Economy & Market Week Ended 12/4/2010

Our article on the Irish bailout by the EU and the IMF and how it came about entitled "Ireland's Indentured Servitude" was republished by Credit Writedowns and then picked up by the Business Insider.  Here is the original  article with the fully embedded sources.  I am in the process of writing another piece on "Surviving the Euro" which deals directly with the structural problems of the eurozone, what needs to be done, and why it is not being done.  These two articles have eliminated a large amount of economic information from this commentary, but there is more to Europe and why we should be watching it as well as China.

We are seeing a replay of last Spring with sovereign debt problems in Europe and efforts by China to raise interest rates and tighten credit.  Both the European and Chinese stock markets have declined similarly.  To add to the similarity with last Spring, the U. S dollar is appreciating again.

The threat of crisis contagion in Europe's appears to be alive and well however costumed, but no political sweet talk and smoothing over seems to have averted eyes from Portugal and Spain.  In fact, government and corporate bond markets continued to sell off across Europe putting pressure on even core eurozone countries.  Even the German bunds became infected.  The failure of the EU and ECB to act in a timely fashion to support the eurozone countries struggling to maintain liquidity in the face of growing international uncertainty as to the willingness of the ECB and EMU to defend the euro in a credit crisis, particularly with Germany and France sandbagging a monetary union without a fiscal mechanism against an eventual tsunami rather than a flood.

While the ECB's Trichet, after the governing board met, tried to calm the market by saying the euro was credible and at first only hinting about buying bonds, which is a contentious issue in the eurozone, while in fact evidently buying Irish and Portuguese debt.  This only creates confusion and uncertainty internationally, while he is forced to play to the internal politics of eurozone member nations, which do not favor the shared costs of normal monetary crisis tools nor will they authorize the ECB to use the monetary tools normally available to a fiat currency central bank.

As Felix Salmon has argued, the problem with Ireland's banks is not artificial risk reduction or Basel capital requirements.  But the failure of Ireland to recognize the full extent of toxic assets on the books of the Irish banks and the extent of mismanagement at Anglo Irish Bank and to quickly strip them out led directly to an over investment in the Irish banks by the Irish government, when they inappropriately, but at the urging of the EU and ECB, made private bank debt public debt.  In turn, the ECB demanded a bailout when it felt the level of ECB and Central Bank of Ireland loans to the banks had reached a dangerous level without direct intervention.  This only increases the speculation that Greece, Ireland, Portugal are essentially insolvent and, as the credit and currency crisis spreads, other eurozone nations will follow.  Willem Buitler, chief economist at Citigroup, opined that not only Ireland, Greece, and Portugal insolvent but Spain will be also when the weaknesses of its banks are recognized as well as the potential threats of political instability and high debt levels in Belgium and Italy and the ESFS rescue fund needs to be much larger in the neighborhood of 2 trillion euro (about 4 times larger).  At the same time the eurozone's growth is slowing down to about 1.6%-1.5%for next year as austerity programs push deteriorating conditions.

Spain is expected to grow only .7% next year rather than the 1.3% the Spanish government is projecting and to continue to lose jobs.  Spain continues to assert its banks are healthy and they are on track in their austerity program, but they have also started to point the finger of blame for the current uncertainty at France and Germany.  Zapatero said that the eurozone needs a common economic and fiscal policy, which is true, but this is interpreted in Germany as more money Germany has to contribute to the monetary union from it has particularly benefited economically.  Some bank analysts are attributing Spanish banks seeking less ECB loans as an indication of a shrinking loan book and the use of market repo funding.  Spain's central bank has imposed more conservative regulations and pushed savings banks consolidations, but some of Spain's mid-sized banks remain vulnerable to interbank lending problems.  While the austerity program continues to damage Spain's economy, the government continues to push austerity, defend the strength of Spanish banks, and is pursuing sovereign wealth funds to invest in Spain.  The pressure on Spanish bond yields put pressure on Italian bond spreads also.  Italy, which has one of the larger economies as a G8 country, has recognized the danger and urged the ECB to buy Spanish and Portuguese bonds in order to protect its own bond spreads as Spain is the keystone in this credit and currency crisis to the core eurozone countries.  Given Italy's debt and large economy, the eurozone cannot afford the credit crisis to spread to Italy.

While Portugal is being pushed to tighten its budget and reduce debt and the report of the Central Bank of Portugal, which is pushing for more austerity, demonstrates how fiscal austerity does not work during a debt deleveraging cycle.  While Greece's austerity program and EU/IMF bailout is on track, the amount of debt to be repaid in 2014-15 (about 110 billion euro) is too large without either an extension or restructuring as I have said in the past.  S&P is weighing whether to downgrade Greece's long term debt if the bailout rules threaten private bond holders of Greek debt.

Germany continues to question and beat its head against the wall by claiming liquidity will not help the credit and currency crisis and risks putting too much money into the economy, despite German bank and insurance company exposure.  If Spain starts to wobble, Germany will have some very harsh realities to face.  Spain is a prisoner of the euro.  German banks are heavily invested in Spain and contributed to its real estate bubble.  The euro created a significant economic advantage to Germany in exporting to other eurozone countries as the result of the exchange rates established within the eurozone.  As such, the potential crisis brewing in Spain was made in Germany.  The policies of Germany today are similar to the policies which lead to the German currency crisis of 1931 and financial  failure which deepen the Great recession globally and the rise of right wing fascism.  Germany's opposition to a euro bond and a fiscal mechanism within the eurozone is based not only on its shared cost but internal politics within Germany where the word for debt also means shame.  The refusal to act in the common good to stimulate the economies of the eurozone and bring them into closer harmonization is only increasing the threat to German banks and, hence, to Germany itself and the unthinkable.  The Irish crisis is consequently a huge test for the eurozone.  When lowering fiscal deficits becomes the priority in minds it denies the stagnation of fiscal austerity excess and higher interest rates as opposed to fiscal retrenchment and economic investment stimulus with lower interest rates which inspire business and consumer confidence which includes, but is not dependent, on exports.  Fear of debt becomes suicidal.

China's leaders have decided to pursue a prudent monetary policy while maintaining a proactive fiscal policy in acknowledgment of a need to promote a quantitative tightening which will require a slow step by step process which will require assessing its positive and negative impacts on disparate sectors of the Chinese economy as hot cash inflows continue.  China has had an active monetary program to sterilize capital inflows and kept inflation down which has made approximately 25% of the money supply illiquid, which means China's money supply is actually smaller than it appears. It is controlling interest rates with the spread between lending and deposits of 3%. In order to reduce its foreign cash reserves from its trade surplus, it  buys U.S. Treasuries by selling U.S. dollars which appreciates the yuan while also helping the United States depreciate the U.S. dollar and maintain a low interest rate economy.  The relationship between the United States and China is very mutually beneficial as well as entangled.  On the first of December, China's leading indicator signaled a warning it may be ready for a stock market downturn and take commodities with it.

The financialization of commodities with derivatives and exchange traded (index) funds has created volatility in the market with more commodity price risk for index funds and increased correlation between stocks and commodities.  At the same time closet indexing by "actively" managed mutual funds brings down the average performance of those funds and of active mutual funds as a whole.

The IRS has issued guidance on in-plan Roth rollovers for qualified plans which have a Roth contribution program.

According to the Federal Reserve Beige (anecdotal) Report, the economy was showing slow improvement in most areas, although housing remains depressed and real estate and construction remains at low levels.

The ISM Manufacturing report showed new orders to inventories ratio going negative at only <.1>, but it is something which should be watched as it has a good track record of turning negative prior to economic downturns.

The employment report for the month of November was released and unemployment rose from 9.6% to 9.8% with only net increase of 39,000 jobs when 115,000 had been expected.  Discouraged workers remained unchanged at 17.0%.  If we still were using the 1980's calculation for determining discouraged workers, it would be approximately 23%. The participation rate remained flat at 64.5%, down from 64.7, indicating people are not rejoining the work force.  Unemployment remains cyclical and not structural, although there is a growing number of 24-35 year old unemployment, more male than female.  I maintain there is the possibility that unemployment for the overthe over 55 (maybe 50) may be structural because they have earned too much money in the past and age discrimination is rampant.  The NFIB small business survey will not be out until December 14th, but advance information indicates that employment picked up to .01 from .00.

In John Hussman's weekly commentary, 11/29/2010, he concentrated on financial reform, particularly referencing the work of Rudiger Dornbusch, who said when you have bad banks you clean them up or they go only one way --- worse.  Cleanings up bad banks is essential to achieving a well functioning economy.  He notes that banks reliance on short term deposits is worse than it was prior to the financial crisis with time deposits declining for seven straight months and the cost of funding assets has dropped below 1% as banks concentrate on the shortest possible liabilities in order to earn the highest interest spreads.  This indicates that, while the economy's monthly progress may be encouraging, the problem is just being kicked down the road.  While the economy is likely to expand 2.3% annually over the next four years, the output gap implies an expectation of 3.8% annually.  A 3.8% real GDP growth would imply a 1.9% growth in jobs or about 200,000 per month or 2.5 million per year when we have lost over 7.5 million jobs.  With respect to the austerity programs in Europe, he said, "Unfortunately, imposing austerity on a weak economy typically results in further economic weakness and a shortfall on the revenue side."  In the U.S., he points out that there is a difference between surface improvements and the latent problems of banks, which as a result of the suspension of the FASB mark-to-market rules and the large amount of mortgage toxic assets on their books, having balance sheets which investors cannot fairly assess the banks real financial condition.  With respect to the market, he notes that in recent weeks he has noticed "risk on" and "risk off" days in which entire classes of securities are treated as if they were a single object with "risk on" days advancing financials, cyclicals, commodities, and speculative issues while the dollar weakens and "risk off days declining with relative strength in in consumer, health, and high quality stocks while the dollar strengthens.

Tobin's Q Ratio indicates the stock market is overvalued by historical standards 49% by arithmetically adjusted methods and 62% by geometrically adjusted methods.

Market: No banks failed this week; the unofficial problem bank list is 919.
                      DOW/Volume                             NASDAQ/Volume
Mon:           <35.91>/up 115.6%                       <9.34>/up 170.5%
Tue:             <46.47>/up 64.9%                        <26.99>/up 30.7%
Wed:           249.76/down 26.7%                        51.20/down 7.9%
Thu:             106.63/up 0.3%                              29.92/down 3.1%
Fri:                19.68/down 18.9%                        12.11/down 11.2%

Total             293.69                                           56.90

Mon: Oil up $1.97 to $85.73; Dollar stronger; despite large volume, indexes were still below average volume; market is still worried about Europe's financial stability; market pared losses during the day; dollar stronger despite QE2 as the result of declining euro.

Tue: Oil down 1.62 to 84.11; Dollar weaker but stronger against the euro; volume above average; Google down on EU antitrust investigation of favoritism in its search rankings; euro at two month low; eurozone bond spreads swell.

Wed: Oil up 2.64 to 86.75; Dollar weaker but stronger against the yen; big surge on lower volume as the big money stays on the sidelines; economic news viewed as growth; oil supplies were up 1.1 million barrels, gas supplies were up 600,000 barrels, and distillate down 200,000 barrels; Europe calm on ECB & IMF bailout hopes for Ireland. 

Thu: Oil up 1.25 to 87.00; Dollar weaker but stronger against the pound; market ignores jobless claims and seizes on pending home sales being up; weekly jobless claims were up 26,000 to 436,000, 4 week moving average was down 5750 to 431,000, and continuing claims were up 53,000 to 4,270,000.

Fri: Oil up 1.19 to 89.19; Dollar weaker; market ignores horribly disappointing November jobs report; Dow ended higher after being down most of the day; Nasdaq reached a new high for year; some market analysts would consider this a confirmed market uptrend but I do not like small gains on down volume.

United States:  Bullard (St. Louis Fed President) expressed concern that the Consumer Financial Protection Bureau is funded by a fixed percentage of central bank expenses which may have no direct relationship to the functional needs of the Bureau.  What would happen if market conditions change?  The mission of the Bureau is significant and potentially broader than regulators current functions.  Interestingly enough, Congressional republicans are preparing to confront Elizabeth Warren who wants transparency and accountability in the financial sector and who has been charged with establishing and setting up the Bureau, by posing the Bureau as big government.

Hoenig (Kansas City Fed President) gave a speech in which he said the financial institutions have become bigger as the result of "too big to fail" subsidies and, as such, they have become too big to succeed and a version of Glass-Steagall needs to be enacted creating smaller and more competitive financial institutions which would not be systemically dangerous.  One economic paper has proposed a macroprudential tax on borrowing during boom times to fund a bailout mechanism as a means of capturing the external costs borrowers impose on society and reducing moral hazard by reducing the incentive to borrow when bailouts in systemic crises are assumed.

A Bank of America employee admitted under oath that it was routine for Bank of America to keep notes after they were sold.  One fact of the servicer driven foreclosure mess is that a significant number of foreclosures involve people who have made every single mortgage payment.  Is this the perfect crime?  It happens with servicer errors and fraud.

The SEC is reviewing SEC official's testimony before Congress for violations of federal law.

Economic disgust with President Obama's alliance with deficit hawks during a high unemployment slow and tenuous economic recovery which is vulnerable to economic shocks continues to grow as his statements and arguments are picked apart as he takes advice from people who have no competent understanding of economics and the type of stimulus needed in a balance sheet recession.  Tax cuts for the wealthy, which are being pushed by deficit hawks, will have little impact on unemployment and aggregate demand and will substantially increase the deficit.  The Bush tax cuts did not promote economic growth and Bush's economic advisers knew full well the cuts would yield a revenue loss.  Changes proposed for Social Security amount to the bottom line of workers will have to work longer because the rich are living longer.  An alternative to the Deficit Commission recommendations, which appear will not receive Commission enough votes to report to The President and Congress, has been published by a group in combination with the Economic Policy Institute, entitled "Investing in America's Economy" which at least is emphasizing the need for investment to stimulate the economy although it has little chance of a rational debate.

President Obama also proposed a Federal employee pay freeze for the next two years.

Yellin, Vice Chairman of the Fed, gave a speech on "Fiscal Responsibility and Global Rebalancing", in which she said the United States economy is different from emerging economies in that with low inflation and slow economic growth, the United States needs to focus on fiscal consolidation long term and concentrate on near term economic stimulus which will support recovery.  She said Fed policy is not a panacea for weak U.S. growth and would be more effective if combined with near term fiscal stimulus.

The Federal Reserve finally released information on who received $3.3 trillion in emergency lending during the financial crisis which showed that the largest U.S. and international banks received most of the money.  Despite the legal requirement under the Dodd-Frank bill, the Federal Reserve refused to release a list of collateral pledged by recipients of $885 billion.

State tax revenues increased 4.9% in Q3 and 2.6% up vs year age, although still 7% below two years ago, with only six states out of 48 not showing improvement.  Illinois sales tax revenue was only up 0.1%

Oil consumption is up 4.9% in September, which is the biggest yearly gain since June '04 and Q3 is up 4.1%, which is the highest demand since Q2 2008.

The ADP private employer survey showed an increase of 93,000 jobs in November (the November BLS report was only 39,000).

U.S. productivity was up 2.3% Q3 (expected 2.4%).

16.3% of consumers used credit cards over Black Friday weekend vs 30.9% last year.

The Case-Schiller 20 city house prices were down 2.0% September (July-September) Q3, after being up 4.7% in Q2.  The expected housing decline has begun in earnest.

Vehicle miles driven were up 1.5% September vs year ago with 3.7 billion miles driven.

Dallas fed manufacturing survey showed production index up November to 13 from 7; new orders up to 9.1 from <4.3> --- first month positive in six months; capacity utilization was up to 9.9 from <2.3>.

Bond mutual funds had $4.33 billion outflows last week for the first time since December 17, 2008.

Consumer bankruptcy filings were down 13.3% in November to a 9 month low.

Worker productivity was up to 2.3% annualized Q3.

GM is carrying $30 billion in Goodwill on its balance sheet and all GM IPO proceeds will go to pay U.S. Treasury and pension funds as well as $2 billion from cash.  Its Q3 SEC filing said disclosure controls and procedures and internal controls were not effective and could materially adversely effect financial condition.

Chicago PMI (Purchasing Manager's Index - wholesale prices) was up to 62,5 in November from 60.6, which was more than expected.

The ISM manufacturing index  was down to 56.6 in November from 56.9; new orders were down to 56.6 from 58.9.

PC sales estimate was cut to 14.3% for year from 17.9% (September) with 2011 sales estimates revised down from 18.1% to 15.9%.

GM vehicle sales were up 21% in November vs year ago; Ford was up 24% excluding Volvo sale; Chrysler was up 16.7%; Toyota was down approximately 3%.

Big Lots Q3 EPS was down 15% while sales were up 2%.  They said they were hurt by strong discount competition and rising credit and processing fees.

Pending home sales were up 10.4% to 8% (expected 0.5% down).

The ISM service index was up to 55 in November from 54.3.

Retail November same store sales were up 5.3%.

Foreclosure sales were down 25% Q3 vs Q2.


U.S. manufacturing new orders were down 0.9% in October for the first drop in 4 months (expected down 1.3%) on weak durable goods demand.

The ECRI WLI (Weekly Leading Indicators) was up to <2.4> from <3.3> the prior week.

International: France is joining Ireland and Hungary in tapping pension funds to pay debt.

European insurance companies are looking at buying 1 billion euro of distressed debts from Irish banks.

Canada's economic growth slowed to 1% in Q3 from 2.3% in Q2 despite corporate capital spending being up 19.2% vs year ago (expected 1.5%); blamed strong currency restraining exports and boosting imports, of which the import of equipment and machinery was up 6.3%.  Inventories were also up.

The United Kingdom's Chancellor of the Exchequer said the UK was vindicated in not adopting the euro.  The eurozone credit and currency crisis threatens the UK's recovery as it attempts to rebalance to a positive net trade and investment balance if the credit crisis boils over into the real economy and axes Continental demand.  When the government's austerity program flounders and if  its export projected recovery is not sufficient, it has no Plan B to stimulate the economy.  The UK recovery is the weakest since World War II according to their Office of Budget Responsibility, which is independent, due to the continued credit crunch and its austerity program.

Investor's were incensed at the UK Financial Services Authority (FSA) refusal to release the report on the Royal Bank of Scotland's (RBS) near collapse which exonerate senior RBS managers.

UK students are not only being asked to pay educational fees which are increasing approximately 300%, but to also pay a graduate tax.  This is causing demonstrations in protest.

European bank stresses have reached the highest levels since last June.

Putin is calling for more Russian and German cooperation in forming a Russian-EU free trade zone.  This is something to watch, because Germany needs new export markets and energy imports.  Russia has energy to export which it is not reluctant to use as an economic weapon and it wants into the EU market economically and to have more influence over NATO.  This would also be consistent with how Germany raised international tensions and uncertainty in 1931.  The Wikileaks cables disclosed a Spanish prosecutor was adamant he had evidence that the Russian government is thoroughly infiltrated if not controlled by Russian organized crime.

The Irish bailout will be 845 billion euro ($115 billion).

Greece will have until 2021 to repay its 110 billion euro bailout at 5.8% (up from 5.5%) as it got extension from 2015.

An Italian bond auction was weakly covered.

India's GDP was 8.9% September annualized (expected 8.3%).

Walmart is paying $2.3 billion for 51% of South Africa's Massmart.


Eurozone growth for 2011 is estimated to be 1.5% down from 1.7% (expected in 2010) with Germany's estimated to be 2.2% (2011) down from an expected 3.7% in 2010.

Eurozone Q3 GDP was up 0.4% not annualized vs Q2.

China's institutions spent 519 billion yuan ($78 billion) in October to absorb foreign exchange inflows, which were the third largest ever and almost double September.

China PMI was up to 55.2 in November from 54.7.

Japanese output was down 1.8% in October.

Eurozone unemployment was up 0.1% to 10.1%; down in France, up in Italy, and flat in Spain and Germany.

Australia Q3 GDP was up only 0.2% (1.1% Q2) below expectations of up 0.5% as the result of higher interest rates.

UK house prices were down0.3% in November.

Portugal 1 year debt sold at 5.28% vs 4.81% two weeks ago.

Thailand's central bank raised interest rates 25 bps to 2% to curb inflation.

German retail sales were up 2.3% in October, which was the best since January '08, but still down 0.7% vs year ago.

Youth unemployment in France was up 0.8% to 25% for ages 15-24 (European average is 20.1%) with overall unemployment at 9.7% (10.1% for EU).

Pepsico is trying to buying a majority stake of Wimm-Bill-Dann in Russia.

Eurozone's service sector PMI was up 2.1 November to 55.4 and October eurozone retail sales were up 0.5%.

Brazil raised bank reserves to curb inflation.

Spain moved up pension reforms, hiked tobacco taxes, and trimmed wind power subsidies to facilitate budget deficit reductions.

After Trichet (ECB) made no mention of plans to increase purchases of sovereign debt, the euro fell.

Germany, on Wednesday, struggled to sell its bonds.

The Spanish bond auction was well received.

The IMF urged China and Hong Kong to implement measures to rein in property bubbles disconnected from fundamentals by increasing real interest rates, higher carrying costs of ownership (property tax), and China should also broaden financial market development to alternative investment vehicles from housing.

China will invest $1.5 trillion over 5-7 years to transition from manufacturing cheap goods to high tech products.

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Economy & Market Week Ended 11/26/2010

Ireland was pushed towards a bailout not of its own choosing as the European Monetary Union and the EU sought relentlessly through the ECB to protect European and other international banks on the impressed bodies of the Irish people.  There was so much information and speculation as to what would or could or should happen from default and retreat from the euro to years of austerity, low economic growth, and debt, as the result of Cowen, the Irish head of government having been persuaded by Trichet, the head of the ECB, demanding in 2008 to not let the Irish banks fail no matter what had to be done, inappropriately creating public debt out of private debt in an amount that overwhelmed the Irish government's ability to fund without its own currency or direct EMU participation.  I found myself spending over parts of two days just trying to organize the week's information and finding myself with the awareness that I would have to try to write three different articles at the same time.  The Irish politicians, knowing the government's days are numbered, have worked over time as lawyers tried to justify the government investing new money in the Irish banks without making senior bond holders share the burden as would have happened in a private bankruptcy reorganization.  I find this argument of pari passu, the senior bond holders having the same status of the depositors, under the Irish Constitution to be not worthy of consideration as the the depositors were covered by insurance and only the amounts above insurance would have been subject to the same treatment as the senior bond holders, who are predominantly European banks.  The Irish politicians sought to dress up and disguise any forthcoming bailout as anything else, while knowing full well that the foolish attempt to assume the private debt of the Irish banks without adequate knowledge of the extent and value of their toxic assets was doomed to failure.  Meanwhile, the IMF drones had descended and, combined with EU operatives and ECB coercion, were busy designing what Ireland must do in their usual elitist attitude oblivious to the rights or needs of the Irish people.  The IMF and EMU are ignoring the political fallout and the inevitable collapse of the Irish government and new elections after the December 7th budget vote --- and we in the United States know how disastrous the 7th of December can be --- as the EU and the IMF essentially run the economy of Ireland for the next three years, without respect to the will of the Irish people, preferring to protect and serve the interests of the European private financial institutions (exposure information is mixed, but bank by bank breakdown would seem to indicate Germany is the most exposed followed by the UK which I will show in another article) with continuation at any cost of the Zombie Irish banks.  It appeared that about an 85 billion euro bailout was being designed and that turned out in this following week ending 12/3/2010 to be the case with 35 billion to go to the Irish banks of which 17.5 billion euro was to be taken from the Irish pension funds with unknown interest rates for the IMF and EMU loans which appeared to average around 5.8%, but the IMF loan was supposedly in the 3.5% range which had many people asking if the EMU was demanding over 7%, despite the bailout being financed on the back of the Irish citizenry in the form of reduced services and social safety nets and increased taxes.  One commentator equated the bailout with an economic occupation of Ireland forcing the people of Ireland into a decade or more of grinding poverty which will safeguard the profits of the banks of Europe.

This mishandled bailout of the Irish banks to save the banks of Europe did not stop the awareness that the euro without a fiscal mechanism will continue to be exposed to currency crisis in the form of international lack of confidence.  Even the cost of swaps and bonds of countries like Germany and France started to go up.  The United Kingdom will participate in lending money, because they need to protect Ireland as a large export market as well as UK banks bur, as we have previously written, there are those in the UK who do not believe it is in the best interests of Ireland to stay in the euro.

During the whole mishandled process of bailout or no bailout, haircuts for bondholders or not, German politicians playing to their electorate and not seeming to care if they were creating international economic and market turmoil, and Irish politicians being pushed around and manhandled as if they were children, the pressure on bond costs, spreads, and swaps continued to grow.  Speculation on who would be next became a parlor game acknowledging that the structural weakness of the euro made continued pressure on all member nation bonds unavoidable.  While poor Portugal was being picked on as the smallest, Spain was also taking its licks.  Spain geared up its proactive stance and made several moves to encourage international confidence in Spain's banks and budget spending cuts.  Portugal tried to draw a line in the sand and huff and puff that the EU could not force them to take money, but economic concerns that their budget is not accurately estimated abound.  While Spain may be the keystone as where the cascade of declining confidence in the euro can be stopped, Italy is the elephant in the room whose debt comprises approximately one-fourth of the debt of EMU countries and much of which has been bought by Italian banks, but which provides very significant exposure for other European banks (Table 9D - Italy on the left and then page through).  The situation has given plenty of room for people to hyperbolize and even suggest the currency contagion will extend to the UK as a misperceived debt contagion as many people remain confused by debt which has been used to frame public debate away from the structural weakness of the euro in not having a fiscal mechanism.  The UK has its own currency and can provide fiscal stimulus if it has the political will.  Given the growing disenchantment and failure of austerity in the UK as inflation grows anyway, the current coalition government may not last to the end of 2011.

The G20 conference was inconclusive and provided no real assistance to the global trade imbalances or the developing problems of the euro which many, such as the author of this article, want to confuse with a debt crisis as exemplified but the article's citation of the Asian debt crisis in the 1990's without reference to it being caused by the Russian currency crisis.

The Pragmatic Capitalist wrote of three things he thinks he thinks which were the recession is over but which recession citing mixed economic data and the euro crisis, corrects Rosenberg on why the stock market rallied in September as not the result of quantitative easing but improving economic data after a technical bottom on August 25th, and his reiteration with cautions that gold and treasuries will continue to be a trading hedge with the growing euro crisis, although I continue to warn that piling into gold on the high end is a magnificent way for the market sharks to harvest the fish.  Gold is a crisis hedge, but it will not maintain its inflated value when crisis abates and economic growth kicks in for real for the 99% of people who are not wealthy.  Interestingly, Treasuries were heading for the second monthly decline.  But long term U. S. Treasuries and intermediate corporate bonds should still remain diversifiers in portfolios.

The Baseline Scenario had a guest post on unemployment, student debt, and college graduate employment bleak prospects entitled, "How are the kids? Unemployed, Underwater, and Sinking".

The Economist's view cites David Cay Johnston at length in his appeal to President Obama to call the deficit hawks bluff when they hypocritically demand continued tax breaks for the rich, which will raise the deficit and slow economic growth.  Brad Delong, in the same vein, took on the flawed logic on tax provisions in the Bowles-Simpson Deficit Reduction Proposal.  The Republican economic commentator, Bruce Bartlett, again takes on the misguided economic concept of Starve the Beast is nonsensical and did not work in the George W. Bush administration where it did not restrain spending much less bring it down.

U.S. bank earnings increased 600% in Q3.  If you pay attention to John Hussman, you know this is something to raise your defensive data mining efforts.  As I and others have been pointing out they have been reducing reserves by lowering their loan loss provisions; this is exactly the wrong time to be doing that.  In fact, under the Basel III reforms, U.S. banks will need to raise $100 billion in capital to meet new 8% capital ratio guidelines.  The continued dispensation from the FASB mark-to-market rules which would require banks to report assets held at fair value allows the banks to legally present fraudulent balance sheet statements which hid true asset value and risk.  I continue to look with disfavor upon mutual fund portfolios with financial institution holdings and concentrations, despite bank stocks going up in value.  Cooked financial books are always risky.

Court testimony has shown that Countrywide never sent mortgages to trust ignoring a proper securitization legal process.  Yves Smith at naked capitalism has been hammering away at the mortgage fraud mess almost every day.

Meanwhile rich bankers, who get wealthy making risky investments and trades inconsistent with a well risk managed bank and regulated financial system, creating systemic risk, and get the government to pass their losses off to you and me while they always rake the profits in, are starting to live the glamorous party life of the rich and special people who's elite status exempts them from the constraints of a democratic society, which is becoming since the 1960's increasingly polarized with historically high wage inequality between the top 1% and the rest of humanity.

Elizabeth Warren is being given credit for the failure of Congress to override the President's veto of the bill which would have made the improper titling process used in the mortgage fraud mess retroactively legal.

The Federal Reserve Open Meeting Committee minutes for the October meeting were released and the raised their projections on unemployment, expect slower growth, and lower inflation. They saw output and employment improving slowly, but the current rate of output is more likely to increase unemployment.  While they do not expect the economy to slide back into recession, it is vulnerable to shocks.  The housing sector remains depressed.  They noted that financial institutions risk losses if misrepresented mortgages are put back to the sellers.  Inflation has tended lower as has nominal wage growth.  Inflation is expected to remain below levels consistent with maximum employment and price stability.  The participants were very divided on quantitative easing in form and consequences but only Hoenig voted against it.  The Fed will buy $600 billion of longer term U.S. Tresuries at $75 billion a month through the second quarter of 2011.  The Econbrowser provides suggestions to the Fed on how it could communicate to the public more effectively by providing the public with a clear explanation of how it plans to do when it returns the interest rate to something higher than zero and the limits of what monetary policy can be expected to do.  The public is confused and worried about inflation and does not really understand the role of inflation in growth and the need to both encourage it and control it.  The quantitative easing program of the Fed is viewed by many economists as ineffective in creating economic growth and employment and by others as a threat of increased inflation.  It has every appearance of primarily creating liquidity and allowing financial institutions to increase their reserves and I have been maintaining that will be its primary result.  We need a stimulus providing targeted programs to increase employment and economic growth in the short term.  The money supply is low and trending lower.  The Fed is deserving of legitimate criticism, but many people are confused about inflation, monetary policy, what the Fed has done and not done, and what the Fed can and cannot do.  Many people have seen the video of the bunnies trying to explain to each other what the Fed is, does, and how quantitative easing works, but the video is not completely accurate as Econbrowser explains.

Actual PCE (Personal Consumption Expenditures) Inflation was only .1% annualized in October and the core PCE fell 3 tenths to .9%.

A proposed Federal Trade Commission rule which is supposedly aimed at protecting families of people who have died in debt is being questioned by consumer advocates as possibly unleashing aggressive collection tactics.

Michael Pettis believes European bank stress tests were not rigorous enough and that Ireland is under such pressure from the ECB, EMU, IMF, and the EU to take a bailout, because European banks could not be successfully restructured.  He also believes that if Spain were to come under pressure to take a bailout, it would leave the euro rather than give sovereignty to Germany.  He also thinks a junk bond market will spring up in Europe as it did in the 1980's in the U.S.  With respect to China, he is skeptical that China's banks will be able to keep within loan quotas, inflation is rising faster than rising interest rates, and he is concerned that raising interest rates may increase inflation rather than reduce inflation as one might intuitive think.  The pegging of the Chinese currency to the U.S. dollar is directly related to the increase of China's trade surplus and raising interest rates, according to BNP Parabas, would increase capital inflows into China.  U.S. quantitative easing effectively reduces the value of the dollar against other free floating currencies, but the renminbi is pegged to the dollar and has generally fallen in value, particularly against the currencies of other emerging market countries, even though the peg has increased 3.1% in the last five months.  On Friday the 26th, the Chinese 3 month yuan bill auction failed to attract sufficient demand for the first time since June, attracting only 11.6 billion yuan ($1.7 billion) from a 20 billion yuan offering and yielded 2.7372% and this is seen as signaling tightening to come.   If China takes liquidity out of the market, it will probably mean that Australia may see its unemployment rate increase, its interest rates not go as high as expected, and it trade terms with China peak.  On the other hand many people think a contraction in China's trade surplus would be a global positive.

The eurozone, emerging Europe, and China are economic sectors which require careful attention.

Sheila Barr, head of the FDIC, weighed into the deficit debate in the Untied States in a disappointing display of not really understanding the problem.  Too many public officials are pandering to a public disaffection with government not getting things done that really help people and are using the deficit as a mask for not providing the stimulus the economy needs to create jobs and improve lives of its citizenry.  Even President Obama appears to have fallen into the deficit hawk pit.  Social Security is not part of the Federal debt and opposition to health reform betrays the fact that health costs are the one of the largest parts of the increase in Federal debt.  Those who would deny unemployment benefits and demand lower taxes for the wealthy while demanding deficit reductions are hypocrites at best.  Ataxingmatter has torn the deficit argument apart in detailed fashion and places the problem on politicians and media, who avoid rigorous analysis.

Krugman bemoans the intellectual, political, and financial instability of moderation in the perception of history after this last Recession as detailed by Brad Delong in his macroeconomic disappointment that, despite economic history, any developed nation would allow a business cycle to wreak havoc to the extent of continued and prolonged high unemployment.  Politicians are playing crowds and public disaffection with inefficient government to advance political agendas that favor the financial interests and wealthy rather than the interests and needs to the people.  Brad Delong also gave a speech in which he reviewed the financial crisis and Recession and how we have become side tracked and economic recovery has been put on the back burner as politicians churn public resentment.

John Hussman in his 11/22/2010 weekly commentary said investors have not learned that historical evidence shows that consistently low yields and elevated valuations are followed by dismal subsequent returns over the next decade.  S&P 500 yield is 1.95% which means one could expect 2.2% annually over the next decade, although his use of normalized earnings result in a projection of 4.8%.  Using forward operating earnings, the projection result would be 4.7%.  This is not a dividend story.  He still is opposed to the Fed's QE2 and cites several economist's with whom he agrees, including Stiglitz, who are opposed or would be opposed and also again affirms the need for targeted investment stimulus.  He also goes into detail on why he thinks the Maiden Lane vehicles created by the Fed to hold toxic securities bought outright from the financial institutions and held for over two years are illegal under The Federal Reserve Act.

In dealing with global imbalances, and imbalances within the eurozone, one of the problems is the focus on current account balances control by using target current account levels when the problem is actually one of fiscal policy and exchange rates.  To correct a deficit current account balance really requires international and national investment, austerity damages investment and nominal wage and price adjustments are not going to create sufficient competitiveness improvement.  Jan Kregel and Rob Parenteau have argued for the European Investment Bank to step in and make investments to create competitive output and I have maintained that it is necessary to invest to create competitiveness internally and with exports.  Unfortunately, the EIB does not provide these types of loans, does not believe it is empowered by the EU to do these types of loans, has a history of infrastructure improvement loans, and does not have the business experience or psychological disposition to make loans that are not consistent with how they do business as bankers. The problem is no one wants to make the necessary investment loans and the euro and austerity deprive EMU member countries of the ability to make efficient internal investment.  This is why a fiscal mechanism (and the relinquishment of national sovereignty to create a fiscal union is not a political reality and it will be necessary to construct without loss of sovereignty --- some, such as Edward Harrison, have suggested fiscal stabilizers) and European bond (Germany is against this type of bond and believes it would require a treaty change) to provide funding is functionally created.  Such a fiscal mechanism will not work if designed to respond to budget deficits rather than investment needs (encouragement or discouragement) to create competitiveness and efficiencies or to cool a nation's economy.

Market: No banks failed the week of 11/26; the problem bank list is 919.
                         DOW/Volume                      Nasdaq/Volume
Mon:             <24.97>/down 16.8%               13.90/down 1.9%
Tue:             <142.21>/up 11.7%                 <37.07>/up 3.7%
Wed:              150.91/down 19.2%                48.17/down 13.1%
Thu:                                         Holiday
Fri:                 <95.28>/down 48.2%             <8.56>/down 60.6%

Total                     <111.55>                               16.44

Mon: Oil down 24 cents to $81.74; Dollar stronger but weaker against the yen; banks down on insider trading raid; eurozone contagion worries; U.S. banks need $150 billion more capital under Basel II.

Tue: Oil down 49 cents to 81.25; Dollar stronger but weaker against the yen; Korean fighting.

Wed: Oil up 2.61 to 83.36 (December contract); Dollar stronger; commodities market ignored oil supply up ; oil price up on Pre-Holiday short covering; weekly jobless claims were down 34,000 to 407,000, 4 week moving average was down 7500 to 436,000, continuing claims were down 262,000 to 4,660,000 -- these are positive news but may reflect seasonal adjustment assumptions that claims increase between Veteran's Day and Thanksgiving Day; oil supplies were up 1 million barrels, gas was up 1.9 million barrels, and distillate was down 500,000 barrels.

Fri: Oil down 10 cents to 83.76 (January contract); Dollar stronger; only half day market; Europe fears of contagion on talk of senior bond holders haircut; Korean conflict; Ireland's banks downgraded.

United States: Agricultural exports are creating an economic boom in parts of the Midwest.

ECRI WLI (Weekly Leading Index) is up to <3.1> from <4.5>.

Mishkin, a former Fed governor, said the Fed is under unprecedented attack for being unable to clearly articulate monetary policies and its credibility has been damaged by its failure to put monetary policy in a long term context and internal dissension.

CoreLogic reported shadow housing (pending supply) inventory of about 2.1 million with total visible and shadow inventory of approximately 6.3 million.

Chicago Fed National Activity Index was up to <.28> October from <.52> with 3 month average down to <.46> from <.33> which is the lowest since November 2009.

Three hedge funds were raided on Monday in an insider trading investigation: Diamond Capital Management, Level Global Investors, and Capital Management.

Kocherlakota (Minneapolis Fed) voiced support to QE2 as "move in the right direction", but he warned that uncertainty over tax policy drags on growth.  He believes inflation is not a concern and that unemployment is dragging the economy.

Health insurers are required to spend 80% of premiums on heath costs and no more than 20% on administration under newly released Federal regulations.

Commercial property prices were up 4.3% September for the biggest monthly gain in the ten years records have been kept.

Mortgage delinquency rate was down to 6.44% Q3 from 6.67% Q2 and up to 6.25% vs year ago (historical average is 1.5-2%) according to Trans Union. 

Q3 GDP was revised up to an annualized rate of 2.5% from 2.0% and real PCE from 2.6% TO 2.8%.  State government expenditures were revised up from <2.%> to .8%.  Continued high unemployment is expected to lower growth.  Non-residential construction investment was revised down to <5.7> from 3.9 as expected.

Existing home sales were down 2.2% October with inventory up 8.4% vs year ago.

Illinois unemployment was down October to 9.8% from 10.9% a year ago.

Richmond Fed Business Activity Survey was up 4 to 9 in October; finished goods inventory was up 10 to 16; raw materials were up 5 to 15; new orders were up 2 to 10.

U.S. PCE was up 1.0% September annualized (2.3% August) with core PCE up .3% (.8% August).

Fannie Mae and Freddie Mac will resume sale of foreclosed home.

Sheila Blair, head of FDIC, wrote a Washington Post opinion piece asserting the next debt crisis could be the U.S. with Baby Boomers impacting government spending, special interest tax codes, military spending, and tax subsidies for housing and health as misallocated resources.  She predicted the debt to GDP ratio could rise from 62% to 185% in 2035.  We have already commented on our disappointment in her display of economic illiteracy.

U.S. durable goods orders were down 3.3% October and down 2.7% ex-transportation in the largest drop since March 2009.

International: The EU has drafted a strategy to obtain continuing sufficient supplies of raw materials.

Estonia PPI (Producer Price Index) was up .3% in October.


Despite a 2.3 bid to cover on 3 and 6 month Spanish bonds, Spain sold less that the 4 billion euro minimum it offered (4-5 billion) indicating the bids received were too low and rejected.

China ordered local governments to ban hoarding of oil, coal, and other key commodities to keep prices from climbing.

Union strikes against austerity measures have shut down public services in Portugal.

Irish government majority fell to two votes with the election of an anti-austerity candidate in special election.

China protested U.S. and South Korea military exercises.

India is expanding its bribery probe among bankers and developers.

Peru GDP was 9.5% Q3.

China will rely next year on fiscal stimulus to maintain economic growth at 8%, set inflation target of 4% up from 3%, further cut bank lending target, and be less reliant on exports.

German inflation was up on food and energy to 1.6% (expected 1.4%) November from 1.3%.

United Kingdom students have renewed educational fee protests.

The People's Bank of China will use price tools (interest rates) and other measures to curb growth.

India arrested 8 bankers and brokers for bribery triggering the biggest one day jump in swaps.

The Australian Central Bank said interest rates will remain steady for the next several months.

Japanese deflation slowed as consumer prices continued to fall for the 20th month, because the increase of tobacco taxes impacted prices.


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Leftovers --- Radio Show 2/20/2010

In the show we covered the Fed's Federal Open Market Committee minutes from January in which it was apparent the Fed is struggling with the meaning and economic impact of currently high unemployment, despite employment being one of the two mandates of the Federal Reserve.  One quandary they were having is whether extended unemployment benefits were "... encouraging some who have lost their jobs to remain in the labor force."  I found this whole paragraph to discouraging in that it tends to validate my long voiced opinion that the Fed is using unemployment to hold inflation down as the the banks recapitalize and adjust their balance sheets.

The whole paragraph is as follows:  "Though participants agreed there was considerable slack in resource utilization, their judgments about the degree of slack varied. The several extensions of emergency unemployment insurance benefits appeared to have raised the measured unemployment rate, relative to levels recorded in past downturns, by encouraging some who have lost their jobs to remain in the labor force. If that effect were large—some estimates suggested it could account for 1 percentage point or  more of the increase in the unemployment rate during this recession—then the reported unemployment rate might be overstating the amount of slack in resource utilization relative to past periods of high unemployment. Several participants observed that the necessity of reallocating labor across sectors as the recovery proceeds, as well as the loss of skills caused by high levels of long-term unemployment and permanent separations, could reduce the economy’s potential output, at least temporarily; historical experience following large adverse financial shocks suggests such an effect. On the other hand, if recent productivity gains were to be sustained, as some business contacts indicated they would be, potential output currently could be higher than standard measures suggested, and the high level of the unemployment rate could be a more accurate indication of slack in resource utilization than usual measures of the output gap."

In conjunction with those passages, we also noted that a recent speech by the Minneapolis Fed President Kocherlakota included the statement: "The point, though, is that the fall is not spread uniformly across all people. Some workers—those who lose their jobs—suffer much bigger falls in income. For this reason, many macroeconomists now believe that the true cost of a recession is not the fall in GDP per se, but the associated increase in the risk of people becoming, and staying, unemployed. "  I have been saying this for over a year in trying to explain how serious the high unemployment rate and the fact that 21.5 - 22% (if you use the formula from the 1990's for determining discouraged workers) of the population is unemployed is in determining if this technical "jobless" recovery is sustainable and how destructive a long, slow growth recovery will be to the structure and membership of the American middle class while income inequality will continue to grow at the benefit of the top 1%.

In that Kocherlakota's speech devolved into a defense of the Fed's role as a necessary regulator of the banking system, it is unfortunate that the Fed did not get the job done.  My opinion is that the Fed needs to continue having that responsibility as a member of a council of regulators.

Greece may (it has not been formally announced) attempt a bond auction this coming week.  The EU has provided no commitments of assistance preferring to ratchet demands for austerity program plans and reports by March 16 and May 1.  The Greek PM has indicated they are ahead of schedule.  They have raised taxes, but they also have an aging population with a low birth rate.  I pointed out that the EU rules for determining debt to GDP ratios is not based on national debt but also includes local government debt.  The causes of the problems in Greece, Spain, Italy, and Portugal, if not Ireland also, goes directly to the formation of the euro, the exchange rates, low ECB interest rates, competitiveness gaps between Eurozone nations, and trade imbalances within a single monetary union of sovereign nations.  If the EU refuses to deal with the problems of the euro and the lack of appropriate tools for the ECB and attempts to ignore the problems with political compromises and hard line positions, the economic consequences could snow ball from country to country.  If the political compromise approach stimulates social protest and disruption in Eurozone countries, who have not enjoyed the benefits of the economic trade imbalances as Germany has, the question could devolve into one of sovereignty.  How much sovereignty must EU nations, who have economically suffered from the adoption of the euro, surrender to please the more economically dominate EU member nations?

Interestingly, the Greek PM made a public statement that Greece did not need assistance from the EU and could handle the problem itself.  He also indicated that if Greece did want help it may seek it directly from the IMF without the cooperation of the EU.  I was struck by how much this was similar to the recent suggestion of Simon Johnson that Greece bypass the EU and approach the IMF for assistance unilaterally and in so ding put immense political pressure on the EU and particularly France, because French President Sarkozy sees the head of the IMF, Strauss-Kahn, as a potential political opponent for president of France.

Spain, which is seen by some as a potentially larger problem than Greece as it has a much larger economy, is struggling with growing unemployment and a EU imposed austerity program, but this last week it had a bond auction in which it offered 5 billion euro 15 year bonds which priced at a 12 basis points premium and an over subscribed book of 12 billion euro orders.  Over all, it was an encouraging auction.

Iceland will hold its Icesave referendum on March 6tt.  We have documented the Iceland, UK, and Netherlands dispute and various proposals for resolution.  The question is not should Iceland make payments, but what constitutes fair payment under EU law and when payments should be made.  The interest rate of 5.55% has already been denounced by many commentators as excessive and unfair.  Anna Sibert of Birkbeck College, London, and a member of the Monetary Policy Committee of the Central Bank of Iceland has published an article on the legal background of the debate and posits that, if the likely recovery of Landsbanki's assets is close to 90%, it will not be crippling to Iceland's taxpayer's who have already experienced an unprecedented fall in disposable income at 3600 euro per capita or 14% of Iceland's GDP at end of 2015 with the average payment burden from 2016 to 2024 less than 1% of GDP per year.

The economist Thorvaldur Gylfason has written "Eleven lessons from Iceland", in which he lays down eight lessons requiring financial regulatory reform, a tenth that government needs to protect jobs and incomes in such financial crises, and an eleventh that the need for financial regulation and separation of government and private banking does not negate a capitalist approach.

Philly Fed business activity index up to 17.6 January from 15.2 (expected 17.0); new orders up to 22.3 from 3.0; inventory up 5 points.

Citibank, whose majority shareholder is the United States government, which has sent letters in the recent past jacking credit card rates up to 29%, has sent letters to deposit account holders in Texas that Citibank reserves the right to demand 7 days notice in writing before money could be withdrawn from checking accounts, money markets, or savings accounts, which are demand deposit accounts.  While they insist this applies to Texas only, the actual disclosure statement is not limited in its application. 

Remember, Citigroup also wrote the new credit card federal legislation which just took effect.  You will find going forward that the fees, increased minimum payments, and lack of any prohibition of usury will not be the informative disclosure and consumer protection promised.

Capital One annualized credit card write offs rose to 10.41% in January from 10.14% and 30 day delinquent only increased to 5.8% from 5.78%.

Humana will reduce its workforce by 5%.

Morgan Stanley may hand over its $2.4 billion investment in a Japanese hotel chain it bought in 2007 to creditors when debt comes due in April.

AIG has said it plans to keep 25% of its derivatives portfolio, with a notional value of $300-500 billion, as its Financial Products unit winds down saying the derivatives have been "derisked" and have upside potential.

Japan Q4 GDP was 1.1%.

All UK MPC members voted not to expand QE citing the likelihood that inflation will be below target for the next 3 years (below 2% medium term) and further QE might increase asset prices (bubble).

Barclays allocated more in pay bonuses as a percent of revenue than Goldman Sachs by setting aside 38%.

Walmart sales disappointed but were up 4.6% to $112.82 billion (expected $114.36 billion) and profit was $1.21/share vs 96 cents/share a year ago.  EPS, after exclusions and tax benefits, was $1.17/share (expected $1.12).

Simon Property made a hostile offer of $10 million for bankrupt General Growth after a private offer was ignored and is promising that $7 million of that will pay in full unsecured creditors.

RIM (makes Blackberry) warned of a bandwidth crisis in urban areas which requires software developers to come up with better applications and efficient services to conserve bandwidth.

Kraft posted 48 cents/share Q4 profit, which is up 12 cents vs year ago.

Merck, which has merged with Schering Plough, had $2.34/share Q4 profit vs 78 cents year ago.

Abercrombie posted 53 cents/share Q4 profit which is down from 79 cents; revenue fell 4.6%; sales fell 13% down 12% in the US but up 86% internationally.

UK consumer prices were up 3.5% January -- a 14 month high -- supposedly from the implementation of VAT and will fall to normal later this year.

Kansas City Fed President Hoenig said, if interest rates are kept low, major inflation could ensue.  While arguing the Fed needs to remain independent of political pressure, he then ventured into the government's fiscal policy and asserted that the politicians should cut spending and increase revenue (taxes?).

Eurozone trade surplus was $6 billion in December, because exports contracted less than imports.

US gasoline demand is down 1.3% vs year ago.  Refinery capacity is 79.8%

UK business loans fell 8.1% in December vs year ago in the sharpest drop since records began in 1999.

UK retail sales fell 1.8% in January but it is up nine tenths vs year ago.

Spain estimates its economy will contract 5 tenths in 2010.  GDP fell 3.6% in 2009.

Russia cut its interest rate for the 11th time in less than a year by 25 basis points to 8.5%.




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Links - What Others Are Saying in Fast Moving Times 2/7/2010

I normally use links to substantiate or provide other views in my posts, but events are moving very fast and I want to follow up to my last post on Greece and Spain, China, AIG/Goldman, and the need for financial regulatory reform.

China:  This past week saw the US and China butting heads over trade restrictions and the whether the yuan should be allowed to appreciate or remain pegged to the US dollar.  Just recently, President Obama said he wanted to double US exports within five years.  Just which other countries of the world would have to contract their exports to accommodate the United States?  China is the obvious target.  Given labor costs and other competitive cost constraints, the United States cannot possibly double its exports in five years, but it can initiate international protectionist trade wars.

On China's asset bubbles, inflation expectations, and cash reserves.
On China's currency.
On China's price pressures and tightening of bank reserve requirements.
On China's loan rate's and new loan restrictions.
What to watch for in China -- the risks.


As I said on the Radio Show yesterday, you have to have been watching China for some time.  The connection to Latin America, particularly Brazil, is obvious and Latin American mutual funds and ETFs are showing the danger.  The recent refusal of the Australian central bank to raise interest rates a fourth time citing a need to evaluate the past raises and what is going on in China was significant.  Australia has developed China as an Australian export market.  Even if China does everything right going forward and does it slowly, the global impact of even that soft landing will be shuddering, just as we have begun to witness in the last two weeks of China's preliminary tightening moves.

Greece and Spain will continue to come under derivative trading attack and it will continue to be a potentially larger European problem.  Our last post, "Greece, Spain, and the Euro Trojan Horse", documented the multiple causes, the need for financial reform, a more effective monetary policy, and the need for the EU and ECB to formulate a program of EU bonds.

Greece and why the IMF will not be the answer.
While the failure of Greece to provide accurate economic data in the past and its corruption are widely known, the problem of the losses on Spanish banks books has been relatively muted.
The market pressure will continue.
While bailout doomsday scenarios abound and demands for budgetary cuts grow, the real problem is the need for financial regulatory reform and the economic impact of the euro on the 16 countries which use the euro.
While budget cuts are necessary to remove ineffective accumulation of public debt, targeted spending and the effective accumulation of public debt to spur economic growth and job creation is the most fiscally responsible governmental path, but the 16 EU countries which use the euro do not have the monetary and fiscal policy options of countries which have their own currency.  
The risk remains that the speculative attack of the derivative traders could create a European and global debt contagion.
Meanwhile 10 billion euro have been pulled out of Greece.

The connection between Goldman Sachs and AIG continue to simmer and escalate, because it goes straight to what was wrong with the bank bailouts and how that bailout actually made the sources of the current global financial crisis larger, more powerful, and more systemically dangerous.

How Goldman Sachs pushed AIG to the edge and profited.
Just how much did AIG not understand the true market values, credit rating, and risks of its CDOs?
If the relationship between AIG and Goldman Sachs been fully disclosed publicly, should the United States government have nationalized AIG and then dealt with Goldman Sachs?

Economic Solvency:  What we do now will have a direct impact on whether we have an economic crisis twenty or thirty years from now.  When you look at China, Japan, Australia, the United States and other countries with respect to population growth and immigration, some have started to ask if there is a population growth solution to sovereign solvency.
Another example is the relation of savings in China to population growth and the one child family.

Economics to be properly applied needs a very multidisciplinary approach.

Financial regulatory reform: We have in the past listed the failure of the US Congress to move real financial regulatory reform forward and the role of financial lobbyists in neutering, gutting, and making proposed "reforms" actually less effective than the one's currently on the books.  Greece, Spain, etc have shown the need for financial reform in their countries also.  Some have tried to delay financial regulatory reform by calling for coordinated global financial reform regulations.  Each country needs to act now.  Global coordination should be pursued, but it is not an acceptable excuse to delay needed reforms in individual countries.  One only has to look at Canada to see how financial regulations there significantly controlled the impact of the current global financial crisis.  In fact, a case could be made that past global coordination agreements are directly inhibiting financial regulatory reform. 

I have repeatedly stressed that these, as well as other, macroeconomic issues not only have a direct effect on economic and political decisions but investment decisions and portfolio management.




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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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