A Year of Sovereign Defaults?

Carmen Reinhart


MIAMI – When it comes to sovereign debt, the term “default” is often misunderstood. It almost never entails the complete and permanent repudiation of the entire stock of debt; indeed, even some Czarist-era Russian bonds were eventually (if only partly) repaid after the 1917 revolution. Rather, non-payment – a “default,” according to credit-rating agencies, when it involves private creditors – typically spurs a conversation about debt restructuring, which can involve maturity extensions, coupon-payment cuts, grace periods, or face-value reductions (so-called “haircuts”).
If history is a guide, such conversations may be happening a lot in 2016.
Like so many other features of the global economy, debt accumulation and default tends to occur in cycles. Since 1800, the global economy has endured several such cycles, with the share of independent countries undergoing restructuring during any given year oscillating between zero and 50% (see figure). Whereas one- and two-decade lulls in defaults are not uncommon, each quiet spell has invariably been followed by a new wave of defaults.
The most recent default cycle includes the emerging-market debt crises of the 1980s and 1990s.
Most countries resolved their external-debt problems by the mid-1990s, but a substantial share of countries in the lowest-income group remain in chronic arrears with their official creditors.
Like outright default or the restructuring of debts to official creditors, such arrears are often swept under the rug, possibly because they tend to involve low-income debtors and relatively small dollar amounts. But that does not negate their eventual capacity to help spur a new round of crises, when sovereigns who never quite got a handle on their debts are, say, met with unfavorable global conditions.
And, indeed, global economic conditions – such as commodity-price fluctuations and changes in interest rates by major economic powers such as the United States or China – play a major role in precipitating sovereign-debt crises. As my recent work with Vincent Reinhart and Christoph Trebesch reveals, peaks and troughs in the international capital-flow cycle are especially dangerous, with defaults proliferating at the end of a capital-inflow bonanza.

sovereign defaults chart

As 2016 begins, there are clear signs of serious debt/default squalls on the horizon. We can already see the first white-capped waves.
For some sovereigns, the main problem stems from internal debt dynamics. Ukraine’s situation is certainly precarious, though, given its unique drivers, it is probably best not to draw broader conclusions from its trajectory.
Greece’s situation, by contrast, is all too familiar. The government continued to accumulate debt until the burden was no longer sustainable. When the evidence of these excesses became overwhelming, new credit stopped flowing, making it impossible to service existing debts. Last July, in highly charged negotiations with its official creditors – the European Commission, the European Central Bank, and the International Monetary Fund – Greece defaulted on its obligations to the IMF. That makes Greece the first – and, so far, the only – advanced economy ever to do so.
But, as is so often the case, what happened was not a complete default so much as a step toward a new deal. Greece’s European partners eventually agreed to provide additional financial support, in exchange for a pledge from Greek Prime Minister Alexis Tsipras’s government to implement difficult structural reforms and deep budget cuts. Unfortunately, it seems that these measures did not so much resolve the Greek debt crisis as delay it.
Another economy in serious danger is the Commonwealth of Puerto Rico, which urgently needs a comprehensive restructuring of its $73 billion in sovereign debt. Recent agreements to restructure some debt are just the beginning; in fact, they are not even adequate to rule out an outright default.
It should be noted, however, that while such a “credit event” would obviously be a big problem, creditors may be overstating its potential external impacts. They like to warn that although Puerto Rico is a commonwealth, not a state, its failure to service its debts would set a bad precedent for US states and municipalities.
But that precedent was set a long time ago. In the 1840s, nine US states stopped servicing their debts.
Some eventually settled at full value; others did so at a discount; and several more repudiated a portion of their debt altogether. In the 1870s, another round of defaults engulfed 11 states.

West Virginia’s bout of default and restructuring lasted until 1919.
Some of the biggest risks lie in the emerging economies, which are suffering primarily from a sea change in the global economic environment. During China’s infrastructure boom, it was importing huge volumes of commodities, pushing up their prices and, in turn, growth in the world’s commodity exporters, including large emerging economies like Brazil. Add to that increased lending from China and huge capital inflows propelled by low US interest rates, and the emerging economies were thriving. The global economic crisis of 2008-2009 disrupted, but did not derail, this rapid growth, and emerging economies enjoyed an unusually crisis-free decade until early 2013.
But the US Federal Reserve’s move to increase interest rates, together with slowing growth (and, in turn, investment) in China and collapsing oil and commodity prices, has brought the capital inflow bonanza to a halt. Lately, many emerging-market currencies have slid sharply, increasing the cost of servicing external dollar debts. Export and public-sector revenues have declined, giving way to widening current-account and fiscal deficits. Growth and investment have slowed almost across the board.
From a historical perspective, the emerging economies seem to be headed toward a major crisis. Of course, they may prove more resilient than their predecessors. But we shouldn’t count on it.

Global inflation

Low for longer

Inklings of inflation in the rich world are outweighed by downward pressure on prices elsewhere

EVER since the financial crisis of 2008, forecasters have scanned the horizon for the next big disruption. There are plenty of candidates for 2016. China’s economy, whose might acted as a counterweight to the slump in the rich world in the years after the crisis, is now itself a worry.

Other emerging markets, notably Brazil, remain in a deep funk. The sell-off in the high-yield-debt market in December has prompted fears of a broader re-pricing of corporate credit this year.

Yet one worry is absent: financial markets are priced for continued low inflation or “lowflation”. A synthetic measure, derived from bond prices, puts expected consumer-price inflation in America in five years’ time at around 1.8%. That translates into an inflation rate of around 1.3% on the price index for personal-consumption expenditure (PCE), the measure on which the Federal Reserve bases its 2% inflation target. Ten-year bond yields are just 2.3% in America, and are below 2% in Britain and below 1% in much of the rest of Europe. The price of an ounce of gold, a common hedge against inflation, has fallen to $1,070, far below its peak in 2011 of $1,900. Yet market expectations are often confounded. Economic recoveries are maturing. Labour markets are tightening. Could inflation be less subdued than expected in 2016?

Rich-world inflation is currently depressed because of temporary influences. In America the PCE index rose by just 0.4% year on year in November—but that is in large part because of a sharp fall in consumers’ energy prices in early 2015, which will soon drop out of the annual comparison. The core measure, which excludes food and energy prices, has been stable at 1.3% for months. It might also be somewhat suppressed by the sharp fall in oil prices, which has held down the cost of producing other sorts of goods and services. An analysis by Joseph Lupton of J.P. Morgan finds that core inflation worldwide has crept up to 2.3%, a rate that has rarely been exceeded in the past 15 years. In biggish emerging markets, including Brazil, Russia and Turkey, core inflation is above the central bank’s target (see chart).

A low blow
In the view of some, lowflation is a relic of the past. Even the euro zone is recovering from its prolonged recession; the business cycle in other rich economies is more advanced. The debt hangover that has troubled them for almost a decade has faded. Job markets are also a lot tighter than a few years ago, when deflation was a serious concern. Unemployment in America has fallen to 5%, a rate which is close to many estimates of full employment. The jobless rate in Britain is 5.2%. In Germany it is 6.3%. If the recent trend of low productivity growth in these economies continues, bottlenecks in the jobs market will emerge and higher inflation may not be far behind. For instance, if America’s GDP grows by 2.3% in 2016, its recent average, and growth in output per worker also matches its recent sluggish trend, the unemployment rate would decline further, to around 4%, reckons Mr Lupton. The lower the jobless rate goes, the more likely it is that wages—and eventually inflation—will pick up.

As rich countries were wrestling to reduce their debts, emerging markets went on a credit binge for which the reckoning is just beginning. Debt in China in particular has risen sharply relative to GDP since 2008. Some of the resulting stimulus went into factories, leading to overcapacity and falling global prices for various goods, from steel to solar panels. But a lot of China’s debt went on financing housing and infrastructure, rather than its export capacity. Moreover, the Chinese authorities’ desire to avoid big lurches downwards in the yuan ought to minimise the risk that it exports lowflation to the rest of the world.

Nonetheless, the expectations projected by bond markets—that lowflation will persist—have sound underpinnings. For a start, the price of oil and other commodities does not yet seem to have reached bottom. The price of a barrel of oil fell to an 11-year low of under $36 before Christmas, before rallying a little on hopes of renewed stimulus in China. Saudi Arabia is pumping at close to capacity, in an effort to force out high-cost producers such as America’s shale-oil firms and thus grab a bigger slice of the global market. The strategy has had some success. For instance, the number of oil-rigs operating in America has fallen from around 1,500 a year ago to just 538, according to Baker Hughes, an oil-services firm. But oil production in America remains above 9m barrels a day, and Iran’s exports are likely to increase in 2016, thanks to the lifting of Western sanctions. For the time being, the oil market heavily favours buyers over sellers.

Where inflation can be found in the world, it is not obviously a function of capacity constraints.

The biggish economies in which core inflation is above the central bank’s target tend to be commodity exporters that have suffered big falls in their currencies. That, in turn, has stoked domestic inflation.

Core inflation is typically well below target in countries that are importers of raw materials.

And despite tighter labour markets in rich countries, wages are not rising very fast. That might in part be because of low expectations of inflation.

It seems likely, also, that the debt burden in emerging markets, and the slower growth that usually comes after a credit binge, will bear down on global prices for a while. Even if China’s spare capacity is not fully exportable, plenty of other emerging markets have built mines and factories in expectation of higher Chinese growth that will now prove redundant. As nervous investors creep back to the comparative safety of developed markets, the upward pressure on big currencies, notably the dollar, will increase—adding to downward pressure on local prices.

As was the case in the late 1990s, rich-world policymakers will find that they have to keep their domestic economies primed with low interest rates to offset disinflation from abroad. The strong dollar has already caused a split in American industry between strong services and weaker manufacturing. Lopsided economies may prove as hard for policymakers to steer as deleveraging ones.

Emerging Markets Outlook 2016: These 3 Factors Make Or Break The Region Next Year

- Emerging Markets were a huge disappointment for investors in recent years and 2015 in particular.
- The leading EM ETF shows a remarkable exposure to Asia and China.
- There are three factors which can revert the negative trend: China, politics & reforms, and reversal of flows.
- Valuations are very attractive, but they will not be enough to change the trend.
- For long-term investment mandates, current levels may offer a decent entry.
2015 hasn't been a great year for emerging markets. In fact, it has been one of the poorest years since the Great Financial Crisis. Investors who play these markets through iShares MSCI Emerging Markets ETF (NYSEARCA:EEM) have lost 14.1% YTD (as at December 24).

Actually investors are back on levels last seen in 2009, which raises the question if the E in EM is still valid. From a fundamental point of view, we witnessed that a number of countries from the EM-spectrum had a rough year. For example, the two BRICs, Brazil and Russia, are experiencing a recession due to a collapse in commodity prices and (geo)political issues. As a whole, the EM-group saw growth slowing down to 3.8%. But 2015 is now largely behind us.

Let's look at what the prospects are for emerging markets and EEM, since this ETF is the most straightforward way for individual investors to play this type of markets.

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Huge Asia-exposure

It is important to realize what exactly you are buying when investing in emerging markets.

Since definitions vary, it is not always clear which country is and which isn't an emerging country. For instance, MSCI regards Argentina as a frontier market, whereas media frequently note the country as an emerging market. EEM, which tracks the MSCI Emerging Market Index, therefore doesn't include Argentina. Furthermore, with all the attention on BRICs, one might expect these four countries to have a large share in the breakdown of the ETF assets.

However, Brazil and Russia don't make it to the top five. The poor performance of Brazil's stock exchange caused exposure to drop to 5.4%.

Russia is, with a weighting of 3.4%, relatively small.

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The chart with the breakdown also highlights the huge exposure towards Asia. In fact, more than 72% of the assets are invested in Asian markets. Latin America and Emerging Europe and Africa (EMEA) have a roughly equal share of approximately 12%.

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A number of analysts point to the importance of commodity prices when investing in emerging markets. This does apply only to a small extent for EEM. A relatively small exposure towards Brazil and Russia explains this in part. Energy (7.0%) and Materials (6.1%) are small sectors.

The top-3 sectors are Financials (26.1%), Information Technology (21.3%) and Consumer (18.1%).

(click to enlarge)

The large weightings of South Korea and Taiwan are directly linked to the significant exposure towards information technology. EEM's largest holding is Korean Samsung Electronics with a weighting of 3.5%. Actually the top-3 holdings are all active in the information technology sector (no.2 is TSMC, no.3 is Tencent). Nonetheless, there's a striking difference between companies from Taiwan and their Chinese and Korean counterparts. While Taiwan is one of the world's largest Original Equipment Manufacturers (OEM) and holds a competitive advantage in cost-efficiency, it is struggling with brand awareness. In fact, whereas in recent years South Korea and China conquered the world with their brands Samsung, LG, Huawei and now Xiaomi, probably few people could name Taiwanese brands. Although HTC is well-known, it is struggling with its sales. The focus of Taiwan on process improvement and cost-consciousness led to a neglect of marketing and sales, or a failure in brand building. This could be an important burden in the future.

First factor for a turnaround: China developments

Obviously with slightly over a quarter of assets allocated towards China, developments in the Chinese economy are an important factor for EEM. But the China exposure doesn't stop at Chinese holdings. A large part of the Asian region is strongly related to the Chinese economy.

For instance, China accounted for 38.7% of Taiwan's exports and 21.6% of GDP in 2014 (source: Lazard Asset Management). Almost 60% of these exports are electronics [IT]. China is South Korea's largest trading partner with bilateral trade amounting $235 billion in 2014 (source: Ecns.cn). But also for commodity markets Brazil and Russia, and South Africa as well, demand from China plays a big role.

A large part of the huge drop in commodity prices is attributed to a slowing Chinese economy.

A further drop on the demand-side would not help the above mentioned economies, however one might wonder how much room there's left on the downside for commodity prices.

The Chinese economy is in a transition to become a more diversified economy. Policy makers are steering the country towards a more consumption driven economy. The good news is that China's consumer sector is growing with double-digits on an annual basis. In November, retail sales increased 11.2% YoY. In the first 11 months of 2015, total retail sales amounted to 27.2 trillion yuan, which corresponds with approximately $4 trillion.

The strong development of the retail sector matters a lot for EEM. Keep in mind that 18% of AUM is focused towards consumers. In addition, a number of the underlying companies are directly benefiting from higher sales through the internet. During the period January to November, online sales increased by 34.5%. The strong rise of internet shopping in China is good news for EEM-constituents Alibaba (NYSE:BABA), JD.com (NASDAQ:JD) and Vipshop Holdings (NYSE:VIPS). All three companies were added to the MSCI EM Index starting from December 1.

We should make an important note on China investments in EEM. This year's turmoil on the Chinese stock market was well covered in the press. But this was related to the mainland-traded A-share market, which is a separate exchange from the typical H-share market. H-shares are listed on the Hong Kong Stock Exchange and these are the shares that are constituents of MSCI indices.

Furthermore, as mentioned above, ADRs listed on US markets can also be included in the MSCI EM Index.

Second factor: political will to reform

As China's example of shifting economic policy targets illustrates, a number of emerging markets need to reform their economic policies. Although the big picture of China's reforms indicates that policymakers are aware that the old investment- and production-driven growth is no longer feasible, recent reforms are a bit disappointing. Real market-oriented reforms that spur competition are still largely absent. To be fair, China's move towards a floating exchange rate is a major step in the right direction.

What's more troublesome, other emerging markets are caught in a struggle for political power and the need to implement unpopular reforms. Brazil's administration is desperately putting all its energies into retaining power as a result of widespread corruption scandals. The current crisis means that there's little attention for implementing reforms that steer the country clear from its major dependence on commodities. Also Russia needs to boldly reform to turn the country into a more diversified economy. The previous crisis in 2008-2009 was apparently too short, i.e. commodity prices recovered too quickly to urge policy makers to take necessary steps. Now with a new collapse in oil and ore prices, the country is in a recession anew.

Domestic politics are of less concern, but geopolitics are.

Foreign investments and access to capital suffered due to the Ukraine crisis. A time path for lifting international sanctions against Russia is still not on the horizon, with the US imposing fresh sanctions recently. The good news is that for 2016 the refinance need for Russian companies is relatively low.

The ruling administrations in South-Africa and Turkey are putting too much energy into party politics, either to retain power or to enhance the position of politicians. This is bad news for reforms.

Some other countries, such as India and Indonesia, but Mexico as well, saw new leaders gain power recently. Although these leaders were elected promising reforms, their ambitions have not turned to reality due to difficulties in implementation. Argentina shows how it should be done by the bold reforms already implemented shortly after a new administration took office. If only Argentina were included in EEM…

But there's another political story that affects EEM: elections in Taiwan. In January, Taiwanese voters will elect a new president as well as a new legislature. These elections are for a large part centered around the country's position towards China. Current polls indicate a victory for Tsai Ing-wen, the leader of the opposition DPP (Democratic Progressive Party).

Although Tsai didn't reveal much of her stance towards China, some worry that ties may struggle more than under candidate Eric Chu from the ruling China-friendly Nationalist Party.

On the other hand, this should not be exaggerated because much of the election was run on domestic issues, such as coping with rising cost of living against stagnant wages. Furthermore, the economic ties between both countries make clear that no one will benefit from increasing tensions.

Third factor: it's all about the flows

In economic flourishing times, politics move to the background of investors' attention. But in the current situation of relatively sluggish growth, even compared to developed economies, this topic does matter. Why would you move funds towards a country with similar growth perspective but with weak governance? This question indicates that it all comes down to a risk/reward evaluation. For the recent years, in particular this year, international flows showed that this question received a negative response. According to the IIF (Institute of International Finance), this year net capital inflows turned negative for the first time since 1988 and could amount to as much as $540 billion. IIF estimates that next year net capital flows to emerging economies will remain negative at a minus of $306 billion.

The steep drop in flows is for a large part the result of a lack of direct investments. Gross inflows halved compared to a year earlier.

The negative trend in flows is also seen in EEM. Compared to February 28, AUM (assets under management) declined from $32.3 billion to $21.7 billion as at December 24. AUM more than halved during an 18-months period. Although a part can be contributed to a decline in share price, the number of shares outstanding decreased from 795.2 million to 662.4 million. To be fair, since late August, some new shares were sold. But compared to less than 18 months ago, the ETF saw its number of shares outstanding decline with approximately a third (see graph below).

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Many market watchers are wondering whether we have seen the top of fund outflows. As indicated in my previous article on Market Vectors Russia ETF (NYSEARCA:RSX), dated October 24, the low valuations attract investors who consider current levels as an attractive entry level. With an average price-to-earnings ratio of 11.7, investors get a discount for EEM compared to the US market. The SPDR S&P500 ETF (NYSEARCA:SPY) is currently trading at a p/e ratio of 18.6 and the Vanguard Total World Stock ETF (NYSEARCA:VT) is trading at a p/e ratio of 17.2. To be fair, a number of individual emerging markets are trading at a much lower p/e ratio. For instance, RSX is trading at a p/e ratio of 6.6.

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Attractively priced or not, the fact is that the larger part of fund managers is heavily underweighted in emerging markets. According to a December 15 survey by Bank of America Merrill Lynch, a net 27% of fund managers hold underweight positions in emerging markets.

This is down from the net 34% in September, which was the largest underweight-position since 2006. Net underweight means that the percentage of underweight is x% greater than fund managers reporting an overweight position. The significant underweight-position doesn't necessarily mean that these fund managers will become buyers of emerging markets in a jiffy, but it indicates that the potential of fresh buyers is substantial. In case momentum turns, there's a large amount of potential inflow.

A look at the chart

As mentioned earlier, current price of EEM is at levels last seen in 2009. Chartists will love the 2015-low, since this one is close to a 61.8% Fibonacci retracement of the bull move from late 2008 until 2011. So EEM may be at a critical level from a chartist point of view.

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2016: a return to green valleys?

That said, before the investment climate turns really positive, significant adjustments need to be made in a number of emerging markets. Current valuations for emerging markets as a group may offer an attractive opportunity when one holds a long-term investment horizon. The cautious inflows for EEM in the second part of 2015 could indicate that some investors are ready to (re-)add exposure towards emerging markets at current prices. But as highlighted in this article, before adding EEM, one has to be a firm believer in Asia and in China in particular. Investors who think individual markets may have gone too low recently, such as Russia or Brazil, are better served with country-specific ETFs.

Nevertheless, with valuations significantly below that of developed markets, EEM offers an attractive investment thesis for 2016 and the years to come.

Fueling Gold's 2016 Upleg

By: Adam Hamilton

Gold certainly had a rough year in 2015, grinding inexorably lower on Fed-rate-hike fears and investor abandonment. But gold is poised to rebound dramatically in this new year, mean reverting out of its recent deep secular lows. The drivers of gold's weakness have soared to such extremes that they have to reverse hard. The resulting heavy buying from dominant groups of traders will fuel gold's mighty 2016 upleg.

Investment demand, or lack thereof, is what overwhelmingly drives the gold price. Investment certainly isn't the largest component of gold demand, a crown held by jewelry at roughly 4/7ths of the total. But that is somewhat misleading, as gold's investment merits are the primary reason Asians flock to gold jewelry. But since global jewelry demand is fairly consistent, it's not what drives the gold price on the margin.

Investment demand is much smaller. According to the World Gold Council, it only accounted for 17.7% of global gold demand in 2013, 19.4% in 2014, and 22.0% in 2015 as of the end of the third quarter. So call investment demand something like 1/5th of total world gold demand.

While that isn't huge, it is a super-volatile demand category. That's where gold's biggest demand swings emerge, driving its price.

The reason gold prices plummeted 27.9% in 2013, slipped another 2.0% in 2014, and then fell 9.6% in 2015 by this essay's data cutoff on the 29th was because investment demand first collapsed and then remained weak. Without strong global investment demand, gold is going to struggle. It is the big swing category of demand, the outlying volatile variable imposed on the steadiness of other demand and supply.

It's hard to believe after the brutal gold wasteland of recent years, but this unique asset hasn't always been despised. Between April 2001 and August 2011, gold skyrocketed 638.2% higher in a mighty secular bull earning fortunes for brave contrarians. The flagship S&P 500 stock index actually slipped 1.9% lower over that same span. Even after gold's summer-2011 peak, its price averaged $1669 in all of 2012.

The collapse of gold's critical investment demand began in early 2013. And it wasn't a normal event, but an extreme market anomaly courtesy of the US Federal Reserve. Back in September 2012, gold traded at $1766 the day the Fed launched its third quantitative-easing campaign.

QE3 was wildly different than its predecessors in that it was open-ended, its bond monetizations had no predetermined size or end date.

Just a few months later in December 2012 as gold traded at $1712, the Fed more than doubled the size of its brand-new QE3 campaign with massive new US Treasury monetizations. Starting in January 2013 the Fed would conjure up $85b per month out of thin air to buy bonds. The purpose of QE3 was to manipulate long-term interest rates lower, which the Fed openly admitted. QE3 radically distorted the markets.

QE3's undefined open-ended nature made it a powerful psychological-operations weapon to use on traders to actively manipulate their sentiment. Whenever the stock markets started to sell off, elite Fed officials would run to their podiums to declare their central bank was ready to expand QE3 if necessary. Traders interpreted this just as the Fed intended, believing the Fed was effectively backstopping stock markets!

So traders started pouring increasing amounts of capital into the stock markets, levitating them.

With a Fed Put in place, a notion that Fed officials aggressively fostered, traders increasingly ignored all the conventional stock-market indicators. They bought and bought and bought, sentiment, technicals, and fundamentals be damned. This relentless stock buying gradually became a self-fulfilling prophecy.

As the stock markets seemingly magically levitated thanks to the Fed's deft use of QE3's undefined nature, they started sucking capital away from other asset classes. Investors love to chase performance, and stock markets were powering relentlessly higher leaving everything else behind. So they started to sell other assets to move that capital into the red-hot stock markets. Gold was collateral damage from this migration.

This mass exodus of investment capital from gold was most evident in the flagship GLD SPDR Gold Shares gold ETF. After hitting an all-time-record gold-bullion-holdings high of 1353.3 metric tons just 3 trading days before the Fed greatly expanded QE3 in December 2012, stock investors started to dump GLD shares faster than gold in early 2013. This soon snowballed into a wildly-unprecedented record selloff.

Since GLD's mission is to track the gold price, it has to act as a direct conduit for stock-market capital to slosh into and out of physical gold bullion. When GLD shares suffer differential selling beyond what is going on in gold, their price threatens to decouple from gold's to the downside. GLD's managers have to avert this failure by shunting that excess share supply directly into gold itself. This requires selling gold bullion.

GLD's managers sell enough of its gold holdings to raise sufficient cash to buy back all the excess GLD shares being offered. In 2013 as the Fed's extraordinary QE3-stock-market levitation blasted the S&P 500 29.6% higher, stock investors dumped GLD shares so fast that its holdings plummeted 40.9% or 552.6t that year! GLD selling alone accounted for over 5/6ths of 2013's total drop in overall global gold demand.

As GLD was forced to hemorrhage vast record torrents of gold bullion into the markets, another group of traders piled on to ride gold's downside. The American gold-futures speculators, whose trading has the greatest impact on gold's price by far, started short selling gold futures at extreme levels. This added to the paper supply of gold, forcing down the benchmark gold-futures price off of which the physical metal is priced.

The more American stock investors jettisoned GLD shares, the faster gold fell. The faster gold fell, the more American futures speculators ramped their short selling. All the resulting gold carnage forced the other futures speculators long gold futures to greatly pare their bets, adding still more selling to the mix. The result was the most devastating vicious circle of selling gold has ever seen, spawning recent years' wasteland.

As gold fell due to extreme selling driven by the Fed-levitated stock markets sucking investment capital out of it, traders tried to rationalize those losses as fundamentally-righteous. So the futures speculators started to believe first the tapering of the size of QE3's monthly bond monetizations, then the end of QE3's new bond buying, then later the Fed's first rate hike would wreak more havoc on devastated gold.

These rationalizations were always weak though, simply masking self-feeding selling driven by out-of-control bearish sentiment. Remember gold traded at $1766 and $1712 when QE3 was originally born and expanded in late 2012. So gold plunged sharply during QE3. If that largest inflationary event in world history was ludicrously very bearish for gold, then why would the end of QE3 prove bearish as well?

The coming slowing and end of QE3's epic monetary inflation was the boogeyman used by traders to justify aggressively selling gold in 2013 and much of 2014. QE3 was first tapered in December 2013, and its new bond buying fully ended in October 2014 even though none of those vast monetized bonds have been sold yet to this day. Once QE3's new bond buying ended, traders shifted their boogeyman to rate hikes.

Fed-rate-hike fears were used to justify futures speculators' and stock investors' ongoing gold selling in 2015. Their rationale was simple. Since gold yields nothing, it will be far less attractive in a rising-rate world where yields climb on competing investments. But again this justification was totally emotional, a reflection of extreme popular bearishness that had nothing to do with gold's actual global fundamentals.

The fatal flaw with this Fed-rate-hikes-are-gold's-nemesis thesis is that history proves just the opposite. I've extensively studied gold's performance within the exact spans of every Fed-rate-hike cycle since 1971. It turns out there have been 11 of them, through all of which gold averaged a stellar gain of 26.9% while the Fed was hiking rates. In the majority 6 where gold rallied, its average gain was a staggering 61.0%!

In the other 5 Fed-rate-hike cycles where gold lost ground, its average loss was an asymmetrically-small 13.9%. Gold's best performance within Fed-rate-hike cycles occurred when it entered them near secular lows and they were gradual. With gold just off major secular lows today, and the coming Fed-rate-hike cycle promised to have the slowest hiking pace ever witnessed, it's incredibly bullish for gold's fortunes.

If higher rates really kill gold, history would be riddled with examples. The Fed is currently estimating that the federal-funds rate it targets will hit 1.25% to 1.5% in 2016. While that's a lot higher than recent years' 0.0% to 0.25% range, it is still trivial by historical standards. Between January 1970 and January 1980, gold skyrocketed 2332% higher when the FFR averaged a super-high 7.1% and gold still yielded zero.

During that later 638% secular gold bull between April 2001 and August 2011, the FFR still averaged 2.1% over that span despite the advent of the Fed's zero-interest-rate policy within it.

Gold has no problem at all rallying mightily during Fed-rate-hike cycles and in much-higher-rate environments as long as global investment demand is strong. All those rampant gold-to-plunge-due-to-Fed-policy fears are baseless.

Thus as 2016 dawns, the whole premise for selling gold near major secular lows is totally wrong.

Gold only hit these lows because investment demand remained low as extreme bearish psychology choked out all logic and reason. But the Fed actually hiking rates for the first time in 9.5 years, ending 7 years of ZIRP, will serve as the acid test to shatter these false notions. 

Gold hasn't plunged post-hike as widely forecast!

And that means gold-futures speculators and stock investors alike are going to have to seriously rethink their whole gold thesis. As they realize that rate hikes won't slaughter gold, investment demand is going to start returning. And coming from such epically-extreme anomalous lows, it is going to take a massive amount of gold buying to restore normalcy in the gold market. That normalization is inevitable in 2016.

Major gold uplegs have three distinct stages of buying, with groups of traders handing off the baton like a relay race. New gold uplegs are initially ignited and fueled by speculators buying gold futures to cover their risky hyper-leveraged shorts. That sparking surge of buying lasts several months or so, propelling gold's price high enough to get speculators interested in redeploying capital in long futures positions again.

Unlike short covering which is mandatory and forced as gold rises to prevent speculators from getting wiped out, long buying is totally voluntary and far less frantic. So it can take a half-year or more for the speculators to reestablish their upside bets on gold. That extends gold's new upleg long enough and high enough to convince investors with their vastly larger pools of capital to start returning, which takes years.

Today gold is in an unprecedented position where the coming speculator gold-futures short covering, speculator gold-futures long buying, and stock investor GLD-gold-ETF buying is all aligned to be utterly huge! As the extreme anomalies of recent years spawned by the Fed's stock-market levitation unwind, the vast gold buying necessary to mean revert that market to norms is going to fuel a mighty new gold upleg.

Let's start with the futures speculators, the early buyers necessary to get gold moving higher again for long enough to motivate investors to return. This chart shows American futures speculators' total short-side and long-side bets on gold weekly over the past several years. These guys are so far out over their skis on the bearish side of this trade it is mind-boggling, and their only way out is extreme gold-futures buying.

Gold Futures Specs 2013-2015

American speculators' aggregate gold-futures positions are released every Friday afternoon current to the preceding Tuesday's close in the CFTC's Commitments of Traders reports. The latest read when this essay was published was December 22nd's. That was the week surrounding the Fed's rate hike which was supposed to obliterate gold. Yet since gold didn't plunge as expected, speculators quickly covered.

They bought 15.5k gold-futures contracts that CoT week, cutting their total shorts from near-record levels to 167.5k contracts. But that is still extremely high by all historical standards, not far from the all-time record of 202.3k in early August. Even during the recent Fed-distorted years, speculators' gold-futures short-side bets generally meandered in the trading range between 75k to 150k contracts shown above.

Merely to return near recent years' 75k-contract support for the fifth time since late 2013, speculators are going to have to buy 92.5k gold-futures contracts to offset and cover their shorts. And to mean revert to total speculator shorts' normal-year average levels of 65.4k between 2009 and 2012 before the Fed's stock levitation started, these traders have to buy a staggering 102.1k contracts. That's an incredible amount of gold!

Each gold-futures contract controls 100 troy ounces of the metal, so that equates to total gold buying in speculators' short covering alone of 317.6 tonnes! For an idea of how enormous this is, quarterly global gold investment demand in 2015 up to Q3 averaged 228.0t. So we are talking about overall world investment demand soaring 139% on speculator short covering alone within a condensed several-month span!

Short covering unfolds so rapidly because traders are legally obligated to effectively pay back the gold they effectively borrowed to sell short. And the leverage in gold futures is so extreme that they can't afford to wait to cover once gold starts rallying. A single gold-futures contract controls $107,000 worth of gold at $1070, yet only requires a maintenance margin of $3750.

That makes for extreme leverage of 28.5x!

A mere 3.5% rally in the gold price at that kind of leverage would wipe out 100% of the capital risked by fully-margined gold-futures speculators. So gold-futures short covering rapidly feeds on itself, with all the covering buying blasting gold's price rapidly higher which forces additional speculators to cover their own shorts. The more short covering, the faster gold rallies. The faster gold rallies, the more shorts are covered.

By the time gold-futures short covering has run its course and fizzled out, speculators buying long-side gold futures start returning. And their bets are exceedingly low right now, which means they also have huge buying to do to mean revert to normal. As of that latest CoT report on the 22nd, American futures speculators only held 189.7k long-side gold contracts. That's their lowest level since way back in April 2014.

In those last normal years between 2009 to 2012, speculators averaged weekly long-side gold-futures positions of 288.5k contracts. Merely to mean revert to those normal levels without even overshooting would require 98.8k contracts of buying equivalent to another 307.2t of gold! In total, American futures speculators alone need to buy the enormous equivalent of 624.8t of gold simply to normalize current extremes!

To put this into perspective, in all of 2013 and 2014 global gold investment demand ran 784.8t and 819.1t per the World Gold Council. In 2015 current to Q3, that number is running 684.0t. Annualize the latter and average these years, and you get yearly gold investment demand of 838.6t. American futures speculators alone are almost certainly going to buy 3/4ths as much gold in 2016 on top of all that normal demand!

And all that mean-reversion gold-futures buying will propel gold high enough for long enough to start to convince investors to return. And their gold positions are as extreme today as speculators' gold-futures ones, a guarantee of massive normalization buying coming. While physical bar-and-coin investment is larger than ETFs, GLD's highly-transparent daily data is representative of radical underinvestment as a whole.

GLD/SPX Value 2005-2015

This chart reveals the total value of GLD's gold-bullion holdings divided by the market capitalization of that benchmark S&P 500 stock index. If offers a glimpse into the proportion of stock investors' portfolios that are deployed in gold. And thanks to the epic gold bearishness in recent years based on those false notions on the extreme Fed policies' implications for gold, American stock investors are radically underinvested.

For many centuries, wise investors have recommended every portfolio have at least a 5% allocation in gold. It is the ultimate insurance policy, a unique asset that moves counter to stock markets. When something bad happens with the other 95% of one's investments, that mere 5% gold allocation will often multiply enough to offset most of the other losses. That old 5% target is probably gold's full-investment level.

But as of the end of November the last time we calculated the S&P 500's market capitalization, the ratio of the value of GLD's holdings to the S&P 500's collective market cap was just 0.115%. American stock investors had just over a measly one-tenth of one percent of their capital invested in gold! That is incredibly low by all historical standards, a Fed-driven anomaly that is as ripe to mean revert as gold-futures bets.

During those last normal years between 2009 to 2012, this GLD/SPX ratio averaged 0.475%.

Seeing stock investors with that nearly 0.5% portfolio allocation to gold is a reasonable conservative baseline. Just to return to 0.475% would require gold's portfolio allocation to soar 4.1x from the recent super-depressed levels. Vast amounts of stock-market capital would have to deluge back into gold to make this happen.

GLD's holdings averaged 1208.5t between 2009 to 2012 before the Fed's stock-market levitation sucked so much capital out of other investments including gold. This week, GLD's holdings were way down around 643.6t. So to return to pre-QE3 GLD-investment levels, stock investors would have to buy up enough GLD shares to force this ETF's managers to purchase another 564.9t of gold bullion in coming years!

And that's third-stage gold-upleg investment buying on top of first-stage speculator gold-futures short covering and second-stage long buying! While it will probably take years instead of months to normalize levels of gold portfolio allocations for stock investors, that's still a tremendous amount of marginal new gold investment demand. 564.9t of GLD buying over 2 years is 282.5t per year, and over 3 years is 188.3t.

The average quarterly gold investment demand in 2015 up until Q3 was 228.0t, so we're talking about an additional 0.8x to 1.2x a quarter's gold demand per year on top of all other gold demand. And don't forget that GLD is just a window into one aspect of gold investing, ETFs.

Global physical bar-and-coin demand is way larger than ETF demand, and the radical underinvestment there is similar to what GLD has revealed.

So with the gold positions of speculators and investors alike so radically skewed by the Fed's extreme market distortions of recent years, vast mean-reversion buying is inevitable in 2016 to start to normalize gold investment back to reasonable levels. Coming off of such an anomalously-low base where virtually everyone loathes gold, all this speculator and investor gold buying is going to fuel a mighty gold upleg.

Gold's performance will trounce the stock markets' in 2016, and it can be played via that GLD gold ETF or physical gold bullion. But the coming gains in the left-for-dead gold stocks will dwarf those in the metal they mine. With their stock prices recently trading near fundamentally-absurd levels relative to their current profitability, down near extreme 13-year secular lows, gold stocks should be 2016's top-performing sector.

With the precious-metals sector poised for such an extraordinary reversal, it's very important to cultivate a studied contrarian perspective. That's our specialty at Zeal, where we've spent 16 years now deeply studying the markets so we can walk the contrarian walk. We fight the crowd and herd groupthink to buy low when few others will so we can later sell high when few others can, multiplying our subscribers' wealth.

The bottom line is gold is poised for a mighty upleg in 2016 after being abandoned during the Fed's surreal stock-market levitation. That sucked incredible amounts of capital out of other assets including gold, which speculators and investors alike jettisoned with a vengeance. The resulting bearishness left gold-futures speculators' bets at epically anomalous levels, and stock investors radically underinvested in gold.

They tried to rationalize their extreme gold selling with Fed-rate-hike fears. But now that the rate hike has happened and gold refused to collapse as advertised, traders will have to start normalizing all their hyper-bearish gold positions. This will require vast buying by both speculators and investors, greatly boosting gold investment demand which will fuel a mighty new gold upleg in 2016. Are you ready to ride it?

The ‘retirement crisis’ that isn’t

By Andrew G. Biggs

Ask pretty much anyone and they’ll tell you: Americans are undersaving for retirement. It’s not just thought to be a few households falling through the cracks. Rather, there’s a perception that, after a “golden age” of traditional pensions that lasted from World War II until about 1970, most Americans won’t have nearly enough income in retirement to maintain their pre-retirement standards of living. Financial writer Jane Bryant Quinn states the view succinctly: “America’s retirement savings system has failed.” All the Democratic presidential candidates have proposed expanding Social Security benefits to address this “retirement crisis.”
But new data shed light on America’s retirement system, both how it compares with the systems in other countries and how retirement savings are developing over time. The results may surprise you.

On Dec. 1, the Organization for Economic Cooperation and Development (OECD) updated its Pensions at a Glance survey of retirement saving in more than 30 countries. The United States’ Social Security program is indeed less generous than most OECD countries’ plans. Americans who earn the average wage each year of their careers will receive Social Security benefits equal to about 35 percent of the current average U.S. income. Note that comparing a country’s retirement benefits with that country’s current average income is different from a “replacement rate” that compares retirees’ benefits with their own pre-retirement earnings.  
Nevertheless, these data show that while Social Security is comparable to retirement programs in Britain (30 percent) and Canada (33 percent), it’s still below the OECD average of 53 percent.
But retirement income security is about more than just government benefits. It also includes private retirement saving and work in retirement, where the United States does very well. The total incomes of Americans age 65 or older are equal to 92 percent of the national average income, according to the OECD. The United States ranks 10th out of 32 OECD countries and above countries such as Sweden (86 percent), Germany (87 percent) and Denmark (77 percent).
In absolute dollar terms, U.S. seniors have the second-highest average incomes in the world, behind tiny Luxembourg.
But what about working-age Americans? Hasn’t their retirement saving fallen? Using Federal Reserve and Social Security Administration data, I tallied the total assets Americans have built for retirement, including 401(k) and Individual Retirement Account balances and benefits accrued under traditional pensions and Social Security. As of 1996, the first year for which full data are available, Americans’ total retirement assets were equal to 2.7 times total personal incomes. By early 2015, retirement assets had risen to 4.1 times personal incomes.

In fact, the historical shift from traditional pensions to 401(k) plans has not reduced retirement saving, Boston College’s Center for Retirement Research recently concluded. It’s true that with 401(k)s, workers themselves bear the risks related to how their retirement funds are invested.

But retirement saving is more widespread: More Americans have retirement plans today than did during the “golden age.” And unlike with traditional pensions, which pay a decent benefit only to long-term employees, members of America’s mobile workforce can carry their 401(k) plans with them as they change jobs.
Are some Americans falling short? Unquestionably, and retirement policy needs to help them.

For instance, unmarried, less-educated women are far less likely to be financially prepared for retirement, in part because many fail to meet Social Security’s 10-year vesting period to qualify for benefits. Paying a universal minimum benefit to all retirees, which Social Security doesn’t currently do, would reduce old-age poverty caused by short working careers.  
Likewise, many small businesses don’t offer 401(k) plans, due to the high fixed costs of establishing the plans. “Starter 401(k)s” with lower regulatory costs or multiple-employer 401(k)s could make offering retirement plans more affordable.
But massive Social Security expansions are unnecessary and unaffordable. Unnecessary because, as the OECD data show, when government retirement programs offer more generous benefits, households do less to prepare for retirement. On average, for each dollar of additional retirement benefits paid by an OECD government, households in that country generate 82 cents less in income through personal saving or work in retirement. Across-the-board benefit hikes would almost certainly result in lower retirement saving by middle- and upper-income households, which receive most of the benefit increases under expansion plans such as those proposed by Democratic presidential candidate Bernie Sanders.
Benefit expansions are also unaffordable. While the Democratic presidential candidates have promised expanded Social Security benefits, none have proposed plans that would enable Social Security to pay for the benefits it already has promised. That’s important, since Social Security’s long-term funding shortfall rose by 58 percent from 2008 to 2015.

The data show that the biggest retirement danger isn’t that Americans haven’t saved enough. It is politicians, both past and present, who promise Social Security benefits without paying for them. That’s the true retirement crisis the presidential candidates need to address.

Andrew G. Biggs, a resident scholar at the American Enterprise Institute, was principal deputy commissioner of the Social Security Administration from 2007 to 2008. He served on the Society of Actuaries’ Blue Ribbon Panel on Public Pension Plan Funding from 2013 to 2014.

martes, enero 05, 2016



Gold and The Public's Complacency

By: Richard Appel

We can all give many reasons why the gold price should be substantially higher. But reality trumps our reasoning, along with our wishes and desires. This is no more evident than in today's market for the precious yellow metal.

Numerous conditions exist that normally act to drive gold higher in price. The world's banking system hasn't fully recovered from the 2008 melt-down. Greece, Italy, Portugal, Spain and other countries are teetering near the edge of a debt default. If a major bank or government defaults couldn't it snowball and create a global financial collapse even worse than before?

Further, monetary creation has exploded world-wide threatening massive inflation! Shouldn't these and other reasons be converging to sufficiently frighten people into taking action and buying gold? But they're not! So we must ask why?

Don't get me wrong. Unless this time is truly different gold will mark its final low and rise from the ashes. But, as it is always in markets, the question is one of timing. More importantly, how can we protect ourselves, and prepare for that time?

I have followed gold and gold equities on a daily basis since the mid-1960's. Since then, each major gold and gold stock Bear Market low was accompanied by a few similar conditions.

First, the HUI after having a greater percentage fall than gold, struck its nadir and began rising while gold further weakened. Later, after gold marked its final low point and reconnected with the HUI, they jointly registered increasingly higher prices. Also, most gold bulls after suffering severe losses had either thrown in the towel and sold their positions, or wished they had. Further, the mood among gold's loyal champions was one of confusion, depression and even betrayal. The cloud hanging over the eternal metal's believers was indeed dark!

To my mind none of these conditions fully exist today. First, the HUI has been working sideways for several months. Until it impressively surpasses140 there is no legitimate reason to believe its decline has ended. For gold, it's weak advance to date gives no indication other than wishful thinking, that it has truly reversed its bear trend. Finally, there remains abundant hope where many believe the worst for gold is over or is nearly so. The usual misery, despair, disgust and comments like, "I'll never look at or buy gold again" are all missing. Despite the fact that they've suffered substantial losses I believe there are still too many people hanging on, for gold to have hit its ultimate low point.

It recently struck me that there are two missing but necessary ingredients required to reverse gold's downward course. The first is "need". Presently, few really believe they need gold for protection!

Further, there is nothing on the horizon that will soon change this state other than a surprise event or an advance resulting from an oversold or other technical condition. And, if either occurs, it may only result in an impressive rally, before the decline resumes its damaging path and takes gold to new lows.

Gold is coveted and needed most when people are afraid. The fear of a government or its collapse, the loss of the purchasing power of a country's money, or fear of a banking system failure are all reasons why citizens run to the safety of gold. However at present these fears are being held at bay, or have been papered over.

The U.S. banking system could have collapsed in 2008. But our citizens' concerns were assuaged by consoling words from the Fed and our government. Greece, Italy, Spain and any of a host of other nations are struggling and may default on their debt. With each threat either the IMF, the European Union or its central bank have stepped in to quell the situation.

Even today there are important global banks that are not truly solvent and may ultimately fail.

Further, the unprecedented creation of trillions of U.S. dollars or their equivalent in yen, euros, yuan and British pounds could unleash massive inflation. But there is no talk of either by the press to concern the world's population. With these potential threats and others, why are the overwhelming majority of individuals unconcerned? I believe that while all of these worries and fears exist in most minds, they don't pose an immediate threat. One by one each of these perils has been temporarily neutralized. They remain in the background and are not impending dangers, so most people won't act upon them. In a word, these nullifying actions have made people complacent. And until the complacency is broken, the need for gold by most citizens will remain subdued, if not absent.

Markets move in anticipation of events, and gold's is no different. I believe there are two possible scenarios that will act to end gold's decline. First, when the most forward observers and thinkers begin to cautiously accumulate gold. This, after sensing the U.S. and other major economies have begun sustainable economic expansions. Or, deflation takes hold and the important countries sufficiently expand their QE programs to threaten rampant inflation.

While neither exists today, let's hope it's the former that prevails!

Puerto Rico’s Debt Trap

Simon Johnson

WASHINGTON, DC – The Caribbean island of Puerto Rico – the largest United States “territory” – is broke, and a human calamity is unfolding there. Unless a constructive course of political action is found in 2016, Puerto Rican migration to the 50 states will rival the scale of the 1930s Dust Bowl exodus from Oklahoma, Arkansas, and other climate-devastated states.
With public debt service (principal plus interest) projected to reach nearly 40% of government revenue in 2016, Puerto Rico needs a new set of economic policies. But austerity will not work; this must be an investment-led recovery, with official measures oriented toward boosting growth by reducing the cost of doing business.
The question is whether Puerto Rico will have that option. Much of its $73 billion debt has been issued by government corporations. But, though federal law allows such municipal debt to be restructured under Chapter 9 of the bankruptcy code in all 50 states, this does not apply to US territories like Puerto Rico. As a result, a protracted series of confusing legal battles and selective defaults looms. The cost of essential infrastructure services – electricity, water, sewers, and transportation – will go up while quality declines.
One response has been to demand further belt-tightening, for example, in the form of wage reductions and healthcare cuts. But residents of Puerto Rico are also US citizens and they vote with their feet – the population has fallen from 3.9 million to 3.5 million in recent years as talented and energetic people have moved to Florida, Texas, and other parts of the mainland.
The more creditors insist on lower living standards and higher taxes, the more the tax base will simply leave the island – causing bondholders’ losses to rise. Disorganized defaults by public corporations will make it hard for any part of the private credit system to function.
Leading conservatives in the US – including at the Hoover Institution – have long argued in favor of using established bankruptcy procedures when large financial firms fail. The same logic applies here: A judge can remove any doubt that actual insolvency exists, while also ensuring that credit remains available during a restructuring. During that process, a judge can rely on precedent and ensure fairness across creditor classes based on the precise terms under which loans were obtained.
Although congressional Republicans have so far refused to allow for a judge-supervised bankruptcy process, bipartisan agreement remains possible. Democratic Senators Richard Blumenthal, Elizabeth Warren, and Charles E. Schumer have proposed legislation that would introduce a stay on creditor lawsuits until March 31, 2016. No one, including Republican Senator Chuck Grassley, Chair of the powerful Senate Judiciary Committee, believes that debt restructuring by itself will bring back growth; but extending Chapter 9 of the bankruptcy code to Puerto Rico would help.
Puerto Rico needs private-sector investment, which requires taking three steps. For starters, bureaucratic hurdles to job creation should be eliminated, including by using state-of-the-art technology to make government more transparent. Pedro Pierluisi, Puerto Rico’s representative in Congress, has long emphasized this point.
Second, the cost of essential inputs for industry needs to fall. Electricity on the island is significantly more expensive than in Florida, in part because of underinvestment. More broadly, there are pressing needs for public investment to improve infrastructure, which implies great opportunities for private-sector participation. But none of this will happen until the debt overhang is removed.
Finally, Puerto Rico needs better fiscal management. The island’s idiosyncratic tax and expenditure system – and the lack of effective local control over fiscal policy – has become part of the longer-term problem. Puerto Rico should, over time, become more like one of the 50 states in its fiscal relationship with the federal government. If Congress is willing to commit to that path, a reasonable quid pro quo would be strong fiscal rules – and a powerful monitoring body.
With congressional support and pro-growth policies, Puerto Rico can attract talented Americans (and legal immigrants) to move to the island, start companies, and work hard.

Higher education in Puerto Rico remains strong, but more than 80,000 people leave every year (and only 20,000 move in).
In part, high levels of net migration reflect Puerto Rico’s badly frayed health-care system. The federal government provides significantly more support to every state health-care system through Medicare (for pensioners) and Medicaid (for low-income households), despite the fact that Puerto Ricans pay the same federal payroll taxes that fund much of the Medicare program.
Likewise, to become eligible for more robust support, including through the earned-income tax credit – a program supported by leading conservatives, such as Speaker of the House of Representatives Paul Ryan – hard-working low-income Puerto Ricans must move to one of the 50 states.
Puerto Rico doesn’t need a bailout. It needs to reduce the cost of doing business – cut the red tape, encourage investment, and attract people to work (and pay tax in) a beautiful place.
It also needs what has been a constructive part of the American economic model over 200 years – the ability to restructure municipal debt through bankruptcy.

Risk Off! For Now

By: John Rubino

The sound money community woke up this morning to a world finally behaving rationally -- which is to say cowering in abject terror at the prospect of insane levels of debt, criminal incompetence at most major governments and geopolitical turmoil on a scale not seen since Vietnam, if not WWII.

Stocks are plunging everywhere (with the Chinese market closed because of instability), gold is surging, and the "buy the dip" voices in the mainstream media are vacillating between bemusement and panic.

And the bad news keeps coming. This morning:

Saudi Arabia's allies Bahrain, Sudan and UAE act against Iran 
(BBC) - A number of Saudi Arabia's allies have joined diplomatic action against Iran after the Saudi embassy in Tehran was attacked amid a row over the execution of a Shia Muslim cleric. 
Bahrain and Sudan have both severed relations with Iran, and the UAE has downgraded its diplomatic team. 
Saudi Arabia on Sunday severed ties and gave Iran's diplomats two days to go.
Bahrain, which is ruled by a Sunni monarchy but has a majority Shia population, on Monday gave Iranian diplomats 48 hours to leave the country. 
It accused Iran of "increasing, flagrant and dangerous meddling" in the internal affairs of Gulf and Arab states. It said the attack on the Saudi embassy was part of a "very dangerous pattern of sectarian policies that should be confronted... to preserve security and stability in the entire region". 
Bahrain, which hosts the US Navy's 5th Fleet, has frequently accused Iran of fomenting unrest in the country since 2011 - a charge Tehran denies. 
A Sudan foreign ministry statement read: "In response to the barbaric attacks on the Saudi Arabian embassy in Tehran and its consulate in Mashhad... Sudan announces the immediate severing of ties with the Islamic Republic of Iran."

U.S. manufacturers still struggling, ISM finds 
(MarketWatch) - U.S. manufacturers have been hurt by a strong dollar and weaker foreign demand. 
The business of American manufacturers contracted in December for the second straight month as heavy industry ended 2015 on a sour note, a survey of executives found. 
The Institute for Supply Management said its manufacturing index slipped to 48.2% last month from 48.6% in November. Economists surveyed by MarketWatch had predicted the gauge would rise to 49.1%. 
Readings under 50% indicate more companies are shrinking instead of expanding. The ISM index has posted sub-50% readings for two straight months for the first time during an economic recovery that began in July 2009.

As Stocks Plunge, Swedish Central Bank Holds Extraordinary Meeting, Says Will "Instantly Intervene" If Necessary 
(Zero Hedge) - Markets have started 2016 with a healthy dose of turmoil, and so many were wondering how long - and who - would be the first central bank to intervene in either directly or verbally in markets. 
Moments ago we go the answer when Sweden's Riksbank announced it has held an extraordinary monetary policy meeting in which it took the decision required to be able to "instantly intervene on the foreign exchange market if necessary, as a complementary monetary policy measure, to safeguard the rise in inflation." 
This is what else it said: 
"The decision involves the Executive Board entrusting to the Governor, together with the First Deputy Governor, the task of deciding the details with regard to possible interventions. 
During 2015, the Riksbank has cut the repo rate to -0.35 per cent, adjusted the repo-rate path downwards and purchased large amounts of government bonds and also announced additional purchases during the first half of 2016. However, since the last monetary policy meeting in mid-December, the Swedish krona has appreciated against most other currencies. If this development were to continue, it could jeopardize the ongoing upturn in inflation. 
The Riksbank still maintains a high level of preparedness to take other monetary policy measures in addition to the currency interventions if this is necessary for inflation to stabilize around 2 per cent. The repo rate could be cut further, the securities purchases could be extended and the Riksbank could lend money to companies via the banks."
The Swedish central bank story is of course the big one, because it illustrates the likely response of the Fed, ECB and BoJ if the world has a couple more days like today.

So one of two things will happen in the coming week: Either traders assume that the Greenspan/Bernanke/Yellen put is still in place and start buying in anticipation of another dose of hyper-easy money, or the Fed and its peers provide the dose.

Then comes the real test. Do the markets melt up the way they have after each of the past dozen or so central bank interventions, or do they finally recognize these interventions as a sign of weakness and respond with an even more pronounced flight to safety and away from risk?

Eventually we'll get the latter. Whether this is that time remains to be seen.