Thursday, July 4, 2013

‘Two Croatias’ at the finish line, not one of them a winner

By Vanja Figenwald and Kristina Kardum

It’s no surprise to many that an economic crisis almost always bears the same unwanted children and Croatia, soon to be the 28th member of the European Union, is no exception. Xenophobia, prejudice, scape-goat mentality, nationalism, conservatism and other forms of collective grouping based on hate and intolerance towards ‘others’, seem to find their way into a popular discourse when economic volatility translates to unemployment, lower wages, job insecurity and an overall decrease in living standards and purchasing power. Croatia’s big celebration on July 1st, when it officially joins the EU, will therefore be an ambiguous, even an ironic affair. On the one hand, it will mark the fulfillment of a dream chased by the country’s elites and shared by majority of its citizens since its independence in 1991, while on the other hand, it will come amidst a significant shift to the far-right in the thinking of ‘ordinary citizens’.

The fact that a declared nationalist, right-wing euro-skeptic politician Ruža Tomašić unexpectedly won a seat in the European Parliament in the April elections probably serves best to illustrate the rift between the ‘two Croatias’. The past year, which saw a rise in unemployment to 18,1 percent (April 2013) and a drop in GDP of 2 percent (2012), has facilitated many

indicative ‘incidents’ clearly 598px-Croatia_EU_svgdemonstrating an erosion of civic values such as tolerance, human rights and secularism already on shaky ground due to a war fought in the region during the first half of the 1990s in which almost a third of Croatia was occupied. A decline in living standards, (according to a market research agency Gfk, more than half of Croatia’s citizens, 58 percent, found their financial situation worse in 2012, a 10 percent increase from the previous year) seems to have provided fertile ground for the success of two recent conservative civic initiatives, one aimed against the gay population and the other against a new high school subject called Health education, encompassing, amongst other things, an open approach to sexuality.

The Catholic Church (86,28% of the population in Croatia declare themselves Catholic) spoke out openly against the Ministry of education’s implementation of this subject and employed a ferocious media campaign calling for an abolishment of a high school subject intended to educate students in basic human sexuality. A non-governmental organization Grozd, led by dissenting parents claimed that the parents hadn’t been consulted on the matter and that the subject matter involved pornography, destruction of traditional family values and stimulated homosexuality and masturbation. After a complaint was lodged at the Constitutional Court, the court found in May the addition to the curriculum unconstitutional and demanded it be abolished.

An initiative that followed, again led by a civic association called U ime obitelji (In the name of the family) started collecting signatures for a referenda to constitutionally define marriage as a community of man and woman, therefore preventing LGBT persons to marry any time in the future. Worth noting is that no such counter-initiative, to legalize homosexual marriages, existed in Croatia, which makes such a zealous appeal all the more curious. The number of collected signatures astounded many in Croatia, having surpassed 700 hundred thousand in a country of 4,4 million people, thus clearly indicating a strong shift to conservative values in the minds of many.

Meanwhile, local elections held in May unexpectedly resulted in a very good performance of HDZ (conservative Croatian Democratic Party) in spite of its president Tomislav Karamarko topping the most unpopular politicians list for months and the party being mired in corruption scandals since the arrest of its former president and Croatian prime minister Ivo Sanader in 2010. HDZ won 59,6 percent of the votes for the county assemblies (Županijska skupština), and even though the ruling social-democrats (SDP) won three out of the four biggest cities in the run for mayors, the result nonetheless demonstrated a substantial support to sometimes highly inflammatory rhetoric of HDZ which often relied on the fear of a communist revival and the destruction of traditional Croatian values.

A professor at the Faculty of philosophy in Zagreb Ognjen Čaldarović agrees that the crisis effects perception and provides an opportunity for the rise of extremism and intolerance. ‘Every crisis causes a shift in perception, but also in the real impression of the society, the problems and the distribution of social fairness with respect to the effects of the crisis – does everyone share the same burden?’ A prominent politician and the leader of the Labor party, the third political power in Croatia, points to the existential fear that leads ‘to the heard, where it smells bad, but it’s warm’. Shifting blame to the minorities in the society, which ever they may be, is a trademark of a crisis nearing its peak, explains Dragutin Lesar. ‘Relevant ideas have a hard way of finding its way within the public rhetoric in such a situation’. Lesar notes that there are similarities between what is happening in Croatia and what became a symbol of any such social decay, the Weimar Republic in the 1930s. ‘All the main indicators are present – unbelievable social differences, economic societal set-back, an indecisive mainstream left and the so-called centrist right, the inability to recognize the dangers of extremist messages, the disappearance or almost disappearance of socially aware intelligentsia, media controlled by interest groups, apathy of the broad social classes waiting to be ignited etc’. 

While this rhetoric is not exclusive to Croatia, it finds support more easily as a result of the recent war, a ruined economy and a troubled transition from socialism to capitalism. Both Čaldarović and Lesar feel that Croatia is not much different than the other European countries, but add that it does provide certain specificities as a result of a rouge privatization process that left bigger differences between classes. Such a situation could lead many citizens to seek a strong leader figure and to unite towards common enemies in our midst. On the other hand, Darko Polšek, also a professor at the Faculty of Philosophy in Zagreb, warns of ‘calling out the devil’ although he agrees similarities to Germany before the rise of Hitler do exist. If one feels such a comparison is far-fetched, a quick look around Europe in which far right movements are gaining force from the Golden Dawn in Greece to True Finns in Finland might persuade him otherwise. Democracy is, as history has shown numerous times, a very fragile creature prone to crack under economic hardship more quickly than many like to think.

All three interlocutors agree, albeit reluctantly, that Croatia’s accession to the EU may alleviate some of the extremist rhetoric. However, skepticism remains as to the extent of the benefits stemming from the influence of the EU on Croatia. While, as mentioned in this article, the rise of right-wing rhetoric in the public discourse is not exclusive to Croatia, it does seem to find a very captivated audience. Also, conservatism and intolerance have managed to appeal to a significant portion of the population, as opposed to other countries where it is still relatively limited and wields little palpable power in defining these societies’ everyday life. The 700 hundred thousand signatures to, in fact, ban gay people from marrying and the Constitutional Court’s verdict attest to that vividly.

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Euroscepticism is rooted in a broader authoritarian worldview that also includes higher levels of nationalism and hostility to ‘outsiders’

By Erik R. Tillman

Since the ratification of the Maastricht Treaty two decades ago, proponents of European integration have faced a dilemma of sorts. Increasingly, public support is necessary for further integration as European issues become more salient in national politics and as member-state governments more frequently call referendums on European questions. At the same time, public support for the European Union (EU) has declined, making it more difficult for European elites to convince their electorates to support further integration.


Scholars who study European politics have naturally sought to understand the sources of growing public opposition to the EU. Early research analysed the economic sources of public attitudes: individuals who believe they and/or their national economies benefit from EU membership are more likely to support it. In the past decade, there has been a shift toward research emphasising the role of social identity in shaping EU attitudes. For example, those that identify strongly with their nationality oppose European integration. Similarly, opposition to immigration and hostility towards members of foreign religions also increase opposition to the EU. The findings from this line of research are important and compelling. What is missing is a broader understanding of how these different indicators of social identity—national identity, xenophobia, and EU opposition—are related.

To answer that question, I draw upon a concept from the study of psychology: authoritarianism. The study of authoritarianism dates back to the immediate postwar years and the publication of The Authoritarian Personality. Authoritarianism describes an individual predisposition characterised by a high need for order, presumably as a means of coping with the uncertainty and anxiety of social life. This need for order manifests in several characteristic traits. Authoritarians display a tendency to rely upon established and traditional sources of authority for guidance. They are more likely to submit their own autonomy to the judgements of established authorities, and they are likely to react with discomfort or hostility towards challenges to those authority figures. They also display a tendency to view the world in binary terms (right vs. wrong, good vs. evil, etc).

Crucially, this pattern of thinking extends to the social world: authoritarians are more likely draw sharp distinctions between members of in-groups, with which they identify closely, and out-groups, and they strive to maintain cohesion within their social groups. By contrast, non-authoritarians (i.e., those who do not display authoritarian traits) display a greater concern for maintaining individual autonomy, along with more willingness to tolerate ambiguity and to accept challenges to traditional sources of authority.

Drawing on this concept allows us to understand the relationship between social identity and EU attitudes described above. Authoritarianism shapes an individual worldview that promotes strong in-group attachment, adherence to traditional values and sources of authority, and hostility towards threats to that traditional authority or in-group cohesion. In the European context, authoritarians should be more likely to identify strongly with their national community and to express hostility to out-groups such as immigrants or members of foreign religions who might undermine social cohesion. The translation of this worldview into actual social and political attitudes depends on the external environment. To generate opposition, there must be a threat. The early years of European integration posed no particular threat to social cohesion or state sovereignty, but the EU increasingly does in the post-Maastricht era. European integration constitutes a threat to the social cohesion of the national community by promoting intra-EU migration (and EU enlargement has increased both the number of potential migrants as well as their diversity). The EU also erodes state sovereignty as power is transferred to supranational institutions, which authoritarians may view as a threat to the legitimate political order. Symbols of European integration, especially the common currency, reinforce this perceived threat. As a result, authoritarians should be likely to oppose European integration.

In a recent study, I find evidence in support of these claims. Opposition to European integration derives from the same underlying authoritarian predisposition that generates hostility towards immigrants and foreign religions. This result suggests that opposition to the EU is rooted in a broader authoritarian ‘worldview’ that also includes higher levels of nationalism and hostility to social or religious ‘outsiders’. This finding also suggests that one cause of the shift in public opinion during the past two decades from a “permissive consensus” to a “constraining dissensus” was the result of increasing opposition by authoritarians.

What does the finding that authoritarians oppose European integration mean for the future of European integration? Authoritarians constitute a bloc of Europeans who are unlikely to support European integration in the near future. If, indeed, public support is important to the future of integration, then European leaders will need to find enough support from other citizens to overcome the opposition of authoritarians. Economic growth or improved EU-level democracy will not be enough; nor will improved information about the EU or its policies.

Given the growing importance of issues such as European integration, immigration, and globalisation, political divisions between authoritarian and non-authoritarian voters and parties may become more salient. Authoritarians are likely to see each of these as a potential threat, and they will be receptive to elite messages to defend the nation-state. The end result could well be a realignment of national party politics, which Hetherington & Weiler argue has occurred in the United States. Because this authoritarian/non-authoritarian divide reflects a worldview rather than a divisible political issue, such a realignment may have negative repercussions for compromise and governability in national political systems.

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The Risk of European Centralization

by Otmar Issing

FRANKFURT – For many European leaders, the eurozone crisis demonstrates the need for “more Europe,” the final aim being to create a full-fledged political union. Given the continent’s history of war and ideological division, and today’s challenges posed by globalization, a peaceful, prosperous, and united Europe that wields influence abroad is surely a desirable goal. But major disagreements about how to achieve that goal remain.

This illustration is by Chris Van Es and comes from <a href=""></a>, and is the property of the NewsArt organization and of its artist. Reproducing this image is a violation of copyright law.Illustration by Chris Van Es

Historically, monetary union was regarded as the route to political union. In the 1950’s, the French economist Jacques Rueff, a close adviser to Charles de Gaulle, argued that “L’Europe se fera par la monnaie, ou ne se fera pas” (Europe will be made through the currency, or it will not be made). Germany’s President Richard von Weizsäcker echoed this view almost a half-century later, declaring that only via a single currency would Europeans achieve a common foreign policy. More recently, German Chancellor Angela Merkel asserted that “if the euro fails, Europe will fail.”

But the crisis confronting “Europe” is not so much about political union as it is about European Economic and Monetary Union. If anything, efforts to hold EMU together may have taken us further from the goal of a common foreign policy by re-igniting within member states (regardless of whether they give or receive financial aid) nationalist resentments that we hoped had died long ago.

Politicians launched monetary union in 1999, despite warnings that the constituent economies were too diverse. It wasn’t long before several states violated the Stability and Growth Pact. Later, the eurozone’s “no bail-out” principle was abandoned. The response to these failings, however, was a demand for greater economic integration, including such intermediate steps as the creation of a “European finance minister” or an EU commissioner with sweeping powers to facilitate closer integration.

Such ideas, of course, ignored the central issues of national sovereignty and democracy, and specifically the privilege of nationally elected governments and parliaments to determine their own taxes and public spending. The fact that sovereign member states did not deliver on their European commitments is hardly a convincing argument for giving up sovereignty now.

In short, all of the measures that would implicitly support political union have turned out to be inconsistent and dangerous. They have involved huge financial risks for eurozone members. They have fueled tensions among member states. Perhaps most important, they have undermined the basis on which political union rests – namely, persuading European Union citizens to identify with the European idea.

Public support for “Europe” depends to a large degree on its economic success. Indeed, it is Europe’s economic achievements that give it a political voice in the world. But, as the current crisis indicates, the best-performing EU economies are those with (relatively) flexible labor markets, reasonable tax rates, and open access to professions and business.

Moreover, the impetus for economic reform has come not from the EU, but from national governments, one of the most successful examples being “Agenda 2010,” launched a decade ago by then-German Chancellor Gerhard Schröder. Numerous academic studies, following the work of the American economic historian Douglass North, support the notion that it is competition among states and regions that lays the groundwork for technological progress and economic growth. The total failure of the Lisbon Agenda, launched in March 2000 to make the EU “the most competitive and dynamic knowledge-base economy in the world” demonstrated the weakness of a centralized approach.

Arguably, in earlier centuries, it was competition within Europe that generated unparalleled dynamism and prosperity across much of the continent. To be sure, this was also a time of wars. However, this does not mean that centralization is the best – much less the only – way to guarantee peace.

But, once again, EU leaders responded by concluding the opposite: the Lisbon Agenda’s failure was interpreted as justifying still more harmonization and centralization of national policies. True to form, in his “State of the Union” address to the European Parliament in September 2012, European Commission President José Manuel Barroso called for a more powerful Commission.

This approach – harmonization, coordination, and centralized decision-making – continues to be regarded as a panacea for Europe’s problems. It is the sort of pretense of knowledge that the economist Friedrich von Hayek denounced as a recipe for constraining freedom and ensuring economic mediocrity. Indeed, the European project should start from the premise that appropriate institutions, property rights, and competition, together with a growth-friendly tax system and solid fiscal policies, are the basis of economic success.

The dangers of a centralizing approach can also be seen in the relationship between the 17 current eurozone members and the 11 non-eurozone EU states. As the former press on with greater integration, the adverse economic consequences of doing so are likely to deter the latter from EMU participation (which may be another sign that institutional competition cannot be suppressed forever).

There are plenty of areas in which common action at the EU level is both appropriate and efficient. Environmental policy is clearly one. But centralization of economic decision-making, as an end in itself, cannot underpin a prosperous and powerful Europe.

Jean Monnet, one of the EU’s founding fathers, once said that, given the chance to start the European integration process again, he would have begun with culture – a dimension in which we neither need nor want centralization. Europe’s cultural richness consists precisely in its diversity, and the basis for its finest achievements has been competition between people, institutions, and places. Its current economic malaise reflects European leaders’ prolonged efforts to deny the obvious.

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The Next American Revolution

by Charles Hugh Smith

Some July 4th thoughts on revolution as a process rather than an event.

The next American Revolution will not be an event, it will be a process. We naturally turn to the past for templates of the future, but history has a way of remaining remarkably unpredictable. Indeed, all the conventional long-range forecasts made in 1900, 1928, 1958, 1988 and 2000 missed virtually every key development--not just in the distant future, but just a few years out.

The point is that extrapolating the present into the future fails to capture sea changes and developments that completely disrupt the supposedly unchanging, permanent Status Quo. The idea that the next revolution will take a new form does not occur to conventional forecasters, who readily assume the next transition will follow past critical junctures: armed insurrection against the central authority (The first American Revolution, 1781), civil war (1861) or global war (1941).

I submit that the next American Revolution circa 2021-23 will not repeat or even echo these past transitions. What seems likely to me is the entire project of centralization that characterized the era 1941-2013 will slip into irrelevance as centralization increasingly yields diminishing returns.

Everything centralized, from the Federal Reserve to the Too Big To Fail Banks to Medicare to the National Security State depends on the Federal government being a Savior State that must ceaselessly expand its share of the national income and its raw power lest it implode. All Savior States have one, and only one trajectory-- they must ceaselessly expand and concentrate wealth and power or they will fail.

They are like the shark, which dies once it stops moving forward: the Savior State must push forward on its trajectory of expansion or it expires.

Stasis is not possible, nor is contraction; the promises made to the citizenry cannot be withdrawn without political instability, but the promises cannot be kept without fatally disrupting the neofeudal financialized debtocracy.

You see the dilemma: The Savior State cannot stop expanding, but the financial system that generates its revenues can no longer support its vast machinery of debt and phantom collateral. This is why I suggest all the centralized concentrations of wealth and power will either implode or fade into irrelevance.

If all the phantom wealth and collateral vanishes in a market clearing event, the Federal Reserve will simply become irrelevant to the vast majority of people. A handful of nimble speculators may well benefit by picking over the carcass of financialization and centralized omnipotence (i.e. central banking), and perhaps the 1/10th of 1% will still have enough assets influenced by the Fed to care, but the forces of disruption will replace centralization with decentralization.

Here is another example: Medicare may not cease to exist, but it will become increasingly irrelevant to most people because it will not longer function. The remaining doctors willing to treat Medicare patients will be working 13-hour days for sketchy pay, and as each one burns out and leaves the system, the system contracts. Eventually it contracts to the point of irrelevance.

The revolution will be in work and social innovations enabled by technology. The conventional view is that technology will magically enable the permanence of the present; this will be proven incorrect, as what technology enables is not the waste, entitlement and centralization that characterize the present but social innovations, some of which are already visible.

If we sought to summarize the profound transformation ahead in one sentence, it would be this: wages are no longer an adequate model for distributing the surplus generated by the economy.

The current Savior State model responds to this by increasing taxes on the dwindling minority with fulltime jobs and increasing entitlement payments to all those without government or private-sector jobs. This model will collapse, politically, socially and economically, as no society or economy can squander half or more of its productive labor force while increasing the burden on the dwindling cohort of productively employed. The inevitable result of this dynamic is a destabilizing Tyranny of the Majority. Tyranny of the Majority, Corporate Welfare and Complicity (April 9, 2010)

Technology is not just disrupting old industries and companies, it is disrupting the entire Savior State/cartel-capitalism model. The disruption has barely begun, but it will pick up speed over the next decade.

I suspect the next American Revolution will begin in the 2015-16 timeframe. A series of interlocking crises will lead to reforms that preserve the Savior State/ cartel-capitalism for another few years, at a lower level of consumption, i.e. burn rate.

But the process of revolution will be far from complete; this initial response of the centralized neofeudal debtocracy will buy time for the Status Quo, and every conventional onlooker will be infused with optimism and hope that the system founded in 1940--the secular religion of consumerism (i.e. aggregate demand), dependence on the Savior State and a ceaseless expansion of concentrated wealth and power--will continue.

But this Springtime for the Savior State/cartel-capitalism partnership will be brief, and by 2018-19 all the systemic flaws and disruptive trends will reassert themselves with renewed vigor.

The entire current model of governance, social order and the economy will be revolutionized not by overthrow but by the process of irrelevance. What will become relevant will no longer be in the control of the Savior State or its partner, financialized cartel capitalism.

Those currently holding all the concentrated power and wealth cannot believe they will become irrelevant, but that's the result of projecting the present as if it is permanent and immutable.

The new system will be better, more humane, more flexible, more transparent, with more opportunity, for it will be everything the current corrupt, sclerotic, parasitic and exploitive system is not.
Three video programs for your viewing pleasure:

Gordon Long and I discuss Window of Opportunity: Blown!

Longtime contributor and fellow writer Zeus Yiamouyiannis discusses his new bookTransforming Economy: From Corrupted Capitalism to Connected Communities with Max Keiser

Kerry Lutz of Financial Survival Network and I discuss the future of work and education--though Kerry titled the show more provocatively....

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US Non-Farm Payrolls Preview

By Aamar Hussain


US Non-Farm Payrolls: 13:30 BST, Friday 5 July 2013


US non-farm payrolls rose 175,000 in May, beating expectations of 163,000. The unemployment rate edged higher to 7.6%, from 7.5% in April.

The payroll data was initially taken as a positive sign that growth in the economy is creating jobs at a reasonable rate (172,000 is the 12 month average). However, the better than expected figure encouraged talk about whether the Fed would begin tapering its asset purchase programme sooner rather than later. These concerns were somewhat tempered by the uptick in the unemployment rate – a measure used by FOMC members as a benchmark for adjusting Fed policy.

Chris Williamson, chief economist at Markit, noted in reaction to last month’s date release: “As the labour market often lags behind changes in output, the case for scaling back policy stimulus is by no means clear cut.”

Williamson added, “The Fed is likely to watch the incoming data flow on business activity and demand closely over the coming months before making clear signals on policy changes, and will probably want to see the actual rate of unemployment come down further before being comfortable that a meaningful and sustainable recovery is in place.”


The consensus forecast for total non-farm payrolls is an increase of 165,000 jobs in June, according to a Reuters survey. The median estimate for the rate of unemployment is 7.5%, according to the same survey.

Economists at HSBC believe “most labour market indicators point to ongoing employment growth at a moderate pace,” and highlight two areas of interest specifically: first, “construction employment appears to be trending higher, but monthly growth was weaker this past spring than during the winter”; and second, “government employment continues to decline in response to budgetary cutbacks”.

HSBC’s total payrolls estimate is below consensus at 155,000. Their economists expect “+16,000 from construction, +1,000 from manufacturing, +143,000 from private services industries, and -6,000 from government payrolls”.

On the participation rate, HSBC note, “The labour force participation rate has been on a downward trend for several years, but has shown some tentative signs of stabilisation in recent months.”

Jim Reid, an economist at Deutsche Bank, draws attention to the fact that “summer payroll numbers have on average been weaker than at other times of the year,” and notes that a couple of labour indicators have led to increased expectations of a softer payrolls report this month.

Mike McCudden, head of derivatives at Interactive Investor, adds, “Certainly recent numbers have been a little less upbeat and there’s a belief building that what had seemed imminent tapering, whilst still inevitable has perhaps been kicked a little further down the road.”

Here’s a look at some of the other labour metrics released in the last month:


The US private sector added 188,000 jobs from May to June, exceeding expectations of 160,000, according to the ADP National Employment Report.

The increase was “driven by gains across all sizes of businesses, and with small companies showing the largest overall monthly increase. Most notably, the goods-producing sector added 27,000 jobs in June, a marked improvement over the decline the previous month,” said Carlos A. Rodriguez, president and CEO of ADP.

The correlation between ADP and the Bureau of Labor Statistics’ monthly survey is hotly contested, but Deutsche Bank’s US economists believe the ADP report is “the single best predictor of monthly changes in payrolls”. They add, “Over the last 12 months, the average error between the difference in private payrolls and ADP has been -14k, which is quite small since the standard error on private payrolls is about 75k per month.”

ISM Manufacturing

Economic activity in the manufacturing sector expanded in June, according to ISM; the index registered 50.9%, an increase of 1.9 percentage points from May.

But, the employment component registered just 48.7% in June, the first sub-50 reading (indicating contraction) since September 2009. Reid commented, “In the week of payrolls that’s clearly sending out hopes of a softer report and hope of a tapering delay.”

Paul Dales, an economist at Capital Economics, also weighed in: “On the face of it, that’s consistent with declines in manufacturing payrolls of over 50,000 a month.” But, he added, “Since this survey has been too pessimistic relative to payrolls for most of the last year, we are sticking to our payrolls forecast of a 150,000 rise in June” – an estimate that is nevertheless below the 165,000 consensus.

ISM Non-Manufacturing

Economic activity in the non-manufacturing sector also expanded in June – but at a slower pace –, according to ISM; the index registered 52.2%. June’s reading reflects the lowest ISM Non-Manufacturing reading since February 2010.

But employment was a bright spot; the sub-component climbed to 54.7%, a four-month high.

Initial Jobless Claims

Initial jobless claims fell again in the latest week (ending June 29) to 343,000, a decrease of 5,000 from the previous week’s revised figure of 348,000. The 4-week moving average now sits at 345,500.

“A downward drift in initial claims for unemployment insurance suggests that labour market fundamentals have improved somewhat, but the change has probably not been strong enough to pull job growth out of its recent range,” said Michael Moran, economist at Daiwa Capital Markets America.


Friday’s non-farm payrolls data could provide the market with an indication as to when the Fed will begin tapering its asset purchase programme. The Fed has placed more emphasis on labour market metrics of late, and the small payrolls increase on last month’s data predicted could compound fears that Fed tapering is imminent.

Here are some economists’ views on the relationship between non-farm payrolls and the Fed’s monetary policy decision-making:

Victoria Clarke - Investec Securities - “Since the 19 June Fed meeting … fears of a Fed exit have notched up, spreading to expectations of a quicker ‘normalisation’ in rates. Given those enhanced fears, next week’s jobs report will once again shape concerns over how quickly and aggressively the Fed tightens policy.”

Paul Dales - Capital Economics - “The Fed is still mostly focused on labour market developments, so the release of June’s non-farm payroll and unemployment figures this Friday could have an even bigger than normal impact on financial markets. We anticipate a 150,000 increase in payrolls. That would be smaller than May’s 175,000 gain and would presumably generate some sort of rally in the bond market.”

Chris Williamson - Markit - “Last month’s better than expected non-farm payroll data added to global financial market jitters that Fed tapering was growing increasingly imminent. The Fed’s strategy to start tapering its $85bn per month asset purchases by the end of the year is dependent on the unemployment rate falling from its current 7.6% to 7.0%. A rate of 6.5% would represent the threshold for rates to start rising.”

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Time to Strike a Gusher in Crude Oil

by Greg Harmon

Crude Oil ($CL_F, $USO) has been moving in a broad tightening channel for months. That is about to change it seems. The daily chart below shows that it has been building for a while. A series of higher lows and higher highs has led to the break higher this week and a new higher high. The Relative Strength Index (RSI) and Moving Average Convergence Divergence indicator (MACD) both support the move continuing. So does the 3 Advancing White Soldiers Pattern.

oil d

But a look out at the weekly chart below is what can get you excited. With one day to go, it is breaking a symmetrical Triangle to the upside. If it holds up Friday the target on the pattern break takes it to 117. This chart also has support for a continued move from the RSI and MACD. At that price there is nothing left in the way as resistance before the previous top at 147.

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What The ECB's "Unprecedented" Forward Guidance Means

by Tyler Durden

Confused what the (non) news of today's "unprecedented" forward guidance announcement by the ECB means? Shocked that the ECB is about as dovish as it has ever been, after having missed the following chart showing the record low European bank lending to the private sector which predicted all of today's action (Stolper's long EURUSD reco fade notwithstanding)...

Then SocGen is here to explain, if only for all those who are seemingly stunned that the ECB isn't planning on hiking rates, or even "tapering" any time soon.

"Forward Guidance" Introduced, from SocGen

The ECB came out with all dovish guns blazing today to reverse the tightening in money and financial market conditions since June, stoking a rally in euribor futures (lower rates) but causing the EUR to drop nearly 1% vs the USD. The only thing that was missing today was a cut in the refi rate and/or negative deposit rate, but neither has not been ruled out given that downside growth risks continue to exist. Casting better macro data side, the ECB officially introduced ‘forward guidance' on rates and said exit is “very distant”.

The introduction of ‘forward guidance' characterises the fact that all key ECB rates will stay low for a longer period. This makes the ECB fall in line with the guidance by the US FOMC on the Fed funds target, the Bank of Canada and most probably, the BoE in August. Put on the spot during the press conference, president Draghi rejected claims the ECB had come off the proverbial fence in response to a changed outlook for US monetary policy given the spill over effect from a steeper US yield curve across the Atlantic and the steepening impact on eurozone core and periphery debt markets. Taking after the BoE earlier (a coincidence, Draghi said), the ECB is worried that the tightening in financial conditions will handicap the prospects for economic recovery in the euro area where the credit growth remains very weak and fragmented.

The move clearly marks an innovative step in the ECB's communication and policy strategy for a bank that previously had always refused to pre-commit on interest rates. Draghi did not commit explicitly how long rates would stay low but hinted that there would be no change for at least 12 months (“extended period is not 6 or 12 months”). The decision to introduce forward guidance was unanimous and how long this bias will be observed will depend on the assessment of three variables ie inflation, growth and monetary developments (credit flows, monetary aggregates). The case for a cut in the refi rate was also discussed but there was no agreement.

The retention of ammunition should the economy move back into reverse was important to the ECB and this probably explains why there was no consensus to cut the refit rate from 0.50%. Draghi categorically said that 0.50% is not the “lower bound” for rates. This implies that further stimulus is still possible. For EUR/USD, key support now rests at 1.2877 before selling towards the April 1.2746 low is stepped up.

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China hikes corn price, 'lifting import prospects'


China, whose poor wheat harvest has revived prices of that grain, may have given a prop to world corn prices too by lifting its support price for domestic farmers to levels well above those in global markets.

China's important National Development and Reform Commission said that it would lift by 6% to 2,220-2,260 yuan the price at which it will purchase corn from growers.

The uplift is aimed at supporting farmers, and avoiding them turning away from a crop crucial to keeping the country's huge hog herd fed, and its people in supplies of pork, China's most popular meat.

A US Department of Agriculture report overnight highlighted how prices of corn left over from last year are already 10% lower than last year, "due to bumper crops and a slowdown in industrial and feed use".

And prices worldwide this year face pressure from the prospect of a record US crop, following on from a record Brazilian harvest too.

Meanwhile, Chinese corn farmers face increasing production costs, with labour and land rental rates expected to increase by more than 10% this year, USDA staff in Beijing said.

'Competition is fierce'

The upgraded support price - while a little below the levels on the Dalian futures exchange, where corn for January closed up 1.0% at 2,364 yuan a tonne on Thursday- is equivalent to $362-369 a tonne, or about $9.20-9.40 a bushel, well above world market values.

Chicago corn for December closed at $5.02 ¾ a bushel on Wednesday, down one-quarter from highs reached 10 months ago, with prices in many other countries lower still, although China tends to buy from the US.

Iowa-based broker US Commodities, flagging that "competition is fierce" among corn exporting countries, said that "Ukrainian corn for October delivery is the equivalent of $4.50 a bushel on December corn futures".

'Will benefit imports'

The gap between upgraded support prices and international values looks like boost the incentive for China to lift corn imports – a sensitive market topic given the country's potential, as a huge consumer of the grain, to alter trade dynamics.

"The hike will benefit imports," an industry analyst with a Chinese official think-tank told Reuters.

Indeed, such a phenomenon has already played out in the cotton market, where Chinese purchases at prices well above market, aimed at supporting farmers, has lifted domestic prices, and so encouraged mills to look abroad for cheaper supplies.

Higher Chinese cotton imports have supported international prices, which remain at historically high levels.

This despite world stocks being at a record high level – although with more than half in China, free-market supplies are squeezed.

China is now reviewing its cotton support policy because of its unintended consequences, which have included lifting prices for domestic mills and so forcing business abroad.

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Draghi Breaks New Ground, Euro Breaks a Cent

by Marc to Market

The ECB took an unprecedented step today. Part of its mantra has been that it does not pre-commit. Today it did. It indicated interest rates will be the same or lower for an extended period of time. Draghi, when pressed, chose not to define extended period, except to note that it does not mean six or twelve months.

Sometimes ECB officials are surprised by the market's reaction, but not today. Interest rates fell. The implied yield on next year's Euribor futures contracts fell 8-11 bp, while the yield on the 2015 contracts fell 12-13 bp. Even further out, the 2-year yields fell 5-7 bp in Germany and France and 14-16 bp in Italy and Spain. As one might expect,the reaction was more muted at the long end of the curve. Benchmark 10-year yields were off only slightly in the core, and 5-8 bp lower in Italy and Spain. Portuguese bonds continue to recover from the dramatic losses as more appear to be coming around to our view that an early election is not the most likely scenario.

The euro fell to new lows since late May near $1.2880.  Reactive bounces have been limited to the $1.2915 area, thus far.    With the US markets on holiday conditions, of course, are thinner than normal, and there is scope for a technical bounce toward $1.2940-50, but dealers will likely sell into it.  The direction and near magnitude of the move we anticipated and continue to look for a test on and eventual break of the trend line drawn off the early April and mid-May lows that comes in near $1.2850 now.

It seems quite clear that both Draghi and Carney were motivated by the backing up in rates in recent weeks. While tapering talk by Fed officials obviously played an important role, we have also noted two other forces at work in recent weeks:  1) the selling of foreign bonds by Japanese investors--and the MOF data out earlier today showed this continued and 2) the liquidity squeeze in China, which continued to ebb today, but which may have also encouraged a sense of the end of so-called easy money and the unwinding of structural positions. 

The source of easy money is shifting.  While many observers expect the Fed to begin tapering in Sept/Oct and it appears that the Fed funds futures are pricing in the risk of the first rate hike at the end of next year, the BOE and ECB signaled no intention on joining it.  In fact, their respective guidance today has eased monetary conditions (rates fell, equities rallied and both sterling and the euro fell).  At the same time, the BOJ remains committed to its QE, which has only been in effect three months as of today.  

This divergence in policy should underpin the dollar on a trend basis.   The US-German 2-year spread, which often closely tracks the exchange rate should move more in the US favor. 

Draghi did what he had to; forced by circumstances.  He had to lean against the increase in market rates.  He had to indicate that the 50 bp refi rate is not a lower boundary.  He kept open the possibility of a negative deposit rate.  Draghi also reaffirmed that the ECB expects the region economy to recover later this year and next, recognizing that the survey data supports this view.  

On balance, this was one of Draghi's more successful press conferences. It should, but probably won't, put to rest claims of central bank impotence.   The ECB is being forced to innovate by circumstances.  It borrows from the Fed's language guide the market. 

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Fear Index June 2013: the eye of the storm

Author: Félix Moreno de la Cova

US M3 is relatively steady at just over $15.1 trillion, following the disinflationary trend of the past few months. Although US M1 and M2 continue to grow, and the Fed has still not relented from its open-ended monthly bond-buying programme, M3 growth has clearly stalled. Together with the slowdown in US industrial production and weak jobs market, and it seems to point to an economic downturn. If we take recent weakness in emerging markets as a leading indicator, it seems that the second part of the much-touted double-dip is just around the corner.

It is therefore ironic, if hardly unprecedented, that just as the monetary authorities at the US Federal Reserve seem ready to announce the end (or at least “tapering”) of the emergency, extraordinary and experimental monetary measures that they took in the aftermath of the bust of 2008, that the world is entering a recession: with the EU expected to contract this year, China’s growth slowing and the rest of the emergent countries almost grinding to a halt.

The Fear Index has dropped to 2.42%, with the 21-month moving average slipping to 2.92%. The price of gold has corrected sharply, in a move strongly reminiscent of the mid-cycle correction of 1975-76.

Fear Index June 2013

In 1976, as you can see below, the price of gold and the Fear Index corrected during a brief period of relative quiet in the middle of the dollar storm of the 1970s.

Fear Index 1969-81

That hope spot was short lived and inflation returned with a vengeance as the guns and butter deficit spending of the previous decade came back to bite the US dollar.

Gold is the ultimate safe haven. As such its allure fades in relatively quiet times. The perceived need for insurance, or a hedge, diminishes when things seem to be running smoothly. As Ronald Stöferle points out in his excellent In Gold we Trust 2013 report, the price of gold outperforms both in times of increasing inflation and deflation, but underperforms in times of decreasing inflation, or disinflation.

Change In Inflation Rate vs. Change in Gold Price

The reason that gold performs well in both extremes of the monetary instability spectrum is that as scarce and independent money it is a good hedge against runaway inflation, but as a physical, tangible commodity that can be possessed directly, it is also devoid of counterparty risk (physical gold only, of course) which becomes particularly important in deflationary times when defaults abound.

The world economic situation might seem calm right now, or at least US investors might be lulled into thinking so, given high equity prices and low bond yields, but there is a veritable flock of black swans approaching. Japan is playing monetary Russian roulette, European periphery countries are itching for another round of bailouts (Portugal, Slovenia and Greece are just waiting until after the German elections). Turkey, Egypt and Brazil are steaming with suppressed discontents; and presiding over it all is the largest debtor nation in the history of the world, attempting to hide a Treasury debt bubble of gigantic proportions behind its back, hoping that a world that uses the dollar as its primary reserve currency will be happy to continue doing so as it is continually debased.

As Mr Jaime Caruana, General Manager of the Bank of international Settlements (BIS), warned in a recent speech to his fellow central bankers: "Central banks have borrowed the time that the private and public sectors need for adjustment, but they cannot substitute for it." In other words, structural imbalances cannot just be papered over or inflated away. Debt-based growth is a recipee for disaster. So we’d better be prepared for it.

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The Euro on the Mend

by Jean Pisani-Ferry

PARIS – A year ago the eurozone was in serious trouble. A series of policy actions – the creation of a rescue fund, a fiscal treaty, and the provision of cheap liquidity to the banking system – had failed to impress financial markets for long. The crisis had moved from the monetary union’s periphery to its core. Southern Europe was experiencing a sell-off of sovereign debt and a massive withdrawal of private capital. Europe was fragmenting financially. Speculation about a possible breakup was widespread.

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Illustration by Tim Brinton

Then came two major initiatives. In June 2012, eurozone leaders announced their intention to establish a European banking union. The euro, they said, had to be buttressed by transferring banking supervision to a European authority.

For the first time since the onset of the crisis in Greece, it was officially recognized that the root of the eurozone’s problem was not the flouting of fiscal rules, and that the very principles underlying the monetary union had to be revisited. The endeavor was bound to be ambitious. In the eyes of most observers, to reach the leaders’ goal of “break[ing] the vicious circle between banks and sovereigns” required centralizing authority for bank resolution and rescue.

The second initiative came a month later. Speaking on July 26, European Central Bank President Mario Draghi announced that the ECB was ready to do “whatever it takes” to preserve the euro: “Believe me,” he said, “it will be enough.” The meaning of these words became clear with the subsequent announcement of the ECB’s “outright monetary transactions” (OMT) scheme, under which it would purchase short-term government bonds issued by countries benefiting from the European rescue fund’s conditional support.

Both measures had an immediate and profound impact on financial markets. Seen from Wall Street, the euro was moving closer to becoming a normal currency. Turmoil in bond markets began to abate.

A year later, where are we? First, the two initiatives resulted in markedly improved borrowing conditions for southern European governments (at least until Federal Reserve Board Chairman Ben Bernanke created new shockwaves with his indication in mid-June that the US would wind down more than three years of so-called quantitative easing). Capital stopped flowing out of southern Europe and speculation eased.

Second, an agreement on authorizing the ECB to oversee the banking sector was reached at the end of last year. In a year, the new regime will be fully operational – not a trivial achievement in view of the complexity of the issue.

Third, discussions are being held to prepare the next steps, namely how to arrange the resolution of failed banks and support for ailing ones. Ministers recently agreed upon a template for action.

So there are clear positive outcomes. But questions remain.

One problem is architectural: any banking union is only as strong as its weakest component. What matters for markets is not what happens in normal times, or even what happens when uncertainty and volatility rise; what markets care about are possible scenarios in truly adverse conditions.

Breaking the negative feedback loop between distressed sovereigns and distressed banks – whereby bank rescues exhaust fiscal resources and make it likely that the next financial institution in trouble will not be able to count on government support – requires ensuring that it will not recur even in extreme circumstances. Merely “weakening” this loop, as European officials recently advocated, could prove deeply insufficient.

There are two ways to eliminate the feedback loop. One is to exclude bank rescues altogether: only creditors would have to pay for bankers’ mistakes. This type of rule could insulate governments from banking risk only if applied systematically, even at the expense of financial stability. Simply put, governments should be ready to let banks fail.

The other solution is to mutualize the cost of rescue at the margin. States could be involved and accept losses, but catastrophic risks would have to be shared among all eurozone members.

Europe these days is vacillating between these two approaches. France does not want to rule out state-financed bailouts; Germany is reluctant to mutualize budgetary costs. A compromise is being worked out, but it must pass the test of reality. Unfortunately, the middle way between two logically consistent solutions may itself not be a logically consistent one.

Meanwhile, the credibility of Draghi’s atomic weapon is being undermined. The miracle of the OMT scheme is that, since it was announced a year ago, it has had its intended effect without ever being used. Strong opposition on the part of the Bundesbank and many German academics, however, has raised questions about whether and how it could ever be used.

To defend its legality in hearings before Germany’s Constitutional Court, the ECB itself has argued that the OMT program is a less potent instrument than many believe. Although the German government has been adamant that it is not a German court’s role to rule on the legality of ECB instruments, markets have taken note.

In a few months, it will be four years since the eurozone crisis began – almost an eternity by historical standards. Much has been done to overcome it. But it is still too early to declare the job done and claim victory.

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Financial Crisis and War

by Harold James

PRINCETON – The approach of the hundredth anniversary of the outbreak of World War I in 1914 has jolted politicians and commentators worried by the fragility of current global political and economic arrangements. Indeed, Luxembourg’s prime minister, Jean-Claude Juncker, recently argued that Europe’s growing north-south polarization has set the continent back by a century.

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Illustration by Paul Lachine

The lessons of 1914 are about more than simply the dangers of national animosities. The origins of the Great War include a fascinating precedent concerning how financial globalization can become the equivalent of a national arms race, thereby increasing the vulnerability of the international order.

In 1907, a major financial crisis emanating from the United States affected the rest of the world and demonstrated the fragility of the entire international financial system. The response to the current financial crisis is replaying a similar dynamic.

Walter Bagehot’s 1873 classic Lombard Street described the City of London as “the greatest combination of economic power and economic delicacy that the world has ever seen.” In one influential interpretation, popularized by the novelist, Labour Party MP, and future Nobel Peace Prize laureate Norman Angell in 1910, the interdependency of the increasingly complex global economy made war impossible. But the opposite conclusion was equally plausible: Given the extent of fragility, a clever twist to the control levers might facilitate a military victory by the economic hegemon.

The aftermath of the 1907 crash drove the hegemonic power of the time – Great Britain – to reflect on how it could use its financial clout to enhance its overall strategic capacity. That is the conclusion of an important recent book, Nicholas Lambert’s study of British economic planning and the First World War, entitled Planning Armageddon. Lambert demonstrates how, in a grand strategic gamble, Britain began to marry its military – and especially naval – predominance and its global financial leadership.

Between 1905 and 1908, the British Admiralty developed the broad outlines of a plan for financial and economic warfare against Europe’s rising power, Germany. Economic warfare, if implemented in full, would wreck Germany’s financial system and force it out of any military conflict. When Britain’s naval visionaries confronted a rival in the form of the Kaiser’s Germany, they understood how power could thrive on financial fragility.

Pre-1914 Britain anticipated the private-public partnership that today links technology giants such as Google, Apple, or Verizon to US intelligence agencies. London banks underwrote most of the world’s trade; Lloyds provided insurance for the world’s shipping. These financial networks provided the information that enabled the British government to discover the sensitive strategic vulnerabilities of the opposing alliance.

For Britain’s rivals, the financial panic of 1907 demonstrated the necessity of mobilizing financial power themselves. The US, for its part, recognized that it needed a central bank analogous to the Bank of England. American financiers were persuaded that New York needed to develop its own commercial trading system to handle bills of exchange in the same way as the London market and arrange their monetization (or “acceptance”).

The central figure in pushing for the development of an American acceptance market was Paul Warburg, the immigrant younger brother of a great Hamburg banker who was the personal adviser to Germany’s Kaiser Wilhelm II. The Warburg brothers, Max and Paul, were a transatlantic tandem, energetically pushing for German-American institutions that would offer an alternative to British industrial and financial monopoly. They were convinced that Germany and the US were growing stronger year by year, while British power would erode.

Some of the dynamics of the pre-1914 financial world are now reemerging. In the aftermath of the 2008 financial crisis, financial institutions appear both as dangerous weapons of mass economic destruction, but also as potential instruments for the application of national power.

In managing the 2008 crisis, foreign banks’ dependence on US-dollar funding constituted a major weakness, and required the provision of large swap lines by the Federal Reserve. Addressing that flaw requires renationalization of banking, and breaking up the activities of large financial institutions.

For European bankers, and some governments, current efforts by the US to revise its approach to the operation of foreign bank subsidiaries within its territory highlight that imperative. They view the US move as a new sort of financial protectionism and are threatening retaliation.

Geopolitics is intruding into banking practice elsewhere as well. Russian banks are trying to acquire assets in Central and Eastern Europe. European banks are playing a much-reduced role in Asian trade finance. Chinese banks are being pushed to expand their role in global commerce. Many countries have begun to look at financial protectionism as a way to increase their political leverage.

The next step in this logic is to think about how financial power can be directed to national advantage in the case of a diplomatic conflict. Sanctions are a routine (and not terribly successful) part of the pressure applied to rogue states like Iran and North Korea. But financial pressure can be much more powerfully applied to countries that are deeply embedded in the global economy.

In 1907, in the wake of an epochal financial crisis that almost brought a complete global collapse, several countries started to think of finance primarily as an instrument of raw power that could and should be turned to national advantage. That kind of thinking brought war in 1914. A century later, in 2007-2008, the world experienced an even greater financial shock, and nationalistic passions have flared up in its wake. Destructive strategies may not be far behind.

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The 6th Longest Bull Market In History

by Tyler Durden

From the lows in March 2009, the S&P 500's 4.3 year rally is now the 6th longest of the 24 bull markets of the last 113 years of data.

Interestingly, of those bull markets, the average performance has been +127.36% (over 3.16 years)- the current market's performance is +127.72%.

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How Gold Lost Its Luster, How the All-Weather Fund Got Wet, and Other Just-So Stories

by John Mauldin

We have not revisited the topic of gold in Outside the Box recently, mostly due to the fact that nearly everything I read on the subject is derivative of what I have been reading for years. There hasn't been much that would cause me to think about gold in a different way, and that is the purpose of Outside the Box: to present new perspectives and make us think.

I have recently started to read the work of Ben Hunt at Epsilon Theory. His ideas are interesting in that he examines markets from a behavioral economics perspective, with ample doses of game theory and history, a combination that few people can bring to the table. (In a random but pleasant development, I will get to have lunch with him next week in Dallas when he visits my town. I look forward to it.)

I have read this piece twice and expect to look at it a few more times. He leads off with some interesting thoughts on the role and significance of sweeping social narratives, and in particular the "Narrative of Gold," but there is more than thinking on gold in today’s Outside the Box. Pure gold bugs will be annoyed, but since I am neither gold bug nor pure, I find this a very useful essay. A small taste –

The source of gold’s meaning, whether you are a market participant in 1895 or 2013, comes from the Common Knowledge regarding gold. J.P. Morgan said that gold is money, and he was right, but only because at the time he said it everyone believed that everyone believed that gold is money. Today that same statement is wrong, but only because no one believes that everyone believes that gold is money….

To market participants in 2013 gold means lack of confidence in money, and their behavior in buying and selling gold similarly reflects this meaning. Buying gold today is a statement that you believe that global economic events may spiral out of the control of Central Bankers. It is insurance against some sort of massive monetary policy mistake that cannot be fixed without re-conceptualizing the global economic regime – hyperinflation in a developed nation, the collapse of the Euro, something like that – not an expression of a commonly shared belief in some inherent value of gold.

Thus the Narrative of Gold is still significant, but mostly in contrast to the narrative that has assumed primacy today: the Narrative of Central Banker Omnipotence. Like all effective narratives, says Ben, this one is simple: central bank policy will determine market outcomes.

Then Ben makes a crucial point:

You may privately believe that J.P. Morgan is still right, that gold has meaning as a store of value. But if you participate in the market on the basis of that belief, then you will buy and sell gold in an incredibly inefficient manner. You would be a smart gold investor in 1895, but a poor gold investor today.

This is some of the best, most fundamental thinking about gold that I have seen. But Ben's thesis is larger than that. He wants to understand the manner in which historical correlations and correlation-based investment strategies come under tremendous stress in markets undergoing structural change. "I get VERY nervous," he says,

when I am told that … a socially constructed behavior such as the assignment of value to highly symbolic securities is "timeless and universal", particularly when the composition and preference functions of major market participants are clearly shifting, particularly when monetary policy is both massively sized and highly experimental, particularly when political fragmentation is rampant within and between every nation on earth.

I am back in Dallas after a long and very tiring trip. I think I overreached in terms of what I tried to do on the trip, and on my return I find myself as exhausted as I have ever been, on top of which I seem to have picked up a nasty virus somewhere along the way. Not that I did not enjoy every moment. Cyprus , Croatia, Switzerland, even France were all fascinating, with so many good times and meetings. I think I need to try and cram less into the schedule. That might mean a personality change is in order, as trying to do too much is one of my real weaknesses. So much opportunity, so little time. A little zen focus might be in order.

And now, I suggest you read Ben Hunt’s essay and appreciate his take on narrative. Have a great week, and for my US readers, enjoy the Fourth of July. I am off to the optometrist now to find out why I'm having such trouble focusing my eyes. I had laser surgery some 15 years ago, and they said it would last about 10 years, so my “sell-by” date is long past. The problem has slowly been getting worse and now demands to be dealt with.

Your thinking about multiple points of focus analyst,

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The Diminishing Effects Of QE Programs

by Lance Roberts

There has been much angst over Bernanke's recent comments regarding an "improving economic environment" and the need to begin reducing ("taper") the current monetary interventions in the future.  What is interesting, however, is the mainstream analysis which continues to focus on one data point, to the next, to determine if the Fed is going to continue its interventions.   Why is this so important?  Because, as we have addressed in the past, the sole driver for the markets, and the majority of economic growth, has been derived solely from the Federal Reserve's programs.   The reality is that such analysis is completely useless when considering the volatility that exists in the monthly data already but then compounding that issue with rather subjective "seasonal adjustments."

The question, however, is whether such "QE" programs have actually sparked any type of substantive, organic, growth or simply inflated asset prices, and pulled forward future consumption, for a short term positive effect with negative long term consequences?  The 4 panel chart below shows the annual changes of real GDP, employment, industrial production, and personal consumption expenditures.   I have noted the beginning and end of the 3 different "QE" programs.


As you can see during the first round of Quantitative Easing, which was also combined with a variety of artificial stimulus, bailout and support programs, the economy got a sharp boost from extremely depressed levels.  The influx of liquidity stabilized the economy and production levels recovered.   However, it is clear that after that initial boost, subsequent programs have done little other than to stabilize the economy while flooding the asset markets with liquidity.  As shown, even with these programs in play, the current annualized growth trends of the data are showing clear deterioration.  This puts the Federal Reserve in a difficult position of trying to exit support as the economy weakens.

David Rosenberg, in his recent missive, made 5 excellent observations about these diminishing effects of QE programs.

"1. Is it still the worst economic recovery ever.

2. The Fed eased and eased and eased, but bank credit growth has been anemic to say the least – a critical element in this expansion and the lack of credit growth has caused the economy's trajectory to have changed materially from what we have experienced in the past six decades.

3. Everyone seems worried about the impact on higher mortgage rates on the housing market and yet this recovery in residential real estate has had little to do with Fed policy or what bond yields are doing. Affordability at is most lucrative levels this cycle did little to entice first time buyers, who still command a recession-like 30% shares of sales activity (the first time buyer shares of resale activity fell to 28% last month from 34% a year ago and 36% two years ago). This has been and remains a housing market dominated by all-cash institutional investor deals aimed at buying-for-rent.

4. The "wealth effect" only works if the positive shock is deemed to be permanent as opposed to transitory. I am amazed that this basic premise of permanency and the impact on expectations managed to escape the Fed escape-velocity models. The newly found net worth must be seen as more than temporary, but who doesn't know that all these capital gains, whether through equities or housing, weren't artificially stimulated by Fed policy as opposed to some major positive shock from underlying private sector economic forces?

5. What the Fed managed to do this cycle was help the rich get richer with no major positive multiplier impact on the real economy. Sorry, but Peoria Illinois, probably does not know how to locate the corner of Broad and Wall. So the Fed, by virtue of its excursions into the private marketplace for capital, manages to engineer the mother of all Potemkin rallies, sending the S&P 500 up 140% from the 2007 trough to attain record highs by May of this year (even with the June swoon, the SP 500 still managed to eke out a 2.4% advance in the second quarter and is up 12.6% for the year in the best first-half performance since 1998 when GDP growth was 5.5% ... for this the Fed should just continue with the status quo?). It took but six years to make a new high in the stock market. In the Great Depression, it took 25 years. Bravo!"

For the Federal Reserve it is highly unlikely that a single data point of inflation, or employment, is going to affect their current monetary policy stance.  However, the real issue is that IF the recent negative trends in consumption, employment and inflationary pressures do not start to reverse it is highly likely that the Fed will not be able to extract the monetary supports anytime soon.  The recent increases in interest rates, combined with still very weak wage growth, higher costs of living and still elevated unemployment is likely to keep the Fed engaged for the foreseeable future as any attempt to remove its "invisible hand" is likely to result in unexpected instability in the financial markets and economy.

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Two contributors to crude oil spike

by SoberLook

While nobody wanted to pay any attention to Egypt ten days ago (see post), all of a sudden the situation there is grabbing headlines. These protests were planned, June 30th was the starting date, and the military has been posturing for some time. And now that we've had the coup, the generals own Egypt's economic mess.
Crude oil popped above $101 in response to Egypt's unrest and its potential implications for the Middle East as a whole. The "Middle East premium" is back in play.

But another, more domestically based surprise driving WTI crude higher was an unexpected and quite sharp decline in US crude oil inventories.

Source: EIA

Some are attributing this decline in crude stocks to higher interest rates, which make storage of crude (cost of carry) more expensive. Perhaps. A better explanation however is the improved transport to the Gulf Coast refineries and a somewhat higher demand for refined products.

Source: EIA

This is not great news for the US consumer. The higher mortgage rates and the end to the mortgage refinancing spree were to some extent offset by a bit lower gasoline prices (although prices are still up on the year).


But given the spike in crude, that benefit of lower gas prices has ended for now. Consumers will pay more at the pump - and spend less elsewhere.

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Gold’s undervaluation is extreme

by Alasdair Macleod

The price of gold fell last week to the $1,200 level. The lemming sentiment in capital markets is uniformly bearish, yet every price-drop brings forth hungry buyers for physical gold from all over the world. Even hard-bitten gold bugs in the West are shaken and frightened to call a bottom, yet it is these conditions that accompany a selling climax. This article concludes there is a high possibility that gold will go sharply higher from here.

There are three loose ends to consider: valuation, economic and market fundamentals.


Adjusted gold price in USD

So far as I am aware nearly everyone is overlooking the obvious. You cannot consider the value of gold without taking account of the changes in the quantities of the currency and the above-ground stock of gold over time. The chart above shows the adjusted US dollar price of gold rebased to 100 in January 2005 when the gold price was $422. In 2005 dollars, using True Money Supply plus excess reserves as the currency adjustment, gold has risen only 13.9% to an equivalent price of $481.

TMS, or Austrian Money Supply, represents cash, checking accounts and savings deposits that can be redeemed for gold under a full convertibility regime. Excess reserves represent the funds deposited by banks at the Fed, which similarly can be redeemed for gold. The sum of TMS and excess reserves are therefore the comparable currency measure.

In 2005 we were in the sunny uplands of growing economic confidence, when systemic risk appeared to have been banished forever. We had recovered from a destabilising economic crisis the previous year, and both stock markets and house prices were rising. Today, eight years later governments are committed to monetary inflation from which there is no practical escape, yet at $1,200 gold is only 13.9% higher today.

The chart above is clear evidence that gold is mispriced to an exceptional degree given the deterioration in fundamental monetary and economic conditions.

Fundamental monetary and economic conditions

The recent episode about tapering, when it dawned on the big-wigs at the Fed that their plan to save the world was not working and that they were caught like rats in a trap with no exit, exposed an important truth. When you rely, credit cycle after credit cycle, on debasing the currency to stimulate economic recovery there comes a time when it fails to work completely, and instead you need to keep issuing new currency to avoid debt liquidation.

The Fed has begun to realise this truth applies today and is trying to find a way out of their mistake. Meanwhile prestigious economic and financial commentators, used to lapping up Fed policy statements, interpret the tapering episode as a “policy signal”, with which the Fed conditions the markets for monetary tightening. This optimistic view does not accord with a realistic assessment of economic prospects, the condition of the banking system and government financing requirements.

It has become clear in the last few months that the US economy is not recovering and if a realistic deflator is applied it is contracting in real terms. At the same time the largest economic area, the eurozone, is sinking into a deepening depression, Japan has resorted to printing yen just so the government can pay its bills, and the UK is in a similarly precarious position as the US.

The major economies have become hampered by too much debt, too much government and too much regulation. Their ability to recover and generate the tax revenues to rescue government finances and the profits to bail the banks out of their bad debts is therefore fatally impaired. It is this dawning realisation that has become every central banker’s worst nightmare.

Meanwhile, the global financial system was brought close to crisis by the mere whisper of higher interest rates, should the Fed try to reduce the pace of currency expansion. Markets were destabilised, and probably rescued only by exchange stability fund intervention.

The issue of rising interest rates is particularly sensitive because there are in Europe undercapitalised banks which cannot afford the losses on government debt from even a modest rise in bond yields, and are almost certain to collapse from the effect of unexpected interest rate increases on their interest rate swap exposure. Indeed, the parlous state of Europe’s banks was paraded before us only last week as the European Commission insensitively debated how to stick bondholders and depositors with the rescue costs.

The governments of the US, Japan and the UK have now become accustomed to financing their deficits by expanding the quantity of currency, and in the case of the eurozone, the expansion of bank credit to finance government debt. The dynamics of this debt trap on governments are concealed by manipulated and self-serving statistics misleading the governments themselves with respect to the true state of affairs. The four major currencies are now irretrievably committed to monetary hyperinflation, and this is illustrated in the chart below, using the example of USD True Money Supply plus excess reserves.

True Money Supply plus excess reserves $bn

The dotted black line is the exponential rate of growth, which is the maximum rate at which TMS can grow without destabilising the monetary system. Since the Lehman crisis the rate of growth has become hyperinflationary. Another way to consider this issue is that to revert to a stable exponential rate approximately $3 trillion would have to be withdrawn from circulation by the Fed. A monetary contraction on this scale is inconceivable, even if it is spread out over a number of years, not least because it would almost certainly collapse the whole monetary system.

The world is now committed to monetary hyperinflation, yet since 2005 gold at $1,200 today has only risen by $59 in adjusted terms.

Market fundamentals

In my preview of 2013 published by GoldMoney six months ago, I identified silver markets as a systemic danger, with the potential to create problems for gold. The problem appears to have been understood by both the central and bullion banks and partially deferred through what can only have been an engineered price slump.

Today the bullion banks have now balanced their gold derivative books on the US futures market, with the four largest actually long by 25,782 contracts on 25 June, and most probably more so on the last price fall. They have achieved this remarkable feat through a combination of increased short positions to record levels in the managed money category (hedge funds), and by producers in the Commercials category selling gold forward to protect themselves from falling prices. The extreme managed money short position is shown in the next chart, and last Friday the level of short contracts was probably even more extreme reflecting the most recent price falls.

Managed Money short position

Hedge funds’ short positions amount to about 240 tonnes, which is unprecedented.

In the last six months on the US futures market, the bullion banks – with the assistance of hedge funds – have booked enormous profits by closing their shorts and have virtually eliminated their exposure to systemic risk from rising gold prices. This can be seen in the chart below.

Gold - largest 4 net position

Silver, which I originally identified as the likely trigger point for a systemic crisis, has not been so easy to deal with and is an entirely different situation. The largest four traders (bullion banks) are still short by 18,846 contracts, but nevertheless have reduced a highly dangerous short position in illiquid conditions.

Silver - largest 4 net position

The problem in silver is that manufacturers are running long positions. Mindful of silver’s volatility they are locking in low silver prices to secure their operating margins. Nevertheless, the bullion banks have managed to stick it to the managed money category, whose short position is truly extreme.

Money managers shorts

Think about it for a moment: here is a bunch of amateurish hedge funds which has sold expecting lower silver prices and is now short of 133,000,000 ounces in an illiquid market, where the manufacturers cannot get enough physical at current prices.

Meanwhile physical is disappearing fast

If ever there was proof that gold is under-priced, it is the remarkable appetite low prices have developed for physical delivery. This is now so great, particularly from China and India, that not even the liquidation of ETF holdings has been enough to make up the difference. I wrote about this two weeks ago where I demonstrated that the western central banks must be supplying the market with bullion. Their motivation is clear: to avert a developing market crisis which was evident last year as a combination of ETF, Chinese and Indian buying led to persistent bullion shortages.

The acceleration of Asian demand from China and India alone last April and May increased the global shortage of physical bullion to record levels, requiring an increased supply to the market from central banks.

The important point to note is that it is erroneously believed in the capital markets that with respect to physical supply ETF liquidation has been sufficient to match increased Asian demand. An examination of the facts shows this to be untrue: the fall in prices has generated global demand on such a scale ETF liquidation is only a minor part of the whole supply picture, and the balance of supply can only have come from western central banks.

This is now the missing piece in the jigsaw: how much more gold will be fed into the markets by central banks? We don’t know how much they have left. We don’t know how short the bullion banks in Europe are, nor do we know the true positions of other members of the London Bullion Market. But we do know central banks are panicking, as evidenced by the tapering episode. We can surmise that they expected to quash the gold price by their actions, only to find that record and unexpected levels of global demand were generated instead.


The conditions are in place for a spectacular price readjustment on valuation and economic grounds alone. Furthermore, the short positions on Comex have been transferred to the hedge funds, leaving the bullion banks less exposed to escalating systemic risks. It is now in the latters’ interests to keep their gold and silver books as level as possible as a bear squeeze on the market shorts gets under way and starts the revaluation process.

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Things In Portugal Are Getting Worse

by Tyler Durden

Despite media rumors that the Portuguese foreign minister Portas, who resigned on Tuesday precipitating a complete collapse in Portugual bond prices and ushering in the latest European political crisis, has agreed to stay in the government as a Deputy PM and economy minister (nothing like some title inflation-pro-quo), things in Portugal are rapidly turning from bad to worse. To wit:


The main reason for the collapse appears to be the near consensus developing this morning that no matter what the government does at this point, a second bailout of the small country is inevitable.

Take what UBS economist Gyorgy Kovacs and strategist Justin Knight wrote in a client note:

  • Political crisis makes Portugal’s exit from EU78b Troika program in 2014 and subsequent return to bond markets unlikely write
  • A second bailout may be necessary if Troika program delayed
  • Austerity fatigue in population with country in third year of recession and unemployment above 18%
  • Continued political instability may require primary market purchases by ESM of Portuguese debt in 2014
  • ECB would avoid OMT as beneficiary country must be able to access open market, likely only after several bond issues

Then there was also Bloomberg's economist David Powell:

Portugal appears increasingly likely to require a second bailout package from its international creditors.

Investors seem to be losing confidence in the sustainability of the Iberian nation’s public finances. The spread between the 10-year sovereign yields of Portugal and those of Germany has risen by 157 basis points to 624 basis points since Monday. The nation has moved increasingly toward insolvency since it was pushed out of financial markets. The debt-to- GDP ratio was projected by the IMF, in its seventh review of the country under its bailout package, to reach 122.9 percent by the end of this year versus 108 percent at the end of 2011, the year during which Portugal lost market access. That report was published last month.

The fund’s economists forecast a peak of that ratio to materialize next year. They looked for a rise to 124.2 percent by the end of 2014 and a decline to 123.1 percent in 2015 and 120.5 percent in 2016.

The forecasts are dependent on the country meeting its budget deficit reduction targets. The IMF staff looked for the primary budget deficit, a measure that excludes the interest costs of government debt, to decline to 1.1 percent of GDP this year from 2 percent of GDP last year. They also forecast the deficit to be transformed into a surplus of 0.4 percent of GDP in 2014, 1.8 percent of GDP in 2015 and 2.4 percent of GDP in 2016.

Those numbers would have contributed to the total budget balance starting to be in positive territory as early as this year. That figure was forecast to be in surplus by 0.8 percent of GDP in 2013, in deficit by 1.4 percent of GDP in 2014, and in surplus by 1.2 percent of GDP in 2015 after including “residual” factors — which encompass asset changes — privatization receipts and payments on government debt. That surplus seems unlikely to materialize.

The secretary of state for the budget, Luis Morais Sarmento, announced on June 28 that the budget deficit widened to 7.1 percent of GDP in the 12 months through March. That compared with a deficit of 6.4 percent for the calendar year of 2012 and 4.5 percent in the 12 months through March 2012, according to the country’s statistics agency.

The finance minister quit after failing to meet the IMF targets. Vitor Gaspar wrote in his resignation letter on Monday: “The repetition of this slippage undermined my credibility as finance minister.” He added: “The risks and challenges of the near future are enourmous.”

One of the major challenges is the stabilization of the economy. Output has declined for 10 consecutive quarters. The most recent year-over-year measure of GDP growth stood at minus 4 percent. Total production is 8.6 percent below its pre-crisis peak. It is at the lowest level since 2000,  indicating more than a “lost decade”.

The banking system also appears to be facing serious funding problems. The year-over-year rate of growth of deposits, excluding those of monetary financial institutions and central government, stood at minus 7 percent in May.

Portugal will probably be unable to access the ECB’s Outright Monetary Transactions program to facilitate its return to financial markets. Mario Draghi said at the monthly press conference in March: “You know that OMTs cannot be used to enhance a return to the market.”

He elaborated in April: “I have defined what we mean by the return to the markets by a country. It has to be able to issue across the whole maturity spectrum, in sizeable amounts to a variety of buyers, and we have also specified other features, which continue to apply.”

That suggests the Troika may be asked for more financial assistance. The current program is scheduled to be wrapped up by next spring with the 12th and last review to be published on May 15.

A visual summary of the Portuguese situation comes courtesy of Bloomberg Brief's Niraj Shah:

And, of course, there is the GDP...

Luckily, Portugal has the ECB's OMT to save it should the country which the crisis had forgotten for so long, suddenly finds itself with an inverted yield curve. Oh wait...

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