June 2012

“You have enemies? Good. That means you’ve stood up for something, sometime in your life.” -Winston Churchill

People, though, soon realised that one of the key things which was driving the dollar rush in the first place was the number of foreign dollar-denominated liabilities outstanding. With the number of eurodollars (those dollars that circulate outside of the US) ultimately capped, pressure on the dollar exchange rate began to show as investors grappled to raise dollar funding to meet margin calls on depreciating dollar-denominated assets.

Currently US Treasury rates are at all-time lows. These rates are due to Federal Reserve interest rate suppression and money credit creation. Assuming that at some point Bernanke decides that his inflationary policy has run far enough, and the Federal Reserve ends the easy money credit creation, then, obviously, market interest rates will rise.

In the context of the initial quote, the holders of Treasury paper, amongst other US assets, like stocks, will see nominal values fall. Higher rates means lower nominal prices for Bonds, and rising rates, at some point, creates a demand for Treasury paper, and a selling of stocks to rotate into Treasury paper, particularly from Pension Funds and Insurance companies that look to match assets/liabilities.

Any shortage of US dollars, driven by these asset re-allocations, will, drive demand for the US Dollar higher, potentially igniting a dollar bull market, which might see a sell-off in Gold and Silver.

Rising rates, will be a trigger to sell, thus reinforcing the rise in rates from any leveraged traders, and as the following chart suggests, there are a few of them out there. The question is how high will rates need to go before the Pension Funds etc start to switch from equities or other assets into Treasury paper based on attractive yields. With a falling stockmarket, where will a bottom eventually be found, which will likely trigger the starting point of another secular bull market.

This puzzle was cracked by Bianco Research who pointed out last year that the Fed is simply misusing the term “household”. It turns out to be nothing more than a residual account – if it doesn’t fall into any other domestic category, it ends up under the household bucket. So if these are not the mom-and-pop accounts, which is what the “household” category sounds like, who is actually buying all these treasuries?

Bianco Research: – Our guess is the domestic buyer is a leveraged carry trader, a mutual fund, a brokerage subsidiary or other group that does not have its own category so it gets “dumped” into the default category of “households.”

That means that other than foreigners, the leveraged trader has been funding the US budget deficit. As much as politicians wish to believe in stable mom-and-pop treasury purchases called “households”, the reality is quite different. The reality is that the US government is relying on slowing Asia and domestic leveraged speculators for its rapidly growing funding needs. And such a scheme is clearly not sustainable in the long term.

If this continued for a few more years a break-up of the euro would become possible without a meltdown – the omelet could be unscrambled – but it would leave the central banks of the creditor countries with large claims against the central banks of the debtor countries which would be difficult to collect. This is due to an arcane problem in the euro clearing system called Target2.

Target2 is the crux of the matter in Europe. Debits/Credits are never settled with real goods/services or like the Federal Reserve system, once a year, with gold certificates. It might be questioned whether there is real gold backing the gold certificate, but that is another question.

Target2 never settles. Therefore the debits/credits can grow to enormous proportions with no check on the reality of settlement ever taking place. So large now are these cumulative totals that a default of a PIIGS, or the withdrawal of Germany, and the edifice collapses.

In contrast to the clearing system of the Federal Reserve, which is settled annually, Target2 accumulates the imbalances. This did not create a problem as long as the interbank system was functioning because the banks settled the imbalances themselves through the interbank market.

See above.

But the interbank market has not functioned properly since 2007 and the banks relied increasingly on the Target system. And since the summer of 2011 there has been increasing capital flight from the weaker countries. So the imbalances grew exponentially. By the end of March this year the Bundesbank had claims of some 660 billion euros against the central banks of the periphery countries.

Correct. The Target2 system both allows, and encourages capital flight. Capital flight does not prevent the losses however due to the intertwined nature of the ECB and National Banks through the debit/credit Target2 clearance through the ECB. The losses at the ECB, are losses in the credits held by the ECB to the relevant National Bank, German in this case. The Germans lose.

The Bundesbank has become aware of the potential danger. It is now engaged in a campaign against the indefinite expansion of the money supply and it has started taking measures to limit the losses it would sustain in case of a breakup. This is creating a self-fulfilling prophecy. Once the Bundesbank starts guarding against a breakup everybody will have to do the same.

It can’t really limit the already incurred losses, all it can really do is prevent taking on new losses, which due to the virtual non-existence of any real value in collateral, is almost guaranteed.

This is already happening. Financial institutions are increasingly reordering their European exposure along national lines just in case the region splits apart. Banks give preference to shedding assets outside their national borders and risk managers try to match assets and liabilities within national borders rather than within the eurozone as a whole.

If that is the case, more fool them. You need to off-load junk, and hold quality. Whether that quality is Greece [highly unlikely] or Germany. The problem is that the destruction of capital now is so great that even formerly quality German assets are now likely to suffer real impairment.

The indirect effect of this asset-liability matching is to reinforce the deleveraging process and to reduce the availability of credit, particularly to the small and medium enterprises which are the main source of employment.

True. The unemployment, worldwide, will I expect start to rise again. I don’t think we have seen the bottom in unemployment, and this is going to be really brutal and ugly.

The market is having a good day [week] so far.

This week’s COT analysis indicates a strong week. Last week the COT, on the bounce, was at 95% which was a +17% change. This week [last week’s data] the COT stands at 99.8% with a change of +29.8%. This indicates that there is substantial buying support from the commercials over the last two weeks.

When the sell-off started [end of April] the COT registered the following: April 28 Index 78% change -6%. May 4 Index 70% change -12%. May 11 Index 78.6% change -4.4%. The bottom, May 28, had a COT Index at 92% change +13%. From there, the COT has been bullish.

It will be interesting to see if this bullish positioning will continue through next week, or whether, there will be a lightening period again. We have the Federal Reserve and Bernanke jawboning, so that will undoubtedly have an impact, if there is a hint, or outright pledge to QE4, the markets will again experience that ‘melt-higher’ type of price action.

The wrong result if you actually wanted some sort of resolution of this mess to take place. What we have now is more of the same that has plagued everyone for the last, what, two years now – Greece runs out of money, further bailout required. The problem though is that Spain & Italy are fast approaching the same point as Greece.

At least with a Greek default, something other than the endless stagnation would have taken place: Greece would have left the Euro and everyone could see what the result was a couple of years down the road. What would have happened is a massive contraction in the “State” and all the pointless bureaucracies and welfare dependency, and an expansion of the free market with an ultimate improvement. It would have been an incredibly painful transition simply because the “State” consumes so much currently, that the final washout could only ever be traumatic.

1958 Gibson Explorer
Notable owner: Eric Clapton
Estimated value: $500,000

The guitar Clapton trotted out to play “Rita” and “Have You Ever Loved a Woman” at the Royal Albert Hall in London on September 21, 1983, is one of only 19 experimental Explorer models Gibson released in 1958. Clapton bought the angular instrument from a fan in Austin, Texas not long before he made it famous onstage that night. In 1999 the guitar sold to an unknown buyer for $120,000 at auction at Christie’s, part of a nearly $5 million sale of Clapton guitars and equipment. These days, experts say, the Explorer would fetch four times that.

British Prime Minister Margaret Thatcher famously said (in a radio interview) that the problem with socialism is that you eventually run out of other people’s money to spend. This has been formalized as the Thatcher Line: the point at which the burden of government begins to overwhelm the ability of the private sector to pay for it.

The Thatcher Line explains the recent wave of reforms on the state and local level. While President Obama complains that state and local governments have been laying off workers, he has apparently never bothered to ask why they can’t afford to hire anyone. It turns out that it’s not because state and local governments have no money. It’s because spending on government employees naturally tends to expand faster than the ability of the private sector to pay for it.

Don’t you just get tired of politicians constantly lying, or distorting the truth to such a degree that essentially it becomes the same thing? Obama, one must assume is not completely brain dead. If so, then he has decided to mislead the general public with his statement, or gaffe, whichever way you want to look at it.

The truly tragic thing is that Romney will be no better, and possibly even worse if that’s possible. After Bush it was hard to imagine that anyone could be worse, and to date, I don’t think Bush has been surpassed, but dang, they just keep trying.

What could possibly cause this? The answer is that American football is in very, very serious trouble.

2,450 players have now filed 89 concussion related law suits against the NFL and Riddle Athletics (helmet manufacturer) . All of the State cases are being referred to Federal Court.

I’m no expert on this topic. I follow (among others) ESPN and NFL Concussion Litigation. I have recently talked with four attorneys (none directly involved – all sue for a living). The cut to the chase question for the lawyers was:
“Will there be financial awards?”

Four out of four were quick to answer:

This will make for an interesting legal case.

I suppose the starting point would be a contract [certainly at the Pro level, & probably at the College level too] The contract would obviously have to address the physicality of the sport and the potential for serious injuries/death from participation.

Without a doubt, the protective clothing/padding, contributes to the speed/strength of collisions/tackles. In rugby, where there is minimal/none of protective padding, the collisions are at lower speeds and impact power. There are still injuries/concussions, but they are I would guess less common frequent. That must therefore open another door as to prescribed/proscribed uses of the equipment.

Then there is the whole area of injury during the game, diagnosis, and management of the player. I read the book “Don’t worry it’s just a bruise” written by an NFL team doctor, and the level of drug useage etc employed to keep key players on the field, and the entire culture around that playing injured. Motorcycle racers ride injured all the time, break a few bones in an off during a practice round, back on for the race: this is not simply an NFL problem, you are dealing with tunnel vision athletes, and as such, very often they may require protecting from themselves, particularly in the case of a concussion where cognitive function will be impaired, and responsible, informed decisions cannot be made.

Ultimately, assuming that the draconian measure of an outright ban, or withdrawal of various participants does not end the game, insurance coverage would seem to be one avenue that could be explored. Of course the issue immediately that comes to mind would be “pre-existing conditions.” Where current players have been playing since grade school, all the way through to pro-level, the insurance risk becomes far higher, and of course, ultimately the insurance would have to commence at the start of the football playing career, in the PeeWee leagues, and be maintained continuously through the playing career.

Tail risk would be a major issue for the insurance companies, someone who played through say College, and developed problems say ten years later, attributable to football injuries. This would be a major stumbling block.

Of course, the game could retrogress as far as protective clothing is concerned. Make the padding far less protective, thus reducing the speed of collisions: remove helmets, return to the leather protective headgear, this will remove the current trend of tackling with the head as a weapon. All you lose are the slo-mo replays of hits that lift people into the air and popping off helmets etc.

Either way, it will be interesting to follow this case and see how it all plays out.

Barron’s has run a piece that essentially calls for a short-lived market rally on the basis of any outcome of the Greek elections:

Syriza, which finished in second place last month, will do well again. It held the momentum last month, but that has been checked. The left-leaning party that tapped into Greece’s anti-austerity feeling has softened some of its rhetoric – it no longer advocates leaving the euro – but outsiders worry about its suitability to govern.

Sort-term might well be the operative word. Certainly all eyes are currently on Greece, and Spain already is wobbling, and any poor result from Greece might well topple Spain, which means that Italy can’t be far behind.

The problem isn’t however all the problem children: what about Germany? The country that will as the various peripherals crash, increasingly come under pressure itself, as the loans made from German banks and the “State” increasingly become worthless?

Essentially it boils down to this: Germany produced goods and services that it exchanged for fiat currency. This fiat currency became converted to loans, which, allowed further purchases of German manufactures. At no point really were the purchases made from Germany exchanges of produced goods and services, as economic law stipulates, for if they are not, then they are, and can only be made by consumption loans.

At some point, those loans must be paid. Greece, Spain, Italy, Portugal, cannot pay those consumption loans. Which simply means that the losses must be absorbed by Germany, and to a lesser extent France and the rest of the world who hold Euro debt from the PIIGS.

So whatever the result of the Greek elections, nothing has changed. Until the PIIGS can produce goods and services, to exchange for other goods and services, the problem remains. The debt load, now so heavy, virtually precludes any investment in production of any description. The only way forward it seems is total default, or a large enough default to allow whatever meager capital remaining, to start again.

The blowback will be felt largely in Germany. The destruction of so much capital cannot but have an adverse effect. Currently German debt is at about 81% of GDP. That debt will be subjected to rising yields as the ability to service that debt comes under pressure from the unfolding crisis. Currently German yields are the lowest in Europe.

Germany simply cannot leave and revert to the DM, the time for that is long past: to do so would require that the PIIGS be able to make good on their Euro liabilities to Germany, which clearly is not the case, thus the losses will need to be absorbed by Germany. However I do think that this [for Germany] is the best outcome, take the losses now. The losses can only grow if Germany remains in the Euro as Europe uses a bank clearing system called TARGET. TARGET essentially balances the trade surpluses/deficits around Europe. Every time a PIIGS runs a trade deficit, Germany as a surplus, subsidises or loans the deficit nation the balance. Clearly, the longer Germany remains in the Euro, and in this clearing system, the larger [ever expanding] will be Germany’s ultimate loss.

Even leaving the Euro, and returning to the DM is not potentially the end of Germany’s woes. German GDP is very heavily dependent on exports. With an inability to pay for German exports, they must necessarily fall, or prices must fall, to allow payment. In both cases, German exports must fall, resulting in falling wages, unemployment, as German production reallocates from an export, to an internal consumption production, which doesn’t just happen overnight. Added to the capital losses already incurred, Germany will experience an economic downturn.

This will, as we are already seeing, drive an increased popularity and move to the political extremes. France has just elected an outright Socialist, who is totally clueless economically, and thinks that endless printing will solve the crisis. Greece is flirting currently with a choice between extremism and “mainstream.” Not that mainstream have anything to offer, it was after all these clowns that got us to this point in the first place: it just seems that crisis brings a change for the worse.

The interesting thing is why is this the case? Largely because doing the right thing is unpalatable. It means sacrifice and hardship. Recession/Depression is the outcome of the totally unhinged credit expansion that has engulfed the world. That is not a popular message. Socialists and at the extremes of that ideology Communism/Fascism, simply lie. Their lies contend that there is a free lunch. That all can be fixed without pain. That someone [point a finger] is to blame.

Unfortunately, even though this debacle has been running for five years already, the end is not even remotely in sight. The worst is yet to come. Until the debt overhang is removed, the depressed economic climate will predominate. You can default en mass, and take the pain all at once, or as the US is trying, you default on some transparently, you default on more via inflation, and you actually try and pay on some. This prolongs the pain, and the adjustments. A fast default might see us out of the worst in 2/3 years, maybe, if we’re lucky slightly less. The slow-motion method, we have another 10yrs of this drivel.

Custom Rosewood Fender Telecaster
Notable owner: George Harrison
Price at auction: $434,750

When Fender wanted to add a solid-body Rosewood Telecaster to its catalogue, it shipped a custom prototype to Harrison in December 1968 — flown to England in its own seat next to a courier — in hopes that it would jump-start sales. When Harrison played it in the famous impromptu concert on the roof of the Apple studio the next January, the guitar became an instant icon. A year later, Harrison gifted the guitar to the singer/songwriter Delaney Bramlett, who sold the guitar in 2004 at an auction at Juliens for nearly half a million dollars.

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