Category Archives: Economy and Meltdown

Peregrine Financial CEO Indicted On 31 Charges

It only took 20 years, a trail of counterfeit documents, superficial and failed audits, dubious tax returns and one unsuccessful suicide attempt, but in the end they got him: the CEO of failed commodity brokerage Peregrine aka PFG, Russell Wasendorf has been indicted on 31 charges of lying to government regulators regarding the failed brokerage’s operations. He faces a maximum sentence of 155 years’ imprisonment on the charges and fines of about $7.75 million, according to a statement from the U.S. Attorney’s Office for the Northern District of Iowa. There is also that whole $215 million in commingled and subsequently stolen client money but that’s another matter. In other words, just like Bernie Madoff, Wasendorf is going away for a long, long time for doing precisely what everyone else does: the first one for engaging in a ponzi even as now everyone acknowledges the entire system is one big ponzi – does that make it better and legitimate: apparently so; the second one for commingling client cash for personal benefit. As a reminder, this is what JPM did with $350 billion in excess deposit cash as part of its London whale trading fiasco, and broadly what every bank in the post Glass-Steagall world does with the roughly $8 trillion in total US bank deposits.

More from the WSJ:

Mr. Wasendorf was arrested July 13 on charges of lying to regulators following a suicide attempt on July 9 that included a confession that authorities say detailed a nearly 20-year fraud against Peregrine’s customers. Regulators have estimated that about $215 million in customer money is missing.


Peregrine, which did business as PFGBest, filed for bankruptcy July 10.


No date has yet been set for Mr. Wasendorf to be arraigned on the charges, according to a statement from the U.S. Attorney’s Office.


A grand jury in Cedar Rapids, Iowa, on Peregrine took just one day to hear testimony and hand up the indictment against Mr. Wasendorf.

Is it good that Wasendorf is going away, most likely for the rest of his life? Of course- the man is a sociopathic criminal. But the problem is that the incentives, the controls, and the “processes” that PFG engaged in to cheat thousands of clients out of their life savings are pervasive throughout the US financial system. It is this, and not an individual appeals court case which incidentally has no impact on a completely standalone bankruptcy process and whose outcome can be appealed under any other jurisdiction, that US investors, or what’s left of them, should be worried about. Because it is the fundamental flaws in the US financial system which virtually assure that all capital currently residing with US banks as financial intermediaries will, sooner or later, in the parlance of MF Global, vaporize.

Sadly, and just like in the stock market, the cognitive bias that “it can’t happen to me” and that “I can always get out first” is dominant here as well. And will be, until both of these delusions are found to be 100% just that.

Finally we have one more thing to add: free Corzine! (who may or may not be found at the contact details for his home office).

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Guest Post: The Keys To Understanding The Collapse Of The Status Quo – Credibility And Expectations

Submitted by Charles Hugh Smith from Of Two Minds

The Keys To Understanding the Collapse of the Status Quo: Credibility and Expectations

When expectations are raised to impossible heights based on the promise of exponential financialization, the credibility of the Status Quo is doomed.

Data is important, but not all trends can be quantified. Longtime readers know that I value data and often use charts to explain the forces of transition/collapse. But there are profound dynamics that are not easily quantified, instances in which quantification may obscure our understanding.

Credibility and expectations are two such dynamics. Both credibility and expectations are very real forces, despite their status as inner states immune to direct measurement.

Beneath the surface of financial statistics, the real bedrock of any political and financial Status Quo is its credibility in the minds of its subjects. Once the people lose faith in the system, it will collapse under its own weight, a process I described in When Belief in the System Fades (March 12, 2008).

The corollary to this structural need for highly motivated, dedicated people to work the gears is that if their belief in the machine fades, then the machine grinds to a halt.

The loss of credibility in the European Union, China, Japan and the U.S. is now in full swing. Credibility is like a sand castle; every false promise, every half-truth, every simulacra “solution,” every secret deal, every surrender to vested interests, every politically expedient but ultimately disastrous “fix” removes a handful of sand from beneath the sand castle.

When enough sand has been removed, the castle collapses under its own weight.

The most interesting characteristic of this hollowing out process is the apparent stability of the Status Quo until the sudden “nobody saw it coming” collapse. In the current era, the Arab Spring is a regional example of this hollowing out of credibility; in the late 1980s, the process was exemplified by the “nobody saw it coming” implosion of the Soviet Empire. In 2007-08, the exposure of phantom wealth tracked a similar pathway, with apparently “solid” institutions imploding “unexpectedly.”

Can anyone seriously claim the European Union, the European Central Bank and its alphabet-soup programs still retain a shred of credibility? Every EU/ECB “save” is fictitious, every “fix” expedient, every promise empty, every face-saving summit a living lie.

Ultimately, all the posturing, promises and saves come down to an impossibility: “rescuing” phantom assets purchased with astounding levels of debt by issuing even more astounding levels of debt.

Does anyone truly believe this absurdity is anything more than a transparent fraud designed to extend the life of a failed, corrupt system constructed on fantasies and lies?

Those with assets are fleeing for less fantastic and dangerous climes. The handful of French millionaires who are supposed to magically bail out a failed-state that absorbs 55% of GDP are busy transferring their assets out of France, a mass exodus of capital that is also playing out in China, where those who embraced the slogan “to get rich is glorious” are transferring their wealth, ill-gotten or well-earned, overseas.

So vast is this outflow of wealth that for the first time the outflow of capital from China exceeds the inflow of investment capital. The smart money is exiting, and the last batch of credulous “China story” rubes are dumping their capital down a rathole.

The same process is visible in global stock markets, where the smart money is selling. The loss of credibility in the digital bucket shop known as the U.S. stock market is evidenced by the outflow of some $200 billion over the past few years. To some degree, this has been offset by the influx of foreign capital desperate to escape the black hole of the euro, but the steady erosion of faith in the U.S. stock market is striking: as noted last week, 80% of the trading is either invisible, officially sanctioned manipulation or computers trading.

If the U.S. legal system weren’t hopelessly compromised, the U.S. stock markets would be shuttered as corrupted beyond redemption.

Globally, the erosion of petrocapitalism (more on that later this week, via correspondent Ray W.) and the self-destruction sequence of financialization are laying waste to the credibility of politicos’ promises. It was so easy to be a politico when financialization (exponential expansion of debt and leverage) raised the global tide, lifting all boats; extravagant promises based on everlasting “growth” could be issued, votes bought and the vested interests of crony-capitalist cartels and public employees lavishly rewarded.

In this environment, expectations were raised to impossible heights. Expectations are the yin to credibility’s yang: together they form a unity, as credibility is linked to the fulfillment of expectations. If expectations are raised and then dashed, credibility is eroded and then lost entirely.

Expectations everywhere have been raised to heights so lofty that the air has become thin: all these expectations are like debt-money claims on the real world: the claims can expand to near-infinity, but the real world remains stubbornly limited.

As lofty expectations are unmet, the credibility of the Status Quo inevitably decays and implodes. We are as yet in the early stages of this process. Let’s check back in 2014 to see if the sand castle of the Status Quo has collapsed in a heap of wet sand, or if it is merely sagging in the pre-collapse phase.

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Alan Simpson Confirms Reality: "All The Things You Love Will Not Come To Pass"

Conjuring images of Jack Nicholson in ‘A Few Good Men’, Alan Simpson laid out the sad and terrible truth that none of us or our politicians can handle in a very direct and sincere interview with Bloomberg TV’s Deirdre Bolton. “Medicare costs stand to squeeze out the rest of domestic government spending,” Simpson said, “it is on automatic pilot. It will use up every resource in the government.” Simpson also said that the current path of debt, deficit and interest is “totally unsustainable” confirming once again the facade that his 18 years in Washington proved to him that he “never saw any projection of any economist ever come true.” From Paul Ryan’s plan to the ‘simple math’ of CBO budget projections, and whether older Americans should be afraid, Simpson pulls no punches as he sums up American society thus: “we don’t care about our money, all we want is more money for our money.”



Simpson on Paul Ryan and whether older Americans should be worried about his plan to rework Medicare:

“Don’t worry about that generation. Worry about yours. Let’s get serious here. These old cats are taking care of themselves. Nothing that has ever been suggested here, whether it is Simpson-Bowles or the gang of six or the gang of eight has a thing to do with butchering up old people at this time. You either get on a path of solvency. I mean, what is the purpose of this whining and moaning about social security where if you do nothing, you will wobble up to the window to get your check in 2033 and it will be 23% less. Medicare is on automatic pilot. It has no cost containment procedures in it until about 10-years out and then we’ll ignore them. Anybody with a brain has to figure that you have a situation where 1,000, 10,000 people turning 65. You have obesity. You have one person that weighs more than the other two. You have Diabetes A and B. You’ve got to do something with tort reform. You’ve got to do something with doctors and hospitals. Come on. And the guy who can get an operation to buy your building does not even get a bill for $200,000 with a heart operation. Let’s get serious.”

On those who say that Ryan’s plan will trickle down and hurt the people that will need support the most.

“If they read the report that was signed on to by five Democrats, five Republicans, one Independent, 11 of the 18 of us, 60%, which Durbin said, ‘I do not like this at all. I hate it like the devil hates holy water.’ Let me tell you, ladies and gentlemen. Either you start to do something now, or pay me now or pay me later. This country is on a trajectory of debt, deficit and interest that is totally unsustainable, unconscionable and totally predictable. If everybody wants to talk about old people and the kiddies and use the stuff that Dave Axelrod will shower on the American people while Obama’s plan, pretty sweet — have a go at it. It is your country.”

On whether Simpson-Bowles accounted for the slowing economy:

“We put in there that we recognize the nature of a fragile recovery. It’s all in there. I always say to people, when everything else fails, read the damn thing. It’s 67 pages in English. It talks about shared sacrifice and skin in the game and going broke. There is no mystery to what it is. Don’t forget, the president asked for $4 trillion. Are they hammering him? No. He said, I want to take $4 trillion in 12 years. Simpson-Bowles wants to do $4 trillion in 10. So grab hold, no specifics at all. The reason they hammer away is because we were solidly specific. We talked about the tax code, which is $1 trillion which is used by only about 10% of the American people. The little guy has never heard of the stuff in there. It goes to the wealthiest people and the smoothest cats that have the best lobbyists to stick it in there with no oversight ever.”

On Ryan’s plan and its call for huge cuts on almost every piece of domestic spending:

“If you want to go into that stuff, we will never get anywhere. It does not make any difference. Let me tell you. Medicare is on automatic pilot. It will use up every resource of the government and squeeze out all the things you mentioned. They will be completely squeezed out. The discretionary budget will be borrowed. We are borrowing $3.6 billion per day. For every dollar we spend, we are borrowing 41 cents. We owe $16 trillion and no one understands what that is. If you want to get to the old playbook out and use infrastructure, airplanes and all that stuff, that is great. You will not even see it because of what will happen with Medicare. You will not even perceive it. It will not come to pass. All the things you love will not come to pass.”

On the CBO’s budget projections:

I have always said if you torture statistics long enough they will eventually confess. I was in Washington for 18 years and never saw any projection of any of economist ever come true in 18 years. The next year, greater growth will be this — never happened. This will happen — GDP. All you have to do is use the math. We don’t use Powerpoint. We do not use graphs. All use is your head. If you want to go into all of the horror stories using emotion, fear, guilt, racism, class warfare, you can kiss it off. It is your country.”

On whether it’s possible to reach a compromise that is good for society:

“I hope so. You see, the thing is, the people that will control this debate do not have anything to do with the things to you and I are talking about right now. The people who will control this are ‘the markets.’ And the markets will say, and they have every reason to say it, the chaos between Election Day on November 6 and December 31 where there will be $5 to $7 trillion washing around ready to go somewhere. If you go too far one way, you end up recession. You have to do some balance and all you have to do is a plan. We have it in legislative language. It is circulating among a very good group of Democrats and Republicans. You do a plan and the markets will lay off of you. If you don’t, they will say very simply, ok. We do not care about Republicans. We do not care about Democrats or Obama, or Romney, or Biden, or Ryan. We care about our money and we want more money for our money. And they will ask for more interest. 1% of interest will knock this country on its face. Where is everybody? I mean, it is absolutely nuts. When it happens, interest rates will kick up. The guy who gets hurt the worst — the little guy. The little guy that everybody talks about day and night. What goofy, goofy hypocrisy.”

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Your Complete, One-Stop Presidential Election Guide

With less than three months to go, the outcome of the November election remains highly uncertain. SocGen notes that, as always, economic performance over the coming months will be a key determinant of who wins and who loses. If the elections were held today, the most likely outcome would be a Republican win in both Congressional races and a Democratic win in the race for the White House. This means that any new significant legislation will almost certainly have to be a product of compromise. In this sense, we may very well be looking at a status quo in terms of bipartisanship and gridlock which have dominated Washington politics over the past few years. This would be bad news at a time when the country faces a number of serious challenges with significant long-term implications. From the economy to long-term fiscal health, and from the debt-ceiling to Housing, Healthcare, and energy policy differences, the following provides a succinct review.


Societe Generale: American Themes – US Elections

There is a strong need for leadership in Washington. The economy is performing poorly and monetary policy options have been nearly exhausted. Unfortunately, the ongoing split promises more of the same from Washington: politics instead of leadership.

A close race for president, coupled with uncertain congressional power. A split in the Congress can inhibit the agenda no matter who wins the presidential race. Unless the president’s party makes gains in Congress, it will be difficult to agree on any changes. The healthcare overhaul was achieved with a Democratic congress during President Obama’s first year in office. Reversing course requires not just a Republican president but a cooperative Senate. Sadly, gridlock is likely to prevail.

In Washington, there is widespread support for fiscal stimulus, at least for immediate support within the context of long-term discipline. Specifically, there is support to reduce the anticipated fiscal drag of higher tax rates and spending cuts that are set for 1 January 2013.

Election-year politics prevent current action. Congress may take action immediately after the election to reduce onerous tax rate increases or may wait until the new government takes office in January before acting. This uncertainty comes at a cost to markets and indeed to the economy in the short-term.

Key main assumptions and potential for surprises:

  • President Obama expected to win re-election but faces a Republican Congress.
  • Challenger Governor Romney victory would be a surprise. Narrow Republican control of Senate would be an obstacle.
  • Choice of vice presidential candidate, Congressman Paul Ryan, hints at a more aggressive entitlement spending overhaul. The differences between President Obama and Ryan are fundamentally ideological and represent a serious choice for voters. Yet, it should not be forgotten that it is Governor Romney who is running for president, and the agenda of the presidential candidate is what will be focused on, no doubt. Moreover, Romney is the underdog.
  • Quantitative approaches for determining whether a Republican or Democratic president are better for the equity market are somewhat flawed by a low sample size. Only 13 presidents have held office since the late 1920s when many current equity indices start with continuous data. Democrats have faired better according to the S&P500. The timing of bubbles, inflation and wars are key drivers, rather than coincidental party affiliation. Simple party alliance is not a driver for fundamental analysis.

Election scenarios – latest odds

Much could still change between now and the 6 November election. However, based on the latest indications from online prediction markets, the Republican Party is seen as the likely winner of both Congressional races.

Democrats are still seen as the favorite in the race for the White House, with President Obama winning re-election. In any case, it is unlikely that one party will control all three institutions. Moreover, any one party in the Senate is unlikely to hold the 60 seats (out of 100) needed to avoid filibusters. Therefore, in the absence of the majority needed for any post-election scenario, significant new legislation will require bipartisanship and compromise. In this context, the risk of gridlock remains high.


With less than three months to go, the outcome of the November election remains highly uncertain. As always, economic performance over the coming months will be a key determinant of who wins and who loses. If the elections were held today, the most likely outcome would be a Republican win in both Congressional races and a Democratic win in the race for the White House (see Charts 1a-c above ). This would give Republicans an improved standing relative to the current configuration (in which they only control the House), but it would nonetheless leave power divided. The latest indications from online prediction markets suggest only a 40% probability that any one party will end up controlling both houses of Congress and the White House, leaving a 60% probability of a split scenario (see Chart 2 below).


It is also very unlikely that any party will win a filibuster-proof super-majority. This means that any new significant legislation will almost certainly have to be a product of compromise. In this sense, we may very well be looking at a status quo in terms of bipartisanship and gridlock which have dominated Washington politics over the past few years. This would be bad news at a time when the country faces a number of serious challenges with significant long-term implications.

US election issues – what’s at stake

There is a lot at stake as we look to 2013. Immediately after the new Congress and/or administration take over, they will have to deal with the fiscal cliff as well as the long-term fiscal challenges, healthcare and financial regulation, and lastly, with energy policy, which is also crucial for long-term economic sustainability. We discuss these issues in greater detail in the following sections.

1. Economy

The first and perhaps the most important decision to be made by the incoming Congress and/or administration will be resolving the fiscal cliff in a way that does not undermine the still fragile economic recovery. If all of the planned spending cuts and tax increases go into effect as scheduled, the economy will experience a reverse stimulus of $600bn next year, or about 3.5% of GDP. A shock of this magnitude would almost certainly lead to a contraction in activity in the first half of 2013, which in turn could push unemployment toward 9.5-10%. The alternative, which is to extend all expiring tax provisions and do away with planned spending cuts, is unfortunately not viable. Maintaining the status quo on fiscal policy would result in a continuation of large deficits which would push the debt/GDP ratio above 90% by the end of the decade. Without addressing entitlements, the ratio would start rising even more rapidly after 2020, largely due to the effects of the aging population.

The ideal outcome is one that addresses long-term fiscal challenges, while recognizing the near-term fragility of the economy. This could be accomplished via a plan which phases in gradual tax increases and spending cuts over the next 10 years. The risk is that a post-election gridlock may lead to a more rapid fiscal consolidation, with adverse implications for the US economy. Given the high odds of a split government, as highlighted above, this is not a non-negligible risk. The most likely scenario is that some portion of the planned fiscal contraction will be delayed. But it is very unlikely that all of it will be legislated away. For example, payroll tax cuts look unlikely to be extended, which by itself could shave about 0.7% from next year’s growth. In our central forecast for the US economy, we have discounted a fiscal drag of about 1.3% in 2013.

Our central economic forecast does not rely on any specific assumption about the outcome of the November election. Indeed, we can envisage our economic scenario under a number of post-election configurations. First, it must be noted that both presidential candidates recognize the need for fiscal reform, and at the same time, neither wants to do consolidation in a way that would significantly undermine the US economy. And, although there are significant distributional differences between their prospective fiscal plans, both will most likely have to work with the opposing party in order to pass any significant legislation. This, then, leads us to two key conclusions. First, the early phases of post-election negotiations may prove highly disruptive, with a non-negligible risk of a gridlock scenario resulting in greater fiscal restraint than is desirable. Second, after all the dust settles, the ultimate fiscal deal could well end up resembling the Simpson-Bowles blueprint which itself was a product of compromise and bipartisanship.


2. Long-term fiscal health

In the tables below, we offer a summary of where the two candidates stand on key issues with respect to fiscal finances and the economy. We also include the Simpson-Bowles recommendations which we consider to be a benchmark for a balanced and pragmatic approach to fiscal reform.


There are significant differences in how the two candidates plan to achieve fiscal balance. President Obama’s plan relies on a combination of revenue increases (to 19.7% of GDP by 2020) and spending cuts (to 22.5% of GDP by 2020), with spending cuts spread across both defense and non-defense budgets. In contrast, Governor Romney’s plan aims to cut taxes further, increase defense spending relative to the baseline and offset the budgetary impact by very large cuts to discretionary spending (see Table 1 for details). Under his plan, federal spending would eventually be capped at 20% of GDP. These ambitious cuts would bring spending below the long-term average despite the aging population and the projected growth in mandatory spending. As a benchmark, the Simpson-Bowles proposal aimed to stabilize federal spending at 22% while bringing revenues to 20.5% by 2020.


Tax Policies Under Competing Proposals


Discretionary Spending Policies Under Competing Proposals


Mandatory Spending Policies Under Competing Proposals


3. Debt ceiling

The debt limit will soon rear its ugly head, but only after the 6 November elections. Fortunately US Treasury debt limits do not overlap the immediate election calendar. In August 2011, politics intertwined with debt ceilings and Congress appeared near the brink of a technical default. The rising risk of dysfunction and the impact it would have had on debt was partly the reason for Standard & Poor’s downgrade of the US’ long-term debt.

The US Statutory Debt Limit is $16.394 trillion. At the end of July 2012, the Treasury had just under $500bn of borrowing authority. Further, Treasury estimates its borrowing need in the second half of 2012 at nearly $600bn – calling it close. Treasury already indicated it could hit debt limit at the end of the year. Importantly, hitting the debt limit and the need for Congress to approve an increase will not occur until after the elections. The US Treasury is very likely to temporarily suspend certain debt transactions and could delay hitting the debt limit until Spring 2013. At that point a new Congress can consider legislation that is free of an immediate election. Congress can tie in the debt limit to legislation to reduce the “Fiscal cliff.”

4. Dodd–Frank Regulation

Reversing elements of the Dodd-Frank financial regulation has been a talking point among many Republican candidates. Yet concrete plans are thin. Romney calls for replacing Dodd-Frank with a streamlined, modern regulatory framework. Streamlining may be hard to differentiate from normal evolutions that would occur in the aftermath of such a major overhaul in financial regulations.

Regulation of financial institutions following the crisis is a force influencing global markets, regulators and economies. Voter sentiment against financial institutions is too strong at the moment. The best scenario may be no more than to dial down the anti-“fat cat” rhetoric. The Republican party may have differing views. The essence of the Tea Party is a grassroots, main-street effort to change the business-as-usual practices of both Washington and New York. Dodd-Frank legislation is already two years underway. Many important provisions, regulatory bodies and market exchanges have yet to be implemented. Nonetheless, considerable progress has been achieved in defining these functions, rules, markets, etc. Re-steering at the margins rather than any major repeal would be a more likely scenario with a Romney presidency. Even the current government, that passed Dodd-Frank legislation, would find needs to modify elements at the margins during a second term. Chances for a major reform is low.

5. Healthcare

The Republican party is more uniform on its healthcare positions, relative to financial regulations. Futile repeals of Obama’s healthcare law (Affordable Care Act) were passed in the Republican controlled House of Representatives, but progressed no further. Repealing what is now termed Obama-care would require a Republican President and Congress. A simple majority in the Senate might not be enough.

Healthcare would be the biggest game in play with a Republican president. Assuming also a Republican Congress in 2013, efforts to repeal the Affordable Care Act would gain momentum. The US Supreme Court only narrowly upheld key portions of the heathcare reforms. Taxation and choice are unifying elements to counter the government-led widespread health insurance coverage advocated.

By the next election, 2016, Obama-care, or Affordable-care will be far more deeply ingrained in the US economy. Modifications rather than a reversal would be more likely. This election is most likely the last chance on a major reversal of the 2009 legislation. Yet the voter interest is not there. Governor Romney has not succeeded in capitalizing on healthcare repeal as a significant campaign issue.

6. Energy policy – no fracking difference

Broadly speaking, the US has not historically had a strong energy policy, in terms of market impact – that is, in terms of the fundamentals and pricing of energy, especially petroleum and natural gas. This has been true since the twin oil crises of the 1970s and it remains true today.

For Obama and Romney, the common ground on energy far outweighs the differences. The bottom line is that growing US natural gas and oil  roduction is good for the economy. It should directly boost GDP, it will narrow the trade deficit and it should be supportive for the dollar.

In conclusion, no matter who wins the election, we believe that energy policy will not be dramatically different, especially given the likelihood of some sort of divided government in Washington. The emphasis will be on encouraging growth in US oil and natural gas production. This pretty much means getting fracking regulations resolved, in coordination with states and industry, and then getting out of the way. We do not expect the election results to have any impact on oil and natural gas prices.

7. Housing—GSE reform

Although not included in the debt figures reported by the government, the US government has moved to more explicitly to support the soundness of obligations of Freddie Mac and Fannie Mae, starting in July 2008 via the Housing and Economic Recovery Act of 2008, and the 7 September 2008 Federal Housing Finance Agency (FHFA) conservatorship of both government sponsored enterprises (GSEs). The on- or off-balance sheet obligations of those two independent GSEs was just over $5tr at the time the conservatorship was put in place, consisting mainly of mortgage payment guarantees. The extent to which the government will be required to pay these obligations depends on a variety of economic and housing market factors. The federal government provided over $110bn to Fannie and Freddie by 2010.

8. President without re-election

President Obama is a known commodity, at least he is perceived that way. As a second-term President, Obama may take a different turn. Without pressures of re-election, President Obama could return to early promises to move beyond partisan politics and build the future by taking steps to control long-term fiscal trends. Tackling long-term deficit trends was too dangerous for the president seeking re-election. Simpson-Bowles offers a blue-print for bipartisan support. This is hopeful – but may be unrealistic. Pressures to take action on the deficit, however are building. The bi-partisan groups in Congress offer some reflection on this. Grassroot efforts are also building and the Tea Party owes its start to one extreme effort to control deficits.

For financial markets, a President intent on building a legacy on long-term deficit reduction would be a positive-risk scenario for financial markets in the medium term. It is doubtful, however, that any immediate market response will occur on deficit reduction.


Following the elections, Washington will focus on the fiscal cliff, that is the currently legislated tax increases and spending cuts that would materially slow the US economy at the start of 2013. Election-year gamesmanship prevents pre-emptive efforts to reduce this fiscal drag on the US economy. A lameduck Senate may not take immediate action on tax cuts, and rapid action may be required in January. This is more timing uncertainty, and path uncertainty, but not eventual outcome uncertainty. At least not for major elements to reduce the threat from a fiscal drag.

The most likely scenario of President Obama and a Republican Congress suggest status quo. Importantly, however, status-quo reduces uncertainty surrounding fiscal policies as well as recently passed legislation on healthcare and regulation. The upside surprise would be a second-term president that wants to build a legacy of long-term deficit control. The downside risk would be a failure to reach compromise on the fiscal cliff despite overwhelming similarities in the party positions.

Within the Congressional elections, the risk versus our scenario would be that the Democrats maintain control of the Senate. This would be more of the status quo. Lack of a super majority in the Senate and a Republican-controlled House of Representatives would still foster gridlock on major economic and financial market legislation. A split Congress would make it difficult for President Obama to reach on a compromise on legacy building.

In the presidential elections, the surprise would be a victory by Governor Romney. With a Republican Congress, there are greater chances to repeal or substantially modify the recent healthcare overhauls. Additionally, reducing fiscal drag in early 2013 would be less complicated. Lastly, with full Republican control, we would expect lower taxes in the medium term and greater efforts on cost control. Drastic changes under a Romney presidency would likely hinge on the degree of control by Republicans in the Senate. Control of the Senate is likely to be razor thin. In the end, the election alone is unlikely to produce major legislative changes. Responses to market, economic and demographic pressures are more likely the triggers for significant legislative action in the next few years.

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Stupid Stuff

I’m amazed that Japan has not yet hit an economic reef. At over 230+%, the country’s debt to GDP is so far out of whack that I keep thinking that something has to give. I’ve been wrong for years.

The trend lines for Japan are awful. A decline in total population coupled with a rapidly aging society is a recipe for slow or no growth. Japan is the world leader in these critical statistics. I don’t think there is anything that Japan can do to reverse its social/economic future. Projections on the critical variables for at least the next ten-years continue to head south.

It's not as if the Japanese are unaware that they are headed for a debt train wreck. They have just passed new tax legislation that could make a meaningful contribution towards stabilizing Japan’s debt to GDP problem. But the new law is a sham. The new taxes will never get paid.


Japan has a consumption tax today of 5%. The new laws will raise the tax to 8% in 2014 and 10% in 2015. Moody’s thought this was a great idea, and said this about the tax hikes: (Link)


"it is an essential component of Japan's fiscal consolidation goal, achievement of which we consider necessary to maintain market confidence in Japanese government bonds."



But here's the joke; in order to get the votes to pass this very controversial legislation, there is a critical stipulation that the new taxes will not come into effect unless the country is increasing GDP at a minimum rate of 2% a year (or nominal growth of 3%).


There is no chance in hell that Japan will achieve the triggers. The folks who passed the laws know that. I think Japan deserves the annual award for the most heinous “kick the can down” tactic. The following chart shows how Japan has limped along for the past 20 years. Note the GDP performance over the past decade. What are the odds that it breaks 2% anytime soon based on the prior track record?



How’s Japan doing today? Is it on it way to achieving the all important 2% GDP target for 2013 (the trigger for the 2014 tax increase)? Not a chance. From the FT this morning:



Moody’s warned about the possibility that the taxes would never be levied:


the gross domestic product growth targets contained in the new law remain an area of uncertainty


How hard do you have to stretch a rubber band before it breaks?



On the Good Efforts by the SEC


The SEC made an important announcement this morning:



The SEC is just now getting around to hiring some people who might have a clue what is going on in the capital markets. Mr. Berman, the head of the office Analytics and Research acknowledged that the SEC had no idea what was actually happening. From the interview with Tradersmagazine (Link):


the SEC learned it was unprepared to sift through the mountains of market data in the current high-speed, rapid-trading marketplace of today. That was evident when it had difficulty understanding what happened in the market on May 6, 2010-the day of the "flash crash."


So two plus years later they get to thinking that they need some “smarts” on board? The SEC gets the award for Rank Incompetence.



No Inflation


Both the Fed and the Treasury have made comments on the tame inflation outlook as the basis for monetary/fiscal policies that potentially have inflationary implications. They have relied on a Cleveland Fed report that measures expectations for the future rate on inflation.


Not surprisingly, the folks in Cleveland are using a measuring stick that says the all-important “expectations” are very low, about 1.25%.


I look at the multi-trillion US Government bond market for a better measure of what those expectations are. The Tips/Coupons spread tells a different story than the nice folks in Cleveland. From Bloomberg – (Link)



The hockey stick higher starts on July 26. That was Draghi saying that he would print to the moon. The second leg higher was Bernanke saying that he was going to act in September.


Like I said, Bernanke ignores the market’s measure on expectations. But I’m absolutely certain that the Chairman, and all of the other Fed Governors, have the market measure of expectations somewhere on their screens. So they are well aware of the fact that the market is now forecasting inflation above the Fed’s target of 2%.


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