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No, Mr. Bond, I Expect You To Die.
'History is moving pretty quickly these days, and the heroes and villains keep on changing parts.'
'An effective zero percent interest rate, as a price for hiding in a foxhole, is prohibitive. '
'I used to think if there was reincarnation, I wanted to come back as the president or the pope or a .400 baseball hitter. But now I want to come back as the bond market. You can intimidate everybody.'
'Don't you miss interest rates?'
'And people with obsessions, reflected Bond, were blind to danger.'
THINGS THAT MAKE YOU GO HMMM... ....................................................3
Mark Carney Plots Assault on Bank of England ....................................................17
Falling Yen Set to Spark Renewed Currency Wars ................................................18
500,000 People Sign Petition Asking Prime Minister Rajoy To Resign ..........................21
Egypt: To the Barricades Again ......................................................................22
Countdown to the Collapse ..........................................................................23
Why the Investment Gods Must Be Crazy ..........................................................24
Retirement Savings Accounts Draw US Consumer Bureau Attention ...........................26
Analysts Debate Meaning of Central Bank's Newest Regulatory Tool ..........................27
CHARTS THAT MAKE YOU GO HMMM... ..................................................28
WORDS THAT MAKE YOU GO HMMM... ..................................................32
AND FINALLY ................................................................................33
2012 marked the 50th anniversary of the release of the first James Bond movie, Dr. No, which had its worldwide premiere at the London Pavilion on October 5th, 1962.
The movie was based on the book of the same name, written by Ian Fleming, a former naval intelligence officer and grandson of Robert Fleming, the Scottish financier who founded Robert Fleming & Co. Ltd. 'Flemings', as it was known, was a UK-based merchant bank which, in 1985, for reasons best known to trusted officers of the company long since departed, was the first institution willing to give a wide-eyed young man named Grant Williams a job in the financial industry.
My love for James Bond has nothing to do with the largesse of my erstwhile employer; in fact, it wasn't until I had been in the employ of the Fleming family for a couple of years that the connection became apparent (along with the realization that Alexander Fleming, the inventor of penicillin, was a scion of the same family). My love for James Bond stems from the place inside every 8-year-old boy where he wants desperately to be a secret agent, drive fast cars, and hunt down 'baddies'. (At that stage in my development, beautiful women were the only thing about James Bond films that I thought they could do without. Hey... I was 8.)
Recently, in conjunction with the release of Skyfall, the latest Bond movie, a study was commissioned by Sky TV in commemoration of the 50th anniversary of Dr. No's release, to determine the best moment in the history of the franchise. Surprisingly, the iconic line 'Bond. James Bond', first uttered by Sean Connery as he sat at a gaming table with a cigarette hanging loosely from his lips, landed in third place with just 5.7% of the vote. The winner of the poll, and incidentally the only other piece of dialogue amongst a litany of car chases, set pieces, and explosions, came from the third Bond film, Goldfinger, which came out in 1964. The quote in question was uttered by the villain of the piece, Auric Goldfinger, in response to Connery's Bond, who, as he lay watching a laser beam slowly cut through a solid gold table toward his groin, asked what, under the circumstances, was a perfectly reasonable question:
'Do you expect me to talk?'
Goldfinger laughed and replied simply, 'No, Mr. Bond, I expect you to die.'
Now, those of you who have read my work for a while will be rolling your eyes at the mention of Goldfinger and will be bracing yourselves for yet another trip into the murky world of conspiracy theories surrounding gold bullion. But, if you've made it this far, you are about to be pleasantly surprised, because that's not where I am taking you. No, that's not where we are headed at all.
Instead, we are going to try and get real about the big picture and understand just how impossible the situation is for the world's governments and central banks and, in turn, how impossible they have decided to make it for honest, hard-working savers. We are going to look at the possibility that, in keeping with Goldfinger's expectations, the bond market may be about to get hit right between the legs by a laser beam; and if it doesn't die, exactly, then it may be about to get rather badly singed.
As I was putting the slides together this week for my presentation to the Cambridge House in Indian Wells, CA, on Feb 23rd (shameless plug concludes), I found myself staring at a snapshot of a world that seems so far distant from today's that it's difficult to comprehend.
That world offered investors and savers the opportunity to park their money in two-year treasuries for a return of 4.8% or, perish the thought, a one-year CD for 5.4%. At the time, CPI inflation was reported to be 2.1%. In short, if you had a nest egg and didn't want to risk it, you could simply be prudent and watch that egg grow in real terms to the tune of 2.5-3.0% per year.
That world still existed in 2007.
In the 65-odd months that have transpired since then, the world has become an altogether different place for those fortunate enough to have any capital. The option of 'safe' investing has been willfully removed by the Federal Reserve, the ECB, the BoE, BoJ, PBoC, and SNB (to name but a few) as they have attempted to force investors to take on risk and put their capital to work instead of hoarding it out of fear of an imminent collapse. Now, the whole idea of an 'imminent collapse' can be a useful thing — just ask Hank Paulson:
(Daily Bail) ... several Congressional members have alluded to a private meeting with Paulson and Bernanke in which vague economic Armageddon was threatened if Congress did not immediately hand Hank $700 billion, with no oversight. As the political debate raged over the next 15 days, several members expressed a sense of shock over the severity of the secret warnings, while refusing to divulge the details to a concerned public. Representative Sherman of California later accidentally revealed that members were warned that Martial Law would follow if the $700 bailout plan were not approved quickly. Days later it was confirmed that the warning was delivered by Treasury Secretary Paulson. [Representative Paul] Kanjorski relates the fear about an electronic run on the banks that was apparently part of the Congressional scare tactics employed by Paulson and staff. You will notice that he says members were told that within 24 hours, the entire political structure of the United States would collapse....
'You know, we're not any geniuses in economics or finances on the Hill. We're representatives of the people.'
But we're getting ahead of ourselves here. Let's stay with the bond market and that 'imminent collapse'.
However, since 2008, after Paulson's warnings about collapse scared the economically and financially challenged inhabitants of the Hill sufficiently that they handed him a $787 billion cheque made out to 'Cash', the world's central banks and governments have been on a mission to convince investors that the idea of an imminent collapse is, in fact, preposterous — the theory being that, once fear has dissipated, growth can magically begin again, organically, propelled by the sudden investment of dormant capital.
Not so fast.
The massive distortions that the various QE programs have caused in markets have broken just about every mechanism for understanding the true price of risk and, by extension, the true cost of capital; and that, ladies and gentlemen, is a problem. A BIG problem.
What am I talking about? Well let's take a look at a few bellwethers of the world's bond market and try to develop some perspective on what should be the true risk-free rate, shall we?
We'll begin with Exhibit A: US 30-year rates going back to before the Civil War.
As can be seen from the chart below, the USA has never — NEVER — been able to borrow long-term capital more cheaply than it can right now. In an ordinarily functioning bond market, that fact would be a fair signal that the creditworthiness of the country had never — NEVER — been better <cough>.
The second chart below shows the debt level of the United States. The US took roughly 200 years to amass a trillion dollars in IOUs and then proceeded to triple that number in a decade, double it again 12 years later, double it again in another 8 years and, overall, multiply it 16 times in a 30-year period.
Source: Bianco Research (via Big Picture)
It is really hard to make a case for such low rates when the USA is facing such a mountain of debt, its economy is stalling, it is essentially politically paralyzed, and ... oh, what was the other thing? ... Oh yes. The Fed will be buying about 90% of the country's new issuance in treasuries and mortgage bonds in 2013.
You have to hand it to them. US Treasuries have long been the absolute representation of the risk-free rate; and by allowing only 10% of issuance to free float, you create tremendous demand for the asset class, drive up prices, and drive down yields. Brilliant!
So brilliant in fact that it has led people who supposedly are economic and financial geniuses to say out loud some things that perhaps they ought to be keeping to themselves. Take for example the proposal this past week of Commerce Bancshares Chairman & CEO David Kemper, who, in an article entitled 'QE Cubed: A Modest Proposal for More Fed Buying. A Lot More', had this to say about the Fed's performance:
(Businessweek) The ongoing depressing news about the American fiscal situation has obscured the startling and very impressive earnings performance recently announced by the Federal Reserve. The Fed, in its usual understated way, just revealed it will be turning over $90 billion in 2012 profits to the U.S. Treasury, a much-needed contribution that will put a sizable dent in our nation’s current $1 trillion federal deficit.
The Fed’s earnings performance over the last several years has been exceptional. It earned more than twice Apple’s after-tax earnings last year, the result of a simple but powerful strategy: borrow money at very low rates, then buy long-term bonds.
Now, some people might question the Fed’s exceptional results and point out that it has an unfair advantage in that it has a monopoly on manufacturing the U.S. dollar. Yes, the Fed does have extraordinary profit margins, since its cost of goods sold is close to zero (basically paper, some bond traders, and access to the Internet), and yes, so far the demand for new dollars seems unlimited. Meanwhile, we as a society seem to have no stomach for trying to reduce our soaring deficit and our accelerating entitlement programs. No one in our federal government seems to be willing to work out a long-term fiscal solution. Why not go with a business model that has proven to be such a winner?
So far, so good (kinda) and, in a normal world, a very valid question: why not pick such a model? Then, Kemper gets his crazy on:
That is why I propose the Federal Open Market Committee’s next move be to take our central bank to a whole new level — a 2013 campaign that I call QE Cubed. Why not expand the Fed balance sheet exponentially, from its current $3 trillion to $33 trillion? Earning an extra 3 percent on another $30 trillion in bonds would allow the Fed to return an additional $900 billion to the Treasury — thus wiping out most of our federal deficit while avoiding actually having to do anything about current government spending.
After reading this, and whilst mopping up my tea, I couldn't help but call to mind Wile E. Coyote, Super Genius.
Accidentally ejected tea cleaned up, I returned to the article, to find ... well ... this:
I’m sure some skeptics will scoff that this might be a little irresponsible.
They may invoke memories of Weimar Germany.
Now, at this point, Kemper's article is most definitely making me think about Jonathan Swift's 18th-century satirical essay, whose title began with the same three words, "A Modest Proposal", and in which he proposed that poor Irish parents might ease their circumstances by selling their offspring as food for the rich. I read on, hoping for dear life that what I was reading was, indeed, satire:
And, oh, by the way, where is the Fed going to find $30 trillion in acceptable bonds? I am the first to admit that the Fed will have to buy all $15 trillion or so of our current U.S. debt, as well as most of our agency and some corporate debt, in order to reach an additional $30 trillion. But we can make this happen!
At this point, Kemper outlines what he calls 'The Plan' — a proposal which is to modesty as Lady Gaga is to demureness. I won't recap it for you, in case my name accidentally gets attached to it in a freak cut-and-paste accident, but if you're interested in getting to the bottom of this, you can read it for yourself . To the sound of approaching sirens, Kemper wraps things up in words that I can only assume were intended to amuse, but that may land in some brains somewhere between the synapses for 'frightening' and 'Barrossian':
Would $30 trillion in extra buying power be inflationary when our entire current GDP is only about $15 trillion? Maybe, maybe not — but we need a game-changer here. First let’s celebrate the Fed’s record profits and its contribution to reducing our deficit. Then let’s seize the moment to do something truly grand: eliminate that stubborn deficit. We have the tools, and I, for one, say let’s give it a try.
No, David, we'd better not.
Now, giving the benefit of the doubt to Kemper would have been far easier in different times; but in today's QE-addled world, sometimes crazy-sounding is just plain crazy. I have a feeling that, one way or another, we shall discover in coming days whether Kemper was being satirical or is just disconnected from reality. Personally, I can't foresee him admitting to the latter. Either way, the fact that there could be any doubt whatsoever about the thinking behind this article tells me how far down the rabbit hole we have ventured.
The chart above further highlights the problem the bond market faces. It shows the yields for 10-year debt in the UK, Germany, Japan, and Switzerland. To clarify things a little more, let's take a look at the returns an investor with $10 million equivalent in local currency could expect to receive today and compare them to returns in the golden days of 2007.
Annual Income (pre-tax)
% Income Reduction
-0.1% (Target 2%)
Suddenly, not only does $10 million not seem like an awful lot of money (especially to those who were expecting to retire on it and live the millionaire's life), but the theft of income that results from the coordinated ZIRP being conducted by the central banks becomes far more obvious.
A look at another phenomenon offers further proof of the confiscation of income from the prudent. The chart below shows personal interest income (red line) and personal dividend income (blue line). As can clearly be seen, the Fed has essentially appropriated $400 billion in interest income from the most conservative investors and effectively handed it to those more willing to take risk in the form of dividend income.
Your government at work, folks.
Until now, investors heavily weighted towards bonds have seen their investments reap significant capital gains as the asset class has soared, thanks in large part to government bids via the various forms of QE, the fear generated by Europe's on-again-off-again meltdown, and recycling of euros bought in massive quantities by the SNB to defend its pegging of the Swiss franc. But on January 7th, 2013, something happened that will have enormous ramifications for bond markets. Fittingly, it came in the form of a European politician opening his mouth.
This time, it was the turn of José Manuel Barosso, the man whom Nigel Farage described in 2012 as '', to throw things for a loop when, against a backdrop of protests on the streets of Madrid, he proclaimed victory (when will they ever learn?):
(UK Guardian) The euro has been saved and the euro crisis is a thing of the past, European commission president José Manuel Barroso has declared.
'I think we can say that the existential threat against the euro has essentially been overcome,' Barroso said in Lisbon. 'In 2013 the question won't be if the euro will, or will not, implode,' he said.
So let's indulge Mr. Barroso, shall we, and assume that the euro crisis is over and there is no more need to be fearful?
Let's ignore for a moment the 11.8% unemployment across the euro region, the faltering growth in its supposedly strongest economy, and the bribery scandal in Spain that has reached to the prime minister himself.
Let's also forget about the existence of a further scandal in Italy that threatens to engulf both the Super Mario Brothers, Draghi and Monti; the tug of war over a potential bailout for Russian oligarchs through Cyprus — a country with a 2011 GDP of €17.9 billion, which somehow now needs bailing out to the tune of €17 billion (see graphic above); and the UK's possible referendum on whether to stay in the EU. Greece? Sooo 2012.
Yes, let's put all that aside and take Mr. Barroso at his word and ask the simplest of questions:
Now that everything is fixed and the crisis is behind us, who would own a 10-year German bond that pays less than 2%? Or a Japanese equivalent that pays less than 1% when the new Japanese government is guaranteeing 2% inflation? Would you lend to the US government for 5 years for an 88-basis-point return?
The answer? You would own this stuff only if you were another government engaged in a currency war or in propping up your own debt. If you are a fiduciary of private money or an investor in your own right, then bonds are, for the most part, a nonsensical place to be.
I have for some time now been banging the drum about the perils of confidence returning.
Last week Bank of America took up the baton in a report warning of something called a 'bond crash':
(UK Daily Telegraph) The return of confidence and healthy growth in the US risks setting off a 'bond crash' comparable to 1994 and triggering a string of upsets across the world, Bank of America has warned.
The US lender said investors face a treacherous moment as central banks start fretting about inflation and shift gears, threatening a surge in bond yields.
This happened in 1994 under Federal Reserve chief Alan Greenspan when yields on US 30-year Treasuries jumped 240 basis points over a nine-month span, setting off a 'savage reversal of fortune in leveraged areas of fixed income markets'.
A similar shock this year is 'likely' if the US economy continues to gather strength. 'The moment we hear the first rhetorical talk of exit strategies by central banks, this could turn,' said chief investment strategist, Michael Hartnett. There was already a whiff of this in the most recent Fed minutes.
Forget the central bank exit strategies, folks. This is not something that will wait for them to dictate terms. Why does everybody think we will never again be subject to 'market forces'? Confident markets do not lend money to insolvent governments at these rates of interest. Period. Throw in the enormous capital gains that bond portfolios have made — and therefore will look to protect — and you have a recipe for disaster.
It has already started. Quietly.
Talk of a 'great rotation' out of bonds and into equities is growing louder, as stock indices have come flying out of the gate in 2013. Simultaneously, since Mr. Barroso's 'victory speech', a rather interesting move has taken place in the bond markets, as the chart below demonstrates.
Now, we are not talking big numbers here, but the quantum of the moves is interesting. German 5-year yields have more than doubled since the beginning of December, French yields have done likewise, and US rates are up by a third. January is going to be the first month in quite some time when portfolio valuations are going to saddle investors with a capital loss. It isn't going to help that those same investors will be reading about the 'great rotation' into stocks and how impressively equities are performing thus far in 2013. Some of those stocks even pay dividends! Go figure.
Bank of America again:
Bank of America said the 'Great Rotation' under way from bonds into equities closely tracks the pattern of 1994, with bank stocks leading the way.
Over the past seven years US investors have pulled $600bn from US equity funds and poured $800bn instead into bond funds. This process is going into reverse. Equity funds have drawn $35bn over the last 13 trading days alone, creating the risk of an unstable 'melt-up' in stocks over coming months.
The Bank for International Settlements has issued an alert on the high-yield 'junk’ bonds and mortgage debt, currently trading at record lows. The Swiss-based watchdog said parts of the credit market credit are 'highly valued in a historical context relative to indicators of their riskiness.'
It will come as no surprise to regular readers that I am very much in Bill Fleckenstein's camp: the 'deflation scare' (if that is what it ever really was) is done. Over. And that means trouble.
True deflationary scares are few and far between. The US has had four significant periods of deflation in the last 200 years, three of which occurred between 1818 and 1896. In each case, they were followed by significant periods of inflation as the remedy applied (inflationary measures) took hold. The last such period was the Great Depression (fear of a repeat of which has dictated policy response for the last four and a half years and counting) and, as the chart below shows, from that day onwards it's been inflation all the way, baby!
We are not out of the woods yet, not by a long way. Europe faces so many crosswinds, headwinds, and downdrafts that it's really is just a matter of time; and that will send investors panicking into sovereign bonds again and cause equities to hit air pockets, which in turn will cause the odd short, sharp fall; but with each renewed outbreak of panic, the circle of bonds that will be deemed 'safe' is going to contract.
Currently, there are only 12 countries ranked AAA by all three major ratings agencies; and of those, four are currently on negative watch by two of the three — which leaves only eight supposedly pristine sovereign credits in the world, none of which is big enough to absorb major inflows (table, below).
With each new panic, another country drops off the list of 'safe' havens. (Finally, it seems, France's dire economic situation is being taken seriously, and it is edging ever closer to the periphery of Europe where it belongs, regardless of its size.) This shrinking pool of 'good' collateral is going to become a major issue.
Last week, a hilarious exchange highlighted just how desperate things are in La Belle France:
(UK Daily Telegraph) France's labour minister sent the country into a state of shock on Monday after he described the nation as 'totally bankrupt'.
Michel Sapin made the gaffe in a radio interview, which left French President Francois Hollande battling to undo the potential reputational damage.
'There is a state but it is a totally bankrupt state,' Mr Sapin said. 'That is why we had to put a deficit reduction plan in place, and nothing should make us turn away from that objective.'
This was amusing enough, but the real kicker came with the frantic response from an altogether expected source:
Pierre Moscovici, the finance minister, said the comments by Mr Sapin were 'inappropriate'.
He added: 'France is a really solvent country. France is a really credible country, France is a country that is starting to recover.'
Until I read this, I was unaware that there were degrees of solvency. I had always assumed that either (a) you could pay your bills or (b) you couldn't, in which case you weren't solvent.
It's good to know that France is, in fact, really solvent — as well as really credible.
With such small things do we begin to see the truth emerge.
Anyway, it's about time for me to wrap this up for another week, so let's get back to where our hero, James Bond, 007, lies strapped to the solid gold table with the laser beam slowly advancing towards his classified documents.
Goldfinger is about to leave the room (and Bond to his fate), when a slightly desperate looking 007 makes one last attempt to avoid a nasty end by resorting to the final option available to any self-respecting secret agent: he starts lying:
Bond: 'You're forgetting one thing. If I fail to report, 008 replaces me.'
Goldfinger: 'I trust he will be more successful.'
Bond: 'Well, he knows what I know.'
Goldfinger: 'You know nothing, Mr. Bond.'
Bond: 'Operation Grand Slam, for instance...'
Goldfinger: 'Two words you may have overheard which cannot possibly have any significance to you or anyone in your organization.'
Bond: 'Can you afford to take that chance?'
Goldfinger decided he couldn't afford to take that chance, and the laser beam was turned off. Sadly for the arch-villain, he should have killed 007 when he had the opportunity. Goldfinger's failure to take drastic action when he had Bond at his mercy meant that he lost everything when Bond ultimately sent the complacent bad guy plummeting to his doom....
But that was all just a movie. It's not as though life ever imitates art, now, does it?
Before I disappear, there are a couple of quick pieces of housekeeping:
Firstly, a quick reminder that I will be speaking at the Cambridge House California Resource Investment Conference in Indian Wells, CA, on February 23/24th. The line-up this year is fantastic: Rick Rule, Greg Weldon, Frank Holmes, and Peter Schiff will all be in attendance, along with my great friends Al Korelin and John Mauldin. So if you are in the vicinity and would like to drop by and hear from any of these fine speakers, you can find all the details at the conference's website, .
I hope to meet some of you there.
Secondly, I will not darken your inboxes next week, but I hope to return in a fortnight.
So what do I have for you this week? Well, there is an in-depth profile of the incoming Bank of England Governor, Canadian Mark Carney; and one can't help noticing that he is rather different from Mervyn King, which should make for some fireworks. Then we head to two troubled countries, Egypt and Spain, to check out two protests of different sorts that could well have similar consequences; we hear how Jens Wiedemann expects German interest rates to rise again; and we find that in the wake of last week's Things That Make You Go Hmmm..., currency wars are definitely uppermost in the minds of, amongst others, Liam Halligan and John Butler.
My great friend David Hay of Evergreen Capital in beautiful Bellevue, WA, explains in his own inimitable style why the investment gods must be crazy; analysts in China try to come to grips with a new regulatory rule; and, in the USA, the Consumer Financial Protection Bureau looks set to take the first step towards herding Americans deeper into government bonds. Hopefully, those targeted will see these cowboys coming in time to dive out of the way. We shall see.
Our charts this week feature a look under the hood of the latest employment report (and whaddya know, it's not as rosy as it looks on the surface), a staggering map of obesity's spread across the globe, some curious data surrounding revisions to non-farm payrolls, and a look at metal prices, as well as something Chris Puplava calls 'the Chart of the Decade'. How can you not want to see that?
Finally, we serve up some good old-fashioned common sense from Rick Santelli; a terrific interview with Bill Kaye, in which he discusses many facets of the precious metals market structure as well as likely price paths; and we hear once again from the always clear-headed Kyle Bass on the likely consequences of money printing.
What are you doing still reading the nonsense I write? Go read the stuff from the smart guys...
Until Next Time.
Mark Carney, the next Governor of the Bank of England, does not look like a man under pressure. On stage before the global business elite at Davos last month, looking comfortable in an armchair and trading whispered jokes with International Monetary Fund president Christine Lagarde, he exuded an air of authoritative calm. His every word may have been under scrutiny, but he seemed to relish the attention.
'Thank you for showing up, as you’re obviously the people who still think there are some tail risks out there,' he told the crowd in a resonant Canadian accent.
The 47-year-old former Goldman Sachs banker is the man of the moment. Since his appointment as Sir Mervyn King’s successor as Governor of the Bank of England on November 26 last year, he has been hailed as everything from the hero who saved Canada from the financial crisis to the Messiah who will deliver Britain back to growth.
'He is quite simply the best, most experienced and most qualified person in the world to be the next Governor and to help steer Britain’s families and businesses through these difficult economic times,' an unrestrained George Osborne said on unveiling the appointment.
Even Ed Balls, not a man known for singing the praises of the Chancellor, had warm words about the appointment. 'I commend the Chancellor on his choice of successor. Mark Carney is a good choice and a good judgment,' the shadow chancellor said.
Peers describe Carney, Governor of the Bank of Canada since 2008, as the 'rock star' of central banking, in reference to his role as chairman of the world’s financial watchdog — the Financial Stability Board — and his youthful good looks.
Carney’s supervisor when he did his DPhil in Economics at Nuffield College, Oxford, in 1995, remembers him in glowing terms. 'He was an exceptionally versatile student, rapidly and seemingly effortlessly mastering and marshalling arguments from a range of different literatures,' Meg Meyer told The Sunday Telegraph.
No one, it seems, has a bad word.
It’s quite a billing, but one Carney bears lightly. Headlining at Davos on The Global Economic Outlook, he showed he wasn’t above a bit of testy verbal sparring. Responding to the suggestion from a fellow panellist that Japan had restarted quantitative easing to debase its currency, Carney could not help himself.
'This cannot stand,' he muttered into the microphone. Turning to Angel Gurria, secretary general of the Organisation for Economic Co-operation and Development (OECD) and a former Mexican finance minister, he declared: 'That’s not the policy,' before staring Gurria down. The contrast with the bookish Sir Mervyn could not have been greater....
In September 2010, the Brazilian Finance Minister, Guido Mantega, pointed a rhetorical finger at the United States and accused the world’s largest economy of conducting a 'currency war'. Suggesting that emerging markets were being unfairly squeezed by a falling dollar, which makes US exports more competitive, Mantega lit the touch paper on a controversy that won’t go away.
For now, 'currency wars' are a relatively arcane debate limited to foreign exchange specialists and diplomats. But this issue has already adversely affected hundreds of millions of people who consider themselves largely immune to the vicissitudes of international markets, not least in the UK. History shows, also, such currency disputes can escalate from rhetorical spats into disastrously counter-productive economic conflict.
'Currency wars' have hit the headlines anew in recent weeks, given Japan’s attempts to force down the yen. Freshly installed prime minister, Shinzo Abe, determined to stimulate a moribund economy, has ordered Japan’s ultra-conservative central bank to be more expansionary.
The Bank of Japan has announced it will raise its inflation target to 2pc, while trying to reach that goal 'at the earliest possible date' and phasing-in hefty government debt purchases. Governor Masaaki Shirikawa will also be replaced by a more compliant successor when he retires in April.
Japan has been treading economic water for over 20 years, ever since its almighty real estate bubble burst in the early 1990s. Still the world’s second-largest economy when the credit crunch began in late 2007, the country has since slipped back to third-place and counting, its GDP having contracted for six of the last eight quarters. Despite all that, Abe’s decision to take drastic measures has sparked a chorus of complaints.
The yen spent 2012 oscillating around 80 to the dollar. Since then, it has fallen rapidly and is now approaching 93 to the US currency. Most analysts expect a further slide — not least as the central bank is now committed to aggressive monetary measures and a higher inflation target.
This has big implications for other Asian exporters, as a weaker yen makes Japanese goods cheaper in foreign markets.
Since the middle of last year, the South Korean won, for instance, has risen over 30pc against the yen. That’s why politicians in Asia’s fourth-largest economy, which competes with Japan in many sectors including autos and electronics, were last week threatening measures to discourage capital from flowing into the won, stopping it rising even more.
Germany, also, is deeply concerned about the yen’s recent fall and the prospect of further weakness. With an eye on his country’s all-important export sector, Bundesbank president, Jens Weidmann, recently mauled Tokyo’s new affinity for loose money, referring to 'alarming infringements' and an 'end to central bank autonomy'....
SPIEGEL ONLINE: Mr. Asmussen, for years you served as a state secretary in the German Finance Ministry. Since the beginning of 2012, you have been a member of the executive board at the European Central Bank. Has being at your new job changed your view of the crisis?
Asmussen: A little bit. At the Finance Ministry, I was a European German, but now I am more of a German European. I used to represent German interests in negotiations with Brussels, but today I have to contribute to finding solutions that are appropriate for Europe.
SPIEGEL ONLINE: As someone who has changed sides, do you find it more difficult to tell your former colleagues in the ministry that they should solve the crisis on their own?
Asmussen: No, I actually find it easier because I still know the way the other side thinks and functions.
SPIEGEL ONLINE: In recent months, there has been an increase in the amount of positive news about the financial markets. Have we overcome the crisis, or has it just been covered up with a lot of money from the ECB?
Asmussen: Well, we are certainly in a better position today that we were 12 months ago. The greatest risk for the current year is that everyone will just sit back and not do anything else.
SPIEGEL ONLINE: Since ECB chief Mario Draghi announced that he would purchase unlimited bonds from crisis-afflicted countries if necessary, the financial markets have recovered. Of course, that doesn't mean there has been a fundamental improvement — it is purely based on the hope that more money will always be available.
Asmussen: There have also been fundamental improvements. Italy now has a primary surplus — meaning the government there is taking in more than it is spending, if you factor out interest payments. And Greece has reduced its deficit by 9 percentage points over the last three years.
SPIEGEL ONLINE: The strongest weapon in efforts to combat the crisis remains the bond-buying program. So far you have only threatened to use it. Will you actually start using the program this year?
Asmussen: We are not currently purchasing bonds. The option of activating the program is always available, but certain conditions are required. A country must submit to the ESM's tough adjustment program, for example.
SPIEGEL ONLINE: By purchasing bonds, the ECB is financing national budgets and relieving governments of their work. Is that really a central bank's job?
Asmussen: We operate within our monetary policy mandate and we do not finance any states. The program is there in order to eliminate disruptions in the circulation of money. The key interest rate issued by the ECB either doesn't reach the member states or varies greatly when it does.
SPIEGEL ONLINE: So is the situation really still so bad?
Asmussen: We are seeing modest improvements. The financial markets were severely fragmented for a long time. That means that bonds for certain countries were only being purchased by domestic banks. That has changed. We still haven't returned to normal conditions, but there has been clear progress.
SPIEGEL ONLINE: What progress?...
The indignation of citizens over payouts and graft in Spain is highlighted by a flood of protests on Spanish social networks. A campaign on Change.org, a platform with 25 million registered has collected a record 500,000 signatures calling for the resignation of Prime Minister Marinao Rajoy.
Via Google translate from El Pais, please consider 500,000 People Sign Petition Asking Prime Minister Rajoy to Resign.
The indignation of the public by publication in the country of the secret papers of the PP extesoreros, reflecting payments to the party leadership, is flooding social networks with messages calling responsibilities to Prime Minister Mariano Rajoy. appear together under tags like # Rajoydimisión or # quesevayantodos , in addition to the proposal for this diary # lospapelesdebárcena s.
This wave of criticism also translates into hundreds of thousands of citizens (over 500,000 in just over a day) have signed a petition asking for 'the resignation of the leadership of the PP', including Rajoy, and 'all who have received payments in black money '.
'I wish we lived in a democracy and could revoke the government for not fulfilling its election and alleged corruption cases like this,' explains Pablo Gallego , petition drives the platform Change.org . This 24 year old from Cadiz that their initiative is collecting 40,000 signatures per hour, a pace that, if continued throughout the day, could mean reaching one million accessions this Saturday.
If that number is reached, Gallego with messages intended to go to the national headquarters of the PP in Madrid.
As I have said repeatedly, one never knows when the tipping point is. However, given the combination of massive government corruption coupled with unemployment of 26.6% and youth unemployment of 56%, it is certain the tipping point will indeed be reached....
With angry crowds across the nation baying against him, Egypt’s president wagged his finger at the people in a late-night televised speech. He declared a curfew for some cities, he called for support for the police, he deployed the army to the streets. Seemingly as an afterthought, he added a conciliatory call for dialogue with his political opponents.
As on January 28th 2011, so on January 27th 2013. As with President Hosni Mubarak, so with President Muhammad Morsi. And in both cases to little effect. After both televised addresses vast throngs gleefully defied the curfew, freshly deployed soldiers ignored the revellers and the head of the army warned of a collapsing state, prompting rumours of an imminent coup. Opposition leaders demanded a government of national unity. Ordinary citizens braced for the unknown.
The drama that has been unfolding since January 25th, the anniversary of the beginning of the uprising which toppled Mr Mubarak two years ago, would have looked peculiarly familiar even without the eerily precise coincidence of the dates.
Some are tempted to see the similarities carried through to the outcome, hoping that Mr Morsi, a stalwart of the Muslim Brotherhood and Egypt’s first freely elected president, will soon fall too.
'It is amazing how history accelerates,' was the catty remark of a prominent defector from the Brotherhood. 'Morsi has got to the point Mubarak reached after 30 years in just six months.'
But though the situation may seem similar, the country itself has changed a great deal since what was at the time seen as a revolution (many shy from the term today). Egypt’s economy has foundered dangerously in the absence of firm government policy. Politics has polarised between an ostensibly empowered Islamist camp and a disgruntled, alienated or outright hostile minority that includes much of the educated, urban elite. Amid this mess, fearful for the future and dispirited by haggling politicians, most Egyptians have little appetite for another big upheaval. The army, which stepped in to shunt Mr Mubarak aside and then lingered too long, is reluctant to dirty its hands again.
The young hotheads at the heart of today’s protests might like nothing more than to see Mr Morsi forced into an ignominious, Mubarak-like exit. But the broader demand is for him to change, not to go—to act more like a leader for all Egyptians and less like a front man for the Muslim Brotherhood. The Brotherhood has shed much of the appeal that won it various recent elections and tentatively protected it against doubts, not least among foreign powers, about Islamist rule. At home its cult of secrecy, hazy pan-Islamic agenda and sense that it rules by entitlement now provoke suspicion and resentment even among many fellow Islamists....
Curiously, in the second half of 2011 and through most of 2012, notwithstanding the escalating euro-crisis, US ratings downgrade, Japan’s protracted nuclear disaster and sharply divergent global growth rates, there was surprisingly little volatility in foreign exchange markets. EUR/USD traded mostly in the historically narrow range of 1.40-1.25. USD/JPY was in a range of from 76-82. The Chinese renminbi held between 6.4 and 6.2. GBP/USD moved within 1.54-162. The Swiss franc was also steady at around 1.20 versus the euro, although this was the result of an explicit Swiss policy of capping the franc at that level.
In retrospect, it appears that this period was characterised by a general ‘cease-fire’ in the global currency wars ignited by the global financial crisis of 2008. Rather than attempt directly to devalue currencies to stimulate exports at trading partners’ expense, the focus during this period was primarily on measures to support domestic demand.
There has now been a resumption of hostilities. The first shots were fired by the Japanese, where national elections were held in December. The victorious LDP party campaigned on a platform that, if elected, they would increase the powers of the Ministry of Finance to force the Bank of Japan into more aggressive monetary easing. The LDP also has voiced support for either a higher BoJ inflation target or a nominal GDP growth target.
Combined with poor economic data, this had a dramatic impact on the yen, which has subsequently declined by about 10% versus the dollar and 15% versus the euro. This is the weakest the yen has been in broad, trade-weighted terms since 2011.
Now it is understandable that Japan should desire a weaker yen. Japan is no longer running a trade surplus, in part because it is importing a record amount of energy following the decision to scale back the production of nuclear energy. Moreover, demographics are such that the proportion of retired Japanese is growing rapidly. As Japan’s ageing population draws down its savings to fund retirement, this implies that Japan will be saving less and consuming more relative to the rest of the world.
But while Japan has an interest in a weaker yen, many other countries have an interest in weaker currencies too. Much of Asia has been following a classic, mercantilist growth model ever since the Asian credit/currency crises of 1997-98, seeking to export more than they import. They are still inclined to follow this model, as it has succeeded in the past.
Of course it is impossible for all countries to be net exporters. The US is by far the world’s biggest importer. But given structural economic problems and associated high unemployment, US policymakers also have reasons to desire a weaker currency to stimulate exports and jobs. Much the same is true of the UK, arguably the leading candidate for the next big devaluation. Then there is the euro-area, which is suffering under a huge debt burden and desires to stimulate exports abroad to offset ‘austerity’ at home....
Any sentient creature, looking back at the tech bubble of the late 1990s, or the lending mania of the mid-2000s, would conclude that the graffiti was all over the subway walls (and tenement halls — if you get that one you are seriously dating yourself ). Yet, millions of investors, as well as countless allegedly 'professional' investors, managed to keep pumping helium into the balloon right up until the explosive end. How could that happen? To answer that, we need to consider a phenomenon that could plausibly be called 'the tyranny of the benchmark.'
Markets these days are largely driven by institutional investors who are entrusted, for better or worse, with assets that frequently belong to normal folks through their 401(k) or direct mutual fund share ownership. The underlying investor has a well-documented tendency to put money into areas that have been rising over the past few years.
To stay up with their benchmarks, and not get fired for lagging, professional investors usually feel compelled to buy even if they believe prices are inflated. Invariably, the asset class that has been running gains even more momentum as the performance-chasing money comes flooding in. This creates even more upward pressure and yet more forced buying. The cycle perpetuates itself until something comes along to serve as the pin prick. Then the air goes out even faster than it went in.
Thus, highly sophisticated investors, like those on the Barron’s Roundtable, may think and talk bearishly but act bullishly — not because they want to but because they feel they have to.
When a mentality forms of 'you’ve got to keep up with it' — whether the 'it' is the market itself or a sector, like tech — it takes a very brave man or woman to resist the pressure to get in on the action. And the end to the festivities is almost always close at hand when even bears begin to behave like bulls.
Evergreen’s partner, Louis Gave, attended the Dick Strong conference in Vail last week. Similar to Barron’s collection of brainpower, the Strong event brings together some of the most muscular investment (and non-investment) minds around. Last year, Louis noted that this group was 'all beared up.' He correctly postulated this would lead to a consensus-confounding rally.
This year, though, the tone was much more upbeat. To contrarians like Louis and me, that is something of a red flag. Similarly, the World Economic Forum in Davos, where the Grand Poohbahs of the global financial system convene each year, just concluded. From all reports, it amounted to a self-congratulatory victory lap for the planet’s central bankers. Last year, they were in panic mode. This extreme mood swing, from despondent to euphoric, further raises my concern level.
It’s also a bit bizarre that the stock market, along with its cheerleaders, is convinced the US economy is accelerating. If this were really true, why does the Fed feel it must produce and inject a trillion dollars a year into the banking system? Clearly, either the market or the Fed has it very wrong.
The big news this week was the revelation that the US economy actually shrank in the fourth quarter. Given the prevailing bullish mind-set, this shocker was quickly dismissed. The reality is that the third quarter was artificially inflated by an almost inexplicable surge in government spending ('almost', except that it was right before the election). The fourth quarter brought a reversal of this, so if you put the two together you get an economy growing at the lackluster 1.5% to 2% rate that has characterized most of this recovery.
But this begs the question I’ve asked before: Is this the best the US economy can do, more than three years after the recession’s end, despite trillion dollar deficit spending and an equivalent amount of Fed money manufacturing? Yes, I realize, the prevailing wisdom was perfectly captured by one pundit on CNBC this week, who called this 'the classic "don’t fight it" market.' In other words, the Fed’s got our backs.
This raises yet another question in my admittedly perhaps too skeptical mind: Based on the Fed’s history over the last 12 years of serial bubble blowing, followed by spectacular blowups, why should that make anyone feel better?
The U.S. Consumer Financial Protection Bureau is weighing whether it should take on a role in helping Americans manage the $19.4 trillion they have put into retirement savings, a move that would be the agency’s first foray into consumer investments.
'That’s one of the things we’ve been exploring and are interested in in terms of whether and what authority we have,' bureau director Richard Cordray said in an interview. He didn’t provide additional details.
The bureau’s core concern is that many Americans, notably those from the retiring Baby Boom generation, may fall prey to financial scams, according to three people briefed on the CFPB’s deliberations who asked not to be named because the matter is still under discussion.
The retirement savings business in the U.S. is dominated by a group of companies that handle record-keeping and management of investments in tax-advantaged vehicles like 401(k) plans and individual retirement accounts. The group includes Fidelity Investments, JPMorgan Chase & Co., Charles Schwab Corp. and T. Rowe Price Group Inc. Americans held $19.4 trillion in retirement assets as of Sept. 30, 2012, according to the Investment Company Institute, an industry association; about $3.5 trillion of that was in 401(k) plans.
The Securities and Exchange Commission and the Department of Labor are the main regulators of U.S. retirement savings vehicles and funds. However, the consumer bureau — established by the 2010 Dodd-Frank Act — sees itself as a potential catalyst for promoting a coherent policy across the government, the people said.
With large numbers of Americans heading toward retirement in the coming decade, the CFPB has referred internally to this concept as 'the rollover moment,' the people said.
Mark Calabria, director of financial regulation studies at the Cato Institute, a research group that promotes free markets, said that while Dodd-Frank didn’t specifically give the consumer bureau jurisdiction over investments, it could step in if the other agencies don’t.
'I could imagine the CFPB growing into a role on investment savings if it seems like the SEC is asleep at the wheel,' Calabria said in an interview.
The bureau could claim jurisdiction through its Office for Older Americans, which was established by Dodd-Frank with a mandate to improve financial literacy. It is run by Hubert H. Humphrey III, the former attorney general of Minnesota.
The retirement savings industry generally has little to do with the CFPB because the SEC is the main investment regulator, said Ianthe Zabel, an ICI spokeswoman. She declined further comment on the CFPB plans....
Shortly after the central bank announced an addition to its regulatory tool kit, the Short-term Liquidity Operation (SLO), analysts started wondering if this meant small-scale quantitative easing.
There is debate over that issue, but most analysts agreed that the new tool will have a significant impact on current principal regulatory instruments: banks' reserve-requirement ratio (RRR) and deposit and lending interest rates.
In its announcement on January 18, the central bank said the new operation would mostly use repurchase agreements or reverse repurchase agreements that mature in seven days or less to supplement existing open market operation tools, which comprise central bills, repos and reverse repos.
The goal is to smooth out sharp liquidity fluctuations and stabilize short-term interest rates, the bank said.
Twelve banks, including the Big Four state-owned banks, have been named as participants in the SLO scheme.
The move is very likely to create a situation where the central bank lends generously at low cost to commercial banks, which in turn can pump the market with liquidity, Xu Hanfei, Guangfa Securities' chief analyst, wrote in a commentary.
He was not alone in predicting a loosening credit environment. Across the financial and business community, mini QE, a reference to the predicted impact of SLOs, has become a buzzword.
Analysts pointed to the fact that the central bank had been using reverse repos to flush the inter-bank market with liquidity in the past several months. It was possible it would continue doing so with the new tool, they said.
However, a source close to the central bank said they were drawing a conclusion too soon. A key difference between QE and SLO, he argued, is that the former is engineered to increase credit supply while the latter can either tighten or relax liquidity.
Indeed, SLO is a two-way valve. The central bank can choose either to conduct repos to mop up liquidity in the market or have it the other way round with reverse repos, the source said....
The January employment report showed that improvements in the U.S. labor market are continuing at a moderate pace, as private payrolls added some 166 thousand jobs during the month. The headline numbers from the Bureau of Labor Statistics however mask the underlying dynamics of job growth. A report from ADP provides a breakdown of jobs created by companies of various sizes (as measured by the number of employees.) It's easy to see where the new jobs are coming from.
Our index of base-metal prices fell by 17% in the five months to June 2012, hit by the euro-zone crisis and the slowdown in China. It has gained some ground since but is still 7% below its level a year ago, and 24% below its peak in May 2007.
Prices are likely to remain flat for the first half of 2013. Many metals are in surplus. Aluminium is facing a seventh year of oversupply. Nickel stocks piled up in 2012 as demand for stainless steel, which accounts for two-thirds of nickel usage, weakened. One exception is tin. Exports from Indonesia, the biggest producer, are forecast to be the lowest for a decade. Most smelters won’t meet a higher purity standard that comes into effect in July. Prices have risen by 40% since July 2012.
Presented without comment:
From the before and after monthly payrolls data comes the chart below showing how the Labor Department’s annual revisions have greatly increased overall payrolls in the last two years. By my calculations, 2011 payroll gains were revised higher by 263,000 and 2012 payrolls by 335,000. As shown in the monthly payrolls data earlier today, this suddenly makes the job gains over the last two years look much better.
Source: Iacono Research
Instead of monthly job gains averaging 153,000 in both 2011 and 2012 (about the same pace as population growth), after the revisions, nonfarm payrolls now average gains of 175,000 in 2011 and 181,000 in 2012, helping to explain how the jobless rate could have declined from 9.1 percent to 7.9 percent during that time.
Another mystery has at least been partially explained via data revisions…
The Most Important Chart of the Decade
Last month brought about many news-grabbing headlines of all-time new highs, a characteristic seen in secular bull markets, not bear markets. The Russell 2000 small cap index hit an all-time new high last month as did the S&P 400 midcap index. The Down Jones Industrial Average exceeded 14,000 for the first time since the October 2007 top and now lies just 200 points away from an all-time new high. While the above indexes have been making headlines, one breakout that has not received as much attention as warranted is the breakout in the stock to bond ratio.
The ratio of the S&P 500 Total Return Index relative to the Merrill Lynch 10-Yr Treasury Total Return Index broke out last month from a bearish trend that has been in place since the secular bear market in stocks began in 2000. This suggests that the long-term outperformance of bonds over stocks may be over with stocks providing higher long-run returns over bonds.
The outperformance of stocks over bonds is likely to continue for more than a decade as we hit a major extreme in long-term relative performance at the March 2009 lows. At the time the 10-year relative return spread between the S&P 500 Total Return Index and the Barclays Long Term Treasury Bond Total Return Fund reached levels not seen since the Great Depression.
Source: Chris Puplava
What does this tube of toothpaste have in common with any potential exit from QE that the Fed may be visualizing in the far distant future? Well, I'll let Rick Santelli explain it to you in this short clip that proves once and for all that he's not afraid of getting his hands dirty. (via Zerohedge)
Bill Kaye gives a fantastic interview with Eric King on the increasing preference of central banks to have their gold where they can see it, as well as the potential implications for the gold and silver prices should any perceived shortages of supply prove to be well-founded.
'The biggest short-squeeze in any asset in the history of the world' — now that could be interesting to watch
This particular space in Things That Make You Go Hmmm... is rapidly becoming Kyle Corner, and once again the erudite Mr. Bass explains the world in simple terms: if we keep printing money, stocks go higher. Sounds great, right? But if your entire stock portfolio will only buy you three eggs, then its nominal value is irrelevant.
Six more minutes of simple brilliance.
Having spent three glorious years in Sydney, I am familiar with the vagaries of the Australian accent and so can understand this clip perfectly.
This is the story of one Aussie Battler's struggle against 'exposure' by a news crew who may just be a little too quick to judge and a little too keen to sensationalize...
Hilarious! (via my kid brother)
Grant Williams is a portfolio and strategy advisor to Vulpes Investment Management in Singapore—a hedge fund running over $250 million of largely partners’ capital across multiple strategies.
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In Q1 2013, we will be closing the Vulpes Agricultural Land Investment Company (VALIC), a globally diversified agricultural land vehicle that will provide truly diversified exposure to the agricultural sector through a global portfolio of physical farmland assets.
Grant has 26 years of experience in finance on the Asian, Australian, European and US markets and has held senior positions at several international investment houses.
Grant has been writing Things That Make You Go Hmmm... since 2009.
As a result of my role at Vulpes Investment Management, it falls upon me to disclose that, from time to time, the views I express and/or the commentary I write in the pages of Things That Make You Go Hmmm... may reflect the positioning of one or all of the Vulpes funds—though I will not be making any specific recommendations in this publication.
A walk around the fringes of finance
THINGS THAT MAKE YOU GO
By Grant Williams
4 FEBRUARY 2013
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