Saturday, January 31, 2015

Italy elects senior judge Sergio Mattarella as president

By Steve Scherer and Paolo Biondi

ROME (Reuters) - Italian lawmakers elected Sergio Mattarella, a constitutional court judge and veteran center-left politician, as president on Saturday, handing a welcome political victory to Prime Minister Matteo Renzi.

Mattarella, speaking at his office in the Constitutional Court after the vote, said: "My first thoughts are of the difficulties and hopes of our citizens."

He later visited the site in Rome where German troops killed 335 Italians in World War Two, saying that Europe must unite to battle terrorism the same way allied nations banded together to defeat "Nazi hate, racism, anti-Semitism, and totalitarianism".

The election shows the 40-year-old Renzi in firm control of both his fractious party and his allies in the ruling majority as he seeks to pass reforms aimed at underpinning an economic recovery in Italy, where unemployment is soaring after six years of on-off recession.

After three inconclusive rounds of voting this week in which a two-thirds majority was needed, his candidate Mattarella was elected in the fourth round, when the required quorum fell to a simple majority.

As the ballots were counted out loud in the Chamber of Deputies, the 1,009 parliamentarians and regional officials eligible to vote burst into applause when Mattarella's name surpassed the 505-vote threshold, making him Italy's 12th president since World War Two.

Mattarella, 73, who is little known to most Italians, got 665 votes. He will be sworn in on Tuesday at 10 a.m. (0400 ET) for a seven-year term, taking over from 89-year-old Giorgio Napolitano, who resigned earlier this month.

"Keep up the good work, President Mattarella. Long live Italy!" Renzi tweeted after the vote, while Pope Francis sent his congratulations by old-fashioned telegram.

The Italian president is a largely ceremonial figure, but he wields important powers at times of political instability, a frequent scourge in Italy, when he can dissolve parliament, call elections and pick prime ministers.

Center-right rival Silvio Berlusconi's Forza Italia party appeared in disarray after the vote.

Berlusconi ordered his party to cast blank ballots after accusing Renzi of betraying what he said was a promise to give him a role in choosing the candidate. Instead, more than 30 refused, opening a wound in the party.

Renato Brunetta, Forza Italia's chief whip in the lower house, said the pact that Renzi and Berlusconi sealed last year to make institutional reforms was dead, but not all his party colleagues were so resolute and Berlusconi himself has yet to comment.

"Renzi made a unilateral decision to break the pact," Brunetta said. "Nothing will be the same now."

Mattarella is the first native of Sicily to become president. He has a reputation for being a reserved but straight-talking former constitutional law professor, whose career in politics began after his brother, Piersanti, was shot dead by the Sicilian Mafia in 1980.

Mattarella's political roots are in Italy's defunct Christian Democrat party that his father Bernardo, an anti-fascist, helped to found after the war.

Though Mattarella is not seen as having vast international experience, he did serve as defense minister in two different center-left governments, from 1999 to 2001.

In 1990, Mattarella resigned as education minister to protest a decree that favored Berlusconi's media empire, and three years later he drafted a voting law, which has since been changed, that was used when Berlusconi won his first of three national elections in 1994.

See the original article >>

Friday, January 30, 2015

Brazil's Economy Is On The Verge Of Total Collapse

by Tyler Durden

Back when the BRICs were the source of marginal global growth, the punditry couldn't stop praising them. However, in the past year, now that China's housing bubble has burst and its shadow banking system has imploded, those who remember what BRIC actually stood for are about as rare as those who recall what it means for the Fed to hike rates. Which is precisely why nobody in the mainstream financial media has commented on the absolutely abysmal economic update reported earlier today out Brazil.

We are happy to do so because today's data follows up quite well to our article from a month ago "Brazil's Economy Just Imploded" and as the earlier article on the crashing Brazilian Real hinted, things for the Brazilian economy how gone from imploding to, well, worse because not only did the twin fiscal and current account deficits rise even more, hitting a whopping 11% of GDP - the worst since August 1999, but its government debt soared to 63.4% in 2014, up from 56.7% a year ago, and the highest since at least 2006. In short - the entire economy is now on the verge of total collapse.

This is what happened in a few bullet points:

  • The fiscal picture has deteriorated very sharply since 2011 at both the flow (fiscal deficit) and stock (gross public debt) levels. The primary and overall nominal fiscal surpluses at year-end 2014 were at levels last seen in the late 1990s.
  • The steady decline of the public sector savings rate is leading to a wider current account deficit despite weaker growth and low investment. In fact, the twin fiscal and current account deficits are now tracking at a combined, very troublesome 10.9% of GDP, the worst picture in 15 years (since August 1999). Repairing the severely unbalanced macro picture would require a deep, structural and permanent fiscal and quasi-fiscal adjustment and a significantly weaker BRL.
  • The new economic team faces, among other things, the very significant challenge of repairing the severely deteriorated fiscal picture.
  • The steady erosion of the fiscal stance pushed net and gross public debt up. Furthermore, fiscal and quasi-fiscal activism undermined the effectiveness of monetary policy, contributed to keep inflation very high and drove the current account deficit to a very high level despite weak growth.

More details from Goldman:

The overall public sector fiscal deficit widened to a very high 6.7% of GDP (from 3.25% of GDP in 2013 and the highest fiscal deficit since August 1999) given the very high 6.1% of GDP net interest bill and steady erosion of the primary fiscal surplus. Given the BRL depreciation during the month, the interest on the stock of Dollar swaps issued by the central bank reached R$17.0bn (adding to the R$8.7bn accrued in November).

Gross general government debt rose to 63.4% of GDP in 2014, up from 56.7% of GDP in 2013 and 53.4% of GDP in 2010 (the highest level since at least 2006).

The consolidated public sector posted a very large and worse-than-expected R$12.9bn deficit in December, driven by the unexpectedly large R$11.3bn deficit recorded by the States and Municipalities. The state-owned enterprises also posted a large deficit in December: R$2.3bn surplus.

Overall, the consolidated public sector posted a 0.63% of GDP primary deficit in 2014, down from surpluses of 1.9% of GDP in 2013, and 2.4% of GDP in 2012. This is the worst fiscal outturn in 16 years (since November 1998) and very significantly below the 1.9% of GDP primary surplus promised by former Finance Minister Mantega. The erosion of the primary surplus in recent years was driven chiefly by the weak fiscal numbers of the Central Government, whose primary balance declined from 1.55% of GDP in 2013, to a deficit of 0.40% of GDP in 2014.

However, the primary surplus of subnational government (States and Municipalities) has also been eroding, a reflection of the authorizations given by the Treasury since 2011 for increased borrowing by the States. For instance, the States and Municipalities posted a 0.15% of GDP deficit in 2014, down from 0.80% of GDP surplus in 2011.

In charts:

And the key numbers:

  1. The Consolidated Public Sector (CPS) posted a significantly worse-than-expected R$12.9bn primary deficit in December, driven by local governments and state-owned enterprises. The Central Government posted a R$755mn surplus but the States and Municipalities recorded a very large R$11.3bn deficit and the state-owned companies an also large R$2.3bn deficit.
  2. Overall, the primary balance of the CPS worsened to a 0.63% of GDP deficit in 2014 from a 1.9% of GDP surplus in 2012 and 2.4% of GDP surplus in 2012.
  3. The overall fiscal deficit (primary surplus minus interest payments) deteriorated further: to a very high 6.7% of GDP given the large 6.1% of GDP net interest bill. This is the largest overall fiscal deficit since August 1999.
  4. Net public debt worsened to 36.7% of GDP in 2014, up from 33.6% in 2013. Gross general government debt rose to a high 63.4% of GDP in December, up from 56.7% of GDP in 2013.
See the original article >>

A Greek Burial for German Austerity

by Joschka Fischer

BERLIN – Not long ago, German politicians and journalists confidently declared that the euro crisis was over; Germany and the European Union, they believed, had weathered the storm. Today, we know that this was just another mistake in an ongoing crisis that has been full of them. The latest error, as with most of the earlier ones, stemmed from wishful thinking – and, once again, it is Greece that has broken the reverie.

Even before the leftist Syriza party’s overwhelming victory in Greece’s recent general election, it was obvious that, far from being over, the crisis was threatening to worsen. Austerity – the policy of saving your way out of a demand shortfall – simply does not work. In a shrinking economy, a country’s debt-to-GDP ratio rises rather than falls, and Europe’s recession-ridden crisis countries have now saved themselves into a depression, resulting in mass unemployment, alarming levels of poverty, and scant hope.

Warnings of a severe political backlash went unheeded. Shadowed by Germany’s deep-seated inflation taboo, Chancellor Angela Merkel’s government stubbornly insisted that the pain of austerity was essential to economic recovery; the EU had little choice but to go along. Now, with Greece’s voters having driven out their country’s exhausted and corrupt elite in favor of a party that has vowed to end austerity, the backlash has arrived.

But, though Syriza’s victory may mark the start of the next chapter in the euro crisis, the political – and possibly existential – danger that Europe faces runs deeper. The Swiss National Bank’s unexpected abandonment of the franc’s euro peg on January 15, though posing no immediate financial threat, was an enormous psychological blow, one that reflected and reinforced a massive loss of confidence. The euro, as the SNB’s move implied, remains as fragile as ever. And the subsequent decision by the European Central Bank to purchase more than €1 trillion ($1.14 trillion) in eurozone governments’ bonds, though correct and necessary, has dimmed confidence further.

The Greek election outcome was foreseeable for more than a year. If negotiations between the “troika” (the European Commission, the ECB, and the International Monetary Fund) and the new Greek government succeed, the result will be a face-saving compromise for both sides; if no agreement is reached, Greece will default.

Though no one can say what a Greek default would mean for the euro, it would certainly entail risks to the currency’s continued existence. Just as surely, the mega-disaster that might result from a eurozone breakup would not spare Germany.

A compromise would de facto result in a loosening of austerity, which entails significant domestic risks for Merkel (though less than a failure of the euro would). But, in view of her immense popularity at home, including within her own party, Merkel is underestimating the options at her disposal. She could do much more, if only she trusted herself.

In the end, she may have no choice. Given the impact of the Greek election outcome on political developments in Spain, Italy, and France, where anti-austerity sentiment is similarly running high, political pressure on the Eurogroup of eurozone finance ministers – from both the right and the left – will increase significantly. It does not take a prophet to predict that the latest chapter of the euro crisis will leave Germany’s austerity policy in tatters – unless Merkel really wants to take the enormous risk of letting the euro fail.

There is no indication that she does. So, regardless of which side – the troika or the new Greek government – moves first in the coming negotiations, Greece’s election has already produced an unambiguous defeat for Merkel and her austerity-based strategy for sustaining the euro. Simultaneous debt reduction and structural reforms, we now know, will overextend any democratically elected government because they overtax its voters. And, without growth, there will be no structural reforms, either, however necessary they may be.

That is Greece’s lesson for Europe. The question now is not whether the German government will accept it, but when. Will it take a similar debacle for Spain’s conservatives in that country’s coming election to force Merkel to come to terms with reality?

Nothing but growth will decide the future of the euro. Even Germany, the EU’s biggest economy, faces an enormous need for infrastructure investment. If its government stopped seeing “zero new debt” as the Holy Grail, and instead invested in modernizing the country’s transport, municipal infrastructure, and digitization of households and industry, the euro – and Europe – would receive a mighty boost. Moreover, a massive public-investment program could be financed at exceptionally low (and, for Germany, conceivably even negative) interest rates.

The eurozone’s cohesion and the success of its necessary structural reforms – and thus its very survival – now depend on whether it can overcome its growth deficit. Germany has room for fiscal maneuver. The message from Greece’s election is that Merkel should use it, before it is too late.

See the original article >>

Dow could peak right here, says Joe Friday!

by Chris Kimble



This chart is the Dow "Quarterly" dating back to 1965. I applied Fibonacci to the Dow's 2000 high and 2002 quarterly lows and then applied Fibonacci extension levels.

The Dow stopped on a dime in 2007, as it hit the 161% Fibonacci extension level at (1).

Now the Dow is hitting the Fibonacci 261% Fibonacci extension level at (2). While at this level, a long-term resistance line comes into play that ties in the 1987 highs and the 2002 lows.

Joe Friday, just the facts....This is not your typical resistance level and the Dow could put in a peak at this combo!

See the original article >>

60% Of Retail Sales Growth In Hong Kong Was Due To The iPhone 6

by Tyler Durden

The impact of the Apple juggernaut on earnings is already well known: as Reuters previously calculated, following the announcement of Apple's results earlier this week, S&P 500 Q4 revenue growth tripled to 1.4% from 0.5% the day before; while if one excludes AAPL S&P500 revenue growth falls to 0.8%.

But what about the impact of Apple on macroeconomics? For a good example we look at Hong Kong Q4 retail sales. As a reminder, in Q4, the Hong Kong economy was substantially impacted due to the Occupy Central movement peaking (and then suffering the same fate as its US peer, when it faded into obscurity), and many predicted the domestic economy would tumble if only until the impact of the city stoppage washed away.

As it turns out, most of those predictions were correct, however one place where pessimism was unfounded was in retail sales. The reason: the Apple iPhone 6.

UBS explains:

The launch of the popular iPhone 6 by Apple in September 2014 was the biggest, and perhaps the only, positive driver for Hong Kong's retail sector during late 2014. Thanks largely to Apple, retail sales grew better than expected at 3.5%y/y in value terms during September and November 2014, despite the temporary disruption from the 'Occupy Central' demonstration. The sales of iPhone, which are captured in other consumer durable sales, grew on average 60%y/y since September, propelled predominately by the launch of new product.

Excluding iPhones, retail sales value would have contracted almost 1%y/y in October, at the peak of the 'Occupy' movement, and expanded a more subdued 1.3%y/y during Sep-Nov 14 (see figure 1). In other words, over 60% of retail sales growth was attributable to iPhone in late 2014.

The strong demand for iPhone has mostly come from the Chinese tourists. The iPhone 6 was launched about a month earlier in Hong Kong (19 September versus 17 October in China). And the selling prices of which are also lower here, making the arbitrage trade profitable (buys in HK; sells in China). Those who live in Hong Kong will be very familiar with the long queues snapping up the phone as well as the big crowds outside the Apple stores trying to make a quick profitable trade.

This explained why tourist arrivals (over 80% of them Chinese) accelerated to 13%y/y during Sep-Nov 14, bucking the 'Occupy Central' disruption, as the timing of which happened to coincide with the iPhone euphoria. The incentives to buy the gadget before the Chinese launch or to gain from arbitrage trade have attracted many Chinese tourists since September. Most of them are day trippers. This is reflected in the average 18%y/y expansion in same-day visitor arrivals since September, which is up from 13.6%y/y in the three months before the iPhone launch. Overnight visitors, however, continued to ease and expand at mid-single digit pace (see figure 2). In particular, non-Mainland Chinese tourist, mostly overnight visitors, contracted in 4Q14. Both the share and, more recently, the absolute level of non-Chinese arrivals have been shrinking. As far as tourism is concerned, Hong Kong can hardly claim to be Asia's world city anymore.

In other words, if anything were to ever happen to the Apple "magic", not only does the S&P get it, but the macroeconomic ripple across the entire world will likely lead to a mini-recession all of its own.

See the original article >>

Wall Street for President?

by Simon Johnson

WASHINGTON, DC – America’s presidential election is still nearly two years away, and few candidates have formally thrown their hats into the ring. But both Democrats and Republicans are hard at work figuring out what will appeal to voters in their parties’ respective primary elections – and thinking about what will play well to the electorate as a whole in November 2016.

The contrast between the parties at this stage is striking. Potential Republican presidential candidates are arguing among themselves about almost everything, from economics to social issues; it is hard to say which ideas and arguments will end up on top. The Democrats, by contrast, are in agreement on most issues, with one major exception: financial reform and the power of very large banks.

The Democrats’ internal disagreement on this issue is apparent when one compares three major proposals to address income inequality that the party and its allies have presented in recent weeks. There are only small differences between President Barack Obama’s proposals (in his budget and State of the Union address), those made in a high-profile report from the Center for American Progress, and ideas advanced by Chris Van Hollen, an influential member of Congress. (For example, Van Hollen recommends more redistribution from higher-income people to offset a larger tax cut for middle-income groups.)

Against this backdrop of programmatic unity, the difference of opinion among leading Democrats concerning Wall Street – both the specifics of the 2010 Dodd-Frank financial reforms and more broadly – stands out in bold relief.

On Dodd-Frank, Democrats – including Obama – are apparently of two minds on the extent to which they should stick up for their own reforms. In December, the White House agreed to a Republican proposal to repeal a provision of Dodd-Frank that would have limited the risk-taking of the country’s largest banks (in fact, the proposal’s language was drafted by Citigroup).

More recently, however, Obama has threatened to veto any further attempts to roll back financial reform. And now he is proposing to impose a small tax on the largest banks’ liabilities, which he hopes will encourage “them to make decisions more consistent with the economy-wide effects of their actions, which would in turn help reduce the probability of major defaults that can have widespread economic costs.”

In contrast, the Center for American Progress report devoted very little space to financial-sector reform – in the authors’ view, such issues hardly seem to be a high priority. Van Hollen does have some concerns – and proposes a financial transaction tax to reduce speculative activities.

But a serious challenge to all of these views has now emerged, in proposals by Senator Elizabeth Warren, a rising Democratic star who has become increasingly prominent at the national level. In her view, the authorities need to confront head-on the outsize influence and dangerous structure of America’s largest banks.

Warren’s opponents like to suggest that her ideas are somehow outside the mainstream; in fact, she draws support from across the political spectrum. In last month’s fight against Citigroup’s successful effort to roll back Dodd-Frank, for example, Warren’s allies included the House Democratic leadership, the Independent Community Bankers of America, Republican Senator David Vitter, and Thomas Hoenig (a Republican-appointed vice chair of the Federal Deposit Insurance Corporation).

Warren’s message is simple: remove the implicit government subsidies that support the too-big-to-fail banks. That single move would go a long way toward reducing, if not eliminating, crony capitalism and strengthening market competition in the financial sector. This is a message that plays well across the political spectrum. And growing support for Warren’s ideas helps the Federal Reserve and other responsible regulators in their efforts to prevent big banks from taking on dangerous levels of risk.

The big Wall Street banks have enormous influence in Washington, DC, in large part because of their campaign contributions. They also support – directly and indirectly – a vast influence industry, comprising people who pose as independent or moderate commentators, edit the financial press, or produce bespoke “research” at think tanks.

These megabanks are making a determined attempt to repeal as much of Dodd-Frank as possible, and the House Republicans seem keen to help them. This is not an issue that will fade away.

The Democrats need to figure out their policy on Wall Street. In the past, they have simply gone for the campaign contributions, doling out access and influence in exchange. It is now obvious that this is not consistent with defending what remains of Dodd-Frank.

Warren offers a plausible, moderate alternative approach to financial-sector policy that would play well in the primaries and attract a great deal of support in the general election. Will the Democrats seize the opportunity?

See the original article >>

Two-Thirds chance NYSE topping pattern in play

by Chris Kimble



Is the NYSE creating a "Giant Topping" pattern? Rising wedge patterns lead to lower prices around two-thirds of the time. At this moment, a top is not proven! For sure I do respect the potential that a rising wedge pattern could have some impact in the near future on this key broad market.

The upper left chart line (1) is based upon monthly closing prices starting with the 1987 lows. Notice that several key lows took place along this line and 2011's highs touched this line as well.

The apex of the rising wedge is narrowing, meaning this pattern should end fairly soon. The NYSE is a fraction below this line as of last night close, as the index has traded sideways for the past 6 months.

Last month SPY may have created a Doji Star topping pattern (lower right chart) at the 161% Fibonacci extension level based upon the monthly closing high in 2007 and monthly closing low in 2009. This "Doji Star" at this time has NOT proven that it is a topping pattern. Should the broad markets grow weak from here, the odds do shift higher that last months SPY pattern becomes more important.

CNBC Pro covered the potential Doji Star topping pattern earlier this month (see here)

See the original article >>

Apple $150 upside target still in play

by Chris Kimble



Apple had positive earning news come out last night and pre-market pricing shows it up.

Wanted to take a 30,000 foot, 30-year look at Apple's prices. As you can see, Apple has stayed inside of rising channel (1) for the past 35-years. Apple last hit channel line (1) back in 2012. After it hit this line, it proceed to lose about a third of its value in the next 9 months.

If one takes the monthly low during the financial crisis and the highs back in 2012 and applies Fibonacci levels to it, the 161% extension level comes into play around the $150 zone.

I find it interesting that channel line (1) and the Fib 161% level both meet around $150 and rising support line (2) gets closer and closer to current pricing.

$150 looks to be an important price point for Apple in the future and this price remains possible.

Apple bulls want/need the stock to remain above line (2)!

See the original article >>

Gold facing most important test in years and years right now!

by Chris Kimble



Gold is now testing the underside of an old 10-year support line, now as resistance. This line is also being joined by another resistance line, at current price levels.

The "X" marks the spot that looks to be VERY important for the future of long-term gold prices.

Keep a close eye on what happens here because it could determine if Gold gets out of its three year downward funk or its gets a breath of fresh air on a breakout.

See the original article >>

Two Ships Pass in the Night

by Marketanthropology

Ships that pass in the night, and speak each other in passing, only a signal shown, and a distant voice in the darkness; So on the ocean of life, we pass and speak one another, only a look and a voice, then darkness again and a silence. - Longfellow

For just the fourth time in the last fifty years, the S&P 500 yields more than 10-year Treasuries. If one was to mine the data, in the three previous occasions where this had occurred, equities rallied sharply over the short-term and strongly performed over the next year - quickly closing the aberration that represented a particular extreme between these two markets.

  • June 1962: +14% 06/27/62 - 08/22/62 (1-year performance + 32%)
  • November 2008: +24% 11/20/08 - 01/06/09 (1-year performance +35%)
  • August 2011: +9% 08/09/11 - 08/31/11 52 (1-year performance  +25%)

That said, we would strongly caution anyone looking for similar returns or bolstering their respective equity biases with this fourth occurrence. From our perspective, the fourth time may be the charm as these two massive trends pass quietly in the night, ending an epoch that first set sail in 1959 as Treasury yields began their long and steep journey to a secular peak in 1981.  

While the Trend-Trading-To-Win and passive investor zen masters might view current market conditions as testament to equity strategies that should continue to outperform, you only need to look at a long-term chart of both metrics to realize, the times they are a changin' - or historically speaking, perhaps sliding back to a market relationship that stood for nearly a century before 1959. To boot, when one considers the equity market drawdowns of the previous three occasions that elicited such condition, the current "downturn" appears more coincidental of juxtaposition - than actionable of signaling a market extreme in equities.

Overall, we view binary "signals" such as this as representative of market conditions that should not be compared to contemporary parallels for insights, such as Fed tightening cycles or recession and equity market impressions from an inverted yield curve. What they all have in common is probabilities and expectations entrenched over the past fifty years where yields were not exceptionally low and the Fed was not enacting or normalizing unconventional and extraordinary policy.
From a historical perspective of the equity and Treasury markets, we still view the closest parallel as the trough of the long-term yield cycle in the 1940's, where the Fed began to normalize policy after extraordinary support was extended to the markets with significant Treasury purchases by the Fed between 1942 and 1946. Our expectations remain that the U.S. equity markets will continue to come under pressure and normalize with policy (QE free), which should recalibrate risk and valuations as the Fed evaluates market conditions in its wake. Moreover, for those looking for guideposts in the road with the Fed allowing or telegraphing when their balance sheet will passively runoff, you'll notice that in the mid 1940's the equity markets revalued swiftly shortly after the Fed's balance sheet peaked - but before it started to decline. We suspect a similar dynamic this time around, which would likely further push back even a ceremonial rate hike by the Fed that some see occurring this year.

While 10-year yields have made their way back to where we expected they would last January - and we suspect they are currently completing the end of that move; from a relative performance perspective we would still favor long-term Treasuries relative to the S&P 500 this year, as these two ships pass, signaling one last time in the darkness.

See the original article >>

Lezione da Atene: questa Europa è troppo fragile

by Pietro Reichlin

Con la vittoria di Syriza alle elezioni, la rinegoziazione del memorandum è ormai inevitabile. Si tratta di un notizia, che evidenzia le molte fragilità del sistema federale europeo. Ma non è il rigore il vero problema dell’economia greca.


Con la vittoria di Syriza si è aperto il fronte della rinegoziazione degli accordi stipulati con la Troika a seguito del fallimento della Grecia del 2010. Molti opinionisti e politici italiani (sia di destra che di sinistra) simpatizzano con Tsipras e ritengono che la sua vittoria possa portare buoni frutti anche per noi. Si tratta, tuttavia, di una strategia piena di rischi. In realtà la vittoria di Syriza è, piuttosto, una cattiva notizia, che fornisce un’ulteriore prova della fragilità del sistema federale europeo. Provo ad argomentare questa tesi nei seguenti quattro punti.

  • Il bail-out della Grecia avvenuto nel 2010 costituisce un precedente fondamentale per capire come funziona il sistema monetario e, più in generale, il nostro modello federale. In un sistema del genere le decisioni fiscali sono decentrate e, quindi, il costo del debito degli stati membri riflette rischi locali. Se le istituzioni centrali dichiarassero che nessuno stato può mai fallire, si determinerebbe un gigantesco problema di rischio morale (assenza di incentivi a controllare i conti pubblici) a cui la federazione non potrebbe sopravvivere. Se, d’altra parte, le garanzie sui debiti statali sono incomplete, si deve accettare che i debiti sovrani non si scambino alla pari, e che gli stati possano fallire. Il sistema monetario europeo si colloca in questo incerto crinale, in cui le garanzie europee esistono ma sono implicite e incomplete. È un problema che interessa molto l’Italia, data la dimensione del nostro debito e l’onere per interessi che grava sulle casse dello stato. Gli investitori vorrebbero capire: l’Europa lascerebbe fallire uno stato? E cosa farebbe in questo caso? In termini generali, un fallimento non è necessariamente un disastro se i costi che ne derivano possono essere contenuti. Gli Stati Uniti sono un esempio ambiguo. Il governo federale americano decise per il bail-out degli stati a fine Settecento ma li lasciò fallire a metà Ottocento senza eccessivi contraccolpi.
  • Il caso della Grecia è il primo esempio di fallimento coordinato nell’Eurozona. Le istituzioni internazionali hanno imposto un haircut del 50 per cento sul debito nei confronti dei privati, un allungamento delle scadenze e l’assorbimento della quasi totalità del debito presso il Fmi e il Fondo salva stati a tassi di estremo favore, condizionatamente all’adozione di misure di consolidamento fiscale. Il successo di questo esperimento dipende da due condizioni: che il governo greco rispetti gli impegni e che il programma di consolidamento non sia talmente oneroso da portare il paese a una nuova bancarotta. Se non si realizza la prima condizione abbiamo la dimostrazione “sul campo” che un bail-out compatibile con l’assenza di un rischio morale eccessivo è impossibile e, quindi, che l’Europa si trova di fronte a un bivio: convivere con il rischio morale o lasciare che gli interessi sui debiti sovrani riflettano interamente i rischi degli stati membri. Nel primo caso avremo, prima o poi, la dissoluzione dell’Unione, e nel secondo caso saremo continuamente soggetti a ondate speculative sui debiti sovrani.
  • Chi simpatizza con il programma di Syriza sostiene che gli accordi con la Troika non siano sostenibili per la Grecia. Il debito greco è, in effetti, molto elevato, ma se i creditori si limitassero ad accettare un contenimento del debito esistente, un’altra ristrutturazione non avrebbe alcuna giustificazione. Non è, infatti, il debito che frena la crescita di quel paese. Il bail-out del 2010 (e 2012) ha posto i titoli pubblici greci al riparo dalla speculazione e ridotto drasticamente il costo degli interessi che, secondo stime recenti, rappresenta un conto meno salato di quello pagato dal governo italiano, spagnolo e portoghese. Un’altra ristrutturazione del debito non equivale ad un classico problema di ridistribuzione delle risorse tra debitori e creditori, come si sente spesso dire in questi giorni. Il conto sarebbe pagato anche da paesi già fortemente indebitati (come l’Italia, la Spagna e il Portogallo) che stanno facendo rilevanti sacrifici per tenere sotto controllo il proprio debito.
  • Se un ulteriore bail-out della Grecia sembra incoerente con la costruzione europea, si può tuttavia porre il problema dei tempi e delle dimensioni del consolidamento fiscale. Questo è il secondo punto del programma di Syriza e raccoglie le simpatie del governo italiano e di altri partner europei. Il rigore fiscale non aiuta a superare le recessioni prolungate, ma questo non significa che la spesa in disavanzo sia sempre e comunque una via per la crescita. Nel caso della Grecia, questa politica creerebbe nuovo debito che il governo dovrebbe collocare sul mercato a tassi ben superiori a quelli che oggi gravano sul debito esistente. È noto che la spesa in disavanzo può essere utile in alcune circostanze e in alcuni paesi. Il problema principale è farlo in modo da non provocare un aumento eccessivo dei tassi d’interesse, che avrebbe l’effetto di spiazzare gli investimenti e quella crescita economica che si vorrebbe generare. I paesi che riescono a indebitarsi a tassi moderati sono quelli che dispongono di una ricchezza privata rilevante e che riescono a costruirsi nel tempo la reputazione di debitori virtuosi, capaci di contenere i disavanzi pubblici quando non fronteggiano una recessione. Inoltre, in assenza di una ripresa degli investimenti privati e della produttività, la maggiore spesa pubblica generata dal governo greco non farebbe che alimentare le importazioni e il disavanzo commerciale, che la Grecia è riuscita a contenere con grande fatica da poco tempo. I sacrifici dei cittadini greci di questi ultimi anni sarebbero completamente vanificati.


Con queste considerazioni non intendo sottovalutare i problemi sociali che derivano dalla crescita della povertà in Grecia, ma sarebbe più corretto e onesto da parte di Tsipras chiedere all’Europa un maggiore e straordinario aiuto per affrontare questo dramma sociale piuttosto che invocare le virtù delle politiche keynesiane. Il malessere sociale dei cittadini greci non deriva principalmente dalle politiche rigoriste imposte dalla Germania, ma dall’incapacità dei governi greci di combattere l’evasione fiscale e utilizzare in modo efficiente le risorse pubbliche. Il Pil della Grecia oggi non è inferiore a quello che essa aveva al momento di entrare nella zona euro e, quindi, alla maggiore povertà di oggi corrisponde la maggiore ricchezza di qualcuno. Siamo sicuri che una parte delle risorse per ridurre le disuguaglianze in Grecia non possano essere trovate anche all’interno del paese?

See the original article >>

Thursday, January 29, 2015

The FOMC and the Markets – Something Has Changed

by Pater Tenebrarum

Still “Patient”, but too Upbeat for the Stock Market

As a look at the WSJ’s FOMC statement tracker reveals, the Fed currently sounds quite upbeat about the US economy. Given that organs of the State are usually the last to recognize a trend (in this case the trend of a subdued, but better than elsewhere US economic performance), this should be taken as a warning sign that the trend may be close to reversing.

There was only one word for liquidity junkies in the statement: the term “patient”, in the context of the widely anticipated, but continually postponed, rate hike. While the Fed ponders rate hikes, US macro data have begun to weaken rather noticeably of late. Not to an extent yet that would be worrisome, but they offer a strange contrast to the upbeat FOMC statement. Also, the Fed keeps stressing that it sees the recent collapse in inflation expectations as “transitory” (it may well turn out to be), again removing a reason for waiting much longer with a rate hike. Meanwhile, central banks from Canada to Singapore are cutting their administered interest rates, or are adopting a dovish stance (New Zealand, Australia), or are engaging in outright money printing (ECB, BoJ). Bond yields keep plummeting all over the show, including those on treasuries, which benefit from still offering a sizable spread pick-up in today’s world of ZIRP, NIRP and negative yields on government bonds.


As a result of having communicated the impending interest rate hike so persistently, the Fed is practically forced to follow through, as it would otherwise endanger its vaunted “credibility”. This is not what stock market participants want to hear in light of the less benign macro-environment and the not overly convincing revelations of the current earnings season.

Who could have known? The strong dollar actually eats into the profits of US multinationals. Interestingly, even some unemployment related data may well be at a turning point, in spite of unemployment being known as a lagging indicator of the economy. The main reason why it is worth pointing this out is that the US stock market exhibits a well-established negative correlation with initial claims data.

Here is a recent chart of initial and continuing claims; both appear set to head higher, which would actually not be too surprising considering that the bulk of US jobs growth since the 2008/9 crisis was produced by the shale oil producing states. It is a good bet that their jobs situation will once again be determined by the oil price, and the oil price keeps hitting new lows.


Unemployment claims data – bottoming out?  – click to enlarge.

As a little aside to the oil market: as of last week’s CoT report, speculators were still net long nearly 287,000 WTI crude oil contracts. Although surveys show that bearish sentiment on crude oil has become quite pronounced, the speculative positioning in this market belies that view. It looks to us like some of the sellers – the net long position has declined from an all time high of approx. 490,000 contracts to today’s level – have been replaced by bottom fishers. It should be noted that although a lot of longs have given up relative to the all time high in net long positioning, the current level is what used to be a record high a mere three years ago. So historically, the current positioning is still revealing a foaming-at-the-mouth bullish attitude, which is more than passing strange. As a result, it should perhaps not be too surprising that the oil market has yet to find even a short term low (admittedly, its inability to put together a bounce lasting longer than a day or two does surprise us a bit).

A Rare Event

Yesterday the stock market began to slide as soon as the FOMC statement hit the wires. This is worth noting, because it hasn’t happened in an eternity that the market falls both the day before and on the day of the statement’s release. We don’t even remember when something like this happened the last time. In terms of the echo bubble it is definitely a first.


Mirabile dictu…the market falls around the FOMC meeting – click to enlarge.

Stock market bulls have reason to be concerned. For instance, margin debt is still close to a record high, but its actual peak occurred several months ago, usually a warning sign, especially when it happens after a very large increase in said debt. Also, as the updated Rydex data below show, traders continue to be “all in” and bears have practically given up completely, with Rydex bear assets all but disappearing. In other words, almost no-one is looking down – and yet, the market appears vulnerable both from a technical and fundamental perspective (however, we must add to this that the evidence is not clear cut – many sector charts continue to look good, and the fundamental picture is at most displaying a few small cracks so far).


Rydex money market fund assets, bear assets and the bull/bear ratio. These data represent a microcosm of market sentiment, and it presumably just doesn’t get any more lopsided than this. We only had to adapt our annotations slightly – for instance, bear assets are currently plumbing new all time lows, but some traders have hopped on the fence, as evidenced by a small rise in money market fund assets.


Market participants were able to look beyond the end of QE 3-4 as other central banks started to go on a printing spree, creating carry trade flows into dollar-denominated assets (e.g. foreign inflows into US stocks have gone bananas, which is by the way also a warning sign). However, now that the Fed is announcing that it is optimistic on the economy, market participants may be having second thoughts – after all, the ZIRP policy was a major driver of debt-funded stock buybacks and a vast bout of re-leveraging in numerous financial markets. At the same time, it should be clear that loose monetary policy has distorted prices, which in turn has undoubtedly caused a lot of capital misallocation in the economy (some of the more adventurous shale oil investments are testament to that). If loose monetary policy is indeed about to be reversed, a great many things could in fact go into reverse as well, possibly faster than generally expected.

The stock market has largely been driven by an expansion of multiples in recent years – overall, actual earnings growth wasn’t all that great, even with stock buybacks flattering per share earnings. The median stock in the US market has never been as highly valued as it is today. It is difficult to rationalize buying at such extreme valuations, and if monetary pumping no longer lends support to the market, it may not be a good time to throw caution to the wind. It’s not as if there were no warning signs in evidence after all – essentially almost all of last year was a big warning sign, with trend uniformity crumbling and high yield debt diverging from stocks. We believe 2015 is likely going to be a quite volatile year.

See the original article >>

Alexis Tsipras’ Open Letter

By Alexis Tsipras

Most of you, dear Handesblatt readers, will have formed a preconception of what this article is about before you actually read it. I am imploring you not to succumb to such preconceptions. Prejudice was never a good guide, especially during periods when an economic crisis reinforces stereotypes and breeds biggotry, nationalism, even violence.

In 2010, the Greek state ceased to be able to service its debt. Unfortunately, European officials decided to pretend that this problem could be overcome by means of the largest loan in history on condition of fiscal austerity that would, with mathematical precision, shrink the national income from which both new and old loans must be paid. An insolvency problem was thus dealt with as if it were a case of illiquidity.

In other words, Europe adopted the tactics of the least reputable bankers who refuse to acknowledge bad loans, preferring to grant new ones to the insolvent entity so as to pretend that the original loan is performing while extending the bankruptcy into the future. Nothing more than common sense was required to see that the application of the ‘extend and pretend’ tactic would lead my country to a tragic state. That instead of Greece’s stabilization, Europe was creating the circumstances for a self-reinforcing crisis that undermines the foundations of Europe itself.

My party, and I personally, disagreed fiercely with the May 2010 loan agreement not because you, the citizens of Germany, did not give us enough money but because you gave us much, much more than you should have and our government accepted far, far more than it had a right to. Money that would, in any case, neither help the people of Greece (as it was being thrown into the black hole of an unsustainable debt) nor prevent the ballooning of Greek government debt, at great expense to the Greek and German taxpayer.

Indeed, even before a full year had gone by, from 2011 onwards, our predictions were confirmed. The combination of gigantic new loans and stringent government spending cuts that depressed incomes not only failed to rein the debt in but, also, punished the weakest of citizens turning people who had hitherto been living a measured, modest life into paupers and beggars, denying them above all else their dignity. The collapse of incomes pushed thousands of firms into bankruptcy boosting the oligopolistic power of surviving large firms. Thus, prices have been falling but more slowly than wages and salaries, pushing down overall demand for goods and services and crushing nominal incomes while debts continue their inexorable rise. In this setting, the deficit of hope accelerated uncontrollably and, before we knew it, the ‘serpent’s egg’ hatched – the result being neo-Nazis patrolling our neighbourhoods, spreading their message of hatred.

Despite the evident failure of the ‘extend and pretend’ logic, it is still being implemented to this day. The second Greek ‘bailout’, enacted in the Spring of 2012, added another huge loan on the weakened shoulders of the Greek taxpayers, “haircut” our social security funds, and financed a ruthless new cleptocracy.

Respected commentators have been referring of recent to Greece’s stabilization, even of signs of growth. Alas, ‘Greek-covery’ is but a mirage which we must put to rest as soon as possible. The recent modest rise of real GDP, to the tune of 0.7%, signals not the end of recession (as has been proclaimed) but, rather, its continuation. Think about it: The same official sources report, for the same quarter, an inflation rate of -1.80%, i.e. deflation. Which means that the 0.7% rise in real GDP was due to a negative growth rate of nominal GDP! In other words, all that happened is that prices declined faster than nominal national income. Not exactly a cause for proclaiming the end of six years of recession!

Allow me to submit to you that this sorry attempt to recruit a new version of ‘Greek statistics’, in order to declare the ongoing Greek crisis over, is an insult to all Europeans who, at long last, deserve the truth about Greece and about Europe. So, let me be frank: Greece’s debt is currently unsustainable and will never be serviced, especially while Greece is being subjected to continuous fiscal waterboarding. The insistence in these dead-end policies, and in the denial of simple arithmetic, costs the German taxpayer dearly while, at once, condemning to a proud European nation to permanent indignity. What is even worse: In this manner, before long the Germans turn against the Greeks, the Greeks against the Germans and, unsurprisingly, the European Ideal suffers catastrophic losses.

Germany, and in particular the hard-working German workers, have nothing to fear from a SYRIZA victory. The opposite holds. Our task is not to confront our partners. It is not to secure larger loans or, equivalently, the right to higher deficits. Our target is, rather, the country’s stabilization, balanced budgets and, of course, the end of the grand squeeze of the weaker Greek taxpayers in the context of a loan agreement that is simply unenforceable. We are committed to end ‘extend and pretend’ logic not against German citizens but with a view to the mutual advantages for all Europeans.

Dear readers, I understand that, behind your ‘demand’ that our government fulfills all of its ‘contractual obligations’ hides the fear that, if you let us Greeks some breathing space, we shall return to our bad, old ways. I acknowledge this anxiety. However, let me say that it was not SYRIZA that incubated the cleptocracy which today pretends to strive for ‘reforms’, as long as these ‘reforms’ do not affect their ill-gotten privileges. We are ready and willing to introduce major reforms for which we are now seeking a mandate to implement from the Greek electorate, naturally in collaboration with our European partners.

Our task is to bring about a European New Deal within which our people can breathe, create and live in dignity.

A great opportunity for Europe is about to be born in Greece on 25th January. An opportunity Europe can ill afford to miss.

An Entire Generation of Fund Managers is Unprepared For the Next Crisis

by Phoenix Capital Research

Last week we touched upon the “white elephant” in the room: that the biggest, most important bubble investors should worry about is in bonds, NOT stocks.

Consider the following…

The financial system is based on debt. US Treasuries, the benchmark for an allegedly “risk free” rate of return, is the asset against which all other assets are priced based on their relative riskiness.

This “risk free” rate has been falling steadily for over 25 years.

The Wall Street Journal estimates that a third of traders have never witness a rate hike. However, the real problem is far greater than this.

Bonds have been in a bull market for over 30 years. Forget rate hikes… an entire generation of investors and money managers (anyone under the age of 55) has been investing in an era in which risk has generally gotten cheaper and cheaper.

This, in turn, has driven the rise in leverage in the financial system. As the risk-free rate fell, so did all other rates of return. Thus investors turned to leverage or using borrowed money to try to gain greater rates of return on their capital.

The ultimate example of this is the derivatives market, which is now over $700 trillion in size. This entire mess is backstopped by about $100 trillion (at most) in bonds posted as collateral.

This formula of ever increasing leverage works relatively well when the underlying asset backstopping a trade is rising in value (think of the housing bubble, which worked fine as long as housing prices rose). However, if the asset ever loses value, you very quickly run into trouble because you need to post more as collateral to backstop your trade. If you can’t do this easily, the margin calls start coming and you can find yourself having to unwind a massive position in a hurry.

This is how crashes occur. This is what caused 2008. And it’s what will cause the next crisis as well.

Despite all of the rhetoric, the world has not deleveraged in any meaningful way. The only industrialized country to deleverage since 2008 is Germany.

This is not unique to sovereign nations either. As McKinsey recently noted, there has been no meaningful deleveraging in any sector of the global economy (the best we’ve got is households and financial firms which have basically flat-lined since 2008).

In the simplest of terms, the 2008 collapse occurred because of too much leverage fueled by cheap debt. This worked fine until the assets backstopping the leveraged trades fell in value, which brought about margin calls and a selling panic.

The big problem however is that NO ONE got the message that leverage was a problem. Instead, everyone has become even MORE leveraged than they were in 2008. And they did this against an ever-smaller pool of quality assets (the Fed and other Central Banks’ QE programs have actually removed high grade collateral from the financial markets).

Thus, we now have a financial system that is even more leveraged than in 2007… backstopped by even less high quality collateral. And this time around, most industrialized sovereign nations themselves are bankrupt, meaning that when the bond bubble pops, the selling panic and liquidations will be even more extreme.

The next round of the crisis is coming, and it’s going to make 2008 look like a picnic.

See the original article >>

Signs That The Economy Is Weakening

by Lance Roberts

"Sign, sign, everywhere a sign
Blockin' out the scenery, breakin' my mind
Do this, don't do that, can't you read the sign?" - Five Man Electrical Band

For months now I have been discussing that despite the "hopes" that this time is different, there is little chance that the U.S. can remain an island of economic prosperity in the sea of global deflation. To wit:

"While none of this analysis suggests that a domestic recession is imminent, it does suggest that the hopes that the U.S. can "decouple" from the rest of the world's deflationary drags are likely misplaced. As shown in the chart below, the U.S. economy has historically been unable to achieve accelerating rates of economic growth when both the EuroArea and Japanese economies have been weak."


"The implications to investors are important. The current growth in domestic profits is one of the last remaining footholds of market "bulls." With valuations now expensive, interest rates near zero and yield spreads flattening, the risks to the markets have risen substantially. While this doesn't seem to be the case as markets push up against all-time highs; it is worth remembering that we saw much the same in early 2000 and 2007. This time is likely no different, only the timing and catalyst will be."

The following series of charts all suggest that current hopes of surging economic growth in the U.S., over the next several quarters, will likely be met with disappointment. I have added brief comments, but primarily you should judge for yourself.

LEI Coincident To Lagging Ratio

The coincident-to-lagging ratio is like a "book-to-bill" ratio for the economy. It is hard to suggest that the economy is "firing" on all cylinders when this ratio is languishing at levels normally indicative of a recessionary economy.


ISM Composite

While the ISM composite survey is near the top end of its range, there are clear signs that the ratio will likely subside in the months ahead. I have mapped the normal cycles of the index in the past. It is important to remember that the ISM survey is a "sentiment" survey that tends to lag actual inputs like new orders and backlogs.


Durable Goods

Speaking of orders, durable goods (ex-aircraft) are showing considerable signs of weakness domestically. The demand for goods has weakened significantly over the last couple of months in particular despite the hopes that falling oil and gasoline prices would buoy spending. (I wrote several articles dispelling this myth see here, here and here.)


Imports vs. Exports

The surging dollar and weak consumer demand are also being reflected in import and export activity. 



The rising weakness in demand for goods and products can be clearly seen in the decline in the shipping index.



Copper, a component used in virtually every facet of manufacturing, production, and consumption, also suggests that economic demand is weakening.


National Activity vs. Economy

We can see this more clearly by looking at the major components of the Chicago Fed National Activity Index (CFNAI) as compared to the relative economic indicators.



The 5- and 10-year breakeven inflation rates continue to suggest that underlying economic strength is much weaker than headline statistics suggests.


These charts all clearly suggest that the real economy is likely weaker than currently believed. In addition, current data would likely already be printing lower growth rates had it not been for revisions a couple of years ago that added more questionably measured components such as "intellectual property."

However, while I am not suggesting that a recession is imminent, i am suggesting that the risk to investors has risen markedly over the last few months. The rising financial instability in the Eurozone, particularly following the Greek elections, combined with the global deflationary tide puts currently extended financial markets in jeopardy.

There is little question that the markets will eventually suffer a rather nasty mean reversion. However, bull markets don't end simply due to old age, it requires a catalyst. The problem remains that throughout history the "catalyst" that finally triggers a market reversion and coinciding economic recession are rarely identified in advance.

This is why I point to the signs. The signs are everywhere that the market is currently a "bug in search of a windshield." It will eventually find one, and as the old saying goes, the last thing that goes through the mind of the bug is its ***.

See the original article >>

Greece Is Once Again a Victim of Democracy

by Bill Bonner

Tempests Everywhere

And then democracy comes into being after the poor have conquered their opponents, slaughtering some and banishing some, while to the remainder they give an equal share of freedom and power.

– Socrates, Plato’s The Republic

A snowstorm battered the East Coast of the US today. Politics rocked southern Europe.

Sitting here on the edge of the beach, overlooking the Pacific Ocean, a gentle breeze stirring the trees… birds singing… surfers carrying their boards across the sand…

… it’s hard to imagine the tempest in North America, let alone the swirling clouds over the Parthenon. The radical left-wing Syriza coalition party won in Greece.

Once again, Greece is a victim of democracy.

papoulias and tsipras

Greece’s elderly president Karolos Papoulias warily eyes Alexis Tsipras as he is about to be sworn in as the country’s new prime minister.

Photo credit: Aris Messinis / AFP

Austerity? What Austerity?

What this means, exactly, is anybody’s guess. The Wall Street Journal struggled:

“Within minutes of the close of the polls, Germany’s powerful central-bank chief, Jens Weidmann, pushed back.

“It is clear that Greece will remain dependent on support and it’s also clear that this aid will be provided only when it is in an aid program,” he said in an interview with television broadcaster ARD.

A message on British Prime Minister David Cameron’s usual Twitter account, meanwhile, warned that the Greek result will “increase economic uncertainty across Europe.”

Increased uncertainty is a good bet.

Meanwhile, the papers reported that Europe’s apparatchiks were working overtime to accommodate the new government so as to keep the system functioning. Also reported was that Greek voters were fed up with “austerity.”

As to the first bit of news we have no doubt. All the powers-that-be don’t want to become the powers-that-used-to-be. They’ll do whatever it takes to hold on to their authority. It’s the second bit of news that makes us say, “Huh?”

Not that we haven’t heard it before. The Greeks… the Spaniards… the Italians… the Portuguese… the French – they’re all supposed to be tired of “austerity.” But what austerity?

According to our sources, the Greek government currently spends 59% of GDP – a figure even higher than in France. Like France, Greece has plenty of civil servants enjoying a cushy life at taxpayer expense. And in the private sector, too, the cronies get their favors, privileges and tax breaks… while as much as half of tax revenue goes uncollected.

Which is probably a good thing. Were it not for the black market, and tax evasion, the Greek economy would probably fall apart. Elsewhere it is reported that 45% of GDP is collected by the Greek government. The difference between collecting 45% and spending 59% is apparently the source of the problem. But we’re not sure. All of the numbers we see are a little fishy.


Many of the data that are readily available are a bit outdated. However, this slightly more up-to-date chart of government spending in absolute terms shows that spending has increased substantially in the summer of 2014 – click to enlarge.

Clever Legerdemain

It was thanks to fishy numbers that Greece was admitted to the EU in the first place. The European Union insists on a certain standard of financial integrity, or it won’t let you in. (Fearing that it might have to bail you out later.)

Greece managed to get in thanks to the clever legerdemain of Goldman Sachs, which disguised some of the nation’s debts. Then, with no more fear of getting paid back in Greece’s dodgy drachma, lenders were happy to open their wallets to Greek borrowers.

Government debt increased from 100% of GDP as recently as 2006 to 177% this year. Spend, spend, spend. Pensions. Health care. Education. And why not guns, too? Greece is even one of the biggest military spenders (as a percentage of GDP) in NATO. This is austerity?

Real austerity is what you get when you spend no more than you make… minus what you need to pay to service yesteryear’s excess spending. Real austerity is what you get when lenders wise up, realize you’ll never pay them back, and don’t lend you anymore money.

Real austerity is what you have when the Germans say nein to any more financial support. Real austerity is not what the Greeks have. And not what Greek voters voted against. It’s what they need. Austerity is what we all need.


The ratio of Greece’s government debt to GDP has increased greatly, as the nominal value of economic output has plummeted. For one thing, malinvested capital was liquidated, for another, Greece’s domestic money supply declined sharply as depositors fled and the banking system became effectively insolvent (it was then recapitalized via a bailout). Since there still remain huge amounts of non-performing loans on the banks’ books, bank credit is likely to remain scarce for the time being – click to enlarge.

See the original article >>

The Swiss Franc Will Collapse

by Keith Weiner

I have worked to keep this piece readable, and as brief as possible. My grave diagnosis demands the evidence and reasoning to support it. One cannot explain the collapse of this currency with the conventional view. “They will print money to infinity,” may be popular but it’s not accurate. The coming destruction has nothing to do with the quantity of money. It is a story of what happens when interest rates fall into a black hole.

swiss tattered flag

Yields Have Fallen Beyond Zero

The Swiss yield curve looks like nothing so much as a sinking ship. All but the 20- and 30-year bonds are now below the water line.

chart-1-Swiss Yield Curve

Swiss yield curve – click to enlarge.

Look at how much it’s submerged in just one week. The top line (yellow) is January 16, and the one below it was taken just a week later on January 23. It’s terrifying how fast the whole interest rate structure sank. Here is a graph of the 10-year bond since September. For comparison, the 10-year Treasury note would not fit on this chart. The US note currently pays 1.8%.

chart-2-Swiss 10 year bond yield

Swiss 10 year government bond yield – click to enlarge.

The Swiss 10-year yield was as high as 37 basis points on Friday January 2. By the next Monday, it had plunged to 28, or -25%. By January 15—the day the Swiss National Bank (SNB) announced it was removing the peg to the euro—the yield had plunged to just 7 basis points. It has been nonstop freefall since then, currently to -26 basis points.

What can explain this epic collapse? Why is the entire Swiss bond market drowning? Drowning is a fitting metaphor. In my dissertation, I describe several harbingers of financial and monetary collapse. The first is when the interest interest rate on the long bond goes to zero. I discuss the fact that a falling rate destroys capital, and that lower rates mean a higher burden of debt.

If the long bond rate is zero then the net present value of all debt (which is effectively perpetual) is infinite. Debtors cannot carry an infinite burden. As we’ll see, any monetary system that depends on debtors servicing their debt must collapse when the rate goes to zero.

I think the franc has reached the end. With negative rates out to 15 years, and a scant 33 basis points on the 30-year, it is all over but the shouting.

Not Printing, Borrowing

Let’s take a step back for a moment, and look at how the recent chapter unfolded. It began with the SNB borrowing mass quantities of francs. Most people say printed, but it’s impossible to understand this unprecedented disaster with such an approximate understanding. It’s not printing, but borrowing.

Think of a home buyer borrowing $100,000 to buy a house. He never gets the cash in his bank account. He signs a bunch of paperwork, and then at the end of the day he has a debt obligation to repay, plus the title to the house. The former owner has the cash.

It works the same with any central bank that wants to buy an asset. At the end of the day, the bank owns the asset, and the former owner of the asset now holds the cash. This cash is the debt of the central bank. It is on the bank’s balance sheet as a liability. The bank owes it.

This is vitally important to understand, and it can be quite counterintuitive. If one thinks of the franc (or dollar, euro, etc.) as money, and if one thinks that the central banks print money, then one will come to precisely the wrong conclusion: that there is nothing owed, and indeed there is no debtor. In this view, the holder of francs has cash, which is a current asset. End of story.

This conclusion could not be more wrong. Certainly, the idea of the central bank repaying its debt is absurd. By law, payment is deemed made when the debtor pays in currency—i.e. francs in Switzerland. However, the franc is the very liability of the SNB that we’re discussing. How can the SNB pay off its franc liabilities using its own franc liabilities as means of payment?

It can’t. This is a contradiction in terms. Thus it’s critical to understand that there is no extinguisher of debt in the regime of irredeemable paper currency. You may get yourself out of the debt loop by paying in currency, but that merely shifts the debt. The debt does not go out of existence, because paying a debt with an IOU cannot extinguish it. Unlike you, the central bank cannot get itself out of debt.

However, it can service its debt. For example, the Federal Reserve in the U.S. pays interest on reserves. Indeed, the bank must service its debts. It would be a calamity if a payment is missed, if the central bank ever defaulted. The central bank must also maintain its liabilities, which is what it uses to fund its assets. If the commercial banks withdraw their deposits—and they do generally have a choice—the central bank would be forced to sell its assets. That would be contrary to its policy intent, not to mention quite a shock to brittle economies.

Make no mistake, a central bank can go bankrupt. This may seem tricky to understand, as the law makes its liability legal tender for all debts public and private. A central bank is also allowed to commit acts of accounting (and leverage) that would not be tolerated in a private company. Regardless, it can present misleading financial statements, but even if the law lets it get away with that, reality will have its revenge in the end. The emperor may claim to be wearing magnificent royal robes, but he’s still naked.

If liabilities exceed assets, then a bank—even a central bank—is insolvent and the consequences will come soon enough. The cash flow from the assets will sooner or later become insufficient to pay the interest on the liabilities. No central bank wants to be in a position where it is obliged to borrow, not to purchase asset but to service a negative cash flow. That is a rapid death spiral. It must somehow push down the interest rate on its liabilities (which are typically short term) to keep the cost of financing its portfolio below the revenue generated on the assets.

This becomes increasingly tricky when two things happen. One, the yield on the asset goes negative. Thus, the even-more-negative (and even more absurd) one-day rate of -400 basis points in Switzerland. Two, the issuance of more currency drives down yields even further (described in detail, below). Events force the hand of the central bank. It goes down a path where it has fewer and fewer choices. That brings us back to negative interest rates out to the 15-year bond so far.

The Visible Hand of the Swiss National Bank

So the SNB issued francs to fund its purchase of euros. Next, it spent the euros on whatever Eurozone assets it wished to buy, such as German bunds.

It’s well known that the SNB put on a lot of this trade to keep the franc down to €0.83 (the inverse of keeping the euro down to CHF1.20). It also helped push down interest rates in Europe. The SNB was a relentless buyer of European bonds.

That leads to the question of what it did in Switzerland. The SNB was trading new francs for euros. That means the former owner of those euros then owned francs. These francs have to stay in the franc-denominated domain. What asset will this new franc owner buy?

I frame the question this way deliberately. If you have a 100-franc note, you can put it in your pocket. If you have CHF100,000, you can deposit it in a bank. If you have CHF100,000,000 (or billions) then you are going to buy a bond or other asset (depositing cash in a bank just pushes it to the bank, which buys the asset).

The seller of the asset is selling on an uptick. He gives up the bond, because at its higher price (and hence lower yield) he now finds another asset more attractive on a risk-adjusted basis. Risk includes his own liquidity risk (which of course rises as his leverage increases). As the SNB (and many others) relentlessly push up the bond price, and hence push down the yield, the sellers of the ever-lower yielding bonds have fresh new franc cash balances.

The Quantity Theory of Money holds that the demand for money falls as the quantity rises. If demand for money falls, then by this definition the prices of all other things—including consumer goods—rises. It is commonly held that people tradeoff between saving money vs. spending money (i.e. consumption). The prediction is rising consumer prices.

I emphatically disagree. A wealthy investor does unload his assets to go on an extra vacation if he doesn’t like the bond yield. A bank with a trillion dollar balance sheet does not dole out bigger salaries if its margins are compressed. So what does trade off with government bonds? If an investor doesn’t want to own a government bond, what else might he want to own? He buys corporate bonds, stocks, or rental real estate, thus pushing up their prices and yields down.

And then, in a dysfunctional monetary system, you can add antique cars, paintings, a second and third home, etc. These things serve as surrogates for investment. When investing cannot produce an adequate yield, people turn to non-yielding non-investment assets.

The addition of a new franc at the margin perturbs the previous equilibrium of risk-adjusted yields across all asset classes. Every time the bond price goes up, every owner of every franc-denominated asset must recalculate his preferences. The problem is that the SNB does not create any more productive investment opportunities when it spills more francs into the Swiss financial system. Those new francs have to chase after the existing assets.

Yields are falling. They necessarily had to fall.

An Increasing Money Supply and Decreasing Interest Rate

The above discussion describes the picture in every developed economy. Interest rates have been falling for 34 years in the U.S., for example.

In a free market, the expansion of credit would be driven by a market spread: available yield – cost of borrowing. If that spread is too small (or negative) there will be no more borrowing to buy assets. If it gets wider, then banks can spring into action.

However, central banks distort this. Instead of the cost of borrowing being a market-determined price, it is fixed by the central bank. This perverts the business model of a bank into what is euphemistically known as maturity transformation—borrowing short to lend long. It’s not possible for a bank to borrow money from depositors with 5-year time deposit accounts in order to buy 5-year bonds. The bank has to borrow a shorter duration and buy a longer, in order to make a reasonable profit margin.

If the central bank sets the borrowing cost lower and lower, then the banks can bid up the price of government bonds higher and higher (which causes a lower and lower yield on the long bond). This is not capitalism at all, but a centrally planned kabuki theater. All of the rules are set by a non-market actor, who can change them for political expediency.

The net result is issuance of credit far beyond what could ever happen in a free market. This problem is compounded by the fact that the central bank cannot control what assets get bought when it buys bonds. It hands the cash over to the former bond holders. It’s trying to accomplish something—such as keeping the franc down in the case of the SNB, or preventing bankruptcies, in the case of the Fed—and it has no choice but to keep flooding the market until it achieves its goal.

In the US, the rising tide eventually lifted all ships, even the leaky old tubs. The result is a steeper credit gradient, and the bank can eventually force liquidity out to its target debtors.

The situation in Switzerland makes the Fed’s problems look small by comparison. Unlike the Fed, which had a relatively well-defined goal, the SNB put itself at the mercy of the currency market. It had no particular goal, and therefore no particular budget or cost. The SNB was fighting to hold a line against the world. While it kept the franc peg, the SNB put pressure on both Swiss and European interest rates.

Something changed with the start of the year. We can understand it in light of the arbitrage between the Swiss bond, and other Swiss assets. The risk-adjusted rate of return on other assets always has to be greater than that of the Swiss government bond (except perhaps at the peak of a bubble). Otherwise why would anyone own the higher-risk and lower-yield asset? Therefore, there are three possible causes for the utter collapse in interest rates in Switzerland beginning 10 days prior to the abandonment of the peg:

The rate of return of other assets has been leading the drop in yields

Buying pressure on the franc obliged the SNB to borrow more francs into existence, fueling more bond buying.

The risk of other assets has been rising (including liquidity risk to their leveraged owners)

#1 is doubtful. It’s surely the other way around. It’s not falling yields on real estate driving falling yields on bonds. Bond holders are induced to part with their bonds on a SNB-subsidized uptick. Then they use the proceeds to buy something else, and drive its yield down.

One fact supports conclusion #2. Something forced the SNB to remove the peg. Buying pressure is the only thing that makes any sense. The SNB hit its stop-loss.

The rate of interest continued to fall even after the SNB abandoned its peg. Why? Reason #3, rising risks. Think of a bank which borrowed in Swiss francs to buy Eurozone assets. This trade seemed safe with the franc pegged to the euro. When the peg was lifted, suddenly the firm was faced with a staggering loss incurred in a very short time.

The overreaction of the franc in the minutes following the SNB’s policy change had to be the urgent closing of Eurozone positions by many of these players. The franc went from €0.83 to €1.15 in 10 minutes, before settling down near €0.96. For those balance sheets denominated in francs, this looked like the euro moved from CHF1.20 to CHF0.87, a loss of 28%. What would you do, if your positions instantly lost so much? Most people would try to close their positions.

Closing means selling Eurozone assets to get francs. Then you need to buy a franc-denominated asset, such as the Swiss government bond. That clearly happened big-time, as we see in the incredible drop in the interest rate in Switzerland. Francs which had formerly been used to fund Eurozone assets must now be used to fund assets exclusively in the much-smaller Swiss realm.

In other words, a great deal of franc credit was used to finance Eurozone assets. This is a big world, and hence the franc carry trade didn’t dominate it. When those francs had to go home and finance Swiss assets only, it capsized the market. And the entire yield curve is now sinking into a sea of negative rates.


A beautiful cemetery in Switzerland, where the Swiss franc could be interred one day.

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The Consequences of Falling Interest

Meanwhile, unnaturally low interest is offering perverse incentives to corporations who can issue franc-denominated liabilities. They are being forced-fed with credit, like ducks being fatted for foie gras. This surely must be fueling all manner of malinvestment, including overbuilding of unnecessary capacity. The hurdle to build a business case has never been lower, because the cost of borrowing has never been lower. The consequence is to push down the rate of profit, as competitors expand production to chase smaller returns. All thanks to ever-cheaper credit.

Artificially low interest in Switzerland is causing rising risk and, at the same time, falling returns. The Swiss situation is truly amazing. One has to go out to 20 years to see a positive number for yield—if one can call 21 basis points much of a yield. It’s not only pathological, but terminal. This is the end.

In Switzerland, there is hardly any incentive remaining to do the right things, such as save and invest for the long term. However, there’s no lack of perverse incentives to borrow more and speculate on asset prices detaching even further from reality. Speculation is in its own class of perversity. Speculation is a process that converts one man’s capital into another man’s income. The owner of capital, as I noted earlier, does not want to squander it. The recipient of income, on the other hand, is happy to spend some of it.

We should think of a falling interest rate (i.e. rising bond market and hence rising asset markets) as sucking the juice (capital) out of the system. While the juice is flowing, asset owners can spend, and lots of people are employed (especially in the service sector).

For example, picture a homeowner in a housing bubble. Every year, the market price of his house is up 20%. Many homeowners might consider borrowing money against their houses. They spend this money freely. Suppose a house goes up in price from $100,000 to $1,000,000 in a little over a decade. Unfortunately, the debt owed on the house goes up proportionally.

With financial assets, they typically change hands many times on the way up. In each case, the sellers may spend some of their gains. Certainly, the brokers, advisors, custodians, and other professionals all get a cut—and the tax man too. At the end of the day, you have higher prices but not higher equity. In other words, the capital ratio in the market collapses.

To understand the devastating significance of this, consider two business owners. Both have small print shops. Both have $1,000,000 worth of presses, cutters, binding machines, etc. One owns everything outright; he paid cash when he bought it. The other used every penny of financing he could get, and has a monthly payment of about $18,000. Both shops have the same cost of doing business, say $6,000. If sales revenues are $27,000 then both owners may feel they are doing well. What happens if revenues drop by $3,500? The all-equity owner is fine. He can reduce the dividend a bit. The leveraged owner is forced to default. The more your leverage, the more vulnerable you are to a drop in revenues or asset values.

Falling interest, and its attendant rising asset prices, juices up the economy. People feel richer (especially if their estimation of their wealth is portfolio value divided by consumer prices) and spend freely. Unfortunately, it becomes harder and harder to extract smaller and smaller drops of juice. The marginal productivity of debt falls.

Think about it from the other side, the borrower. The very capacity to pay interest has been falling for decades. A declining rate of profit goes hand-in-hand with a falling rate of interest. Lower profit is both caused by lower interest, and also the cause of it. A business with less profit is less able to pay interest expense. Who could afford to pay rates that were considered to be normal just a few decades ago? It is capital that makes profit, and hence capacity to pay interest, possible. And it is capital that’s eroded by falling rates.

The stream of endless bubbles is just the flip side of the endless consumption of capital. Except, there is an end. There is no way of avoiding it now, for Switzerland.

How About Just Shrinking the Money Supply?

Monetarists often tell us that the central bank can shrink the money supply as well as grow it, and the reason why it’s never happened is, well… the wrong people were in charge. I disagree.

To see why, let’s look at the mechanism for how a central bank expands the money supply. It issues cash to an asset owner, and the asset changes hands. Now the bank owns the asset and the seller owns the cash (which he will promptly use to buy the next best asset). A relentlessly rising bond price is lots of fun. It’s called a bull market, and everyone is making profits as they reckon them (actually consuming capital, as we said above).

How would a contraction of the money supply work? It seems simple, at first. The central bank just sells an asset and gets back the cash. The cash is actually its own liability, so it can just retire it. And voila. The money supply shrinks. Not so fast.

There is an old saying among traders. Markets take the escalator up, but the elevator down. Central bank buying slowly but relentlessly bid up the price of bonds. Tick by tick, the bank forced it up. What would central bank selling do? What would even a rumor of massive central bank selling do? Bond prices would fall sharply.

The problem is that few can tolerate falling bond prices, because everyone is leveraged. Think about what it means for everyone to borrow and buy assets, for sellers to consume some profits and reinvest the proceeds into other assets. There is increasingly scant capital base supporting an increasingly inflated—as in puffed-up with air, without much substance—asset market. A small decline in prices across all asset classes would wipe out the financial system.

Market participants have to be leveraged. Dirt cheap credit not only makes leverage possible, but also necessary. How else to keep the doors open, without using leverage? Spreads are too thin to support anyone, unlevered.

Banks are also maturity mismatched, borrowing short to lend long. The consequences of a rate hike will be devastating, crushing banks on both sides of the balance sheet. On the liabilities side, the cost of funding rises with each uptick in the interest rate. On the asset side, long bonds fall in value at the same time. If short-term rates rise enough, banks will have a negative cash flow.

For example, imagine owning a 10-year bond that pays 250 basis points. To finance it, you borrow at 25 basis points. Well, now imagine your financing cost rises to 400 basis points. For every dollar worth of bonds you own, you lose 1.5 cents per year. This problem can also afflict the central bank itself.

You have a cash flow problem. You are also bust.

The Bottom Line

The problem of falling rates is crushing everyone, but raising the rate cannot fix the problem. It should not be surprising that, after decades of capital destruction—caused by falling rates—the ruins of a once-great accumulation of wealth cannot be repaired by raising the interest rate.

I do not see any way out for the Swiss National Bank and the franc, within the system of irredeemable paper money. However, unless the SNB can get out of this jam, the franc is doomed. I can’t predict the timing, but I believe the fuse is lit and the powder keg could go off at any time.

One day, a bankruptcy will happen. Soothing voices will assure us it was unexpected. Then another will happen, perhaps triggered by the first or perhaps not. Then the cascading begins. One party’s liabilities are another’s assets. ABC’s bankruptcy wipes out DEF’s asset. Since DEF is leveraged, it cannot absorb much loss until it, too, is dragged under.

Somewhere in the midst of this, people will turn against the franc. Today, it’s arguably the most loved paper currency. However, I don’t think it will take too many capital losses in Switzerland, before there is a selling stampede. The currency will fall to zero, in a repeat of a pattern that the world has seen many times before.

People will call it hyperinflation (I don’t prefer that term). Call it what you will, it will be the death of the franc. It will have nothing to do with the quantity of money.

Two factors can delay the inevitable. One, the SNB may unwind its euro position. As this will involve selling euros to buy francs, the result will be to put a firm bid under the franc. Two, speculators will of course know this is happening and eagerly front-run the SNB. After all, the SNB is not an arbitrager buying when it can make a spread.

It is a buyer by mandate (in this scenario) and must pay the ask price. Even if the SNB does not unwind, speculators may buy the franc and wait for it to happen. And of course, they could also buy based on a poor understanding of what’s happening, or due to other perverse incentives in their own countries.

Bankruptcies aside, the franc is already set on a hair-trigger. Something else could trip it and begin the process of collapse. There is little reason for holding Swiss francs in preference to dollars. The interest rate differential is huge. The 10-year US Treasury pays 1.8%. Compare that to the Swiss bond which charges you 26 basis points, and the difference is over 208 points in favor of the US Treasury. Once the risk of a rising franc is taken out of the market (by time or price action) this trade will commence. A falling franc against the dollar will add further kick to this trade. A trickle could become a torrent very quickly.

I would not be surprised if the process of collapse of the franc began next week, nor if it lingered all year. This kind of event is not susceptible to a precise prediction of when. What is clear is that, once the process begins in earnest, it will be explosive, highly non-linear, and over quickly (I would guess a matter weeks).

I plan to publish a separate paper revisiting my Gold Bonds to Avert Financial Armageddon thesis in light of the Swiss crisis. I will save for that paper my assessment of whether or how gold bonds can provide a way out for the Swiss people trapped in the terminal phase of irredeemable paper money.

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