Fed calls time on $5.7 trillion of emerging market dollar debt

World finance is rotating on its axis. The stronger the US boom, the worse it will be for those countries on the wrong side of the dollar

By Ambrose Evans-Pritchard

9:27PM GMT 17 Dec 2014
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A share trader takes a phone call as he is seen behind a false one dollar bill at the German stock exchange in Frankfurt

Emerging markets have collectively borrowed $5.7 trillion in US dollars, a currency they cannot print and do not control Photo: Reuters
 

The US Federal Reserve has pulled the trigger. Emerging markets must now brace for their ordeal by fire.
 
They have collectively borrowed $5.7 trillion in US dollars, a currency they cannot print and do not control. This hard-currency debt has tripled in a decade, split between $3.1 trillion in bank loans and $2.6 trillion in bonds. It is comparable in scale and ratio-terms to any of the biggest cross-border lending sprees of the past two centuries.
 
Much of the debt was taken out at real interest rates of 1pc on the implicit assumption that the Fed would continue to flood the world with liquidity for years to come. The borrowers are "short dollars", in trading parlance. They now face the margin call from Hell as the global monetary hegemon pivots. 
 
The Fed dashed all lingering hopes for leniency on Wednesday. The pledge to keep uber-stimulus for a "considerable time" has gone, and so has the market's security blanket, or the Fed Put as it is called. Such tweaks of language have multiplied potency in a world of zero rates.
 
Officials from the Bank for International Settlements say privately that developing countries may be just as vulnerable to a dollar shock as they were in the Fed tightening cycle of the late 1990s, which culminated in Russia's default and the East Asia Crisis.

The difference this time is that emerging markets have grown to be half the world economy.

Their aggregate debt levels have reached a record 175pc of GDP, up 30 percentage points since 2009. Most have already picked the low-hanging fruit of catch-up growth, and hit structural buffers.
 
The second assumption was that China would continue to drive a commodity supercycle even after Premier Li Keqiang vowed to overthrow his country's obsolete, 30-year model of industrial hyper-growth, and wean the economy off $26 trillion of credit leverage before it is too late.
 
These two false assumptions have blown up simultaneously, the effects threatening to feed on each other with wicked force. Russia's Vladimir Putin could hardly have chosen a worse moment to compound his woes by tearing up the international rulebook and seizing chunks of territory from Ukraine, a country that gave up its nuclear weapons after a pledge by Russia in 1994 to uphold its sovereign borders.
 
Stress is spreading beyond Russia, Nigeria, Venezuela and other petro-states to the rest of the emerging market nexus, as might be expected since this is a story of evaporating dollar liquidity as well as a US shale supply-glut.
 
Turkey relies on imports for almost all its energy and should be a beneficiary of lower crude prices. Yet the Turkish lira has fallen 12pc since the end of November. The Borsa Istanbul 100 index is down 20pc in dollar terms.



Indonesia had to intervene on Wednesday to defend the rupiah. Brazil's real has fallen to a 10-year low against the dollar, as has the index of emerging market currencies. Sao Paolo's Bovespa index is down 23pc in dollars in three weeks.
 
The slide can be self-feeding. Funds are forced to sell holdings if investors take fright and ask for their money back, shedding the good with the bad. Pimco’s Emerging Market Corporate Bond Fund bled $237m in November, and the pain is unlikely to stop as clients discover that 24pc of its portfolio is in Russia.
 
There could be a cascade if - as many predict - the Kremlin is forced to impose capital controls, triggering the automatic ejection of Russia from benchmark indices. One might rail against the injustice of indiscriminate selling. Such are the intertwined destinies of countries that have nothing in common.
 
The Fed has already slashed its bond purchases to zero, withdrawing $85bn of net stimulus each month. It is clearly itching to raise rates for the first time in seven years. This is the reason why the dollar index (DXY) has jumped 12pc since May, smashing through its 30-year downtrend line, a "seismic change" in the words of HSBC.
 
The US economy has shaken off its long malaise. It grew 3.9pc in the third quarter, an incipient boom. The latest confidence survey by the University of Michigan said expected wage gains "rose to their highest level since 2008". More spoke of job gains than "any other time in the last half century". Consumers are the most positive in "30 years."

This is powerful stuff. New York Fed chief William Dudley has strongly hinted that rate rises may come faster and harder than markets expect, more like the bond crash cycle of 1994 than the dilatory style of 2004.
 
Fed vice-chairman Stanley Fischer said the Fed will look through the oil crash. "The lower inflation that we'll get is going to be temporary. I wouldn't worry about that very much. (It is) more likely to increase GDP rather than reduce it," he said.
 
World finance is rotating on its axis, says Stephen Jen, from SLJ Macro Partners. The stronger the US boom, the worse it will be for those countries on the wrong side of the dollar. 
 
"Emerging market currencies could melt down. There have been way too many cumulative capital flows into these markets in the past decade. Nothing they can do will stop potential outflows, as long as the US economy recovers. Will this trend lead to a 1997-1998-like crisis? I am starting to think that this is extremely probable for 2015," he said.
 
This time the threat does not come from insolvent states. They have learned the lesson of the late 1990s. Few have dollar debts. But their companies and banks most certainly do, some 70pc of GDP in Russia, for example. This amounts to much the same thing in macro-economic terms.




Private debt morphs into state debt since governments cannot allow key pillars of their economies to collapse. Does anybody believe that the Kremlin can walk away from $50bn of external debt owed by its oil giant Rosneft? Or that the $170bn debt owed by Brazil's Petrobas is a purely private matter?

Standard & Poor's says the only reason it has not yet slashed Petrobras to junk is because of implicit state support.
 
These countries have, of course, built $9 trillion of foreign reserves, often the side-effect of holding down their currencies to gain export share. This certainly provides a buffer. Yet the reserves cannot fruitfully be used in a recessionary crisis because sales of foreign bonds automatically entail monetary tightening.
 
Russia learned this the hard way in 2008 when it burned through $220bn in six weeks defending the rouble. This caused the money supply to contract at double-digit rates and set off a systemic banking crisis. The financial bail-out ultimately cost the Kremlin $170bn.
 
In other words, these reserves are a mirage. If you deploy them in such circumstances, you choke your own economy unless you can sterilize the effects. China can do this at any time by slashing its reserve requirement ratio to single digits from a giddy 20pc. This would inject $2 trillion or more into the economy. Others do not have such luxury.
 
Investors are counting on the European Central Bank to keep the world supplied with largesse as the Fed pulls back. Yet the ECB could not pick up the baton even if it were to launch a blitz of quantitative easing, and there is no conceivable consensus for action on such a commensurate scale.
 
The world's financial system is on a dollar standard, not a euro standard. Global loans are in dollars. The US Treasury bond is the benchmarks for global credit markets, not the German Bund. Contracts and derivatives are priced off dollar instruments.
 
Bank of America says the combined monetary stimulus from Europe and Japan can offset only 30pc of the lost stimulus from the US. If you think that the sheer force of the US recovery will lift the whole global economy regardless of fading monetary stimulus, none of this may matter.
 
My own view is that a world awash with excess capacity cannot withstand a fully-fledged dollar tightening shock. The effects will ricochet back into the US eventually, but that could be a long time hence, and this in a sense is the problem for asset markets.
 
In the end, the Fed may not be able to raise rates, or at least not by much. By the same token, it is questionable whether China's leaders can easily purge the excesses left from their investment bubble without paying an escalating political price.
 
Both of the G2 monetary superpowers may have to pull the stimulus lever yet again. First markets must endure a rare few months of chilly discipline.
 


Signing Off

By Grant Williams

December 17, 2014
         

“But what if all the tranquility, all the comfort, all the contentment were now to come to a horrifying end?”
 
­–
 
 
 
 

“Lonely, lonely,
Tin can at my feet.
Think I’ll kick it down the street,
That’s the way to treat a friend.”
 
“And the open road rolled out in front of us.”
 

 
You’ve changed me forever. And I’ll never forget you.”
 


 
On Christmas Eve 1979, 27 days before I became a teenager, in a surburban street in Moseley in Britain’s West Midlands, a group of musicians put the finishing touches on their debut album.
 
The musicians — Brian Travers, Astro, James Brown (no, not that one), Earl Falconer, Norman Hassan, Mickey Virtue, and twins Ali and Robin Campbell — had a unique approach to the music business.
 
Eighteen months prior to completing their first album, Ali Campbell and Travers had plastered the streets of Birmingham with leaflets promoting the band, which had taken its name from the document issued to people claiming unemployment benefits from the UK government’s Department of Health and Social Security (DHSS). The name of the form — and thus the band — was UB40.
 
Having advertised themselves and with dreams of making a big splash on Britain’s reinvigorated music scene running wild in their heads, the band had just one remaining item on their to-do list — learn to play their instruments.
 
Things%20To%20Do%20small.psd
 
The members of UB40 made an agreement to spend the next year doing nothing other than learning their instruments and practising their songs until they felt they were good enough.
 
(I know, I know! This IS analagous to many modern-day Central Bank policy efforts, but that’s not where I’m going with this, so stop jumping ahead.)
 
Anyway, after about a year, the band felt competent enough to play in public; and they made their debut on the 9th of February, 1979, in an upstairs room at the Hare & Hounds, a small pub in King’s Heath. They had been “booked” by a friend to celebrate his birthday.
 
Following on the success of their first gig (apparently, the birthday boy was delighted), the band secured a series of similar shows, all in local pubs, at which they planned to unleash their blend of reggae and dub onto an unsuspecting public who, though they didn’t realise it, had been waiting for UB40 for years.
 
Remarkably, at one of these pub gigs, Chrissie Hynde just happened to be in attendance, no doubt supping a couple of pints of Throgmorton’s Dubious Explanation (a real ale so thick it’s served by the slice); and she liked what she saw so much, she offered the band a supporting slot on The Pretenders’ upcoming tour of the UK.
 
Simple.
 
Fast-forward to Christmas 1979, and the story of the recording of the band’s debut album burnishes the legend yet further:
 
(Wikipedia): The band approached local musician Bob Lamb as he was the only person they knew with any recording experience. Lamb had been the drummer with the Steve Gibbons Band for much of the 1970s and was a well-known figure within the Birmingham music scene.... However, as the band were unable to afford a proper recording studio, the album was recorded in Lamb’s own home at the time, a ground-floor flat in a house on Cambridge Road in Birmingham’s Moseley district....
 
Brian Travers recalled just how basic the recording facilities of the original Cambridge Road “studio” really were:
 
Because we couldn’t afford a studio and he was the only guy we knew who knew how to record music, we did the album in his bedsit. I remember he had his bed on stilts. So underneath the bed was a sofa and mixing desk. And so we recorded the album there on an eight-track machine, with the same 50p coin going through the electric meter continually because we’d booted the lock off it. And, with it being a bedsit and us being eight in the band, we’d record the saxophone in the kitchen — because there was a bit of resonance off the walls, a bit of reverb — before putting the machine effects on it. While the percussion — the tambourines, the congas, the drums — we’d do in the back yard. Which is why you can hear birds singing on some of the tracks! You know, because it was in the daytime we’d be shouting across the fences “Keep it DOWN! We’re RECORDING!”
 
Lamb remembered the process fondly:
 
Nothing was hard work about that album, it was a bit of a dream that sort of fell out of the sky... It was almost effortless to make in that they were so good at the time, and so happy at the time with the success that they got, there was no effort in it.
 
The title of the album, “Signing Off,” was inspired by the process of the band members ending their claim on UK unemployment benefits — and becoming pop stars.
 
The LP (Google it, Gen Y-ers), released on August 29, 1980, spent 71 weeks on the UK albums chart, peaking at number 2 and turning platinum (when doing such a thing used to mean something). It was greeted with rapture by Britain’s music press:
 
(Sounds): Five stars out of five. It is an (almost) perfect album.... It’s rare to find a debut album so detailed, so excellently played and so packed with bite — I sometimes think it hasn’t really happened since The Clash.
 
The album would go on to make Q Magazine’s “100 Greatest British Albums Ever” (#83, if you’re interested) and is featured in a book somewhat somberly titled 1001 Albums to Hear Before You Die.
 
I think it’s fair to say I played my part in the success of the band by spending the pocket money I had saved up on a copy of “Signing Off” (though the band have so far not publicly acknowledged my involvement).
 
Anyway, as I am now signing off from Mauldin Economics, I felt it would be appropriate to take stock of a few of the issues I have covered ad nauseum repeatedly during my two-plus years working with John and his team; and I thought I’d also take those of you unfamiliar with UB40’s debut album through a few of the tracks (and remind those of you who know the band just how spectacular that album was).
 
 
The “King” referred to in the second track on “Signing Off” was, of course, Martin Luther King, Jr. The song was short on lyrics but big on impact; however, the undoubted “King” in markets today is once again King Dollar, and the world’s reserve currency is making some serious waves right now, which threaten to cause chaos in world markets.
 
At this point I’ll throw things over to my friend and partner in Real Vision Television and author of The Global Macro Investor, Raoul Pal, who has been warning of the likelihood of a major move in the dollar for longer than just about anybody. In his most recent report, he explained the ramifications of a dollar bull market in the clearest, most concise way possible:
 
(Raoul Pal): Debt dynamics, deflation, positioning and technicals all suggest that a dollar bull market of some considerable velocity and length is underway.
 
When dollar bull markets occur, emerging markets get hit.
 
When dollar bull markets occur, carry trades get unwound.
 
When dollar bull markets occur, they tend to usher in disinflationary forces as commodities and goods get re-priced.
 
The preceding three factors lead to a self-reinforcing of the dollar bull market, creating more of the same in a cycle of liquidation and bad debts, creating more demand for US dollars.
 
As I said, clear and concise.
 
I watched Raoul present at the iCIO Summit this past week, and his presentation was compelling, to say the least. As he pointed out in a panel discussion with Mark Yusko, Dennis Gartman, David Rosenberg, and myself, “When currencies begin to trend, they can do so for decades.”
 
A sobering thought.
 
A look at the long-term charts of the DXY Index shows just how massive the potential reversal of this trend is; and based on Raoul’s roadmap, the sheer size of the reversal gives us a strong hint of the degree of carnage that will be wrought upon a world in which the dollar carry trade has reached somewhere between $5 trillion and $9 trillion.
 
DXY%20LT.psd 
 
Incidentally, one of those estimates is Raoul’s, and one belongs to the BIS, and I bet your first guess as to which is which would have been wrong.
 
A closer look at a shorter-term chart demonstrates the recent break clearly:
 
DXY%20ST.psd 
 
The BIS report to which I refer was published last week, and it was astounding in terms of the sheer size of the dollar carry trade it depicted.
 
According to the BIS, US dollar loans to China’s banks and companies have jumped to $1.1 trillion — that’s TRILLION — from virtually zero just five short years ago. The annual rate of increase of those loans is a mind-boggling 47%.
 
However, the fun doesn’t stop there.
 
Consider Brazil, for example, where cross-border dollar credit now stands at $461 billion, or roughly 20% of GDP. For Mexico those numbers are even more eye-watering. A country with a GDP of just $1.1 trillion has outstanding cross-border dollar credit of $381 billion — or roughly 30% of GDP.
 
Frightening.
 
Meanwhile, in Russia the same metric has reached $751 billion. Why does this matter? Well, the charts below, which show the appreciation of the US dollar against those three currencies in the last five years, highlight the danger to countries that have been able to borrow seemingly endless amounts of (relatively) stable dollars to finance business operations and expansion.
 
Lastly — and perhaps most importantly — witness the change in direction of the Chinese renminbi which, after trending higher against the dollar for many years (and, in the process, moving virtually everybody to the same side of the boat in the belief that a stronger Chinese currency was a given), has suddenly started to look as if it may also succumb to the renewed strength of the dollar. The only difference here being that the Chinese may actively be looking now to devalue their currency in light of the ongoing attempt by the Japanese to devalue their way back to competitiveness. Few thought this a likely scenario until very recently; consequently, few are positioned accordingly; and when things like that happen in the macro world, you can get some REALLY funky moves.
 
When currency wars break out, they can get very nasty very quickly.
 
 
2558.png 
2573.png 
2585.png 
 
Under no circumstances should you take your eyes off the US dollar, folks. The sheer number of places where you will witness the knock-on effects of a soaring dollar — chief amongst them emerging markets and the commodity space — will be breathtaking.
 
I will write at greater length on the likely effects of the dollar’s move on gold in a few weeks, as it warrants a piece all its own; so stay tuned for that one.
 
In a series of conversations I’ve been fortunate to have had with some of the best macro traders in the world in recent months through Real Vision Television, there has been one overarching takeaway from every one of them: macro is back, and 2015 is shaping up to be an epic year for the guys who trade these fundamental shifts. To a man, after several years of little action in the macro world, they are positively licking their lips at the potential opportunities that are headed their way next year.
 
One person’s opportunity is another person’s crisis. You have been warned.
 
 
Track 3 was an instrumental number called “12 Bar,” a reggae reimagining of the 12-bar blues that highlighted Brian Travers’ remarkably good saxophony skills (given his lack of attention to learning to play the instrument before forming the band).
 
Obviously, during my time with Mauldin Economics, the “bars” which have preoccupied me have been those of the gold variety — and for the most part, their constant movement in an easterly direction.
 
I have written article after article and given presentation after presentation about the dichotomy between paper and physical gold and have regularly highlighted the magnitude of the flow of gold out of the West and into strong Eastern hands. In the previous edition of this publication (“How Could It Happen?”), I imagined a future in which this stunning relocation of physical gold had finally mattered; and between publishing that piece and penning this one, a couple of interesting things have happened. Firstly, my friend Barry Ritholtz took a big, fat shot at me in a Bloomberg column entitled “The Gold Fairy Tale Fails Again.” Barry’s article (which was entirely consistent with his very public and oft-stated thinking and was, as is always the case with Barry, very well-written) took apart what he sees as the various failed narratives in the gold markets. He began with gold’s link to QE:
 
(Barry Ritholtz): [T]he most popular gold narrative was that the Federal Reserve’s program of quantitative easing would lead to the collapse of the dollar and hyperinflation. “The problem with all of this was that even as the narrative was failing, the storytellers never changed their tale. The dollar hit three-year highs, despite QE. Inflation was nowhere to be found,” I wrote at the time...
 
... moved on to the recent SGI:
 
Switzerland was going to save gold based on a ballot proposal stipulating that the Swiss National Bank hold at least 20 percent of its 520-billion-franc ($538 billion) balance sheet in gold, repatriate overseas gold holdings and never sell bullion in the future. This was going to be the driver of the next leg up in gold. Except for the small fact that the “Save Our Swiss Gold” proposal was voted down, 77 percent to 23 percent, by the electorate....
 
... then hit upon the recent Indian import restrictions and reports of gold shortages, which Barry clearly feels are spurious, before eventually finding his way to yours truly:
 
Perhaps the most egregious narrative failure came from Grant Williams of Mauldin Economics.
 
He imagined a conversation 30 years from now about China’s secret three-decade-long gold-buying spree, dating to November 2014. Well, we only need to wait 30 years to see if this prediction is correct.
 
Now, in response to the lighting up of my Twitter feed after Barry’s article was posted (and my thanks to all those who kindly pointed it out to me), I would say this: Barry is right on all counts.
 
For now.
 
I am delighted to be able to call Barry a friend and have absolutely no problem with his calling me out on what I said. Those of us who possess sufficient hubris to deem our thoughts worthy of distribution wider than the inside of our own heads are absolutely there to be taken to task should others disagree with us. We make ourselves fair game the second we hit the wires.
 
Sadly, none of us actually KNOW anything. How could we? We all take whatever inputs we find and then use them to reach our own conclusions based mostly on probability, and more often than not those conclusions are wrong.
 
HOWEVER... if your logic is sound and your thought processes rigorous, being wrong is often a temporary state — something that can also be said about being right, of course. In my humble opinion, the issue with gold today is not one of narrative, as Barry suggests, but rather that the extent of the current interference in markets by our friends at the various central banks around the world has meant that being wrong (no matter which part of the financial jigsaw puzzle you may be concerned with) has never been easier — even though being right has never, in my own mind at least, been more assured in the long term, certainly as far as gold is concerned.
 
As I slumped against the literary ropes, Barry threw one more punch when he suggested that the reader would “only need to wait 30 years to see if this prediction is correct,” but this is where I stop covering up and finally flick a jab or two of my own.
 
I think the chances of having to wait 30 years to see the gold conundrum resolve itself (in materially higher prices, I might add) lie close to those of Barry’s being invited to give the opening address at the next GATA conference. The evidence is crystal clear that significant quantities of physical gold have been pouring into Eastern vaults (due to both private- and public-sector activity); and gold is, after all, a finite resource. Not only that, but the “weakness” in gold (which remains roughly 500% above its turn-of-the-century low, despite the recent 30% correction) is confined to the paper market.
 
Whilst this distinction between paper and real gold hasn’t mattered up until now, there will come a day when it absolutely does — to everybody — and at that point, anyone not positioned correctly will be in a world of hurt.
 
China%20Gold%20Withdrawals.jpg 
(Charts above and below courtesy of Nick Laird at Sharelynx and Koos Jansen)
 
RussiaReserves.jpg 
 
Tightness in the physical market has increased consistently as the likes of Russia continue to stockpile ever-increasing amounts of gold and as Chinese imports as well as withdrawals from the Shanghai Gold Exchange maintain a torrid pace. The only missing piece of the puzzle is the lack of any official acknowledgement that the Chinese have been doing the same thing to a far greater degree; and, as I wrote in “How Could It Happen?”, there is a curious demand for absolute proof from those who dispute official figures, whilst the principle of reasonable doubt continues to hold sway on the other side of the argument.
 
I suspect that imbalance will right itself — possibly very soon — and when it does there will be absolutely no putting the genie back into the bottle.
 
In the meantime, as Barry so confidently predicted, the Swiss Gold Initiative failed, but that was overshadowed (in my mind at least) by a couple of very interesting developments that were covered beautifully by two of my buddies, Willem Middelkoop (author of The Big Reset — a phenomenal read) and Koos Jansen.
 
Firstly, Koos reported on the increasing drive to allocate the gold held within the Eurosystem:
 
(Koos Jansen): [M]ost of the Eurosystem official gold reserves are allocated, and since January 2014 (which is as far as the more detailed data goes back) the unallocated gold reserves are declining, as we can see in the next chart.
 
Unfortunately we do not know what happened prior to 2014.
 
 
2638.png 
 
 
Note, allocated does not mean the gold is located on own soil, but it does mean the gold is assigned to specific gold holdings, including bar numbers, whether stored on own soil or stored abroad.
 
Unallocated gold relates to gold held without a claim on specified bar numbers; often these unallocated accounts are used for easy trading... The fact the Eurosystem discloses the ratio between its allocated and unallocated gold and, more important, the fact that the portion of allocated gold is far greater and increasing, tells me the Eurosystem is allocating as much gold as they can.
 
Secondly, another repatriation request was unearthed — this time made by perhaps the least likely source imaginable:
 
(Koos Jansen): In Europe, so far, Germany has been repatriating gold since 2012 from the US and France, The Netherlands has repatriated 122.5 tonnes a few weeks ago from the US, soon after Marine Le Pen, leader of the Front National party of France, penned an open letter to Christian Noyer, governor of the Bank of France, requesting that the country’s gold holdings be repatriated back to France; and now Belgium is making a move. Who’s next? And why are all these countries seemingly so nervous to get their gold ASAP on own soil?
 
Funnily enough, the answer to Koos’ rhetorical question about who’s next was answered just a few days later:
 
(Bloomberg): The Austrian state audit court says central bank should address concentration risk of storing 80% of its gold reserves with the Bank of England, Standard reports, citing draft audit report. Court advises central bank to diversify storage locations, contract partners.
 
Austrian central bank reviewing gold storage concept, doesn’t rule out relocating some of its gold from London to Austria: Standard cites unidentified central bank officials. Austria has 280 tons gold reserves, according to 2013 annual report. Austrian Audit Court Will Review Nation’s Gold Reserves in U.K.
 
Say what you want about the gold price languishing below $1200 (or not, as the case may be, after this week), and say what you want about the technical picture or the “6,000-year bubble,” as Citi’s Willem Buiter recently termed it; but know this: gold is an insurance policy — not a trading vehicle — and the time to assess gold is when people have a sudden need for insurance.
 
When that day comes — and believe me, it’s coming — the price will be the very last thing that matters. It will be purely and simply a matter of securing possession — bubble or not — and at any price.
 
That price will NOT be $1200.
 
A “run” on the gold “bank” (something I predicted would happen when I wrote about Hugo Chavez’s original repatriation request back in 2011) would undoubtedly lead to one of those Warren Buffett moments when a bunch of people are left standing naked on the shore.
 
It is also a phenomenon which will begin quietly before suddenly exploding into life.
 
If you listen very carefully, you can hear something happening...
 
 
 
The lyrics to “I Think It’s Going to Rain Today” include a line with a phrase that has become all too familiar in recent years. The quote graces the front page of this edition of Things That Make You Go Hmmm... and it bears repeating:
 
Tin can at my feet

Think I’ll kick it down the street...
 
Since the Lehman collapse, every central banker and every politician in the world has embraced the idea of kicking the can harder and farther down the road than their predecessors did (and that is something I have indeed written about ad nauseum). Nowhere has the art of can kicking been more egregiously consistently practised than in Japan.
 
When I moved to Tokyo all the way back in 1989, people were talking about the impending demographic timebomb that would explode in Japan as its ageing society began to die. But, of course, that was 25 years away, and so nobody paid any attention to it.
 
Japan%20Demographics.psd 
Suddenly ... 25 years later ... the fact that Japan’s population is now declining by roughly 20,000 people every month has seemingly crept up on the world and taken everybody by surprise.
 
Right.
 
The only answer to Japan’s demographic problem is mass immigration. Simple.
 
The odds on Japan allowing that to occur are longer than those for a Ritoltz/GATA lovefest.
 
Japan%20Demographics.psd 
 
In the meantime they have Abenomics — the solution to virtually none all of their problems.
 
Abenomics has been a favourite topic of mine since it was announced, as it was clear from the outset (to anybody who had spent any time in Japan) that the policy was doomed to failure for one very simple reason: it required structural reform — something the Japanese just don’t do, I’m afraid. (Real Vision subscribers can watch my presentation from the Strategic Investment Conference earlier this year, in which I outlined the extent to which perception and reality have diverged with regards to Japan).
 
Kuroda-san’s actions have just compounded the eventual problems for the Japanese, and yet the madness perpetrated by the governor of the Bank of Japan has been cheered to the echo, right around the globe.
 
This will end very, very badly.
 
This past week, as the world geared up for yet another Japanese election (called by Abe in an attempt to give him the old “well-you-guys-voted-for-it” excuse clarify public support for his policies), the desperation was almost palpable.
 
Firstly, Japanese GDP numbers were revised, and guess what...
 
(WSJ): Japan’s economy shrank more than previously estimated in the third quarter, contracting 1.9% as capital spending declined and private consumption remained weak, the government said Monday.
 
The economy has now contracted for two consecutive quarters, a common definition for recession, the data confirmed, less than a week before general elections that Prime Minister Shinzo Abe has framed as a referendum on his economic policies.
 
Last month, the government estimated that gross domestic product contracted 1.6% during the July-September period. Soon after, Mr. Abe cited the weak economy in saying he would delay a second increase in the nation’s sales tax, and called a snap election in search of a mandate.
 
In recent days, though, many economists had predicted that the third-quarter contraction would actually turn out to be smaller than initially estimated — or perhaps be revised to flat or a slight expansion — after the Ministry of Finance reported late last month that capital spending by businesses rose 3.1% during the quarter, compared with a previous estimate of a 0.2% decline.
 
Business investment accounts for around 14% of GDP.
 
I know, right? Who could have seen THAT coming?
 
Oh... but it got worse:
 
(WSJ): Private consumption, the most important pillar of the economy, remains anemic, rising just 0.4% in the third quarter from the second, as consumers continue to stagger following a sales tax increase in April and a decline in the yen of more than 30%, which has raised the cost of imports.
 
The downbeat consumer mood was most evident in weak sales of big-ticket items such as houses and automobiles. Residential investment and consumption of durable goods both fell sharply for two consecutive quarters.
 
The government also revised its growth figures for the second quarter, saying the economy contracted 6.7% instead of the initially reported 7.2%. It also lowered first-quarter growth to 5.8% from 6.7%.
 
Another unexpected figure Monday was the nation’s current-account surplus, which was a strong ¥833.4 billion ($6.9 billion) in October. However, a weak yen and overseas investment income masked a large trade deficit due to weak exports.
 
All this followed hot on the heels of another “surprise” — a downgrade of Japanese sovereign debt (and subsequently the banking sector, for obvious reasons) by Moody’s.
 
A surprise. A surprise like Christmas Day’s falling on December 25th this year.
 
Clearly, a strong sense of irony and the ability to deadpan are important character traits when working in Moody’s press department:
 
(Moody’s): Moody’s Investors Service today downgraded the Government of Japan’s debt rating by one notch to A1 from Aa3. The outlook is stable.
 
The key drivers for the downgrade are the following:
 
1. Heightened uncertainty over the achievability of fiscal deficit reduction goals;

2. Uncertainty over the timing and effectiveness of growth enhancing policy measures, against a background of deflationary pressures; and

3. In consequence, increased risk of rising JGB yields and reduced debt affordability over the medium term.
 
A few days later, Fitch (rather belatedly) jumped on the dogpile and warned that next year there could be another “surprise” (spoiler alert: in 2015 Fitch will downgrade Japan):
 
(CNBC): Japan’s “A-plus” credit rating is under threat, after Fitch Ratings placed the country’s debt on negative watch on Tuesday.
 
The ratings agency said it could cut Japan’s rating in the first half of next year, following the government’s decision to delay a consumption tax hike to April 2017 from October 2015.
 
“The delay implies it will be almost impossible to achieve the government’s previously-stated objective of reducing the primary budget deficit to 3.3 percent of GDP by the fiscal year April 2015–March 2016,” said Fitch in a report on Tuesday.
 
Fitch estimates the proportion of Japan’s debt to the size of its gross domestic product would reach 241 percent by the end of this year, up from 184 percent at end-2008. The 57 percentage point rise in the ratio would be the second-highest over the period in the A or double-A category after Ireland, the agency noted.
 
Sorry folks, but Japan is toast.
 
Exports are still “weak” despite a near-30% weakening in the yen; the bond market is utterly broken; corporate bankruptcies have hit new highs; and the country is now in a quadruple-dip recession (yeah).
 
 
Japan%20GDP.jpg 
Japan%20Bankruptcies.jpg Source: Zerohedge
 
And so we go into this weekend’s election with Abe’s approval ratings at a two-year low and the possibility that a backlash of sorts may ensue.
 
The results will be in by the time you read this, and the polls suggest Abe will maintain a “super-majority,” which will give him and his central bank an extended license to continue Japan’s journey to oblivion; but the graphic below will give you a handy guide as to the outcome should the result be any kind of surprise:
 
abe%20election%20outcomes.jpg 
 
No matter which way the Japanese turn, the future of their country relies on a ridiculous concept: that “investors” will keep funding the government’s borrowing requirements or, if not, look the other way whilst the Bank of Japan prints money and buys the entire issuance of JGBs.
 
Meanwhile, Japan’s leaders need their ageing population to remain docile while their savings are eviscerated through a “promised” 2% per year inflation rate and a 30% (and counting) theft of their purchasing power through the outright debasement of the yen.
 
They also need to rely on the Chinese, the Koreans, the Taiwanese, and even the Germans not retaliating when the yen’s destruction makes their own manufacturing industries and exporters uncompetitive.
 
Luckily, the oil price has fallen, and the second phase of the consumption tax hike has been cancelled postponed so... that’s... well... great, right?
 
Wrong.
 
Lower oil is undoubtedly a positive for Japan, but there are a couple of problems that linger.
 
Firstly, it happens just as the country has begun restarting its nuclear power plants after Fukushima, and so the amount of oil being imported will continue declining as those plants come back on line. Secondly, the crumbling yen is negating a large portion of the benefits of lower crude in dollars.
 
Also, you can file this under “damned-if-you-do...damned-if-you-dont”:
 
(Reuters): The yen edged higher on Tuesday as a fall in oil prices dented risk appetite and prompted investors to trim short positions in the Japanese currency.
 
The Japanese are not about to abandon their nuclear program just because oil has temporarily dipped into the $60s. Sixty-dollar oil would have been REALLY useful for the last few years; and while it is certainly something of an unexpected tailwind for Abenomics, they need something a lot more powerful at their backs when sailing into the teeth of a hurricane.
 
Bon Voyage, Abe-san
 
 
This song — another of the instrumental tracks on the album — was illustrative of the inflationary pressures of the 1970s. The song took its title from the wage increases demanded by the UK’s trades unions in the late 1970s to give them what became known as a “living wage.” This concept meant that a person working 40 hours a week, with no additional income, should be able to afford the basics for quality of life: food, housing, utilities, transport, health care, minimal recreation, childcare, and one course a year to upgrade their education.
 
In Greece today, there are three 25% figures to be concerned with: the 25.9% fall in Greek GDP, the 25.7% support the incumbent New Democracy Party clings to (versus Syriza’s 31%), and the 25.9% unemployment rate that still haunts the country.
 
2748.png 
 
Some time ago, I wrote about Alex Tsipras and the potential that he could be the first of a new breed of politicians at the fringes of the political spectrum (I will deliberately avoid the use of the word extreme in this case as, when applied to politics, it is more straitjacket than adjective) who could threaten the very existence of the EU.
 
2762.png 
After a series of political happenings in Greece in recent weeks (you can find out what happened here, should you desire), the upshot is the distinct possibility of a snap election being called in January — an election that, given the current polling, Tsipras’s Syriza party would likely win with ease.
 
The problem with such a win is Tsipras’s oft-stated position on the bailout funds advanced to the country by the Troika (remember that band?):
 
(UK Daily Telegraph): As matters stand, it is more likely than not that a defiant Alexis Tsipras will be the elected prime minister of Greece by late January. His Syriza alliance has vowed publicly and persistently that it will overthrow the EU-IMF Troika regime, refusing to implement the key demands...
 
Mr Tsipras is a polished performer on the EU circuit. He can no longer be caricatured as motorbike Maoist. But the fact remains that he told Greek voters as recently as last week that his government would cease to enforce the bail-out demands “from its first day in office”.
 
The logical implication is that Greece will be forced out of the euro in short order, unless the EU institutions capitulate. Syriza’s deputy, Panagiotis Lafazanis, is plainly willing to take this risk, warning in October that the movement must “be ready to implement its progressive programme outside the eurozone” if need be. His Aristeri Platforma holds 30pc of the votes on Syriza’s central committee.
 
Next July and August, whoever holds the purse strings in Athens is bound to repay €6.7 billion to the ECB, and whilst that sort of money ceased to be anything to be concerned about on September 16, 2008, it remains an amount of money that Greece doesn’t have.
 
Adding to the fear over a possible Syriza victory was a recent Greek “road show” in London, during which several high-ranking members of Syriza sought to allay fears as to the upheaval that might ensue should they actually do the unthinkable and win any election.
 
I think it’s safe to say — based on this account from the UK Daily Telegraph — that things didn’t exactly go to plan. In fact, as regards a successful outcome to an overseas trip, this mob made Neville Chamberlain look like a political genius:
 
(UK Daily Telegraph): The Syriza road show in the City last month went horribly wrong.
 
“Everybody coming out of the meeting wants to sell everything Greek,” said a leaked memo by Capital Group’s Joerg Sponer.
 
The reported shopping list was: a haircut for creditors; free electricity, food, shelter, and health care for all who need it; tax cuts for all but the rich; a rise in the minimum wage and pensions to €750 a month; a moritorium on private debt payments to banks above 20pc of disposable income; €5bn more in EU subsidies; and demands for 62pc debt forgiveness on the grounds that this is what Germany received in 1952. “The programme is worse than communism (at least they had a plan). This will be total chaos,” said Mr Sponer.
 
“It was a disaster,” said Professor Yanis Varoufakis from Athens University, a man tipped to play a key economic role in any Syriza-led government.
 
Greece is back, front and centre — just as it was at the beginning of the euro crisis in 2010 and at the depths of the euro crisis in 2011. The only difference is that now, after several more years of depressionary policies have been foisted upon the people of that proud nation, the likelihood of an establishment victory (and thereby a continuance of the status quo) is far less than at either of those previous junctures.
 
The Athens stock index fell 13% in a single session last Tuesday — its biggest fall since 1987, eclipsing anything seen at even the shakiest points in the euro crisis — which should tell you that the stakes are far higher now than they were previously.
 
Along with the US dollar, keep a very close eye on Greece in the next few weeks. It has the potential to spring another nasty surprise on the market which will have multiple knock-on effects — none of them good.
 
 
Since the day John approached me to write Bull’s Eye Investor for him and offered to take Things That Make You Go Hmmm... under the Mauldin Economics umbrella, I have had the opportunity to work with a wonderful group of people; and though there isn’t enough time to thank everybody personally, there are a few special people I can’t sign off without mentioning.
 
To Dody and Brent, thank you for all your hard work and support and for putting up with my crazy schedule. To Charley and Lisa, my tireless copy editors, your patience is boundless and your command of the English language puts me to shame. To Clara, thank you for doing such a wonderful job being the “List Runner.” To Johnny Grand — keep rolling, my man. I’ll see you North of the Border soon. And an extra special thank you to Shannon for getting a million things done flawlessly and within seemingly impossible timeframes whilst somehow continuing to be such a wonderful person — a truly remarkable achievement. I salute you all.
 
Special thanks also go to Robert Ross, an exceptional young analyst with a great future ahead of him; to Marin Katusa — a more brilliant mind and better company you couldn’t hope to find; and to Ed and Olivier for working so hard to make me a part of the Mauldin/Casey family.
 
Lastly, there are three more important acknowledgements which I can’t sign off without making.
 
Firstly, to Worth Wray: I offer a huge thank you for your warmth, friendship, and incredible insight. Those with whom you share your wisdom are lucky indeed, and I am genuinely thrilled at the prospect of watching your career unfold. Onwards and upwards, my young friend.
 
And then, of course, there is John himself.
 
Like so many thousands of folks all around the world, I started reading your thoughts over a decade ago; and throughout that time you have been a constant source of wisdom, insight, and level-headed analysis in an ever-more hyperbolic world. You have introduced me to so many brilliant people (both through your writing and in person) and have been so gracious with your time and your advice. I cannot thank you enough and am humbled to be counted amongst your many friends.
 
Lastly — if you’ve indulged me and made it this far — I want to thank you, my wonderful readers.
 
For five years you have welcomed me into your homes and your minds, humbled me by taking the time to read my words, and enlightened me with the benefit of your collective wisdom.
 
So many of you have taken the time and the trouble to write to me, either to offer feedback on Things That Make You Go Hmmm..., to provide further information on a subject I covered, to suggest new areas where I might go hunting for ideas, or to call me out on mistakes I have made. I have, to the best of my knowledge, answered each and every one of the many hundreds of emails I have received; but in case I somehow missed one here or there — I’m sorry! Send it again, and I’ll get back to you — hopefully with the benefit of hindsight, by which to try and make myself look smarter!
 
To those of you who will step off the train at this point, thank you for coming this far — truly. I’ve loved having you along for the ride, and I will miss you.
 
To those of you staying aboard, rest assured, there are plenty of plans in the works to make the all-new Things That Make You Go Hmmm... bigger, better, and bolder than ever before, and I am genuinely excited about having you on board.
 
Thank you.
 
Until next time...

The Oil Collapse: How Seasoned Traders Are Responding

Jared Dillian, Editor, The 10th Man

December 17, 2014

 
I was in Memphis last week visiting some folks. I found myself in a conference room with some very seasoned commodity traders… veterans of the floor, some going back to the ‘70s. Let me tell you something: if you ever find yourself talking to a 40-year veteran of the commodities markets, you should listen to what he has to say. Anyone who can last that long trading futures is pretty smart.

Funny thing is, I’ve been around long enough that now I am one of the old traders!

But I’m not a commodities guy by training. I’m one of those slicked-back-hair moneychanger guys who is never going to get to heaven. But I always learn a lot when I go to Memphis—which, by the way, is the third-biggest futures trading city after Chicago and New York. There are quite a few large trading firms that specialize in grains, meats, and cotton. Memphis is a big deal, and probably the best-kept secret in the financial world.

So I asked about what it was like to trade live cattle during the BSE (mad cow) outbreak about 10 years ago.  “How about limit down for an entire week?” they said. Small traders went under. Cattle ranchers went under, guys who lifted their hedges at exactly the wrong time. It was downright ugly.

That was bad.

But what’s happening to oil is a million times worse.


There are a lot of folks who get pretty angry when you suggest that a near-50% drop in the price of oil might be a negative in the short term. They look at you like you’re dumb. They talk about the massive benefit to consumers, the synthetic “tax cut” that everyone’s getting, what it’s going to do to consumption, etc.

All of this is true. But if you take a major commodity and slice it in half in the span of a month or two, there are going to be major consequences.

When I say that the commodities markets haven’t seen anything like this since 1980 when gold went haywire, I mean it. And you don’t put gold in your gas tank. Sure, there have been some minor calamities, like when cotton went parabolic a few years ago, but crude oil is perhaps the world’s most important commodity when you take into account both its economic and geopolitical significance. People go to war over the stuff. Routinely. And with oil falling from $105 to $57 in just six months, it might happen again.

We’ll get to that in a second. But for perspective, when people look at this move in oil 10 years from now, they’re going to call it the “Crash of ‘14.” That’s my prediction. A move of this magnitude in a short amount of time is a crash. When stocks went down 19% in a week in 2008, that was also a crash.

What’s the definition of a crash? I say any move over six standard deviations. For comparison, the Crash of ‘87 was 25 standard deviations—a move so uncommon, so statistically rare, that it wasn’t supposed to happen in a length of time greater than the age of the universe.

I haven’t done the math on oil yet, but if it’s not six standard deviations, it’s close.

*   *   *   *

As you probably know by now, the move in oil has been more of a supply story than a demand story. We were drilling holes all over the planet in search of it. My wife works in the Turkana Basin, on the border of northwest Kenya and Ethiopia, which is one of the most remote spots in the world. They were drilling for it there, too.

That’s what happens when oil gets to $140 a barrel. People are incentivized to look for it. It takes time to explore and produce the stuff. It takes years for wells to finally come online and for supply to hit the market.

There are still projects that may never be completed, like Vaca Muerta in Argentina, that Yacimientos Petrolíferos Fiscales (YPF) is developing in conjunction with Chevron. The poor Argentinians—screwed again.

And like we’ve been seeing in the mining industry, once a company has brought production online, it’s difficult to take it offline. It’s hard to start it back up again, to get all the permits, to hire everyone back. So people will continue to produce at uneconomic levels for a long time, hoping that the price will come back, while simultaneously ensuring that it won’t for a long time.

So back to my earlier point—is it bullish or bearish for the US? It’s not a hard question to answer. People are making it hard. 20 years ago, it would have been unequivocally bullish. Now, maybe not. We produce slightly more oil than we consume. There will be winners and losers, which is being reflected in the stock market.

For some countries, it’s unequivocally bearish, especially for adversaries like Venezuela, Iran, and Russia. But also for allies, like Canada, which is probably in the most precarious economic position of any country in the world.

The takeaway is: an oil crash makes the world less stable. 

I am a decent economic historian, but kind of a crappy political historian. People keep telling me scary stories about Russia—how Russia today closely resembles Germany in the 1930s. How Putin is in the midst of a full-blown currency crisis. How the West is (perhaps foolishly) applying sanctions. How the threat of annexation of Russia’s smaller neighbors could be higher than we think. How the willingness of the West to challenge it would be very low.

All because the price of a commodity crashed.

Russia is very much a petrostate. There are others. Norway has been enjoying a phenomenally high standard of living for years, with some of the highest incomes and the strongest currency in the world on a purchasing-power parity basis. A lot of that had to do with a very successful and well-managed state-owned oil industry, and one of the largest sovereign wealth funds to boot. If you’ve seen a chart of Norwegian krone (NOK) vs. the Swedish krona (SEK) recently, you know that oil’s plummet has been a game-changer.



I fear oil. But I don’t fear oil because oil will make the stock market go down—which it will. I fear oil because there are going to be second- and third-order political effects that we cannot even conceive of right now. Take Venezuela—my prediction is that Venezuela will descend into anarchy and hyperinflation—a failed state. This has consequences for the entire region, but especially Colombia. Take Venezuela and multiply it by 100, and you get a sense of the magnitude of the problem that we’re facing.

* * * *

Old traders know: price moves like this do not happen in a vacuum. There’s a chain reaction that extends out for years. So in situations like this, I do what an old trader does: I reduce risk. I cut back my exposure to things that gain from stability, and I increase my exposure to things that gain from volatility.

Nobody has a playbook for this, because nobody saw it coming. But a leveraged long position with no cash is probably a bad idea right now.

World News

Global Life Expectancy Increases by About Six Years

Study in Lancet Says Rise Is Result of Dramatic Health-Care Advances

By Gautam Naik

Updated Dec. 17, 2014 9:03 p.m. ET



Global life expectancy for men and women has increased by about six years over the past two decades, according to one of the most comprehensive studies of global health done so far.

The rise in global life expectancy is mainly the result of dramatic advances in health care. In richer countries longer lifespans are spurred by a big drop in deaths related to heart disease, while poorer countries have seen big declines in the death of children from ailments such as pneumonia, diarrhea and malaria.

But there are worrying signs, too. While global deaths from infectious disease dropped by about 25% over the past two decades, the number of deaths linked to noncommunicable diseases has jumped by about 40%. Noncommunicable maladies, such as cancer, heart disease and diabetes, tend to be chronic in nature and often more expensive to treat.

“That’s a very profound shift and it will affect how countries deal with” the future health of their populations, said Christopher Murray, lead author of the study and director of the Institute of Health Metrics and Evaluation, or IHME, at the University of Washington, which oversaw the analysis.

The study was published Wednesday in the journal Lancet. It is part of an exhaustive analysis known as the Global Burden of Disease Study done by an international team of more than 700 researchers led by the institute. It was funded by the Bill & Melinda Gates Foundation.

The study analyzes yearly deaths from 240 different causes in 188 countries from 1990 to 2013. The last such report was published in 2010. Governments use the data to make policy decisions; scientists use the data to decide what areas of medical research to pursue; and donors use the data to decide which areas of global health they should support.

The Lancet study “is based on an unprecedented amount of information that has been crunched using very sophisticated tools,” said Igor Rudan, global health expert at the University of Edinburgh, who wasn’t involved in the Lancet study. “In an information-based world, whoever controls the information controls the agenda.”

The World Health Organization compiles similar data. Its last update of health statistics was published earlier this year and spanned the 2000-12 period.


Although it lacked the breadth and depth of the IHME analysis, the WHO’s number-crunching also concluded that the average global life expectancy had risen by six years since 1990.

“The big picture is generally similar, with the exception of historical trends in Africa where they’re more pessimistic than we are,” said Colin Mathers, who oversees global health statistics at the WHO and is familiar with IHME’s analysis.

The WHO data, for example, has lower figures for African deaths linked to malaria and HIV/AIDS.

The latest IHME study estimates that global life expectancy increased by 5.8 years for men and 6.6 years for women. If the pattern of the past two decade continues, a girl born in 2030 will live to be 85.3 years old on average, while a boy born then will live to be 78.1 years on average.

In many places, better disease-prevention and treatment efforts have made a big dent in mortality rates. For example, deaths from measles and diarrhea fell by 83% and 51%, respectively.

In India, which is on track to become the world’s most populous country in less than two decades, life expectancy at birth rose from 57.3 years to 64.2 years for males, and from 58.2 years to 68.5 years for females, according to the Lancet study.

The exception is southern sub-Saharan Africa, where HIV/AIDS has shortened lifespans by an average of five years since 1990.

Despite big strides in prevention and treatment efforts, HIV/AIDS remains the biggest cause of premature death in more than a dozen sub-Saharan countries.