Time to take bets on Frexit and the French franc?

Marine Le Pen. (Photo: EPA)
Marine Le Pen. (Photo: EPA)
We have a minor earthquake in France. A party committed to withdrawal from the euro, the restoration of French franc, and the complete destruction of monetary union has just defeated the establishment in the Brignoles run-off election.
It is threatening Frexit as well, which rather alters the political chemistry of Britain's EU referendum.
Marine Le Pen's Front National won 54pc of the vote. It was a bad defeat for the Gaulliste UMP, a party at risk of disintegration unless it can find a leader in short order.
President Hollande's Socialists were knocked out in the first round, due to mass defection to the Front National by the working-class Socialist base. The Socialists thought the Front worked to their advantage by splitting the Right. They have at last woken up to the enormous political danger.
The Front National is now the most popular party in France with 24pc according to a new Ifop poll. Both the two great governing parties of the post-War era have fallen behind for the first time ever. The Gaullistes (UMP) are at 22pc, and the Socialists at 21pc.
I will negotiate over the points on which there can be no compromise. If the result is inadequate, I will call for withdrawal. Europe is just a great bluff. On one side there is the immense power of sovereign peoples, and on the other side are a few technocrats.
Asked if she intended to pull France of the euro immediately, she hesitated for a second or two and then said: "Yes, because the euro blocks all economic decisions. France is not a country that can accept tutelage from Brussels."
Officials will be told to draw up plans for the restoration of the franc. Eurozone leaders will face a stark choice: either work with France for a "sortie concerted" or coordinated EMU break-up: or await their fate in a disorderly collapse.
"We cannot be seduced. The euro ceases to exist the moment that France leaves, and that is our incredible strength. What are they going to do, send in tanks?"
Her four sticking points on EU membership are withdrawal from the currency, the restoration of French border control, the primacy of French law, and what she calls "economic patriotism", the power for France to pursue "intelligent protectionism" and safeguard its social model. "I cannot imagine running economic policy without full control over our own money," she said.
As I wrote in June, the Front has been scoring highest in core Socialist cantons, clear evidence that it is breaking out of its Right-wing enclaves to become the mass movement of the white working class.
Hence the new term in the French press "Left-Le-Penism". She is outflanking the Socialists with attacks on banks and cross-border capitalism. The party recently recruited Anna Rosso-Roig, a candidate for the Communists in the 2012 elections.
Mrs Le Pen's EMU withdrawal plan is based on a study by economists from l'École des Hautes Études in Paris led by Professor Jacques Sapir. It concludes that France, Italy, and Spain would all benefit from EMU-exit, restoring lost labour competitiveness at a stroke without years of depression.
Their working assumption is that the eurozone's North-South imbalances have already gone beyond the point of no return. Attempts to reverse this by deflation and wage cuts must entail mass unemployment and loss of the industrial core.
Prof Sapir said the gains are greatest in a coordinated break-up with capital controls where central bank intervention steers the new currencies to target levels. The model assumes that the D-mark and guilder are held to a 15pc rise against the old euro, while the franc falls 20pc.
The gains are less if EMU collapses in acrimony and currencies overshoot. This would inflict a violent deflation shock on Germany, but would still be strongly positive for the Latin bloc.
I don't wish to get into a debate about whether or not the Front National has genuinely purged its anti-Semites, or whether its immigration and culture policies must inevitably lead to a drastic showdown with France's 5m-plus Muslims. This is a finance blog.
My own impression is that she is more relaxed about gay rights and abortion than she lets on, closer in some ways to the assassinated Dutch populist Pim Fortuyn than to her father Jean-Marie Le Pen, who in turn complains that she picked up "petit bourgeois" views in Paris schools.
The fact is that her campaign of "dédiabolisation" or image detox seems to have worked. Only a minority of voters still thinks the Front is a "threat to democracy". Mrs Le Pen is winning over white working-class women in droves. The feminised Front is no longer the party of the angry white male.
While her father called the Holocaust an historical "detail", she calls it the "pinnacle of human barbarism". I can understand why a lot of people disregard this as cynical repackaging. Parties don't change their character so quickly. But as Socialist advisers have warned Mr Hollande, the game has changed. It is not longer enough to keep insisting that the Front is beyond the pale. There is a new fact on the ground.
I might add that the Front is nothing like Ukip, a mostly pro-American, Right-leaning, libertarian, anti-welfare, free-market party. Marine Le Pen is an ardent defender of the French welfare model. Her critique of capitalism gives her a Leftist hue. Some call it 1930s national socialism, and here we are starting to touch on the populist appeal.
She fulminates against Washington and Nato, calling for France to retake its place as "non-aligned" voice in a multipolar world, and lashing out at the Gaulliste UMP for selling its soul to Europe and the Anglo-Saxon order. "There was a de Gaulle of the Left, and a de Gaulle of the Right. There were two de Gaulles. We stand for both," she said.
The rise of the Front National is yet another reminder that the slow-burn political crisis in Europe has yet to reach its climax. Mass unemployment and the gruelling effects of debt deflation are chipping away at the foundations of the establishment, just as they did in the early 1930s under the Gold Standard, so like EMU today.
France endured the same slow torture then, stoically accepting the "500 deflation decrees" of premier Pierre Laval. That dispensation seemed stable for a while. It was not. The dam broke in 1936 with the once unthinkable of the Leftist Front Populaire, with Communist support. The Gold Standard collapsed.
Angela's Merkel's Fiscal Compact (to use the term broadly) is really just a modern version of Laval deflation. There was no good macroeconomic reason for forcing France to squeeze fiscal policy so violently over the last two years, tipping the economy back in recession. The measures were shoved down France's throat done because austerity for its own sake (without offsetting monetary stimulus) is EMU doctrine, and because France has allowed Germany to call the shots.
We can argue over whether the policy has been counterproductive in economic terms. What is crystal clear is that it has shattered the mould of French politics, opening the door to the Front National.
It is now highly likely that the Front will sweep the European elections next May, a vote perfectly suited to their agenda. It will not be alone. Euro-sceptics look poised to storm the Strasbourg Hemicycle. That will be another fact on the ground.

The worst fears of the EU elites are starting to come true. It is entirely their own fault.

10/16/2013 06:47 PM

Emerging Challenges

What's In Store for the New Global Powers

An Essay by Erich Follath

China, India and Brazil are taking the global economy by storm, becoming more politically confident on their way. But even as they form a front against the West, they will have to tackle slower growth and major domestic problems that their newly prosperous citizens are no longer willing to tolerate.

What will be the world's most important cities in the future? To answer this question, the US-based journal Foreign Policy and the McKinsey Global Institute examined criteria such as economic growth and receptiveness to technology. The result? Shanghai edged out Beijing and Tianjin, followed by the first non-Chinese mega-city, São Paulo in Brazil. No Western European city ranks among the top ten "most dynamic cities." Berlin, Frankfurt and Munich don't even appear among the top 50, but other cities in China, India and Brazil do. If we are to believe the study's conclusions, humankind will be speaking Mandarin, Hindi and Portuguese in its urban centers in 2025. "We are witnessing the biggest economic transformation the world has ever seen," the experts say.

And what are currently the most competitive countries in terms of industrial production, and what will they be in the future? The management consulting firm Deloitte Touche Tohmatsu has established that China is now ahead of Germany, the United States and India. But according to the projection, for which 550 top executives of leading companies were surveyed, the hierarchy will already have shifted by 2017. Germany and the United States will drop out of the top ranks, and "old" powers will no longer lead the pack, having been replaced by China, followed by India and Brazil.

What's more, according to the 2013 United Nations Human Development Report, "the rise of the South is unprecedented in its speed and scale." For the first time in 150 years, the combined output of the developing world's three leading economies -- Brazil, China and India -- is about equal to the combined GDP of the longstanding industrial powers of the North -- Canada, France, Germany, Italy, United Kingdom and the United States. In addition, this year Beijing will, for the first time, import more oil from the OPEC countries than the United States.

Getting in on Western Commerce

It isn't just the sheer land mass and huge numbers of consumers in these three countries, which make up close to 40 percent of the world's population. China, India and Brazil are also stunning the world with their impressive performance in many areas, including research and technology. The owner of the world's biggest beer brewery is Brazilian billionaire Jorge Paulo Lemann, who acquired US-based Anheuser-Busch. The South American country is also considered an international leader in food research. São Paulo, together with the surrounding area, is the world's top location for German business, with about 800 branches of German companies headquartered in the area. Brazil has literally taken off, providing a home to Embraer, the world's third-largest aircraft manufacturer after Boeing and Airbus. And Rio de Janiero is an undisputed party capital, especially now that the city has been selected to host the 2014 World Cup and the 2016 Summer Olympics.

The most expensive private residence in the world, owned by entrepreneur Mukesh Ambani, is in the Indian city of Mumbai. Anyone who drives a Jaguar or a Land Rover is driving a car made by an Indian company, now that Tata Motors has bought the traditional British automaker. India is the world's largest producer of polyester and a leading force in renewable energy. Pune in western India is home to wind turbine maker Suzlon, which acquired Hamburg-based REpower. New Delhi is one of the world's leading producers of computer software and space technology. Though, on a less positive note, India spends more on arms imports than any other country.

Volkswagen has been selling more cars in China than in Germany for a long time, and the company plans to open five new plants there in this year alone. Conversely, the Chinese are also investing in Germany, where they already own automotive supply companies and have purchased some of the pearls of Germany's mid-sized companies, known as the Mittelstand. Changsha-based Sany, for example, has acquired Putzmeister, a concrete pump manufacturer based in southwestern Germany's Swabia region. The people who assemble London taxis, which are about as quintessentially British as Bobbies or plum pudding, report to Chinese bosses, as do many workers at the port of Piraeus in Germany. It seems that nothing works anymore without the wealthy Chinese, who have accumulated the world's largest foreign currency reserves. Beijing is also home to the world's fastest computer.

Forming a Front

Politically speaking, the new major powers are also becoming increasingly self-confident -- and sometimes form a united front against the West. In the United Nations Security Council, China blocks every Middle East resolution it doesn't like, while the Chinese navy flexes its muscles in the waters of the Far East. India is bucking the international trend by beefing up instead of reducing its arsenal of nuclear weapons. Brazilian President Dilma Rousseff demonstratively cancelled a trip to the United States and a meeting with US President Barack Obama to protest the NSA's surveillance practices. It's difficult to imagine German Chancellor Angela Merkel taking such decisive steps to represent Germany, which has seen similar treatment by the NSA.

A few years ago, the three emerging economies joined forces with Russia and South Africa to form the BRICS group. In March, the BRICS leaders decided to launch their own development bank, with a starting capital of $100 billion. It is apparently intended as an alternative to the US-dominated World Bank. Together, these countries are also trying to thwart the imposition of stricter environmental protection rules on their industries and gain influence in the traditional international centers of power. With Beijing's and New Delhi's votes -- and against the wishes of the United States -- Brazilian Roberto Azevêdo was chosen as the new head of the World Trade Organization (WTO) in May, and is now in a position to help shape the flow of goods around the world.

Forty years ago, Brazil was still a bankrupt military dictatorship, India was a backward agricultural country and China was groaning under the harsh dictates of the Cultural Revolution, with no private automobiles in the streets. But today we are on the edge of a new historical turning point.

Confronting Domestic Turmoil

But that's only one side of the success story that is constantly and proudly repeated in Beijing, New Delhi and Brasilia, not to mention by international institutions. There is another truth that isn't as pleasant: China, India and Brazil are currently being shaken by inner turmoil. In all three countries, people are taking to the streets to protest corruption, nepotism and inefficient government. At the same time, the economic recovery is flagging.

Ironically, the emerging nations have begun to see a considerable weakening of their economies in recent months, just as they pull ahead of the West. Growth rates in 2013 are expected to be about half of what they were in the boom year of 2007, declining in China from 14 to about 7.5 percent, from about 10 to 5 percent in India and from 6 to an estimated 2.5 percent in Brazil. These are still better figures than in the United States and the European Union, but they are not good enough to satisfy the rising powers' expectations. And now that the glitter is fading, differences are also coming to light once again. The three new powers may be in agreement most of the time when it comes to opposing Western dominance and a possible dictate on CO2 emissions, but their political differences are substantial.

They couldn't be more different when it comes to their own development models. China is a centralist, one-party dictatorship with clear elements of brute capitalism. India is a federal, chaotic democracy that is often its own worst enemy. And Brazil has a presidential governing system with a calcified party landscape. Shockingly, little has changed for hundreds of millions in the rural areas, where farmers have generally not benefited from the booming economy. But a new urban middle class has also taken shape. And, while earlier it seemed to be politically sedated by the steady rise in standard of living, priorities are shifting now that their basic economic needs have been met and the economic upturn has slowed down, at least temporarily. People are increasingly noticing societal injustice, the nepotism that enriches officials and the sharp divide between rich and poor.

The People Demand Justice

Ironically, the very people from whom the political elite believed they could expect gratitude, or at least tacit support, are now taking to the streets. It's a testament to the theory of French world traveler Alexis de Tocqueville, who wrote in the mid-19th century that it is not the impoverished masses who bring about change, but the people who have something to lose. In India, they are protesting the construction of pollutive factories and a sluggish legal system. In China they are speaking out against toxic food and the privileges of the party elite. And in Brazil, they are protesting the lack of educational opportunities and sinfully expensive vanity projects. They have become increasingly self-confident in demanding accountability, responsibility and good governance from their politicians.
Which of the three models can best cope with the economic setbacks and react most flexibly in the interest of its citizens? Are authoritarian systems better equipped for the challenges of the future than democratic systems? Is this just a temporary economic weakness, or have the predictions for these three new powers been too euphoric all along? And what does all this mean for the United States and Europe? Will they continue to fall behind, or could the West be on the verge of a comeback?

Some experts would have us believe that we are truly ailing, while Beijing, New Delhi and Brasília merely have a slight cough. But does Germany really have to get used to rising unemployment? Or can we actually expand the edge we still have when it comes to demanding jobs and high-tech research?

Corruption Remains a Problem

A few years ago, Harvard Professor Amartya Sen, the Indian winner of the Nobel Prize in Economics who helped create the UN's Human Development Index, told me that while GDP and per-capita income are important, they are by no means the only criteria that determine quality of life. "In my view, development means material prosperity as well as access to education, basic medical care, the right to free exercise of religion, the ability to exert political influence and protection against police repression," he said.

And this is where he sees considerable deficits among the new global players. "One country's weakness is another country's strength. China has achieved greater successes in expanding basic medical care and education. Life expectancy is high and the illiteracy rate is low. India fares better when it comes to protecting civil rights. The governments must comprehend that development means freedom -- freedom from poverty and tyranny." Sen is convinced that democracy, despite many setbacks, has proved to be successful on the whole. Unlike autocracy, said Sen, democracy helps to correct extreme aberrations.

And yet Sen, 79, was overcome by rage when he spoke about his native country. He deplored India's high child mortality rate, and the lack of access to clean drinking water and toilets. There are reasonable social programs in India, he said, but the authorities have failed in terms of implementation -- unlike Brazil were, despite many problems, things are at least slowly progressing. The South American giant has surged ahead of China and India in Sen's UN index. However, all three countries fare poorly on Transparency International's Corruption Perceptions Index, with Brazil ranked 69th, China 80th, and India in last place among the three powers at 94th.

Difficult Stage Ahead for New Powers

A visit with Lee Kuan Yew, the former prime minister of Singapore and a globally respected elder statesman of Chinese descent, provides another perspective. Even the political leadership in Beijing reveres this man who, in his 45 years as premier and senior minister, transformed the former British colony into a flourishing city-state -- and one with a largely authoritarian government. "I will cultivate an intelligent, constructive opposition," he said in 1986 during our first interview.

Lee, 90, a friend of former German Chancellor Helmut Schmidt and former US Secretary of State Henry Kissinger, has long seen a shift in global policy in the direction of Asia. "The 21st century will be an age of competition between China and the United States. I cannot predict how long the Americans can remain ahead. China is relentlessly on its way to number one," he says. Lee sees most of the excessive human rights violations in India, not in the land of his ancestors. "However, the idea of human rights is only gradually beginning to take hold in China. The notion that the state is the supreme authority, and that it cannot be questioned, still dominates their way of thinking," he adds.

Singapore's leader was long a devotee of Confucian values, and he is pleased that the great philosopher enjoys considerable respect in the People's Republic once again, after being banned for many years. But Lee doesn't just see Confucian teachings as promoting authority. Instead, he believes that Confucius emphasized education and the government's responsibility to the people. The absence of constitutional mechanisms and Chinese culture's mistrust of a free competition of ideas is harmful in the long term, says Lee. These are astonishing words for a thinker who spent a significant portion of his life flirting with the superiority of Asian values.

Necessary Competition

Lee believes that the new Chinese leadership has recognized, under the "impressive" Communist Party leader Xi Jinping, that the system must become more open. But Lee does not feel that this will automatically lead to a Western-style multi-party system. According to Lee, a confrontation with the United States can only be prevented if Beijing interacts intensively with the West in all areas.

Nobel laureate Sen and political professional Lee agree that the West has no reason to timidly withdraw from the competition between systems. So what could the world look like in 2025? Can we combine the predictions of economists, academics and politicians and, by conducting our own research, arrive at a relatively solid prediction?

China, India and Brazil are likely to continue their unstoppable ascent in the coming decade, but at a slower pace and without achieving the record growth rates of the past. It is now a question of the next, more difficult development stage, in which the three countries will be forced to recognize that the road from the world's underclass to its middle class is easier than the road to the top. In Beijing, in particular, something called the Lewisian turning point, named after a British economist, is likely to occur. This is when low-wage farm workers, long beneficial for the economy, are increasingly absorbed into the industrial sector, where they become a burden because of rising wages and the fact that the government must now provide them with health insurance and retirement pensions. India and Brazil, which, with their high birth rates, have at least a theoretical advantage over China and the West, are exposed to another unpleasant phenomenon -- the "middle income trap," in which the rising cost of production causes rapid, relatively simple growth to stagnate.

What About Europe?

In 2025, no one will be talking about the "Chinese dream" anymore, which Communist Party leader Xi Jinping recently touted as an alternative to the American dream. By then, everyone's illusions about Beijing's brand of authoritarian state capitalism will have been shattered, much like what happened with the so-called "Washington Consensus" of market fundamentalists who advocated giving completely free rein to forces in the financial sector. China, India and Brazil will have to find the ideal development model on their own. Models that have proven to be effective in Western societies cannot necessarily be transferred to other regions, at least not directly. But in the face of pressure from their increasingly well-informed citizens, they will have to turn their attention to the environment and strengthen institutions in the next decade. Russia will likely face the most difficult path. The population is shrinking, the economy is based almost exclusively on commodities, and civic participation in government has long since fallen victim to cynicism. In international diplomacy, Moscow's clever use of tactics on the Syrian issue was nothing more than a last gasp. Russia's rival China will get the better of Moscow, from Central Asia to Africa.

Despite the tendency toward self-destruction that it has demonstrated once again with its current government shutdown in Washington, the United States has a strong economic outlook, and it can be summed up in one word: fracking. As a result of this environmentally controversial technology for extracting natural gas from substantial depths, the United States will become independent of energy imports in the coming decade and can focus on nation-building at home.

But Europe remains the big puzzle. Will the old Continent, which former German Foreign Minister Joschka Fischer once called a "European chicken yard," have pulled itself together by 2025, after embarrassing years of petty disputes? Berlin will play a key role in the next decade. The successors of Germany's dithering Chancellor Angela Merkel could agree to a communitization of debts through Eurobonds, under strict conditions, and the institutions in Brussels could become more effective, transparent and democratic. A banking union could become reality, and there could be a sharp decline in youth unemployment in the south. A few high-tech jobs will likely return to Germany, when it becomes apparent that conditions abroad are not as favorable as some had believed.

That's the optimistic scenario. But it's also possible that Europe will persist in its current lethargy and become a pawn in the hands of the new powers -- a cultural amusement park that will be visited and admired by the winners of globalization as something of a well-preserved museum. According to a study by the Mercer consulting firm, Vienna, Zurich, Auckland and Munich are the cities with the highest quality of life worldwide. It is up to us to decide whether they simply remain pleasant places to live or also become dynamically oriented toward the future.

Translated from the German by Christopher Sultan

October 15, 2013

Europe’s Populist Backlash

The politics of populist anger are on the march across Europe, fueled by austerity, recession and the inability of mainstream politicians to revive growth.
In Greece, the main problem is Golden Dawn, whose violent neo-Nazi thugs have finally provoked a belated government crackdown. In France, it is the anti-immigrant, anti-Europe, National Front, whose clear victory in a local council race on Sunday sent shock waves through both mainstream parties. And in Italy, it is the anti-politics Five Star Movement, which feeds on popular resentment of an out-of-touch political class, austerity directives from Berlin and Brussels, and increased migration of refugees from North Africa and the Middle East.
Prime Minister Enrico Letta of Italy, who is scheduled to meet with President Obama in Washington on Thursday, warned this week of the danger that rising populism poses to political and economic stability across Europe, especially given the likelihood of strong populist gains in next spring’s European Parliament elections. But it will take more than warnings to turn back this tide. Mainstream governments like Mr. Letta’s must convince voters that they can do more than administer the austerity demanded by Germany and can deliver the economic relief demanded by their citizens.
Mr. Letta, in office since April, has, until now, been constrained by his need to avoid offending former Prime Minister Silvio Berlusconi, who controlled enough votes to bring down the government. But after winning a parliamentary showdown with Mr. Berlusconi this month, Mr. Letta is freer to act on needed reforms.
Mr. Berlusconi, a defendant in multiple court cases, pressed to weaken the powers of judges and prosecutors. Those powers need to be strengthened to assure swifter, surer justice. As an autocratic political boss, Mr. Berlusconi resisted democratizing the way candidates are chosen, and changing the way seats are allocated to make parliamentary deadlock less likely. With him out of the picture, it is more likely that center-right politicians will be more willing to negotiate over these issues.
On others, like moving from centralized national wage bargaining to more flexible, localized arrangements, the opposition comes from within Mr. Letta’s own Democratic Party. Mr. Letta needs to pressure his party to act more responsibly on this and other pro-growth reforms that union leaders in its ranks resist.
The most effective way to reduce populist anger before it further corrodes European unity would be to loosen the constraints of fiscal austerity that European Union governments have agreed to at Germany’s behest. That austerity has brought on double-digit unemployment rates across most of Europe (and more than 25 percent in Greece and Spain), which have darkened the prospects for the younger generation. Unless Mr. Letta and other European leaders can reverse this disastrous trajectory, political disillusionment will mount and destructive populist movements could emerge the only real winners.

Redefining 'Risk-Free' U.S. Treasuries

Oct 15 2013, 10:35

In my opinion, the term "risk-free" and the rate it usually pertains to in the world of debt markets is misleading at best. Holders of U.S. debt embrace the fact that the "full faith and credit" of the United States (i.e., the authority of its government to tax) is a guarantee for their principal. They see no substantial downside risk to their investment, let alone a default risk. Here in the U.S., we view the "risk-free" rate as the yield on the 1-month T-Bill. As you can see from the chart below, this rate is spiking.
(click to enlarge)
* source: zerohedge
At the beginning of the week, the "risk-free" rate was 0.08% and by the end of the week it had spiked to 0.25%. That is a substantial basis point rise in something that is considered to have no risk.
Why the Spike in Rates?
This spike is due to the fact that we are quickly approaching a deadline in which Treasury Secretary Jack Lew says the United States will breach the $16.7 trillion debt limit. In combination with a partial government shutdown, the U.S. is approaching a dangerous moment given the opposition for any kind of compromise on either side of the aisle.
Why Does it Matter?
The issuance of T-Bills is vital because they are the most liquid collateral for the $70 trillion shadow banking system. Without the constant liquidity and demand for these short-term T-Bills to provide for derivative markets, our banking system fails.
While I don't think a full-blown default is likely to happen, a "technical default" is possible in the next month, only affecting the timing of the payments that are due. Yet, the future chances of a complete U.S. default is far from "risk-free" if not inevitable if fiscal policies aren't drastically changed.
If or when a full-blown default happens, it will occur when major U.S. debt holders (China, Japan, etc.) realize the mighty U.S. dollar is not what is used to be and start selling their massive debt holdings.
Just last week Zhu Guangyao, the vice-finance minister of China, told reporters in Beijing: "We ask that the United States earnestly takes steps to resolve in a timely way before 17 October the political [issues] around the debt ceiling and prevent a U.S. debt default to ensure safety of Chinese investments in the United States and the global economic recovery. This is the United States' responsibility." China is the largest foreign holder of U.S. debt, owning about $1.28tn of U.S. Treasury bonds at the end of July, according to the Treasury. Along with that statement, Zhu added, "we hope the United States fully understands the lessons of history," referring to the 2011 downgrade of the U.S. credit rating, which led to a sharp 15%+ decline in the S&P500 (SPY)(DIA)(QQQ).
Additionally, commentary on the Chinese state news agency Xinhua said Sunday (October 13th), "The cyclical stagnation in Washington for a viable bipartisan solution over a federal budget and an approval for raising debt ceiling has again left many nations' tremendous dollar assets in jeopardyand the international community highly agonized." They also expressed that, "Instead of honoring its duties as a responsible leading power, a self-serving Washington has abused its superpower status and introduced even more chaos into the world by shifting financial risks overseas". In that same commentary, they stated that they believe U.S. fiscal failure warrants a "de-americanized" world. Lastly, and most importantly, they proposed a "new international reserve currency that is to be created to replace the dominant US dollar" (USD). If the past is any prediction on what the future will bring, we could come to the conclusion that a reserve currency status does not last forever, and the USD is no exception.
(click to enlarge)
* Source: zerohedge
Quantitative Easing?
Since 2008, Ben Bernanke and Federal Reserve has been implementing an economic experiment to epic proportions. Currently, the Federal Reserve is spending $85 billion a month in an attempt to prop up the economy (TLT)(TBT). Subsequently, the Federal Reserves balance sheet has been growing at an exponential rate since the start of Quantitative Easing in 2009. You can see this below:
* Source: Marketshadows
The Federal Reserve has been creating value out of "thin air" to provide the monthly stimulus that has more or less created a treasury and asset bubble of unprecedented size. At some point, the Federal Reserve will have to manage their massive treasury position, which has been pumping up the bond market bubble since 2008.
What can I do?
A collapse of the USD would send a shockwave through the world economies. According to Jamie Dimon, the CEO of J.P. Morgan (JPM), a US default "would ripple through the global economy in a way you couldn't possibly understand". Additionally, Deutsche Bank (DB) co-CEO Anshu Jain called the possibility of even a small default "utterly catastrophic". He noted that the potential consequences are so immeasurable he couldn't offer any legitimate recommendations on how to react. Even ignoring a complete default, Jim Cramer suggested that "given the fragility of the globe's economies it is difficult to see how this stalemate doesn't throw the world into a recession."
Personally, I have been accumulating physical gold/silver (GLD) (SLV); the only true protection against the debasement of the currency. In the end, Article I, Section 10, Clause 1 of the Constitution states "no state shall… coin Money; emit Bills of Credit; make any thing but gold and silver coin a tender in payments of debts…". Gold and silver is the only real currency and all fiat currencies are purely paper backed by debt filled central banks and governments.
However, back in 1933, during the Great Depression, FDR banned the private possession of precious metals (GLD) and ordered all US citizens to turn there gold in to the government under Executive Order 6102. The people who did were paid around $20 per ounce even though the actual price of their gold was worth $33 per ounce. Effectively the government stole 70% of their wealth overnight. Thus, if you're smart enough to hold precious metals as a hedge against the inevitable collapse of the dollar/paper currency, be aware of the historical executive orders against the individual possession of these metals. In that case, you will be prepared once the crisis occurs and the government implements their drastic capital controls.
(click to enlarge)
* Source: Forbes
For the first time on record, U.S. government debt (short-term T-Bill) is riskier than U.S. bank debt (short-term LIBOR) (BAC)(WFC). The yield on the short-term T-Bill is greater than the LIBOR, presenting a larger risk. Thus, given the implications of the absence of a purely "risk-free" rate, typical asset pricing models used today seem flawed if not irrelevant.
Nevertheless, the political gridlock in Congress and their reluctance to raise the debt ceiling alone is a substantial risk to the solvency of U.S. debt. Given that they would hold up the whole government and risk default just because they don't get their way on one specific issue is enough of a reason to take the label of "risk-free" off U.S. Treasuries. In other words, merely the presence of Ted Cruz and his allies in Congress present a threat to the soundness of U.S. debt, even ignoring our massive debt and deficits.
The next few months will be vital to the direction of the stock market and the USD. In the future I see an eventual steepening of the yield curve before the bond market completely implodes. To put it in perspective, the outstanding government debt is 23 times the $517 billion Lehman Brothers owed when it filed for bankruptcy on September 15th, 2008. Given the importance of the U.S. Treasury market to worldwide banking, the inevitable bond market collapse will make the crash of Lehman Brothers in 2008 and the recession that followed look like a cake-walk.

miércoles, octubre 16, 2013



The Federal Reserve’s Captive Minds

Luigi Zingales

15 October 2013
CHICAGO – Before the US government shutdown took center stage in American politics, all attention was focused on President Barack Obama’s likely pick as next Chair of the Federal Reserve. Indeed, the appointment of Vice Chair Janet L. Yellen to succeed Ben Bernanke highlights an important point: What used to be a technical appointment, of interest only to nerdy economists, has now become a major cause of political tension, not only dividing Republicans and Democrats (it does not take much to do that), but even splitting the Democratic Party.
Interestingly, the point of contention was not the candidates’ stands on inflation, but their positions on bank regulation. Why has the job of Fed Chair become so politically important? And why is bank regulation more interesting than inflation to US senators (who must confirm Obama’s appointee)?
These changes are simply a consequence of the 2008 financial crisis and of the policies that Bernanke adopted to overcome it. In an effort to save the financial system from collapse – and, later, in pursuit of economic recovery – the Fed has engaged in very active policies: near-zero interest rates, massive asset-purchase programs, remuneration of banks’ reserves, and so forth. While partly successful in stimulating the economy, these policies have had massive redistributive effects: from small savers to banks, from underwater homeowners to rich investors, and from pensioners to financiers.
These redistributive effects are forcing economists to rethink optimal central-bank governance, which has rested on a powerful dogma that emerged in the late 1970’s and early 1980’s, in response to high inflation: central bankers need to be independent of the political system.
Back then, the demise of the Bretton Woods system of fixed exchange rates had left central bankers exposed to political pressure in favor of more expansionary policies and even monetary financing of fiscal deficits. The most famous example of such undue interference was President Richard Nixon’s pressure on then-Fed Chair Arthur Burns to ease credit conditions during his 1972 presidential campaign.
In the long term, such pressure damaged the credibility of the very politicians who applied it. For this reason, central banks changed their statutes to ensure greater independence from the government. The European Central Bank’s governance framework is the poster child for this approach.
Yet political independence can lead to a complete lack of political accountability. And so it did. Liberated from political pressure, central bankers fell prey to intellectual capture, owing to a natural inclination to please those most like them: bankers and banking scholars. When the Fed’s job was, as former Chair William McChesney Martin famously put it, “to take away the punch bowl” as soon as wages started to rise faster than productivity, intellectual capture was not a concern: central bankers were not spending much time with workers and union leaders.
At the end of the twentieth century, however, the central banker’s job began to change. Strong competition from China kept wages and consumer prices in check. Thus, the main reason “to take away the punch bowl” was no longer a surge in consumer prices, but a surge in asset prices. Here, however, the problem of intellectual capture is much more severe.
In 1996, after then-Fed Chair Allan Greenspan raised the possibility that investors were suffering from “irrational exuberance,” he was criticized so sharply that he never dared to say anything like that again, even in the middle of the Internet bubble. It is difficult for central bankers to ignore that the financial sector stands to benefit enormously from a rise in asset prices. Even when, like Bernanke, the Fed chair does not come from that world, the intellectual formation is the same as that of bankers (as are the conferences they attend).
As if intellectual capture were not enough, the problem is exacerbated in the US by antiquated governance at the 12 regional Federal Reserve Banks. Regional Fed presidents are chosen by a board representing the local business community, in particular the local bank community. The board of the New York Fed reads like a who’s who of the banking world. How can we expect these governors to be independent from bankers when they have lived, breathed, and eaten the banking perspective for their entire careers?
Now that Obama has appointed Yellen, attention should turn to that question. Political pressure is the only known antidote to bankers’ pressure. Too much of either will take the Fed in the wrong direction. But now, after three decades in which political independence has exposed central banks to intellectual capture, a bit of rebalancing is necessary.

Interview of James Rickards About Central Bank Manipulation of Gold and Silver Markets

Publication date : 2013-10-14

If you study the gold and silver market long enough you can’t but acknowledge that the precious metals are manipulated. Last friday drop (october 11th) in gold was another example : 2 millions ounces of paper gold were sold in less than 3 minutes (read the explanation here) at a time when the market is the most illiquid and when the CFTC (US market regulator) is closed due to US government shutdown.
The manipulation that triggered a 2 years correction can be very difficult  for gold investors to experience, unless they recognize that it create an opportunity to acquire physical gold at an artificially low price.
The question all gold investors have in mind is “When will the manipulation end ?”. In the interview below, James Rickards, author of the bestseller “Currency Wars : The making of the next global crisis” give some very interesting answers you won’t read in the mainstream media. It is high level information from an an expert who anticipated long ago what’s happening today.
With China now openly calling for the end of the dollar as the international reserve currency, we are getting closer to major events that will change our international monetary system.

You can read my interviews of two other prominent analysts about the gold and silver manipulation here: Chris Powell (GATA)Jim Willie (Goldenjackass.com) and James Rickards.
Here is the third interview with James Rickards.

James Rickards is the author of the national bestseller, "Currency Wars: The Making of the Next Global Crisisand a Partner in Tangent Capital Partners, a merchant bank based in New York. He is a counselor and investment advisor and has held senior positions at Citibank, Long-Term Capital Management and Caxton Associates. In 1998, he was the principal negotiator of the rescue of LTCM sponsored by the Federal Reserve. His clients include institutional investors and government directorates. He has been interviewed in The Wall Street Journal and has appeared on CNBC, Bloomberg, Fox, CNN, BBC and NPR and is an Op-Ed contributor to the Financial Times, New York Times and Washington Post. Mr. Rickards is a visiting lecturer at Johns Hopkins University and the School of Advanced International Studies, has delivered papers on risk at Singularity University, the Applied Physics Laboratory and the Los Alamos National Laboratory and has written numerous articles on risk management. He is an advisor on capital markets to the Director of National Intelligence and the Office of the Secretary of Defense. Mr. Rickards holds an LL.M. (Taxation) from the NYU School of Law; a J.D. from the University of Pennsylvania Law School; an M.A. in economics from SAIS and a B.A. from Johns Hopkins.

Follow James Rickards on Twitter : @JamesGRickards

Fabrice Drouin Ristori (FDR)Mr Rickards, thanks for accepting this interviewHow long the manipulation of the precious metal markets can last ?
James RickardsCentral bank manipulation of gold markets can and will last until physical shortages become so acute that banks and exchanges can no longer deliver on futures and forward contacts when requested by customers. At that point, contracts will be terminated and exchanges will order that trading be conducted "for liquidation only" which means that futures customers can close out or rollover contacts, but they cannot receive physical delivery of gold. 

FDR: What will put an end to it ? Physical demand ? Geopolitical event (BRICS) ?   
JR: Physical demand will remain strong until the world returns to a gold standard. Once the world is on a gold standard, gold may move from country to country in settlement of balance of payments accounts, but there will be no reason to acquire extra gold because the value of gold will be fixed in terms of each major currency. When you are on a gold standard, gold and currency are freely interchangeable. However, gold will continue to be in demand until a gold standard is implemented. This is because the market price of gold is considerably less than the implied non-deflationary price of gold under a gold standard. As long as this situation prevails, there will be an arbitrage motive to exchange currency for gold. 

FDR: What will be the signs proving that the manipulation is ending ?
JR: The signs that the manipulation is coming to an end will include depletion of warehouses, price spikes and notifications from banks that they will no longer allow the conversion of gold forward contacts into physical gold. 

FDR: Do you anticipate an overnight ending of the manipulation or a progressive process ?
JR: Both. The process will proceed slowly at first, then gain momentum, then reach a panic buying stage where the termination of deliveries under futures and forward contacts will be announced very suddenly. At that point, physical gold will be scarce and interested parties will not be able to acquire it in small quantities at any price. 

FDR: Is the gold/silver paper spot price still relevant to value physical gold and silver ?
JR: It is relevant in the sense that it is still possible to acquire gold and silver at prices significantly below the implied non-deflationary price under a gold standard. This is a type of arbitrage that will be available until the world returns to a gold standard or until countries use executive orders to abolish gold trading. 

FDR: What direct consequences would a free gold/silver market have on people worldwide -- not investors, people in general ?
JR: We have a free gold/silver market today. Anyone can buy or sell as much gold or silver as they like at market prices and exchange it freely with willing counterparties. To the extent that central banks act to depress the price of gold or silver, this acts like a gift to those interested in purchasing it at an artificially low price. If the world returned to a gold standard, the price of gold would be boring and the trading uninteresting because it would be fixed in terms of a currency and interchangeable with the currency. 

FDR: I would like to thanks again James Rickards for taking the time for this interview.

Mysterious Gold Seller Is Back With Periodic High Volume Slams, Fails To Break Market

Submitted by Tyler Durden 

10/15/2013 10:50 -0400

 Unlike on the two prior occasions when the "mysterious" (coughBIScough) gold seller sold so much gold he briefly broke the gold market not once but twice, this morning's concerted gold selling episodes, which briefly took gold to a three month low, were unable to obliterate the entire bid stack (at least for now) and crush enough liquidity to force the CME to announce another "stop logic" 10-20 second trading halt.
However, there were some other peculiarities surrounding today's now recurring morning gold battering (which as we noted in a market where the CME no longer supervises any and all manipulation, were and are certain to continue). Specifically, what is curious is that starting at 3:48 am Eastern Time, Nanex found "six instances (there may be more) of 1 second periods in Gold futures with a high number of trades (700 or more)." As those who have been covering our coverage of HFT manipulation will note, these are precisely the kinds of momentum ignition, and notrational price discovery, events that seek to manipulate prevailing prices lower (or higher). The good news is that as everyone knows, aside from equity, electricity, FX, libor, aluminum, and credit derivative markets (in just the case of JPM) gold is never manipulated: Blythe Masters promised. So there's that.
These are the specific volume spiking intervals that Nanex has noted in the latest overnight trading session of note.
  • 03:48:04
  • 04:46:46
  • 05:30:42
  • 07:43:22
  • 08:43:26
  • 09:43:29
As Nanex further observes, "Note that the last 3 are almost exactly 1 hour and 3 seconds apart. That's not likely a coincidence."
And the actual bid-soaking trading slams in chart format:

03:48:04 ~ December 2013 Gold (GC) Futures Depth of Book






Watch what China does with US debt, not what it says

The latest data shows that China's foreign reserves soared by $163bn in the third quarter to $3.66 trillion, one of the biggest jumps ever.
Mark Williams and Qinwei Wang from Capital Economic called the rise "astonishing". They estimate that China's central bank must have bought $70bn of foreign bonds last month in a frantic bid to hold down the currency.
We won't know for a while where the money went, but a big chunk must have gone into US Treasuries. So bear that in mind when you read the Xinhua claims that the US debt ceiling fight "has again left many nations' tremendous dollar assets in jeopardy and the international community highly agonised."
Or when it says:
A new world order should be put in place, according to which all nations, big or small, poor or rich, can have their key interests respected and protected on an equal footing. To that end, several corner stones should be laid to underpin a de-Americanised world.
Talk, talk, talk.
China's soaring reserves expose the truth. (And no, excess reserves are not a sign of strength, they are a sign of a deformed economy). Beijing is not in fact opening up its capital accounts and preparing to let the market decide the exchange rate.
The good news for China is that is no longer an emerging market in any meaningful sense. It was a safe haven during the great summer squall that hit India, Indonesia, Turkey, Brazil, South Africa, Ukraine, Serbia, et al. China did not suffer capital flight. It suffered a surge of very unwelcome capital inflows.
But there is a darker side to this. For all the talk of reform, China still refuses to give up its mercantilist trade policy. It is holding down the yuan to cling onto global market share and protect the wafer-thin margin of its exporters, not always successfully.
I have grave doubts about the new consensus view that China is roaring back. There is a high chance that this will fizzle out. You can see from Simon Ward's money data at Henderson Global Investors that China's money supply has rolled over:

Click to enlarge
Mr Ward's measure of six-month real M1 growth is an early warning for the economy, roughly six months ahead. So it points to a fresh slowdown over the late winter/early spring. Be prepared.
In any case, the recent burst of growth has been driven almost entirely by reverting to the bad old ways of top-down investment in heavy industry, and excess credit (yet again), as both the IMF and World Bank hinted in their latest reports.
The economic "efficiency" of debt has collapsed. Each extra yuan of loans now yields just 0.18 yuan of GDP growth. The credit cycle is played out. Debt has jumped from $9 trillion to $23 trillion in five years, reaching 200pc of GDP. Keeping it going is playing with fire. The experts in Beijing know exactly what this implies, but they can't easily stop it. Political vested interests are at play.
Zhiwei Zhang from Nomura has published a note, "China: Why the Economic Recovery is Unsustainable", citing seven reasons why the latest expansion is unhealthy and doomed to wilt like a failed souffle.
The one that struck me most was the finding in the IMF's Article IV report that China's full fiscal deficit (including local government) was 7.4pc of GDP last year. It was 9.7pc excluding land sales, which should be exclude because that sort of funding is a Ponzi scheme.
This is actually worse than the US, as you can see from the chart below:
This does not mean that the wheels will fall off the Chinese economy. What it does show is how far the Chinese growth model is living on borrowed time. All the low-hanging fruit has been picked.
It will be a much harder slog from now on.