The Epochal Consequences Of Woodrow Wilson’s War

by David Stockman

January 21, 2015

Committee for the Republic
Washington DC January 20, 2015


My humble thesis tonight is that the entire 20th Century was a giant mistake.

And that you can put the blame for this monumental error squarely on Thomas Woodrow Wilson——-a megalomaniacal madman who was the very worst President in American history……..well, except for the last two.

His unforgiveable error was to put the United States into the Great War for utterly no good reason of national interest. The European war posed not an iota of threat to the safety and security of the citizens of Lincoln NE, or Worcester MA or Sacramento CA. In that respect, Wilson’s putative defense of “freedom of the seas” and the rights of neutrals was an empty shibboleth; his call to make the world safe for democracy, a preposterous pipe dream.

Actually, his thinly veiled reason for plunging the US into the cauldron of the Great War was to obtain a seat at the peace conference table——so that he could remake the world in response to god’s calling.

But this was a world about which he was blatantly ignorant; a task for which he was temperamentally unsuited; and an utter chimera based on 14 points that were so abstractly devoid of substance as to constitute mental play dough.

Or, as his alter-ego and sycophant, Colonel House, put it:  Intervention positioned Wilson to play “The noblest part that has ever come to the son of man”.  America thus plunged into Europe’s carnage, and forevermore shed its century-long Republican tradition of anti-militarism and non-intervention in the quarrels of the Old World.

Needless to say, there was absolutely nothing noble that came of Wilson’s intervention. It led to a peace of vengeful victors, triumphant nationalists and avaricious imperialists—-when the war would have otherwise ended in a bedraggled peace of mutually exhausted bankrupts and discredited war parties on both sides.

By so altering the course of history, Wilson’s war bankrupted Europe and midwifed 20th century totalitarianism in Russia and Germany.

These developments, in turn, eventually led to the Great Depression, the Welfare State and Keynesian economics, World War II, the holocaust, the Cold War, the permanent Warfare State and its military-industrial complex.

They also spawned Nixon’s 1971 destruction of sound money, Reagan’s failure to tame Big Government and Greenspan’s destructive cult of monetary central planning.

So, too, flowed the Bush’s wars of intervention and occupation,  their fatal blow to the failed states in the lands of Islam foolishly created by the imperialist map-makers at Versailles and the resulting endless waves of blowback and terrorism now afflicting the world.

And not the least of the ills begotten in Wilson’s war is the modern rogue regime of central bank money printing, and the Bernanke-Yellen plague of bubble economics which never stops showering the 1% with the monumental windfalls from central bank enabled speculation.

Consider the building blocks of that lamentable edifice.

First, had the war ended in 1917 by a mutual withdrawal from the utterly stalemated trenches of the Western Front, as it was destined to, there would have been no disastrous summer offensive by the Kerensky government, or subsequent massive mutiny in Petrograd that enabled Lenin’s flukish seizure of power in November. That is, the 20th century would not have been saddled with a Stalinist nightmare or with a Soviet state that poisoned the peace of nations for 75 years, while the nuclear sword of Damocles hung over the planet.

Likewise, there would have been no abomination known as the Versailles peace treaty; no “stab in the back” legends owing to the Weimar government’s forced signing of the “war guilt” clause; no continuance of England’s brutal post-armistice blockade that delivered Germany’s women and children into starvation and death and left a demobilized 3-million man army destitute, bitter and on a permanent political rampage of vengeance.

So too, there would have been no acquiescence in the dismemberment of Germany and the spreading of its parts and pieces to Poland, Czechoslovakia, Denmark, France, Austria and Italy—–with the consequent revanchist agitation that nourished the Nazi’s with patriotic public support in the rump of the fatherland.

Nor would there have materialized the French occupation of the Ruhr and the war reparations crisis that led to the destruction of the German middle class in the 1923 hyperinflation; and, finally, the history books would have never recorded the Hitlerian ascent to power and all the evils that flowed thereupon.

In short, on the approximate 100th anniversary of Sarajevo, the world has been turned upside down.

The war of victors made possible by Woodrow Wilson destroyed the liberal international economic order—that is, honest money, relatively free trade, rising international capital flows and rapidly growing global economic integration—-which had blossomed during the 40-year span between 1870 and 1914.

That golden age had brought rising living standards, stable prices, massive capital investment, prolific technological progress and pacific relations among the major nations——a condition that was never equaled, either before or since.

Now, owing to Wilson’s fetid patrimony, we have the opposite: A world of the Warfare State, the Welfare State, Central Bank omnipotence and a crushing burden of private and public debts. That is, a thoroughgoing statist regime that is fundamentally inimical to capitalist prosperity, free market governance of economic life and the flourishing of private liberty and constitutional safeguards against the encroachments of the state.

So Wilson has a lot to answer for—-and my allotted 30 minutes can hardly accommodate the full extent of the indictment. But let me try to summarize his own “war guilt” in eight major propositions——a couple of which my give rise to a disagreement or two.

Proposition #1:  Starting with the generic context——the Great War was about nothing worth dying for and engaged no recognizable principle of human betterment. There were many blackish hats, but no white ones.

Instead, it was an avoidable calamity issuing from a cacophony of political incompetence, cowardice, avarice and tomfoolery.

Blame the bombastic and impetuous Kaiser Wilhelm for setting the stage with his foolish dismissal of Bismarck in 1890, failure to renew the Russian reinsurance treaty shortly thereafter and his quixotic build-up of the German Navy after the turn of the century.

Blame the French for lashing themselves to a war declaration that could be triggered by the intrigues of a decadent court in St. Petersburg where the Czar still claimed divine rights and the Czarina ruled behind the scenes on the hideous advice of Rasputin.

Likewise, censure Russia’s foreign minister Sazonov for his delusions of greater Slavic grandeur that had encouraged Serbia’s provocations after Sarajevo; and castigate the doddering emperor Franz Joseph for hanging onto power into his 67th year on the throne and thereby leaving his crumbling empire vulnerable to the suicidal impulses of General Conrad’s war party.

So too, indict the duplicitous German Chancellor, Bethmann-Hollweg, for allowing the Austrians to believe that the Kaiser endorsed their declaration of war on Serbia; and pillory Winston Churchill and London’s war party for failing to recognize that the Schlieffen Plan’s invasion through Belgium was no threat to England, but a unavoidable German defense against a two-front war.

But after all that—- most especially don’t talk about the defense of democracy, the vindication of liberalism or the thwarting of Prussian autocracy and militarism.

The British War party led by the likes of Churchill and Kitchener was all about the glory of empire, not the vindication of democracy; France’ principal war aim was the revanchist drive to recover Alsace-Lorrain—–mainly a German speaking territory for 600 years until it was conquered by Louis XIV.

In any event, German autocracy was already on its last leg as betokened by the arrival of universal social insurance and the election of a socialist-liberal majority in the Reichstag on the eve of the war; and the Austro-Hungarian, Balkan and Ottoman goulash of nationalities, respectively, would have erupted in interminable regional conflicts, regardless of who won the Great War.

In short, nothing of principle or higher morality was at stake in the outcome.

Proposition # 2:  The war posed no national security threat whatsoever to the US.  Presumably, of course, the danger was not the Entente powers—but Germany and its allies.

But how so?  After the Schlieffen Plan offensive failed on September 11, 1914, the German Army became incarcerated in a bloody, bankrupting, two-front land war that ensured its inexorable demise. Likewise, after the battle of Jutland in May 1916, the great German surface fleet was bottled up in its homeports—-an inert flotilla of steel that posed no threat to the American coast 4,000 miles away.

As for the rest of the central powers, the Ottoman and Hapsburg empires already had an appointment with the dustbin of history. Need we even bother with the fourth member—-that is, Bulgaria?

Proposition #3:  Wilson’s pretexts for war on Germany—–submarine warfare and the Zimmerman telegram—-are not half what they are cracked-up to be by Warfare State historians.

As to the so-called freedom of the seas and neutral shipping rights, the story is blatantly simple.

In November 1914, England declared the North Sea to be a “war zone”; threatened neutral shipping with deadly sea mines; declared that anything which could conceivably be of use to the German army—directly or indirectly—-to be contraband that would be seized or destroyed; and announced that the resulting blockade of German ports was designed to starve it into submission.

A few months later, Germany announced its submarine warfare policy designed to the stem the flow of food, raw materials and armaments to England in retaliation.  It was the desperate antidote of a land power to England’s crushing sea-borne blockade.

Accordingly, there existed a state of total warfare in the northern European waters—-and the traditional “rights” of neutrals were irrelevant and disregarded by both sides. In arming merchantmen and stowing munitions on passenger liners, England was hypocritical and utterly cavalier about the resulting mortal danger to innocent civilians—–as exemplified by the 4.3 million rifle cartridges and hundreds of tons of other munitions carried in the hull of the Lusitania.

Likewise, German resort to so-called “unrestricted submarine warfare” in February 1917 was brutal and stupid, but came in response to massive domestic political pressure during what was known as the “turnip winter” in Germany.  By then, the country was starving from the English blockade—literally.

Before he resigned on principle in June 1915, Secretary William Jennings Bryan got it right.

Had he been less diplomatic he would have said never should American boys be crucified on the cross of Cunard liner state room so that a few thousand wealthy plutocrat could exercise a putative “right” to wallow in luxury while knowingly cruising into in harm’s way.

As to the Zimmerman telegram, it was never delivered to Mexico, but was sent from Berlin as an internal diplomatic communique to the German ambassador in Washington, who had labored mightily to keep his country out of war with the US, and was intercepted by British intelligence, which sat on it for more than a month waiting for an opportune moment to incite America into war hysteria.

In fact, this so-called bombshell was actually just an internal foreign ministry rumination about a possible plan to approach the Mexican president regarding an alliance in the event that the US first went to war with Germany.

Why is this surprising or a casus belli?  Did not the entente bribe Italy into the war with promises of large chunks of Austria? Did not the hapless Rumanians finally join the entente when they were promised Transylvania?  Did not the Greeks bargain endlessly over the Turkish territories they were to be awarded for joining the allies?  Did  not Lawrence of Arabia bribe the Sherif of Mecca with the promise of vast Arabian lands to be extracted from the Turks?

Why, then, would the German’s—-if at war with the USA—- not promise the return of Texas?

Proposition #4:  Europe had expected a short war, and actually got one when the Schlieffen plan offensive bogged down 30 miles outside of Paris on the Marne River in mid-September 1914. 

Within three months, the Western Front had formed and coagulated into blood and mud——a ghastly 400 mile corridor of senseless carnage, unspeakable slaughter and incessant military stupidity that stretched from the Flanders coast across Belgium and northern France to the Swiss frontier.

The next four years witnessed an undulating line of trenches,  barbed wire entanglements, tunnels, artillery emplacements and shell-pocked scorched earth that rarely moved more than a few miles in either direction, and which ultimately claimed more than 4 million casualties on the Allied side and 3.5 million on the German side.

If there was any doubt that Wilson’s catastrophic intervention converted a war of attrition, stalemate and eventual mutual exhaustion into Pyrrhic victory for the allies, it was memorialized in four developments during 1916.

In the first, the Germans wagered everything on a massive offensive designed to overrun the fortresses of Verdun——the historic defensive battlements on France’s northeast border that had stood since Roman times, and which had been massively reinforced after the France’s humiliating defeat in Franco-Prussian War of 1870.

But notwithstanding the mobilization of 100 divisions, the greatest artillery bombardment campaign every recorded until then, and repeated infantry offensives from February through November that resulted in upwards of 400,000 German casualties, the Verdun offensive failed.

The second event was its mirror image—-the massive British and French offensive known as the battle of the Somme, which commenced with equally destructive artillery barrages on July 1, 1916 and then for three month sent waves of infantry into the maws of German machine guns and artillery. It too ended in colossal failure, but only after more than 600,000 English and French casualties including a quarter million dead.

In between these bloodbaths, the stalemate was reinforced by the naval showdown at Jutland that cost the British far more sunken ships and drowned sailors than the Germans, but also caused the Germans to retire their surface fleet to port and never again challenge the Royal Navy in open water combat.

Finally, by year-end 1916 the German generals who had destroyed the Russian armies in the East with only a tiny one-ninth fraction of the German army—Generals Hindenburg and Ludendorff —were given command of the Western Front. Presently, they radically changed Germany’s war strategy by recognizing that the growing allied superiority in manpower, owing to the British homeland draft of 1916 and mobilization of forces from throughout the empire, made a German offensive breakthrough will nigh imposible.

The result was the Hindenburg Line—a military marvel based on a checkerboard array of hardened pillbox machine gunners and maneuver forces rather than mass infantry on the front lines, and an intricate labyrinth of highly engineered tunnels, deep earth shelters, rail connections, heavy artillery and flexible reserves in the rear. It was also augmented by the transfer of Germany’s eastern armies to the western front—-giving it 200 divisions and 4 million men on the Hindenburg Line.

This precluded any hope of Entente victory. By 1917 there were not enough able-bodied draft age men left in France and England to overcome the Hindenburg Line, which, in turn,  was designed to bleed white the entente armies led by butchers like Generals Haig and Joffre until their governments sued for peace.

Thus, with the Russian army’s disintegration in the east and the stalemate frozen indefinitely in the west by early 1917, it was only a matter of months before mutinies among the French lines, demoralization in London, mass starvation and privation in Germany and bankruptcy all around would have led to a peace of exhaustion and a European-wide political revolt against the war makers.

Wilson’s intervention thus did not remake the world. But it did radically re-channel the contours of 20th century history. And, as they say, not in a good way.

Proposition #5:  Wilson’s epochal error not only produced the abomination of Versailles and all its progeny, but also the transformation of the Federal Reserve from a passive “banker’s bank” to an interventionist central bank knee-deep in Wall Street, government finance and macroeconomic management.

This, too, was a crucial historical hinge point because Carter Glass’ 1913 act forbid the new Reserve banks to even own government bonds; empowered them only to passively discount for cash good commercial credits and receivables brought to the rediscount window by member banks; and contemplated no open market interventions in debt markets or any remit with respect to GDP growth, jobs, inflation, housing or all the rest of modern day monetary central planning targets.

In fact, Carter Glass’ “banker’s bank” didn’t care whether the growth rate was positive 4%, negative 4% or anything in-between; its modest job was to channel liquidity into the banking system in response to the ebb and flow of commerce and production.

Jobs, growth and prosperity were to remain the unplanned outcome of millions of producers, consumers, investors, savers, entrepreneurs and speculators operating on the free market, not the business of the state.

But Wilson’s war took the national debt from about $1 billion or $11 per capita—–a level which had been maintained since the Battle of Gettysburg—-to $27 billion, including upwards of $10 billion re-loaned to the allies to enable them to continue the war. There is not a chance that this massive eruption of Federal borrowing could have been financed out of domestic savings in the private market.

So the Fed charter was changed owing to the exigencies of war to permit it to own government debt and to discount private loans collateralized by Treasury paper.

In due course, the famous and massive Liberty Bond drives became a glorified Ponzi scheme.

Patriotic Americans borrowed money from their banks and pledged their war bonds; the banks borrowed money from the Fed, and re-pledged their customer’s collateral.  The Reserve banks, in turn, created the billions they loaned to the commercial banks out of thin air, thereby pegging interest rates low for the duration of the war.

When Wilson was done saving the world, America had an interventionist central bank schooled in the art of interest rate pegging and rampant expansion of fiat credit not anchored in the real bills of commerce and trade; and its incipient Warfare and Welfare states had an agency of public debt monetization that could permit massive government spending without the inconvenience of high taxes on the people or the crowding out of business investment by high interest rates on the private market for savings.

Proposition # 6:   By prolonging the war and massively increasing the level of debt and money printing on all sides, Wilson’s folly prevented a proper post-war resumption of the classical gold standard at the pre-war parities.

This failure of resumption, in turn, paved the way for the breakdown of monetary order and world trade in 1931—–a break which turned a standard post-war economic cleansing into the Great Depression, and a decade of protectionism, beggar-thy-neighbor currency manipulation and ultimately rearmament and statist dirigisme.

In essence, the English and French governments had raised billions from their citizens on the solemn promise that it would be repaid at the pre-war parities; that the war bonds were money good in gold.

But the combatant governments had printed too much fiat currency and inflation during the war, and through domestic regimentation, heavy taxation and unfathomable combat destruction of economic life in northern France had drastically impaired their private economies.

Accordingly, under Churchill’s foolish leadership England re-pegged to gold at the old parity in 1925, but had no political will or capacity to reduce bloated war-time wages, costs and prices in a commensurate manner, or to live with the austerity and shrunken living standards that honest liquidation of its war debts required.

At the same time, France ended up betraying its war time lenders, and re-pegged the Franc two years later at a drastically depreciated level. This resulted in a spurt of beggar-thy-neighbor prosperity and the accumulation of pound sterling claims that would eventually blow-up the London money market and the sterling based “gold exchange standard” that the Bank of England and British Treasury had peddled as a poor man’s way back on gold.

Yet under this “gold lite” contraption, France, Holland, Sweden and other surplus countries accumulated huge amounts of sterling liabilities in lieu of settling their accounts in bullion—–that is, they loaned billions to the British. They did this on the promise and the confidence that the pound sterling would remain at $4.87 per dollar come hell or high water—-just as it had for 200 years of peacetime before.

But British politicians betrayed their promises and their central bank creditors September 1931 by suspending redemption and floating the pound——-shattering the parity and causing the decade-long struggle for resumption of an honest gold standard to fail.  Depressionary contraction of world trade, capital flows and capitalist enterprise inherently followed.

Proposition # 7:  By turning America overnight into the granary, arsenal and banker of the Entente, the US economy was distorted, bloated and deformed into a giant, but unstable and unsustainable global exporter and creditor.

During the war years, for example, US exports increased by 4X and GDP soared from $40 billion to $90 billion.  Incomes and land prices soared in the farm belt, and steel, chemical, machinery, munitions and ship construction boomed like never before—–in substantial part because Uncle Sam essentially provided vendor finance to the bankrupt allies in desperate need of both military and civilian goods.

Under classic rules, there should have been a nasty correction after the war—-as the world got back to honest money and sound finance.  But it didn’t happen because the newly unleashed Fed fueled an incredible boom on Wall Street and a massive junk bond market in foreign loans.

In today economic scale, the latter amounted to upwards of $2 trillion and, in effect, kept the war boom in exports and capital spending going right up until 1929. Accordingly, the great collapse of 1929-1932 was not a mysterious failure of capitalism; it was the delayed liquidation of Wilson’s war boom.

After the crash, exports and capital spending plunged by 80% when the foreign junk bond binge ended in the face of massive defaults abroad; and that, in turn, led to a traumatic liquidation of industrial inventories and a collapse of credit fueled purchases of consumer durables like refrigerators and autos. The latter, for example, dropped from 5 million to 1.5 million units per year after 1929.

Proposition # 8:  In short, the Great Depression was a unique historical event owing to the vast financial deformations of the Great War——deformations which were drastically exaggerated by its prolongation from Wilson’s intervention and the massive credit expansion unleashed by the Fed and Bank of England during and after the war.

Stated differently, the trauma of the 1930s was not the result of the inherent flaws or purported cyclical instabilities of free market capitalism; it was, instead, the delayed legacy of the financial carnage of the Great War and the failed 1920s efforts to restore the liberal order of sound money, open trade and unimpeded money and capital flows.

But this trauma was thoroughly misunderstood, and therefore did give rise to the curse of Keynesian economics and did unleash the politicians to meddle in virtually every aspect of economic life, culminating in the statist and crony capitalist dystopia that has emerged in this century.

Needless to say, that is Thomas Woodrow Wilson’s worst sin of all.

January 25, 2015 7:15 pm

Draghi’s QE is an imperfect compromise for the eurozone

Wolfgang Münchau

By protecting itself from losses, the ECB recognises the possibility of European sovereign default

 
 It was a decent decision given the circumstances, and in one way it exceeded my expectations.

Not that it was particularly large. Mario Draghi’s announcement of approximately €800bn in sovereign asset purchases by the European Central Bank over a 19-month period is what informed observers should have foreseen. If you expected less, then either you did not believe that the ECB president meant it when he promised at the end of last year to increase the ECB’s balance sheet by about €1tn, or you counted wrong. The additional quantitative easing is merely consistent with the goal he had already stated.
 
The positive surprise, however, was the explicit link to the ECB’s inflation target, which carried a faint whiff of Mr Draghi’s 2012 pledge to do “whatever it takes” to save the euro. The phrasing of the actual statement was more circumspect. Each word was carefully chosen, as Mr Draghi said himself.

The goal was not stated in terms of inflation rates or expectations, but in terms of the “path of inflation”. This is about the journey, not the destination. Asset purchases can stop before inflation is back to the official target of just under 2 per cent. This leaves the ECB a maximum degree of discretion on when to end the programme.

The first question therefore is: how will the central bank use that discretion? This is where it becomes tricky. I struggle to come up with a scenario that would extend QE beyond September 2016. If the policy succeeds, it will rightly be stopped. If it fails to lift inflation rates at all, opponents will argue that it is ineffective and should be abandoned. What about the neither-here-nor-there scenario where inflation goes up by a few decimal points (in line with the market expectations implicit in the pricing of various financial assets)?

And what if the oil price were to rise moderately? The anti-inflationary impact of the low oil price is due to diminish towards the end of this year. Headline inflation rates could then jump by about one percentage point. In that case the balance of opinion in the ECB’s governing council might shift away from QE. Those who supported the measure reluctantly this time would say the deflation threat is over.

The second question I have is about wider economic policy. I am not talking about structural reforms. The prevailing wisdom in Brussels and Berlin notwithstanding, these are largely irrelevant to the success of the programme. They matter, but for other reasons.

My main concern is the effect on fiscal policy. German policy makers in particular consider QE inappropriate for the German economy because of its large savings surplus. The German media and the banking lobby portray QE as an assault on the German saver for the benefit of scheming Anglo-Saxon speculators, because it will probably lower interest rates further. Another point is that Germany’s retirement system — where pensions are not invested in the stock market, but in low-yielding government bonds — is not equipped for an environment in which interest rates are at zero for long periods.

Europhobes also feed the conspiracy theory of QE as a eurozone sovereign bond through the back door. Or they portray QE as a device to save southern European banks at the expense of northern European taxpayers. Such fears are irrational, of course. Those who hold them seem to favour permanent austerity: if government debt did not exist, it would not need to be bought by a central bank.

I would therefore expect the German establishment to force the eurozone on to a path of permanent fiscal surpluses. The monetary relaxation by the ECB would be compensated for — or possibly overcompensated for — by further fiscal tightening. If you are a monetarist, you might even welcome this. But then, you would presumably not have bothered with QE in the first place. You would have preferred a stimulatory helicopter drop — print money and send a big cheque to every citizen. If you are a Keynesian, you would be alarmed by any hint of further fiscal tightening and conclude that the overall effect is negative. In any case, neither scenario brings joy.

We are left with a programme to purchase less than 10 per cent of the outstanding stock of European debt. Of those purchases, 92 per cent will formally remain on national balance sheets. This is neither very large nor very risky. By protecting itself from losses in this way, the ECB has in effect officially recognised the existence of a non-trivial possibility of European sovereign default. This may have been a price worth paying to secure the acquiescence of Germany. But it is a price nonetheless. It might have been the best deal on offer. But it is no bazooka.

According to a French proverb, a bad compromise is better than a good lawsuit. The proverb does not tell us whether the compromise is good enough.


Mario Draghi's QE blitz may save southern Europe, but at the risk of losing Germany

The ECB has put German political consent for the euro project at risk

By Ambrose Evans-Pritchard, in Davos

5:18PM GMT 22 Jan 2015


Mario Draghi has achieved a spectacular triumph. His headline offering of €60bn (£45bn) a month in quantitative easing comes in the face of scorched-earth resistance from the German Bundesbank and the EMU creditor core. It is finally big enough to make an economic difference.
 

Yet today's shock-and-awe action by the European Central Bank (ECB) comes three years late, after the eurozone has already been allowed to drift into deflation, and very nearly into a triple-dip recession.
 
The fact that the ECB is having to act on this scale a full six years into the world's post-Lehman recovery is in itself an admission that policy has been horribly behind the curve. Mr Draghi told us year ago in Davos that warnings of deflation were jejune and that QE was out of the question.
 
His hands were tied, of course, whatever he really thought at the time. He could not move too far beyond the ECB's centre of gravity. He had to demonstrate that all else had failed, and all else did then fail.
 
It comes after six years of mass unemployment that has ravaged southern Europe, eroded the job skills of a rising generation, left hysteresis scars, and lowered the growth trajectory and productivity speed limit of these countries for a quarter century hence. It comes as the eurozone's GDP is still languishing well below its pre-Lehman peak, with Italian industrial output down 24pc, back to levels first achieved in 1980.

The bond purchases will not begin until March. They are cribbed about with conditions that may ultimately prove damaging and possibly fatal.
 
Adam Posen, a former UK rate-setter and now head of Washington's Peterson Institute, said the QE blitz is large, but not as overwhelming as some think. "It will make some difference. It's not going to be enough to fully offset deflationary forces, let alone restore growth, but to the degree that Draghi was able to make it sound open ended is a good thing," he said.
 
"Ultimately, €1.1 trillion over 18 months versus euro area GDP is roughly a third of what the Bank of England or Federal Reserve did under similar circumstances, and it's likely to take more money to get the same effect in Europe right now," he said.
 
The limits of delayed action are by now well known. Bond yields are already down to 14th Century lows. The ECB cannot force them much lower, though Mr Draghi did say cheerfully that it would buy debt with negative rates, prompting audible murmurs of alarm from German journalists.
 
The decision amounts to an act of political defiance by a majority bloc in the Governing Council - unmistakably a debtors' cartel of Latin states and like-minded states - and therefore opens an entirely new chapter of the EMU story.
 
This Latin revolt is to violate the sacred contract of EMU: that Germany gave up the D-Mark and bequeathed the Bundesbank's legacy to the ECB on the one condition that Germany would never be out-voted on monetary issues of critical importance.
 
Nor is the irritation confined to Germany. The Tweede Kamer of the Dutch parliament was up in arms today, the scene of fulminating protests from across the party spectrum. "Dutch taxpayers should not be made liable for the debts of the Italian state," said the liberal VVD party.
 
Mr Draghi said there was a "large majority on the need to trigger (QE) now, so large we didn't need to vote". That is an elegant way to describe a pitched battle. No doubt we will learn over coming days just how many hawks voiced their protest, and with what vehemence.
 
He also said that the decision to pool 20pc of the risk through collective purchases was pushed through by "consensus", the ECB's euphemistic term for disagreement. This is an uncomfortable fudge.
 
It is enough to irritate those in the creditor states who oppose any "fiscal transfers" through debt mutualisation. Yet at the same time, it means that 80pc of the bonds will be bought by national central banks at their own sovereign risk, entrenching the sort of "negative feedback loop" that EU leaders vowed to end in 2012. It is a step back towards fragmentation.
 
Chancellor Angela Merkel said in Davos that the ECB's independence must be respected. Yet she also warned that its actions must be within "reasonable bounds" and in accordance with EU law.

Mr Draghi was quick to tell us that the entire ECB Council had signed off on the principle that QE is a "true monetary policy tool in the legal sense". This gives him some defence against the coming lawsuit by eurosceptic professors in Germany's top court. Serial litigator Peter Gauweiler has already vowed to file a case.
 
Yet this is a thin shield. Prior rulings of the court have made it clear that scale matters. The bigger it is, the more clearly it leaks into fiscal policy and violates the budgetary prerogatives of the German parliament. This is a sensitive matter. The court has ruled that no supranational body may usurp the budgetary powers of the Bundestag, for to do so would be to rip the heart out of Germany's post-War democracy. This legal battle will drag on.
 
Let me be clear: I have argued for at least three years that the Latin bloc should seize control of the ECB's machinery and call the German bluff, and this is exactly what has just happened.
 
They have perfect right to do so. The ECB's policy has been far too tight even for Euroland as a whole. For them it has been disastrous. The slide towards deflation - and contracting nominal GDP - has caused their debt trajectories to spiral upwards even faster.
 
Yet nobody should have any illusions about the implications of such defiance. What is at stake is German political consent for the euro project. Bernd Lucke, the leader of the AfD anti-euro party, called today's decision an "act of desperation and the introduction of eurobonds by the back door" by the ECB.
 
The Bavarian Social Christians (CSU) are also furious. "With this decision, the ECB has crossed the Rubicon," said Angelika Niebler, the party's parliamentary leader. The Bavarian finance minister, Markus Soder, said: "unlimited purchases of sovereign bonds threaten to bring down the whole system."

On the Left, Die Linke lashed out at the decision, calling it a gift for insiders. It plunders the savings of the poor to make the "super-rich even richer" by driving up asset prices.
 
Mr Draghi may have saved Italy from a debt-deflation trap in the nick of time. He may have gained another year or two for Southern Europe to recover before radical populist parties sweep the stale elites from the political scene. But in doing so he risks losing Germany.

Europe’s Jihadi Generation
.
Javier Solana
.
JAN 27, 2015

 Muslim youth men
MADRID ‒ He came from Algeria seeking a better life, anticipating an escape from poverty, oppression, and hopelessness. In Paris, he found a low-skill job and had children and grandchildren. As French citizens, they had the right to an education and health care. But they grew up in the ghettos that ring France’s major cities, surrounded by families like theirs, literally on the margins of society. Unable to integrate fully, they had few opportunities for economic advancement. Paradise was never gained.
 
This story has been repeated millions of times in the countries of Western Europe, with immigrants and their families ending up poor and excluded. In the worst-case scenario, they are recruited by extremist groups that seem to offer what they are missing: a sense of belonging, identity, and purpose. After a lifetime of marginalization, participation in a larger cause can seem worth the lies, self-destruction, and even death that inclusion demands.
 
In the wake of the attack on the French satirical magazine Charlie Hebdo in Paris and the thwarting of another attack in Belgium, Europe needs to take a good look at itself. It must recognize that second- and third-generation immigrants are susceptible to the blandishments of terrorist organizations because European citizenship has not translated into social and economic inclusion. If anything, growing inequality – exacerbated by years of crisis – is making the problem worse.
 
People need hope. They need to believe in a vision, a project that promises a better future for them and their communities. European countries once offered that sense of hope. But the crisis, and the official response to it, has replaced hope with frustration and disillusionment.
 
This has created fertile ground for anti-immigrant populists and Islamist terrorists alike. More than 1,200 French citizens are estimated to have joined the jihadi cause in Syria, along with 600 from the United Kingdom, 550 from Germany, and 400 from Belgium. Other European countries, including Spain, are experiencing a similar phenomenon. And some European citizens, like the Charlie Hebdo assassins, have acted at home.
 
While intelligence services and police forces must be engaged to prevent attacks, devising an effective strategy to counteract extremist movements requires, first and foremost, understanding what drives them. Western countries must go beyond defending freedom of speech and improving police coordination to develop lasting solutions that address adherents’ economic and social marginalization, while avoiding cultural confrontation and reliance on repression alone.
 
More fundamentally, such solutions require abandoning the false dichotomy of liberty and security. If security concerns trump basic rights and freedoms, fanaticism will have scored a victory; and the same thing will happen if expressions of Islamophobia and xenophobia increase.
 
A week after the Paris attacks, German Chancellor Angela Merkel reiterated the sentiment expressed by former President Christian Wulff in 2010: standing beside Turkish Prime Minister Ahmet Davutoğlu, Merkel declared that Islam is as much a part of Germany as Judaism and Christianity.
 
This statement represents the right way forward. Muslim immigrants, whether first-, second-, or third-generation, must be able to integrate fully into European society, gaining the same opportunities as Europe’s other residents and citizens.
 
That principle should be applied at the global level as well, through the establishment of an inclusive framework that fosters development – and encourages the rejection of fanaticism – in the Islamic world. The aggressive fundamentalism and infighting that held down Christian societies for centuries has been relegated to the past, and that is where it must remain.
 
A religion is not only a belief system; it is also an institution, a language, and even a kind of market actor, competing for supporters. Radical terrorist groups attempt to consolidate their distorted version of “true” Islam as the only institution, imposing their language to win the entire Muslim market.
 
Today, groups like the Islamic State and Nigeria’s Boko Haram have joined Al Qaeda in a struggle to attract Muslims from all over the world, thereby securing their leadership in global jihad. These groups take advantage of unruly environments and weak or collapsing institutions to gain a territorial foothold.
 
Indeed, it was the failed transitions in Syria, Libya, and Yemen after the Arab Spring revolts that fueled the Islamic State’s emergence. Millions of young people, though disillusioned by decades of social paralysis, unemployment, and brutal dictatorships, had dared to expect better. Though Tunisians have made progress, the other affected populations, like many Muslim immigrants in Europe, have had their hopes shattered.
 
Jihad, like any other reductionist political program, is capable of seducing a wide variety of people. The attribute they almost always share is a sense of futility or a lack of purpose.
 
The West must recognize that, as Afghanistan and Iraq have shown, conflict in the Arab world cannot be resolved through foreign military intervention. The only way to restore order and spur progress in the region is by empowering moderate Muslims, so that they can triumph over the forces of radicalism and violence. The West’s role is to identify them and offer them acceptance and support.
 

Read more at http://www.project-syndicate.org/commentary/european-muslim-immigrants-exclusion-by-javier-solana-2015-01#7j85lIMLbMkEl2yr.99

Decoding the Gold COTs: Myth vs Reality

By: Dan Norcini

Monday, January 26, 2015
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Over the many years that I have been writing about the commodity futures markets, I have tried to make a point of homing in on the fact that it is the presence of high-powered speculative money flows that drive market action.

Whenever commentators speak of fundamental factors that should go into determining the price of any commodity, they tend to generally speak in terms of demand for the physical product versus the amount of supply for that same product. More often than not, omitted from the discussion is the role that speculators play.

Now some may find that odd, but nonetheless, it is a fact, that a failure to understand the role of speculative money flows, leads to a failure in understanding their role in the price discovery process.

Take gold for example - most of the time, the fevered gold bugs are usually ranting about the "corrupt Comex paper market" or "the Crimex" as they delight in calling it. One rarely hears a peep out of this crowd whenever gold is storming higher for it is as if "The Crimex" has suddenly become virtuous and a place overabounding in pristine purity. Let the price of gold fall for any reason, and the place once more suddenly morphs into a "den of thieves", "a cesspool of iniquity" which must one day get its comeuppance from one of the many new gold futures market that appear outside of the US.

What these dense-minded nitwits seem incapable of understanding however, is that speculative demand in the PAPER markets greatly influences the physical markets. We see this all the time in the livestock markets where the cattle or hog markets will break lower or rally higher BEFORE THE CASH MARKET responds. Once the Board moves, the cash then follows. The reason for that is simple - those entities which do business in the physical market will establish HEDGES prior to action they take in the cash markets. That allows them to get the hedges on at advantageous prices.

After their buying or selling moves the Board far enough, speculators then pile on as the initial buying or selling of the commercials triggers the movement in price that in turns moves the technical indicators which determines the buying or selling of the specs.

This is an important thing to understand because the very purpose of the futures markets coming into being was to serve as a place where commercial entities, producers, end users, etc., that deal with the actual underlying commodity, could offload RISK to speculators who were willing to assume that risk in the hope of making a profit by so doing.

HEDGERS count on this speculative activity - at least good hedgers do! (Poor hedgers forget that they are HEDGERS and morph into speculators too often - that is when they usually end up wrecking themselves). Wise specs understand that signs of commercial hedging are clues to the DEMAND or SUPPLY coming into the market. They then react accordingly.

That being said, following the speculator activity, gives one the sense of SENTIMENT and it is sentiment that drives markets. This brings me to the current sentiment in the gold market.

Following will be two charts that portray this for us. The First is the NET POSITION of the largest group of speculative forces in the markets today and that is the Hedge Funds. Overlaid upon that graph is the price of gold.

Hedge Funds Net Positions in Gols versus Gold Price


Notice how precise the movement of the speculative Hedge Fund category is in relation to the gold price. As their net long position increases, the price of gold rises. As that same position falls, so too does the price of gold. The relationship is absolutely perfect. It does not matter what some "evil gold cartel" might or might not be doing. As long as these hedge funds are buying, the price rises. Once they stop, the price falls.

As you can currently see by the sharp rise in the BLUE LINE, sentiment in favor of gold has been rising recently among the hedge fund contingent. Look at how the gold price has responded. Again - it is all about money flows.

There is something however that I have also noted when studying the charts. That is what this next chart illustrates.

This is the TOTAL OUTRIGHT LONG positions held by ALL THREE CLASSES of speculators - (1.) the hedge funds, (2.) other large reportable traders such as floor traders, non-registered CTA's and CPO's and large private traders, and (3.)the small traders or general public. By looking at this number, ita true sense of speculative demand or the lack thereof can be determined.

Total Spec Longs and Shorts Chart 1

Are you noticing anything about this chart? You might have seen the ENORMOUS SPIKE in the total long positions being held by the speculators. Clearly speculators have come rushing back into gold here to start off the new year (they did the same exact thing to start of last year as well). As a matter of fact, the amount of new long positions has catapulted sharply higher leaping a whopping 70,000 new long positions in the last 4 weeks!

Total Spec Longs versus Gold Price


Look at the gold price however and compare where it is currently trading ( remember this is through Tuesday of last week) and to the level where it was formerly trading the last time the total long position of the speculative category was up at these lofty levels. Do you see that? Gold was trading near $1700 back in late 2012 when the combined number of speculative long positions was near its current level. (I have sketched a rectangle across the chart to show the level of long positions).

That is rather disconcerting if one is inclined to be bullish the metal. What it tells us is that a very large number of market participants are eager to sell gold. How else to explain the inability of the bulls to take the gold price anywhere near $1700 when the same level of buying was able to do so back in late 2012.


Total Spec Longs and Shorts versus Gold Price


Here is the reason for this: This is the same chart but this time it includes the TOTAL OF OUTRIGHT SHORT positions held by all three speculative categories comparing that to the price of gold.


Total Spec Longs and Shorts Chart 2


Digging in a bit further and actually comparing the outright spec long positions against the number of outright spec short positions yields further insight. Run your eye across the chart and look at those lines I have drawn in. The upper line notes the last time that the specs were holding a combined total number of long positions near the current level - that was back in Late November 2012/early December 2012 when gold was nearer $1700.


Total Spec Longs and Shorts Chart 3


Now drop down the line vertically and note the number of combined short positions of the specs at that time. It was near the LOWEST LEVELS in some time. That tells me that relatively few speculators were bearishly inclined towards gold back when it was trading near $1700.

Now move your eye back to the right to the current week and look at how many more speculators are bearishly inclined towards gold than at that previous period. It is a bit difficult to tell the exact number from the chart but there are approximately 50,000 more short positions being held by speculators at the current time than when the comparable number of outright longs was last held by this same group.


Hedge Funds Net Positions in Gols versus Gold Price Chart 2


The last chart is merely a repetition of the first one shown but which can now be viewed with perhaps a bit more understanding/perspective. You can see the sharp surge in the NET LONG position of the hedge funds only. Run your eye across to the left and note the last time it was near this level. Again, same time frame as above, late November 2012-early December 2012. You can clearly see the significantly higher gold price at that time.

I ran through this entire exercise not to bore the reader with minutiae but rather to illustrate the internals in this market. While there are clearly a revived number of bulls at work in the gold market of late, it is also equally clear that there is a growing number of speculators who are bearish on gold. That tells me it is going to take significantly more buying to drive the price of gold higher this time around than it took several years ago. They face much more resistance from a much more skeptical crowd of speculators within their midst than those who opposed them previously.

Just keep this in mind whenever you read the wild and outlandish claims that are coming out of the gold bug community and its gurus. Once more at the risk of repeating myself - stay objective and keep your emotions in check and use your head. If you listen to the market you will not go wrong. If you choose to listen to the sensationalists who have been wrong time after time after time, you will once more be setting yourself up for heartache.


January 23, 2015 11:01 am

Markets’ misplaced faith in central banks

Tracy Alloway

ECB revives cult with €60bn a month of bond buying

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An illuminated euro sign is seen in front of the headquarters of the European Central Bank (ECB) in the late evening in Frankfurt January 8, 2013. The cost of living in the euro zone rose more than expected in December but remained benign enough to allow a possible cut in interest rates in 2013 to support the bloc's feeble economy. The ECB's Governing Council meets on Jan. 10, with policymakers appearing unwilling to countenance a rate cut so early in the year. REUTERS/Kai Pfaffenbach (GERMANY - Tags: BUSINESS POLITICS) - RTR3C7Z9©Reuters
Our Draghi, who art in Frankfurt, hallowed be thy name.
 
 
Mario Draghi’s €1.1tn of shock and awe — €60bn a month of bond buying until September 2016 — might yet turn out to be insufficient to kickstart a moribund eurozone, but it is possible that it has achieved something more important for the animal spirits of markets: a revival in the cult of central banks.
 
For the last six years many on Wall Street have knelt at the altar of central banks, singing the praises of bulk asset purchases and taking for granted the omnipotence of the men and women who run them.

The influence of central banks has been felt across almost every asset class and the belief in the ability of monetary policy to heal all financial wounds has turned traditional market relationships on their heads.

To wit, those who have begun working in the financial industry in the past four-and-a-half years likely lack any first-hand experience of a period without ultra-low interest rates and the corresponding suppressed volatility levels.
 
Many are likely to be unfamiliar with a time when corporate default rates were anything more than low single-digits. Nor are they likely to remember, say, the days when investors bought government bonds for income; Bank of America Merrill Lynch analysts reckon that 52 per cent of all government bonds now yield less than 1 per cent.
 
In Switzerland, Japan and the eurozone there is now a whopping $7.3tn worth of negative-yielding government debt. The same BofAML analysts estimate about 83 per cent of the free-float stock market to be supported through low interest rates.

It is not that traders and investors necessarily took a view one way or the other on the efficacy of the central bankers’ commandments in healing the wider economy or improving the return profile of these assets.

Rather that the belief in the potential for central bank support gave succour to those who needed the comfort of a friendly, caring, all-knowing higher monetary policy power.

As Ben Hunt, chief risk officer at asset manager Salient Partners, puts it: “We pray for extraordinary monetary policy accommodation as a sign of our central bankers’ love, not because we think the policy will do much of anything to solve our real-world economic problems, but because their favour gives us confidence to stay in the market.” Sometimes ‘cult’ is too soft a word.

And yet the market’s faith had been shaken when, last week, the Swiss National Bank abandoned its currency peg, removing in one fell swoop what Jean-Pierre Danthine, SNB vice-president, had labelled a “pillar” of monetary policy only three days before.
 
For investors who had taken the SNB’s maxim that it would defend the cap with the “utmost determination” as gospel, this was a shock to the system.

For apostates, the SNB’s move was proof that central banks were far from the infallible beings markets have believed them to be for so long.


 
As Marc Ostwald at Monument Securities put it at the time: “This is symptomatic of the whole mirage of stability that the developed world central banks have sought to foster in the post-crisis era starting to unravel in a rather disorderly fashion.”

Whatever one’s monetary policy ideology, the results of the SNB move proved truly painful, with large banks, hedge funds and brokers taking hefty losses on the move — evidence again that the belief in the central banks’ dominion has come to saturate large swaths of the market.

Risk management models have been calibrated by years of low volatility and near zero rates, while many investors had come to rely on a stable Swiss franc to finance myriad other trades.

But it seems that Super Mario has now stepped in to calm those whose adherence to the cult had begun to waiver.
 
No doubt his benevolence this week will encourage the believers to pile into European stocks and bonds in the short term, but how many more economic miracles can the central banking cult call upon? Sooner or later, the market’s belief system will be tested again.

Crises of faith are rarely pleasant experiences and the unwinding of the central bank cult — when it comes — looks set to be no different.


Mark Carney warns of liquidity storm as global currency system turns upside down

Governor tells audience at Davos that monetary tightening from the Federal Reserve will "test the resilience of the financial system"

By Ambrose Evans-Pritchard, and Szu Ping Chan, in Davos

5:50PM GMT 24 Jan 2015

Mark Carney at Davos 2015

Divergences in monetary policy could bring a new wave of global instability, warned Mr Carney Photo: Reuters
 
The Governor of the Bank of England has warned markets to brace for possible trouble in 2015 as the US Federal Reserve tightens monetary policy and liquidity evaporates, fearing that the new financial order has yet to face its first real test.  

Mark Carney said diverging monetary policies in the US, Britain, Europe, and Japan may set off further currency turbulence and "test capital flows across the global economy, including to emerging markets."
 
It is the latest sign that officials at Threadneedle Street are worried about the global fall-out from the rising dollar, which poses a mounting threat to companies in the developing world that have borrowed up to $9 trillion in US dollars.
 
Mr Carney said regulators have cleaned up the banks and tried to prepare for the tectonic shift taking place in the international currency structure but major risks remain.
 
"This will test the resilience of that new financial system. It has a potential feedback and we have to be aware of that," he told an elite group of central bankers at the World Economic Forum.

"We are particularly concerned about an illusion of liquidity that has existed in a number of financial markets. I would say that illusion of liquidity is gradually being disabused," he said, adding that the so-called 'flash crash' in the US Treasury market last October was a wake-up call even if the "bouts of losses" have been small so far.
 
Mr Carney said the global authorities have clamped down on excess leverage and the sort of behaviour by banks that caused the financial crisis seven years ago, but new worries have emerged.

"The big question for us now is about liquidity cycles that come from fund managers that don't have leverage. It's $35 trillion of mutual funds that invest in relatively illiquid securities," he said.
 
Global watchdogs say the scale is so large -- and subject to "clustering" and crowd psychology - that these funds may all rush for the exits at the same time in a crisis and amplify the effects.
 
The concerns were echoed by Benoît Cœuré, a board member of the European Central Bank. 
 
"The system is untested. We had a wave of new financial regulation, which has mostly focussed on banks, so we're pretty sure that banks are much safer," he said.
 
Mr Cœuré said the ECB was forced to throw caution to the winds and launch a €60bn blitz of bond purchases on Thursday, given that inflation expectations in the eurozone have collapsed, with outright deflation in December.
 
"It was pretty clear we had to do something. The only discussion was how to do it," he said. 
 
"Being patient is a risk that we just don't want to take. We need growth in Europe. With entrenched unemployment, people are being forced out of the labour market, and we are seeing the whole foundation of the European project being weakened. This cannot last for too long," he said. 

Mr Cœuré warned that no central bank can work magic and that the real burden lies with fiscal policy and structural reform. "There is nothing we can do at the ECB to lift growth in a lasting way. We did our part, governments have to do their part," he said.
 
Mr Carney defended quantitative easing against those who argue that it leads to asset bubbles and leads to rising inequality without doing much to boost the real economy. "All monetary policy has distributional consequences. We lower interest rates and it benefits debtors at the expense of people who've saved money, and I can assure you I hear from savers and I understand that," he said.
 
Yet the moral imperative of battling high unemployment is greater. "When people are unemployed for too long, they lose their skills, so called hysteresis. There has been a race against hysteresis. In the UK, we created over 600,000 jobs in the last year. Wages are starting to pick up, and we're winning that race," he said.
 
The Governor vowed to bring inflation back to its 2pc target after it dropped to 0.5pc in December, and may soon go negative by some estimates. "We have a very low inflation environment right now, largely caused by commodity prices," he said.
 
Mr Carney said the Bank will "look through" the latest dip but do whatever it takes meet its mandate over the next two years. "We have the means, and the will, and the responsibility to do it, and we will do it. People can rely on that," he said.

The Currency Wars’ “Pearl Harbor”

by James Rickards.

Jan 22, 2015.

The Currency Wars'


The most dramatic battle yet in the currency wars took place last Thursday. It was the financial equivalent of a Pearl Harbor sneak attack…

“I find it a bit surprising that he did not contact me,” IMF Director Christine Lagarde told CNBC’s Steve Liesman that day, “but, you know, we’ll check on that.”

You can almost imagine the conversation afterwards between Mario Draghi of the European Central Bank (ECB) and Swiss National Bank (SNB) President Thomas Jordan…  

Mario Draghi: “Did you tell Christine?”
 
Thomas Jordan: “I thought you were going to tell her…”
 
Mario Draghi: “Wait, I thought you were!”
 
Switzerland had just abandoned its peg of the Swiss Franc to the Euro. The result was mayhem with an immediate 30% drop in the value of the Euro against the Franc, and billions of dollars of trading losses by banks and investors around the world.

Several foreign exchange brokers went bankrupt because their customers could not settle their losing trades. The Swiss operated in total secrecy.

Currency wars resemble real wars in the sense that they do not involve continuous fighting all the time. At certain times, there are intense battles, followed by lulls, followed by more intense battles.
 But there is nothing new about the Swiss National Bank’s move. It’s the latest salvo in the currency war that President Obama started in 2010 and it won’t be the last. It was in 2010 that the president announced his National Export Initiative designed to double U.S. exports in five years.

The most dramatic battle yet in the currency wars took place last Thursday.

The only way to do that was with a cheaper dollar, so the president’s policy amounted to a declaration to the world that the U.S. wanted other countries to let their currencies go up so the dollar could go down. Ten months later, the Brazilian Finance Minister, Guido Mantega, shocked global financial elites by publicly proclaiming what everyone knew, but no one would say — that the world was in a new currency war.

The problem with currency wars is they last a long time; sometimes even fifteen or twenty years. The reason is they have no logical conclusion, just back-and-forth devaluations and revaluations as countries retaliate against each other.

We have seen this seesaw pattern re-emerge. The weak dollar of 2011 has turned into the strong dollar of 2015. Countries that complained the weak dollar was hurting their exports in 2011 now complain that the strong dollar is hurting their capital markets in 2015.

That’s the other problem with currency wars — no one wins and everyone loses. Currency wars don’t create growth; they just steal; growth temporarily from trading partners until the trading partners steal it back with their own devaluations.

The surprise revaluation of the Swiss Franc on Jan. 15 will not be the last such surprise. There are many important pegs left in the international monetary system they are vulnerable to being broken.

Right now the Hong Kong dollar and the major Arab currencies are all tightly pegged to the U.S. dollar.

The Chinese Yuan is loosely pegged to the U.S. dollar, too. If the U.S. raises interest rates this year as the Fed has warned, the stronger dollar may force those countries to break the peg because their own currencies become too strong and hurt their exports.

If the Fed does not raise interest rates, the result could be a violent reversal of current trends and a weaker dollar as the “risk on” mantra causes capital to flow out of the U.S. and back to the emerging markets. Either way, volatility is the one certainty.

The other problem with the currency wars is what the IMF calls “spillover” effects, also known as financial contagion. Many mortgages in Poland, Hungary, and other parts of Central and Eastern Europe are made not in local currency but in Swiss Francs. The stronger Swiss Franc means those borrowers need more local currency to pay off their mortgages.

This could lead to a wave of mortgage defaults and a mortgage market meltdown similar to what the U.S. experienced in 2007. This shows how a decision made in Zurich can wipe out a homeowner in Budapest. Financial contagion works just like Ebola. Once an outbreak begins, it can be difficult to contain. It may not be long before the Swiss Franc sneak attack infects investor portfolios in the U.S.

We’ll be monitoring the danger on your behalf. Financial contagion can also be a two-way street. It not only creates dangers, it creates opportunities for investors who can connect the dots in the currency wars. The easiest conclusion you can draw and act on is this simple truth: Do not believe government and central bank lies.

This maxim is not without historical precedent. You’ve probably heard about Franklin Roosevelt’s own sneak currency attack. In 1933, President Roosevelt devised a plan to increase the price of gold in dollars, effectively a dollar devaluation. But he had a problem. If he increased the price of gold while Americans owned it, the profit would go to the citizens, not the U.S. Treasury. He knew that he had to lie to the American people about his intentions in order to pull off the theft of the century.

So Roosevelt issued an emergency executive order confiscating the gold at about $20.00 per ounce, and then revalued it to $35.00 per ounce, with the Treasury getting the profits.

On Thursday, the Swiss National Bank pulled a similar stunt. Last November, the Swiss citizens voted on a referendum to require an informal link of the Swiss Franc to gold. The Swiss National Bank argued against the referendum on the ground that it would cause them to break the peg of the Swiss Franc to the Euro.

The people believed them and voted “no” on the referendum. But now the Swiss National Bank has broken the peg anyway. The price of gold is spiking as a result, but the Swiss citizens have lost the benefit of that because the referendum is now a dead letter. The Swiss National Bank lied to the Swiss people about their intentions with regard to the peg.

The lesson of history is that citizens should own some gold, store it safely, and don’t believe government and central bank lies. In fact, we could see more investors fleeing to the safety of gold in the coming months as trust in central bankers wanes.


January 25, 2015 1:47 am

Swiss private banks fight for survival


The logos of Switzerland banking giants Credit Suisse and UBS are seen on December 5, 2014 in the city of Basel. AFP PHOTO / FABRICE COFFRINI (Photo credit should read FABRICE COFFRINI/AFP/Getty Images)©Getty
 
The sudden appreciation of the Swiss franc has intensified pressure on Switzerland’s private banks, raising the prospect of job cuts and bankruptcies.
 
The Swiss National Bank’s decision two weeks ago to abandon the cap it imposed to stop the Swiss franc appreciating against the euro caused the domestic currency to soar, before the franc pared back some of the gains last week.
 
Analysts and bankers believe the dramatic central bank u-turn will be extremely damaging for Swiss private banks and asset managers that have a high proportion of their costs in Swiss francs, but most of their revenues in foreign currencies.
 
Moody’s, the rating agency, said Julius Baer, Zuercher Kantonalbank, Credit Suisse and UBS will “suffer most” from currency translation effects on their foreign currency-denominated asset bases.
 
A spokesman for Julius Baer, Switzerland’s largest private bank, confirmed to FTfm that staff cuts are one of the measures under consideration to reduce costs as a result of the currency spike.

Thomas de Saint-Seine, chief executive of RAM, a Geneva-based wealth manager, said his group will restrict hiring in Switzerland and negotiate terms with its service providers to try and mitigate the currency turmoil.

The chief executive predicted the group’s net profitability will fall 15-20 per cent if the foreign exchange rate remains at the current level.

“This will make [survival] very difficult,” said Christian Hintermann, Zurich-based partner at KPMG, the consultancy. “The large private banks will handle this. The small banks [with less than SFr10bn ($11.4bn) in assets] are really the ones in danger.”

The worst-affected banks will lose between 10-15 per cent of their fee income, according to Mr Hintermann. This will exacerbate pressure on the Swiss banking sector, which is already grappling with a global shift towards onshore assets, increased tax transparency and a US investigation into Swiss banks that had undeclared American customers.

Burkhard Varnholt, Julius Baer’s chief investment officer, said: “The surge of the franc has been a blow to all companies whose costs are predominantly Swiss. Investors hate volatility and uncertainty and this is exactly what has happened over the past few days. It is a challenge to any private bank around the globe.”

The SNB’s simultaneous decision to lower interest rates from -0.25 per cent to -0.75 per cent will reduce the profitability of domestically orientated banks, in particular St Galler Kantonalbank, Berner Kantonalbank, Valiant Bank and Clientis, according to Moody’s.

Berner Kantonalbank said its net interest margins were likely to narrow further but declined to comment on the impact on profitability.

A spokesperson for St Galler Kantonalbank said: “The SNB decision has taken us by surprise. We are currently analysing the effects of this decision to our profits and revenues.”

Other large private banks and fund groups moved to reassure investors and shareholders that they would be resilient despite the currency setback.

Martin Moeller, head of equities at UBP, the Geneva-based private bank, said: “Private banking has had a couple of difficult years already. I don’t think this will lead to any bankruptcies but [some private banks] will consider their options.”

Swiss private bank Notenstein added that 70 per cent of its customer base is in Switzerland and that it had not incurred any losses. EFG International predicted a single-digit impact on its profits before tax.

Ray Soudah, founder of Millenium Associates, the Swiss strategic consultancy, was less optimistic.

He said: “The first likely action is further staff reductions and cost cutting at home, as well as domestic takeovers. Foreign buyers of Swiss banks will hesitate.”

The Americas

Who Killed Alberto Nisman?

First his death was declared a suicide; now Argentina’s president says it was the work of her enemies. What about Tehran?

By Mary Anastasia O’Grady

Jan. 25, 2015 7:37 p.m. ET

     Alberto Nisman Photo: Reuters