Euro in crisis
A failed euro would define Angela Merkel’s legacy
Germany’s critics feel vindicated. This will be stronger if Greece leaves, writes Marcel Fratzscher
By: Marcel Fratzscher
Bubbles Never Pop Painlessly
By: Michael Pento
Monday, June 29, 2015
Investors are obsessed over predicting the timing of the Fed's first interest rate hike. Will it raise the Fed Funds rate in September, or wait until next year? But it is far more important to get a grasp on the pace of rate hikes. Will it be a one and done move, or does this mark the beginning of an incremental tightening cycle? Those of us who are not in the inner circle are forced to only speculate.
But one thing is certain: If history is any guide, whatever they do the Fed will get it wrong.
Most market commentators place unfounded belief in the Fed's acumen. But the truth is: I wouldn't trust the Fed to tell me what the weather is going to do in the next 30 seconds -- even if they were looking out the window.
Once you understand the nature of bubbles -- how they are created and how they burst -- you can be assured this latest manifestation will also end in disaster. If the Fed raises rates in the manner in which the dot plots currently suggest it will quickly burst the bubbles already created in the real estate, stock and bond markets. On the other hand, if the Fed opts to only make a small token move higher in the cost of money it will allow asset bubbles to spin out of control until inflation destroys the vestiges of economic growth.
Our Central Bank has been deluding itself into believing it can easily escape from its nearly $4 trillion expansion of the monetary base and 7 years of virtually free money. But that is a spurious belief. Bubbles never die slowly and always bring about dire consequences. The bigger the bubbles the worse the backlash--and never before in the history of economics have central banks distorted market prices to this extent.
All bubbles share the conditions of the asset being overpriced, over-supplied and over-owned when compared to historical norms. And all bubbles are built on a massive increase in debt.
For examples; the Tech Bubble was fueled by a rapid increase of margin interest, and the housing bubble was fueled by the ownership of properties with little to no equity. Bubbles always sit atop a humongous pile of borrowed money. Today we have a tremendous amount of margin and leverage in both equities and fixed income assets.
For example, we see in this chart from the NYX data website that the percentage growth rate of margin debt vastly outstripped S&P 500 returns in real terms just prior to the collapses of 2000 and 2008.
Continued debt accumulation only makes sense if the underlying asset is increasing in price.
Once the principal of the asset stops rising, there is a massive unwinding of leverage, which causes the asset in question to plummet in value. Why do asset prices stop increasing in price?
Because the spigot for new credit gets turned off once the cost of borrowing funds becomes unprofitable for banks and/or consumers.
This is why true bubbles always bust in violent fashion. Overleveraged buyers are forced to panic out of the investment as soon as its price plateaus. And that panic selling begets more selling until there is a total washout of leveraged ownership; that is, until prices can be supported easily by highly-liquid investors.
However, the Fed wants investors to believe it can raise interest rates at the absolute perfect pace that will not deflate the bubbles in equities, real estate and all fixed income classes. But this a just a sophomoric and quixotic fantasy.
If the Fed raises rates expediently (in other words, gets ahead of the inflation rate in short period of time) the yield curve will flatten out more quickly than in past tightening cycles. This is because the spread between the Fed Funds rate and the belly of the yield curve is currently at a historically low starting point.
And importantly, the Fed won't be raising rates into an environment of robust inflation, as in the norm: instead, it will be raising rates just because it has become exceedingly uncomfortable being at the zero bound range for so many years. Once the yield curve flattens or inverts, money supply growth will get chocked off and asset prices will tumble into a deflationary death spiral similar to what occurred in 2008. This is exactly what will occur--after she begins liftoff from ZIRP -- if Ms. Yellen doesn't convince the market that she has fully repudiated the Fed's current dot plot model, which has the F.F. Rate at 1.625% by the end of 2016.
On the other hand, if the Fed stays at zero, or does a token one-and-done move on rates, asset prices could become even more grossly distorted in the immediate future. Then, after several more quarters of free money and asset bubble growth, the rate of inflation will begin to pick up serious momentum -- especially since the rise in the dollar on the DXY from 80, to 100 during the past year will quickly unravel.
In this case, pressure building up on long-term rates should explode in a sudden and violent manner.
Rates will soar not because the Fed is increasing short-term rates but precisely because the free market will awaken to the idea that our central bank has, at least temporarily, caused inflation to become intractable.
The Fed's "success" with creating inflation and the concomitant spike in long-term interest rates will, by definition, pop the fixed-income bubble, which will then cause a pernicious collapse in real estate, most equities and the economy as a whole. There shouldn't be any doubt that spiking long-term rates will become the bane for the additional $8 trillion increase in non-financial debt piled onto the U.S. economy since 2008.
Our view at Pento Portfolio Strategies is that the Fed will take the latter approach and cause the rate of inflation to grow at dangerous and intractable pace. But a prudent investor needs to be prepared for either scenario because the slope of the central bank's increase in the Fed Funds Rate will be crucial in determining the outcome. And the investment course will be vastly different for each situation. Most importantly, it is essential to be aware that an unprecedented period of market and economic turmoil lies just ahead. The good news is having the proper preparation and strategy will enable investors to profit from it.
What is Full Employment?
JUN 29, 2015
CAMBRIDGE – In an important sense, the US economy is now at full employment. The relatively tight labor market is causing wages to rise at an accelerating rate, because employers must pay more to attract and retain employees. This has important implications for policymakers – and not just at the Federal Reserve.
Consider this: Average hourly earnings in May were 2.3% higher than in May 2014; but, since the beginning of this year, hourly earnings are up 3.3%, and in May alone rose at a 3.8% rate – a clear sign of full employment. The acceleration began in 2013 as labor markets started to tighten. Average compensation per hour rose just 1.1% from 2012 to 2013, but then increased at a 2.6% rate from 2013 to 2014, and at 3.3% in the first quarter of 2015.
These wage increases will soon show up in higher price inflation. The link between wages and prices is currently being offset by the sharp decline in the price of oil and gasoline relative to a year ago, and by the strengthening of the dollar relative to other currencies. But, as these factors’ impact on the overall price level diminishes, the inflation rate will rise more rapidly.
Accelerating wage growth implies that the economy is now at a point at which increases in demand created by easier monetary policy or expansionary fiscal policy would not achieve a sustained rise in output and employment. Instead, this demand would be channeled into higher wages and prices.
There are of course other definitions of full employment. Some would say that the United States is not at full employment, because 8.7 million people – about 6% of those who are employed – are looking for work. There are millions more who would like to work but are not actively looking, because they believe that there are no available jobs for people like themselves. And an additional 6.7 million are working part-time but would like to work more hours per week.
In many cases, these unemployed and underemployed individuals are experiencing real hardship. By that indicator, the US economy is not at full employment. But, for the Fed, it is, in the sense that excessively easy monetary policy can no longer achieve a sustained increase in employment. At the same time, other types of policies that change incentives or remove barriers can lead to increased employment and higher real incomes, without raising wage and price inflation.
Consider, for example, the high rate of non-employment among men aged 25 to 54, a group too old to be in school and too young to retire. More than 15% of men in this age group are not employed. Among those in this age range who have less than a high school education, 35% are not employed. Programs to provide market-relevant education and training should be able to raise employment among this group.
Or consider the employment experience of men and women over age 65. This group is eligible for Social Security (pensions) and Medicare (health insurance), and the majority are retired. But experience shows that the decision to retire or to work fewer hours is influenced by the compensation that members of this group receive. And this amount partly reflects the fact that employed people who collect Social Security and Medicare are subject to the payroll tax that finances them.
The payroll tax paid by employees is 6.65% (employers pay the same rate), and is in addition to the personal income tax. Moreover, because of the complex rules that govern the level of Social Security benefits, the older worker who pays this payroll tax is likely to receive no extra benefits.
For many older workers, the choice is not whether to work, but how much. We now have less than full employment in the sense that the payroll tax encourages older workers to work fewer hours than they otherwise would.
The Affordable Care Act (“Obamacare”) also reduces hours worked, in two different ways.
First, for some individuals, working fewer hours reduces incomes enough to entitle them to a larger government subsidy for health insurance. Second, some employers are being incented to reduce the number of working hours for individual employees, because, above a specified number, Obamacare imposes a larger burden on them.
Or consider minimum-wage legislation, which reduces employers’ willingness to hire low-skilled workers. As the minimum wage is increased, employers’ incentive to substitute equipment or more skilled employees strengthens. This reduction in the demand for low-skilled workers could be offset by taking into account the hourly equivalent of transfer payments when calculating the minimum wage.
For example, someone who receives $8,000 a year in transfer payments (such as food stamps, housing assistance, and the Earned Income Tax Credit) might be deemed to have received the equivalent of $4 an hour toward meeting the minimum wage. That individual’s combined income would be achieved with a lower cost to the employer, increasing the individual’s ability to find employment.
I could easily extend this list. The basic point is that employment can be increased, and unemployment decreased, by removing barriers to job creation and reducing marginal tax rates. By contrast, increasing demand by prolonging easy monetary policy or expanding fiscal spending is likely to result in rising inflation rather than rising employment.
Read more at http://www.project-syndicate.org/commentary/what-is-full-employment-by-martin-feldstein-2015-06#j6qP1f6mieFyJEyi.99
The Next Gold Bull Market
- The gold bull market died in 2011.
- Die hard supporters are throwing in the towel.
- Investors seeking the next gold bull market need to watch one key variable.
Even the most ardent supporters - buyers of physical bullion and coins - have scattered. US Mint gold coin sales have dropped in half since 2010 (see chart from Bloomberg below).
(click to enlarge)
Physical dealers are feeling the hit. From a recent Bloomberg article:
"Some of the coin buyers are the diehard believers in gold, and seeing them stay away from the market means their faith may have been shaken," said Phil Streible, a senior market strategist at RJO Futures in Chicago who has been following prices for 15 years. "Demand for all kinds of physical gold products has taken a hit."Why Did the Gold Bull Market Die?
After all, weren't pundits calling for $3,000, $5,000, $10,000 gold? The arguments all seemed quite rationale. Here are a few popular ones:
- Gold-to-DJIA Ratio: At the peak of the 1970s gold bull market the ratio approached 1. People argued that we wouldn't see another peak until the gold-to-DJIA ratio again approached this level.
- Massive Money Printing: People pointed to the huge growth in assets bought and held by the Federal Reserve as an eventual trigger for runaway inflation.
- Debt-to-GDP Ratio: Some argued that the public debt-to-GDP ratio would eventually destabilize the financial system as government debt is monetized (see point 2 above).
The 'real interest rate' is the rate on a risk-free asset, adjusted for inflation. There are different measures, but one example is the 1yr US Treasury [1-3yr US Treasury ETF (NYSEARCA:SHY)] yield minus the 1yr change in CPI. Real interest rates can swing from positive to negative, depending on the economic environment. These rates say a lot about the state of the markets.
A negative real interest rate implies that investors are not adequately compensated for investing in US Treasuries. This makes US Treasuries less attractive to investors seeking safety.
In contrast, a positive real interest rate suggests that US Treasury investors are staying ahead of inflation. This makes US Treasuries more attractive to investors seeking safety.
As you have probably surmised, the appeal of gold (any asset, for that matter) is partly derived from the relative appeal of competing assets. For those that view gold as a safe haven, US Treasuries will become more attractive as real interest rates rise.
The chart (data source: St Louis Fed) below compares the real interest rate (right scale) to the price of gold (left scale). Real interest rates bottomed in September 2011 and have risen ever since. With this rise in real interest rates, gold became less attractive relative to other safe havens and has since collapsed by 40%.
Going back further, you can see the relationship between real interest rates and gold prices is fairly strong:
- During the gold bull market that ended at the end of the 1970s, real interest rates were low / negative.
- During the gold bear market from the early 1980s to the early 2000s, real interest rates were high / positive.
- Finally, during the gold bull market from the early 2000s to 2011, real interest rates were low / negative.
Investors watching gold today need to pay attention to real interest rates. If the real interest rate continues to strengthen, the relative attractiveness of gold will continue to erode. I believe the next gold bull market will occur when there is a clear and lasting indication that real interest rates are headed towards negative territory.
Greece threatens top court action to block Grexit
Exclusive: European leaders warn in concert that a 'No' vote on Sunday means Greece will be pushed out of the euro
By Ambrose Evans-Pritchard
9:52PM BST 29 Jun 2015
“The Greek government will make use of all our legal rights,” said the finance minister, Yanis Varoufakis.
“What is at stake is whether or not Greeks want to stay in the eurozone or want to take the risk of leaving," said French president Francois Hollande.
Sigmar Gabriel, Germany’s vice-chancellor and Social Democrat leader, said the Greek people should have no illusions about the fateful choice before them. “It must be crystal clear what is at stake. At the core, it is a yes or no to remaining in the eurozone,” he said.
Chancellor Angela Merkel – standing next to him after an emergency meeting of party leaders – was more oblique, but the message was much the same.
She praised hard-liners in her own party and insisted that the eurozone cannot yield to any one country. “If principles are not upheld, the euro will fail,” she said.
The refusal to hold out an olive branch to Greece more or less guarantees that it will not repay a €1.6bn loan to the International Monetary Fund on Tuesday, potentially setting off a domino effect of cross-default clauses and the biggest sovereign bankruptcy in history.
Any request for an injunction against EU bodies at the European Court would be an unprecedented development, further complicating the crisis.
Greek officials said they are seriously considering suing the European Central Bank itself for freezing emergency liquidity for the Greek banks at €89bn. It turned down a request from Athens for a €6bn increase to keep pace with deposit flight.
This effectively pulls the plug on the Greek banking system. Syriza claims that this is a prima facie breach of the ECB’s legal duty to maintain financial stability. “How can they justify setting off a run on the Greek banking system?” said one official.
Mr Varoufakis said Greece has enough liquidity to keep going until the referendum but acknowledged that capital controls introduced over the weekend were making life difficult for Greek companies.
The one-week closure of the Greek banks and the drastic escalation of the crisis over the weekend caught investors by surprise. Most had assumed that a deal was in the works.
Yields on Portuguese 10-year bonds spiked 47 basis points to 3.17pc before falling back as hedge funds look more closely at other EMU crisis states suffering from political dissent and austerity fatigue.
The sell-off ripped though debt markets in southern and eastern Europe. Yields jumped 24 basis points in Italy and Spain, and 22 points in Romania. German Bund yields dropped 13 points to 0.79pc on safe-haven flight.
The iTraxx Crossover index measuring risk on European corporate bonds jumped 42 basis points to 332 in one of the most violent one-day moves since the Lehman crisis in 2008, an ominous sign that any fall-out from ‘Grexit’ may be harder to contain that supposed.
European leaders insist that there is no longer any serious risk from contagion now that the EMU bail-out fund (ESM) is in place and the ECB has full power to act as a lender of last resort, if necessary by buying the bonds of vulnerable states on a mass scale.
This insouciance is not shared by the US Treasury or the US Federal Reserve. Britain’s Chancellor, George Osborne, warned that Grexit could be traumatic. "I don't think anyone should underestimate the impact a Greek exit from the euro," he said.
The clash between Greece and the creditor powers has become deeply personal. “Goodwill has evaporated,” said Jean-Claude Juncker, the European Commission’s president.
He lashed out at the radical-Left Syriza government, accusing premier Alexis Tsipras of failing to tell his own people the “whole truth” about the terms on offer. “Playing off one democracy against 18 others is not an attitude worthy of the great Greek nation," he said.
Mr Juncker said angrily that he had “tried again and again” to stick up for the Greek people but warned that there is little he can do to stop events running their fateful course. "A 'No' would mean that Greece had said 'No' to Europe," he said.
"This isn't a game of liar's poker. There isn't one winner and another one who loses,” he said, adding that he felt betrayed by the “egotism, and tactical and populist games” of the Greek government.
Yet at the same time, Mr Juncker intruded deeply into the internal matters Greek democracy, exhorting voters not to “commit suicide" and kicking off what amounts to a referendum campaign by the Commission itself.
He denied that the creditors were demanding pension cuts as part of the deal, a claim dismissed a “preposterous lie” by one Greek official. In fact Brussels wants a cut equal to 1pc of GDP by next year, including a phasing out of the low pension supplement, and other indirect measures.
One Syriza MP, Dimitris Papadimoulis, caught the mood in Athens. “Juncker is calling for the overthrow of the government,” he said.
June 29, 2015 3:53 pm
Shadow banks take up the running in risky lending
For decades local upstarts and foreign powerhouses have tried to crack the US corporate banking sector, usually resulting in expensive failure (looking at you, HSBC). In the latest offensive, however, the challengers may have an unwitting ally: regulators.
In March 2013, the US Federal Reserve, Office of the Comptroller of the Currency, and Federal Deposit Insurance Corporation updated their decade-old views on leveraged loans — the financing that backs private equity buyouts or companies whose credit is speculative. They were trying to rein in systemic risk in the financial system at a time when the Fed’s easy money policy was potentially creating asset bubbles.
The new guidance was not intended as a strict test, but banks focused on a provision that expressed concerns about transactions where the resulting leverage would be six times cash flow or greater. This boundary, the agencies said, “would raise concerns” about the borrowers’ ability to repay the loans.
The guidance initially did not restrain risky lending. Leveraged loan volume in 2013 and 2014 continued its post-financial crisis surge. Investors were eager to gobble up floating-rate loans and confusion about or indifference towards the new standards did not stop the big banks from feeding that beast.
But since late last year, the mood has shifted. In November, the bank regulators clarified and reinforced the standards. Their annual audit of lending also said that a third of loans in the previous year “exhibited structures that were cited as weak”. Separately, it was widely reported that Credit Suisse had been rebuked for flouting the leverage guidance.
But the questionable deals have not ceased. Rather, Jefferies and friends have increasingly stepped up to provide big leverage that the banks did not. This has raised both their profile (Jefferies, Macquarie and Nomura are all now in the top 15 of the leveraged buyout finance standings) and the eyebrows of market observers. In one example that has become emblematic, Bain Capital secured a loan from Jefferies for the $2.4bn buyout of Blue Coat Software at well in excess of six times cash flow.
Despite their growth, the big three non-banks’ share of the leverage loan market share still adds up to only 8 per cent, according to Thomson Reuters. The regulated banks still have the heft and expertise needed to lead complex loan assignments. And sometimes they do still push the envelope on risky lending.
One head of a non-bank lender pointed to the recent $5bn buyout of another software company, Informatica, where leverage was seven times cash flow. The lending group featured not only Macquarie and Nomura but also Bank of America Merrill Lynch, Goldman Sachs, Deutsche Bank and Royal Bank of Canada. Still, overall leveraged lending is down by a third this year, at least partially because the big banks have curtailed their underwriting and the unregulated firms have only partially filled the void.
For bankers, the market has become a source of frustration and wounded psyches. They argue that leveraged loans, whether arranged by big banks or entities that do not take deposits, are almost fully purchased by third-party investors rather than retained on balance sheets.
Renovating the World Order
JUN 29, 2015
WARSAW – Russia-instigated violence has returned to Ukraine. The Islamic State continues its bloodstained territorial conquests. As violent conflicts and crises intensify worldwide, from Africa to Asia, it is becoming abundantly clear that there is no longer a guarantor of order – not international law or even a global hegemon – that countries (and would-be state-builders) view as legitimate and credible.
Les doy cordialmente la bienvenida a este Blog informativo con artículos, análisis y comentarios de publicaciones especializadas y especialmente seleccionadas, principalmente sobre temas económicos, financieros y políticos de actualidad, que esperamos y deseamos, sean de su máximo interés, utilidad y conveniencia.
Pensamos que solo comprendiendo cabalmente el presente, es que podemos proyectarnos acertadamente hacia el futuro.
Gonzalo Raffo de Lavalle
Las convicciones son mas peligrosos enemigos de la verdad que las mentiras.
Quien conoce su ignorancia revela la mas profunda sabiduría. Quien ignora su ignorancia vive en la mas profunda ilusión.
“There are decades when nothing happens and there are weeks when decades happen.”
Vladimir Ilyich Lenin
You only find out who is swimming naked when the tide goes out.
No soy alguien que sabe, sino alguien que busca.
Only Gold is money. Everything else is debt.
Las grandes almas tienen voluntades; las débiles tan solo deseos.
Quien no lo ha dado todo no ha dado nada.
History repeats itself, first as tragedy, second as farce.
We are travelers on a cosmic journey, stardust, swirling and dancing in the eddies and whirlpools of infinity. Life is eternal. We have stopped for a moment to encounter each other, to meet, to love, to share.This is a precious moment. It is a little parenthesis in eternity.
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