Tuesday, January 31, 2012

January 31 2012: Goal-Seeked Analyses for Gold

Unknown Dreaming of great fortunes 1858
California gold miner joining the British Columbia goldrush

Ashvin Pandurangi: After the Fed’s latest announcement on January 25, in which the central bank said very little more than the obvious ("exceptionally low" fed funds rate at least through late 2014), we have returned to typical speculations about how much “money printing” (or quantitative easing) by central banks we will see in upcoming months to accompany these low rates. Chief among these speculators is always Tyler Durden at ZeroHedge, who never backs down from an opportunity to re-assert (or manufacture) the near-term bullish arguments for gold.

This article will review some of the more notable and ridiculous opportunities seized over the course of only the last few days. Each one was a relatively short and sweet post that showcased a nifty-looking correlation chart. I do realize that Durden did not claim that any of these posts put forth a hardcore and irreproachable analysis, but he did decide to put them up! Soon after the Fed’s announcement, ZH ran the following headline and analysis [emphasis mine]:

Market Now Pricing In $770 Billion Increase In Fed Balance Sheet
As we have pointed out previously, the primary if not only driver of relative risk returns (because in a world of relative fiat value destruction, it is all relative, except for gold which is revalued relative to all on a pro rata basis), will be who of the big two - the Fed and the ECB - can print more. And up until now, at least since the end of December when the market "suddenly" realized that the ECB's balance sheet has soared to unseen records, the consensus was that it was the ECB that would be the primary source of easing. Especially when considering that there is another ~€500 billion LTRO due on February 29.

Yet today's rapid reversal in the EURUSD, driven by Bernanke's uber-dovish comments suggest that something has changed and that the Fed is now expected to ease substantially. How much? For that we look to the latest balance sheet cross-correlation, where if we go by simple correlation, the market is now pricing in (based on the EURUSD cross ratio) that the relationship of the two balance sheets will rise from a multi year low of 1.08 as of a few days ago to 1.15, at least based on the rapid move in the EURUSD higher as can be seen in the chart below. Indicatively, the actual value of the two balance sheets is €2.706 trillion for the ECB and $2.92 trillion for the Fed (or a 1.08 ratio).

So now that the EURUSD has risen as high as it has, it implies that the pro forma "priced in" ratio is about 1.15. But wait: one should also factor in the fact that the ECB's balance sheet will rise by at least another €500 billion in just over a month, which will bring the ECB's balance sheet to €3.2 trillion. Which means that to retain the 1.15 cross balance sheet relationship, the Fed's own balance sheet will have to rise to $3,687 billion, or a whopping $767 billion increase!"

Essentially, he is saying that the reaction in the EUR/USD pair after Bernanke’s statement had implied that the movers and shakers in the currency markets expected the dollar to be devalued by the Fed in the near future through quantitative asset purchases. Since the pair moved to levels that "imply" a ratio between the size of the Fed and ECB's balance sheets higher than currently established (based on loosely-correlated movements over the course of 2 years), and the ECB is expected to unleash at least another €500bn next month, we can project that the Fed will unleash a response of $767bn (or thereabouts).

To Durden’s credit, he provides a partial explanation of why we should probably dismiss this entire train of thought in the very next sentence that he writes.

Naturally, that's a simple heuristic based on only what the EURUSD pair is implying. Of course, this is not a scientific way of predicting where Bernanke will go, but that is at least what the market seems to be telling us.

To only say that this mode of prediction is non-scientific is to do all forms of non-scientific economic analysis a huge disservice. It is patently ridiculous to think there is any connection whatsoever between the immediate reaction of a currency pair to a Fed speech and either the expectations OR the actual value of future asset purchases by the Fed (even ignoring the fact that Bernanke's comments were not much more "uber-dovish" than they have ever been over the past year).

It is much more likely that the EUR/USD has simply been moving with the perception of financial risk in the Eurozone, and perhaps with the expectation of ECB “money printing” since early 2011. The perception of risk may also be tied to the Fed’s QE measures (or lack of them in 2H 2011), but all that is a very far cry from the currency pair acting as a predictive indicator of money printing. Durden almost admits as much above before reverting back to the goal-seeked nonsense analysis in pursuit of a predictable conclusion.

So at the end of the day, the balance sheets of the world's two biggest central banks will increase by about €500 billion for the ECB and ~$770 for the Fed and $655 billion for the ECB.

Incidentally, this analysis assumes all else equal which, with Greece on the verge of default and Portugal potentially in its footsteps, isn't...

Thus our question is: gold is not on its way to $2000 yet why again?

It is really unfortunate that such an informative and clever site occasionally feels forced to produce such weak arguments in favor of, what else, gold. The truth is that no one can be certain when Bernanke will decide to pull the trigger on QE3 or how much the Fed’s  balance sheet will actually be expanded in nominal terms or relative to the ECB’s balance sheet, and analyses such as the one above provide us with no clearer picture of those possibilities than we had before. It only serves to confuse the issues at hand and provide us with a sense of predictive confidence that we simply can’t have.

What we do know is that the Fed’s perpetually low interest rates and the potential for another few hundred billions in QE are very unlikely to make a dent in the ongoing global deleveraging tsunami, and therefore the natural flight to safety away from currencies such as the Euro for U.S. Treasuries and the U.S. Dollar.  That is even truer if the ECB floods the European banks with another €500b to €1tn of LTRO funds in February, since very little of that money will actually make it to the distressed consumers, businesses and sovereigns that need it the most.

The next day, ZeroHedge asked semi-rhetorically whether Bernanke has become a “gold bug’s best friend”. The logic contained within this brief analysis is similar to the one presented above, as it tries to connect the Fed’s statement and Bernanke’s comments on Wednesday to the subsequent positive returns of gold (and “implicitly silver”) over the 24 hours that came after [emphasis mine].

Has Bernanke Become A Gold Bug's Best Friend?
Below we present the indexed return of ES (or stocks) and of gold over the past 24 hours since the Bernanke announcement of virtually infinite ZIRP, and the latent threat of QE3 any time the Russell 2000 has a downtick. It is unnecessary to point out just when Bernanke made it all too clear that the Fed has nothing left up its sleeve, expect to directly compete with the ECB over "whose (balance sheet) is bigger," as it is quite obvious.

What is not so obvious, is that for all intents and purposes, Bernanke may have unwillingly, become a gold bug's best friend, as gold (and implicitly silver) has benefited substantially more than general risk. Much more. So for the sake of all gold bugs out there, could the Fed perhaps add a few more FOMC statements and press conferences? At this rate gold should be at well over $2000 by the June 20 FOMC meeting.

Granted, the first bolded statement above is quasi-hyperbole, but, then again, it’s not. ZeroHedge and others have been identifying the “latent threat of QE3” in the Fed’s various statements since the early days of 2011, well before QE2 even ended, which may as well "any time the Russell 2000 has a downtick". The reality is that the Fed has no other choice but to leave open the possibility of further monetary easing in the near future, because otherwise it would be responsible for an uncontrollable downward cascade of markets around the world.

And if one is looking hard enough to be vindicated for consistently repeated predictions of money printing to, as Buzz Lightyear would declare, “infinity and beyond”, then one will certainly find latent threats of such printing contained within almost all of the statements released by almost every central banker in the world. What’s much more disturbing is the notion that knee-jerk market reactions to these statements by precious metals (which is fittingly compared to “general risk” in the graph) are somehow indicative of a sustainable price trend.

In the next paragraph, we get the caveat that it is not all “smooth sailing” for gold, because rumors of CME margin hikes or actual hikes could surface at any moment and destroy the otherwise developing moonshoot in gold and silver. That’s actually not really a caveat as much as a re-assertion of the flawed premise that market demand for PMs is indestructible outside of centrally-coordinated “takedowns”. What they don’t mention is that debt deleveraging (something quite prevalent these days) is the equivalent of demand destruction, and that’s all a margin hike really is.

To top off a series of highly flawed and misleading analyses, Durden follows up the next day with a posting in which he states that Tim Geithner has been added to ZeroHedge’s list of “best Goldbug friends”. Why, you ask? Because there appears to be at least some correlation between increases in the U.S. debt ceiling and increases in the price of gold over the last 10 years. Therefore, the latest increase of $1.2tn in the debt ceiling means Geithner can spend more money for at least a few more months, which means gold can keep going up!

Tim Geithner Added To List Of Gold Bugs' Best Friends
Today we note that it is not only the Fed, but the US Treasury, and specifically the ravenous Mr. Geithner, who just got a green light to issue another $1.2 trillion in debt, and bring total debt to $16.4 trillion, which would still be 107% of today's GDP (which we don't see growing much if at all over the next year), that can be added to the list of best Goldbug friends. As the chart below demonstrates quite vividly, in addition to global and local monetary expansion, the price of gold tends to correlate quite well with the US debt ceiling.

Which means that per yesterday's Senate 52-44 vote authorizing Timmy to go hog wild (which in turn means that Bernanke will have to step in and monetize much of this new debt issuance), the price of gold just got a green light for at least $250 in upside - the implied price just got raised to $1960. Of course, anyone who thinks the US will stop issuing debt there needs a brain MRI stat. Thank you Senate. And thank you Timmy. And, of course, thank you Ben.

Frankly, I don’t see much of a correlation until at least 2005, besides both the debt ceiling and price of gold steadily increasing over the last decade, which should be no surprise for either of them (excluding the sharp declines in gold price during risk-off phases of 2008 and late last year). To the extent a meaningful correlation does exist, there is really no reason to infer any sort of causation when a whole slew of variables independent of the debt ceiling can explain why gold has generally been on the rise since 2009, including all of the policies that have suppressed the dollar (such as low interest rates and monetization of MBS/Treasuries).

Of course there is a connection between the government spending/borrowing and the Fed monetizing debt in unprecedented amounts. The USG already made clear it would be spending/borrowing this money last year (and more), and of course it will end up becoming a huge problem for the U.S. and its currency down the line. How exactly any of that, or this specific instance of Congress raising the debt ceiling, translates into a “green light” for gold to reach $1960/oz. soon is a very different story. It is a story that really has no credible basis in reality and serves only to support a pre-determined objective.

Among the plethora of very useful reports/analyses produced by ZeroHedge on a daily basis, these brief postings may not seem like such a big deal. However, they represent a goal-seeked mentality and modus operandi that is frequently on display within the HI/gold crowd and can lead to very misleading conclusions. I can’t be certain, but I’m pretty sure we will see many, many more postings like the ones above over the course of this year, and they will appear almost exclusively when it comes time to discuss gold.

None of the above is to suggest that the price of gold will necessarily plunge into the abyss in the near future, but it most certainly does suggest that there are significant risks gold will fail to hold its current valuations around $1700/oz, let alone reach $2000/oz and beyond. The risks are especially formidable when we stop pretending like the Fed, ECB, Bernanke, Geithner or anyone else is in a good financial or sociopolitical position to halt the upcoming waves of debt deflation. We here at The Automatic Earth only ask that you keep these risks in mind as you continue to read and contemplate.

Saturday, January 28, 2012

The Report That Will Blow Up The Eurozone

Jack Delano Hot Sugar January 1942
Guanica, Puerto Rico. "Burning a sugar cane field. This process destroys the leaves and makes the cane easier to harvest"

Ilargi: No, I’m not talking about the fact that Germany and Holland want to take over as the de facto government in Greece, as Noah Barkin writes for Reuters (that they want to do it through Brussels is a mere technicality).

Germany wants Greece to give up budget control
Germany is pushing for Greece to relinquish control over its budget policy to European institutions as part of discussions over a second rescue package, a European source told Reuters on Friday.

"There are internal discussions within the Euro group and proposals, one of which comes from Germany, on how to constructively treat country aid programs that are continuously off track, whether this can simply be ignored or whether we say that's enough," the source said.

The source added that under the proposals European institutions already operating in Greece should be given "certain decision-making powers" over fiscal policy. "This could be carried out even more stringently through external expertise," the source said.

The Financial Times said it had obtained a copy of the proposal showing Germany wants a new euro zone "budget commissioner" to have the power to veto budget decisions taken by the Greek government if they are not in line with targets set by international lenders.

"Given the disappointing compliance so far, Greece has to accept shifting budgetary sovereignty to the European level for a certain period of time," the document said. Under the German plan, Athens would only be allowed to carry out normal state spending after servicing its debt, the FT said.

Ilargi: Nor do I mean the report from the Kiel Institute for the World Economy that Ambrose Evans-Pritchard cites for the Telegraph, and which implies a second bailout for Portugal is looming near:

Investors fear mounting losses in Portugal as second rescue looms
Portugal is fighting a losing battle to contain its public debt and may be forced to impose haircuts of up to 50pc on private creditors, according to a top German institute.

A report for the Kiel Institute for the World Economy said Portugal would have to run a primary budget surplus of over 11pc of GDP a year to prevent debt dynamics spiralling out of control, even in a benign scenario of 2pc annual growth.

"Portugal's debt is unsustainable. That is the only possible conclusion," said David Bencek, the co-author, warning that no country can achieve a primary budget surplus above 5pc for long. "We won't know what the trigger will be but once there is a decision on Greece people are going to start looking closely and realise that Portugal is the same position as Greece was a year ago."

Yields on Portugal's five-year bonds surged on Thursday to a record 18.9pc, reflecting fears that the country will need a second rescue from the EU-ECB-IMF Troika. Three-year yields hit 21pc.

Ilargi: Or even the true meaning behind the steep drop in the Baltic Dry Index, on which Sebastian Walsh reports for Financial News:

Chart of the Day: The Baltic Dry Index
Statistics from the Office of National Statistics this morning showed that the UK went into reverse in the last quarter of 2011, when the economy shrank by 0.2% – but as the Baltic Dry Index shows, the global economy is looking even more worrying.

The index – often used as a proxy for the health of the global economy as it reflects the prices charged for shipping commodities such as metals, coal or grain around the world – has fallen by 61% since October. The index was at 842 at yesterday’s close – down from its 12-month high of 2173 last October.

Nick Bullman, managing partner at risk consultant Check Risks, said the index is a good way of looking at the risks to the global economy, "as it tends to be where they hit first".

According to Bullman, its initial collapse in October was driven primarily by a fall-off in demand from China, where declining housing prices pushed purchasing managers to cut back on orders for the raw materials whose transport the Baltic Dry Index reflects.

He said: "This collapse looks similar to the falls we saw in the Baltic Dry ahead of the recessions of the late 1970s and early 1990s – but this drop is actually steeper."

Bullman added that it was also a more direct indicator of global economic health than government-produced statistics. "Personally, I’m not interested in employment data and GDP figures because they’re manipulated," he said. [..]

Bullman said that shipping companies have also been deliberately slowing down their journeys to save fuel, with trips from China to the US going now taking around 50% longer than they were early in 2011.

Instead, he said he was surprised by how long the Baltic Dry took to fall. The NewContex index – an indicator of prices for transporting products in container ships – started falling in April last year. Bullman said: "When we saw that happening in April, we realised that risks had returned to pre-2008 levels. We thought the Baltic Dry would start falling too, but it was actually relatively resilient."

"What this is signalling is that the world economy is slowing down much more quickly than people have been thinking."

Ilargi: The report I refer to in the title requires a little background info:

In Holland, where I'll be for a few more days, there's a "rogue" right-wing party named PVV (Party for Freedom). It has no cabinet ministers, but the minority moderate right-wing government needs its support to stay in the saddle. The PVV, like other European right-wingers, is, among many other things, against much of what the European Union stands for. It's certainly against the Euro, and the bailouts with Dutch taxpayer money of countries like Greece and Portugal.

A few months ago, the PVV announced they had commissioned a report from British financial consultancy firm Lombard Street Research on the economic consequences of staying in the Eurozone versus returning to the guilder.

That report is about to be published "within days". It will prove to be highly explosive material. And the PVV will do all it possibly can to make sure it receives a lot of media attention. It may tear down the incumbent government, which is a heavy advocate of all things Europe, and which will have to quit once the PVV support dies, but for that party that's not the no. 1 concern.

And if and when Holland has a large scale discussion on the report and the issues it raises, Germany won't be able to ignore it and stay behind. And then, neither will France.

Max Julius of Citywire.uk did a piece on the report, without mentioning it directly, 10 days ago:

Why Germans and Dutch will exit 'suicide pact' eurozone
Germany and the Netherlands are likely to quit the eurozone rather than swallow an indefinite number of 'unrequited transfers' to the union’s crisis-stricken nations, according to Charles Dumas, chief economist at Lombard Street Research.

Speaking at an event in central London, he said that before joining the single currency, German incomes had stayed level but their purchasing power had increased as the Deutschmark appreciated. With the weaker euro, the economist said, they have seen 'tremendous' wage restraint, leading to huge growth in German firms’ market share but ‘no serious growth of the economy’ and a squeeze on disposable incomes. Meanwhile, consumption rose elsewhere in the eurozone, he said.

'So what you’re actually dealing with here... is a German population which has had a rotten deal – and that’s why they’re all so angry' noted Dumas, who is also chairman of the macroeconomic forecasting consultancy. Branding the monetary union a 'suicide pact', he continued: 'So what this exercise in uniting Europe has achieved is to divide Europe.'

Dumas [noted that] the 'Club Med' nations needed about 5% of gross domestic product in annual debt refinancing 'more or less indefinitely'.

This would amount to €150 billion a year, of which Germany would have to stump up just over €60 billion, France a little under €50 billion and €15 billion from the Netherlands, he said. And this would be on top of the shortfall in consumer spending, in addition to the fact that wages and consumption may have to be held down in the future, Dumas warned.

Ilargi: This morning, Dutch daily Algemeen Dagblad cited Dumas as saying these numbers are "cautious estimates". They are valid only if Greece and Portugal would leave the Eurozone in 2012 - which Dumas expects will happen -. If they don't, the payments will be even higher.

He predicts the costs of a return to the guilder will be much less than for instance the Dutch government's Central Planning Bureau claims, which warns of huge losses if Holland were to leave the Euro.

Dumas: "It's just like in a religion: first they promise you heaven, and if that doesn't work out, they threaten you with hell."

The economist dismissed the notion that the region would be able to turn itself around so as to make such support from its 'core' unnecessary. Citing the example of the persisting transfers from west to east Germany, he pointed out: 'The ones that need the money to flow in carry on needing the money to flow in, or just stay poor.'

Dumas also warned that austerity was only worsening Greece’s budget deficit, and that it was 'difficult to imagine' the deeply indebted state receiving the four quarterly batches of financing it is due this year. ‘It’s almost impossible to imagine people continuing to stump up the money, because they simply have not actually gone into this thing with the intention of unrequited transfers to Greece ad infinitum,’ he said as the country resumed talks with its creditors over a planned debt swap.

Calling the one-off damage of splitting up the eurozone 'seriously exaggerated', Dumas warned that as the crisis deepens, he believes 'Germany and the Netherlands will actually realise that they had better call it a day and jump out.'

Ilargi: Sure, the Dutch government, and certainly the EU and the banking system, have formidable PR machineries at their disposal. We’ll see a lot of numbers being floated that contradict Lombard's report. And we'll have to wait a few days to see exactly what numbers Dumas et al. come up with.

But the people of Germany and Holland are already very nervous about the fact that they face austerity and budget cuts while billions of euros are transferred to southern Europe. Up until now, the fear of economic disaster predicted in unison by government leaders have kept them quiet. Now that a reputable economic research firm flatly contradicts these predictions, and states that, instead, it's staying within the Eurozone that will be the far more costly option, the people will grow increasingly restless.

Charles Dumas again, from Algemeen Dagblad:
"The Dutch people have lost thousands of euros in purchasing power per year since the currency was introduced."

Governments in Berlin and The Hague will have a lot of explaining to do. They have to do so against a backdrop of (near-)failing Greek debt swap talks, which will at the very least force them to admit that they have a lost tens of billions in taxpayer money to Club Med countries already.

With a second Portugal bailout waiting in the wings. And lots of negative news on Italy and Spain. And more domestic budget cuts.

They’ll realize that their governments have painted far too rosy pictures about the issues so far. And they’ll expect them to deliver more of the same. This is what we call a receding trust horizon.

It's not the report alone, it's the entire combination of factors. The report will "merely" serve as the catalyst that blows up the powder keg. It may take a few months, but it will happen. The publicity hungry rogue PVV party that commissioned it, followed by anti-Eurozone voices elsewhere, will make sure of that.

Here's another interview with Nicole, conducted by Nicholas Bawtree for Italian magazine Terra Nuova, October 2011 in Florence, Italy.

Partial transcript (thanks to John Rubino at dollarcollapse.com):

When you have economic contraction you also have a substantial contraction of the trust horizon. This deprives political institutions at the national and international level of the trust that would give them political legitimacy. They become stranded assets from a trust perspective. People no longer internalize the rules that those institutions are attempting to impose. The response is typically surveillance, coercion, and repression. This picture basically suggests that it is pointless to look for solutions from the top down. It is not solutions that will come from the top down but more problems.

So politicians typically make a bad situation worse as expensively as possible. The systems that we have established have become sclerotic and unresponsive, hostage to vested interests with no ability to adapt quickly to give people abilities to cope with rapid change. I don’t look for solutions from them. The people who are part of that system are typically the people who have gained significant amounts from the status quo. These are the last people who are likely to change things, so I don’t look for political actions.

In many parts of the world, especially in parts of Europe, people always ask me if they should take political action, change their policies at a national level to solve these problems. And I tell them unfortunately not because there isn’t any mechanism for these large bureaucratic institutions to offer anything that would realistically help, and that they‘re far more likely to try to maintain their own existence by sucking even more resources out of the periphery in order to maintain the center.

This is a bit like when a body becomes hypothermic, not enough heat. It shuts off circulation to the fingers and toes in order to preserve the body temperature of the core. That’s what we can expect politicians and political systems to do. Unfortunately for us, we are the fingers and toes and we have to look after ourselves. Nothing is coming from the top.

My solutions, such as they are, are grassroots solutions. We have to build things from the bottom up. Our centralized life support systems will fail over time because they’re critically dependent on tax revenues that won’t be there and cheap energy that won’t be there. These centralized systems won’t be able to deliver the goods and services we’ve come to rely on.

What we need are alternatives that come from the bottom up. The reason these work is because they operate within the trust horizon. They don’t have to stay small. They can grow to whatever size the trust supports and that can be different in different places. The crucial thing is that they come from the bottom up, they’re small and responsive and not bureaucratic, they make the best use of very small amounts of resources because they don’t have enormous administrative overhead.

It’s amazing what can be done at a very small scale. It wouldn’t replace what the centralized services have given us, but we can cover the basics. The key point is that we have to do it right now because we don’t have much time before we start to see centralized systems failing to deliver what they have delivered in the past. The amount of money in the system can contract very quickly. That undercuts what these centralized systems are capable of delivering in the next few years. So we must start right now building grass roots initiatives, and community is crucial to that.

We need to begin at the individual level because if we are on a solid foundation ourselves we can then help others. If we are not then our attempt to help others is fundamentally weakened. So we have to get our own house in order but then we have to think much more broadly. We must build community. Relationships of trust are the foundation of society. So we need to work with our neighbors, we need to know our neighbors and we need connections with family and community so we’re less dependent on money.

In many parts of the world where people really don’t have any money anyway, their society functions on barter and gifts, working together, exchanging skills. This works as a model. It doesn’t get you a large fancy sophisticated industrial society because it doesn’t scale up that well. But it works very well at a small scale, and this is the kind of structure that we need to rebuild.

In some parts of the world there’s a lot more of that than in other parts. So it’s actually interesting to think that it’s not necessarily the places that are the wealthiest at the moment that will do best in the future.

The analogy I use is that if you’re going to fall out of a window how much it hurts when you hit the ground depends on how many floors up you were at the time. If you were on the hundredth floor and you do nothing to prepare before you fall it’s going to be fatal. If you’re much further down it’s less painful. If you fell out of a ground floor window you might not even notice. You just pick yourself up, dust yourself off and not very much has changed.

So the places that will do best are the places where there is already a lot of trust at the foundational level, where people are used to working together, where people are not that far removed from the land. Places where there’s an enormous disconnect between resources that are available in that area and what resources that are actually used, where societies are highly atomized and used to a very high standard of living, those places will see enormous shock to the system because those people don’t have any skills or connection to land or family to fall back on.

Wednesday, January 25, 2012

January 25 2012: Occupy Your Own Space

Dorothea Lange PlantationJune 1937
"Wife and child of tractor driver. Aldridge Plantation, Mississippi"

Ilargi: For today’s global financial problems, there are no solutions that are favorable to either incumbent politicians or wannabe leaders (unless they’re extremists, perhaps), let alone to the people they claim to represent. All our herd of leaders can do is to postpone the inevitable outcome of inevitable processes as long as possible.

That's why we see Obama presenting yet another housing plan that won't work, and Europe setting up the umptieth Save Greece concoction that is doomed to fail before it's signed - if that happens at all -. Obama knows it, and so do Europe's leaders.

The disaster they're seeking to avert, it seems, is not so much economic depression as it is their being voted out of office. And this pattern is not going to change, not as long as they can keep up appearances by seizing ever more of our children's future wealth, not as long as we let them.

Greece is negotiating a deal with investors to achieve a 70% haircut on existing bonds, up from 21% hardly more than half a year ago, and it still won't be enough. The 49% increase since last summer should be a huge red flag for everyone.

Why that increase? Well, first of all of course because 21% was always ridiculously low. But something else is happening too: the biggest developing problem for Europe is that a Greek default can increasingly be enormously profitable for certain parties in the market. And why should they then work to "save" Greece?

It has been clear for a long time now that Greek bonds have no value left at all. During that time, the smarter kids in the class have been able to position themselves according to that fact. Therefore the noose around the EU and ECB necks gets pulled in tighter as we go along. And as the ridiculous notion of the 70% haircut being labeled as "voluntary" keeps being touted.

The IMF is pressuring the ECB to also take a haircut. Other central banks and sovereigns are next in line. Hello, Fed! Hey, China! The ECB wants to sell its Greek paper to one of the European emergency funds, which can then take the haircut. Musical chairs is making a come-back as a highly popular game these days.

The smarter kids are laughing all the way to all the banks as they are paid all the money they want by all the bankrupt nations seeking to hide their insolvency from their own citizens, squandering those very citizens' scarce remaining wealth in the process.

We can only keep our societies alive and running by telling a seemingly neverending series of lies. And if everyone had the same interests, this delusion could last quite a while; we’ve been doing it for 4-5 years already, after all (and arguably for much longer). But not everybody has the same interests, not anymore.

This lying eyes mirage system is almost perfect, but, in the words of Leonard Cohen: "there's a crack in everything; that's how the light gets in". Still, people believe most of the lies, and add their own with impunity, because they don't want to see things for what they are. So we just keep talking about economic growth, and we'll make up the numbers we need to prove it as we go along.

The plans discussed for Greece involve interest payments on new bonds of 4-5% or so. It doesn't matter one bit what percentage they come up with. Greece won’t be able to pay any interest, never mind principal, for many years to come. And everybody with a seat at the table knows it. These are your proverbial exercises in futility. They're all that's left us.

Financially bankrupt, politically bankrupt, morally bankrupt. As every additional dollar issued as debt no longer adds to GDP, but instead subtracts from it, there's no doubt where this is going. But yes, it's true, we can still choose to look the other way and wait for it to hit us over the head. Matter of preference.

If houses in countries like the US, Britain, Holland, Spain, China are ever to reach a level where they become affordable, we will find they no longer are, no matter how low prices become - receding horizons in reverse, sort of -. Because if they do reach that level, the entire contraption that is our economy will have crumbled.

So governments choose to prop up home prices. Helped in arriving at that decision by the knowledge that homeowners are a formidable political force they don’t want to turn against them. But propping up home prices means supporting price levels that were established by hot air credit in combination with liar loans and other "criminal legalities" in the first decade of the millennium.

The hot air credit is rapidly vanishing because it's put everyone and their pet hamster neck deep into debt. People can't afford to borrow anymore, a simple truth that is almost entirely ignored. Hence, to prop up today's prices at yesterday's levels, governments themselves need to step in. Can't have that ole market working its magic. What this does is it lets every single citizen pay for every single underwater homeowner's debt. And why should people who already have a hard time pay for someone else's home?

Obama's State of the Union mortgage plan, provided it doesn't simmer down and die like all the preceding plans, is based on refinancing at lower interest rates. If nothing else, this will put potentially substantial ($100 billion? $300 billion?) additional pressure on Fannie and Freddie. Which already have negative capitalization rates. And sit on trillions of dollars "worth" of highly dubious paper, most of which has not been written down to anything like reasonable, realistic levels.

Of course all the negative aspects of this were dealt with a few years back through the brilliant move to let everyone decide their own accounting standards. A move that is as dangerous as it is brilliant, however. Because nobody knows what anything is truly worth anymore. You can have lender A having a home loan on its books for $200,000, while bank B has issued securities for a strikingly similar home next door "worth" $400,000, and the just as similar home next to that one has been sold for $50,000 just last week.

Now if the "owners" of either the first or the second home default, what happens to the value of those loans and/or securities written on them? At some point, someone will demand to know the truth. But neither the government, nor the lenders, nor the borrowers want that truth to be known. Small wonder that banks would rather let homes sit empty or let borrowers stay put for years without paying. Price discovery is a bitch, and never more so than after a long period of lying about that price.

There's only one thing a government can reasonably do when faced with a conundrum such as this: nothing. Unfortunately, that's not what governments think they're for, doing nothing, and - luckily for them - neither does the majority of people they represent. In this particular case, all those homeowners want action. They demand that the government protect the value of - what they see as- their property. And so we have another plan.

America likes to tout its status of a free market country. But that's just nuts. Delusional nuts. And no, it's not that all of a sudden we see socialism or communism, popular as those accusations may be; that just comes from people who don't understand what those words mean.

What has happened is that America is electing a Liar-in-Chief every four years. His/her job is to keep the herd in the faith, to let them buy stuff all the time, preferably with borrowed money. To keep all noses pointing in the same direction, namely perpetual growth, especially when there isn't any.

The Liar-in-Chief is far more a religious leader than a political one. You can't have the herd disperse and separate and all its members running off in different direction to go and do their own thing. Nothing to do with Obama specifically either, it's simply in the job description. Taking the job, though, is indeed his own responsibility.

If Obama were a political instead of a faith-based leader, he would take his hands off the US real estate market, and let the market do what it does best: price discovery. Shut down Fannie and Freddie and their ilk, the biggest economic disaster in US history, and sell off their "assets" to the highest bidder. Write down all the losses, let holders of loans and securities take the haircuts they are entitled to, and go on with life. Look at the future instead of being stuck in the past.

There is zero chance that US home prices will ever reach their recent peak again, unless some sort of huge inflation were to take place, and that is obviously not in the cards for many years (if it were, it would have been here already) . So before that happens, other factors will have made sure that home prices are driven down relentlessly. Like, for instance, most Americans, or the ones that have jobs at least, a select group, making the kinds of wages that are current today among burgerflippers in China or Vietnam.

Fannie and Freddie are to a significant extent responsible for the fact that the financial sector has been able to take over and govern US society, including its political sphere. Whenever I say things like this, there are always people that point to all the good the GSEs have done: allowed ordinary people to afford a home etc. But in fact, from the get-go, they have driven up prices by "raising affordability", and that has allowed for the banking sector to get a stranglehold on the US population.

Today this has culminated in a situation where personal debt levels and federal debt levels have reached ridiculous levels. Debts which will never ever be serviced. All that's left is trying to let people continue to believe that they will, until creditors bring down the guillotine. Which they will, simply because there's a profit to be made.

Releasing Fannie and Freddie from their misery would amount to certain election defeat, or so goes the perceived wisdom. So that's not going to happen. We're going to have to wait for the markets to judge that the time has come when profits from wagers are more attractive than hand-outs and bail-outs. At that point, governments and central banks will be exposed as being absolutely powerless to influence anything at all, and least of all interest rates or home prices.

And that is a sad reality. For all of us who don't have seats at the big casino tables in Washington and Brussels and Davos.

It's not like I'm alone in my judgment of Fannie and Freddie, even if that's a small consolation in view of the enormity of the consequences of the decision to let an election victory prevail over the health of an economy. If you ever wonder what kind of person wants a job like POTUS anyway, keep that in mind.

Mike Mish Shedlock is one of the few people I know who shares - some of - my views. He had this to say last week:

Time To Concede Home 'Ownership' Is A Fraud
I have long-stated the best thing to do is nothing. Indeed if nothing is done, home prices will drop low enough that investors will want to buy them. Delays in foreclosures only serve to delay the housing recovery. 

Ilargi: Mish then quotes his friend BC, who provides a very astute observation:

The only long-term durable solution to the unreal estate mess is to cease further securitization by agencies and shut them down.

It's time to concede that "homeownership" is a fraud.

When there is $16 trillion in mortgage and consumer debt outstanding and an estimated $16 trillion in residential unreal estate value, with the risk of another 20% decline in prices, there is no "ownership".

Rather, virtually everyone with a mortgage is renting debt-money from a lender and leasing the land from a local taxing authority. The mortgagees have a "dead pledge" in the value of the debt owed, not an "asset". The lenders and taxing authorities are the "owners" of a lien (a bond or constraint on the real property), which entitles them to income in the form of compounding interest and tax receipts in perpetuity. 

Ilargi: Well, it’s not going to happen on a voluntary basis, this admission of fraud. We're going to see the financial markets having to tear the delusion of ownership and economic recovery from the cold dead hands of all those implicated in that fraud, from lenders to investors to borrowers and governments. And that will be a pleasant. sight to behold.

George Soros is in his eighties. He seems to now feel free to speak out on what he sees coming, to hold his cards a little less close to his chest. Soros is dead on, and, if anything, holding back in this Daily Beast piece.

George Soros on the Coming U.S. Class War
"We are facing an extremely difficult time, comparable in many ways to the 1930s, the Great Depression. We are facing now a general retrenchment in the developed world, which threatens to put us in a decade of more stagnation, or worse. The best-case scenario is a deflationary environment. The worst-case scenario is a collapse of the financial system."

Soros draws on his past to argue that the global economic crisis is as significant, and unpredictable, as the end of communism. "The collapse of the Soviet system was a pretty extraordinary event, and we are currently experiencing something similar in the developed world, without fully realizing what’s happening."

To Soros, the spectacular debunking of the credo of efficient markets—the notion that markets are rational and can regulate themselves to avert disaster—"is comparable to the collapse of Marxism as a political system. The prevailing interpretation has turned out to be very misleading. It assumes perfect knowledge, which is very far removed from reality. We need to move from the Age of Reason to the Age of Fallibility in order to have a proper understanding of the problems."

Take Europe. He’s now convinced that "if you have a disorderly collapse of the euro, you have the danger of a revival of the political conflicts that have torn Europe apart over the centuries—an extreme form of nationalism, which manifests itself in xenophobia, the exclusion of foreigners and ethnic groups. In Hitler’s time, that was focused on the Jews. Today, you have that with the Gypsies, the Roma, which is a small minority, and also, of course, Muslim immigrants."

As anger rises, riots on the streets of American cities are inevitable. "Yes, yes, yes," he says, almost gleefully. The response to the unrest could be more damaging than the violence itself. "It will be an excuse for cracking down and using strong-arm tactics to maintain law and order, which, carried to an extreme, could bring about a repressive political system, a society where individual liberty is much more constrained, which would be a break with the tradition of the United States."

Ilargi: Ironically and unfortunately, the economic growth faith delusion is too strong to make people, even if they acknowledge that harder times lie ahead, understand that they need to focus some place other than how much their gold is worth today, or their pension. That things other than monetary items will be much more important to their survival and well-being.

That land and community and practical skills will in the future trump all the things they've ever seen as valuable. And, to be honest, how can you be expected to change your myopic points of view when everyone around you holds on to them in the exact same way that you do? You look around, and everything seems alright, nothing a spoonful of austerity and hard work can't cure.

But, just as the only good thing to do for Obama right now is to abolish Fannie and Freddie and Sallie Mae and the FHA and FHFA, to get out, which he won’t, there's an equivalent for Jill and Jack on Main Street. And that is also to get out. Get out and cut, to the extent possible, all dependence on the government that makes its decisions for all the wrong reasons, and on all other top-down systems that rely on it.

Because those systems are going to crash, and there's no doubt that they will bring all the Jack and Jills that depend on them, down with them. Obama and Merkel won't get out of the way, and that increases the urgency for Jack and Jill to do so.

There are people whose role in this unfolding tragedy will be to Occupy Wall Street or Tahrir Square. And there are people whose role it will be to find and occupy their own space. Those are the only main roles that will be available for this movie. The extras will all be cast as cannon fodder.

Nicole Foss - Question and Answer, January 2012

Sunday, January 22, 2012

January 22 2012: The End is the Beginning is the End

Tyne & Wear Archives and Museums Just watch me June 9 1902
Fron album of prisoners brought before the North Shields Police Court in England between 1902 and 1916.

Time has stopped before us
The sky cannot ignore us
No one can separate us
For we are all that is left
The echo bounces off me
The shadow lost beside me
There's no more need to pretend
Cause now I can begin again."
Smashing Pumpkins, The Beginning is the End is the Beginning

Ashvin Pandurangi: The latest revolution of the Euro Crisis Cycle has brought us back to talks of restructuring Greek sovereign debt through "Private Sector Involvement" (PSI), which are somehow taking place in a Universe where debt restructuring is not allowed to be confused with "debt default" or "bankruptcy". On Friday January 20, the IIF (representing some of Greece’s creditors) and the Greek government announced that they had finally reached an "agreement" on the basic structure of the restructuring (or the basic restructuring of the structure?). 

Here’s the live blog update from The Guardian on Friday, which really stood out to me:

A framework of the deal -- the basic structure of the bond swap that the Greek finance minister Evangelos Venizelos wants to present at Monday's eurogroup meeting -- has been accepted by both sides, "put in place" and I understand committed to paper.

But it would also seem that other aspects of the agreement - be them legal, technical or matters of substance -- remain unresolved and will be discussed at negotiations that resume at 7:30pm local time [6.30 GMT] and look set to continue over the weekend

If Greece's massive €360 bn debt load is to be made manageable much will depend "on the inter-related role of all the interests at stake" insiders say. Even if a decisive agreement is reached, the proposal will have to be put to technocrats -- given the complexity of the deal -- and they could very likely change it again.

"The outline won't be the end of the beginning but the beginning of the end," said another source again requesting blanket anonymity because of the delicacy of the talks.

That’s how these anonymous blankets, with their linear mindsets and scripts, really think about the process and justify the charade to everyone else who looks on in anticipation. We have not reached the end of the beginning, but the beginning of the end! Or is it really the beginning of the end of the beginning? Let’s just go ahead and say that the end is the beginning, which is also the end. It’s a circle, a cycle, a never-ending series of revolving points; an optical and psychological illusion of mass proportions.

M.E. Escher - Up and Down

Of course, not more than two hours after the live update from above, I stumbled across another live update from The Guardian that, in combination with all the reports over the course of just one week, was starting to make the Escher Stairs look like a straight, non-stop, round trip flight from Athens to Brussels and then back to Athens… and then back to Brussels.

"At the risk of just adding to the confusion over what is or is not happening with the discussions between Greece and the private bondholders, CNBC is reporting no deal has been reached on the terms of a debt swap. Nor is there apparently a press conference planned for tonight.

However that does not rule out the idea that a framework has been agreed, and further details will be hammered out over the weekend, as we reported earlier."

So now we should just be glad that we can’t "rule out" the possibility that a framework has been established to "hammer out" further details in upcoming days. What all of this really means is that there are way too many vested interests fighting over the pieces of the same wealth pie which is continuously dwindling in size, and it will take way too long for them to actually sign their names to an agreement that is suitable to all interested parties, as opposed to continuously cycling rumors of "progress" being made.

But, alas, even the framework of a deal didn’t last past Saturday, as the parties involved kept making right turns until they came full circle to the point of "stalled talks". Here’s a report from Dow Jones on Saturday January 21, via ZeroHedge:

Talks between Greece and its private sector creditors over a debt writedown plan appeared to stall Saturday as the banks' top negotiator left Athens amid signs of fresh disagreements over how much Greece would pay its bondholders in the future.

Officials close to the talks said they may not conclude before a meeting Monday of euro-zone finance ministers where a second bailout which will keep Greece from defaulting is supposed to be discussed. Without a deal on the write-down of the debt held in private hands, the loan can't be released.

Institute of International Finance chief Charles Dallara, who has been negotiating with Greek officials on the bond swap plan for the last two days, left Athens Saturday as hurdles remained over the interest rate the new bonds would pay private sector creditors.

"Right now there are no talks. There will be consultations with the EU and the IMF to determine where we stand and then we'll see. It (negotiations) has again become complicated with the new demands over the coupon," said a person with direct knowledge of the talks.

And here’s Paul Anastasi and Farry White from The Telegraph with a similar report, except with a slightly more optimistic spin, courtesy of official "spokespersons" from the IIF and Greek government.

Charles Dallara, managing director of the Institute of International Finance (IIF), a lobby group representing private creditors who have lent €47bn (£39bn) to the Greek government, has so-far failed to reach agreement on the key interest rate of the new bonds Greece will issue.

Athens was anxious to strike a deal ahead of a meeting of eurozone finance ministers on Monday, which could have set in motion the paperwork and approvals necessary to give Greece its next tranche of aid, worth about €130bn.

This will prevent a disorderly debt default when €14.5bn of Greek bonds mature in March. However, Greek government officials said on Saturday that the crisis talks had now been postponed for a few days.

A spokesman for the IIF said that Mr Dallara had travelled to Paris for a long-standing social arrangement and his departure was "in no way a reflection on the talks". The talks have made "substantial" progress, the spokesman said, noting that Mr Dallara was in phone contact with the Greek prime minister and could return to Athens at any point.

International private creditors have already accepted a 50pc "haircut" or loss of their investments in Greek bonds, a move that would cut €100bn from Greece's €360bn debt pile. However, the sticking points appear to be the term to maturity of the new replacement bonds and the rate of interest, or coupon, that they will pay.

"We are now expecting a solution in a few days," the Greek government official said. "Nobody expects a failure, as that could raise the spectre of a default. But it would have been convenient to have wrapped things up this weekend, because of the simultaneous presence in Athens of the Troika.

Not much commentary necessary, right? "Back to the drawing board" would imply that they had actually managed to upgrade from the drawing board to some more concrete stages of action, so that doesn’t work. The talks allegedly continue, but the questions of about what, between whom and to what end are all blowing in the wind. These PSI talks, and the Eurozone in general, are still stuck in the depths of an Escher diagram, where every ounce of "progress" is simply a function of some Eurocrat and mainstream media outlet declaring it to exist.

No one wants to accept the fact that, until the entire system is fundamentally transformed (through disorderly collapse or otherwise), this vicious crisis cycle will never end. The Greek PSI negotiations are a perfect example of the hamster wheel that is Europe. In theory, it is both necessary and just for private creditors (mainly banks) to take large haircuts on the net present value of their Greek bond holdings. But as long as the "restructuring" is treated as a means to avoid outright default/bankruptcy, stabilize the structurally imbalanced Eurozone and continue business as usual in the future, it will fail to produce any meaningful results.

You simply can’t satisfy all of the vested parties in a fundamentally broken and collapsing system. After a prolonged period of running around in circles, someone is bound to crash into someone else. The revolutions of the Euro Crisis Wheel are bound to spark an actual revolution that forces the system to do that which is unspeakable - change. It is now starting to look like the disorderly Greek default in March (there is no "orderly" version), which was always inevitable but never until now capable of being marked on a calendar, will be the event that sets that particular ball rolling.

Let’s face it – even after a credit market "rally", the Greek government is paying close to 400% for a year’s worth of money. The hold outs in the PSI right now are the hedge funds who have loaded up on Greek bonds and CDS insurance, as they figure it is better for them to try and get paid out in full on one or the other than agree to "voluntarily" participate in the swap deal and relinquish their rights as bondholders. Indeed, this literal leverage has given them a degree of negotiating leverage that was certainly under-estimated by the mainstream until now.

If they do not take place in the debt swaps, then they can avoid taking a haircut on their bonds, and if they are "coerced" into a restructuring by retro-actively inserted "collective action clauses" (allows a majority of creditors to override the minority), then the CDS most likely get triggered. On top of that, ZeroHedge just produced a lengthy and complex report that describes, among many other things, the various other implications of a retro-active change of local law.

Before we, like Reuters and like JP Morgan, accept that even the local-law debt can be crammed down, we point readers to a seminal paper by none other than Lee Buchheit, the same one who is currently advising Greece on its bankruptcy negotiations (to call a spade a spade), called How To Restructure Greek Debt from May 2010, in which he says the following:

[Buchheit] 'No country in Greece’s position would lightly consider a change of local law as an easy method of dealing with a sovereign debt crisis. The following factors, among others, counsel extreme caution before embarking on such a remedy.

• If done once, future investors will fear that it could be done again. The debtor country may therefore be compelled in future borrowings (in which international investor participation is sought) to specify a foreign law as the governing law of its debt instruments.

• A dramatic change in local law by one country might allow a worm of doubt to slip into the heads of capital market investors in other similarly-situated countries, driving up borrowing costs around the board.

• The official sector supporters of the debtor country will presumably balk at any action of this kind that could unleash the forces of contagion and instability upon other countries whose debt stocks also contain predominantly local law-governed instruments.

• The more dramatic or confiscatory the effect of the change of law, the higher the likelihood that it would be subject to a successful legal challenge

The report also describes how a stripping of the creditor protections offered by Greek bonds issued under U.K. law, which contain CACs and have been accumulated by these holdout hedge funds, will probably have even more severe implications for sovereign bond markets around the world. We should also remember that no one really knows what the knock-on effects of CDS triggers would be throughout the global financial system, since it is entirely unclear how many billions worth of derivatives have been written on Greek debt.

It’s really the space between a huge, jagged rock and a very hard place for just about everyone involved, as it has always been. Besides the two direct parties involved (Greece and its creditors), we also have the European Commission, ECB and IMF, who obviously don't want the Greek government to compromise to the point where no meaningful debt reduction is made and they are simply writing checks (endorsed by Western taxpayers) to both the Greek government and its bondholders for nothing in return. English language Katimerini reports a bit on this angle:

Talks between Athens and the steering committee of private creditors concerning the Private Sector Involvement plan (PSI+) will resume by telephone on Sunday as the committee’s head, Charles Dallara, left Greece unexpectedly on Saturday.

According to reports on Skai radio the International Monetary Fund, the European Commission and the European Central Bank are not happy with the provisional agreement between the Greek government and its private creditors, as they believe it does not secure the sustainability of the Greek debt.

As a result Dallara, who is also the head of the Institute of International Finance flew to Paris on Saturday to discuss developments with lenders and funds which hold the bulk of the privately-held Greek bonds worth 206 billion euros.

Finance Minister Evangelos Venizelos told reporters on Saturday that negotiations would continue on Sunday by phone.

Both the IIF and the government have leaked that there is progress in the talks but any agreement would require the approval of Brussels, Berlin and the IMF.

Sources suggest that the Greek side proposed to private creditors a 3.5 percent interest rate for bonds maturing by 2014, 3.9 percent for those maturing by 2020 and 4.6 percent for those expiring after 2021. There will be a 10-year grace period and the new bonds will be under British law.

Reuters cited an unnamed source saying that "things are complicated, we are getting closer on the numbers but there is still quite some work ahead. An agreement is unlikely before next week, if there is an agreement at all.

For argument’s sake, though, let’s say the Troika, the Greek government and the holdout creditors manage to come back full circle (via telephone conference) to "progress" being made and a deal "nearly within reach" in the next night or two, and then put an actual deal to paper. What will that mean for the Euro Crisis Cycle? Simple – it will continue rolling on in a broader and more devastating fashion. First of all, Greek debt will still not be sustainable in any meaningful sense of that word, as this comprehensive report from Barclays makes clear (via ZeroHedge).

6) Does the PSI in its current form make the Greek debt sustainable?

The October Troika debt sustainability report highlights that the current PSI with nearly universal participation gets debt/GDP close to 120% by 2020.

First, this number is still on the high side to conclude that Greek debt is sustainable. Second, the underlying macroeconomic assumptions by the October Troika report in terms of GDP growth and primary balance post-2015 are still optimistic (c.3.8% average nominal growth and average 4% primary balance).

If these macroeconomic assumptions are reduced to a more realistic 2.5-3%, then the debt sustainability picture would look much worse. As seen in Figure 1, a 50% national haircut with 50% participation does not get Greece close to 120% debt/GDP by 2020, as envisaged even with the relatively optimistic macro economic assumptions of the Troika.

Only if 100% participation is achieved would close to a 120% debt/GDP target be reached. For this reason, the Troika does not want to sacrifice universal participation and is determined to do whatever is necessary to maintain it. When worse macroeconomic assumptions are used, the notional haircut needed for a reasonably sustainable debt path is about 80%.

Therefore, if Greece and the Troika go ahead with October summit broad parameters for the PSI, even with 100% participation Greek debt is not likely to be sustainable in the absence of substantial fiscal and structural adjustment by Greece in the years ahead.

That's right - even if 100% of private creditors participated in the proposed debt swap arrangement for a 80% haircut to notional value (not going to happen!), Greece's debt would still remain at entirely unsustainable levels for many years to come (and that's assuming a 100-120% debt/GDP ratio is the threshold for sustainability). Secondly, the Greek situation is obviously only one piece of a much larger puzzle in Europe. Peter Tchir remarks on those other debt-swamped Eurozone countries who sure would love to have some "voluntary debt swaps" of their own.

"So it looks like we should get an announcement sometime today about the proposed Greek PSI deal.  Yes, proposed, not finalized.  Asides from the obvious fact that there will be limited or no documentation for the deal, we still have no clue who has agreed to what.

As far as I can tell, no one has given the IIF negotiators any binding power.  Obviously some of the institutions that the IIF negotiators are associated would have trouble not approving the "deal", but how many bonds do they really represent?

I think this will be a relatively small portion of bondholders and then the real game begins.  The carrot and stick that the EU and ECB can use with other holders and the desire to maximize profits (or minimize losses) on the other side.  So far, this news seems to be acting inversely to the "downgrades" price action, as early front-running is meeting sell the news.

If the terms of the deal being leaked are true, it will be extremely interesting to see what other countries do.  Not only will Greece receive a 50% notional reduction (except from the ECB and other "public" holders), but they will get very long dated money at very low rates.  Who wouldn't want that? 

Why should Spain be going through semi-legitimate auctions when Greece can get longer dated money at lower rates?  Why should Portugal or Hungary bother with painful steps to reduce debt when the alternative is spend more, reduce debt via restructuring, and get lower rates on that reduced debt?"

There is absolutely no way that European private banks can afford to take another 50-100% haircut on the bonds of Portugal or Ireland on top of Greece, let alone Spain or Italy. Any attempts towards such an outcome would be even less "voluntary" than the Greek swaps, and that’s really saying something.  And who would even want to buy the bonds of these countries after the most coercive restructuring in history just took place? This time it was a few hedge funds that have brought us to the brink of potentially catastrophic debt deflation, next time (if there is one) it will be a much broader force of resistance.

The economic, financial and political divides within Europe will simply deepen to the point where the internal hemorrhaging overwhelms any and all top-down "solutions". So IF this Greek PSI deal is finalized soon, the IMF bailout money is disbursed and Greece gets through the next few months, the focus will simply shift back to those equally troubled and much bigger debt issuers across Europe (and perhaps the world). We’ll be right back at the end of the beginning or the beginning of the end, depending on which way the crisis propaganda decides to spin on any given day.

Thursday, January 19, 2012

January 19 2012: Don't Be Fooled : Nothing's Priced In

National Photo Co. Bond Vault 1914
"Treasury Department, Office of Comptroller of Currency -- bond vault. Contains bonds to the value of $900 million securing government deposits and postal savings fund"

Ilargi: Double treat today: a thourough big picture interview with Nicole by KMO at C-Realm, and Ashvin doesn't think there's much priced in in equity markets at all.

Infinite Rehypothecation
An interview with Nicole Foss


KMO welcomes Nicole Foss (AKA Stoneleigh) of The Automatic Earth to the C-Realm to discuss the need for re-localization; something which central authorities will work to quash lest it interfere with the conveyance of wealth from the periphery to the center.

Nicole explains what she means when she describes cash as a pile of unmade choices and why she cannot offer her uncomplicated support for political movements like the Tea Party or Occupy Wall Street. She does voice her strong support for permaculture and for restoring soil fertility.

Ashvin Pandurangi:

Don't Be Fooled: Nothing's Priced In

I’m not a technical analyst or a fundamental analyst or any other type of equity market analyst. What I am is just a guy who likes to think he can spot completely nonsensical propaganda when he reads or hears it.

You know, the type of non-stop propaganda that attempts to manage perceptions/expectations and convince "investors" that, while things are obviously very bad in the real economy, everything is still just hunky dory in the wonderful world of equities.

Case In Point
Some mainstream market analysts chimed in after the serial S&P ratings downgrades of nine Eurozone countries, and specifically the one-notch downgrade of France from AAA to AA+ (ratings outlook still negative), to say that the market had already "priced them in" and therefore they are really no big deal. S&P had put all of these countries on negative watch back in December before the latest and unsurprisingly innocuous EU Summit, so the downgrades were no surprise.

Here are just two examples of a very pervasive and perverse logic, presented by The Telegraph:
S&P cuts ratings of nine eurozone countries: reaction
Fabrice Seiman, head of Lutetia Capital, said:

"S&P is absolutely right. France is paying the price of 30 years of irresponsibility in public finances. French politicians on the right and on the left fell short of the job by not taking measures to reduce  spending."

I think this is already priced in. There should not be any sizable reaction, but there could be a technical reaction on the Franco-German spread. It should be limited to the long-term and if there is a reduction in spending."

Bill O'Grady, chief market strategist at Confluence Investment Management, said:

"If France had been downgraded more than one level it would have precipitated a crisis. This is not good but it was anticipated, baked in. For oil it is probably a neutral event. If it raises concerns about a worsening economic environment it would be bearish."

Ashvin Pandurangi: That logic does sound appealing on the surface and many others like to parrot it, but the first question to pop into my mind was this – how can the market "price in" very significant developments in Euro sovereign credit markets by steadily increasing in valuation since they became aware those developments would occur?? Since the S&P put a bunch of EZ countries on negative watch on December 5, 2011 and the EU Summit on December 9, the S&P500 has risen almost 6%.

That’s a boat load of downgrades the market appears to have priced in over the last month while very little "positive" news has come out of Europe. Now I’m confident that the initial reaction to my question above would be, "that’s a really simple and stupid question to ask!". Fortunately, there are several great analysts out there who have reached similar conclusions about these equity markets, which have allegedly "priced in" everything under the Sun, and have provided us with slightly more nuanced arguments than my own.

The U.S. Dollar (and Treasuries) has been increasing in value alongside U.S. equities, so the pundits should find it very difficult to explain the upwards "pricing in" market action of the last month by saying it is a nominal increase of shares priced in dollars. What we have is a very significant divergence between the dollar index and equities, as Charles Hugh Smith outlines in his piece, A Useful Fiction: Everybody Loves a Melt-Up Stock Market, and one that must close in the near future. The following charts of the dollar index ($DXY) and 5-year Treasuries are from M3 Financial Analysis:


The truth is that the very notion of the market "pricing in" events as the investor collective becomes aware of them is flawed. In the comprehensive TAE classic of 2010, Fractal Adaptive Cycles in Natural and Human Systems, Nicole Foss delves into Robert Prechter's theory of "Socionomics" (among other things) and how it can explain market valuations as a function of endogenous factors, such as the collective mood of investors, rather than exogenous events relayed by "the news".

Bob Prechter's socionomics model combines Elliott's observed fractal patterns with an understanding of human herding behaviour, comprising a comprehensive challenge to prevailing notions such as the Efficient Market Hypothesis by reversing causation and recognizing the role of emotional/irrational behaviour as the prime market driver. While the real economy demonstrates negative feedback loops, finance is thoroughly grounded in positive feedback.

Ashvin Pandurangi: Mish Shedlock also touched on this concept in a post earlier this week. He illustrated that, at best, the market should be viewed as a contrarian indicator for future economic trends due to its function as a gauge of extreme sentiments, and, at worst, it shouldn't be viewed as an indicator of anything at all.

Cherry Picking Timeframes on Alleged Leading Indicators; Big Change In LEI on January 26
"The stock market is not a leading indicator of the economy. Rather, the stock market is a coincident indicator of sentiment towards equities.


Far from being a leading indicator, on an absolute basis the S&P has a perfect track record of peaking right before or just as a recession starts. This is just as one might expect from a gauge of equity sentiment which tends to peak right before a downturn in the economy (with everyone extrapolating good times forever into the future).



On a percentage change basis, the S&P 500 is not leading, not lagging, and not coincident. Instead it is completely useless mush."


Ashvin Pandurangi: It's not just the "fringe bloggers" drawing these conclusions about the market, but also such "reputable" financial institutions as UBS. Granted, the well-intentioned bankers over there also point out that the French downgrade, among others, was expected and shouldn't affect near-term credit spreads too much. Instead, they choose to focus on the effects it will have on the state of realpolitik in Europe’s core, and how that is certainly not something which is "priced in" at all. Indeed, only market shills and fools can even pretend to separate the two (finance and politics).

UBS Explains Why AAA-Loss Is Actually Relevant
"France has not only lost its AAA status. Critically, France has lost AAA status at a time when Germany has not. France also retains a negative outlook against a stable outlook for Germany, compounding the distinction. The relative decline of France’s credit rating is something that has potential political implications.

There are parallels here to the relative positions of the UK and the US in 1949, in the wake of sterling’s devaluation against the dollar. The devaluation was simply a confirmation of economic reality, but the visible confirmation of that shift in relative economic reality served as a defining moment in the shift of the bilateral relationship in political terms.

Since the foundation of the Coal and Steel Community in 1951, the history of (continental) European politics has been essentially a story of France and Germany holding each other in check. Indeed, this was the explicit aim of the ECSC’s founders. With the downgrading of France relative to Germany, there is now a de jure as well as a de facto inequality between the two states. The ability of France to act as a counterbalance to Germany in economic decision-making has been compromised.

In the wake of the downgrade of the EFSF, it is clear that the actions of S&P have elevated the role of Germany (and perhaps, to a lesser degree, the Netherlands) in any collective economic decisions within the Euro area. Any economic decision that requires money to be spent will require wholehearted German endorsement if rating agency determined credit credibility is to be maintained. The bargaining power of Germany in the economic councils of Europe has been correspondingly increased."

Ashvin Pandurangi: So if the equity markets are "pricing in" anything, it's the pure hope that all of these downgrades of countries, banks and corporations will continue to be glossed over by bond markets, that political/economic imbalances in Europe haven't been exacerbated, that the Greek government and its creditors aren't helplessly struggling to reach a "voluntary" debt reduction deal before a technical default in March becomes inevitable, that China/India aren't facing "hard landings" and that the U.S./U.K. economies will not be dragged down by their own housing markets, corporate [lack of] earnings, unemployment trends or any of the above.

Some people will tell you that the only thing the markets need to keep their manic phase intact is the inevitable QE money printing that the Fed will officially announce, which has conveniently been "just around the corner" for almost a year now. Despite those consistent predictions of QE3, I made clear that I didn’t expect the Fed to relent in 2011, and many of the same financial and political reasons underlying that expectation still stand. The primary reasons being the conundrum reflected by the fact that the S&P is still hovering around 1300 (and oil around $100/bbl), which makes the marginal benefits of QE very slim, and the politically volatile situation in the run-up to November’s elections.

On the other hand, the financial threats from the Euro crisis and a strong dollar (weak euro) have clearly intensified over the last few months, and the ECB is even more constricted from printing than it has ever been (at least for anything other than sub 3-year sovereign paper through its indirect LTRO, which still doesn’t reflect net cash entering EZ bond markets). Perhaps these developments will finally convince the Fed to "pull the trigger" on QE3, but then many questions still remain – how many trillions are needed to boost "risk appetite" for more than a few weeks and what happens when those trillions are perceived as "not enough"?

Like I said at the beginning, I'm not any sort of market analyst, but there do seem to be a whole slew of developments starting to weigh on collective investor sentiment right now, which will only get heavier in the upcoming weeks and months. No one can tell you that any of these negative and ongoing developments herald an imminent market crash or how exactly they will impact shares. What I can say with confidence, though, is that none of them are insignificant bumps in the road. They certainly did not "remove any uncertainty" from the markets and they have in no meaningful way been "priced in" by these markets either.