Abandon Ship - Its Every Man for Himself

By: Captain Hook

Monday, February 9, 2015

The following is commentary that originally appeared at Treasure Chests for the benefit of subscribers on Monday, January 26, 2015.

Who could forget those piercing words shouted out from the Titanic's Captain Smith as he gave the command "abandon ship - its every man for himself", as it became obvious all was lost. To just about everybody's amazement, the unsinkable Titanic was going under, and there was nothing the crew or engineers could do about it. Fast forward to today, and this makes for some powerful imagery when put against our supposedly unsinkable modern day fiat currency economies - bubble economies that only those as delusional as those thinking the Titanic could not sink would dare to characterize as stable - steady as she goes. Central, in this we regard, we have central bankers (see Draghi's comments attached), who are the 'rock stars' of our Keynesian based interventionist economies.

It's important to understand all this before we go on to talk about how is change is in the wind right now, even as the European Central Bank (ECB) has just instituted a new Quantitative Easing (QE) program in the Eurozone (excluding Greece); this, where it should be noted former Bank of England head Mervyn King commented recently that QE does not work, because it didn't in the States according to Alan Greenspan. It's amazing these guys will only tell the truth once they are out of office - no? Why is this the case? Answer: By design, QE is not aimed at enriching the middle class because this would bring on uncontrollable inflation outside of asset prices, which would not be the prescription for central authorities and their increasingly enriched corporate masters. (i.e. think oligarchs.)

It must be remembered the aim of central banks is to do whatever is best for the larger banking community (meaning the too big to fail mega-banks these days), whose interests are directly aligned with the larger bureaucracy due to incestuous relations that range from currency creation mechanisms to political contributions from the largest lobby in the world - the mega-banks and their ilk. Funny thing is though, because the life cycle of these characters raping and pillaging the globe is now fully mature, the ship appears to be taking on water with calls beginning to come in to break up the biggies before it's too late. Of course Jamie Diamond's ego would never allow for that, so he will likely go down with the ship eventually.

Be that as it may, it's important to notice we are rapidly approaching a point where like the Titanic, despite what appeared to be a situation that was totally under control, and that the best minds of the time were on the job, Mother Nature struck out at the arrogance of man pushing beyond his boundaries to teach a lesson - a lesson that is still revered symbolically to this day.

Certainly the Swiss National Bank's (SNB) decision to break its peg to the euro ahead of the ECB's QE announcement is a shot across the bow in this regard, sending the message 'we know that in the end it will be every man for himself', so they capitulated and turned rudder ahead on what would surely have been seen as an unnecessarily expensive exercise in the end, a sentiment the Danish will possibly entertain at some point in the not too distant future.

So while the SNB decision to abandon its cap against the euro was not abandoning ship on the system as it were, again, it is a warning shot across the bow that increasingly desperate measures buy increasing numbers should be anticipated as Mother Nature claws back at these characters, which is definitely a sentiment that is growing (think anti-Western posture) - one that will be perceived by the market at some point that will disseminate to individuals acting in their own defense (against a collapsing West) eventually as well. And once the top 1%'ers get into the act, it will be like the Titanic going down for the Anglo-American Alliance, Central Bankers, and West as we know it today. (i.e. think Europe moving closer to the EurAsian Economic Union, where it is being speculated this is the real reason the SNB acted secretly in the removal of its peg.)

And while the SNB may not have abandoned ship on 'the system' (because they still needs to print money), it does looks like its getting closer to doing so in terms of Western alliances however, which should be viewed as a warning short across the bow for all to see, including Eurozone countries. (i.e. Switzerland is not a member of the European Union [EU], so it can establish new alliances more easily.) Eventually, this sentiment will spread and take on an 'abandon ship' like candor at some point, which is when the dollar($) will be destroyed. 

Certainly the fact periphery economies are having to cut rates (think the Danes [see above] and Canada most recently) with all the stimulus that has been injected into the global system since 2009 is testament to the fact that not only does QE not work (only for the top 1%), but the entire Western model comes into question, which is why the SNB is increasingly moving towards Asia. It was not a rash decision on the part of the Swiss last week, but a strategic one.

Why Asia, and more specifically, China? Because unlike Western QE (money printing), when you raise wages 60% overnight for a large part of the workforce, meaningful growth actually occurs in your economy because the money is getting into people's hands. With no deficits the Chinese can do this, whereas an already bloated and over-indebted West cannot. See why the SNB broke their peg to the Euro now? Expect increasing numbers (from entire countries to individuals) to recognize this condition set soon and start thinking in an entirely new manner.

Just look at Iran, who has already de-dollarized (because they were another easy target for the US to pick on), and one can understand why Russia and China have been proactive in building their defenses against the world's biggest bully - America. This is essentially the reason the Dow / Gold Ratio (DGR) cannot hold above the all-important 233-month exponential moving average (EMA), because it may not look like it on the surface, but the world is pulling away from the US. (See Figure 1)

Figure 1

All-important - is the DGR really the all-important technical measure of the world's financial markets? Answer: Yes. I have written on this subject many times before, but I never get tired of it. Of all the symbols of Western power against Mother Nature, who in the end will judge all markets, we have the DGR, with the Dow symbolizing Anglo-American success in capitalizing on 'the system', and gold, the ultimate judge and primary measure of real status quo success in measuring asset prices in real terms. (i.e. what it really costs to produce these prices.) This is why, when the system is in its end game, like it is now, where it takes more printed money to produce the same prices because of diminishing returns acceleration of our fiat currency economy, we get a collapse in the DGR until it reaches the vicinity of unity, essentially removing any optimism from man's desire to overreach his earthly constraints once shown his true state of fragility.

This then, ladies and gentlemen, is why the DGR is 'it' in terms of indicators, taking in all available information about the 'true state' of the economy and giving you a factor to gauge its condition. This is why I spend so much time on the DGR, and why it will be the only chart that will be featured today in our foray into technical analysis. This knowledge does you no good if one does not know how to read the charts / know the important measures, but thankfully I do, an art not properly practiced widely these days. So, what is the DGR telling us at the moment?

In looking at the monthly chart, which is the prescription these days considering the increasingly wild swings in an ever-destabilizing macro-condition, we are actually looking at a possible 'classic set-up' for a reversal, where although the nominal Dow could in fact make new highs in coming days, it may not be confirmed in the DGR, or real terms, suggestive a turn lower in both measures should be expected sooner, rather than later.

Good investing all.

The Eurozone: Collateral Damage

By John Mauldin

Feb 09, 2015

Collateral damage. Unintended consequences. Friendly fire. Certainly no one intended to have a global banking meltdown when they let Lehman Bros. go under.

Now we’re watching another Greek drama that could have significant unintended consequences – far beyond anything the market has priced in today. Then again, maybe not. Maybe the market is right this time. When we enter unknown territory, who knows what we will find? Fertile valleys and treasure, or deserts and devastation? Today we look at the situation in Europe and ponder what we don’t know. Greece provides a wonderful learning opportunity.

Greece in a Nutshell

Let’s see if we can briefly summarize the situation in Greece. When Greece plunged into crisis three to four years ago, its debt-to-GDP ratio was about 120%. Greek interest rates rose precipitously as investors began to be concerned as to whether they would actually get their money back. The interest rate on the Greek 10-year bond went to 48.6%.

Everybody agreed that Greece couldn’t actually pay that debt; and since so much of it was owed to French and German banks (with not an insubstantial amount owed to Italian banks and those in other countries), the Eurozone decided to bail out Greece, which was a backdoor way of bailing out their own banks. (Seriously, you can go to the IMF minutes, in which they admit that the bailout was about saving the banks and the rest of Europe, not about Greece. Cyprus was cut loose when it would have been a rounding error for the EU to save it – but there were no European banks involved. (The lesson every politician should learn from this is that if you think you’re going to need a bailout someday, make sure your banks owe everybody else a lot of money.)

Everyone breathed a sigh of relief, and Greek interest rates fell to even lower levels than before the crisis, as you can see on the chart above. Meanwhile, because the solution forced Greece into a depression that reduced GDP by 25%, saw unemployment rise to 25% (nearly 60% among youth), forced Greeks (at least some of them) pay their taxes, and obliged the Greek government to try to balance its budget (kind of, sort of), the debt simply got worse. Now debt-to-GDP is 175%. If the Greeks couldn’t pay their debt at 120%, they have zero chance of paying it at 175%.

Eventually, Greek voters noticed that the agreement with the Troika (the ECB, the IMF, and the European Commission) didn’t seem to be working for them, so last month they voted in a new government that promised to change the agreement. The party that won the election, Syriza, had made lots and lots of promises about how they would make those mean old Germans back down and fork over the money. If we threaten to not pay the debt, the new government assured its citizens, the Europeans will give us more money, and we can even make them change the agreement. Of course, if the Greeks don’t get more money their system will be completely bankrupt, and their economy will collapse even further. (The technical economics term is that their economy will be screwed.)

This threat is somewhat like holding a gun to your own head and threatening to commit suicide if you don’t get your way. This is generally not a workable strategy when you are asking the politicians of other countries to pay a lot of money to keep you alive, especially when you are not very popular with the voters who elected those politicians. However, the new Greek government seems to think this is a perfectly reasonable bargaining tactic. Their new finance minister has written five books on game theory. It seems he has negotiating theory down pat, but in practice things are not working out according to his theory.

Because the Greeks agreed as a condition of their bailout to do something that is impossible – to pay off their debt – the rest of the Eurozone (led by Germany) actually wants them to continue to commit to doing the impossible in order that they might be given even more money, so that their debt, which they can’t possibly pay, can rise even further. (Yes, I know you may have to read that sentence three or four times to make sense out of it. That’s because the Eurozone’s position doesn’t make any sense.) The rest of Europe seems to be just fine with Greece’s going further into debt that it can’t pay, as long as they at least promise to pay it. The fact that their doing so will mean a permanent depression in Greece doesn’t really rank very high on their list of concerns.

Greek Finance Minister Yanis Varoufakis (until recently a professor at the University of Texas and as fine, or maybe more to the point, as typical a socialist as you will find at a US university) went on a tour of Europe to drum up support for the idea that, far from wanting more bailout money, Greece just wanted to buy time, via a “bridge agreement,” to work out a better plan. He came back home with a big fat nothing. He did elicit a little sympathy here and there, but no one offered any money or promises. And after he met with ECB President Mario Draghi, in what was at first thought to have been a cordial meeting, Draghi simply cut Greece off at the knees. From the Financial Times:

The French president said he supported the newly elected Syriza government in its efforts to secure a better deal from its international bailout creditors – possibly through an extension of debt maturities – as long as Greece committed to remaining in the euro, reforming its economy and honouring its debts.

Mr. Hollande also backed the European Central Bank’s surprise decision on Wednesday night to ban Greek lenders from using their country’s debt as collateral to access cheap liquidity. The move has been widely interpreted as a warning from the ECB to dissuade Athens from following through with a promise to abandon its EU bailout when it expires on February 28.

“The European Central Bank’s decision forces Greece and Europeans to sit at the same table to outline a new programme,” the French president said. “It’s legitimate.”

As the saying goes, with friends like this, who needs enemies? Greece is essentially isolated. As I understand it, the offer on the table is to extend the term of the debt, reduce the interest payments, and lighten up a little on austerity measures.

There is considerable debate as to whether the ECB actually had the authority to take the (highly political) action of declaring that Greek government debt is no longer acceptable collateral. The entire Greek finance program expires on February 28. Until that time, Greek banks can get Emergency Liquidity Assistance (ELA), which will cost them a great deal more. But ELA is available only to solvent banks with acceptable collateral. Further, the ECB has kept ELA for Greece limited to €60 billion. Ambrose Evans-Pritchard estimates that an amount closer to €100 billion will be needed, and very quickly. It is highly questionable whether the board of the ECB will grant any increase in the ELA program to Greece, absent an agreement. (You can find out more about Greece and the ELA here.)

Not only can Greek banks use only certain types of debt to access the ELA, that debt has to be free and unencumbered; and it’s not clear how much unencumbered collateral Greek banks actually have. Their consolidated balance sheet suggests they held close to €293 billion in loans and bonds as of the end of the December. Only €12.4 billion was actually Greek government debt. But €42 billion was in government-guaranteed bonds, which are not eligible to serve as collateral. Greek banks are already using €50 billion of ECB funding. Further, Greek banks had almost €40 billion in funding from non-Greek banks in the interbank market. It is highly likely that some of their assets, probably of the highest quality available, are pledged against that commercial paper. Further, 35% of Greek bank loans are nonperforming loans that are not eligible for ELA, and the rest would be subject to a severe haircut for collateral purposes (Davies).

The problem is compounded by the fact that money is beginning to leave Greek banks. “Flying out the door” might be a more accurate way to put it. Honestly, I can’t imagine leaving any significant assets in a Greek bank beyond what I would need for basic business transactions. Almost €14 billion were withdrawn from Greek banks in January, which was equivalent to the peak monthly outflow during the crisis of the last few years. You can bet the outflow did not turn around when Varoufakis came back empty-handed from his trip.

Essentially, Draghi told both the Greeks and the rest of the Eurozone that they needed to come to an agreement and do it fast. ECB collateral rules are arbitrary, and Draghi has arbitrarily put a time limit on the decision process. The total amount of time left is under three weeks, but there are interim deadlines that are even more important. The Greeks are to submit their financing proposals to the Eurozone finance ministers at their meeting on February 11 (next Wednesday).

Greece can probably fund itself into March by stretching out payments and engaging in a few bits of financial chicanery. But if the ECB does not extend their financing past February 28, the Greek banks are finished as solvent institutions. The ECB is basically saying that unless Greece agrees to continue to honor its agreements, funding will not be renewed or extended. At that point, Varoufakis would essentially have to issue Greek “scrip” in order to allow the banks to continue to function, but who would want that paper?

Things may come to a head even sooner than February 28:

Jeroen Dijsselbloem, who chairs the Eurogroup of eurozone finance ministers, told Reuters that Greece had to apply for an extension of its reform-for-loans plan by February 16 to ensure the eurozone keeps backing it financially. He stressed that the meeting on this date would be Greece's last chance to apply for the bailout extension, because some eurozone countries will need any agreement approved by their parliaments. The EFSF eurozone bailout fund, which is in charge of lending to Greece, will need time to complete its formalities, too.

But extending the bailout program, even temporarily, would mean agreeing to its terms that are hotly contested by Greece, leaving little common ground between Athens and the eurozone. (The Telegraph)

The clock is ticking. The 16th is just a week away. Not a lot of time for negotiations, and the rest of Europe doesn’t appear to be willing to give Greece more time. This seems to be a take-it-or-leave-it offer.

I’ve been talking with a number of people who have insights into the Greek issue.

One trader/analyst at a major hedge fund, whose job it is to know these things, says that it’s very difficult to get a handle on how much interbank debt there is and who owes what to whom. Some of the big banks are telling us things are okay, but he worries about whether we can trust them.

How much of that €40 billion in interbank debt to Greek banks is subject to haircuts or defaults? How do you ring-fence that debt? If you don’t, it could be massively deflationary in an already deflation-prone system. We simply have no idea of the repercussions. Maybe the ECB steps in and makes the various banks whole if Greece leaves. Then again, maybe it decides that moral hazard must not be encouraged. It is certainly taking a hard line already with Greece.

On Friday after the close of US markets, Standard & Poor’s downgraded Greece to B- from B, just one level above default range. It kept its outlook negative, which means that Greece’s rating is likely to be cut further. “S&P said the downgrade ‘reflects our view that the liquidity constraints weighing on Greece’s banks and its economy have narrowed the timeframe during which the new government can reach an agreement on a financing programme with its official creditors” (The Telegraph).

It is not clear what the Greeks will do. A significant majority of the population wants to stay in the euro. But if Tsipras and Syriza back down, it is unlikely their government will last the year.

The problem is compounded by the fact that Greeks have already started not paying certain of their taxes that Syriza has indicated it wants to cut or eliminate. That drying up of revenue worsens the funding crisis the Greek government will face in early March.

Even if Greece were to leave the Eurozone and go back to the drachma, the promises the new government has made cannot be kept without further harming the country. They want to expand the government bureaucracy, raise the minimum wage, and increase taxes on businesses. None of these measures will spur economic growth and create jobs, which is what the country needs. Unit labor and productivity cost in Greece since the creation of the euro in 2000 has been roughly three times that in Germany. Even with the cost of labor dropping significantly, Greece is still not competitive on a productivity-per-worker basis with Germany and much of rest of Northern Europe.

A Game of Chicken, European-Style

We have two implacable forces moving toward each other at rather high speed. Let’s turn now to my friend Kiron Sarkar, who summarized the thinking on the European side of the table this morning in an email to me:

In addition to the issues I have already reported on, (basically, it's politically impossible for the EZ to accept an overt debt haircut on Greece's outstanding debt to the EZ at this stage), a number of other issues have popped up which will harden the EZ's/ECB's resolve and, in effect, make them get tougher with Greece. They include:

·       Spain wants the EZ to get tough with Greece, as the government does not want to provide further ammunition to Podemos, the anti-austerity party (basically the Spanish Syriza), to gain further support. The crushing of Syriza will stem support for Podemos and other fledgling anti-austerity/EU parties, which have been gaining support in the EU. Spain is a far greater potential problem for the EZ than Greece;

·       The upcoming French bi-election could result in Marine Le Pen's National Front winning – Hollande/French support for Tsipras will hurt him/the current regime further;

·       Finland and Holland are getting tougher with Greece, to appease their own electorates, who are opposed to a debt haircut for Greece;

·       German resolve is stiffening. The German's have had enough of references to the Nazis by Tsipras/Mr V/the Greeks. There has been a huge domestic political backlash, following Tsipras’/Mr V's comments;

·       Mr. V. [Varoufakis] had disastrous meetings with Mr. Dijesselbloem and Mr. Schaeuble, the German finance minister. That is not going to do the Greeks any favours;

·       France will not cross Germany; and better Italian data, together with Mr. Renzi's win over Berlusconi over the election of the President, has emboldened Renzi – forget the public comments; 

·       PM Mr. Orban in Hungary has his own domestic problems and is not liked in the EU, in any event. It is felt that Slovakia and Austria can be contained. Ireland will shut up and hope that Greece accepts the better deal (which they will get, either way) in due course;

·       Furthermore, the recent Greek habit of not paying their taxes has emboldened the hawks in Berlin. They have told Merkel that it is yet another sign of Greek unreliability; 

·       German domestic public opinion (which Merkel follows closely) is turning sharply against Syriza/Tsipras/Mr. V. There is a growing opinion in Mrs. Merkel’s CDU and their sister party, the CSU, that the contagion risks of Grexit can be contained!!! The SPD do not want to alienate voters by supporting Greece. Finally, further aid to Greece requires the approval of the German Parliament – the Bundestag – no done deal;

·       Initial US support for Greece is softening (turning?);

·       Cyprus is starting to play up again – a “victory” for Syriza will encourage them to play act again;

·       The threat (oh yeah) that Greece will turn to China/Russia for financial support is unrealistic, long-term. China does not want to cross Germany and, in any event, will move cautiously. Russia is a wilder card, but they have enough financial and other problems of their own;

·       Syriza's coalition partners (the Independent Greeks) have the defense ministry portfolio and are pro-NATO. Unfortunately, the Defense Minister is an unsavory character and is also seriously anti-Semitic. The current coalition agrees only on its opposition to the bailout programme – expect violent disagreements (a bust-up?) once that has been settled, either way; 

·       Finally, Germany (and a number of other important EZ countries) are fed up with Greece/Cyprus's attitude towards issues such as Macedonia/Cyprus itself/EU sanctions on Russia re Ukraine, etc.

Greece’s position was not helped by a Varoufakis press conference in Germany during which he talked about Nazis. Yes, I know he was referring to the Nazi party in his own country, but he reminded the Germans that they were once run by Nazis, and it didn’t work out very well for them, so they should understand and give Greece a lot of money. I’m not sure why he thought that would be a helpful analogy, but it just further poisoned the well.

Then Tsipras gave his first major speech to the Greek Parliament on Sunday, in which he said again that Greece wants no more bailout money, that he still plans to renegotiate its debt deal, and that he still seeks a “bridge agreement” to tide the country over until a new pact is sealed. He apparently believes that Draghi and the Eurozone finance ministers in Europe don’t really mean it when they say there will be no bridge agreement without an agreement to maintain previous commitments.

As Kiron noted above, there seems to be a growing consensus that Europe can contain the problems from a Greek exit of the Eurozone. What are the chances of Greece’s leaving, either willingly or unwillingly? After the speech Tsipras gave today, I think it’s a 50-50 thing. Tspiras and Varoufakis seem to believe that the risk of a major Eurozone crisis if Greece leaves is a big enough threat to force Europe to fund them in order to avoid it.

European Deflation

The European Commission has put out its projections for 2015. Buried in the tables is its projection for inflation for Europe: -0.1%. They have Greece at -3.3% year-over-year and Spain at -1.5%. Italy is expected to experience mild deflation.

Japan is fighting deflation with a level of quantitative easing that is 15% of its GDP, and it is not clear that it’s winning. The European Central Bank wants to fight deflation with half that level of QE, spread out over a longer period. Rates are already so low that it is essentially meaningless to try to drive them down. How much can 20 basis points actually do for you? Ask Japan.

QE may indeed help spur European stock markets, and banks will benefit, but what does that do for Main Street Europe?

A Greek exit from the Eurozone will only make deflation pressures worse. The chart below shows where Greece owes its €323 billion. I assume that the vast majority of this debt will go “poof” at the moment of exit. The ECB can paper over a lot of it, or at least I think they can, but the question is, how much of the private debt will they cover?

And how will the interbank debt be dealt with? What about the remaining debt that is held by foreign banks, as well as Greek bonds in all sorts of funds?

Does Greece remain in NATO? Do we really want an anti-NATO country in the Balkans? That would be rather a nuisance. Can Greece stay in the free trade zone created by the European Union even if it leaves the European Monetary Union (the Eurozone)? Can the Greeks run a dual-currency system somewhat the way Argentina does, one where the official currency is the drachma but real transactions are done in euros? If the current Greek government gains the power of the printing press, it is quite likely that we will see very high inflation in short order, at least in terms of the drachma.

Could it be that Tsipras really wants to leave the euro but feels it will be better for him politically if it appears that Greece is forced out of the euro because the ECB has taken away the ELA? If you go back to his early speeches, he was all for leaving the euro unless Greece got total debt forgiveness.

Exactly what could the ECB and the rest of the EU do if Greece leaves? It’s not as if they can repossess a few Greek islands. Can you go after private Greek assets outside of the country? That approach would seem to be highly problematical. The lawyers could be fighting over this for years.

There are no clear answers for any of these questions. We have an inexperienced government trying to bluff in a poker game full of professional card sharks. The good news is that the situation is unlikely to remain unresolved for months or years. We are talking days and weeks.

After the last bailout, I said that Greece would end up defaulting again. The bailout agreement was not unlike the one imposed upon Germany at the end of World War I. It was simply mathematically impossible for it to work. I have sympathies for both sides.

Many of us have had the uncomfortable experience of watching a marriage of close friends come apart. Sometimes, a divorce really is the best thing, but it is nearly always painful and very expensive. The old joke goes something like this: Why is divorce so expensive? Because it’s worth it.

In the end, I think Greece will be better off leaving the euro and negotiating as hard as possible to stay within the European Union. Europe, after absorbing the cost, will be able to move on and begin to deal with the sovereign debt problems of the other troubled countries, including France. In a way, Greece is just a distraction from the very real crisis brewing in the rest of Europe. Stay tuned.
I will be somewhere close to a beach as you read this, either on Little Cayman with my friend Raoul Pal or at a conference on the large island later in the week. I will be presenting with my friend Nouriel Roubini at the Cayman Alternative Investment Summit, one of the premier alternative investment conferences of the year. They always attract very interesting speakers and entertainment. I see a few days of R&R on the beach (as well as in the gym) before and after the conference. Maybe I can catch up on some of my reading, too.

Then I will be back in Dallas to speak at an open forum for financial advisors, sponsored by S&P and called “Managing Risk and the Future of Factor-Based Strategies.” If you are an investment professional, you can register at this link.

At the beginning of March I will be in Orlando to do a keynote presentation for the American Banking Association and share a dinner with my old friend Greg Weldon. A few weeks after that, I fly to Geneva and Zürich, where I have a very packed schedule. In addition to speaking, I’m particularly looking forward to being with Dylan Grice and meeting Bill White for the first time, plus lots of other friends. I’m sure I will be staggered by the cost of everything in Switzerland, but the train ride from Geneva to Zürich is worth every penny. On a side note, Bill White was smart enough to negotiate his speaking fee in Swiss francs while I’m getting dollars for mine. That should probably tell you all you need to know about whose advice you should listen to.

I have some other speeches in Dallas and will then head to New York at the end of March.

The twins are in town to see their new nephew (Henry Junior), and it appears that I’m going to get all my kids together for brunch. I’m pretty excited about that. I’ll write next week about what I learned in the Caymans. Have a great week in the meantime.

Your wondering how cheap a Greek vacation will get analyst,

John Mauldin

February 8, 2015 7:21 pm

Only raise US rates when whites of inflation’s eyes are visible
I cannot recall a moment when the gap between what markets expect the US Federal Reserve to do and what the Fed itself has forecast it will do has been as large. Markets predict that the Fed will raise rates only to 1.6 per cent by the end of 2017; the Federal Open Market Committee’s average forecast is 3.5 per cent.

Such a divergence raises the risk of volatility and poses a communications challenge for the Fed.

More important, it raises the question of what should guide future policy.
Especially after Friday’s very strong employment report, there can be no doubt that cyclical conditions are normalising. The unemployment rate now is at its postwar average level, and continues to fall. Job openings are above their historic average. Other indicators such as the insured unemployment rate suggest a normal or rapidly normalising economy. All of this taken in isolation would suggest that interest rates should not remain at zero much longer.
On the other hand, the available inflation data suggests little cause for concern. The core consumer price index has averaged 1.1 per cent over the past six months; if housing costs were stripped out it would be zero. Wages actually fell in December and over the past year employment costs have risen 2.25 per cent which, in conjunction with productivity growth of only 1 per cent, suggests inflation of below 2 per cent. Perhaps most troubling: market indications suggest inflation is more likely to fall than rise .

The Fed has rightly made clear that its decisions will be data dependent. The further key point is that it should allow the flow of information on inflation rather than on real economic activity to determine its timing in adjusting interest rates. And it should not raise rates until there is clear evidence that inflation, and inflation expectations, are in danger of exceeding its 2 per cent target. Here are four important reasons why.

First, real wages for most workers have been stagnant. Median family incomes are down by 4.5 per cent over the past five years and the economy is about $1.5tn — or $20,000 for the average family of four — below pre-recession estimates of its 2015 potential.

In such circumstances efforts to reduce demand and growth require a compelling justification. Yet the idea that below normal unemployment will necessarily lead to accelerating inflation as suggested by the so called Phillips curve is very uncertain. Contrary to such predictions, inflation did not decelerate by much even a few years ago when unemployment was in the range of 10 per cent. Nor was there much evidence of accelerating inflation in the 1990s when the unemployment rate fell below 4 per cent.

Second, if inflation were to accelerate a bit this would be a good thing. It is now running and is expected to run below the Fed target. Prices are about 4 per cent below where they would have been if 2 per cent inflation had been maintained since 2007. So there is a case for some inflation above 2 per cent to catch up to the Fed’s price level target path. They may also be a case for inflation a little bit above 2 per cent for the next few years to allow real interest rates low enough to promote recovery when the next recession comes.

Third, a plane that accelerates too rapidly as it takes off may cause passengers discomfort while a plane that accelerates too slowly may crash at the end of the runway. Historical experience is that inflation accelerates only slowly so the costs of an overshoot on inflation are small and reversible with standard tightening policies. In contrast, aborting recovery and risking a further slowing of inflation is potentially catastrophic — as Japan’s experience demonstrates. So in a world where economic forecasts are highly uncertain, prudence in avoiding the largest risks counsels in favour of Fed restraint in raising rates.

Fourth, the US has never been more intertwined with the global economy. Higher interest rates and the stronger dollar they would bring would mean greater debt burdens for debtor countries, a growing US trade deficit that damages manufacturing, and growing protectionist pressures.

There is already a danger given all the problems in Europe, Japan and emerging markets that safe haven flows will drive the dollar up to the point where the US economy could be significantly slowed. Raising rates without evidence of rising inflation could dramatically increase real rates and exacerbate these risks.

None of this is to say that rates should never be raised or that inflation indicators might not justify a rate increase before long. It is to say that the Fed could inject much needed confidence in the economy today and minimise future risks by announcing and following a strategy of not raising rates until it sees the whites of inflation’s eyes.

The writer is Charles W Eliot university professor at Harvard and a former US Treasury secretary

The Outlook

Central Banks Move to Drive Down Currencies, Yielding Domino Effect

Interest-Rate Cuts, Asset Purchases Ricochet Through Foreign-Exchange Markets; ‘Unspoken Currency War Has Broken Out’

By Brian Blackstone

Updated Feb. 8, 2015 7:28 p.m. ET

Central-bank moves world-wide have helped push up the U.S. dollar, complicating life for the Federal Reserve, above. Central-bank moves world-wide have helped push up the U.S. dollar, complicating life for the Federal Reserve, above. Photo: Bloomberg News

The central-bank stimulus spree of 2015 has the look of a global currency war. In quick succession, countries representing about a third of the world’s economic output—from the eurozone to China, Australia and Canada—have taken steps that have driven down the value of their currencies.

But if it’s a war, it’s a gentle one so far.

Half the central banks representing the Group of 20 developed and large emerging economies, whose top monetary and finance officials meet to discuss the global economy this week in Istanbul, have taken easing steps so far this year.

The moves—mainly in the form of interest-rate cuts but also asset purchases—have ricocheted through foreign-exchange markets, driving the currencies of some countries down and those of others, primarily the U.S., up. That helps the economies of countries that are easing while complicating life for some central banks, such as the Federal Reserve, and creating challenges for exporters, from the U.S. to Switzerland and Denmark.

“There is a growing consensus in the market that an unspoken currency war has broken out,” David Woo and Vadim Iaralov at Bank of America Merrill Lynch said in a note to clients, noting that the magnitude of currency-market swings this year has hit its highest noncrisis level in 20 years.

Mention of currency war evokes images of countries deliberately trying to force their currencies down to boost exports and curb imports at their neighbors’ expense. By definition, it’s a zero-sum game.

This is a bit different: Central banks by and large aren’t specifically aiming to achieve a certain—weak—exchange rate, for instance by buying up foreign currencies on the open market, as in currency wars of the past. They are doing what they think is best for their economies and, if their currencies weaken in response, so much the better.

With the possible exception of Switzerland, whose economy may be rattled by the sudden surge in the franc after the country’s central bank unexpectedly dropped its currency ceiling against the euro last month, there aren’t any clear victims yet.

Indeed, there’s a positive-sum aspect to these currency wars. As one central bank eases, others are forced to follow suit to offset the upward pressure on their currencies.

Unlike past easy-money campaigns, these latest efforts—from economies totaling about $36 trillion in annual output—aren’t aimed at addressing financial crises, as with the U.S.-led global effort six years ago. Rather, central banks are taking aim at the risks of too-low inflation and weak economic growth.

The frenzy of easing policies began in Europe, once a center of conservative central banking with Germany’s Bundesbank at its core. The European Central Bank announced a bond-buying program, mostly government debt, last month that could swell beyond €1 trillion (about $1.13 trillion) by the fall of 2016.

That sent a tidal wave through the continent. Switzerland responded before the program was even announced last month by abandoning the ceiling it had set on the franc’s level against the euro, as markets widely anticipated the ECB’s move, while Denmark slashed interest rates four times in three weeks. Switzerland and Denmark also accumulated massive amounts of foreign currencies last month to keep a lid on their currencies’ strength. Sweden and Poland might cut rates in coming weeks, analysts say, and the Czech central bank has said it is ready to take steps to keep its currency weak against the euro.

Europeans have turned the common-sense idea that official interest rates can go only so low on its head. Deposit rates on bank reserves set by the Swiss and Danish central banks are each at -0.75%.

The ECB also has a negative deposit rate, at -0.2%, which means banks must pay a fee to park excess cash with their central bank.

“We are sort of testing the limits,” said Ángel Ubide, senior fellow at the Peterson Institute for International Economics.

These policies have brought bond yields to rock-bottom levels and pushed equities higher. The hope is that all this global easing will bolster global demand.

But there are doubts as to how much more stimulus officials can get from asset markets.

That leaves currencies as the main transmission channel. In an era of weak global growth and very low inflation, central bankers can take aggressive currency-weakening measures such as printing money or pushing rates into negative territory without having to worry about any inflationary consequences.

That makes exports cheaper in economies with looser monetary policies, and more expensive in those that are holding the line. Even if recent measures haven’t been directly aimed at currencies, “the impact of domestically oriented policies naturally has an impact on the exchange rate,” said Hung Tran, managing director at the Institute of International Finance.

The U.S. is already seeing the negative effects of a stronger dollar, with trade slicing one percentage point from fourth-quarter growth. Still, its economy is cranking out jobs at a rapid pace.

With Europe still wrestling with stagnation and political turmoil in Greece, and growth softening in key emerging markets such as China, the pressure on central banks will likely remain intense.

—Tommy Stubbington contributed to this article.

Two Cheers for the New Normal
Jim O'Neill
FEB 4, 2015

 Newsart for Two Cheers for the New Normal

JAKARTA – The conventional wisdom about the state of the world economy goes something like this: Since the start of the 2007-2008 financial crisis, the developed world has struggled to recover, with only the United States able to adjust. Emerging countries have fared better, but they, too, have started to flounder lately. In a bleak economic climate, the argument goes, the only winners have been the wealthy, resulting in skyrocketing inequality.
That scenario sounds entirely right – until, on closer examination, it turns out to be completely wrong.
Start with economic growth. According to the International Monetary Fund, during the first decade of this century, annual global growth averaged 3.7%, compared to 3.3% in the 1980s and 1990s. In the last four years, growth has averaged 3.4%. This is far lower than what many had hoped; in 2010, I predicted that in the coming decade, the world could grow at a 4.1% annual rate. But 3.4% is hardly disastrous by historical standards.
To be sure, all of the large, developed economies are growing more slowly than they did when their economic engines were roaring. But it is only the eurozone that has badly disappointed in recent years. I had assumed, when I made my projections in 2010, that the region’s poor demographics and weak productivity would prevent it from growing at more than 1.5% a year. Instead, it has managed only a meager 0.3%.
For Japan, the US, and the United Kingdom, the prospects are brighter. It should be relatively straightforward for them to grow at an average rate that outpaces that of the last decade – a period that includes the peak of the financial crisis. In addition, the dramatic drop in the price of crude oil will serve as the equivalent of a large tax cut for consumers. Indeed, I am rather baffled by the IMF’s decision to downgrade its growth forecast for much of the world. If anything, with oil prices falling, an upward revision seems warranted.
Another factor supporting a more positive outlook is the rebalancing that has occurred between the US and China, the world’s two largest economies. Each entered the financial crisis with huge current-account imbalances. The US was running a deficit of more than 6.5% of its GDP, and China had a surplus of close to 10% of its GDP. Today, the US deficit has fallen to about 2%, and the Chinese surplus is less than 3%. Given that their intertwined imbalances were key drivers of the financial crisis, this is a welcome development.
It has recently become fashionable to disparage the economic performance of the large emerging countries, particularly China and the other BRIC economies (Brazil, Russia, and India). But it is hardly a surprise that these countries are no longer growing as fast as they once did. In 2010, I predicted that China’s annual growth would slow to 7.5%. It has since averaged 8%. India’s performance has been more discouraging, though growth has picked up since early 2014.
The only real disappointments are Brazil and Russia, both of which have struggled (again, not surprisingly) with much lower commodity prices. Their lethargic performance, together with the eurozone’s, is the main reason why the world economy has not managed the 4.1% growth that optimists like me thought was feasible.
The conventional wisdom on wealth and inequality is similarly mistaken. From 2000 to 2014, global GDP more than doubled, from $31.8 trillion to over $75 trillion. Over the same period, China’s nominal GDP soared from $1.2 trillion to more than $10 trillion – growing at more than four times the global rate.
In 2000, the BRIC economies’ combined size was about a quarter of US GDP. Today, they have nearly caught up, with a combined GDP of more than $16 trillion, just short of America’s $17.4 trillion. Indeed, since 2000, the BRICs have been responsible for nearly a third of the rise in nominal global GDP. And other emerging countries have performed similarly well. Nigeria’s economy has grown 11-fold since 2000, and Indonesia’s has more than quintupled. Since 2008, these two developing giants have contributed more to global GDP growth than the EU has.
Statistics like these utterly disprove the idea that global inequality is growing. Gaps in income and wealth may be shooting up within individual countries, but per capita income in developing countries is rising much faster than in the advanced economies. Indeed, that is why one of the key targets of the United Nations Millennium Development Goals – to halve the number of people living in absolute poverty – was achieved five years ahead of the deadline.
None of this is meant to deny that we are living in challenging and uncertain times. But one thing is clear: economically, at least, the world is continuing to become a better place.

Read more at http://www.project-syndicate.org/commentary/global-economy-new-normal-by-jim-o-neill-2015-02#VAGDTDgpFmk4viX5.99

Markets Insight

February 9, 2015 6:17 am

Global tug of war is focus for investors

Mohamed El-Erian

Markets are already responding to divergence between US and rest of world
There is an economic and policy tug of war going on between the US and most of the rest of the world. Data releases, official statements and markets underline the power of this divergence. It is also consequential for investor positioning.
In spite of impressive job creation and robust personal spending, the US economy is still struggling to achieve lift-off. Imports are surging ahead of domestic production for foreign markets and companies remain reluctant to unleash capital investment plans, partly because a sharply rising dollar makes it harder to compete overseas.

In an unusual occurrence for a central bank that is domestically oriented in its policy focus and communication, the tug of war made it to the Federal Reserve statement issued on January 28.

Observing that “economic activity has been expanding at a solid rate” — a view that will be confirmed by the “wow” monthly employment report released on Friday — Fed officials noted “international developments” as one of the factors to take into account in assessing future policy steps.

For their part, financial markets have already been responding to the divergence, particularly when it comes to the more macro-dominated currency and fixed income segment.

Over the past six months, the dollar strengthened markedly against a basket of its trading partners, with an even stronger move against the euro. Meanwhile, market-determined yields for US Treasuries were pulled down by German Bund rates that have plummeted in response to both a weaker eurozone economy and new quantitative easing from the European Central Bank.
The yield curve also flattened, with yields on longer-maturity Treasuries declining a lot more than those on shorter-dated ones.
Volatility from these two market segments spilled over into equities, shaking the comforting notion of a “low vol paradigm” that had provided major and consistent support to stock prices.

There is little reason to expect the underlying forces of economic and policy divergence to change any time soon, especially when it comes to the contrast between the US on the one hand, and the eurozone and Japan on the other.

The US economy should heal further, aided by a surge in consumer confidence fuelled by lower energy prices. Continued robust job creation and a further decline in unemployment will support wage growth.

All this, along with concerns about the risk of future financial instability, is likely to translate into the Fed tweaking its “patient” language in March, and starting its rate rise cycle this summer. This would involve small, measured moves, be supported by reassuring forward policy guidance, and involve a policy end rate below the historical average of 4 per cent.

Unfortunately, European and Japanese prospects remain quite different. Persistently sluggish growth dynamics will be threatened even more by the spectre of damaging deflation. Central banks will keep pressing hard on the QE stimulus accelerator, but the transmission to higher growth and inflation will remain patchy.

Meanwhile, tricky national politics, as illustrated by last week’s frosty meeting between Greek and German officials, and greater vulnerability to geopolitical shocks (particularly the escalation of violence in eastern Ukraine) will add significant downside risks to economic growth.
All this makes absolute market calls a lot tougher than the relative ones. To navigate well such a tug of war, investors need to be able to gain exposure to relative as well as absolute positioning — be it in the foreign exchange markets favouring further dollar strength, in the government bond markets favouring additional flattening of “high quality sovereign” yield curves, or in the corporate markets favouring higher quality bonds versus those issued by high yield and low quality emerging market companies.
In scaling such relative positioning, investors would be well advised to keep one more issue on their radar screen. The prospective moves in markets implied by the divergence theme would tend to complicate rather than facilitate policy making in a world subject to increasingly bimodal distribution of potential outcomes and low availability of broker-dealer liquidity during transitions.

The possibility of policy mistakes and market accidents inevitably rises, as does that of a US-led global economic breakthrough.

Mohamed El-Erian is chief economic adviser to Allianz and chair of President Obama’s Global Development Council

SPX: The Consolidation Could be Over

By: TheWaveTrading

Mon, Feb 9, 2015

  • It has been an impressive bullish week.
  • Odds should favor the end of the consolidation phase and the resumption of the uptrend.
  • For the short-term time frame Friday's reversal should lead to further corrective action next week.

Weekly time frame:

  • Weekly Oscillators remain a concern. We have an observable improvement as the RSI has bounced off the 50 line reaching the trend line resistance from the December high. Stochastic and MACD remain with a bearish cross.
SPX Weekly Momentum Chart
  • We do have a Weekly bullish Outside candlestick that has engulfed the previous 4 weeks price action. This has allowed to reclaim the 20 w, 5 w and the 10 w moving averages and the breakage of the trend line resistance in force since the December high. The Outside candlestick is suggesting an end of the consolidation phase (Pending confirmation)
  • Barring a still possible Triangle, a pullback in the range 2046-2033 should give an appealing Risk/Reward long setup.

SPX Weekly Zoom Chart
  • It is possible that SPX is forming a large Rising Wedge. If this ending pattern pans out it would open the door to a multi month/year retracement of the rally from the 2009 low.

SPX Weekly Wedge Chart

The lack of impulsive downside price action and breadth are the major arguments that favor a pending end of the consolidation phase.
  • NYSE Summation Index has a bullish cross and the RSI has not entered yet the overbought zone
NYSE Summation Index Chart
  • Weekly Stochastic (5,3,3) has a bullish cross with plenty of room to the upside before crossing the overbought line
NYSE Summation Index Chart
  • Cumulative Tick is clearly bullish
Tick Chart

Daily time frame:

  • In my opinion from the December high price should have completed a continuation pattern with a Zig Zag. If this is the case a potential pullback should bottom in the range 2044-2031 (50 dma - 20 dma). If the 20 dma does not hold then probably we should reconsider the Triangle scenario

SPX D-Flat Chart

If the scenario of a short-term pause is correct next Monday we should see the NYSE TRIN rise above 1, while the bottom of the assumed pullback should be established with a spike above 2

TRIN Chart

Also an increase of CPCE above 0.75 should provide a setup for a long entry

CBOE Options Equity Put/Call ratio Chart

The Dollar Will Die with a Whimper, Not a Bang

by James Rickards.

Posted Feb 6, 2015

Trading partners of the U.S. who earned dollars could cash those dollars in to the U.S. Treasury and be paid in gold at the fixed rate.

In 1950, the U.S. had about 20,000 tons of gold. By 1970, that amount had been reduced to about 9,000 tons. The 11,000-ton decline went to U.S. trading partners, primarily Germany, France and Italy, who earned dollars and cashed them in for gold.

The U.K. pound sterling had previously held the dominant reserve currency role starting in 1816, following the end of the Napoleonic Wars and the official adoption of the gold standard by the U.K.

Many observers assume the 1944 Bretton Woods conference was the moment the U.S. dollar replaced sterling as the world’s leading reserve currency. In fact, that replacement of sterling by the dollar as the world’s leading reserve currency was a process that took 30 years, from 1914 to 1944.

The real turning point was the period July–November 1914, when a financial panic caused by the start of the First World War led to the closures of the London and New York stock exchanges and a mad scramble around the world to obtain gold to meet financial obligations.

At first, the United States was acutely short of gold. The New York Stock Exchange was closed so that Europeans could not sell U.S. stocks and convert the dollar sales proceeds into gold.

But within a few months, massive U.S. exports of cotton and other agricultural produce to the U.K. produced huge trade surpluses. Gold began to flow the other way, from Europe back to the U.S. Wall Street banks began to underwrite massive war loans for the U.K. and France. By the end of the First World War, the U.S. had emerged as a major creditor nation and a major gold power. The dollar’s percentage of total global reserves began to soar.

Scholar Barry Eichengreen has documented how the dollar and sterling seesawed over the 20 years following the First World War, with one taking the lead from the other as the leading reserve currency and in turn giving back the lead. In fact, the period from 1919–1939 was really one in which the world had two major reserve currencies — dollars and sterling — operating side by side.

Finally, in 1939, England suspended gold shipments in order to fight the Second World War and the role of sterling as a reliable store of value was greatly diminished apart from the U.K.’s special trading zone of Australia, Canada and other Commonwealth nations. The 1944 Bretton Woods conference was merely recognition of a process of dollar reserve dominance that had started in 1914.

The significance of the process by which the dollar replaced sterling over a 30-year period has huge implications for you today. Slippage in the dollar’s role as the leading global reserve currency is not necessarily something that would happen overnight, but is more likely to be a slow, steady process.

Signs of this are already visible. In 2000, dollar assets were about 70% of global reserves.

Today, the comparable figure is about 62%. If this trend continues, one could easily see the dollar fall below 50% in the not-too-distant future.

It is equally obvious that a major creditor nation is emerging to challenge the U.S. today just as the U.S. emerged to challenge the U.K. in 1914. That power is China. The U.S. had massive gold inflows from 1914-1944. China has massive gold inflows today.

Officially, China reports that it has 1,054 metric tonnes of gold in its reserves. However, these figures were last updated in 2009, and China has acquired thousands of metric tonnes since without reporting these acquisitions to the IMF or World Gold Council.

Based on available data on imports and the output of Chinese mines, it is possible to estimate that actual Chinese government and private gold holdings exceed 8,500 metric tonnes, as shown in the chart below.

Assuming half of this is government owned, with the other half in private hands, then the actual Chinese government gold position exceeds 4,250 metric tonnes, an increase of over 300%. Of course, these figures are only estimates, because China operates through secret channels and does not officially report its gold holdings except at rare intervals.


China’s gold acquisition is not the result of a formal gold standard, but is happening by stealth acquisitions on the market. They’re using intelligence and military assets, covert operations and market manipulation. But the result is the same. Gold is flowing to China today, just as gold flowed to the U.S. before Bretton Woods.

China is not alone in its efforts to achieve creditor status and to acquire gold. Russia has doubled its gold reserves in the past five years and has little external debt. Iran has also imported massive amounts of gold, mostly through Turkey and Dubai, although no one knows the exact amount, because Iranian gold imports are a state secret.

Other countries, including BRICS members Brazil, India and South Africa, have joined Russia and China to build institutions that could replace the balance of payments lending of the International Monetary Fund (IMF) and the development lending of the World Bank. All of these countries are clear about their desire to break free of U.S. dollar dominance.

Sterling faced a single rival in 1914, the U.S. dollar. Today, the dollar faces a host of rivals — China, Russia, India, Brazil, South Africa, Iran and many others. In addition, there is the world super-money, the special drawing right (SDR), which I expect will also be used to diminish the role of the dollar. The U.S. is playing into the hands of these rivals by running trade deficits, budget deficits and a huge external debt.

What are the implications for your portfolio? Once again, history is highly instructive.

During the glory years of sterling as a global reserve currency, the exchange value of sterling was remarkably stable. In 2006, the U.K. House of Commons produced a 255-year price index for sterling that covered the period 1750–2005.
The index had a value of 5.1 in 1751. There were fluctuations due to the Napoleonic Wars and the First World War, but even as late as 1934, the index was at only 15.8, meaning that prices had only tripled in 185 years.

But once the sterling lost its lead reserve currency role to the dollar, inflation exploded. The index hit 757.3 by 2005. In other words, during the 255 years of the index, prices increased by 200% in the first 185 years while the sterling was the lead reserve currency, but went up 5,000% in the 70 years that followed.

Price stability seems to be the norm for money with reserve currency status, but once that status is lost, inflation is dominant.

The decline of the dollar as a reserve currency started in 2000 with the advent of the euro and accelerated in 2010 with the beginning of a new currency war. That decline is now being amplified by China’s emergence as a major creditor and gold power. Not to mention the actions of a new anti-dollar alliance consisting of the BRICS, Iran and others. If history is a guide, inflation in U.S. dollar prices will come next.

In his 1925 poem The Hollow Men, T. S. Eliot writes: “This is the way the world ends/ Not with a bang but a whimper.” Those waiting for a sudden, spontaneous collapse of the dollar may be missing out on the dollar’s less dramatic, but equally important slow, steady decline. The dollar collapse has already begun. The time to acquire inflation insurance is now.