Category Archives: Economy and Meltdown

On The Hypocrisy Of Central Banks Removing Tail-Risk

Via Martin Sibileau of “View from the Trenches”,

One cannot but wonder at the idiocy blindness of those who sustain that both the European and the US central banks removed “tail risks” in the last days, with their new measures. To start, the whole idea that a tail risk exists is simply a fallacy of Keynesian economics. It assumes there is a universe of possible outcomes and, as if humans acted driven by animal spirits, randomly, each one of them has a likelihood of occurring. In all honesty… what else can occur if a central bank prints money to generate a bubble? Why would the bursting of the bubble be called a tail-risk, rather than the logical outcome? Why, if that was tried in 2001 in the US, resulting in the crisis of 2008… why would it be any different now, when there is an explicit announcement to print billions per month? Why?


…as if that was not clarifying enough, as an example of the chaos that the Fed and ECB’s actions have engendered on the world via uncertainty over risk-free rates – and the stunning realization that the global risk-free rate curve is now split between Europe (ST) and US (LT)…

With the European Central Bank backstopping short-term EU sovereign debt (as long as the issuer submits to a fiscal adjustment program), we should see two trends taking place:


The first one, mentioned in our last letter, is that the market should arbitrage between the rates of core Europe and its periphery, converging into a single Euro zone target yield. The Italian auction mentioned above, together with continuous weakness in Germany’s sovereign debt, the movement of capital out of the US dollar to the Euro zone (lifting the Euro to $1.31) and the rally in EU banks, would seem to indicate that this convergence is slowly materializing. The critical piece here, the one that will really nail this coffin, is the return of deposits transferred to the core of the Euro zone, back to the periphery that originated them. This is what’s behind the ongoing negotiations towards a banking union. Ironically, if the banking union was successful, making deposits return to banks of the periphery, it would make it easier for the Germans to leave the Euro zone, because the current imbalances of the Target 2 system would disappear, radically lowering the cost of the exit!


The second trend, the one we missed last week, consists in that –perhaps- we will no longer be able to talk about “the” risk-free rate of interest, when we refer to the US sovereign yield. If the first trend proves true, there would be no reason to believe that the short-term US sovereign yield should keep as low as it is vs. the equivalent EU sovereign yield. For all practical purposes, in the segment of up-to-3 years, the European Central Bank would set the value of the world’s risk-free rate! The big assumption here is of course, that the first trend, above, holds true. Only then, the arbitrage between the US sovereign yield and the EU sovereign yield could be triggered.


What would the levels be, for the up-to-3 year yields? As we know, the European Central Bank will not pre-commit to a yield target. Of course, they don’t want to be challenged, because there is only so much they can sterilize before they start suffering a net interest loss, as we explained last week. But from a dynamic perspective, what counts is not the level, but the driver: In the long run, as the sterilization fails (also explained in our last letter and first proposed back on May 13th, 2010), the short-term “risk-free” rate of interest would be driven by the consolidated fiscal deficit of the Euro zone.

Having said this, the remaining question is what determines the value of the long-term risk-free rate of interest. The Fed, in our view, although not announced last Thursday, will eventually continue to purchase long-term US sovereign debt. Effectively in the beginning, the Fed would set the value of the risk-free yield curve, past the three-year point. When things get out of control and inflation expectations for the US dollar take the lead (in a few years), the fiscal deficit of the US should determine the dynamics of the long-end of the curve….Does that make sense? No! (At least not, if you are not Keynesian) Because if “things get out of control”, we must say good bye to long-term interest rates altogether. That market will evaporate, and the US will only be able to sell short-term debt.

At that point, if the Euro zone still exists as we know it, the battle for the ownership of the risk free rate will have been won by the European Central Bank, by definition. Why? Because by definition, if the Euro zone still exists, it is because they succeeded in stabilizing their fiscal problems. Otherwise, the shortening of the term horizon for the US sovereign yield should continue contracting, until hyperinflation completely wipes it out.

Spain is Greece… Only Bigger and Worse



Swing by for more market commentary, investment strategies, and several FREE reports devoted to help you navigate the coming economic and capital market changes safely.


As I’ve outlined in earlier articles, Spain will be the straw that breaks the EU’s back. The country’s private Debt to GDP is above 300%. Spanish banks are loaded with toxic debts courtesy of a housing bubble that makes the US’s look like a small bump in comparison. And the Spanish government is bankrupt as well.


Indeed, in the last month alone we’ve seen:


  1. Spain’s banking system saw a bank run to the tune of €70 billion in August. The market cap for all of Spain’s banks is just €114 billion. So Spanish banks need to raise at least €20+ billion or so per month in the coming months to stay afloat. This is without depositors pulling additional funds in September onwards. That’s really bad news.


  1. Spain’s now nationalized Bankia just took another €5.4 billion from Spain’s in-country rescue fund. This indicates that once nationalized, problem banks DO NOT cease to be problems.


  1. The region of Andalusia is requesting a bailout from the Spanish Federal Government. This comes on the heels of bailout requests from the regions of Valencia, Murcia and Catalonia (none of which want any “conditions” on the funds).


  1. Spain has set aside €18 billion to bailout its regions. The current bailout requests already amount to €10.8 billion. That’s just from this year alone.


If you need more info on Spain, the bullet items from them that you need to know are that:


  1. A huge portion of Spain’s banking system (representing over 50% of mortgage loans AND deposits) was totally unregulated up until just a few years ago.
  2. Spanish banks were drawing €337 billion from the ECB on a monthly basis to fund their liquidity needs.
  3. Every political figure and bank in Spain is HIGHLY incentivized to lie about the true nature of the Spanish banking system (a private text message from the Prime Minister claimed the REAL capital needs were closer to €500 billion… which is assuming he knows what he’s talking about/ the banks were honest with him… which I HIGHLY doubt).


Indeed, the markets are beginning to figure out the Spain is DONE regardless of what the ECB does. The truth is that Spain is in as bad a shape as Greece if not worse. Expect things to get very, very ugly soon.


The reason is two fold:


  1. Spanish banks need to roll over (meaning renew terms on) more than 20% of their bonds this year.
  2. Spanish sovereign bonds are collateral for hundreds of billions of Euros’ worth of trades.


With Spanish banks already under severe funding stress (again, they drew €337 billion from the ECB before the new OMT program… and depositors took €70 billion out of the system last month), they’re in no position to start paying out higher interest payments to bondholders.


And with investors realizing that Spain’s banks are all lying about the state of their balance sheets (remember, Bankia was talking about paying a dividend just one month before it collapsed and revised its €41 million 2011 profit to a €3.3 billion LOSS), we’re going to be seeing plenty of bank failures this year.


Remember, Spain’s initial request was for the EU to bail out its banks NOT the country itself. However, with some six Spanish regions (probably more) looking for bailouts Spain is now facing both a sovereign debt AND a banking crisis.


The timing of this issue will be difficult due to the ECB’s intervention, but at the end of the day, the math doesn’t add up. Spain has big problems and when the market figures out that the ECB cannot solve them… it’s going to be a very difficult time in Europe.


Swing by for more market commentary, investment strategies, and several FREE reports devoted to help you navigate the coming economic and capital market changes safely.


Good Investing!


Graham Summers







Postcards From A Furious China

Over the past 48 hours we have written much, describing the perfectly expected surge in nationalist fervor and anti-Japanese sentiment, as the Senkaku Islands Snafu hits its boiling point – a Japan whose GDP is now declining in real terms, whose economy has been crippled by years of deflation, whose infrastructure is impaired due to anti-nuclear power sentiment, and one which generally can not afford an all out diplomatic, political and economic conflict with China, and may thus ask itself: why escalate and just who prompted it do so now? A Japan whose economic status is best summarized with the following chart:

Instead we’ll let the pictures do the talking.

From brightonatreddit

Demonstrations in Changsha, Hunan

A store display in Nanjing bears the sign THE DIAOYU ISLANDS BELONG TO CHINA!.

A banner on a store called pattad reads: “pattad firmly defends China’s right to the Diaoyu Islands. / We will give a 15% discount to customers who yell THE DIAOYU ISLANDS BELONG TO CHINA! in the store / We will give a 20% discount to customers who yell JAPAN ALSO BELONGS TO CHINA!”

Demonstrations in China

Chinese protestors congregate outside the Japanese embassy in Beijing.

At an auto show, a Chinese brand car is draped in a PRC flag that reads PATRIOTIC SPENDING / BUY CHINESE GOODS.

Chinese flags outside a sushi restaurant.

A sushi restaurant in Suzhou is demolished by protestors.

Rioters in Qingdao demolish shops.


Rioters smash cars, burn buildings

Rioters smash cars, burn buildings


Protestors rally outside a Heiwado shop in Changsha, Hunan.


A pig wears a headband that resembles the Japanese flag

Rioters loot a Rolex store

Demonstrations in this location turn violent

A hair salon named “Korean-style Haircuts” hangs a banner that says JAPANESE AND DOGS NOT ALLOWED INSIDE


Demonstrators flanked by policemen

Protestors in Chaoshan hold up a sign that says GET OUT OF THE DIAOYU ISLANDS, JAPANESE DOGS

Japanese brand cars are overturned by rioters

A woman tries to stop rioters from demolishing her Japanese brand car

An unidentified building is set on fire

The sign in the foreground reads DEFEND DIAOYU ISLANDS TILL OUR DEATHS and FUCK JAPAN

A private company has rented a bus to drive around town bearing the messages THE DIAOYU ISLANDS BELONG TO CHINA and GET THE FUCK OUT OF DIAOYU, JAPAN

A woman discovers her Japanese brand car has been demolished

A display outside a Uniqlo shop

A Honda owner drove his car to the nearest Honda dealership and set it on fire; banners in the back read DEFEAT THE JAPANESE DEMONS

A Toyota dealership in Shanghai is set on fire

Demonstrators in Chongqing

Demonstrators in Nanjing


Demonstrations in Yunnan
And since there is still confusion over what all the hoopla is about, here is a map:
areas disputed in China, Japan, and Koreas
h/t John Aziz

The Chart Spain's Mariano Rajoy Wishes Could Be Swept Under The Rug

A week ago, after peripheral European bonds soared and yields plunged on more hype and more promises that the ECB may monetize debt on the one condition that insolvent countries hand over sovereignty to the Troika ala Greece, we were not all surprised to learn that “suddenly, nobody in Europe wants the ECB bailout.” And why should they? After all, The whole point of the gambit was to lower bond rates, which happened, which would allow insolvent government to stack even more debt courtesy of lower rates on top of record debt, taking the insanity of the old saying “fixing an insolvency problem with liquidity” one step further, and revising it to “fixing an insolvency problem with more insolvency.” Furthermore, if the mere threat of the ECB stepping in and crushing any shorts or supporting longs was enough, why even bother with actual intervention. Simple: even infinite monetary dilution has its limits. That limit is and always has been cash flow, because a central bank can only dilute wealth, never create it. And for Spain said limit is approaching fast.

Recall that as we calculated on September 3, Spain is rapidly running out of cash: its consolidated cash balance has plunged from over €50 billion in March to just over €20 billion in July and dropping at an alarming rate. The cause for this drop: a budget deficit that refuses to go away, and with ~25% unemployment, what the government does to the tax rate is irrelevant as the Laffer curve crosses into the twilight zone of the Laughter Curve.

Recall also that Goldman made it very clear that Rajoy has to request an ECB bailout last week, because while he may posture for political reasons knowing once he invites the Troika his political career is done, and such posturing will cause even greater conditionality to be ultimately imposed on Spain, the real gating issue is cash.

Enter the chart that Rajoy wishes did not exist: the net cash in/outflow into the Spanish treasury due to bond/interest activity.

As is quite obvious on the chart above, and explains Goldman’s urgency with a formal Spanish ECB activation request, the closer we get to October, the closer Spain gets to running out of cash. And in that particular case none of the currently implemented reality countermeasures will do anything to hide the fact that Europe’s emperor was naked from the very beginning.

The flowchart then becomes as follows:

1. Find out what the Spanish cash balance was as of August. If the economy indeed contracted far more than expected, which it likely did, this number should dip below €20 billion for the first time since August 2011.

2. The September number will not be known until a month later. However, it is safe to assume that it will not be a blockbuster cash surge.

3. If the total cash balance extrapolated going into October is close to the ~€15 billion needed to satisfy the Net Cash Requirement, watch out below, as “Plan Silvio” comes into play.

3.5. What is “Plan Silvio” you may ask? Simple – in November 2011, the ECB made it very clear it would no longer purchase Italian bonds as long as Berlusconi was in charge. In essence, this was the first act of the now totally political ECB, courtesy of its then-brand new president Mario Draghi, who had replaced JC Trichet days earlier. End result: Italian bonds soared to their post-Eurozone highs, and Silvio was promptly replaced with a Goldman technocrat. Just as was planned from the beginning.

4. Of course, Plan Silvio will be called Plan Mariano in its 2012 version. It will, however, manifest itself in identical terms to its prior iteration: a bond curve inversion which forces the current administration to do the biddings of the market. Should the Spanish bond curve, however, invert, it would mean that the 2 years will literally implode, as the matched yield will soar by 300-400 bps.

5. Next steps: in 2011, one firm that literally bet the farm that the ECB would not allow a curve inversion in Italy (it did), as a catalyst to replacing the current government, was everyone’s favorite client money vaporized: MF Global. Should Plan Mariano be a “go”, we can only wonder how many other hedge funds and prime brokers will suffer the MF Global fate, now that buying the Spanish short end is the “no brainer” trade of 2012.

Naturally, all of the above assumes that the Spanish economic contraction has continued, and its funding needs are over and above those budgeted at the beginning of the year when the Treasury bond issuance schedule was announced.

One thing we do know: the wall of worry is now officially gone courtesy of coordinated intervention between the ECB and the Fed, both of which have gone all in on the reflation trade. And with no wall of worry to be surmounted, everyone will now be on the same side of the trade. Hopefully, for “everyone’s” sake, the central planners are better equipped to dominate reality this time around, than they were back in 2006 when “subprime was contained.” Sadly, they never are. Which means that the current attempt at reflation will fail, only to be followed by yet another sharp deflationary crunch, which in turn will be followed by even more CTRL-P based reflation attempts, and so on, until finally one day, disgusted by the central-planners intention to defer the advent of reality at all costs, leading to record amplitudes in prices at ever increasing frequency, money itself, in its current form, will be overthrown by the same people who use it. Because every ponzi scheme lasts only as long as there is at least one more sucker.

It is at that point that the lunacy of the status quo will finally end. Seen in this light, we actually wish to thank the central planners for taking the steps they did in the past two weeks: they simply made the arrival of the final monetary phase transfer that much quicker.

The Fed’s Drugs Won’t Work Anymore

QE3. No QE3. The markets have been injected with this hopium for months and have been let down on every occasion except for this last one. The Fed’s issuance of this last round of quantitative easing has rendered future doses of this drug ineffective.

It was explicitly stated that the Fed would issue QE as needed in unlimited amounts until the market is able to create enough jobs to stimulate dramatic growth. This means that there will not likely be any future spikes in the market as a result of another QE announcement…the market no longer questions whether or not more drugs will come, now they expect them.

The Fed had been using “QE hype” to rally the markets. Every time we were on the verge of a collapse another QE announcement would be made bringing us a few feet back from the fiscal cliff. But that tactic wont work anymore…

The Fed’s actions are fiscally irresponsible and the U.S. will quickly suffer the consequences of this poor decision. If the economic change needed to return to growth is structural then a monetary fix, or QE, isn’t the remedy.

The U.S. Dollar is on the decline against other major currencies, and investors are losing confidence in the Fed’s ability to manage the ensuing risk of another recession. Question that remains, what happens when the QE drug gets taken away?

It’s time to hedge; if the value of the U.S. dollar collapses how will you respond? Diversification is key. Learn to manage your risk by looking a head; join the Forward Thinking waiting list now.

Your currency analyst,

Justin Burkhardt



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