay what they once could for commodities under such circumstances are effectively nil. It is as if we were playing a giant game of musical chairs, where there is only one chair for every hundred people playing the game. When the music stops, most will be out of the 'game' after a short but chaotic wealth grab.

If we see a resurgence of demand in BRIC countries sooner rather than later, perhaps accompanied by future price spikes and resources grabs, the firming up of price support at that time would almost certainly price a large number of people in depression-gripped western countries out of the commodity market entirely, since their purchasing power would not have recovered. This would be a recipe for significant socioeconomic unrest in a large part of the world.

Mr Martenson asserts that:

"There's been $3 trillion of new credit created in the consumptive portion of the economy since the start of the financial crisis in 2008, and it's almost entirely thanks to government borrowing. Not too shabby.”

We would argue that demand supported by government borrowing is entirely artificial, amounting to a further episode of bringing demand forward at the expense of the future. This cannot be realistically argued to be a positive effect on the global economy going forward, as it will result in a further paucity of future demand, and consequent downward price pressure. The future pain in store for suppliers, and the probability of a consequent future supply squeeze, are amplified by this action.

Mr Martenson's third condition involves the demand for money versus the demand for tangible stores of value. He suggests that we should bear in mind the shift from perceived value of paper assets towards commodities and other real assets. While we would agree that over the long term such a shift will indeed take place, our view is that we are about to see a sharp reversal of this trend in the short term. Cash is king in a deflation.

In our view, we are going to see a rapid and substantial shift towards a desire to maintain liquidity, on the grounds that liquidity represents uncommitted choices, and that people will be anxious to maintain their freedom of action to respond to massive uncertainty. This is likely to last into the medium term (ie probably a number of years). It is absolutely vital to anticipate this type of trend change. Extrapolating past trends forward is simply not good enough.

Mr Martenson points to measures of monetary expansion as evidence that deflation is not in fact occurring:

There is absolutely nothing deflationary in the M2 chart. It is exactly what we would expect to see from a culture that placed a man at the monetary helm on the basis of his promise (Jackson Hole, 2002) to run the printing presses if deflation came knocking.

We would argue that expansion of narrow measures of money are largely irrelevant, since they are dwarfed by credit contraction over the same period, and deflation is defined as contraction in the supply of money plus credit. Also,it cannot be ignored that the velocity of money is plummeting, which is characteristic of the developing economic seizure we anticipate in a depression. This will resemble Dante's Ninth Circle of Hell - a frozen lake where nothing moves.

Gustave Doré Satan trapped in the frozen lake Cocytus in the Ninth Circle of Hell 1857
Illustration for Dante Alighieri’s Commedia [Divina]: Inferno

To cast a different light on the purported expansion of the tiny (relative to credit) 'money' fraction of the effective money supply, consider that the expansion of M2 likely reflects not traditional money printing, but capital flight from Europe in response to the eurozone crisis.

Larry Kudlow for the National Review - 
The Deflationary M2 Explosion:
Amidst the financial flight-wave to safety, with stocks plunging, gold soaring, and Treasury bond rates collapsing — and all the European banking fears which go with that — there’s an important sub-theme developing: An almost-forgotten monetary indicator, M2, which is mostly cash, demand-deposit checking accounts, savings deposits, and retail money-market funds, has been soaring. 

According to the St. Louis Fed, M2 is up 24.2 percent at an annual rate over the past two months. Almost out of the blue, that comes to a near $500 billion increase. In rough terms, the M2 explosion breaks down to $165 billion in demand deposits and $335 billion in savings deposits. 

What’s going on here? There’s a flight to government-guaranteed accounts. Some people believe Europeans are withdrawing from their own banking system and parking their money in the U.S. banking system, guaranteed by Uncle Sam. Kelly Evans reports in her Wall Street Journal column of a $30 billion outflow from equity mutual funds that has probably gone into cash. 

This is a very disconcerting development. Normally, big M2 growth would signal a faster economy, and maybe even higher inflation. But as economist Michael Darda points out, the velocity, or turnover, of money seems to be plunging. 

"The recent pickup in broad money in the U.S. looks like a dash for risk-free cash assets," writes Darda. He also notes that widening corporate-credit risk spreads and shrinking government-bond rates signal a recession risk, not a coming boom. 

So contrary to monetarist theory, the M2 explosion seems more closely related to a deflation/recession risk. Economist-blogger Scott Grannis writes, "The recent growth of M2 surpasses even the explosive safe-haven demand for money that accompanied 9/11 and the financial crisis of late 2008. Something big is going on, and it can only be the financial panic that is sweeping Europe as money flees a banking system that is loaded to the gills with PIIGS debt." 

Grannis concludes, "In short, it looks like there is a run on the European banks and the U.S. banking system is the safe-haven of choice.

The game changed on May 2nd. We need to consider where we are now headed and why, and the answer is a long way from anything remotely resembling our comfort zone. The sea-change involved in the resumption of the credit crunch cannot be underestimated.

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Time to stop torturing Greeks
by Mary Ellen Synon - Daily Mail

You've already read it on the news pages, but I wonder if you've spotted the puzzle: the Greek government has confirmed it will miss its 2011 deficit projections, and GDP will fall by over 5 percent this year and by 2.5 percent next year. The news has rattled the financial markets.

Got it?  The puzzle is why the markets were in anyway surprised by any of that: of course the deficit projections have been missed, and of course the GDP will go on falling. That is all that could happen in Greece under the EU regime of extreme forced deflation. What else were the markets expecting from Athens -- fiscal rectitude and growth while the world heads into recession and Greece is trapped in a deadly currency union?

There is another puzzle, too, and that is why the Greek prime minister can only look at the suffering of his country under the Brussels-enforced scheme and instead of rebelling and saying 'Enough!' he just goes on with the abasement of his nation. He looks at the ruin of debt, unemployment, and misery his country's agreement to 'save the euro' has brought, yet all he can say is: 'We will be unswerving in our goal: to fulfill all that we have promised to ensure the credibility of our country.'

So, to save his country's 'credibility' in the eyes of the ideologues of Brussels -- because heaven knows he is not saving its credibility in the eyes of international investors -- Papandreou is willing to oversee the destruction of his country's economy.

It's getting spooky, as if the man's brain has been taken over and reprogrammed by a cult. What he needs to say is: 'Enough of this torture. Time to leave the euro.'

At least, that is what Charles Dumas of Lombard Street Research is saying this morning, and I'd say he is dead right: 'How long before the malignant euro-fanatics give up on the nightmare of a unified Europe? Most previous attempts to unify Europe have led to mass murder. It is time for Euroland authorities to return to reality and give up their deluded visions, rather than torture Greeks.'

Why Europe Is Right and Obama Is Wrong
by Michael Sauga - Spiegel

US President Barack Obama has recently suggested that Europe must take on more debt to stimulate the economy. Such reliance on cheap money, though, is what got us into the current crisis in the first place -- both in Europe and in the US. America's problem isn't too little money. It's a lack of competitive products.

"The Broken Jug" is one of the most frequently performed plays in German theater. With the village judge Adam, who passes judgment on a crime he committed himself, Heinrich von Kleist created one of the classic comedic figures of world literature.

US President Barack Obama currently seems to be portraying a modern version of Kleist's village judge. He is increasingly vocal in his criticism of Europeans for supposedly having exacerbated the ongoing economic crisis with their caution. His audience, however, seems to sense that the plight Obama is lamenting originated in his own country.

It stems from a doctrine that has dominated economic thought for the last two decades and consists of two elements: turbo-capitalism, whose only tenet is that any regulation of financial markets inhibits growth, and its more accommodating but no less dangerous brother, turbo-Keynesianism.

American economists, central bankers and fiscal policy makers have reinterpreted British economist John Maynard Keynes's clever idea that government spending is the best way to counteract a serious economic downturn -- and have turned it into a permanent prescription. In their version of the Keynesian theory, declining growth or tumbling stock prices should prompt central banks to lower interest rates and governments to come to the rescue with economic stimulus programs. US economists call this "kick-starting" the economy.

Laying the Groundwork for the Next Crash
The only problem is that this method of encouraging growth has not stimulated the US economy in recent years, but in fact has put it on a crash course. From the Asian economic crisis to the Internet and subprime mortgage bubbles, economic stimulus programs by monetary and fiscal policy makers have regularly laid the groundwork for the next crash instead of encouraging sustainable growth. In the last decade, the volume of lending in the United States grew five times as fast as the real economy.

Cheap money created the fertilizer for the excesses of the US financial industry. Low interest rates seduced mortgage providers into talking even the homeless into taking out mortgages. And the same low rates made it easier for investment banks and hedge funds, using increasingly risky loan structures, to transform the once-leisurely insurance and bond markets into casinos.

Now the bubble has burst. This has not, however, prompted the US government to conclude that its prescriptions could have been wrong. On the contrary, now it wants to increase the dose. Obama plans to follow the largely unsuccessful 2008 economic stimulus program with a new program this year. Meanwhile, Federal Reserve Chairman Ben Bernanke says that he intends to flood the economy with cheap liquidity -- for years, if necessary.

The real problem, though, is a different one. The US economy doesn't lack money. Rather, it lacks products that can compete in the global marketplace. The country has a deep trade deficit, yet the Obama administration is borrowing money at the same rate as near-bankrupt Greece.

A Rapid End
Not even the financial sector, with its affection for cheap money, believes that this is the way to guide the United States out of the crisis. When the Fed recently announced a new version of its low-interest-rate policy, with the snappy name "Twist," it led to a sharp decline in the stock market instead of the expected boost.

It is all the more disconcerting that Obama is now recommending that the Europeans emulate his failed strategy. To save the euro, the president has proposed that Europe take on more debt to augment their bailout funds and stimulate their economies. Like a doctor caught prescribing performance-enhancing drugs, Obama has not chosen to cease his activities. Rather he is trying to ensure that as many people as possible have access to his wares.

The fact that Europeans are unwilling to comply with Obama's strange logic gives reason for hope. It makes no sense to pile up more and more debt on already unstable piles of debt. The world doesn't have too little debt, but too much. Obama should retract his advice, or he might end up like the village judge in Kleist's comedy. When his deception was discovered, he was forced to flee and his days as a judge came to a rapid end.

Germany won't give more to bail-out fund
by Skynews

German Finance Minister Wolfgang Schaeuble has ruled out Germany contributing any more money to the beefed-up EU bail-out fund than the 211 billion euros ($A294.51 billion) approved by parliament.

'The European Financial Stability Facility has a ceiling of 440 billion euros, 211 billion of which is down to Germany. And that is it. Finished,' he told the magazine Super-Illu in an interview published on Saturday.

He also suggested the European Stability Mechanism, which is due to replace the EFSF by 2013 at the latest, would be smaller. 'Then it will be only a matter of 190 billion in total, for which we will be guarantors, including interest,' he explained.

Germany's lower house of parliament, the Bundestag, on Thursday approved the beefing up of the eurozone bailout fund, which cleared its final hurdle on Friday when it was rubber-stamped by the Bundesrat (upper house).

The vote had been seen as a crucial test of Chancellor Angela Merkel's authority amid fears of a backbench rebellion. However she secured an overwhelming majority of her own deputies to back the move. A majority of Germans (58 per cent) consider it was a mistake to boost the EFSF, according to a poll to be published on Sunday in the weekly Bild am Sonntag.

German Foreign Minister Guido Westerwelle said he wanted the debt-ridden countries put under tighter surveillance in an interview given to Saturday's Sueddeutsche Zeitung. 'A right to scrutiny and make recommendations isn't enough. The states, which in the future will benefit from the solidarity of the rescue fund, should give the European authorities the right to intervene in their budgetary decisions,' the minister said.

Protectionism beckons as leaders push world into Depression
by Ambrose Evans-Pritchard - Telegraph

The world savings rate has surpassed its modern-era high of 24pc. This is the killer in the global system. It is why we are at imminent risk of tipping into a second, deeper leg of intractable depression.

The International Monetary Fund (IMF) expects the savings mountain to rise yet further next year as the governments of Europe, Britain, and the US tighten belts, in unison, by up to 2pc of GDP. This is double the intensity of the last big synchronized squeeze in 1980.

They will do so before the private sector is ready to grasp the baton, and without stimulus from the trade surplus states (Germany, China, Japan) to offset the contraction in demand. Put another way, there is a chronic lack of consumption in the world. "This probably comes as a surprise to most people, gorged on propaganda about excessive debt and the need for retrenchment," said Charles Dumas from Lombard Street Research.

The inevitable outcome of one-sided austerity polices in the Anglo-sphere and Club Med is a self-feeding downward slide for the whole global system, a variant of 1930s debt-deflation. "Excess savers refuse to acknowledge that if world savings are demonstrably too high, healthy recovery depends on the surplus countries saving less," he said.

Mr Dumas said China's "grotesque and destructive" policies of over-investment (50pc of GDP) and under-consumption (36pc of GDP) are unprecedented in history, but at least China's currency advantage is being eroded by wage inflation.

His full wrath is reserved for the "fallacious and malignant policies" of Angela Merkel and Wolfgang Schauble in Germany. They are enforcing a Gold Standard outcome on the whole eurozone. "Suffused with self-righteousness, they insist that the imbalances must be put right only by deficit-country deflation."

The sheer scale of global imbalances is made clear in a paper by Stephen Cecchetti at the Bank for International Settlements. His paper contains a chart showing that combined surplus/deficits reached 6pc of world GDP in the boom, far beyond the extremes that led to the US losing patience in 1985 and imposing the Plaza Accord. The gap narrowed post-Lehman but is widening again.

Money flows are even more out of kilter. Cross-border liabilities have jumped from $15 trillion to $100 trillion in fifteen years, or 150pc of global GDP. This creates a very big risk.

"Gross financial flows can stop suddenly, or even reverse. They can overwhelm weak or weakly regulated financial systems," said Mr Cecchetti. Well, yes, this is now happening. Did anybody think about this when they unleashed globalisation with its elemental deformity, free trade without free currencies?

The self-correction mechanism is jammed. China holds down the yuan against the dollar through a dirty peg. Germany and its satellites hold down the D-mark against Club Med covertly through the mechanism of EMU.

This outcome in Europe is not deliberate (I hope); it is not a German plot; it is the unintended effect of a currency union created by ideologues against Bundesbank advice, and which has calamitous implications for German foreign policy and for Latin social stability.

My sympathies go to the hard-working citizens of Germany, Spain, Italy, Portugal, and Ireland for being led into this impasse by foolish elites. A global system biased towards export dumping has had unhappy effects on the US, UK, and Club Med. These countries have faced a Morton’s Folk over recent years: an implicit choice between job losses at home, or accepting credit bubbles to mask the pain.

They chose bubbles. That was a mistake. This strategy of buying time cannot safely be repeated because fiscal woes are already near "boiling point", in the words of the BIS. “Drastic improvements will be necessary to prevent debt ratios from exploding," it said.

Bank of England Governor Mervyn King called recently for a "grand bargain" of the world's major powers to break the vicious circle and ensure that the burden of adjustment does not fall on debtors alone. "The need to act in the collective interest has yet to be recognised. Unless it is, it will be only a matter of time before one or more countries resort to protectionism. That could, as in the 1930s, lead to a disastrous collapse in activity around the world," he said.

We are not there yet, but a global double-dip would take us to the edge. US democracy cannot allow America’s precious stimulus to leak out to countries that have bent their exchange rates, tax systems, and industrial structures towards predatory export advantage. It cannot let broad (U6) unemployment ratchet up to 20pc or more. If the White House will not do it, Congress will. Capitol Hill is already launching its latest bill to label China a currency violator, and open the way for retaliatory sanctions.

"They get away with economic murder and thus far our country has just said, 'Oh, we don't care. This legislation will send a huge shot across China's bow,” said Senator Chuck Schumer. The risk – or solution? – is that the US will opt for a variant of Imperial Preference, the pro-growth bloc created behind tariff walls by the British Empire with Scandinavia, Argentina and other like-minded states in 1932. This experiment has been air-brushed out of history by free trade hegemonists.

One can imagine how this might unfold. North America would clamp down on dumping, at first gingerly, before escalating towards a cascade of Smoot-Hawley tariffs and barriers. Mexico and Central America would join. Brazil and Mercosur would find it irresistible because that is where the demand would be, and BRIC solidarity would wither on the vine.

By then you would have the US recovering behind its wall, while surplus states were recoiling from severe shock. Britain would face the moment of truth, offered salvation in the `Pact of the Americas’ or slow asphyxiation by trade ties to EMU’s deflation machine. Portugal and Spain would face the same fateful choice. This is how the EU might end.

Ultimately, America would get its way. Korea and the Asian Tigers would come knocking. The austerity brigade and mercantilists would be shut out until they capitulated. The rules of world trade system would be redrawn.

The IMF's Christine Lagarde understands the risks intuitively. The global economy is entering a "dangerous new phase", she warns. Leaders must prepare for "bold and collective action to break the vicious cycle of weak growth and weak balance sheets feeding negatively off each other". Central banks must stand ready to "dive back into unconventional waters as needed."

But how many infantry divisions does the IMF command, to paraphrase Stalin? Power resides in the G20, where debtors and creditors have radically contrasting views. The body cannot even start to offer a solution.

A US double-dip is not yet a foregone conclusion. America’s M3 money supply is last growing decently again at 5.6pc, which would in normal circumstances signal some recovery next year. The latest GDP and confidence data in the US have not been as bad as feared.

Ajay Kapur from Deutsche Bank said investors have to decide whether the market slump of recent weeks is a “panic like the LTCM sell-off in late-1998 that proved to be a great buying opportunity, or the first leg in what could eventually be a pervasive global recession. We believe it is the latter.”

He said the triple warnings from US leading indicators (ECRI, the Philly Fed’s 'Anxious Index', and the earnings revision index) all point to recession, while China is “probably over-tightening” into a global slump.

In Europe, policy is still on deflationary settings, with Italy and Spain having to tighten fiscal yet further to meet their budget targets. The European Central Bank is overseeing a collapse in real M1 deposits in Italy of around 6pc, annualized over the last six-months.

Michael Darda from MKM Partners said the ECB has made such a hash of monetary policy that nominal GDP for the whole eurozone may even start to contract. That is astonishing. If correct, there is no hope of averting a debt spiral in Italy and Spain. Any such outcome will test the EU’s bail-out machinery to destruction within months. Mr King’s “disastrous collapse” is staring policy-makers in the face.

If it doesn't do something about its underwater mortgages, America could sink without trace
by Heather Stewart - Observer

Stimulating the economy is all very well in the short term. But the national legacy of unpayable property debt will weigh the US down for years

It's now more than six years since Alan Greenspan, in the days when he was still known as the "maestro" of the world economy, conceded that there might be a little "froth", perhaps even a few "local bubbles", in the American housing market.

Subsequent events showed that he was a master of understatement, but not of much else. The sub-prime frenzy, which had seen cut-price loans to borrowers with dodgy credit histories squeezed through the slice-and-dice operations of Wall Street banks and sold on as top-quality investments, had helped to inflate an almighty bubble right across the US. When home prices started to decline, it triggered a worldwide credit crunch and what became known as the Great Recession; but it also took a painful toll on American society.

House prices have bounced back marginally from the depths of 2009, but they remain more than 30% below their peak. In some cities, where the boom was at its wildest, prices have fallen even further. In Las Vegas, for example, homes bought at the height of the sub-prime frenzy are now worth 59% less than their purchase price. So it's not surprising that more than one in five mortgage-holders are in negative equity, and many thousands of Americans have lost their homes.

Even the merest glimpses of Washington, caught between the IMF's glass-and-steel headquarters and the brownstones of Georgetown on a week-long visit last month, revealed a much larger than usual number of rough sleepers and vagrants huddled in doorways or begging on street corners – just the most visible manifestation of the ongoing social and economic crisis.

And while the world's eyes are on Athens, where state employees are facing yet another pay cut to satisfy the demands of the international bond markets, life on Main Street, USA is as tough as it has been in many years. The stagnant housing market continues to erode families' wealth and saddle them with ever more unpayable debts.

President Obama's ambitious jobs package, announced last month, is a valiant attempt to tackle the recalcitrant problem of unemployment, which remains above 9%. But even if he manages to get the plan past a ferociously partisan Congress, where his proposal to increase the marginal tax rate for millionaires has been described as "class war", it's unlikely to deliver a permanent solution to the economic malaise unless the housing market can be stabilised and the legacy of mortgage debt resolved.

Ben Bernanke at the Federal Reserve is trying to do his bit: Operation Twist, his latest wheeze, is directly aimed at driving down long-term interest rates and making mortgages more affordable, while the Fed is also continuing to invest in mortgage-backed securities to stop the credit markets drying up.

But the Fed's powers are limited, especially with conspiracy-minded Republicans breathing down Bernanke's neck. Just as in poor old Greece, the underlying problem in the US housing market is that the debts run up in the years of plenty will be a millstone around the neck of the economy for many years – and may ultimately be impossible to repay.

Even the IMF, hardly known as a champion of aggressive government intervention, said in its latest world economic outlook that Washington should try to find ways of writing down the value of some of these overblown loans.

"The large number of 'underwater' mortgages poses a risk for a downward spiral of falling house prices and distress sales that further undermines consumption and labour mobility," it warned, calling for courts to be allowed to write off a proportion of mortgages where borrowers have got themselves in trouble; for the taxpayer-backed mortgage guarantors Fannie Mae and Freddie Mac to encourage writedowns; and for an extension of state-level programmes to support troubled homeowners.

Each of these would be controversial, and they carry a risk of "moral hazard": the fear that reckless borrowers will in future feel they can take on eye-watering loans and assume the state will bail them out. But the alternative may be years of stagnation. Just as in Europe, pumping up short-term demand is fine, but tackling the legacy of a decade-long credit glut must be the starting point for stabilising, and ultimately rebuilding, the American economy.

Eurozone fix a con trick for the desperate
by Wolfgang Münchau - FT

We are now in the stage of the crisis where people get truly desperate. The latest crazy idea, which is being pursued by officials, is to turn the eurozone’s rescue fund into an insurance company, or worse, a collateralised debt obligation, the financial instrument of choice during the credit bubble. This is the equivalent of putting explosives into a can, before kicking it down the road.

To illustrate the danger of the CDOs as a solution to the eurozone crisis, it is important to recall a few facts about what happened during the credit bubble. CDOs lured investors to put money into mortgages. The CDOs themselves had triple-A credit ratings, even though they invested in bad assets.

What at first appeared to be a violation of the laws of economics, physics and logic, ultimately had a simple explanation. The overall risk of the CDO was lower than the sum of its parts. When the bubble burst, governments stepped in and prevented a catastrophe.

So why use such a toxic instrument to construct a product to save the eurozone? The current lending size of the European financial stability facility (EFSF) is €440bn, which is equal to the guarantees given by the 17 eurozone member states. If you want to leverage the CDO without increasing the liabilities of governments, then this €440bn would become the equity tranche of the new CDO.

The equity holders in the CDO are supposed to be the ultimate risk-bearers. You can leverage the structure by creating more senior tranches of bonds that would be open to outside investors. You could expand the structure further through a mezzanine layer – which carries less risk than that of the equity tranche but more than that of the senior bonds. You could look at those senior tranches as eurozone bonds.

The big difference between a eurozone CDO and a subprime CDO is the the nature of the backstop. When the eurozone CDO fails, there are no governments that can bail it out because the governments themselves are already the equity holders of the system. This leaves the European Central Bank as the last man standing.
But the whole idea of setting up a eurozone CDO is to avoid this outcome.

If you wanted an ECB-backed solution, you could simply grant a banking licence to the EFSF, which would make it eligible as an official central bank counterparty. I also like George Soros’ idea to focus the eurozone rescue fund solely on bank recapitalisation, in addition to a mechanism that allows eurozone countries to issue short-dated discount bonds at low interest rates.

Both solutions rely heavily on active co-operation by the ECB. Unfortunately, Europe’s central bank may not accept such a role because of the way it interprets its mandate, as described by the Maastricht Treaty and its own statutes.

The real reason why European officials are pursuing the CDO option is to get round this technical obstacle. Remember that one of the main reasons why banks created CDOs in the first place was “regulatory arbitrage”, as it was euphemistically known at the time. In that case, the idea was to circumvent capital adequacy rules. CDOs allowed banks to push risky assets off their balance sheet, which gave more room to make further loans.

In the case of eurobonds, the idea is also to circumvent Article 123 of the European Treaties (which says that the ECB must not monetise debt); the ECB’s governing council; the German Constitutional Court; as well as the Bundestag and other national parliaments. What better instrument than a opaque CDO to get round those inconvenient obstacles of democratic opposition, constitutional law and international treaties.

Do not get me wrong: I am in favour of an enhanced EFSF. The current mechanism is not big enough to protect Italy and Spain, and inject fresh capital into eurozone banks. That would require a lending ceiling three of four times the current size. But we cannot get there through dirty financing tricks that have demonstrably failed in the past. If this CDO were to collapse, the eurozone might face an imminent break-up that could trigger a global financial crash.

If you accept the political and legal constraints as a given, there are no easy policy options left. There exist only two categories of solutions to the crisis: a fiscal solution or a monetary one. Politics blocks the first, European law blocks the latter. The CDO is an alluring idea from the perspective of a technocrat who has to come up with something that satisfies current political preferences and that respects perceived or actual legal constraints.

On the surface, it appears as if a CDO was a third category in itself. But that is not the case because it ultimately dumps the burden on the ECB, just as the subprime mortgage CDOs became a liability for governments.

As I have argued previously, European laws and current political preference are inconsistent with the survival of the eurozone. Something will have to give. A CDO is not a solution to the crisis. It is the last confidence trick in the toolbox of the truly desperate. The eurozone is about to kick the can a final time.

Dexia on brink as France and Belgium work on lifeline
by Dylan Lobo -

French and Belgium officials are working around the clock to provide beleaguered bank Dexia a lifeline.

The Franco-Belgium bank, which narrowly avoided a collapse in the 2008 crisis, continues to face major headwinds due to the freeze in inter-bank lending markets and its high exposure to Greek debt. The bank needs to find away to dispose of another €20 billion of bad debt after managing to dispose of around €80 billion worth of toxic loans since the credit crunch.  

Reports suggest ministers from France and Belgium are set to meet to discuss a rescue package for Dexia as the possibility of a Greek default grows by the day. The situation has become even more critical after the Greek government warned it would miss it deficit targets.

The French banking system is close to breaking point due to its relatively large exposure to Greek debt, along with other weak members of the eurozone. On 14 September Moody's downgrade Credit Agricole and Societe Generale, while BNP Paribas was put on review for a potential downgrade.

Dexia put on downgrade watch
by Stanley Pignal - FT

Dexia, the Franco-Belgian banking group, on Monday was put on a negative downgrade watch by Moody’s, which cited concerns about a further deterioration in its liquidity position.

The three main operating entities of the Brussels-based group are being targeted for a possible re-rating, which would come on top of a downgrade in early July. Shares in Dexia dropped 9 per cent in morning trading on the news.

Moody’s said “worsening funding conditions in the market” for banks triggered its new stance and reiterated its July concern. “In Moody’s view, Dexia has experienced further tightening in its access to market funding – even to short-term unsecured funding – since the most recent rating action on 7 July,” it said.

Dexia is majority owned by the French, Belgian and Luxembourg governments and state-led bodies such as the Caisse des Dépôts et Consignations, the French sovereign wealth fund. It has traditionally been the biggest operator in the funding of French municipalities, but also runs sizeable retail networks in Belgium and Turkey.

The bank said last week it was “continuing to examine strategic options”, amid press reports that it is actively engaged in talks with France’s Banque Postale and the Caisse des Depots to form an alliance which would help secure its funding.

Dexia declined to comment on the reported moves or on Monday’s downgrade. But people close to the group acknowledge that the current financing situation is “strained”, as short-term markets on which it relies for part of its financing have dried up .

The markets situation has caused a slump in the value of French banks, which are also being hurt by their holdings of Greek sovereign debt. In the last three months, Dexia’s shares have fallen 40 per cent to €1.33. BNP Paribas shares have fallen 48 per cent and Société Générale 56 per cent in the same period.

Dexia has ample capital reserves under the Basel II framework, and passed the recent stress tests with a core tier one ratio of 10.4 per cent. But it is short of tangible equity, another measure of capital favoured by analysts, with only about €5bn left.

Dexia was one of the first European banks to be bailed out in 2008 due to its unorthodox funding strategy, which involved making long-term loans to municipalities funded by short-term borrowings on the financial markets. The same strategy laid low Britain’s Northern Rock, a major mortgage lender.

“The negative [Moody’s] review comes at a time when Dexia is still facing challenges on how to fund its operations. These are to some extent felt by all banks, but Dexia is more exposed because it still has significant short-term financing needs,” says Matthias De Wit, analyst at Petercam, a brokerage.

Dexia’s management, including Jean-Luc Dehaene, a former Belgian prime minister who acts as Chairman, and chief executive Pierre Mariani, a former top aide to French president Nicolas Sarkozy, have the job of de-risking the bank, even at the cost of sacrificing short-term profitability. The bank’s actions are also constrained by the European Commission, which as an antitrust watchdog has imposed strict operating conditions on Dexia.

Banking crisis set to trigger new credit crunch
by Harry Wilson - Telegraph

The global financial system is on the edge of a new credit crunch as the cost of insuring the bonds of banks across the world hits new highs, analysts have said.

Credit default swaps on lenders as far afield as China and Australia, countries that until recently seemed immune to the chaos, have doubled in the last two months to levels not seen since the financial crisis.

In Europe, French and Belgian government officials are due to meet on Monday to discuss the crisis enveloping Dexia as speculation mounts about a possible break-up of the Franco-Belgian lender. Last week, the cost of insuring Dexia bonds hit an all-time high of 900 basis points, nearly double the level just two months ago, meaning the annual cost to insure €10m (£8.59m) of the bonds is £900,000.

"The money ran out in June and what you are seeing now is the beginning of a new credit crunch, except this time it will be truly global, not Western," said one senior London-based credit analyst. Dexia, along with other European lenders, has been hard hit by the closure of the interbank lending markets and the continuing unwillingness of investors to buy the bonds of eurozone banks. "Nothing is really working at the moment. None of the markets are functioning. Until Greece defaults it's hard to see any resolution," said one senior London-based credit analyst.

In China the publicly quoted cost of insuring the bonds of its three lenders for whom prices are available all closed on Friday at the highest levels in more than two years. Credit default swaps on Bank of China bonds have more than doubled since the beginning of August and hit 316.53 basis points at the end of last week, their highest level since March 2009, while the lender's shares hit a 12-month low.

"The worries on China's banks are around the slowdown in growth, however, the symptoms are the same as those we are seeing in Europe," said Simon Adamson, a banks analyst at CreditSights.

A report published last week by CreditSights drew attention to the growing problems of the Chinese banking sector, with some estimates putting the proportion of the lenders' loan books that are non-performing at more than 40pc.

Australian banks, which have been major users of wholesale funding markets, are among those getting caught in the new crunch. Credit default swaps on the bonds of National Australia Bank and Australia and New Zealand Banking Group are not far off double the level they were just two months ago and last week reached 12-month highs.

Markets remain unconvinced that European politicians are capable of dealing with the region's problems. Greece was yesterday reported to have missed the deficit cutting target set for it by the EU and the IMF as part of the terms of its bail-out. According to Reuters, the Greek budget deficit will reach 8.5pc of GDP this year, missing a target 7.6pc.

An emergency meeting of eurozone finance ministers will today meet in Luxembourg to discuss the progress of Greek reforms that are necessary to secure the next €8bn tranche of bail-out money. Greece is to unveil new austerity measures.

Mad Hatter's tea party that is the eurozone crisis
by Larry Elliott - Guardian

Alice in Wonderland has nothing on the absurd world of Europe's financial policymakers

Curioser and curioser, as Alice said in her adventures in Wonderland. The longer the crisis in the eurozone has gone on, the more it has come to resemble something penned by Lewis Carroll.

Here are just a few of the surreal aspects of the current state of affairs. The answer to a lack of growth in struggling countries such as Greece is austerity of such ferocity that recessions deepen. The solution to a financial crisis caused originally by the over-leveraging of banks and individuals is to turn Europe's bailout fund into a leveraged €2tn hedge fund.

Meanwhile, many of the politicians in Britain who battled long and hard to keep the pound – George Osborne and Ed Balls to name but two – are now born-again evangelists for full fiscal union. How to make sense of all this? It's hard, but as the king says as he presides over the court in Alice in Wonderland: "Begin at the beginning and go on till you come to the end: then stop."

Monetary union was born out of two developments: the idea that there should be ever closer union in Europe and the breakup of the postwar fixed exchange rate system in the early 1970s. The idea was that member states would pool their monetary sovereignty to form one currency that would have one interest rate set by one central bank. Architects of the grand design argued there would be multiple benefits from the new arrangements: Europe would grow closer together, it would become more stable and it would grow faster.

To those who insisted that a one-size-fits-all monetary policy would never work, and that slower, asymmetric growth would lead to the build-up of economic and financial pressures, the response from those banging the drum for the single currency was classic Carroll: "No, no! Sentence first – verdict afterwards."

Predictably, the stresses and strains inherent in a monetary arrangement that involved yoking together countries as diverse (not just economically but culturally) as Germany and Greece, Portugal and Finland, Austria and Spain quickly manifested themselves. The weaker countries on the periphery saw their costs of production rise more rapidly than those at the core, and gradually became less competitive as a result. Although Europe as a whole saw its trade balance remain close to zero, Germany ran a hefty trade surplus at the expense of Italy, Spain and Greece.

Speculative orgy
Just as China recycled its trade surplus into the global economy through the purchase of US treasury bonds, so Germany's surplus headed south to fuel property bubbles in Spain and to finance excessive borrowing by Greece. The actions of China and Germany kept the speculative orgy going for a while, but only by making the eventual hangover worse.

In the days before monetary union, a country that had seen its competitiveness eroded had an easy, if not painless, remedy. It would devalue its currency, making its exports cheaper and its imports dearer. Inflation would go up and structural weaknesses would be ignored, but it was a way of rubbing along. Inside the single currency, there is only one way a country such as Greece can compete with Germany and that is to lower the cost of the goods and services it produces.

That means lower wages, smaller pensions and deep cuts in public spending. And not just for one or two years: the adjustment process within monetary union involves decades of austerity. For the Greeks and the Italians, the message is jam tomorrow and jam yesterday but never jam today.

The climax of Alice in Wonderland is the courtroom scene in which the issue is "Who stole the tarts?" In the case of the eurozone, the easy answer is that it is Greece, which failed to play by the rules, borrowing too much and cooking the books so that the rest of the members of the single currency club were ignorant of the dire state of the Hellenic public finances.

In fact, the real culprit is Germany, which has failed to appreciate that for monetary union to work, the big creditor nations have a responsibility to help the debtor nations by expanding domestic demand. The German political class appears to believe both that every country in the euro area can be as competitive as Germany and that Germany, in those circumstances, will continue to run a massive trade surplus. That's a logical absurdity the Reverend Dodgson would certainly have appreciated.

To make matters even more deliciously weird, Berlin now faces a dilemma. The crisis in the euro area has been allowed to fester for the best part of two years, allowing the contagion to spread from Greece to other peripheral countries. As a result, the cost of cleaning up the mess has grown enormously. The first bailout for Greece in May 2010 was just over €100bn.

By the time of the emergency eurozone summit in July 2011, it was deemed necessary to expand the European financial stability facility to create a €440bn fighting fund. Two months or so later, the perception is that Europe will need to have €2tn, perhaps even €3tn, to face down the financial markets.

It is unclear, as yet, how European policymakers intend to turn one euro into five, but it seems to involve setting up a special purpose vehicle backed by Germany and France. At its core will be the EFSF, which will be underpinned by financial guarantees from Berlin and Paris. The EFSF will not be increased from €440bn, but will be used as collateral to expand the scale of bond purchases to support the weaker states.

Even assuming the rating agencies are happy with this (and they may not be), Germany and France would be putting their creditworthiness at risk. Put simply, they would be betting the farm on a highly leveraged special purpose vehicle. Deja vu, anyone?

Yet the alternative does not look all that attractive either. Germany could, in theory, declare that it was no longer prepared to write the bailout cheques for the rest of Europe. It could start printing some lovely new deutschmarks or perhaps start exploratory talks with the Austrians, Finns and Dutch about a hardcore euro made up of half a dozen broadly convergent economies.

But even assuming this could be achieved without plunging not just Europe but the rest of the global economy into a second Great Depression (and it probably could not), the upshot would be that German banks would face potentially ruinous losses on a wave of sovereign debt defaults, while German exporters would be priced out of overseas markets because the new DM would appreciate sharply on the foreign exchanges.

Up until now, policymakers have solved this dilemma by refusing to admit that it exists. The assumption has been that the events of the recent past have all been a bad dream from which Europe will wake up. Only recently has it been recognised that the single currency really is plunging down a rabbit hole and is going to hit the ground with an almighty bump.

And to those who say that out of the wreckage will emerge a full-blown fiscal union that Britain stands apart from at its peril, the adventures of Alice provide the perfect riposte. "If everybody minded their own business," said the Duchess, "the world would go round a good deal faster than it does."

Is Germany's Finance Minister Going Rogue?
by Laura Gitschier, Peter Müller, Christian Reiermann and Michael Sauga - Spiegel

He used to be regarded as Germany's safest pair of hands when it comes to the euro crisis. Now, criticism of Finance Minister Wolfgang Schäuble is growing within the government parties. Some believe that Schäuble wants to exploit the crisis to push through his vision of a United States of Europe.

A pall of silence fell over the German parliament as Finance Minister Wolfgang Schäuble went up to the lectern last Thursday. The debate over the expansion of the euro backstop fund, the European Financial Stability Facility (EFSF), had already been going on for over an hour. Previous speakers addressing the Bundestag had tried their hand at a number of different roles. Schäuble's predecessor in office, Peer Steinbrück of the left-leaning Social Democrats (SPD), had tried to present himself as a European statesman, whereas Rainer Brüderle, the parliamentary floor leader for the business-friendly Free Democratic Party (FDP), had vehemently attacked the opposition.

Now, it was the turn of Schäuble, a member of the center-right Christian Democratic Union (CDU). He feigned the honest broker who tries to mediate between the parliament's legitimate demand to have a say in such important matters and the exigencies of international political crises. "No one here sees this as an easy decision," he said. The question at hand, he continued, is whether politicians are capable of "controlling these developments."

The government, it seems, is certainly able to exercise control, at least when it comes to maintaining discipline within its own ranks. German Chancellor Angela Merkel and Peter Altmaier, the conservatives' parliamentary secretary, exchanged congratulatory text messages after winning the key Bundestag vote on the euro bailout fund: "Our efforts paid off."

Two things became clear at the end of last week -- a week that many pundits had prematurely predicted would spell the end of the center-right coalition of the CDU, its Bavarian sister party the Christian Social Union and the FDP. First, the government can rely on its own parliamentary majority to push through euro bailout legislation -- at least for the time being. Second, Merkel's finance minister, of all people, has sown doubt about the government's crisis management. In the days running up to the vote, Schäuble needlessly fueled a debate over expanding the euro backstop fund, and his comments sparked renewed tensions within the coalition.

Keeping His Cards Close to His Chest
FDP parliamentarians have long been convinced that the finance minister is not playing with an open hand, and that he would prefer to force them out of the coalition. But there has also been an increasing amount of discontent over Schäuble among the ranks of the CDU/CSU parliamentary group. Quite a number of his fellow conservatives accuse him of undermining their rights as parliamentarians and forging agreements on a European level that he largely keeps under wraps at home. The CSU even suspects that the finance minister is paving the way for a European super-state, something that the Bavarians strongly oppose.

This criticism is directed at one of the last political heavyweights in Merkel's cabinet. For months now, Schäuble has topped the opinion polls as one of Germany's most popular ministers. No one else on the nationwide political scene enjoys such high regard, even across party lines. The Germans believe that if anyone can steer the country through the perils of the euro crisis, it's Schäuble, with his extensive experience in political maneuvering. The veteran party and parliamentary group leader stands at the twilight of his career and doesn't have to prove anything to anyone anymore -- and is not aspiring to any position.

This makes him a formidable figure, but it also feeds his longstanding tendency toward arrogance and his penchant for political intrigues. Many conservative parliamentarians, regardless of their position on the common currency, feel as if they are being treated with contempt. His statements made during the euro crisis have rarely been unequivocal; he always leaves himself a way out. Not only does this confuse his political friends and foes, it also flusters the financial world, with its propensity for panic.

Many German politicians are also insinuating that he has a hidden agenda. They fear that one of the last fully committed supporters of the European project is taking advantage of the crisis to advance his dream of a United States of Europe -- at almost any price. Even the chancellor is sometimes annoyed by the finance minister's moves.

Pithy German Wisdom
Schäuble's antics last week were a perfect example of his modus operandi. It began with business as usual. At the fall meeting of the International Monetary Fund (IMF) and the World Bank in Washington, the finance minister used quaint German phrases to broach the topic of the crisis in the euro zone. Referring to the fact that every country in the monetary zone is first and foremost responsible for the soundness of its own finances, he recited a quotation by Goethe: "Let everyone sweep in front of his own door, and the whole world will be clean."

Schäuble finds himself irresistible at such moments. He is not bothered by the fact that foreigners and representatives of the international media who he is addressing have no idea what to make of such Teutonic pearls of wisdom.

To make matters worse, Schäuble often doesn't even adhere to his own admonishing axioms. "Silence is golden," he decreed in Washington, a reference to the need to avoid panicking markets with loose talk. But then he heedlessly allowed himself to be drawn into a dangerous debate over whether the EFSF could get a banking license and leverage its assets to borrow even more money from the European Central Bank (ECB).

Most of his German predecessors in office would have rejected such notions with indignation and referred to Germany's traumatic experiences during the 20th century, when governments printed money to finance public expenditure, causing the value of the currency to plummet.

Merkel Intervenes
Not once, however, did Schäuble clearly reject the proposals, which had been spearheaded by his American counterpart, US Treasury Secretary Timothy Geithner. Instead, he talked about alternatives to a banking license, which would make it possible to achieve similar leverage effects. Schäuble did not exactly say just what these alternatives might be, but he did mention that Berlin is considering bringing forward the launch of the European Stability Mechanism (ESM), the permanent bailout fund for the euro zone, from 2013 to 2012.

In addition to being imprudent, Schäuble's comments showed bad timing. Ironically, during the very week in which the coalition was struggling for a parliamentary majority to extend the reach of the euro backstop fund, Schäuble was publicly contemplating yet another reform of the initiative.

German Vice Chancellor Philipp Rösler, the leader of the FDP, is appalled. "Granting a banking license to the European bailout fund would be the wrong approach," he says, adding that such a step could be interpreted as a sign "that the finance minister has been given a license to print money." It took an intervention by the chancellor herself to clear up the matter. She informed Schäuble that there would be no solution that involved integrating the ECB.

Concealing His True Intentions
The chancellor and her supporters had spent weeks ensuring that the center-right coalition government could muster an outright majority in favor of the euro backstop fund. In exchange for their votes, parliamentarians were offered significantly greater oversight of EFSF operations. Everything was going well -- until the finance minister made his botched appearance in Washington.

Just how much is at stake for the chancellor was made clear by a comment that she made, almost in passing, as she ended her speech to the conservatives' parliamentary group last Tuesday. Merkel told them that she didn't want to be dependent upon the votes of the two main opposition parties, the SPD and the Greens, who had both pledged to support the bill. Then, she made a direct appeal to her parliamentarians, saying she couldn't allow that to happen because "I still have far too many plans for us." In other words: She wants to continue to govern with the current coalition.

However, there has long been much speculation within the ranks of the coalition over whether the finance minister shares that goal. Schäuble has repeatedly indicated his support for a so-called grand coalition with the SPD, similar to the one that ruled German between 2005 and 2009. His ongoing tendency toward secrecy has caused much consternation within the coalition. Recently, for instance, the finance minister only shared his first draft for the new EFSF agreement with the parliamentary floor leaders of the different parties and a number of interested politicians.

By contrast, Schäuble didn't say a word about it to the CDU/CSU parliamentary group. A senior member of the parliamentary group caustically commented that Gregor Gysi, the floor leader of the far-left Left Party, "knew about it before Schäuble's own colleagues in the CDU."

Once again, the coalition parliamentarians had the feeling that they were the last ones to be informed by the minister. And, once again, they discovered that Schäuble was using a torrent of words and statements in an attempt to conceal what he is really planning and thinking.

Bag of Tricks
Schäuble's political style is also characterized by a good deal of posturing. No other politician in Berlin can so convincingly play the innocent bystander, and no one is better than the finance minister at deflecting attention from his own mistakes.

Last Thursday, as the entire country was talking about the idea of leveraging the bailout fund, he profusely vented his indignation in front of the FDP parliamentary group about others who had supposedly broached this dangerous issue. He told them that he was "exceedingly" annoyed that Olli Rehn, the European commissioner for economic and monetary affairs, was making "such proposals." Then he spelled out his position: "We are not increasing the scope of the fund; we are merely safeguarding the €440 billion." This still leaves Germany with a liability risk of €211 billion, he said. "I am not committing to anything beyond that, just so you don't later accuse me of telling you something that isn't true."

That certainly sounded convincing, but Schäuble had merely demonstrated another tactic from his bag of tricks as a seasoned politician: the denial that isn't actually a denial. At issue here was not whether the fund would be expanded even further, but whether there were plans to pursue clever leveraging with the volume available. "On Thursday, the parliamentarians were voting on a black box," says CDU financial expert Manfred Kolbe, who voted against the EFSF ratification.

Indeed, it is now already clear that, along with the planned guarantees for €440 billion, a considerably larger sum of money will also be mobilized among banks and insurance companies to support, if necessary, Italy and Spain, should Greek Prime Minister Georgios Papandreou be forced to declare his country bankrupt.

Increasing Risk
It would work like this: The EFSF fund would promise investors that if they purchase Italian or Spanish government bonds it would cover, say, up to 20 percent of their loses. This would render the bonds from these countries more attractive to investors, making them more willing to make fresh money available.

The effective financing volume of the bailout fund would thus increase fivefold. If the fund were to cover 25 percent of losses, the firepower of the EFSF would be ramped up by a factor of four. What makes this solution so appealing is that, according to government lawyers, the entire process could take place within the legal framework of the euro backstop fund, and its regulations would not have to be amended and passed by the Bundestag again. The approval of the parliament's budget committee would suffice. Nevertheless, this approach would further increase the government's credit risks.

Furthermore, the idea of granting the EFSF access to money from the central bank is still on the table, despite the fact that Merkel has tried to put a lid on the issue. Schäuble has been extremely coy about revealing his preferences, but others are openly calling for the move. Within the European Commission, Olli Rehn is the staunchest backer of this scheme, while among the member countries of the monetary zone the idea is embraced by France and the ailing peripheral countries.

Just Amend the Treaties
The notion is certainly not opposed by everyone at the ECB, either. The head of the Austrian central bank, Ewald Nowotny, is open to this approach, ECB Vice President Vítor Constâncio from Portugal supports it, and future ECB President Mario Draghi, an Italian, has no objections.

By contrast, current ECB President Jean-Claude Trichet rejects it, along with Jens Weidmann, the president of the German central bank, the Bundesbank. It is also opposed by Jörg Asmussen, the ECB's future chief economist, who is currently serving as a state secretary in the German Finance Ministry. Not even Klaus Regling, the German in charge of the Luxembourg-based EFSF, likes the idea.

Opponents of the scheme have legal concerns. They say that such a plan violates European treaties that prohibit the ECB from propping up national finances. Schäuble remains undeterred by such objections. If need be, he says, the treaties simply have to be amended. He sees Europe's current crisis as merely a stage on the road to even greater integration.

'European Dreams'
Not only is the FDP shying away from Schäuble's course, but the CSU is also annoyed. This was patently evident at the meeting of the CSU parliamentary group last Monday. The finance minister's comments in Washington were still fresh in everyone's mind, and the mood was understandably dour. Bavarian governor and CSU leader Horst Seehofer was irked that Schäuble had once again propagated his vision of a United States of Europe. Seehofer knows that this position is unpopular at home. In fact, Bavaria even amended its state constitution to make it perfectly clear that the CSU would only accept a "Europe of regions," said Seehofer.

This was followed by a statement that couldn't have been clearer: "Thus far and no further," the CSU leader proclaimed. He is concerned that the euro bailout policies in Berlin could jeopardize his party's success in the upcoming Bavarian state parliamentary election.

The CSU is still trying to pin Schäuble down. "It's still unclear to me what the German finance minister is angling at," says Georg Nüsslein, the economic policy spokesman for the CSU parliamentary group. "If Schäuble wants to realize his European dreams in this crisis, then he is no longer doing his job justice."

Schäuble's fellow cabinet member, German Interior Minister Hans-Peter Friedrich, who is also a member of the CSU, has clearly distanced himself from the finance minister. "Anyone who concludes from the current debt crisis that European centralism now has to be bolstered has embarked on the completely wrong path," he says. All across Europe, even in Germany, there is a growing sense of euroskepticism, he adds. "This cannot be countered by stripping even more powers from democratically elected national parliaments and governments."

The government may have survived yet another vote last Thursday, but the hurdles will be even higher next time around.

Banks plan a full-on assault on regulators
by Brooke Masters and Tom Braithwaite - FT

The industry is preparing a full-on assault on a deal regulators see as the best way to prevent future financial meltdown – and the question is whether the accord will be left with enough teeth

Two weeks ago , the simmering battle over how to make the financial system safer turned nasty.

On one side: Jamie Dimon, chief executive of JPMorgan Chase, one of the world’s largest banks and one of the few institutions to emerge from the financial crisis relatively unscathed. On the other: the silver-tongued Mark Carney, formerly of Goldman Sachs, now governor of the Bank of Canada. He too was speaking from a position of strength because the banks he supervised survived the turmoil of 2008 in good shape.

The setting for the showdown was the National Archives building in Washington, the grand neoclassical home of the American constitution, the Bill of Rights and a copy of the Magna Carta. But the document that sparked the fight was a much more modern affair – one that curtails freedom rather than guarantees it.

Basel III, named after the Swiss-based international committee of regulators that issued the rules, is a complex package of reforms designed to make banks more resilient and less likely to need taxpayer rescue in future. It forces all lenders – particularly the largest – to build up buffers of equity, cash and liquid assets to protect themselves against unexpected losses or another market crisis.

According to some of the 30 or so people gathered in a meeting room at the archives, Mr Dimon lambasted Mr Carney – complaining vehemently that the Basel committee’s plan to subject his own and other large institutions to even higher capital requirements than those faced by smaller peers was ill-thought-out and economically and philosophically wrong. He also insisted that some provisions discriminated against US banks.

European bankers were left wide-eyed by the outburst but many of them have been launching their own, usually quieter, attacks on Basel III from the other side of the Atlantic. They argue that parts of the liquidity and capital rules unfairly penalise their universal banking model, which combines both insurance and banking in a single group and is found mainly in France and the Benelux countries.

The ill-tempered exchange in Washington was more than a lone instance. Behind complaints about level playing fields, the entire industry is warming up for a full-on assault on the Basel deal, which was hailed last year as the single most important step towards preventing the next financial Armageddon. The next year or so could determine whether that accord will be left with enough teeth to reshape banking fundamentally – or cease to be worth the paper it is written on.

“The large banks are seeking to undo the relatively moderate progress that has been made on improving regulation thus far, using the very economic crisis they helped trigger as an excuse,” says Sony Kapoor, managing director of Re-Define, a financial think-tank.

As the bankers see it, they are preserving the already shaky world economy and the global financial system. Forcing them to hold more capital and low-yielding liquidity will, they say, make many of their business lines unprofitable and drive up costs for customers. The Institute of International Finance, an industry group, estimates that the reform package could push up borrowing costs by 3.5 per cent, cut global output by 3.2 per cent by 2015 and cost 7.5m jobs.

Regulators see it differently. To them, the real threat comes from an unreconstructed industry still addicted to short-term funding that can dry up at the drop of a hat. They also argue that profits remain too dependent on risky derivatives and proprietary trading. Their “impact studies” suggest that enforcing a build-up of capital would trim growth only mildly in the short term. Any pain would be far outweighed over the long run by the benefits of stability.

“The crisis is akin to a heart attack for banks. Some people would like to go on smoking and drinking, but what we are asking banks to do is have the same market discipline as non-banks,” says Tom Huertas, who represented the UK in many of the Basel talks.

Supervisors are also adamant that forcing banks to shore up their capital over time, rather than paying out earnings in staff bonuses and shareholder dividends, is the correct thing to do.

The Basel committee, a group of regulators from 27 large economies, late last month reaffirmed its plans to slap a surcharge on big international banks, forcing them to hold extra capital on top of the global minimums set last year. That means JPMorgan, for example, must hold top-quality capital equal to 9.5 per cent of its assets weighted for risk – whereby the riskiest loans need to carry more capital against them than safer assets.

“If some institutions feel pressure today, it is because they have done too little for too long, rather than because they are being asked to do too much, too soon,” Mr Carney said in a speech two days after Mr Dimon’s verbal onslaught. Too bad, says the industry, but no surprise. Mr Carney was just target practice. The only hope, according to several senior executives, is that politicians will ride to the rescue.

Bankers now want to reopen, or at least delay the implementation of, last year’s overall Basel III deal, arguing that to adopt it would be to kill off the nascent economic recovery. With world leaders scheduled to endorse the big bank surcharge at a meeting of the Group of 20 leading nations in Cannes in November, they sense that time is running out.

At the same, time lobbyists are making the case to legislators and national regulators in charge of implementing Basel III in each country that changes are needed to make sure their local banks are not disadvantaged.

On this level, the banks are starting to score some successes. In Europe, the draft version of the regulation that would enshrine Basel III in law includes a clause that would make it easier for French banks to count the capital in their insurance subsidiaries towards their overall total. With the market already suspicious about French banks’ resilience, the change would help them keep their capital ratios – an important measure of bank strength – high.

The EU draft also appears to gut the “leverage ratio” – a measure backed by the US and UK that seeks to keep banks from bulking up their total assets in relation to their equity. High leverage has been cited as an important reason for the 2008 collapse of Lehman Brothers.

The cap on insurance subsidiaries, meanwhile, formed part of a grand trade to tighten up the definition of what could be counted as capital – again a response to problems uncovered in the financial crisis, when many items previously classified as capital turned out to be useless. If the French win their special category, then what, observers ask, is to stop the Germans, Japanese and Americans from doing the same?

The various moves have alarmed some global banks that would prefer a single set of consistent standards to a raft of local rules, even if some are more favourable. “It opens the door to everyone else cheating too,” says one weary industry lobbyist.

American banks are also starting to gain local traction with some of their complaints – particularly Mr Dimon’s allegation that European lenders are manipulating the way they measure risk in order to reduce their capital requirements.

Under Basel rules, the amount of capital a bank needs depends on the size and riskiness of its assets – and banks are allowed to use their own internal models to measure risk. Yet the difference between a group’s risk-weighted assets and its unweighted total assets varies considerably by institution and by country, suggesting that some may be cutting their capital needs by understating their risk.

Mr Dimon and other US bankers are convinced their European counterparts are cheating, a charge that has drawn some sympathy from Barney Frank, the senior Democrat on the House of Representatives financial services committee. “It’s plausible to me that there could be some manipulation on the risk-weighting,” he says. He fears some European countries might weaken the regulation in practice by undervaluing risk.

On this gripe, US banks have not only the likes of Mr Frank behind them but also a number of regulators. Andrea Enria, head of the European Banking Authority, expressed concern at the variation in risk-weights that EU banks used during stress tests that produced results the market branded laughably positive. A UK pilot project to test bank models also found enormous differences.

Last week the Basel committee announced plans to conduct a formal study of the issue, to decide once and for all whether some banks and their regulators are fiddling the figures. It is also to put out report cards highlighting when countries put the rules in place and when they depart from them.

Bank complaints about the liquidity rules are also starting to bear fruit. The eurozone sovereign debt crisis has certainly boosted the argument that the definition of safe assets – which included the bonds of countries such as Greece – needs a fundamental rethink. The Basel group has agreed to speed up planned adjustments to the way this requirement is calculated to “provide greater market certainty”. The changes could please banks by broadening the kind of assets they can count and reducing the overall amount they have to hold.

Time is the bankers’ best hope. If the global economy is still reeling next year and in 2013, governments may be more willing to take the fetters off the big banks. If Barack Obama fails to win a second presidential term in 2012, a Republican White House may be more sympathetic.

For now, however, most regulators and politicians are still in favour of standing up to the banks, particularly on the fundamental question of capital requirements. Mr Frank, for instance, has no interest in ditching the capital surcharge that so angers Mr Dimon – and insists he does not want the rules to be watered down, just made fair.

The global redrawing of financial regulation should, he says, be “a race to the top and not the bottom”.

There are four key elements to the Basel III deal aimed at making banks more able to survive unexpected losses or funding problems and less likely to need taxpayer rescue.
The rules will be fully phased in by 2019.
  • Capital Banks must have top quality (“core tier one”) capital equal to 7 per cent of assets, adjusted for risk, or face restrictions on paying bonuses and dividends.
  • Surcharge The biggest “systemically important financial institutions” have to carry an extra 1-2.5 per cent in capital, for a total of up to 9.5 per cent of risk-weighted assets.
  • Liquidity Banks have to keep enough cash and easy-to-sell assets to survive a 30-day market crisis.
  • Leverage The ratio of core tier one capital to a bank’s total assets, with no risk adjustment, may not exceed 3 per cent.

Impact of regulation: Business shifts towards the shadows
For all their Sturm und Drang over capital rules, banks are still only feeling their way into how their businesses will be changed, writes Tom Braithwaite.

This much is known: big, risky, long-term loans all become more costly to finance. “Much of the capacity that used to be available quite liberally is not there anymore,” says Tyler Dickson of US lender Citigroup. “The golden age of bank capital funding almost everything is over.”

He sees some activity that is currently financed on banks balance sheets – loans for big infrastructure schemes such as bridge-building, for example – migrating to a model where it is originated by banks but then syndicated to investors.

Some business is also moving to the so-called “shadow banks” – hedge funds, private equity firms, insurers and other institutions that provide bank-like activity but with lighter supervision. In Washington last weekend Gary Cohn, Goldman Sachs president, said clients were already moving because “the banks ... need to charge a substantially higher rate than other unregulated or third-party capital providers are willing to provide that money at”.

He added: “If you take a look back into the 2008 crisis in the United States, some of the biggest bail-outs were into the shadow banking system not into the regulated banking system. I know people want to forget that, but it’s just a fact.”

Global regulators are aware of the dangers of making banks safer only to drive risk to less transparent parts of the system. But although it is an area that attracts attention – for example in speeches this month from Bill Dudley, president of the Federal Reserve Bank of New York, and Mark Carney, governor of the Bank of Canada – there is little sign of action.

New US law does allow regulators to designate shadow banks as systemically important, subjecting them to standards of transparency and safety similar to those faced by their banking counterparts. AIG, the insurer that received a massive bail-out at the start of the financial crisis in September 2008, has been earmarked, as has GE Capital, the financing arm of General Electric that was a heavy user of cheap government funds during the crisis.

With the threat of closer regulatory scrutiny, few in the shadow sector want to crow too loudly that they are taking business from the banks. But they are – and the repercussions for the system’s safety remain, well, shady.


scrofulous said...

Martin Armstrong interview on King World News.

Ashvin said...

I'm glad Stoneleigh decided to rebut Chris Martenson's latest attempt at undermining the deflation argument with respect to commodities, which was yet another analysis supporting the "stagflation" scenario, a.k.a. the most unlikely of all possible outcomes. Although many analysts still confuse high inflation with potential HI, they are entirely distinct events. Prolonged deflation will give way to currency collapse, without any sustained period of stagflation before or in between.

scandia said...

@Stoneleigh, Thank-you for your wonderful essay. I especially appreciated your phrase, " debt becomes less and less well collateralized." I think, by the way, you are the first of the pundits to shine the spot light on collateral quality.
I had just been reading on ZH
" ...Finland will indeed get the Greek collateral it desires only it will be in the form of worthless Greek bonds that can't be touched for 15 or so years..." If that deal is acceptable collateral then one has to wonder about other collateral on the books keeping the system afloat.
The Finnish people just got screwed big time.
The Quatari were smart enough to trade a Greek rescue in dollars for gold bullion.

Jim R said...

Karl Deninger says the seize-up is starting _now_.

I'm sort of wondering how low silver will go. The silver-bugs are buying any they can get when it goes below $30.

If it goes to $15, will you be able to find a broker who will sell it to you for anything less than a 100% premium?

NZSanctuary said...

Subgenius/Bluebird from the last thread - further to that Brooklyn Bridge incident, I see the media are playing their part to manipulate public perception: It only takes 20 minutes to shift the blame

Ashvin said...

Urban Roman,

The farther we travel down the debt deflationary path, the more acute the risk of physical shortages which lead to increasingly high premiums on PMs, IMO. I believe that risk is much higher for gold than silver, since the former is primarily demanded for its ability to act as a long-term wealth reserve, while the latter is also demanded for a wide range of industrial purposes. I think these premiums would only become a significant barrier to acquiring physical once prices come down 50-75% from current levels.

rapier said...

The primary reason most people do not understand the foundational role that credit has in producing GDP growth, is that if you accept that credit produces most growth then you have eliminated all the conceits that the winners claim for themselves. Meaning the winners always assume they win because of hard work and smarts etc. etc. This holds true for individuals, organizations and nations. Nobody enmeshed in the system wants to face the possibility that all the metrics of success they believe in are not the result of superior intellect of hard work but simply the result of borrowing and creating money. Very few want to face that possibility. To accept that is negate most of what those holding power and wealth, and those who circle below them are.

Many would chose death, figuratively if not literally, rather than admit the system they believe in isn't the system we actually have. When Fed and the government fail to 'fix' our economic problems you can be sure most will not embrace a reassessment of the system but will continue to believe that continued failures are simply the result of policy errors.

This is particularly evident in so called neo liberal circles. The nativist right and large portion of 'Movement Conservatives' tend to punt on monetary and macro issues because they believe if social conditions aligned with whatever it is they want, no abortions and a balanced budget and so on, then the economy would take care of itself.

The latter group is beyond reasoning with but to a large degree so is the former.

el gallinazo said...

Urban Roman

If it (silver) goes to $15, will you be able to find a broker who will sell it to you for anything less than a 100% premium?


The retail holders will sell it back into the market when they hit 97 pounds. As to the brokers, no need to assume that have unlimited fiat to price fix the market unless they are connected to the Fed at the back door. Also silver is much more a commodity/industrial metal than gold and has suffered from centuries of contempt as money by the elites. What was the largest denominational bill in the US backed by silver (as opposed to gold)? The Cowardly Lion was crucified on a cross of gold when he attempted to garner the Presidency and make silver money. Silver will be well under $10 an ounce in less than 4 years (unless we up the production of cruise missiles by 1000%).

Jim R said...

97 pounds of silver or 97 pound silverbugs?

(formerly known as DIYer, I have chosen the nym I used to join ZH, as I like this one better)

progressivepopulist said...

Have you seen the cover on the most recent issue of The Economist? Cute.

agtefc said...

@ Stoneleigh...

Good Evening. :)

Well done!

The clarity and flow of your writing is a wonderful thing to witness... In addition to empirical evidence, logic, and explanatory power of course.

A devastating rebuttal.

Ilargi said...

Added an interview with yours truly at the top of the post, also available here:

Ilargi Interview with Alex Smith of Radio Ecoshock, October 3 2011


Stoneleigh said...

Comments open.

Nassim said...

Comments open

Well past my bedtime. :)

Asmita said...

Ilargi: Pension are ponzi schemes....
You will always need fresh input...

Alex Smith: But that can't happen because in many western countries there are fewer younger people working than the baby boomers.

Ilargi: This is where we say bingo


Clarity and Brilliance and Humor.

Please speak more, Ilargi!

Jack said...

I also like video/audio interviews.
Because I can listen to them while I exercise.
Thanks Ilargi
Stoneleigh also has good video/audio
I like that.
Maybe Ash can make a few, I am sure many people would like that.

Ashvin said...

It will be interesting to see how the markets react to Benny's statements today. I suspect him to repeat the same old stuff about a "possibility of further easing if economic conditions continue to get worse", but if he makes any stronger statements without committing to anything, I would still expect the markets to remain weak. That would be a great example of what Stoneleigh repeated in today's post - the Fed is useless.

el gallinazo said...


I wouldn't say that the Fed is completely useless. It is quite useful in transferring the money of the 99.9% to the 0.1%.

Ashvin said...

El G,

True. I just meant useless in terms of stimulating risk appetite again, like it had done in 2009-10.

Ashvin said...

Senator Bernie Sanders went pretty hard on Benny about growing wealth inequality and why the Fed keeps supporting large TBTF financial institutions, instead of allowing the government to break them up before the next panic (which has arguably already started) and/or the Fed lending to small businesses...

Benny said something like, "I'm concerned about that stuff, but I can't do anything about it".

el gallinazo said...

Yeah, Bernie, the (formerly) socialist senator from the Peoples Republic of Vermont is one of the better guys.

For the second day straight we are seeing a huge "gap" between the SPX and the DAX, though today truly hugisimo of 4%. Did Benny make various hopeful sounds including belches, hiccups, coughs, and farts to inspire our ever optimistic USA markets?

ogardener said...

The Myth Of Bernie Sanders

RobM said...

My two favourite people battling it out with grace and intellect. What could be better? Best of all we get to see who is right very soon. Personally, I think they are both right. Defaulting debt vaporises both the paper money and the future physical wealth it represents. Into this debt deflation we have been and will continue to print. These printed dollars will chase non-discretionary stuff. So we will have deflation (very little money) and rising prices for the things we need (food, energy).

el gallinazo said...


Stoneleigh is the first to put forward that products of essential need will maintain higher prices than luxuries or frivolous items. In terms of "price inflation" as expressed in nominal terms, few items in the USA will actually increase in nominal price once deflation really kicks in. (Actually, deflation really kicked in a while ago but has been hidden by fraudulent, mark to fantasy accounting. What is occurring now, first in Europe, is that this mark to fantasy is collapsing as the casino banks must pay cash on the barrel head or go running to their political enablers.) Petro based products could be the exception not too far down the road as she explains in detail in various essays in regard to how peak oil versus peak finance will play out.

I think this point may well be the most important to understanding and surviving the near term collapse. Prices for most things, even most essentials, will decrease, but earning power will decrease much faster. Essentials will become more expensive in regards to the household budget. Debt which cannot be defaulted on will increase exponentially in real terms while staying the same in nominal terms. This is why getting out of debt is numero uno in the life boat.

BTW, Mish pointed out in a recent article that while approximately half the states appear to be non-recourse states in respect to mortgages, only nine of them prevent lenders from going for judgments against holders of mortgages who do a jingle mail, and then the lenders/banks sell the house. The lenders go after the former mortgagees for the difference, which is often very large as well as gigantic fees and usurious annual interest. Actually, the banks usually don't go after borrowers but sell the debt for pennies on the dollar to Vinnie the Horse for collection. If one is in a situation where jingle mail appears to make sense, be sure to consult a knowledgable (and honest if possible) attorney first.

seychelles said...

EG said

".... ..consult a knowledgable (and honest if possible) attorney first."


el gallinazo said...


I just read your comment again, and wanted to add this. You are describing "stagflation." First of all, the Fed is not printing money in the sense that Weimar or Zimbabwe has. It is extending free credit to its cronies and owners. The friends have been using the credit to speculate with, essentially doubling down on their previous losing bets. Most of this money doesn't go into the real economy, but rather speculative assets as stocks or commodities. Admittedly, this speculation in commodities has caused some price inflation. Some of the money is scammed on dumbamerica by the banks borrowing at zero interest and then parking the money in long term treasuries, paying 2-3.5%. Nice swindle if you can get it. Beats paying 30% on your credit cards.

The current "crisis" though is being caused by mark to fantasy accounting breaking down. The banks are insolvent, and when they legally must pay up, they have to sell something. And when they do sell something, suddenly the items switch from mark to fantasy to mark to market. So any free money that the banks will get from their enablers in the future will probably go directly into zombie life support and not speculation. I wouldn't bet on stagflation.

Additionally, things have reached the point this week where banks and hedge funds are blowing up which will kick in the CDS derivatives. The writers of these derivatives never expected to have to pay off on them prior to their retirement to that isolated Caribbean island villa. They have no reserves with which to pay off as opposed to insurance companies in the somewhat regulated, pre-fraud economy. This is a positive feedback loop which can only continue to accelerate. Meaning that the recipients of free credit from the central banksters and politicians will need the free credit to continue their zombie excuse of an existence and will have little to spare for further speculation. Of course they can still write derivatives as this doesn't cost anything as long as you don't pay off.

BTW I, el Buzzard, am offering a $100 million CDS on Greek debt at a very attractive price of $5000 down. Don't miss this opportunity to hedge against losses. Just send your checks to el Gallinazo at Banco de los Bandidos, Navojoa, Mexico. Thank you for your patronage. And for the first hundred customers I am also offering a vegematic, a toaster, and a Passbook to Heaven. :

AdvanceHeating said...

It's good to see the NYSE is putting its shoulder to the wheel. They're investing their hard earned margins in a boost to our economy. Their vision will bring - and just in time to where it's needed - greatly appreciated finance to our close knit international community of businesses:

Still trying to work out whether the following gag on the discovery of post-Einstein neutrino's actually works, or if it's just too soon to tell...

"...We don't allow faster-than-light neutrinos in here," says the barman. A neutrino walks into a bar...

Fascinating article on picking apart the physical and psychological influences on bubbles and money/credit supply, Stoneleigh. I'm amazed that we have the luxury of observing and commentating this all in such slow motion. Nice one.

My search for a safe deposit account did not end successfully at last week's trip to the local Co-operative store with cheque book in hand. The funds I might have placed in my Co-op share holder's account would be completely exposed to the survival of the Co-op in a crash, and even in these relatively good times there was no crush of customers fighting over the goods for sale. As I can't see the genuinely worthy Co-op suddenly becoming the nation's favorite compared to discounter Aldi in a crash, I have remained the rather guilty-feeling owner of just one Co-op share (£1).

When planning ahead for bank runs, unfortunately storing cash is a topic that makes little sense to research or publish on the Internet.


doctorbob said...

Hi Stoneleigh,

Thanks for an excellent article, though yours always send a shiver through me. A question, or rather a few on the same theme. What sort of timescale are we talking about before deflation really hits hard and sends the buying power of people in western Europe - and prices of commodities such as oil sharply down? A few weeks ago when asked where we were right now in relation to the 1930s, you said '1937'. I was intrigued by what you meant by this - what do you see happening in two years or so from now, the equivalent of 1939? Are we talking about major wars, social dislocations that would have the same effects or something else?

Keep up the good work.

Dr. M.

RobM said...

el gallinazo,

I understand and agree with most of what you are saying. There is no doubt that asset prices will collapse. Where we differ I think is on rising prices of non-discretionary items like food and energy. About 1 out of every 2 dollars the government spends is printed or effectively printed since the debt will never be repaid. I expect this printing to increase as people take to the streets and elections approach. So while the macro story is deflation and depression, I expect printed money to push the price of essentials up.

el gallinazo said...

Rob said...
el gallinazo,

About 1 out of every 2 dollars the government spends is printed or effectively printed since the debt will never be repaid. I expect this printing to increase as people take to the streets and elections approach. So while the macro story is deflation and depression, I expect printed money to push the price of essentials up.


Time will tell. But I disagree with your theory. Defaulted debt is defaulted credit meaning that it disappears from the money - credit supply. This, in fact, is the core basis of the collapse. Credit that the Fed extends and that manages to enter the mainstream of the economy would have an inflationary effect. However, this is minuscule compared to the credit disappearing from the shadow banking and banking systems. As previously mentioned, the reality of this disappearance has been partially hidden by fraudulent accounting, but as counterparties demand cash payments, these games of hide the salami are falling apart.

Ilargi said...

"Rob said...
Best of all we get to see who is right very soon. Personally, I think they are both right."

Stoneleigh and Martenson can't both be right, they argue polar opposites.


scrofulous said...

"So while the macro story is deflation and depression, I expect printed money to push the price of essentials up."


"The retail holders will sell it back into the market when they hit 97 pounds.

While I love your idea of being 97 lbs again, looking at the second table in Wiki about the silver Panda, it looks like the Chinese are doubling their silver panda production from last year. Also, from what you say about printing and buying food with those USD, that may be a surer way to skin that fat. LOL

Ashvin said...

Another day, another dose of not-so-healthy volatility. Markets are trying to catch up to daily lows and Europe into the close, after absolutely nothing risk positive happened during the day. PMs remain crushed.

Ashvin said...

Always amusing to watch the headlines.

When markets rallied from lows - "Bernanke says willing to provide further support if necessary"

When markets sold off again - "Bernanke says economy is 'close to faltering'"

jal said...

It is very likely that previous civilizations had to deal with similar economic, financial problems that we are going through.
Eventually, the rulers found that they had to find ways of imposing solutions so as to save their social and ruling structures.
Otherwise, Debt, interest and leverage, (too much printing of money), would destroy everything and the citizens would leave for other pastures.
They had to force the rich to periodically, (7 years, a jubilee), forgive the debt of the people. ( I assume that if they refused they would lose their head and their wealth). As long as the rich still controlled the cash flow, (taxes and fees), then the rich would never become poor.
Another solution, was for the rulers/rich to use their accumulated stored wealth to build public infrastructures, such as temples, public buildings roads and bridges to occupy the idle workers which would end up benefiting society and of course the rich.
Notice the differences from now.

It wasn’t loans, at interest, by the rich, given to the gov. so that the idle would be employed to shovel snow.


This time its different. The rich have transfered all their debts, ( uncollectible loans), to the gov.
There is no accumulated wealth under the control of the gov. to employ and appease the destitute and build infrastructures.
The rich have no intention of using their accumulated wealth to save the present system which cannot be saved.
The rich, cannot find a solution.
They only see GROWTH as a solution. They only see GROWTH OF DEBTS as a solution.
They are dammed if they do and dammed if they don’t.

RobM said...

Ilargi and el gallinazo,

I've read most everything written by Stoneleigh and Martenson. It's indeed possible that my biases color my perception however my view is that Stoneleigh and Martenson are not that far apart. The differences are more to do with timing and the unknowns of political response. Stoneleigh predicts a long deep deflation (falling income and falling prices for everything) followed by inflation. Martenson predicts falling incomes, falling asset prices, and rising commodity (essentials) prices. The difference I see is rooted in the political response. How much will governments print? Stoneleigh would argue that printing is irrelevant because defaulting debt will overwhelm government printing. I am making the case that government printing, even though it will be overwhelmed by defaulting debt, can still cause the price of essentials to rise. This is because price is determined by the ratio of paper wealth (cash + credit) to physical wealth. When debt defaults both the paper wealth AND the future physical wealth it represents is vaporised. Thus the balance is maintained, and in the absence of printing, prices of essentials (which are the only things people will want to buy) should remain reasonably stable. With printing the balance will distort and the price of essentials will rise. Time will tell if I am right.


Gold has been steadily rising for 10 years. Even with the recent decline it is still out performing equities and real estate. There is nothing you could have purchased 10 years ago that would have done better. Exactly how then is gold getting crushed? PM's are inherently volatile. Do not buy them if you cannot stomach wild swings.

Ashvin said...

Equities decided to completely disconnect from credit and Euro markets on, what else, flimsy headlines of Dexia offloading toxic assets onto Belgium/French taxpayers (which they can't really afford to guarantee) and an Oli Rehn generated rumor that EU leaders are coordinating plans for bank recaps (which was explicitly refuted by the Spanish finance minister earlier in the day).


Did you even read Stoneleigh's article? If so, then you simply don't understand the argument, which is not at all compatible with CM's argument. There are no two ways around that, and most here aren't going to forget that simply because you so "they are both right". So now we should expect commodity inflation in food, energy and... gold (why am I not surprised?). I said PMs were remaining under selling pressure ("crushed") again today, but if you really want to get into the issue of extrapolating past price trends indefinitely into the future... we can do that too.

Ashvin said...

Rob, you said:

"This is because price is determined by the ratio of paper wealth (cash + credit) to physical wealth. When debt defaults both the paper wealth AND the future physical wealth it represents is vaporised. Thus the balance is maintained, and in the absence of printing, prices of essentials (which are the only things people will want to buy) should remain reasonably stable. With printing the balance will distort and the price of essentials will rise."

What does this even mean? I prefer this explanation of price dynamics in a debt deflationary environment:

Stoneleigh (from yesterday's article): "The dramatic move in 2008 from $147/barrel to under $35/barrel had essentially nothing to do with supply and demand, and everything to do with speculation shifting into reverse, in other words the implosion of a speculative commodity bubble.

The fact that the entire commodity complex showed essentially the same behaviour at the same time, and that financial crisis was becoming acute, strongly suggests that the fundamentals of any particular industry have little to do with prices in the short term, and that financial conditions are a major driver in their own right."

Ilargi said...

'T is a curious world.

According to BI, a report in the FT, which features EU finance ministers discussing plans to recapitalize their banks, caused the aggressive 4-5% upswing on Wall Street in the last half hour or so of trading.

But if you read the report, you find that what these ministers actually do is admit that the banks are in far worse shape than they have previously let on.

So, panic short covering?! With a full re-trace of the gains in after trading or early in the morning?!


Ashvin said...

Ilargi said..."With a full re-trace of the gains in after trading or early in the morning?!"

Can't say for sure, but I don't think Moody's downgrade of Italian sovereign debt from Aa2 to A2 will help keep the party going.

RobM said...


Please delete my comments above as it appears my opinions may cloud the clarity in Stoneleigh's excellent article.

el gallinazo said...

The Financial Times has become the official mouthpiece for hopium blather from the Eurozone apparatchiks. Reminds me a little of Judith Miller, formerly of the Toilet Paper of Record, except the FT usually quotes it sources while Miller tried to hide the fact that Dick Cheney wrote her columns. And FT is actually taking pride in the purity of its hopium as it enters the veins of the panicked herd of Wall Street. In its electronic update:

"Wall Street surged 4 per cent in the final hour of trading after this FT report was initially published."

As with many drugs, there is a lot of money to be made peddling hopium, especially when you know exactly when it's going to hit the Street.

But as to substance, all one learned was that our financial leaders of Europe regard the situation as serious and that our leaders are seriously pursuing a solution, which may involve a coordinated effort of individual nations to shore up its banks. But they don't mention where the money is going to come from. Oh, I know. They will sell sovereign bonds to shore up the sovereign bonds :-)

Or since M. Juncker is heading up the discussions, perhaps it means a major lie is in order. In the end, some idiot sheep are going to OD on this daily fix.

A moderator said...


If you wish, you can delete your own comments by clicking on the little trash can. Blogger gives all commenters this option for their own comments.

However, the premise for this action, that you are clouding the clarity of Stoneleigh's essay strikes me as dubious. You expressed an economic opinion. Ash and el Gal countered your ideas. It was all done on a civil and logical level. If Stoneleigh's ideas are correct, then you didn't cloud them. If they have faults, then you aided the readers of this blog. Discussion and debate on this level is a large part of what this comment section is about.

Ilargi said...

"Ash said...
I don't think Moody's downgrade of Italian sovereign debt from Aa2 to A2 will help keep the party going"".

Dexia says Belgium is sure to follow soon, and I'd say France is standing with one foot on the brink and the other on the verge.


RobM said...

Thank you. I stand by my views. I will leave the comments.

Ilargi said...

They done it....

Dexia: Belgium to create 'bad bank' for assets

Belgium approved Tuesday the creation of a "bad bank" to house assets at risk at the Franco-Belgian bank Dexia, whose financing the two countries had guaranteed on reports that it was to be broken up.

"There was an agreement to isolate past charges, coupled with a need for guarantees from the Belgian and French states in order to guarantee the activities of Dexia Bank Belgium," Prime Minister Yves Leterme said after a meeting with his key cabinet ministers.

What I find boggling is that this decision, which involves a bank with liabilities of 180% of its host country's GDP, is made in a country that hasn't even had a government in forever (and feel free to add a day), just a crisis cabinet that should not for all -purely legal- intents and purposes be allowed to make deals larger than the size of their own lunch bill.

These people weren't even democratically elected, yet they get to take the risk to plunge the country into some potentially very nasty quicksand.

A bad bank is the financial equivalent of a fat singing lady.


Ashvin said...


I apologize if I came off as being a bit short with you in my comment. It's just that there always seems to be someone showing up on the very same thread where an issue is discussed in an article/comments, stating the exact opposite of the conclusions reached by that discussion, but also arguing their statements are actually consistent with those conclusions and they are just providing a unique perspective. If you were to simply state that you agree with most of the argument, but completely disagree with the part about broad-based commodity price decreases during the debt deflation (including oil, PMs, etc.), then it would go over better. At least, for me it would.

Joe in NC said...


I enjoyed listening to your interview - thanks.

Re: They Done it...

Does this mean new austerity measures will likely be implemented in Belgium and France sometime down the road?

It seems TPTB get kinda serious if there's a chance of a derivatives "event" happening. I wonder how long they can can keep all the balls in the air?

tooearly said...

surely you don't deny that the money supply has increased dramatically especially relative to outstanding credit market debt? Where is the deflation?

el gallinazo said...


What do you figure the actual ratio is between M2 and total credit, even only weighing derivative credit in at 20%?

ben said...

c(Ash) money is a army... :)

and martenson, you lined up for that one. and got served! the lights came up on the stag party a couple months ago. someone else is wearing the pants now.

Herbal Floyd said...

Say we go to DOW 9000

and then the banks are recapitalized and we springboard.

How do you know it won't be another 2 year springboard like 2009-2011.

Back in Spring 2009 you were sure the bounce would only last until fall 2009. I imagine we'll start seeing green shoots shortly after DOW 9000. Those shoots could sprout for years.

Herbal Floyd said...

Did anybody see that +6% springboard in the Russell 2000? That's a springboard. That's Greg Louganis circa 1988.

el gallinazo said...

Alex said...
Say we go to DOW 9000

and then the banks are recapitalized and we springboard.


How do you envision the politics and process of this "recapitalization?" If all hidden assets in the TBTF (Fed Primary Dealer) banks were marked to market right now, how deep in the hole would you figure them? What is the USG going to do with F&F and $5T potential liability? How big and how much do you think the Fed will allow itself to fill its balance sheet with toxic waste? If PIIGS collapse trigger the CDS market, how will the banks pay off their debts to counterparties?

el gallinazo said...

Alex said...
Did anybody see that +6% springboard in the Russell 2000? That's a springboard. That's Greg Louganis circa 1988.


I suspect the editors and publishers of FT foresaw it before they published that ridiculous article and now are laughing all the way to their friends at their bank. You think this kind of volatility based on stupid rumors and articles is indicative of a healthy, bull market? I say it's time to pull out the defibrillator.

Ashvin said...


"Did anybody see that +6% springboard in the Russell 2000? That's a springboard. That's Greg Louganis circa 1988."

That's a needle filled with that last bag of dope and a shotgun on standby. Kurt Cobain circa 1994.

scrofulous said...

El Gal

What do you figure the actual ratio is between M2 and total credit, even only weighing derivative credit in at 20%?

Hey, I would like to know that! also how much of that 20% derivative credit do you think would be self cancelling, and is that an unladen American or European derivative?

el gallinazo said...


Most of those perfect, algorithmic hedges are based on no counterparty default. I guess if you have a 100% default (not improbable in the end times shortly after the plague of locusts), they all cancel :-)

scandia said...

@El G, when I read, " Defaulted debt is defaulted credit supply. This, in fact, is the core basis of collapse." I slapped my forehead and uttered, " NOW I get it!!!"
It's as if you described the key faultline.
Thanks,El G, for the bingo moment...

SecularAnimist said...


A moderator said...

closing comments

Stoneleigh said...

Comments open.

Stoneleigh said...


surely you don't deny that the money supply has increased dramatically especially relative to outstanding credit market debt? Where is the deflation?

Deflation is the contraction of money plus credit relative to available goods and services. Credit is deflating, and at a much greater rate than any expansion of the money fraction. We are therefore in a net deflation.

Credit represents the vast majority of the effective money supply. On the way up money and credit are equivalent, but on the way down credit loses 'moneyness', because it is recognized as being excess claims to underlying real wealth. We will be left with only the money fraction plus a tiny amount of credit by the time deleveraging is over. That means the total money supply crashing by something measured in orders of magnitude, and over the space of a few short years. It will be devastating.

The price support that has led to prices rising is a lagging indicator of the reflation from the rally. Now that we have turned the corner, that price support will dissipate.

ben said...

alright, nassim, let's blast this joint.

i thought SFV's previous post, the kids aren't alright, on the Occupy protests, was some big-picture brutality. i better take down my photo.

"Bankers and businessmen need to be held accountable but doing so will not revive the waste-based economy. The protests in Greece are against ‘austerity’. Protests in China are against government corruption and a lack of access to a heavily advertised-for middle class. So are demonstrators on Brooklyn Bridge. Protesters in Madrid are against unemployment, protesters in Syria are against the privilege of the few, so are the protesters in Lower Manhattan. All of them may as well protest against gravity. The future of the world is less, the pie in the sky that is set to be divided into finer increments is diminished. The world’s economy has stopped growing. The banks, finance, Wall Street, the ECB, the intransigent Germans, the Worker’s World Party and Tim Geithner along with the rest have become inadvertent instruments of energy conservation. The frustrated youths demand the system work as promised, and deliver the goods to them. The youths refuse to understand the system is designed to deliver goods to the oligarchs with the leftovers distributed in the form of lottery winnings. The winners are the sainted ‘innovators’ and ‘entrepreneurs’. Nobody wants to know that modernity itself is bankrupt and cannot deliver goods to anyone without removing equal amounts of goods elsewhere, that demonstrators in New York can only succeed if those in Cairo fail."

NZSanctuary said...

rapier said...
The primary reason most people do not understand the foundational role that credit has in producing GDP growth, is that if you accept that credit produces most growth then you have eliminated all the conceits that the winners claim for themselves.

Delusion is strong in our culture - that's for sure!

Nassim said...

OK ben, here goes.

Last night, I attended a Meetup in Melbourne for aspiring entrepreneurs. There were only around 20 people present and I was probably 30+ years above the median age. The optimism and energy of the participants was a real tonic to me - especially after reading too much TAE. Obviously, they were much too busy and constructive to worry about the world of finance. I certainly did not have the heart to even mention what was in store for all of us. After the meetup, some of us went to a cafe and had some tea and exchanged a lot of banter and tried to pick holes in each others' ideas or to suggest improvements.

I have been to some of these meetups and it seems quite easy to get one organised for your locality and for your area of interest. I think it costs perhaps $70/year and you get an awful lot of bang for that - no need to program and so on. It seems to me to be an excellent platform for propagating the somewhat more gravity-bound topics discussed on this blog.

ben said...

i thought this was a good MSM article by michael lewis in vanity fair called, 'california and bust', about the municipal bond market, the gutted and on its way to being gutted cities of vallejo and san jose, respectively, a neuroscientist with a questionable theory about american life, and featuring, of course, a gonzo ahnold you can't help but love in some respects.

Alexander Ac said...


thanks for the nice interview!

Nice to hear you after some time ;-)



ben said...

paul craig roberts is really pissed off about that awlaki business. he compiles the laundry list of US abuses on the road to serfdom and advises all those 'young enough' to leave the country. good thing i'm already living in the city.

the day america died

humphrey flowers said...

el gallinazo said... "If PIIGS collapse trigger the CDS market, how will the banks pay off their debts to counterparties?"

New regulations, the Frank-Dodd act, have given the market a central counterparty for the derivatives.

Luckily, this central counterparty has assets, because it is also custodian for 90% of the stock and bond in the US.

Now the derivative contracts can be paid with the stocks and bonds that are held with the custodian.

After all, a deal is a deal. I hope nobody minds this solution.

Ashvin said...

Ben and SFV,

"Nobody wants to know that modernity itself is bankrupt and cannot deliver goods to anyone without removing equal amounts of goods elsewhere, that demonstrators in New York can only succeed if those in Cairo fail."

I somewhat agree with the underlying point, although I'm not sure it's about "delivering" goods right now, as much as delivering cash to buy the excess goods and assets. Also, I like to think about it this way - what if those protests in the developed world just never occurred? It's hard to see how they are not, at the very least, better than nothing, i.e. allowing those with adequate wealth/resources to ateer this sinking ship known as the global economy without making a peep.

ben said...


"I'm not sure it's about "delivering" goods right now, as much as delivering cash to buy the excess goods and assets."

as i read it the use of 'deliver' in front of 'goods' implies credit as the failing mechanism, as precipitated by the price of oil.

"Also, I like to think about it this way - what if those protests in the developed world just never occurred? It's hard to see how they are not, at the very least, better than nothing, i.e. allowing those with adequate wealth/resources to ateer this sinking ship known as the global economy without making a peep."

but nothing was never a possibility. i'm convinced there'll be armed resistance at some point let alone protest. a lot of veterans out there have done political 180s but still do what they do best, which is shoot. gangs. assorted gun toting americans.

but sure, it's high time it happened. anything but this. i'm heading downtown thursday for the start of ours. who knows, perhaps the post-civ kids will bring their A game and it'll take seed over the next decade. doubt it though.

Lynford1933 said...

If you read through this editorial, you will understand anothr POV of what I & S are talking about.

VK said...

Great interview Ilargi! :)

Lynford1933 said...

On TV I saw some of the protesters Occupying Wall Street and it looked more like a Halloween party. Something to do with Zombies. Zombies seem to be quite the topic the last few years; for what reason I don‘t know. Maybe it's a Buffy thing.

el gallinazo said...

Show me the money (dept.) - Jerry Maguire

The market can stay irrational longer than you can stay solvent. - J M Keynes

It's like the DAX is selling shoes and someone let Emelda Marcos in. - el Gallinazo


Do you have a link to the detailed mechanism of the Dexia bailout? How soon will France and Belgium have to put actual money on the barrelhead? How are they going to get it?

el gallinazo said...


The Zombie get-up refers to zombie banks, which of course refers to the TBTF insolvent banks that are kept out of bankruptcy by bailouts from the central bankers and the governments of the world permitting fraudulent bookkeeping. Actually shows a bit of financial savvy. Creative kids need a little theater. The term was first used for the Japanese banks after the 1989 collapse.

Keeping the zombies "alive" through shifting their losses to the debt slaves of the world is the heart of the crisis.

Ashvin said...


"as i read it the use of 'deliver' in front of 'goods' implies credit as the failing mechanism, as precipitated by the price of oil."

Yeah, I see credit markets breaking down as being precipitated by the failure of the capitalist economic model, rather than energy shortages per se. That's why I think energy-hungry, entitled Americans or Europeans protesting the current financial/political mechanisms of this economic system are at least somewhat productive, even if they have been significantly infiltrated by corporate agents (which may be the case in NY at least).

el gallinazo said...

Veteran Wall Streeter, Art Cashin, gives a colorful play-by-play of yesterday's explosive rally.

ogardener said...

Blogger el gallinazo said...

It's like the DAX is selling shoes and someone let Emelda Marcos in. - el Gallinazo

Belly laugh of the day!


DIYer where have I seen that image before? It's like deja-vu.

jal said...

Whether you believe him or not, he is on the inside and shaping our future.
Geithner: Jobs bill will create jobs

Erin Burnett Out Front

Lynford1933 said...

Of course Zombie Bank, I thought maybe they were refering to this:

ben said...


"Yeah, I see credit markets breaking down as being precipitated by the failure of the capitalist economic model, rather than energy shortages per se."

affordable energy shortages. i don't disagree with you. i thought about putting 'partly' before 'precipitated' but i didn't want to editorialize what i thought steve wrote in that specific context. obviously he's no tom therramus (no disrespect). fwiw, i think he referred to himself as a Digger once, when pressed, or at least a pre-Marxist.

Ashvin said...


"Maybe Ash can make a few, I am sure many people would like that."

I saw your comment before, but forgot to respond. I'm not nearly as articulate and interesting as I&S, but you still may be interested in this interview I did with The Extra Environmentalist earlier in the year. It was about my series "The Debt-Dollar Discipline", and therefore mostly deals with abstract/philosophical big picture type stuff. Quite lengthy including the Intro and what not, which is actually quite good and may be better than the interview itself!

Here's the link (be careful what you ask for...) -

Generally, The EE podcast has gotten a lot of fascinating guests (myself not included) and I highly recommend people check it out. At the very least, you gotta love the music they throw in there.

ghpacific said...

An article that warns of the consequences of a strong dollar.

scrofulous said...

El Gal

"perfect, algorithmic hedges are based on no counterparty default"

Seems about as dumb a thing to produce as this vaugely related question on the flight of unladen American or European sparrows or is that American or European derivatives? I would think that degrees of counterpart default would be written in to those algorithms, or are we talking cross-purposes?


"Currency Wars: European Debt Crisis and the Next Phase of Global Finance" Jesse's Cafe

Stoneleigh said...


What sort of timescale are we talking about before deflation really hits hard and sends the buying power of people in western Europe - and prices of commodities such as oil sharply down?

I think we'll see a substantial impact within the next year, with the downtrend in place for several years. There's an almost unimaginably long way to go to the downside.

A few weeks ago when asked where we were right now in relation to the 1930s, you said '1937'. I was intrigued by what you meant by this - what do you see happening in two years or so from now, the equivalent of 1939? Are we talking about major wars, social dislocations that would have the same effects or something else?

I think the risk of conflict is uncomfortably high. Hopes dashed a second time seems to be harder to deal with than the initial instance, as people are forced to stop believing in recovery when they had invested so much of themselves in the thought. One worry is that Europe faces a high risk of Balkanization over the looming break up of the eurozone. The recriminations that could emerge from such a situation could be massive.

Ashvin said...


That was a very good analysis, and I think it speaks well to a belief commonly held by some HI advocates - those who believe deflationists are arguing that the US economic situation is better than everywhere else, and that a strong currency is somehow a reflection of that relative health. That couldn't be farther from the truth. A rapidly appreciating dollar is horrible on so many different levels and not just for the American people, but for the rest of the world and for the environment. I would much rather prefer we skip right to the hyperinflationary part now, because at least that would lead to a situation in which debts are nullified, basic economic structures are rebuilt and some level of confidence is restored. Unfortunately, that's not how things are shaping up at all.

Stoneleigh said...


There is no doubt that asset prices will collapse. Where we differ I think is on rising prices of non-discretionary items like food and energy. About 1 out of every 2 dollars the government spends is printed or effectively printed since the debt will never be repaid. I expect this printing to increase as people take to the streets and elections approach. So while the macro story is deflation and depression, I expect printed money to push the price of essentials up.

I don't doubt there will be a major differential between the price of essentials and the prices of everything else. I do think this will happen at a lower price level than today, but price is much less of an issue than affordability. What matters is not what something costs, but the ratio between prices and how much money you happen to have in your pockets. If something is going to become drastically less affordable, it doesn't perhaps matter so much at what price level it becomes so.

Where it matters is in the strategy you use to prepare. Since it is possible to preserve purchasing power by cashing out in advance, you need not experience crashing affordability as most will. For those who still hold cash, many opportunities will be available at very low cost. Those who use their good fortunate to look after as many people as possible may then end up with the most important factor in terms of personal security - having their survival be in the best interests of those around them.

In the longer term, the price of essentials may well rise in nominal terms as well as in real terms, but deflation has a very powerful depressive effect on prices in the short term, and can be expected to lower prices initially (while affordability simultaneously gets worse).

Asmita said...

A short History of Credit Bubbles and This Time is Different. I don't see the lasting correction?

1690-1695 = Credit Bubble
Bubble Asset = stocks
Fetish Asset of the Bubble = Diving Bell Companies to salvage sunken treasure.
Bubble Pops. Banks Fail and Riots
Consequences = Bans on various forms of speculation (e.g. short-selling, trading options and futures contracts)

1720 = Credit Bubble
Bubble Asset = stocks
Fetish Asset of the Bubble = South Sea Company Stock
Bubble Pops
Consequences = (see above)

1822-25 = Credit Bubble "Emerging Market Bubble"
Bubble Assets = Stock in South American Mines and Sovereign Debt from Newly Liberated South American Republics.
Bubble Pops aka "First Latin American Debt Crisis" All of South America minus Brazil Default, Banks fail and riots
Consequences = see above.

1837 = Credit Bubble "Emerging Market Bubble in USA"
Bubble Assets = toll roads, canals, land, railroads
Bubble Pops.
State Governments Default on Debt, Banks Fail, riots.
Notice a pattern.

1865-1873 US Railroad Bubble.

etc. etc. etc.

In each of these bubbles we can see a similar pattern. New Technology leads to Euphoria and then to across all sectors of society (rich to working-class). Banks extent massive amounts of credit. Politician are corrupted and enriched. Bubble Pops. Scapegoats identified. Popular revulsion against speculation. New laws.


In what sense is it "different this time"

In essence. TAE's description of the consequences of this bubble are that "it's different this time" in terms of the magnitude of the consequences. Do we really have hard numbers comparing the scale of the credit bubble here to previous ones?

Asmita said...

It was not uncommon for stocks and bonds to rise 10-20 fold during speculative manias throughout the ages.

Only to crash back down again after the deluge.

How is that different than a fall to DOW 1000 (roughly a 10-fold drop from here)

Ashvin said...


What new technology is going to "save the day" this time? Green technology, or the new I-product from Apple? What undeveloped land or untapped asset is capital going to infiltrate? Which large "sovereign" country is not up to its neck in debt right now? From that latter statistic alone, we can see why the this time the credit (or should we say "capital") bubble has been much, much larger than before, and has actually built off of all those previous bubbles you listed.

el gallinazo said...


The reason all the pundits told us in 2008 that liquidity froze and the Libor went through the roof was that most of the banks knew they had serious solvency problems, assumed that other banks did also and perhaps even worse than their own, and they all were terrified to lend to each other, even overnight.

Since we appear to be approaching that same situation again, and since banks are permitted to keep their derivative book details hidden, how can these banks possibly know what the counterparty default rate would be? As I suggested yesterday, in the end days when a plague of locust that sting like scorpions will torment those without the Seal of God on their foreheads (i.e. bankers) for five months, then the default rate on CDS's with approach 100%.

P.S. my favorite from this film is "I fart in your general directions." No disrespect intended.

Stoneleigh said...

Comments are closed. Someone just posted a bogus comment as me. We do not appreciate being impersonated. We watch this comment section and will delete any comments that do not not come from the people they say they come from.

Stoneleigh said...

I've added my photo to my google profile. With any luck this will make my comments distinct from impersonations. If it doesn't there's always the spam button.

Stoneleigh said...

Apparently profile photos don't prevent impersonation by themselves. If you are wondering if a comment came from me, click on my profile name and you will see that I have been registered on been on blogger since January 2008, when TAE was founded. Spoof profiles will either be closed or will have a recent date (September or October 2011).

Ash said...

Comments re-opened.

Gravity said...

"We downgraded this sovereign because its banks are loaded with the debt of another sovereign we downgraded last week, who suddenly became undercapitalised as a direct result of our previous downgrade, sovereigns whos banks hold any arbitrary quantity of the sovereign debt we've now downgraded shall be held accountable next week, as soon as we've positioned our interests against them."

We recommend that underperforming rating agencies be downgraded to enemy combatant-status and assets seized on indictments for financial sabotage and systemic insider trading.

scrofulous said...

El Gal

"P.S. my favorite from this film is "I fart in your general directions." No disrespect intended.

As one old fart to another, no disrespect taken.

"how can these banks possibly know what the counter-party default rate would be?

How indeed? But remember, even if they didn't, they still won last time and who knows what cute tricks they have learned since then ... those cagey little rascals!

In the meantime I hold gold, cash and know how to can tomatoes! Hows that for diversification?

Jack said...

Hi Ash
Some days I cant read and audio interviews like this one are a good change.
It is very interesting.

Herbal Floyd said...
This comment has been removed by the author.
Herbal Floyd said...

Bank Nationalization.
Withdrawal limits.
13-week T-Bills.

How on earth do T-bills protect you from that? Is somebody going to carve out an exception on withdrawal limits derived from maturing 3-month T-Bills?

On what basis would one suppose that? There is no precedent to suspect such a thing and nobody has offered or even implied that kind of guarantee.

A bank deposit is a bank depost, regardless of whether is comes from maturing 3-month T-Bills or the sale of Intel Stock.

Some extra protection from deposits derived from T-Bills seems like sheer delusion. Maybe you can sleep better at night with by imagining it, but its strikes me as wishful thinking all the same.

Perhaps your nominal principal is better preserved through T-Bills as opposed to Intel Stock, but there's simply no reason to believe that you'll have any better access to your capital than John Smith and his retail checking account with GMAC bank.

YesMaybe said...


When debt defaults both the paper wealth AND the future physical wealth it represents is vaporised.

Ash was confused by the paragraph where you wrote this, and I think I have an idea of what the issue is. As I see it, this is false because it conflates physical wealth and claims to physical wealth. Take an example: I loan a friend of mine $100 for a year, she buries it and forgets the location, and then defaults on my loan. The $100 have gone away, but there's no change to physical wealth. It's essentially the same as if I had buried it myself and forgotten where, without any debt being involved. What disappears when she defaults is the future claim on future wealth, not the future wealth itself. Of course, monetary changes can affect physical wealth indirectly, through changes in investment and allocation of resources. But there is no direct effect of the kind you suggest. Anyway, I hope this helps clear the debate up a little.


Ashvin said...

France has just pulled a LEEERROOYYY JENKINS and announced that it may bailout "2 or 3" of its banks "just in case" and only "if needed". Whether in an online role playing game such as Everquest, or in a core EU country at the heart of a banking meltdown in absolutely no coordination with other relevant institutions, such brazen moves usually don't end up working out so well. At least they may have some crepes left when it's all said and done.

Gravity said...

This attack of the clones seems too blunt a tool for cognitive infiltration schemes, but the Susstein agenda may be extremist enough to consider harassment a legitimate tactic.

It is criminally offensible [for a government agency to pay people] to purposefully disrupt blogging operations if material damages are incurred or in case of harassment.
Repeatedly impersonating people for defamatory ends is harassment, although charges of defamation of an anonymous person or nom-de-plume, as unidentifiable, may be dismissable.

In case of harrassment by repeated impersonation of the blog's hosts, one could attain a court order for an IP trace of offensive blogger profiles back to whatever [government] server or computer, and sue for damages. Impersonators are totally uncool.

scrofulous said...

Poyais said...

Bank Nationalization.
Withdrawal limits.
13-week T-Bills.

Wouldn't that be considered a default on US currency? If you are worried about that happening I would suggest holding gold bullion. My goodness gracious, I would suggest that anyway! ;)

Herbal Floyd said...
This comment has been removed by the author.
Herbal Floyd said...

@ scrofulus,

Wouldn't that be considered a default on US currency?

Withdrawal limits aren't default. You get the money, just not at the rate you might want it. And the exchange rate/purchasing power may indeed change while you're waiting to collect. There is nothing at all radical in this proposition. In fact, it's by far the most likely outcome. There is absolutely no way we're going to avoid massive socialization of inevitable losses. I question the supposition that deposits derived from T-Bills are immune or exempt from withdrawal limits. You can't liquidate T-Bills directly. Banks are always the intermediary. No way around that.

Ashvin said...


I do know a few attorney friends specializing in internet communications law. Copyright infringement, defamation, libel, material misrepresentations, undue harassment, etc. - all those types of common issues. It's actually not that hard to get court-issued warrant for IP/server tracing when you have the proper connections and the least bit of reasonable suspicion or probable cause. So I'll look into that more, talk to some people, and the next time the criminally liable perpetrator shows up around here, I'll log as much information as possible and send it all on to my people so they can construct a PC showing for the magistrate. I hear the state and federal penalties can get pretty high for these types of unsolicited, malicious and repeated offenses.

Nassim said...

Paris prepares a plan to help its banks
(Google translation of leFigaro article)

scrofulous said...

Poyais said:

"You can't liquidate T-Bills directly. Banks are always the intermediary. No way around that."

I think most countries are aware of that.

Ashvin said...

The choices for France seem simple enough -

1) save your own banks (and Dexia), get downgraded from AAA (don't listen to Fitch, it's just a little bit conflicted...) and let the rest of the EMU fall apart OR

2) preserve your AAA rating and let your own banks fall apart when Greek inevitably defaults.

Both options are, to say the least, not good for the status quo, but I would prefer #2. However, the rumor mills and common sense are suggesting the French officials are panicking and choosing door #1. We shouldn't have to wait very long to find out for sure.

el gallinazo said...


I see from your Blogger profile that you are new (at least to commenting) to TAE. So perhaps you haven't read Stoneleigh's lifeboat primers closely enough. Or perhaps like the wolf in the three little pigs, you prefer to blow over straw houses. Me too.

Of course it is no easier to withdraw T-bill money from a bank than money that has sat in a checking account since the stone age. That is why Stoneleigh recommends that one keeps 3-6 months cash, as in small green linen/cotton sheets for Usanistanis, under ones personal control. The theory being that even bankers can't take a holiday for over half a year.

From Wikipedia FDIC:

"In light of apparent systemic risks facing the banking system, the adequacy of FDIC's financial backing has come into question. Beyond the funds in the Deposit Insurance Fund above and the FDIC's power to charge insurance premia, FDIC insurance is additionally assured by the Federal government. According to the website (as of January 2009), "FDIC deposit insurance is backed by the full faith and credit of the United States government". This means that the resources of the United States government stand behind FDIC-insured depositors."[35] The statutory basis for this claim is less than clear. Congress, in 1987, passed a non-binding "Sense of Congress" to that effect,[36] but there appear to be no laws strictly binding the government to make good on any insurance liabilities unmet by the FDIC."

The reason that T-Bills are preferable to FDIC deposits, is when SHTF, the FDIC is far more likely to renege on the insurance than the Treasury is to default on bills. A default on bills is game over and also triggers massive CDS claims. TTBOMK there are no CDS's (for the moment) on the FDIC. Furthermore, the FDIC is not likely to make an outright repudiation of claims, but likely to dribble out the pay off like a 100 year old geezer with a prostate the size of Alaska.


It's Cass Sunstein, famous constitutional lawyer. He published a paper prior to moving into the White House, the substance of which revolved around how the government should infiltrate and disrupt the truther movement. He never recommend that the easiest way would be for the government to start telling the truth, but among his remedies was hiring paid buttheads to disrupt the internet communication. It is my theory that this lofty constitutional lawyer has made a deal with O'bumma for a slot on the SCOTUS if a justice should kick off prior to O'bumma leaving the WH via the back door. Gravity, perhaps you haven't gotten the message yet, but the Constitution is now sold in Washington supermarkets in soft adsorbent rolls. And least we forget, Cass's new Harvard bride, Samantha Power, who is supervising the slaughter of Libyan babies.

Greenwood said...

With the passing of Steve Jobs today, we are seeing 'peak Apple'.

Apple took on the symbolism that technology triumphs. As James Kunstler mentioned, people mistake real technology achievement with whether or not a new ipod is created this year.

As cool as techno gizmos are, they don't help me plant food in the garden and Apple hasn't made solar panels or wind turbines or mass transport systems. Stuff that would be handy in a coming deflationary depression, and as JHK says, might even have helped alleviate the tragedy of previous investments, like spiritually devoid suburbs and unsustainable cityscapes.

If computers survive the coming Deluge, the only interface the average serf will have with them will be the microchip under their skin and the scanner that reads their barcode tattoo.

The world crumbles as iTunes fiddles.

It is a fitting metaphor for the age and the declining Boomers in the upcoming reality TV show,'The Greatest Depression on Earth'.

Jobs was 56.

His billions did not matter.

Ashvin said...

And let's not, in our "mourning", forget even very recent history's illustration of real human costs necessitated by the multinational corporate profit model.

Apple Factories Accused of Exploiting Chinese Workers

"The spate of suicides made headlines around the world. Last May, seven young Chinese workers producing Apple iPads for consumers across the globe took their own lives, prompting an investigation into working conditions at the Foxconn factory in Shenzhen, southern China.

Nine Chinese sociologists wrote an open letter to the media calling for an end to regimented and restrictive work practices which they condemned as "a model where fundamental human dignity is sacrificed for development".

One year on, swaths of anti-suicide netting surround the huge worker dormitories in Shenzhen. But an investigation by two NGOs reveals that many workers making iPhones and iPads for eager world markets are exploited and living a dismal life.

In Shenzhen and Chengdu a joint Foxconn workforce of 500,000 is providing the labour that, in the first quarter of 2011, contributed to Apple Inc net profit of $6bn (£3.6bn). Interviews with mainly migrant employees and managers have laid bare the dark side of those profits: a Dickensian world of work that would be considered shocking in the west."

el gallinazo said...


His billions did not matter.


Actually his billions bought him quite a few years. The average debt slave would have been dead in months with his condition. Whether they were quality years, only those closest to him would know.

Frank said...

@Greenwood if your computer isn't helping you plant food in your garden, then your computer is vastly underused.

The information, and the access to seeds and supplies available over the internet to J. Random Gardener is mind boggling to someone who remembers when it wasn't there.

Ash said...

Comments open

Nassim said...

Apple's share price

In 1987, I became the proud owner of a Macintosh SE - at a cost of some US$6,000 as that is what it cost in France. This amazing machine could run Excel (essentially the same Excel) and Powerpoint (essentially the same). Excel belonged to Microsoft - a Windows version only came about much later. Powerpoint belonged to Forethought which later was bought up by Microsoft for the then amazing sum of US$14 million. I impressed my clients immensely by preparing presentations in German and French - they didn't know how I did it as they only used DOS. The investment repaid itself many times over. The last Macintosh I bought was a PowerMac in 1994 - a disaster.

John Sculley was brought in from Pepsico in 1983 to provide "professional management". IMHO, he very nearly bankrupt the company and certainly made Windows the winning operating system.

I cannot help wondering if Apple is currently being taken over by "professional managers"? If so, then it is an excellent medium-term shorting opportunity for those so inclined.

Jack said...

What will happen when Greece defaults.
They are saying that the timing is already arranged.
Probably this isnt going to lead to the big crash because than people wouldnt buy stocks with this kind of news floating around.
Than again they are saying that it will effect people in the USA.

scandia said...

@Nassim, I just caught a headline this morning that shares of RIM are up in response to Job's passing. And RIM was in need of some " luck ".

Joe in NC said...

Hmmm, Greece needs 400 tanks?

400 M1A1 Abrams to Greece

I wonder if this is part of a plan to reinvigorate their sagging tourism business. Maybe they will
start a new ad campaign - "Our tanks will protect you from the pesky protesters".

Ashvin said...

Trichet's parting words (paraphrased):

'Euro countries need to figure out ways to "recap" (bail out) their banks, while also making "structural adjustments" (devastating a large majority of their popualations with austerity) to address sovereign debt problems...

But don't worry, the ECB is still "credible", because we are leaving interest rates unchanged.'

Good riddance, Trichet. Now let's welcome the new boss, former Goldmanite (you know, the bank that helped Greece hide their debt for years) Mario Draghi.

Joe in NC said...

This NYT article supports Ash's earlier comment regarding the two choices for France:

Europe Calls for Infusion of Capital for Banks

“The problem is that if you recapitalize the banks, then you have a problem with sovereign debt,” said one European official not authorized to speak publicly. “That is Paris’s big issue.”

Jack said...

Joe in NC
Those tanks are not for the outside enemy forces.
It looks like they are getting ready for guerilla warfare.

Jack said...

The country has been taken away from their hands.
I think they will have one puppet gov after another.

el gallinazo said...

If there are not enough Greek thugs, tanks, and jackboots to handle the situation, NATO will move in.

Ashvin said...

Joe in NC,

I think that if one needed more evidence of the pace at which this latest round of the financial crisis is unfolding, then one must only look to the discussions surrounding the EFSF in Europe right now. From the NYT article you linked:

"Daniel Gros, director of the Center for European Policy Studies, said that the best solution would be to focus on recapitalizing the banks, using the currency’s bailout fund. “There is no easy way out,” he said. “You need to have many things happening at the same time.”

It was, what, a few weeks ago that they were discussing The EFSF's adequacy for supporting the sovereign finances of the PIIGS and floating rumors about expanding/leveraging it for the sake of Italy and Spain, and now they are discussing whether the $500 or so billion should just be used to give money DIRECTLY to the major Euro-area banks (which probably need AT LEAST half of that to stabilize their balance sheets short-term).

bluebird said...

The picture at the top is very sad, forlorn and depressing. Maybe it is my deceiving eyes, but the picture seems different, more gray, than a few days ago.

BTW, both an excellent intro by Stoneleigh and interview by Ilargi.

el gallinazo said...

Joe in NC

Note that those 400 Abrams tanks to Greece are being "granted" as in gifted by the American debt slave. Perhaps we might title the program a Hell Grant. And who says we don't make or export anything anymore? We are so good at exporting stuff that we can give it away. Being that generous gives me almost as great a warm, moist feeling as peeing in my pants.

Joe in NC said...

Maybe someone here can help me understand something regarding Banks & derivatives - hedging & netting. I understand hedging in general...but how does this apply to banks derivatives hedging? And what is meant by "netting".

Oh, and it would be nice if you could include a fart or pant piss joke in the explanation - not to limit any answers to El G :-) I like to laugh while I learn.


Ashvin said...

Joe in NC,

I could be wrong, but I don't think "hedging" really applies to derivative instruments. For instance, if a bank holds certain bonds as assets, it could hedge that exposure in various ways, such as purchasing CDS contracts for those bonds, or by purchasing another instrument that typically has an inverse correlation to those bonds (so it can hedge using derivatives or other assets). However, if it wanted to decrease its exposure to the value of the CDS contracts that it has bought, it would simply sell them. Again, I'm not positive about that, but I'm having a hard time figuring out how they would "hedge" derivative exposure, other than selling the derivative instruments or purchasing the underlying asset that is "hedged" by those instruments.

"Netting" is just the accounting process of offsetting the value of obligations or liabilities owed between institutions. So if Bank A owes Bank B $100B and technically defaults, it could offset that liability by the value of what Bank B owes to Bank A in other contracts. I believe the details of what can actually be netted will depend on the specific terms of the existing contracts between the parties.

Ashvin said...

The non-explanation for Tuesday's insane last hour market ramp from Mish:

"The most likely explanation of this rally is purely technical. Support was breached, no more sellers stepped in and a short-covering rally from deeply-oversold commenced as bears covered. If you prefer, "short-term psychology changed for unattributable reasons"

It is highly doubtful this all happened because of non-statements with no details from Olli Rehn. Rather, Rehn just happened to be spouting nonsense right as the market was ready to reverse on short-covering."

Ashvin said...

One of the few reasons to be thankful for the illusion of two political parties in the US:

"Obama stopped short of explicitly endorsing the bill, which calls for U.S. tariffs on imports from countries with deliberately undervalued currencies, and restated White House concerns that any measure must comply with global trade rules.

But the president's tough language echoed sponsors of the bill, which narrowly cleared a hurdle to limit debate and set the clock ticking for a final vote, which could come later on Thursday. The measure, which has drawn warnings from Beijing that it could trigger a trade war, is widely expected to pass.

...A vote to pass the bill later on Thursday in the Democratic-led Senate would send the bill to the Republican-controlled House.

House Speaker John Boehner reiterated his opposition on Thursday to the bill

Lynford1933 said...

Joe in NC: I lived in Greece a long time ago. I enjoyed the comment section of your M1A1 tank link. Yep, it is Greek. Thanks.

davefairtex said...

Ash - hedging CDS exposure

How else? Buy more CDS, of course.

Let's say you own some bad Greek bonds. And you've hedged your exposure (on the books anyway) by purchasing a CDS from SocGen. But now you're suddenly concerned SocGen will die, possibly from too much Greek debt, leaving you unhedged. So you go and hedge your SocGen exposure by buying some CDS on SocGen itself from - oh I don't know, DB. Or Goldman. Presumably it is someone you guess won't end up in the dustbin and will be good for the cash if things go south.

It is also definitely cheaper to buy a CDS on SocGen than it is to get yet more Greek bond CDS at this point in the game.

See, you have a lottery ticket: the SocGen-backed CDS on Greek Debt. You just want to make sure it pays off if you need it to. But if you sell the ticket AND the bad Greek debt now, you will lose money, since the Greek haircut hasn't happened yet. And you wouldn't want that.

It astonishes me that these things aren't exchange-traded requiring healthy margins. Shows the extent of total regulatory capture in the US, I guess. Writing puts is extremely profitable, until a bunch of them get exercised at once, and then you're totally screwed.

Herbal Floyd said...

Bank Of England Resumes QE today

Says more QE likely

I thought we were done with QE?

Ashvin said...


Good point. When facing massive losses and having doubts about what to do, double down, kneel and pray that the wheel doesn't stop spinning. That's one of the HUGE known unknowns about our highly inter-connected global financial system, and something none of the politicians or central bankers know how to contain. Speaking of potentially unlimited CDS exposure, here's Alessio Rastani Part Deux on BBC, except this time it's not an unknown "trader", or the head of a major Italian bank, but an "advisor" to the IMF.

BBC Does It Again: "In The Absence Of A Credible Plan We Will Have A Global Financial Meltdown In Two To Three Weeks" - IMF Advisor

"What we don't know is the state of credit default swaps held by banks against sovereign debt and against European banks, nor do we know the state of CDS held by British banks, nor are we certain of how certain the exposure of British banks is to the Ireland sovereign debt problems."

jal said...

@ Ash
re.: IMF Advisor
UK has just done (a recapitalization), more printing for its banks. And in the interview he said that the UK banks were okay. ahahahaha

So ... the IMF Advisor is saying that the EU better get on board and print more money because all the banks have lost all of their investments and will go bankrupt in 2 to 3 wks if they don't.

Someone has got to tell me how all this printing of new money to replace the bad debts can turn out to be a good thing.
Where are they going to bury the bad debts so that they do not rise from the dead?


Herbal Floyd said...

The fact of the matter:

Stoneleigh is wrong about QE. She said it was done. Today we got more QE and an announcement for more on the way, as needed.

I&S: Wrong about QE. Plain Wrong.

Nassim said...

re: The U.S. approved to grant 400 M1A1 Abrams to Greece

"Beware of Americans bearing gifts ..."

Nassim said...

Even if he wanted to, Mr Cook would be hard pressed to assume all of Jobs’ mantle. The co-founder took the company from within 90 days of bankruptcy when he rejoined it in the late 1990s, to become the second most valued in the world by market capitalisation in just 14 years, overturning the music and mobile phone industries in the process.

In some ways Jobs acted as if he were the only customer who mattered, ignoring market research and focus groups and selecting from among Apple employees the ideas he found most appealing.

Mystery men with Apple in their blood

Ashvin said...


No one is ever "done" with QE. The Fed is jut finding it extremely difficult to launch its own QE program right now due to domestic (internal, political and popular dissent) and international pressures, so it sub-contracts out to other central banks. Unfortunately for them, they don't have nearly enough firepower to soothe financial markets for long. Neither does the Fed, really.

It's quite telling that people are already talking about how the BOE needs to do more QE, only hours after it announced it was expanding its balance sheet by almost 40%! That just goes to show how utterly ineffective QE by the BOE is at stimulating risk.

"Michael Saunders, UK economist at Citi, said: "With the recent large deterioration in the economic outlook, the MPC will probably have to do QE on a very big scale. We expect the cumulative total will eventually reach £500bn or so. It may go even higher than that."

I suggest you make an attempt to actually understand the arguments of I&S before childishly declaring they are wrong.


Yeah, the IMF guy is obviously pimping "solutions" that will only help the banks in the short to medium-term by taking such a dire tone. However, the reason that works so well is because it is essentially true. If nothing massive is done, the global financial system goes down. That's a good thing, especially if its done voluntarily with an eye towards protecting depositors, workers, taxpayers, etc., but obviously not for people like him.

Joe in NC said...

Ash & Dave - Thanks for the hedging explanation/discussion. I think I understand it better now.

I suppose their mentality is: Why not double down? We know the taxpayers will bail us out.

Makes me want to puke.


Herbal Floyd said...

How much QE can the BOE do?

Is the taxpayer responsible for the BOE balance sheet?

How? No central bank has ever gone bust.

The Anonymous said...

"Jack said...
What will happen when Greece defaults.
They are saying that the timing is already arranged.
Probably this isnt going to lead to the big crash because than people wouldnt buy stocks with this kind of news floating around."

Thats potentially a big deal IMO. When bear went under, the unofficial govt mantra was "not to worry, we will bail out what needs to be bailed out", thus the 2007 implosion of Bear Stearns turned out to be a great big nothingburger.

Up next was Lehman. Everyone assumed that the Bear bailout mechanisms were still de rigeur. Thus when the govt said "f*ck it, let em fail" it was indeed a shock to the system in large part because it was a change in policy not properly telegraphed to the markets.

Greece has been on the chopping block for a while now -- the market has had what 2 years to acclamitize to the possibility of implosion? Well now that day of implosion seems to be drawing near, yet since the markets seem to be somewhat aware of this, we are not seeing the same levels of extreme distress in the vix, Ted, A1 P2, etc.

Personally, I am watching these very carefully. I was stopped out of the market a few months back, and while not yet at critical levels, things do look serious.

Thus, the next few months could bring the "wooosh" catastropic decline that so many here have been preparing for for years, or yet another nothingburger as the can is kicked that much further down the road...

Stay tuned!

jal said...

@ Ash

"If nothing massive is done, the global financial system goes down."

I agree. However, how are those debts/losses going to be made to disappear so that they don't come back to life.

How can putting a little bit of money into a special fund and then leveraging that fund to +2TB and letting that fund go bankrupt make the debts/losses disappear?

Herbal Floyd said...

The BOE has been around since 1695.

It's bailed out banks for several hundred years.

Stress, Release, Stress, Release, Stress etc....

It's an old story.

Herbal Floyd said...

In many previous bear markets, investors who gave up on stocks missed out on the dramatic rebounds that followed," she said. "If you're patient during periods of stress and dislocation, we believe it's more likely than not you'll eventually be rewarded for your willingness to take risk. Strong bull markets have tended to begin suddenly, even explosively, and by the time you notice that a rebound is occurring, it may be too late to take advantage of that growth.

The bottom line: Being out of the stock market when a recovery occurs can be costly, and if you cut your losses when the market slumps, you may actually be taking on more risk than if you stayed the course. Reviewing nine bear markets between 1960 and 2010 (defining a bear market as a decline of 20% or more in the Standard & Poor's 500 Index over at least a two-month period), you'll see that in eight out of nine cases, the stock market experienced a strong rally during the year after hitting bottom.

Herbal Floyd said...

Jobs or Pope.

My Death Parade is bigger than yours.
This nonsense has got rival the "Death of a Pope" circus.

Jack said...

Geopolitics of Asia Minor
Սարկոզին Ծիծեռնակաբերդում

Joe in NC said...


I didn't see the word "secular" in your comment. In a secular bear market, the prize is captial preservation. You go ahead and play games with falling knives. There simply isn't enough panic yet for me to play at this time.

Herbal Floyd said...

Isn't the message of TAE some variant on US Army Major Phil Cannella's

'It became necessary to destroy the town to save it,'

Ashvin said...


"I agree. However, how are those debts/losses going to be made to disappear so that they don't come back to life."

I believe CB Myers' dictum holds true. "Ultimately, every penny of every debt must be paid - if not by the borrower, then by the lender". Although if we factor in the relevant social, political and environmental costs, we could say that even more must be paid.

So the debts will not "disappear". There are, however, multiple ways that borrowers and lenders can be forced to "pay". The borrowers either pay through their future income or savings (i.e. saved cash or collateralized assets). The lenders can pay by writing off the under-secured value of the loans, which would force them into bankruptcy (restructuring or liquidation) at this point, or they could be bailed out by sovereigns until they are caught in a currency crisis which destroys the value of their currency-denominated assets, which also makes them go bankrupt. We are most likely going to have a combination of both - extensive write downs and bankruptcies eventually followed by currency collapse, which finishes off whoever is left standing.

jal said...

@ Ash

Your response seem to be "according to the old way of thinking".

They want the system to survive.

I get the impression that timmy and all the central bankers THINK that they have found a way to make all those bad bets disappear.

I can't see it.


Ashvin said...


I have my ideas about what "bigger schemes" these guys may be planning, but, at the end of the day, it's tough to figure exactly when and how they will try to implement them. I'm just saying that no matter what they want to do to preserve their own wealth/power, they will still have to go through the motions of destroying debt, i.e. making the borrower, lender or both pay. There is no other way around that.

jal said...

" making the borrower, lender or both pay. There is no other way around that."

Then they must have some wisss kid locked up in a basement running models that look good at first blush.
If their models don't work out then its the big reset.

The 30 yr is now below 4%. People are still not buying houses. Maybe the models aren't so good after all.


ogardener said...

Blogger jal said...

"They want the system to survive."

Austerity ain't makin' it.

jal said...

You got to watch
Lang & O'Leary Exchange

October 6, 2011'Leary_Exchange/1319430780/ID=2149202610
Chris Hedges interview

Maybe CBC made a mistake by having Chris Hedges ,The Truthdig columnist speak his mind.

See his blog

jal said...
This comment has been removed by the author.
Ilargi said...

New post up.

Occupy This: Mark the Banks to Market


scrofulous said...

Chris Hedges gets called a Nutbar on Lang and O'Leary Exchange. Kevin is at his arrogant best, a must view.