Tuesday, August 30, 2011

Market & Economy: Hussman and Schiller

 John Hussman always publishes a weekly market and economy commentary on Monday.  In this commentary he is commenting on Fed policy, the current economy and state of U.S. financial institutions, market valuation in which he estimates the ten year S&P 500 total return is down to 5.1%, and changed his market climate to hard negative and he notes there seems to be less willingness to lend to corporations.  It is not a very pretty picture.  Read it here.
 
Robert Schiller, in an interview, discussed the economic malaise effecting investing and the general economy, cites current market volatility as unhealthy and possibly indicative of a potential equity downturn but definitely fragile.  He still finds equities expensive, that housing will remain under pressure, and tells why he likes TIPS. Watch it here.

These are two viewpoints.  Like all information, it should be read critically, which means that you do not have to agree with everything or every detail to gain value and knowledge.  Information is most valuable when it can be compared and evaluated through comparison and content for relevance.

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Monday, August 29, 2011

Is Buffett Feasting on Bank of America?

A reader has asked me to comment and explain Warren Buffett's purchase of Bank of America preferred shares in the amount of $5 billion.

Bank of America has a need to raise about $100 billion and has approximately $50 billion in overvaluation of its second loans as well as other mortgage and mortgage related legal exposure.  Like Yves Smith at naked capitalism, I have no love for Bank of America, because it is too big, systemically dangerous, and needs to shed the risks of combined commercial banking and investment banking activities.  I have asserted, that since the global financial crisis, U. S. banks have been allowed legally to present public accounting statements which, if presented by any other U. S. business entity, would be considered fraudulent.  It has recently been selling business segment, such as its Canadian credit card business, and other assets to raise money.

I have indicated when discussing European banks, and it holds true for all banks globally and in the U.S., that the recent market downturn has reduced bank stock prices and bank equity, which puts pressure on them to raise money to maintain Tier I and Basel III liquidity ratios.  Bank of America's stock has declined steadily from 1/14/2011 at $15.25 to $6.42 on 8/23 and then rose to $7.76 on 8/26 with the Buffett deal.


If you compare the Goldman Sachs deal Buffet made with this Bank of America deal, you will find it is not as good as the Goldman Sachs deal.  Both were for $5 billion in preferred shares, but the Goldman dividend was 10% while Bank of America is paying 6% (8% accumulation if it suspends dividend payments); Bank of America is callable at a 5% premium while the Goldman Sachs shares were redeemable at a 10% premium; with Goldman Buffet received $5 billion in common share warrants with a strike of $115 and exercisable over five years while Bank of America gave Buffett 700,000,000 warrants for common shares with a exercise price of $7142857 ($5 billion) for a seven year period.  Some sources have characterized this as a $3 billion gift to Buffett from Bank of America, but the correctly calculated amount of the gift is $1.435 billion with the total value of the assets received at $6.45 billion.  Buffett extracted a substantial "fee" from Bank of America. Warren Buffett got a 22.5% discount on total value.

Bank of America preference share class x (Tier 1 equity) had a 7% coupon and was trading at $21 with a $25 par value on the day of this deal for an 8.3% yield.  Buffett's Bank of America preferred shares are Tier 2 debt/loss reserves and should have had a market yield of 9%; he is getting 6%.  At the time of the deal Bank of America shares were $6.88 and his exercise on the warrants were higher at $7.14 rounded.  Linus Wilson, a finance professor, has calculated the market value of the warrants to be $3.17 billion and would be dilutive, of course, of common shares outstanding if exercised.

Since Bank of America needs to raise $100 billion or more, if this deal brings the Buffett imprimatur to Bank of America, it could able to lower financing costs.  If their financing costs would be70 basis points lower, it would save $1.4 billion.

With Goldman Sachs, Buffett took the deal on the fixed side and with Bank of America he is taking it on the equity side.  Does this make Bank of America an attractive stock?  There are hedge funds and mutual funds betting that Bank of America will never be allowed to fail and they are presently losing money.  If eurozone banks develop serious liquidity problems and eurozone austerity dries up the European economy with global ramifications as the U.S. economy continues to slow down with continuing high unemployment, because U.S. political leaders refuse to provide fiscal policy to stimulate aggregate demand, then the global, and that includes the United States, economy is going to contract and stay contracted for a significant period of time.  If that serious economic decline begins to manifest itself, one of the early signs will be bank liquidity stress.

This is not a market for individual investors to be in individual stocks.  Even mutual funds with high financial exposure should be evaluated for the risk of their investments and role within a given portfolio.  This is a time for a well diversified mutual fund portfolio individually consistent with age, assets, risk tolerance, income needs, and affordable quality of life.  All of the big banks are facing headwinds.

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Saturday, August 27, 2011

Uncertainty and European Bank Risks

The stress of the global financial crisis continue to haunt European banks as the economy continues to slow and bond vigilantes target sovereign debt of countries (such as the countries of the eurozone) who do not have their own fiat money.  The emergency lending facilities of the ECB have become more important for many European banks. On last Monday, banks deposited 128.7 billion euro with the ECB and borrowed 555 million euro overnight from the ECB Marginal Lending Facility, which was up from 90 million the prior day.  As Greek default becomes more inevitable and other eurozone countries struggle with sovereign debt financing, the interbank lending market has shown increasing stress as the skepticism about bank liquidity throughout Europe grows.  On Tuesday, European banks borrowed 2.82 billion euro overnight from the ECB, despite the stigma attached to the Marginal Lending Facility.

As the result of increasingly perceived risk by investors, European banks will pay more for the $100 billion of cash they need to raise by the end of the year.  Banks are hoarding cash, depositing it with the ECB, rather than lend it to other banks as political leaders squabble and preach deficit reduction which will only slow the economy faster.  Credit Agricol, with significant Greek exposure, posted profits which beat forecasts and felt compelled to complain about unjustified market irrationality and volatility.  A Bundesbank board member stressed in public comments that recent dollar money market tensions were far from the 2008 crisis levels and European banks are not facing a funding crisis as the result of U.S. money market funds becoming more selective to whom they lend.  The Bundesbank board member emphasized the liquidity available through repos and the ECB's readiness to mitigate problems with the swap agreement with the Fed. On Thursday, the Greek central bank (Bank of Greece) announced it had activated an Emergency Liquidity Assistance program to insure liquidity funding and all small, medium, and large Greek banks, except the National Bank of Greece, have indicated they will participate.  A Fitch survey of U.S. money funds showed a 9% decreased exposure to Europe last month and significant caution with respect to Italy and Spain.  Bankers have estimated that Italy lost $40 billion worth of money market funding in July.  While these figures are miniscule compared to the 8000 billion euro funding of the 91 eurozone banks, it does show the true state and reliance of eurozone banks on short term funding with some 58% of that funding needing to rolled over in two years and 47% in less than one year, but the official line is that there is nothing really wrong with the eurozone banks.

Today, Christine Lagarde of the International Monetary Fund, in a speech at Jackson Hole, said that European banks may need urgent forced capital injections to stem the eurozone's sovereign and financial crisis as they must be strong enough, in her words, to withstand the risks of sovereigns and weak growth.  She indicated that while private funding should be the priority, public funding, perhaps through the EFSF, should be ready.  She emphasized the IMF's change from immediate fiscal tightening to fiscal programs which allow spending to continue now while economies stay weak and reduce deficits over the long term.  This speech occurred at the same time as the second and third largest Greek banks announced an all share merger to be followed with a 500 million euro capital injection.

This IMF changed emphasis which acknowledges the need for public spending to feed growth during periods of declining aggregate demand is a refreshing change from the 1997 austerity mistake the IMF imposed on Japan which stifled growth.  Eurozone banks will remain key indicators in a global economy which is slowing down and economic contraction which eurozone austerity has accelerated.

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Friday, August 26, 2011

Radio Appearance Discussing Global Economy

On Saturday, August 20th, I was a guest on Saturday Session with Bishop on WMAY and streaming live to discuss the global economy.  The conversation focused more on China and the United States and briefly touched on Europe, which is a larger and more looming problem, due to time constraints.  I am providing a MP3 link to the interview appearance.  It is all about growth globally and jobs in the United States and several eurozone countries.

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Thursday, August 25, 2011

Does High Frequency Trading Stoke Volatility?

There is a lot of speculation in the financial media and among individual citizen traders about whether high frequency trading is responsible for market volatility because it ignores fundamental analysis for data trends.  Obviously, high frequency trading could increase trading volume and accelerate market trend through volume.  While the sheer volume and speed can effect prices and there has been speculation that a high frequency trader could, and maybe has from time to time, driven an equity or futures price up on sells and buys to itself, the real question is the fairness of access.  All high frequency traders have direct access to the market through broker-dealers making trades in nanoseconds, causing the question to be raised whether they have the proper structure to insure proper margins and other technical regulatory safeguards.  Since a single high frequency trader could send a million or more messages a day to a market with few trades, the cost to the stock exchanges for adequate data networks is very expensive.  Individual traders do not have direct access to the market and must meet all regulatory conditions as do broker-dealers who have direct access to the market.  The bottom line question is, consequently, one of fairness.  Do individual traders get speedy market execution and a fair market price? 

The Review of Futures Market has a special issue (Volume 19)of which the first article reviews the research literature and methodologies on high frequency trading and the last article is on the effect of high frequency trading in the futures market.  The first study finds high frequency trading is a natural evolution of the trading process, add "quality" to the market through added liquidity, lower trading prices, and reducing bid-ask spreads at the cost of shifting profits, however small on individual trades, through trading volume, only pose a modest manipulative threat because they typically do not hold positions overnight, and only present a problem when they withdraw liquidity from the market causing system breakdown or cascading.  The study suggests the need to design electronic trading systems and to slow or interrupt trading and/or change the trading mechanism.  The last study finds that high frequency trading increases liquidity in the futures market.

Individual investors would be wise to not spending time researching and fretting about the effect of high frequency trading on equity prices and concentrate on the technical and fundamental information of the equity and the market.  You never fight the market and individual investors need a very profound analytical and economic reason to be in individual stocks during a market correction.  Consequently, individual investors would be wise to pay attention to not just price movement of the equity and the market, but the volumes.  This market is not only in correction but it has been testing March lows for the last two weeks with temporary reflexive rallies of short duration.  A week ago last Monday, Monday the 15th, was the fourth market day in successively lower trading volume (down 16.6% that day) even though it went up 213.88 on the DOW.  The next day was down in price but up only 6.1% in volume.  The next day was up marginally on 14.6% down volume.  Thursday of that week it went down 419.63 on up volume of 63.5%.  Monday of this week (22nd) the DOW was up only 37.00 on down volume of 20.4%.  On Tuesday it was up 322.11 on only 1.7% up volume.  On Wednesday, the DOW was up 143.95 but on down volume of 8.5%.  All of these days of trading have been volatile.  The likelihood that today would be a down price day with up volume would have been a reasonable bet and, in fact, that is what is occurring at this time.  By watching price, volume, and economic news, which means knowing what economic reports are coming out on what days not just event news, the individual investor should have some reasonable trend indication which will serve them well as they stay out of individual stocks during any correction and research stocks to buy when the market trends up for more than a short reflexive rally. 

Pay attention to technical and fundamental information on both the equities you are researching and the market itself.  You can control your buy and sell decisions and learn from them.  You cannot make yourself a better trader by researching the effects of high frequency trading.

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Gold is Correcting

When Gold hit a record $1917 an ounce this week, which was up 16% from earlier this month, trend profit taking set in creating a market correction and gold has been dropping.  The Shanghai Gold Exchange on Tuesday raised gold margins by 26% and the CME in the United States on Thursday raised gold margins 22%, both of which undoubtedly created margin calls and more selling.  Professional traders have learned and practice profit harvesting in which they reduce positions to capture and lock in gains over 20%, depending on the market and position, and definitely when they have substantial gains, such as 100%.  Even private investors who have gold at $400 or $800 basis should have been reducing their positions to no less than their original investment to lock in profits.  Gold is a crisis hedge and has been going up accordingly.  With the continuing crisis in the eurozone and the determination of eurozone leaders to pursue austerity which will only increase and magnify the problems slowing growth in Europe and globally, gold will stop its downward moves on economic news perceived negatively and start back up.  What one wants to avoid is the historically documented reversals of gold from highs to prior lows such as $400 and $800.

Some have characterized this correction in gold prices to panic selling, because it was overbought, and to fears the FED will not satisfy the market with comments on Friday from the Jackson Hole economic discussion meeting, which is reaching for causation since the FED has little it could announce from such an academic exercise.  With the margins being raised, we are seeing the same market correction silver saw in May.  It was time then to sell silver and it is time now to sell gold and harvest profits.
Dennis Gartman of the Gartman Letter was one of the professional trading advisors who began cutting their gold holdings on Tuesday when gold got "frothy" at $1910. On the same day, Nouriel Roubini was sending messages that gold was in a hyperbolic bubble, which implies a possible correction, although he also acknowledged, as I stated above, that uncertainty is rising and gold should consequently continue upward after a correction.  It does not appear that any gold correction will burst the bubble given the uncertainty in Europe and slowing global growth which will make the economies of Europe worse faster, but it will briefly reduce the size of the bubble as the professional and smart traders lock up their profits.



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Thursday, August 18, 2011

European Bank Liquidity


Starting last week we started seeing questions surfacing regarding the liquidity needs of European banks as a result of the volatile swings in the stock markets (if bank stock equity goes down they face the need to raise more capital) and potential opening market attacks on French banks (which I find hard to believe resulted from misinterpretation of a fictional series in a French newspaper). On August 10th, ECB overnight lending facility use jumped $5.75 billion dollars (4.058 billion euro), although it could have been from timing issues as banks awaited the arrival of ECB six month funds.  It was noted last week that the LIBOR-OIS (bank credit risk) spread with EURUSD basis swaps was widening but differently than it did in 2008.  The LIBOR-OIS was due to a rise in the LIBOR which would indicate the gap is being driven by liquidity measures, but the EURUSD basis swap was increasing on the short end implying near term caution rather than systemic risk.  Short term wholesale funding problems are magnified when access to long term funding in senior unsecured debt markets become more independently difficult for banks.  Nomura  noted the net stable funding ratio shows CASA, SocGen, Bankia, UniCredit, Commerzbank, and Intesa with the lowest ratios, but no European banks have reserve problems and, as of last week, no European bank had gone to the ECB for USD liquidity.  In relation to the short term liquidity functions last week, it also appeared that the peripheral eurozone countries were having a collateral crunch as well as a credit crunch.

Yves Smith at naked capitalism noted this week that mid-tier banks are finding it harder to get funding in interbank markets, that five year CDS of eurobanks are trading wider than they did in 2008m U.S> money market funds have cut back on exposure to European banks, eurobanks are have a harder time borrowing euro from the ECB to swap for US dollars, and the eurozone is not prepared for any large scale recapitalization of banks program.

On Wednesday of this week, one European bank borrowed $500 million, which was an unusually large amount for one bank, from the ECB in US dollar liquidity for the first time since February.  This would indicate it was probably a larger European bank under temporary stress.

Today, the Wall Street Journal wrote that the New York FED is meeting with the U.S. offices of large European banks to gauge their vulnerability to to escalating financial conditions and potential funding difficulties as U.S. branches of foreign banks became net borrowers of dollars from their overseas affiliates for the first time in a decade.  The New York FED President, Dudley, was quick to publicly state this was just a standard FED review.

On this Wednesday, excess liquidity in money markets actually rose 167 billion euro as Euribor lending rates went down.

This has led to a renewed discussion, involving nerves, noise and funding fears, of what level of funding stress European banks may or may not be facing.  While there are indications of stress in the wider markets, the spread on the three month Euribor rate and the overnight  index swap OIS rates has widen but nowhere near the post-Lehman 2008 peak.  What is interesting is the spike is from a drop in the OIS rate not the Euribor, which implies banks think the swap rates will drop and liquidity improve.  This would indicate the situation is not one of extreme stress, but an evolving situation which requires watching.

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Inflationistas Beware

When the PPI (wholesale prices index) report came out yesterday for the United States, it caught everyone off guard, because core PPI went up 4 tenths to 2.5% when it was expected to go up two tenths and headline PPI went up 2 tenths  to 7.2% when it was expected to be unchanged.  The increase in the core PPI was a jolt and prompted many of us to dig into the report and wait to see the CPI report today with every expectation it would exceed expectations of up 2 tenths for both CPI and core CPI.  Today, the CPI report showed headline CPI went up 5 tenths to 3.6% and core CPI went up the expected 2 tenths to 1.8%.

When looking at the PPI numbers, it should be remembered that PPI has been more volatile than CPI, although it has been trending  with CPI more closely recently.  The headline whole sale prices were up on tobacco, trucks, and pharmaceuticals.  Looking at crude prices were down for the third straight month declining 1.2 with commodities down, but core crude prices were up on copper and corn.  We have previously written about copper in relation to China as loan collateral and the slowing global growth should bring it down as well as corn being up temporarily on weather conditions and Japan.  Crude foods were down 8 tenths.  Finished goods were up 6 tenths on fresh fruit (which are in season), melons (in season), eggs, dairy, coffee, and beef and veal with crude down 9 tenths but processed up 7 tenths.  Intermediate prices for foods were up only one tenth on processed eggs and natural, imitation, and processed cheese.  The FED is more likely to look at intermediate prices for future trend.

Headline CPI was up on food at home, dairy, fruit, energy, gas, and apparel.  Core CPI was up on shelter and medical care.

It is apparent in the CPI prices that there is impact from past higher commodity and transportation prices which have since started to decline and this decline in commodity and transportation prices is not yet reflected in the current CPI.  When looking at CPI, it should be remembered that headline CPI is more subject to transitory volatility which does not stick.  Consequently, core CPI is a more effective tracking of inflation/deflation trends.  While this does not help the pain of a pocket book in a grocery store today, it is significant in having a more accurate macroeconomic perspective.  Core CPI went up the expected amount and, at 1.8% annualized, it is still below the FED 2% target for growth.

Growth remains the problem not inflation long term.

Still, it is historically relevant to realize that if the CPI figures were as calculated in the 1980s, it would be approximately 11%; if they were as calculated in the 1990s, it would be approximately 7%.

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Tuesday, August 16, 2011

Links 8/16/2011: Eyes on Growth

These are links from last week through 8/13/2011.  A little hindsight never hurt objective analysis.

Hussman's market commentary beginning of last week.

Grantham last week on global economy, seven lean years, and investing in a corrupt world.

Kudlow Comedy Capers.

Facing reality

Investor flows and 2008 Oil prices.

Index funds and commodity prices.

Equity prices and growth scares.

Down stock market not S&P downgrade but lack of growth.

S&P decision irrelevant.  Bill Mitchell

David Levey on S&P downgrade as unwarranted.  Rajiv Sethi

Defining economic interests.

Limitations of ECB are its failures.

Market reaction and default. Paul Krugman

Eurobonds or bust.

Slithering to the wrong kind of union.

Stagnant and paralyzed.

Tax Expenditures are big government and should be cut (what the rich do not want to hear).

Target2 & ECB liquidity management.

An experiment in austerity. Bruce Bartlett

An alternative to austerity.  L. Randall Wray

Bank of England's substantial risks.

Deficits and defense spending.

The many ways to count Chinese debt.

Eurocrisis reaches the core.

We don't have a long term debt problem.  James Galbraith

It is a weak economy not a AAA credit rating downgrade.

Illinois budget does not address pension payment backlog.  Moody's

Still waiting for expansionary contraction in UK.

The crisis is unemployment not debt.

Income inequality is bad for rich people.  Yves Smith

The FED dissenters.

Failed monetary policy created this crisis.  Joseph Stiglitz video interview

The return of the Bear.  Steve Keen

Debunking demand and supply analysis.  Steve Keen

Fractious national leaders cannot lend stability to Europe.

Irish NAMA bad debt assets.

Freedom is not built on free market corruption.

Europe's rational idiocy.  Yanis Varoufakis

Why ECB must issue eurobonds for its own survival.  Yanis Varoufakis (I have long advocated need for eurobonds but I do not believe the ECB would be the proper issuer)

Chaos is dawning on dysfunctional governments.  Andy Xie

German taxpayers willingly subsidize bankers.  Michael Hudson

Germany must defend the euro.

Tea Party not factually correct; a conservative criticism. Simon Johnson

Shorting ban on euro banks and macroeconomic threats.


Will the Swiss franc be pegged to the euro?

Swiss franc exposes foreign currency denominated debt exposure of Hungarian banks.

Unofficial U.S. problem bank list at 988.


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German GDP less than Spain GDP Q2 2011

German GDP for Q2 2011 came in at one tenth of a percent growth; five tenths was expected.   Spain had a growth of two tenths of a percent.

Eurozone GDP Q2 grew two tenths of a percent; three tenths was expected.  The eurozone and German economy are slowing.  The French Q2 GDP was unchanged (zero growth).  Manufacturing and exports declined and the eurozone trade deficit widen even though imports declined 4.1%.

Yesterday (Monday), a VOXEU paper asked if Germany can be Europe's engine of economic growth and concluded that Germany needs, as many economists have been urging for some time in discussing the current account imbalances within the eurozone, to rebalance sustained growth toward domestic demand with increased domestic investment and higher incomes which implies less unemployment if done right.

Meanwhile the credit crunch in the eurozone periphery continues as European banks struggle to obtain short term funding at a time when lower stock equity from the recent market downturn will require many banks to raise capital.

The European markets are down and you can expect the U.S. markets to open lower.

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UK Riots and Unemployment Map

Here is a map which provides UK riot incidents information on an unemployment map.  You can move it around as if it is a Google map and you can click on individual locations for specific incident information and you can see the color coded unemployment rates on the map.  It is not coincidence that these riots took place in high unemployment areas as we have written previously.

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Monday, August 15, 2011

Michael Pettis on Hidden Debt in China

In Michael Pettis' private newsletter received July 31st, I covered the first half on why china needs to buy U.S. bonds here and the second half of his July 31 private newsletter began with "Thinking about balance sheets".  Since July 31st, Pettis has also published in the Wall Street Journal an article on why China's export economy cannot continue and will slow down.

Since all four scenarios under which China can sell U.S. government bonds is unlikely (see link above for the first half of the newsletter), the purchase of U.S. government bonds is going to continue until there is a dramatic change in global imbalances.  Despite rumors every six months that they will stop buying U.S. Treasuries, they cannot until they have rebalanced their economy  and eliminated their large trade surplus.  this will take a long time and PBoC domestic debt is going to rise dramatically.  The rise in PBoC domestic debt is going to become an increasing problem for China, which most economists writing about China do not understand, according to Pettis, "...the root causes of Chinese imbalances and the vulnerabilities in the growth model. They do not see the relationship between rising debt, financial repression, and low consumption. What is worse, too many analysts see the problem of local government debt as specific to local governments and caused by misguided polices on their part, whereas in reality it is a systemic problem."

Pettis believes his approach to understanding the Chinese balance sheet is quite different as he tries to understand the development of the system as a whole and then tries to figure out how it will "...logically evolve within balance-of-payments, balance sheet, and monetary constraints."  He admits to being addicted to reading about finance and economic history, with understanding historical precedents key to his approach.  "Furthermore the work of economists like Hyman Minsky, Charles Kindleberger and Irving Fischer drives my sense of balance sheets and how changes in the structure of balance sheets affect economic outcomes. Among other things it leaves me very skeptical about prospects for financial systems, like China’s, that are engineered to maintain stability at all costs.



"Not only do these kinds of financial systems typically sacrifice efficiency for stability but, as any good Minskyite could tell you, regulatory regimes that force stability onto the financial system always result in increasingly destabilizing behavior by the agents within the system. Instability, in other words, is simply repressed and pushed forward, and the financial system must become increasingly inefficient in order to suppress the increasingly irrational behavior of agents within the system. In any financial system, as Minsky famously said, stability is itself destabilizing."
In Pettis' view, it was apparent in 2004-5 that using the balance sheet approach, the rise in Chinese debt argued that within a few years there would be real questions about debt sustainability, because "...there was no logical way for the growth model to continue functioning without an unsustainable rise in debt, and it was already pretty clear that without reform and liberalization in the Chinese financial system we were eventually going to run into another banking crisis. And ignore what you may have heard from other analysts – there has been absolutely no meaningful financial sector reform in the past decade."  He then credits Charlene Chu and her team at Fitch with best analysis of the Chinese banking system and creativity in discovering and counting debt as well as Victor Shih at Northwestern  and Logan Wright at Medley Advisors. 
Pettis specifically cites the Fitch report, "Growth of leverage still outpacing GDP growth" as an example.

Earlier this year, the PBoC unveiled the concept of "Total Social Financing" in an attempt to measure real growth in bank related credit by including various type of important loan growth which had not been included in older measurements.  For many years the key measure of credit growth was the new Renminbi denominated loans made by Chinese banks.  "By setting annual, quarterly or monthly quotas for the maximum amount of new RMB-denominated loans, the PBoC hoped to maintain some control of credit expansion in China."  But it does not work that way, because as the PBoC limited the growth of that kind of credit, the banks found innovative ways around the constraints and pushed new lending into other forms of lending.

When the PBoC produced Total Social Financing numbers earlier this year, the data showed that RMB loans were 92% of total TSF, but by 2010, new RMB loans had dropped to 56% of TSF.  "Clearly loan growth, correctly measured, far exceeded the already-very-high numbers that we had all been looking at. Among other things this meant that M2 was even less useful as a measure of monetary growth than in most other economies because much of the growth in deposits had been disintermediated. The real growth in the form of money for which M2 is a proxy was much higher than actual M2 growth."
Pettis hypothesizes that the intention of the PBoC in releasing the TSF data was 1) it needed a way to demonstrate how amazing the expansion of credit has been to the pro-growth faction in the State Council and 2) "...they wanted to reassert control over credit expansion by widening the scope of credit instruments they were monitoring."  Pettis immediately made what he believes was an obvious prediction, given his belief "...that growth is determined mainly by increases in investment, which are themselves determined mainly by increases in credit", the the TSF would quickly lose its usefulness by September of this year.  However, Fitch has already found additional credit instruments other than those included in TSF which have been expanding quickly and he quotes Fitch:  "The main portions of this uncaptured financing include letters of credit (LoCs), credit from domestic trust companies, lending by other non-bank financial institutions (NBFIs) and loans from Hong Kong banks."
 
The adjusted Fitch TSF numbers are interesting, because they show "RMB loans are down for the first half of the year, with new renminbi bank lending declining by 9.7%, from RMB 4.6 trillion in the first half of 2010 to RMB 4.2 trillion in the first half of 2011.  

"TSF is also down for the first half of the year, but of course by a lot less than new RMB loans. It declined by 4.7%, from RMB 8.1 trillion in the first half of 2010 to RMB 7.8 trillion in the first half of 2011.

"So overall credit growth is down, right? Perhaps not. It looks like Fitch’s adjusted TSF is actually up, and this doesn’t even include private lending pools and non-bank sources of lending, which anecdotal evidence suggests is way up."  Pettis then relates a communication from a PhD student who had been doing research in Ordos Municipality in Inner Mongolia relating finding a tremendous amount of informal financing schemes with some have monthly interest rates as high as 4%.  Pettis is not surprised by this as "The relationship between credit expansion, investment growth and GDP growth means that as long as GDP growth rates are high, credit growth is going to be accelerating."  He challenges if you do not see this you are not looking at the right numbers.

One last point he wanted to make was the the LGVF bonds issued by local government financing vehicles are getting hammered in the market, declining in the last month from 2-10% depending on maturities.  Pettis believes that less than 10% of LGVF debt is in bonds and roughly 80% in the form of bank loans.  He believes this will have implications for debt going forward, because, if one is a newly appointed mayor and how you perform over the next five years will determine future promotions within the political machine and you realize you have inherited a crushing debt burden and few revenues with which to cover the debt, what do you do. Soldier on and hope something turns up within 5 years and you do not get blamed for the revenue shortfalls?  Or do you make a big stink about debt immediately to establish it was not on your watch?  Could a noise be expected by mid 2012 to have arisen?  

Pettis also says it is not clear how many of the LGVFs can meet debt servicing costs and some of their land collateral may have already been pledged more than once.

Sunday, August 14, 2011

Were UK Riots Symptoms of Larger Global Unrest With Austerity and Inequality?

The UK recent riots have been characterized as nihilist acts of thugs, looters, and common thieves, yet, they lasted four days and spread to other neighborhoods in London and other cities and the participants crossed racial lines.  Much like the UK riots in 1981, there was a general dislike and distrust of authority and the police.  The authorities and mainstream media played the riots as criminal anarchy resulting from poor parenting and a history of government coddling which should be suppressed and order restored in order to proceed with government austerity programs supported by the financial services sector which is seeing a concentration of power in their protected status from failure without regard to systemic risk.

Austerity deepens and intensifies social-economic inequality, which brings into question government austerity programs which slow and destroy growth.  As is being seen in Greece, Spain, and Italy, as well as Israel, where protests and demonstrations are becoming common, as well as past UK demonstrations over social and education cuts; just as protests in Egypt, Tunisia, Yemen, Bahrain, Libya, and Syria sought social justice, democracy, and opportunity, when the concentration of power increasingly disenfranchises citizens and/or fiscal consolidation intensifies the likely reaction against corruption and self-serving elitism, historically, is social unrest.  Global economic uncertainty in one form or another is a breeding ground for social unrest.  When it gets so bad it seems as if you have nothing more to lose and you hate the life from which you have no opportunity to improve, civil disorder gets the attention of those in authority and privilege and it then becomes a question of whether they will eventually listen or if they will keep cutting of the heads of the people to restore order.

Living standards and social-economic inequality have been bad in the UK and austerity has magnified the problem.  These UK rioters are being brought before Magistrate's Court for a few minutes of summary hearing before a judge.  Some are as young as 11 and many are over 35 years of age; some young adults are voluntarily surrendering when they realize they looted and not just protested as everyone who thinks is asking why rather than condemning.  During the riots and currently, there are those in the media, politics, and UK government who are attempting to minimalize and paint the rioters not just as thieves and thugs but leaches on the public dole.  This serve no good public purpose in a democracy.  The global financial crisis, protection of financial interests, continuing high unemployment,  social service, health care, and education cuts limiting survivability, much less quality of life, and access to opportunity and the level playing field of a free society not only breed social unrest seeking justice and equality of opportunity, it also breeds right wing extremism.

Edward Harrison of CreditWritedowns has elegantly summarized the the right wing threat and growing crisis in Europe succinctly in the failure of the EU and the eurozone to confront the obvious defects of the euro and act democratically in unity for a common purpose and common safety to provide eurobonds and insure liquidity in a monetary union in which necessary fiscal transfers and fiscal union are perceived as "taxes" and "costs" rather than the normal resolution of current account trade imbalances within the monetary union.

My graduate and post graduate work has concentrated on social economic changes, not just the turning or tipping points, but the periods immediately prior and after.  We are in a period in which the actions of our politicians in all the countries of the world and the citizens of those countries are going to determine in society continues to evolve democratically or if it prefers the neo-feudalism of a corporatist state in which the government and the private financial sector have the same interests.  The economist Nouriel Roubini in a recent interview not only assessed the probability of recession at 50%, but also observed that we are at a stage where it is possible that capitalism could destroy itself.

What do you choose?  Freedom or security?  Access to opportunity or special privilege? 
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Friday, August 12, 2011

Unites States Treasury Auctions After S&P Downgrade

The 3 year Treasury auction for $32 billion this week had a high yield of 0.50% ( the prior auction in July had a yield of 0.670%), a bid-to-cover of 3.24, foreign purchases were 35.36%, and direct purchases were 31.66%.

The 10 year Treasury auction for $24 billion had a high yield of 2.140% (the prior auction in May had a yield of 3.210%), a bid-to-cover of 3.29%, foreign purchases of 46.92%, and direct purchases of 11.09%.

The 30 year Treasury auction for 16 billion had a high yield of 3.750% (the prior auction in July had a yield of 4.380%), a bid-to-cover of 2.08 (average for 6 months is 2.70), foreign purchases of 12.16% (weakest demand in 2 1/2 years --- averages 40%), and direct purchases of 19.62% (from 10.9% last auction).

The yield drops in all three, particularly the 30 year Treasury, were impressive and a strong vote for the strength and safety of United States government bonds.  For the yield to come out any lower on the 30 year, it would have meant paying over the face value of the bond.  This was only the second 30 year auction in history in which all winning bids achieved par value.  While there was some disorderly bidding and a large tail (1.3% in cash terms), unlike European distressed bond auctions where those factors resulted in nightmares, the result for this 30 year U.S. Treasury was a winner's curse.

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Are French Banks Under Self-Fulfilling Market Attacks?

 On Monday August 8th, the cost of CDS and bond yields of  both France and Germany went up, when one would have expected them to go down with the ECB buying Italian and Spanish bonds.  The euro also declined in value to the Scandinavian currencies, which would indicate the Scandinavian currencies were perceived as safer.  Together, France and Germany constitute 1/3 of the equity of the ECB and are the two largest economies in the eurozone.  France's AAA credit rating became the target of market rumors that it could be downgraded as the result of the United States downgrade and the realization the ECB bond buying would be a temporary stop gap on Spanish and Italian yields with the EFSF needing significant expansion if it was to have the economic resources to handle intervention into Spain and/or Italy.  France has gained the perception of being in the market eurozone crisis crosshairs with the illusion that Germany would be the remaining safe haven, despite its bond yields and CDS also going up.  Standard and Poor's was quick to state publicly that France is more serious in addressing its public debt than the United States and is implementing higher taxes and spending austerity, which is not very encouraging because France is suffering from slowing growth just as Spain, Italy, and Germany are to different degrees. 

The realization that bond buying by the ECB will only be temporary and the EFSF will need more money and the creation of eurobonds, as we have advocated, may actually be unavoidable has caused overnight lending to tighten and eurozone banks to be perceived as more risky sending bank shares down lead by the French banks SocGen and CreditAgricole.  Rumors of a French bank having problems pervaded the market, while the more likely reality was a recognition of broader macroeconomic issues of growth and deteriorating eurozone stability with the euro effectively being shorted and the decline in bank equity values only magnifying the potential need of eurozone banks to raise capital.  At least one Asian bank cut the credit lines of French banks.  The willingness of banks to lend to each other continued to diminish with more pressure on short term lending raising questions of pressure on the long end of lending and the increasing likelihood the ECB would have to do much more to maintain liquidity besides by sovereign debt.

Commerzbank, which is 25% owned by the German government, announced it's profits would decline 93% on Greek debt writedowns and its shares still went up 4.5% on Wednesday, but the illusion that German banking is strong and Commerzbank (and any other German bank or landesbank that discloses risks or funding needs) is a special case continues to be promulgated.  The continuing uncertainty of the eurozone's continued failures in the deepening implementation of austerity and refusal to create a democratic fiscal union with eurobonds is showing itself in the declining equity value of European banks and the need of those banks to raise more capital in what is forming up as a potential global crisis. 

Despite statements to the contrary, after the market in the United States closed Thursday, Spain, Italy, Belgium, and France banned short selling.

The euro was defectively constructed with fiscal union and the means to fiscally adjust eurozone internal trade imbalances legally prohibited creating a monetary union with no fiscal union transfer process as a sovereign nation with fiat money has and monetary union in which all of its sovereign nation members were effectively reduced to nations using and financing sovereign debt in a foreign currency (the euro).  They are reaping the harvest of that crop.

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Thursday, August 11, 2011

Michael Pettis on Why China Needs to Buy United States Debt

 In Michael Pettis' private newsletter which arrived July 31, he discussed two issues: 1) why China needs to buy U.S. debt and 2) hidden debt in China.  I intend to cover why China needs economically to buy U.S. debt in this article and cover hidden debt in China in another article if time permits.

Pettis notes the growing concern over a possible U.S. default, which is unlikely, in China as political positioning since it would be a economically non-event for China.  There has been speculation on whether China would sell its U.S. bonds in Chinese media, but Pettis' is emphatic that will not happen and the speculation is based on a fundamental misunderstanding of how China's purchase of U.S. bonds is a necessary function of its trade policy.  "You cannot run a current account surplus unless you are also a net exporter of capital, and since the rest of China is actually a net importer of capital (inward FDI and hot money inflows overwhelm capital flight and outward FDI), the PBoC must export huge amounts of capital in order to maintain China’s trade surplus. In order the keep the RMB from appreciating, in other words, the PBoC must be willing to purchase as many dollars as the market offers at the price it sets. It pays for those dollars in RMB."

When China buys those U.S. dollars it must put in a market large enough to absorb the money and whose economy is willing and able enough to run a trade deficit.  "This last point is what everyone seems to forget when discussing Chinese purchases of foreign bonds. Remember that when Country A exports huge amounts of money to Country B, Country A must run a current account surplus and Country B must run the corresponding current account deficit. In practice, only the US fulfills those two requirements – large and flexible financial markets, and the ability and willingness to run large trade deficits – which is why the PBoC owns huge amounts of USG bonds."

 If China were to decide it no longer wants to hold U.S. government bonds, there are only four possible choices if decides to purchase fewer U.S. government bonds:
  1. "The PBoC can buy fewer USG bonds and purchase more other USD assets.
  2. "The PBoC can buy fewer USG bonds and purchase more non-US dollar assets, most likely foreign government bonds.
  3. "The PBoC can buy fewer USG bonds and purchase more hard commodities.
  4. "The PBoC can buy fewer USG bonds by intervening less in the currency, in which case it does not need to buy anything else."
 Pettis then proceeds to examine each of these scenarios to demonstrate.  With respect to #1, purchasing U.S. assets rather than U.S. government bonds, "The pool of US dollar savings available to buy USG bonds would remain unchanged (the seller of USD assets to China would now have $100 which he would have to invest, directly or indirectly, in USG bonds), China’s trade surplus would remain unchanged, and the US trade deficit would remain unchanged. The only difference might be that the yields on USG bonds will be higher by a tiny amount while credit spreads on risky assets would be lower by the same amount."  There would be no change in the balance of payments and nothing would change.


With respect to #2, purchasing non-U.S. assets which would most likely be foreign government bonds, of which Europe is the only market large enough, there are only two ways the Europeans could react.  One is the Europeans would turn around and buy a similar amount of U.S. assets and the U.S. and China trade balances would remain unchanged.  Europe, however, might be unhappy with this, because it would probably be transacted through the ECB and cause an increase in the money supply, according to Pettis.  If Europe was to not purchase U.S. assets, then the U.S. imports from Europe must go down that amount while the imports to Europe must go up that amount.  This will actually improve the U.S. position and be expansionary for the U.S. economy by the creation of jobs.  "This is the key point. If foreigners buy fewer USD assets, the US trade deficit must decline. This is almost certainly good for the US economy and for US employment. When analysts worry that China might buy fewer USG bonds, they are actually worrying that the US trade deficit might contract. This is something the US should welcome, not deplore."    For Europe it is another story, because as the US trade deficit declines the European trade surplus must decline while China's remains unchanged.  "This deterioration in the trade account will force Europeans either into raising their fiscal deficits to counteract the impact of fewer exports or letting domestic unemployment rise. Under these conditions it is hard to imagine they would tolerate much Chinese purchase of European assets without responding eventually with anger and even trade protection."

With respect to #3, in which China buys hard commodities, the scenario is the same as above except the exporters of those hard commodities will face the same choices Europe would face.  The exporters can either buy U.S. assets or absorb the deterioration in their trading account, perhaps through a reduction in manufacturing capacity.  This scenario also has problems for China since stock piling commodities is a bad strategy since commodity prices are volatile and that volatility is inversely correlated with the needs of the Chinese economy.  It would be a good investment for China only if China grows rapidly.  This would be the wrong national economy balance sheet position any country could engineer as it would exacerbate underlying social economic conditions and increase economic volatility, which is never a good thing for the poor.

With respect to #4, in which China intervenes less in the currency and does not buy anything else, China's surplus will decline by the same amount and the U.S. trade deficit will decline by the same amount.  The net change on U.S. financing costs would be unchanged, while China's unemployment would rise unless it increases its own fiscal deficit, which is politically undesirable. 


Pettis concludes this first half of his private newsletter with "It's about trade, not capital", which is counterintuitive to many people who do not understand how the global balance of payments works, because "...countries that export capital are not doing anyone favors unless incomes in the recipient country are so low that savings are impossible or unless the capital export comes with needed technology, and countries that import capital might be doing so mainly at the expense of domestic jobs. For this reason it is absurd for Americans to worry that China might stop buying USG bonds. This is what the Chinese worry about."  Despite the U.S.-China trade dispute about China buying U.S. government bonds and the U.S. not wanting them to do so, in reality, if China's trade surplus declines then the U.S. trade deficit declines, which means China buys less U.S. government bonds and, contrary to what you may read or hear, this reduction is purchases of U.S. government bonds would not cause the U.S. interest rate to fall.  To insist otherwise is to say, if a country's trade deficit rises, its domestic interest rates decline which is patently false.  Pettis brings up a standard argumentative response to his observations on trade and capital exports writing "...someone will indignantly point out a devastating flaw in my argument. Since the US makes nothing that it imports from China, they will claim, a reduction in China’s capital exports to the US (or a reduction in China’s trade surplus) will have no impact on the US trade deficit. It will simply cause someone else’s exports to the US to rise with no corresponding change in the US trade balance. In that case, they say, less Chinese buying of USG bonds will indeed cause an increase in US interest rates.



"No it won’t. Unless this other country steps up its capital exports to the US and replaces China – which is pretty unlikely, and which anyway would mean the same amount of foreign purchasing of USG bonds – it must cause a reduction in the US trade deficit."
The basic point is a reduction of Chinese exports to the U.S. would be matched by increase in the same amount of exports to the U.S. from a another foreign country which would then have the impact of either lowering that foreign country's exports to other countries (if it enjoyed full employment) or a rise in imports or the foreign country (if it has unemployment).  What Pettis leaves unconsidered it what would happen if there is a global contraction.

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Wednesday, August 10, 2011

Yves Smith: S&P Broke Law in Leaking US Downgrade

Yves Smith at NakedCapitalism wrote that the S&P leaked information of the US downgrade prior to the public announcement to banking clients on Thursday and hedge funds on Tuesday with Twitter alight with the information Friday morning effectively allowing the banks and hedge funds to pre-trade on the information, which was not publicly released until after the market on last Friday (8/6/2011).  Such an act is specifically prohibited under SEC Rules.

I have been unable to find any other news coverage or discussion of this allegedly illegal conduct except, interestingly enough at Fox News in an article by Charlie Gasparino and a video of Gasparino on Fox News disclosing the leaks by S&P.  EconProph is the only other source commenting on this and extensively quoted from Yves Smith's article.

This only reinforces my previous questions as to whether S&P has a political agenda in combination with other major players in the financial sector.

Given the failure to bring prosecutions against the bankers and ratings agencies who provided us with toxic derivatives and deadly mortgage fraud as well globally risky trading activities --- all of which were profitable for those financial companies, including the ratings agencies, I am not going to hold my breath that Standard and Poor's will suffer from this allegedly illegal conduct as the financial sector is evidently too important and special to go to jail.  Jail is for people who protest social injustice.


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Who Owns United States Debt?

The Australian economist Bill Mitchell has been following data sets to analyze US debt and who owns it and, as of March 2011, the largest owner of US debt is the US government, which owns 41.7% (including the FED which is not an actual government agency but a private bank authorized by Congress) of its own debt.  China is third at 8% behind private domestic owners at 26.9%.  He also provides in the link above not only a pie chart, but a succinct macroeconomic explanation of sovereign debt and how it is not like a household (you and me) or a city, county, or other form of regional government (such as the State of Illinois) which are revenue constrained but have a guaranteed revenue stream (unlike you and me) in taxes and fees which make it easier for them to borrow.  Since sovereign debt is not the same as household debt macroeconomically, it is very counter intuitive for most people no matter how educated they are.  Consequently, there is much useless discussion in public debate from individuals on both sides of the political abyss who do not understand what they are talking about.

Mitchell also has come unrelated comments at the end on the UK social unrest including the belief that it would be possible to forecast social unrest  by mapping the failure of governments to provide services, good education, and jobs.


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Large UP and Down Market Days Since 1950

Calculated Risk has published two tables showing the largest one day percentage market declines and one day percentage market increases and what the market looked like six months later.  If you are a believer in perspective and appreciate historical data you need to study those tables at Calculated Risk in the links above.  They will not tell you what the market will look like six months from now, but if you use the information and keep your eyes on growth in the United States and globally, you will have a better concept on how growth or the lack of growth will affect the market long term and on day to day news and economic data releases and periodic scheduled reports.

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FOMC and the Thundering Herd

Since this last weekend, I have been privately commenting that the Tuesday meeting of the Federal Reserve Open Market Committee (FOMC) would little to say other than they were continuing to watch and are prepared to act.   There have been no significant changes in liquidity needs.  There is no need to buy US Treasuries with short tern yields negative as investors pay for safety.  They cannot do anything to create jobs as that is primarily a fiscal policy issue and the failure of Congress and the President.  I also said the announcement on Tuesday was likely to affect the market and, if I was the FED, I would make the usually very carefully worded announcement after the market closed to give the market overnight to digest it, because there is nothing more stupid than cows in a nervous herd.

The FED statement was as expected, although longer than usual, with an extension of low interest rates into 2013, no changes in policy, and a change in language acknowledging slower recovery (growth) over coming quarters than previously estimated.  These were obvious and to be expected, although three members wanted to essentially keep prior statement language.  The FED made this at 2:15 eastern time during the market, which almost immediately swung down from positive action as the cows failed to stop and think --- and the herd took off in a storm of fear.

The Tuesday market was volatile the whole day going up and down and up, which is not a good indicator of future market action.  The market ended up 429 points at the end, as some of the cows woke up after the cowboys started buying and the realization that the FED was only stating the obvious about the reality of slowing (a soft word for declining) growth.

The economy has an increasing amount of uncertainty in it to the point that statements of truth are disruptive.  Rather than deny truth and reality, we need to increase certainty and growth by creating jobs which provide the confidence for people and corporations to buy.  Creating jobs requires increased sales in the private sector and spending in the public sector to directly provide job creation and sales.

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Monday, August 8, 2011

Market Reacting to Declining Growth Not S&P Downgrade

As I have written extensively since August 3rd, the stock market is reacting to the problems and data confirming that the United States, Europe, China, and the Global economy is slowing down significantly.  The market is not reacting to the S&P downgrade of United States debt, which was not economically warranted and was based on political perceptions and a corporate agenda. 

If the stock market was reacting to debt problems, bond prices would be declining as well as equity prices.  That is not happening.  Bonds are stronger today while the stock market is showing the weakness of being overvalued in a global and national economy of declining growth.  We have warned readers, newsletter recipients, and clients about the overvalued market and growth problems for an extended period of time. 

Those who have not planned for investment growth consistent with risk tolerance, age, and quality of life needs with an individualized defensive growth diversification and limited losses on ETFs and stocks did not listen to me or did not take my advice.

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Sunday, August 7, 2011

Feeds of Blog Posts

Evidently feeds of six blog posts after July, 2011 did not feed.  I believe the problem has been corrected and Feedburner indicates a valid update ping.

The six posts were:

S&P's Rating Folly, Part 2: Grading Political Will

Links 8/6/2011:Eyes on Growth

Unemployment - July 2011: Less Workers=Less Unemployed

Links 8/4/2011: Eyes on Growth

Eyes on Growth: Update Links 8/3/2011

Keep Your Eyes on Growth: United States and Global  Are Declining Not Slowing


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S&P's Rating Folly, Part 2: Grading Political Will

 In April, we thoroughly covered how a threatened S&P downgrade of US debt would be economically meaningless to a sovereign nation with debt issued in its own currency.  The April S&P warning fueled the political divisiveness of public debate placing the S&P directly in the political game as a player influencing political debate.  Credit ratings agencies are federally licensed and regulated businesses as NRSRO's (Nationally Recognized Statistical Rating Organizations) and they are not lobbyists, although they escaped financial reform after the Global Financial Crisis which they helped precipitate with misleading credit ratings for companies that failed and investments which were actually toxic.

On Friday, S&P downgraded United States debt from AAA to AA+ despite a $2 trillion S&P error in their analysis.  Economically, this is meaningless.  You only have to look at the low yields on Japanese bonds after losing their triple A credit rating almost ten years ago.  Is the S&P engaged in a political agenda contrary to its regulated purpose?

It appears from the S&P report that the primary concern was the lack of political will by elected representatives and officials to come to a reasonable agreement prior to a repetitive political drama over extension of the debt ceiling.  The job of the S&P, as a NRSRO, is to provide an independent statistical analysis of financial credit worthiness which can be relied upon by investors and they have not demonstrated any compelling analysis in the report.

Felix Salmon has noted that default is an act of political will not an econometric decision and that "...it’s fair to pin the lion’s share of the blame on the existence of the debt ceiling."  The political debate over the debt ceiling was vicious and destructive and exactly why Section 4 of the 14th Amendment to the U.S. Constitution was passed after the Civil War.  The debt ceiling law is not only destructively counter productive, it is legally superfluous.  Conservative economic commentator, Megan McArdle, went so far in noting the lack of political will in the debt debate and the obvious necessity to increase the debt ceiling that she said, "...I'm afraid I think that the lion's share of the blame goes to the GOP, which escalated to this completely unnecessary showdown, and then gave up any hope of a grand bargain because it would have required some revenue increases."  Given that President Obama believes, and has voted in the past to not raise the debt ceiling as a Senator, in deficit reduction and aided and abetted the deficit hawk elements, although he recognized the need for revenue increases, he appears to be getting off light in the lack of political will department, which is unfortunate since he has demonstrated little political will since assuming office.

Did the S&P downgrade United States debt on the lack of political will in the political process in the United States?  On page four of the report which is linked above, the S&P states "We have changed our assumption on this because the majority of Republicans in Congress continue to resist any measure that would raise revenues, a position we believe Congress reinforced by passing the Act."  They are saying the Republicans in Congress lack the political will to to do what is reasonably necessary to govern in a fiscally responsible manner consistent with the economic needs extant.  The mainstream media has ignored this sentence in the report, because it exposes the political charade of the debt ceiling debate as economically incompetent wasted demagogic rhetoric on the debt rather than one of governance.

The S&P, however, used these same tactics, in combination with Moody's, in the 1990's in Canada to assist financial interests in slashing unemployment insurance and health care just as they used their power in 2000 to squash mortgage lending reform.  As the economist Rajiv Sethi argues, perhaps, it is time that the credit ratings agencies, which were so instrumental in profiting from credit ratings which were so unreliable they directly contributed to the Global Financial Crisis, be stripped of their legally protected status and monopoly power and made to compete on merit of work with full legal fiduciary liability to the investing public in a democratic society.  It is coming to a decision point about whether we are a corporatist market state or a republican democracy.

Jesse's Cafe Americain observed that Friday's market showed visible signs of movement of knowledge of a hidden agenda with respect to the expected S&P announcement, as Felix Salmon and Megan McArdle also mentioned, and concludes that the class war will only intensify now as governance is being cast aside.

Futures at this point in time are mixed with the DOW positive and the Nasdaq and S&P 500 negative.  The German Dax futures are negative.  The Middle East stock markets on Sunday were down with the Israeli stock market down 6.99% (TA-25), supposedly as a reaction to the US downgrade.  Any down movement on Monday solely attributed to this downgrade would be foolish herd behavior and soon recognized as such.  However, the eurozone meeting of Central bankers is this Sunday night and the professional market will be watching what the ECB does on Monday.  Here are the economic reports, including retail, household debt, and FOMC meeting (which is expected to result in the FED saying they are watching and waiting), which will come out this week and could potentially impact the market.


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Saturday, August 6, 2011

Links 8/6/2011: Eyes on Growth

US employment saw a modest monthly increase which should only take a little over 74 years to get unemployment down to 5%.  Basically, the July report showed a decline in the working population which is translating itself into a decline in unemployment.

The employment report
Part time workers and duration of unemployment
Employment to population ratio has fallen to 1953 levels
as jobless benefits end, recession looms
still mystified over unemployment (Menzie Chinn)

study: unions decline increases wage inequality

Jobs report means FED will announce next week they will think about it for awhile (Tim Duy)

Inflation, what US inflation?(Paul Krugman)

Study: tax flight by businesses is a myth

James Galbraith on why economist's will not discuss fraud in financial sector

another explanation of why debt-to-GDP ratio is mathematically incorrect

Unofficial US problem bank list down to 988 banks
The Bank of America deathwatch
Bank of America has no clue what its mortgage losses will be

RBS losses on Greek writedowns
How different European banks treat Greek bonds
Dexia losses most in history

Balanced budget amendment in US would defeat economic purpose of government (Simon Johnson)
Austerity defeats the purpose of government which is to serve the people (Bill Mitchell)

Top ten misconceptions of eurozone crisis (take this with a critical grain of salt -- some people do not have the courage to default correctly if they prefer to be indentured servants for generations)

The contagion of bad ideas (austerity & protecting financial companies rather than citizens) since the Global Financial Crisis is destructive of economic fundamentals (Joseph Stiglitz)

Is the eurozone lost in the depth of structural reforms and the growth destruction of austerity (apply critical analysis to this piece)   (Daniel Gros)

Will wage cuts with debt reduction decrease prices and make Greece more competitive in time to survive?  Oh! the pain, the pain!

the liquidity problems of the eurozone without a central bank acting as lender of last resort = inevitable failure (Edward Harrison)

The argument for eurobonds issued by ECB, which has no authority to issue bonds (Yanis Varoufakis): why is the EIB not being considered as Rob Parenteau has suggested? Is it because the EIB is an investment bank run by investment bankers who do not understand a societal role?

Germany is in denial that it is a member of a monetary union

Meanwhile, Ireland tries to manipulate the price of distressed property owned by NAMA


The FED and the ECB  are both behind the learning curve of debt deflation (Tim Duy)

Italian and Spanish growth slow as austerity pinches
sluggish growth threatens recovery

Why Italy? Why Spain? The EFSF will fail as long as the toxic debt-to-GDP ratio lives in its heart (Yanis Varoufakis)

Portugal's austerity fails to reduce bond yields (does the market understand it is hard to make interest payments if growth is impaired by austerity?)

Europe's plan will not cut Greek debt

Austerity and public safety in Athens

Spain cancels August 18th bond auction

Greece cannot recover on innovation because research, education, and innovation require spending



The Parade of the EU and ECB in the celebration of a Failure of Political Will as demonstrated this past week:

Trichet's purchase of Portuguese and Irish bonds fails to help Italy and Spain
ECB's shock-and-awe wimps into whimper
temporarily throws Italy and Spain to the wolves
the international markets react impatiently
Barroso constructively suggests reconsideration of EFSF and receives anger in return
Italy must cut services to people as condition for ECB to help
Italy will accelerate austerity and balance budget in 2013 (want to bet on the plunge in growth into recession?) to get ECB help
ECB agrees to buy Italian and Spanish bonds next Monday


Economically knowledgeable people internationally have been urging  to buy Spanish and Italian bonds to constrain the market and provide support to their ability to make their debt payments in the future since they have no ability to exercise the normal sovereign nation's escape valves through fiat currency depreciation, because they use a foreign currency (euro) of a monetary union with no fiscal transfer mechanism to correct current account imbalances resulting from trade lack of competitiveness within in a currency union.

But these very same economically knowledgeable people also know this is only a very necessary stop gap and very temporary if the eurozone will not start acting as if all of its citizens are members of a single union:

We have seen this before (Cullen Roche).
It is incredibly difficult to stabilize finances in a debt-deflation spiral (Tim Duy) if they cannot print their own currencies.

S&P downgrades United States to from AAA to AA+ despite $2 trillion S&P error is their analysis.  Economically, this is meaningless.  You only have to look at the low yields on Japanese bonds after losing their triple A credit rating almost ten years ago.  Is the S&P engaged in a political agenda contrary to its regulatory constraints?


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