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Guest Post: Shale Gas Will Be The Next Bubble To Pop


Submitted by James Stafford of OilPrice.com,

The “shale revolution” has been grabbing a great deal of headlines for some time now. A favourite topic of investors, sector commentators and analysts – many of whom claim we are about to enter a new energy era with cheap and abundant shale gas leading the charge. But on closer examination the incredible claims and figures behind many of the plays just don’t add up. To help us to look past the hype and take a critical look at whether shale really is the golden goose many believe it to be or just another over-hyped bubble that is about to pop, we were fortunate to speak with energy expert Arthur Berman.

Arthur is a geological consultant with thirty-four years of experience in petroleum exploration and production. He is currently consulting for several E&P companies and capital groups in the energy sector. He frequently gives keynote addresses for investment conferences and is interviewed about energy topics on television, radio, and national print and web publications including CNBC, CNN, Platt’s Energy Week, BNN, Bloomberg, Platt’s, Financial Times, and New York Times. You can find out more about Arthur by visiting his website: <span style="color: #0000ff;”>http://petroleumtruthreport.blogspot.com

In the interview Arthur talks about:

•         Why shale gas will be the next bubble to pop
•         Why Japan can’t afford to abandon nuclear power
•         Why the United States shouldn’t turn its back on Canada’s tar sands
•         Why renewables won’t make a meaningful impact for many years
•         Why the shale boom will not have a big impact on foreign policy
•         Why Romney and Obama know next to nothing about fossil fuel energy

Interview conducted by James Stafford of Oilprice.com

Oilprice.com: How do you see the shale boom impacting U.S. foreign policy?

Arthur Berman: Well, not very much is my simple answer.

A lot of investors from other parts of the world, particularly the oil-rich parts have been making somewhat high-risk investments in the United States for many years and, for a long time, those investments were in real estate.

Now these people have shifted their focus and are putting cash into shale. There are two important things going on here, one is that the capital isn’t going to last forever, especially since shale gas is a commercial failure. Shale gas has lost hundreds of billions of dollars and investors will not keep on pumping money into something that doesn’t generate a return.

The second thing that nobody thinks very much about is the decline rates shale reservoirs experience. Well, I’ve looked at this. The decline rates are incredibly high. In the Eagleford shale, which is supposed to be the mother of all shale oil plays, the annual decline rate is higher than 42%.

They’re going to have to drill hundreds, almost 1000 wells in the Eagleford shale, every year, to keep production flat. Just for one play, we’re talking about $10 or $12 billion a year just to replace supply. I add all these things up and it starts to approach the amount of money needed to bail out the banking industry. Where is that money going to come from? Do you see what I’m saying?

Oilprice.com: You’ve been noted suggesting that shale gas will be the next bubble to collapse. How do you think this will occur and what will the effects be?

Arthur Berman: Well, it depends, as with all collapses, on how quickly the collapse occurs. I guess the worst-case scenario would be that several large companies find themselves in financial distress.

Chesapeake Energy recently had a very close call. They had to sell, I don’t know how many, billions of dollars worth of assets just to maintain paying their obligations, and that’s the kind of scenario I’m talking about. You may have a couple of big bankruptcies or takeovers and everybody pulls back, all the money evaporates, all the capital goes away. That’s the worst-case scenario.

Oilprice.com: Energy became a big part of the election race, but what did you make of the energy policies and promises that were being made by both candidates?

Arthur Berman: Mitt Romney, particularly, talked about how the United States would be able to achieve energy independence in five years. Well, that’s garbage.

Anybody who knows anything about oil, gas and coal, knows that that’s absurd. We were producing a little over 6 million barrels a day thanks to an all-out effort in the shale oil play. We consume 15 million barrels of oil a day and that leaves the gap of 9 million barrels per day. At the peak of U.S. production, in 1970, the U.S. produced 10.6 million barrels per day. Like I said, either the guy doesn’t know what he’s talking about, or is making a big joke of it.

Obama didn’t talk so much . . . He’s a hugely green agenda kind of president and I’m not opposed to that, but he’s certainly not for the oil and gas business. It wasn’t until he got serious about thinking about his re-election that he decided to take credit for what really happened.

Oilprice.com: Japan recently announced that they are going to be phasing out nuclear power. What are your views on nuclear? Are we in a position to abandon this energy source?

Arthur Berman: No. Japan is a special case. The disaster at Fukushima, the nuclear reactor, was right on top of a major fault. So, that was a dumb place to put it.

To wholesale abandon nuclear power because one reactor was incredibly stupidly planned, to me seems like a bit of a . . . well, I can’t tell people how they should react, but if I were a Japanese citizen, and the truth was that we have no oil, we have no coal, we have no natural gas, the next question is, “Well, if we get rid of nuclear, what are we going to do?”

It’s a really good question to ask. If you don’t have anything of your own, how are you going to get what you need? The answer is that they have to import LNG and that’s very expensive.

Right now, natural gas is selling in Japan for $17 per million BTUs. You can buy the same BTUs in Europe for $9 today, or in the US for $3.25

Oilprice.com: What about Germany’s decision to also phase out nuclear power?

Arthur Berman: For Germany to abandon nuclear… that decision is truly delusional because they haven’t had any problems over there. Nor is Germany particularly earthquake prone or tsunami prone. They have forced themselves into a love relationship with Russia.

Oilprice.com: What are your views on Canada’s tar sands? Are they a rich source of oil that the U.S. needs to exploit? Or do you think they’re a carbon bomb, which could do irreparable damage to the climate?

Arthur Berman: Well, that’s a very good question. I suppose they’re both, as are virtually all things that burn. Right? They’re a very rich source of oil. And they’re dirty. It requires a lot of natural gas heating to convert them into some usable form, a lot of processing, but here’s the thing, if the United States doesn’t buy that oil from Canada, do you think Canada’s just going to say, “Oh. Okay. Nevermind. We’ll forget about all this.”

No. They’re going to sell it somewhere else. They’ll probably sell it to Asia. So, the issue of the carbon bomb doesn’t get resolved by the United States not taking the oil.

So, to me, that’s off the table. Yes. I think it’s an incredibly sensible play to get your oil from a neighbour, and a neighbour who you trust, and it doesn’t require overseas transport and probably getting involved in periodic revolutions and civil uprisings.

Oilprice.com: Is there any technology, any development you see coming in the future that can help us get where we need to be? Is conservation really the only answer or do you have any hopes for some of the alternative energy technologies, such as solar or, even, some of these more advanced technologies such as Andrea Rossi’s E-cat machine?

Arthur Berman: Oh. I have all the enthusiasm for technology that you could ask for. I’m a scientist and I love technology but I heard a very good presentation several years ago on your exact question and the man who gave a talk said, “I’m going to give you a rule to live by. If it’s not on the shelf today, then a solution is no sooner than ten years in the future.” So, when you talk about E-cat and you talk about algae and all this kind of stuff, it’s not on the shelf today. So, that means it’s in some sort of pilot stage of testing.

Work harder guys. Work harder and faster because you’ve got a lot of work to do. So, yes, I’m enthusiastic. I think there are some great ideas out there but I don’t see any of them helping us in the coming five to ten-year period.

Oilprice.com: Environmentalists talk about the evil of fossil fuels, but have they really done their research to see how vital it is to pretty much everything that we base our modern lives upon?

Arthur Berman: Well, that’s exactly right. My oldest son and his family until recently lived in California, and in California people think electricity comes from the wall. They don’t have any idea that most of their electricity comes from horrible coal-fired power plants in New Mexico and Arizona. As long as they don’t have to see it, they don’t have a problem.

But, in this world, and in this life, we’re all connected and if you see something you don’t like, there’s a good possibility that whatever they’re doing there has something to do with something you’re using. So, this is an issue.

Oilprice.com: Arthur, thank you for taking the time to speak with us. For those readers who may be interested in contacting Arthur please take a moment to visit his website: http://petroleumtruthreport.blogspot.com/

Spain Begs Former Colonies For Bailout


Irony of ironies. While the world awaits the Spanish request for ‘help’ from its friends in Europe (which the market ‘hopes’ will escalate to EUR740bn very rapidly), it seems the King of Spain and his trusty Prime Minister have another cunning ‘inverse-conquistador’ plan. AP reports that “Spain receives Latin American investment with open arms,” as Rajoy asks the former LatAm colonies to help. Falling back on the assured quid pro quo, Rajoy said Spain had invested heavily in Latin America during its crisis 10 years ago… so fair’s fair right? Now that the roles were reversed, he called upon those nations to increase their participation in his struggling empire’s economy. The perfect irony is complete as the Iberoamerican Summit at which he was begging speaking was held in Cadiz – the country’s main gateway for importing Aztec and Inca treasure!

 

Via AP:

CADIZ, Spain (AP) — Spain’s prime minister on Saturday joined its king in asking former Latin American colonies to help the EU nation overcome a deep financial crisis by channeling investments its way.

 

Prime Minister Mariano Rajoy said Spain had invested heavily in Latin America when it suffered a crisis 10 years ago, and now that the roles were reversed, he called upon those nations to increase their participation in his country’s economy.

 

“Spain receives Latin American investment with open arms,” he said.

 

Rajoy was speaking at the Iberoamerican summit being held in Spain’s southwestern port of Cadiz, once the country’s gateway for importing Aztec and Inca treasure.

 

King Juan Carlos made the same plea Friday, saying “our eyes turn to you, we need more Latin America.”

 

He added that Spain had “seen difficult situations emerge caused by the financial and economic crisis.”

 

Guest Post: So How Many Ounces Of Gold (Or Silver) Should You Own?


Submitted by Adam Taggart of Peak Prosperity,

This week, Chris talks with Jeff Clark, Senior Precious Metals Analyst at Casey Research, where he serves as editor of their Big Gold newsletter.

They tackle head-on many of the questions weary precious metals investors are wondering after enduing the volatile yet range-bound price action of gold and silver over the past year:

  • Have the fundamentals for owning gold & silver changed over the past year? No
  • What are they? currency devaluation/crisis, supply-chain risk, ore grade depletion
  • How should retail investors own gold? Mostly physical metal, some quality mining majors (avoid the indices), and ETFs only for trading
  • Is gold in a bubble? No
  • Could gold get re-monetized? Quite possibly
  • Where is gold flowing? From the West to the East. At some point, capital controls will be put in place

What the politicians are doing is the exact opposite of what they need to be doing. We continue adding to our debt, we continue raising the debt ceiling, we continue deficit spending, we continue borrowing money, and, of course, we continue printing money. We are doing the exact opposite of all the things that would lead us away from inflation. So yes, I think that is an important point.

 

I will add that inflation has occurred very quickly, very rapidly, very suddenly many times in the past, just in recent history. If you look back at the high inflationary times, just in the past 100 years here in the U.S., many of those that hit 12%, 14%, 15% — two years prior to then, the CPI was completely benign. It was 1%, 2% – I think at one point it was 4% – and then all of a sudden within 24 months, it was 12%, 14%. So it can happen very suddenly, and my fear is that is what is going to happen this time. People are in a lull; no one is expecting it: the CPI is low; nothing is really happening with all this money printing; there has been no fallout. But I think that is the critical point. You cannot do these kinds of things we are doing forever and not experience any consequences. Sooner or later there are going to be consequences to what we are doing, and my fear is that it is going to be nasty, catch a lot of people off guard, and really hurt our society. The bottom line for me is, that is why I am buying gold and silver, still, to this day.

For these reasons and others, Jeff strongly believes everyone should have exposure to gold and silver as a defense for preserving the purchasing power of their weath. The key question is: how much exposure?

You want to focus on how many ounces you own, not necessarily looking at whether the price is $5 higher today than it was yesterday. How many ounces do you own? That is really the question you want to ask yourself, so you can focus on how much you are really going to need, and the amount really comes down to this.

 

For me, I am probably going to use some of this gold if we get high inflation. How are you going to protect your standard of living if we get some kind of runaway inflation? And let’s say it's not runaway hyperinflation; let’s just say it's high inflation, 10%, 15%. Remember it was 14% in 1980, so the odds of us getting high inflation are realistic. So if I am going to use that gold to cover my standard of living, you are going to need about two thirds of an ounce of gold for every thousand dollars of monthly expenses. If you want to protect your standard of living and not have your house be ravaged by inflation, so to speak, so that is a good guideline to follow.

 

So if inflation lasts a couple years, well, you are going to need 15 ounces of gold for every thousand dollars of monthly expenses. That is a good guideline to think about. And if your expenses are more per month, you are going to need more gold than that. If inflation lasts longer than two years, you are going to need more than that, but you can actually use the sales of gold and silver to protect your standard of living. You sell some gold and silver, you are going to get U.S. dollars or Canadian dollars with it and you can use the increase in the gold and silver price to offset the increase in the goods and services you are buying.

 

So I think that is the way to view it, to look at how you are going to use it. And so the focus again comes back to how many ounces do you own? So if you do not have any, you need to obviously start buying. 

Here are two tables — one for gold and the other for silver — Jeff offers in his newsletter to help investors calculate the requisite ounces needed to protect against rising inflation over time:

The point here is that you're probably going to need more ounces than you think. Look at your bank statement and assess how much you spend each month – and do it honestly.

 

The other part of the equation is how long we'll need to use gold and silver to cover those expenses. The potential duration of high inflation will dictate how much physical bullion we need stashed away. This is also probably longer than you think; in Weimar Germany, high inflation lasted two years – and then hyperinflation hit and lasted another two. Four years of high inflation. That's not kindling – that's a wildfire roaring through your back yard.

 

So here's how much gold you'll need, depending on your monthly expenses and how long high inflation lasts.

 

Ounces of Gold Needed to Meet Expenses During High Inflation
Monthly expenses in US dollars Monthly expenses in gold, oz* Inflation Duration
6 months  1 year  18 months 2 years 3 years 4 years 5 years 
$500
0.31
1.9
3.7
5.6
7.5
11.2
15.0
18.7
$1,000
0.63
3.8
7.5
11.3
15.0
22.5
30.0
37.5
$2,000
1.25
7.5
15.0
22.5
30.0
45.0
60.0
75.0
$3,000
1.88
11.3
22.5
33.8
45.0
67.5
90.0
112.5
$4,000
2.50
15.0
30.0
45.0
60.0
90.0
120.0
150.0
$5,000
3.13
18.8
37.5
56.3
75.0
112.5
150.0
187.5
$10,000
6.25
37.5
75.0
112.5
150.0
225.0
300.0
375.0
$20,000
12.50
75.0
150.0
225.0
300.0
450.0
600.0
750.0
*Based on $1,600 gold price

 

If my monthly expenses are about $3,000/month, I need 45 ounces to cover two years of high inflation, and 90 if it lasts four years. Those already well off should use the bottom rows of the table. How much will you need?

 

Of course many of us own silver, too. Here's how many ounces we'd need, if we saved in silver.

 

Ounces of Silver Needed to Meet Expenses During High Inflation
Monthly expenses in US dollars Monthly expenses in silver, oz* Inflation Duration
6 months  1 year  18 months 2 years 3 years 4 years 5 years 
$500
17.9
107.1
214.2
321.3
428.4
642.6
856.8
1,071.0
$1,000
35.7
214.3
428.5
642.8
857.0
1,285.6
1,714.1
2,142.6
$2,000
71.4
428.5
857.0
1,285.6
1,714.1
2,571.1
3,428.2
4,285.2
$3,000
107.1
642.8
1,285.7
1,928.5
2,571.4
3,857.0
5,142.7
6,428.4
$4,000
142.9
857.1
1,714.2
2,571.3
3,428.4
5,142.6
6,856.8
8,571.0
$5,000
178.6
1,071.4
2,142.8
3,214.3
4,285.7
6,428.5
8,571.4
10,714.2
$10,000
357.1
2,142.6
4,285.0
6,427.8
8,570.4
1,2855.6
17,140.8
21,426.0
$20,000
714.3
4,285.7
8,571.4
12,857.0
17,142.7
25,714.1
34,285.4
42,856.8
*Based on $28 silver price

 

A $3,000 monthly budget needs 1,285 ounces to get through one year, or 3,857 ounces for three years.

 

I know these amounts probably sound like a lot. But here's the thing: if you don't save now in gold and silver, you're going to spend a whole lot more later. What I've outlined here is exactly what gold and silver are for: to protect your purchasing power, your standard of living. 

Jeff discusses the Hard Assets Alliance as a solution worth considering when purchasing bullion. For more information on the HAA can be found here. 

Click the play button below to listen to Chris' interview with Jeff Clark (46m:01s):

 

Putin and Merkel Tango in Moscow, Gazprom Stirs Up Old Ghosts, But Deals Are Signed


Wolf Richter   www.testosteronepit.com   www.amazon.com/author/wolfrichter

Last week, the German Parliament passed a resolution that asked Chancellor Angela Merkel to needle Russian President Vladimir Putin about the resurgence of repressive, antidemocratic tendencies in Russia. It did not go unnoticed at the Kremlin. And it paved the way, so to speak, for her trip to Moscow on Friday—to re-cement their “strategic partnership.”

Complaints about the resolution filtered back to the point where Foreign Minister Guido Westerwelle, just before departing for Moscow, warned his countrymen not to overdo their criticism of Russia. It’s in the interests of Germany, he mused, to expand the “strategic partnership”; Russia was needed as a geopolitical and economic partner.

Indeed. Merkel arrived in Moscow with her entourage that included eight ministers and corporate chieftains by the planeload—she doesn’t leave home without them. With Merkel and Putin looking on, these chieftains and their Russian counterparts signed contracts for billions of euros, a ritual that German chancellors have to perform when abroad. It’s part of Germany’s mercantilist foreign policy. Siemens CEO Peter Löscher bagged perhaps the biggest deal, a declaration of intent to deliver 695 electric locomotives for €2.5 billion ($3.2 billion) to Russian Railways (RZD), an elephantine state-owned company with 950,000 employees.

That’s what really mattered. Criticism of Russia—carefully calibrated and range-bound—would be for consumption at home, where anti-Russian sentiment has been rising. With elections coming up next year, Merkel, the consummate political animal, is treading a fine line: deliver a bland rebuke that would barely satisfy voters in Germany and help arrange deals that would fully satisfy German industry.

The initial meeting was at the concluding session of the annual Petersburg Dialogue, a four-day forum, this year titled ominously, “Russia and Germany: the Information Society Facing the Challenges of the 21st Century.” So the first question from the audience was posed by a Russian participant: what about the recent deterioration in the Russian-German relationship—a reference to the resolution—and its consequences on economic cooperation?

A government had to be able to digest criticism, Merkel said in response. Yes, some of the recent laws the State Duma had passed “irritated” her. “I cannot see that they further freedom,” she said. “We ask ourselves if that is good for the development of Russian society or not.” But that didn’t change the intense relationship between both countries. “If I were offended every time I opened the paper at home, I couldn’t be chancellor for three days,” she said. Putin smiled.

It kicked off a bizarre tangle of questions and answers, comments, attacks, and counterattacks, fact-based or not, that carried over into a panel discussion and press conference. Putin claimed that Germany had been criticized by human rights groups because some of its states didn’t have laws for the protection of information. Which baffled attendees. And about Merkel’s statement—incomprehensible, given current conditions—that Europe always tried to speak with one voice, Putin retorted: “That’s called a cartel.” Even the Pussy Riot case came up.

A representative from Gazprom, the giant state-owned Russian natural gas company without which no German-Russian meeting is complete, and on which Germany depends for much of its natural gas, complained about the “gloomy atmosphere” in the relations between both countries that was hindering making deals.

The meeting was a far cry from when Gerhard Schröder was still Chancellor. He’d raised the “strategic partnership” to new heights through his close personal and political relationship with Putin. For example in November 2004, he described Putin as a “flawless democrat,” which stirred up a ruckus even in Germany. He also championed the Nord Stream gas pipeline that would pump gas from Russia directly to Germany via the Baltic Sea, without crossing other countries, a very costly project. Gazprom controlled the Nord Stream consortium. A deal was signed in October 2005. It included a loan guarantee by the German government of €1 billion. That’s how close German-Russians relations were.

On November 22, 2005, Schröder got kicked out of office. Days later, Gazprom appointed him Chairman of Nord Stream AG, causing another ruckus in Germany; it was clear what his intentions had been all along, now that he was on the lavish payroll of the Russian government. Turns out, the Baltic pipeline would allow Russia to cut off gas to countries its other pipelines crossed on their way to Germany, while still supplying Germany—a powerful political weapon against those countries. The “strategic partnership” had made it possible.

Gazprom is deeply involved in the rest of Europe as well. For example, why would France suddenly prohibit shale gas exploration? Sure, there are environmental issues. But French governments have had, let’s say, an uneasy relationship with environmentalists. Its spy service DGSE, sank Greenpeace’s flagship, the Rainbow Warrior, killing one person. No, there must have been another reason. Read… Russia’s Gazprom Tightens Its Stranglehold On Europe: The Natural Gas War Gets Dirty.

With the euro debt crisis came absurdities. Now the currency is creating artificial problems between peoples. And by being “irreversible,” as ECB President Mario Draghi had said, it has become a curse—and a religious dictum that must not be questioned regardless of how much havoc it may ultimately wreak. Read…  The Curse Of The “Irreversible” Euro.

Kyle Bass: Fallacies Such As MMT Are "Leading The Sheep To Slaughter" And "We Believe War Is Inevitable"


Below are some of the key highlights from Kyle Bass’ latest, and as usual, must read letter:

On central banks and the final round of global monetary debasement:

Central bankers are feverishly attempting to create their own new world: a utopia in which debts are never restructured, and there are no consequences for fiscal profligacy, i.e. no atonement for prior sins. They have created Potemkin villages on a Jurassic scale. The sum total of the volatility they are attempting to suppress will be less than the eventual volatility encountered when their schemes stop working. Most refer to comments like this as heresy against the orthodoxy of economic thought. We have a hard time understanding how the current situation ends any way other than a massive loss of wealth and purchasing power through default, inflation or both.

 

In the Keynesian bible (The General Theory of Employment, Interest and Money), there is a very interesting tidbit of Keynes’ conscience in the last chapter titled “Concluding Notes” from page 376:

 

[I]t would mean the euthanasia of the rentier, and, consequently, the euthanasia of the cumulative oppressive power of the capitalist to exploit the scarcity value of capital. Interest today rewards no genuine sacrifice, any more than does the rent of land. The owner of capital can obtain interest because capital is scarce, just as the owner of land can obtain rent because land is scarce. But whilst there may be intrinsic reasons for the scarcity of land, there are no intrinsic reasons for the scarcity of capital.

 

. . .

Thus we might aim in practice (there being nothing in this which is unattainable) at an increase in capital until it ceases to be scarce, so that the functionless investor will no longer receive a bonus[.] (emphasis added)

This is nothing more than a chilling prescription for the destruction of wealth through the dilution of capital by monetary authorities.

 

Central banks have become the great enablers of fiscal profligacy. They have removed the proverbial policemen from the bond market highway. If central banks purchase the entirety of incremental bond issuance used to finance fiscal deficits, the checks and balances of “normal” market interest rates are obscured or even eliminated altogether. This market phenomenon does nothing to encourage the body politic to take their foot off the spending accelerator. It is both our primary fear and unfortunately our prediction that this quixotic path of spending and printing will continue ad?infinitum until real cost?push inflation manifests itself. We won’t get into the MV=PQ argument here as the reality of the situation is the fact that the V is the “solve?for” variable, which is at best a concurrent or lagging indicator. Given the enormity of the existing government debt stock, it will not be possible to control the very inflation that the market is currently hoping for. As each 100 basis points in cost of capital costs the US federal government over $150 billion, the US simply cannot afford for another Paul Volcker to raise rates and contain inflation once it begins.

Hayek was, of course, right:

The current modus operandi by central banks and sovereign governments threatens to take us down Friedrich von Hayek’s “Road to Serfdom”. Published in 1944, its message, that all forms of socialism and economic planning lead inescapably to tyranny, might prove to have been prescient. In the 1970s, when Keynesianism was brought to crisis, politicians were vociferously declaring that attempting to maintain employment through inflationary means would inevitably destroy the market economy and replace it with a communist or some other totalitarian system which is the “perilous road” to be avoided “at any price”. The genius in the book was the argument that serfdom would not be brought about by evil men like Stalin or Hitler, but by the cumulative effect of the wishes and actions of good men and women, each of whose interventions could be easily justified by immediate needs. We advocate social liberalism, but we also need to get there through fiscal responsibility. Pushing for inflation at this moment in time will wreak havoc on those countries whose cumulative debt stocks represent multiples of central government tax revenue.

 

The non?linearity of expenses versus revenues is what will bring them down.

“Pavlov’s Party” is ending, and when it does, it will happen so fast no reaction will be possible:

Through travel and meetings around the world, it has become clear to us that most investors possess a heavily anchored bias that has been engrained in their belief systems mostly through inductive reasoning. Using one of the Nobel Laureate Daniel Khaneman’s theories, participants fall under an availability heuristic whereby they are able to process information using only variables that are products of recent data sets or events. Let’s face it – the brevity of financial memory is shorter than the half?life of a Japanese finance minister.

 

Humans are optimistic by nature. People’s lives are driven by hopes and dreams which are all second derivatives of their innate optimism. Humans also suffer from optimistic biases driven by the first inalienable right of human nature which is self?preservation. It is this reflex mechanism in our cognitive pathways that makes difficult situations hard to reflect and opine on. These biases are extended to economic choices and events. The fact that developed nation sovereign defaults don’t advance anyone’s self?interest makes the logical outcome so difficult to accept. The inherent negativity associated with sovereign defaults brings us to such difficult (but logical) conclusions that it is widely thought that the powers that be cannot and will not allow it to happen. The primary difficulty with this train of thought is the bias that most investors have for the baseline facts: they tend to believe that the central bankers, politicians, and other governmental agencies are omnipotent due to their success in averting a financial meltdown in 2009.

 

The overarching belief is that there will always be someone or something there to act as the safety net. The safety nets worked so well recently that investors now trust they will be underneath them adinfinitum. Markets and economists alike now believe that quantitative easing (“QE”) will always “work” by flooding the market with relatively costless capital. When the only tool a central bank possesses is a hammer, everything looks like a nail. In our opinion, QE just doesn’t stimulate private credit demand and consumption in an economy where total credit market debt to GDP already  exceeds 300%. The UK is the poster child for the abject failure of QE. The Bank of England has purchased over 27% of gross government debt (vs. 12% in the US). UK bond yields have all but gone negative and are now negative in real terms by at least ?1%. Unlimited QE and the zero lower bound (“ZLB”) are likely to bankrupt pension funds whose expected returns happen to be a good 600 basis points (or more) higher than the 10?year “risk?free” rate. The ZLB has many unintended consequences that are impossible to ignore.

 

Despite reading through Keynes’ works, we didn’t find a single index referencing the ZLB or any similar concept. In his General Theory, there are 64 entries in the index under “Interest” but no entry for the ZLB, zero rates, or even “really low rates”.

 

Our belief is that markets will eventually take these matters out of the hands of the central bankers. These events will happen with such rapidity that policy makers won’t be able to react fast enough.

On the lunacy of such “modern” “economic” “theories” as MMT (which may or may not stand for “Magic Money Trees”)

The fallacy of the belief that countries that print their own currency are immune to sovereign crisis will be disproven in the coming months and years. Those that treat this belief as axiomatic will most likely be the biggest losers. A handful of investors and asset managers have recently discussed an emerging school of thought, which postulates that countries, as the sole manufacturer of their currency, can never become insolvent, and in this sense, governments are not dependent on credit markets to remain fiscally operational. It is precisely this line of thinking which will ultimately lead the sheep to slaughter.

The inevitable end of that supremely flawed monetarist experiment – the Eurozone:

Each subsequent “save” of the European debt crisis has been devised by the Eurocrats coming up with some new amalgamation of an entity that is more complex than its predecessor that is designed to project size, strength, and confidence to investors that the problem has been solved. Raoul, a friend of mine who resides in Spain, put it best:

 

“Let’s just clear this up again. The ECB is going to buy bonds of bankrupt banks just so the banks can buy more bonds from bankrupt governments. Meanwhile, just to prop this up the ESM will borrow money from bankrupt governments to buy the very bonds of those bankrupt governments.”

 

The EFSF, the IMF, the ESM, and the OMT (and who knows what other vehicles they will dream up next) have all been developed to serve as an optical backstop for investors globally. The Eurocrats are sticking with the Merkelavellian playbook of hiding behind the complexity of these various schemes. All one has to do is review the required contributions to said vehicles from bankrupt nations to realize that the circular references are already beginning to show in broad daylight. Does anyone stop to consider that the two largest contributors to the IMF are the two largest debtor nations in the world? Are things beginning to make sense now?

 

 

In the end, the EMU won’t look the same, if it exists at all.

And finally, a less than rosy outlook for the entire “developed” world.

Trillions of dollars of debts will be restructured and millions of financially prudent savers will lose large percentages of their real purchasing power at exactly the wrong time in their lives. Again, the world will not end, but the social fabric of the profligate nations will be stretched and in some cases torn. Sadly, looking back through economic history, all too often war is the manifestation of simple economic entropy played to its logical conclusion. We believe that war is an inevitable consequence of the current global economic situation.

All this and much more, including the usual detailed summary depicting the Japanese ultra slow-motion trainwreck (which is picking up speed as none other than Seiji Maehara, state minister for economic and fiscal policy, admitted yesterday when he said that “[The Japan economy] is in a dire state“) in the full letter below: