viernes, octubre 21, 2016




Matthew, Near Misses and Flash Crashes

Doug Nolan
Clearly, the National Hurricane Center, The Weather Channel, meteorologists and disaster consultants have succumbed to the cult of fear mongering. “Extremely dangerous” Matthew was poised to deliver death and vast destruction. A Thursday afternoon headline from CNBC: “Hurricane Matthew could inflict $200 billion in damage to coastal homes.”

While the damage will be significant, at least much of the Florida coastline dodged a bullet. The storm drifts 25 to 30 miles west and it’s a very different outcome. Yet most people will forget the seriousness of such a Close Call. Instead they’ll imbed the notion of “fear mongering” further into their thinking. The complacency that developed over a decade of no hurricane encounters will become only more instilled. Surely the next dangerous storm warning will be readily dismissed.

Going back to early CBBs, I have used a parable of a “Little Town on a River” that enjoyed booming growth and prosperity engendered by the newfound availability of cheap flood insurance. On the “financial” side, writing flood insurance during an extended drought was about as close to free money as one can get. It was exciting, sophisticated and lavishly rewarding. Truth be told, the insurance market was a rank speculative Bubble in disguise. On the real economy side, the building boom along the river powered a self-reinforcing generalized economic Bubble. The little town that got a lot bigger was wonderful and awe-inspiring. And it all came crashing down when torrential rains commenced and the undercapitalized “insurance” industry rushed to offload flood exposure (into an illiquid market).

As an analyst of risk, I was struck by a key hurricane Matthew data point. Apparently, five million new residents have relocated along the SE coast since the last major hurricane back in 2004. So the risk of a catastrophic event has risen significantly. Matthew’s near miss notwithstanding, risk will continue to accumulate so long as affordable insurance is readily available.

It was a week to ponder risk, from the SE coast to global markets more generally. There are similarities and important differences between property casualty risks and market risks. Casualty losses are generally random and independent. Actuaries can use historical loss data to calculate insurance pricing and loss reserves to ensure sufficient wherewithal to pay future damage claims.

Market (and Credit) losses tend to arise unexpectedly and in waves. They are specifically neither random nor independent. For the most part, those writing derivative “insurance” don’t hold reserves against future losses, expecting instead to sell and buy securities (or other derivatives) when necessary to hedge exposures.

In contrast to the weather, government policymakers have the capacity to significantly impact market behavior. Cheap insurance coupled with a decade without a major hurricane ensures a much higher probability of a catastrophic event. Similarly, eight years of unprecedented government market intervention/manipulation with attendant cheap market “insurance” virtually ensures a market calamity. Going on 30 years of central banks ensuring liquid and continuous markets have nurtured hundreds of Trillions of derivatives and unprecedented market vulnerabilities. A historic market liquidity event would seem unavoidable. Occasional market dislocations – and hints of calamity potential - have come to be called “Flash Crashes.”

Five Friday headlines from the Financial Times: “Pound Struggles to Recover After Plunging 6% in 2 Minutes”; “How ‘All Hell Broke Loose’ on Flash Crash Friday”; “UK Chancellor Seeks to Reassure Market After Pound Plummets”; “Brexit Bliss Suffers Rude Awakening with Flash Crash”; “Pound’s Plunge Joins Growing List of ‘Flash Crashes’”.

And Friday from Bloomberg (Sarah McDonald): “Pound Is the Latest Flash Crash That Traders Won’t Easily Forget.” The article summarized some recent Flash Crashes: May 6, 2010: U.S. Stocks (“Dow Jones Industrial Average tumbled as much as 9.2%”); October 15, 2014: U.S. Treasuries (“37-basis-point range during a 12-minute period”); August 24, 2015: U.S. Stocks (“$1.2 trillion of market value… erased”); Aug. 25, 2015: New Zealand Dollar (“8.3% intraday”); January 11, 2016: South African Rand (“9% in 15 minutes”); May 31, 2016: China Index Futures (“suddenly dropped… 10% daily limit”). And let’s not forget “frankenshock,” the January 2015 dislocation (39% move) in Swiss franc trading as the SNB untethered the swissy peg from the euro.

Perhaps traders won’t forget the latest Flash Crash. Yet markets have enjoyed a remarkably short memory when it comes to market dislocations. There are these days extraordinarily serious market issues to contemplate. Clearly, algorithmic trading has evolved into a major problem across securities, currency and commodities markets. Market liquidity in general presents a huge vulnerability. Trend-following trading strategies have grown to overpower - and overhang - the marketplace. Moreover, the proliferation of derivative-related dynamic-hedging trading strategies (options and swaps, in particular) deserves special attention.

Rather abruptly, Brexit risk this week returned to the forefront. The June Brexit vote amounted to a market Close Call. Markets recovered almost immediately, further emboldened that global policymakers have no tolerance for market instability. Additional QE from the Bank of England – along with as much extra as needed from the ECB and BOJ. More ultra-dovishness from the Fed. Clearly, UK and EU policymakers would work closely together to ensure the best possible outcome for, of course, the securities markets.

Global markets became so conditioned to assume the best. Today, there remains an underlying denial that the global backdrop is rapidly evolving. I wrote at the time that I believed Brexit marked an important inflection point. Complacent markets would be forced to recognized that they were no longer in control. The good old days of markets holding sway over policymakers had given way to an exasperated electorate majority ready to dictate real political and economic change. But with QE infinity and the tidal surge of liquidity, markets were determined to move briskly past the Close Call and reject any notion that the backdrop had fundamentally changed.

The pound was clobbered 4.1% this past week, in alarming trading action for one of the world’s most actively traded currencies. Suddenly, the markets have turned their attention to the potentially far-reaching consequences of a “hard Brexit.” Currency traders pointed to tough comments from French President Francois Holland: (Deutsche Welle) “’There must be a threat, there must be a risk, there must be a price, otherwise we will be in negotiations that will not end well and, inevitably, will have economic and human consequences,’ he said, adding that he believed Britain had voted for a ‘hard Brexit.’”

October 5 – Financial Times (George Parker): “Theresa May has denounced a rootless ‘international elite’ and vowed to make capitalism operate more fairly for workers, as she promised profound change to reunite Britain after June’s vote to leave the EU. In a speech to the Conservative party conference, Mrs May said the Brexit vote was a cry for a new start, setting out an agenda of state intervention, more workers’ rights, an assault on failing markets and a crackdown on corporate greed. The prime minister’s speech drew comparisons with the supposedly anti-business rhetoric of former Labour leader Ed Miliband, but one Tory official said: ‘Perhaps only a Tory government can save capitalism from itself.’ Mrs May told activists that the Conservatives would respond to the Brexit vote by putting ‘the power of government squarely at the service of ordinary working-class people…’”
Further from the FT: “But [the Prime Minister’s] comments also reflect her view that the Brexit vote was a symptom of a widening divide in Britain between London and the rest of the country, between a relatively affluent older generation and the young, and between a ‘privileged few’ and millions of ordinary voters struggling to ‘get by’. She suggested the Bank of England’s quantitative easing programme should draw to a close, saying that it had caused some ‘bad side effects’, pumping up asset prices but leaving people without assets, or living on savings, worse off.”
Is Britain’s new Tory Prime Minister challenging the global order? Is a conservative leader of a G7 country calling for the end of QE? Is Mark Carney’s job leading the Bank of England in jeopardy? To be sure, the world is changing fast, and the balance of power is shifting away from the securities markets and market-pleasing monetary stimulus.

Especially since 2012, global central bankers have fully embraced “whatever it takes.” This historic gambit just didn’t work, and this unfolding failure is proving extraordinarily divisive. 
Societies and political parties are deeply divided. Central banks from Tokyo to Frankfurt to Washington are deeply divided. This ensures an extraordinarily uncertain future. Things are simply no longer lined up for markets to always get their way.

The pound was not the week’s only notable market development. The Japanese yen declined 1.6%. Gold dropped 4.5% ($59) and Silver sank 8.7%. Natural gas surged 9.6%. Brazil’s Bovespa index surged 4.7%. While the S&P500 ended the week down less than 1%, markets had the feel of heightened vulnerability.

Some of the week’s most consequential moves were in global bond yields. German bund yields jumped 14 bps this week to 0.02%. Italian yields surged 20 bps, and Portuguese yields rose 25 bps to an almost eight-month high. UK gilt yields jumped 23 bps. Ten-year Treasury yields rose 13 bps to an almost four-month high.

Rising yields provided global financial stocks somewhat of a tailwind. Deutsche Bank rallied 4.4%, with Europe’s STOXX 600 Bank Index recovering 2.4%. Italian banks gained 2.4%. 
Japanese bank stocks rallied 3.4%. Hong Kong’s Hang Seng Financials jumped 3.2%. US Banks (BKX) jumped 2.8%. Indicative of the pressure on “low risk” equity yield plays, U.S. utilities (UTY) sank 3.6% this week.

Rising financial stocks notwithstanding, I’d be remiss for not suggesting that this week’s big movers (pound, yen, bunds, European periphery debt, Treasuries, gilts and gold) all have big derivatives markets. So are markets now more vulnerable to illiquidity and so-called “Flash Crashes” because of heightened stress (and risk aversion) at Deutsche Bank and the other big derivatives operators, more generally?

I’ll posit that to sustain the global government finance Bubble at this point requires both ongoing securities market inflation and ever-increasing monetary inflation. Rather suddenly it seems that global central banks are much less confident in QE infinity. There is serious disagreement in Japan as to how to move forward with monetary policy. And there were even this week rumors of ECB “tapering” ahead of the March 2017 designated end to its QE program. Say what? Are the ECB “hawks” ready to take control?

Meanwhile, markets seem to be pointing to an important downside reversal following this year’s historic melt-up in global bond prices. With Italian, Portuguese and UK bonds leading this week’s losers list, it’s tempting to imagine that fundamentals might start to matter again. 
And it’s going to be a real challenge to sustain global Credit growth in the face of rising bond yields. All bets are off if China’s latest attempt to tighten mortgage Credit actually works. 
That’s one scary Credit Bubble, and there are already indications that outflows are picking up again from China.

How the west has lost the world

We are at a hinge point and the postwar settlement has been eroded

by: Philip Stephens

It was only the day before yesterday that the rich democracies imagined a post-cold war global order fashioned in their own image. Now they are running away from the world.

There were to be three pillars to the new order. As a benign hegemon, the US would underwrite the international peace and advance the spread of liberal democracy. Europe would export its model of postmodern integration to its near neighbourhood and beyond — remember those predictions that the Association of Southeast Asian Nations would soon be like the EU? A declining Russia would join China and the rising powers of the east and south in recognising their national advantage in becoming stakeholders in a western-designed system.

That was then. The US is still by a margin the pre-eminent power but, whether Hillary Clinton or Donald Trump wins the presidency in November, the domestic political impulse is to pull back from the world.
Europe is too busy filling the cracks in its own project to pay heed to what is happening elsewhere. Engulfed by crises — the eurozone, migration and most recently Brexit — it is a continent that has lost the capacity to think strategically. Meanwhile, China and Russia have no inclination to accept rules written by the US.

What happened? The war in Iraq, intended to demonstrate the reach of American power, instead delineated its limitations. The global financial crash of 2007-08 cruelly exposed the weaknesses of liberal capitalism.

Europe’s integrationist dreams were shattered by the consequent eurozone shock. China grew a lot faster than anyone had expected, accelerating the redistribution of power in the global system.

The common thread now is nationalism. In the US this takes the form of “America-first” — some say, belligerent — isolationism. For Vladimir Putin, armed revanchism is about all he has left: Russia is weak in all the dimensions of power except the military. Europe, with its populism and pocket-sized authoritarians such as Hungary’s Viktor Orban, is unlearning the lessons of its history. China wants to expunge the memory of 100 years of humiliation. You could say they are all Westphalians now.

I was reminded of the gulf of misunderstanding and mistrust at a gathering this week in Beijing. The annual Xiangshan security forum is the place where China’s military and political elites speak to the world. It is a fascinating event for a westerner — a place where the voices of Europeans and Americans have to compete for time at the podium with those of such nations as Timor-Leste, Cambodia, Mongolia and, of course, China’s ally of convenience, Russia.

The chosen theme for 2016 was the search for a “new model of international relations”. The subliminal message was that the west should recognise that the old order has passed and it is time to engage with China in co-designing its replacement.
Western talk of adapting the existing system to accommodate Beijing failed to recognise that what is required is something entirely new. Above all, the US, as the status quo outsider in east Asia, should adjust to the new realities. The alliance system of the second half of the 20th century does not fit the geopolitical realities of China’s rise.

Apart from some sharp words about Beijing’s resolve to protect its claims and interests in the South China sea, the language of the hosts was mollifying. China seeks positive sum co-operation and is determined to avoid the “Thucydides trap” of a clash between an established and rising power. But the new order cannot look like the old.

Like what then? You catch talk in the background about a new concert of great powers, modelled on the work of Metternich at the 19th-century Congress of Vienna. Or perhaps a series of regional power balances with the US and China at the apex? A less sanguine view is that order will simply be replaced by half-organised disorder.

There yet is another school of thought — call it realism, pragmatism or, more realistically, fatalism — that says there is simply nothing to be done. Later, if not sooner, this multipolar world will find a new equilibrium. Let nations sort out their own problems and conflicts, proponents of this view argue. A new balance will eventually emerge.

The snag is that eventually may be too late. The Middle East is burning and Russia wants to upturn the post-cold war settlement in Europe, but the really dangerous great power flashpoints are in east Asia. Add North Korea’s nuclear programme to regional rivalry in the East and South China seas and it is not hard to see US-China competition turning to confrontation and worse.

The world is at a hinge point. The post-cold war settlement, organised around unchallenged US power, western-designed global institutions and multilateral rules and norms, has been eroded.

The rule of power is chafing against the rule of law, nationalism against internationalism.

Some think that the simple fact of economic interdependence will save the day — conflict would throw up only losers. But the dynamic can operate in the other direction. It is no accident that the International Monetary Fund’s latest annual report cites political risk as the biggest threat to the world economy. The liberal economic system depends above all on global security order.


Why they’re wrong

Globalisation’s critics say it benefits only the elite. In fact, a less open world would hurt the poor most of all

IN SEPTEMBER 1843 the Liverpool Mercury reported on a large free-trade rally in the city.

The Royal Amphitheatre was overflowing. John Bright, a newly elected MP, spoke eloquently on the merits of abolishing duties on imported food, echoing arguments made in The Economist, a fledgling newspaper. Mr Bright told his audience that when canvassing, he had explained “how stonemasons, shoemakers, carpenters and every kind of artisan suffered if the trade of the country was restricted.” His speech in Liverpool was roundly cheered. 

It is hard to imagine, 173 years later, a leading Western politician being lauded for a defence of free trade. Neither candidate in America’s presidential election is a champion. Donald Trump, incoherent on so many fronts, is clear in this area: unfair competition from foreigners has destroyed jobs at home. He threatens to dismantle the North American Free Trade Agreement, withdraw from the Trans-Pacific Partnership (TPP) and start a trade war with China. To her discredit, Hillary Clinton now denounces the TPP, a pact she helped negotiate. In Germany, one of the world’s biggest exporters, tens of thousands took to the streets earlier this month to march against a proposed trade deal between the European Union and the United States.

The backlash against trade is just one symptom of a pervasive anxiety about the effects of open economies. Britain’s Brexit vote reflected concerns about the impact of unfettered migration on public services, jobs and culture. Big businesses are slammed for using foreign boltholes to dodge taxes. Such critiques contain some truth: more must be done to help those who lose out from openness. But there is a world of difference between improving globalisation and reversing it. The idea that globalisation is a scam that benefits only corporations and the rich could scarcely be more wrong.

The real pro-poor policy
Exhibit A is the vast improvement in global living standards in the decades after the second world war, which was underpinned by an explosion in world trade. Exports of goods rose from 8% of world GDP in 1950 to almost 20% a half-century later. Export-led growth and foreign investment have dragged hundreds of millions out of poverty in China, and transformed economies from Ireland to South Korea.

Plainly, Western voters are not much comforted by this extraordinary transformation in the fortunes of emerging markets. But at home, too, the overall benefits of free trade are unarguable. Exporting firms are more productive and pay higher wages than those that serve only the domestic market. Half of America’s exports go to countries with which it has a free-trade deal, even though their economies account for less than a tenth of global GDP.

Protectionism, by contrast, hurts consumers and does little for workers. The worst-off benefit far more from trade than the rich. A study of 40 countries found that the richest consumers would lose 28% of their purchasing power if cross-border trade ended; but those in the bottom tenth would lose 63%. The annual cost to American consumers of switching to non-Chinese tyres after Barack Obama slapped on anti-dumping tariffs in 2009 was around $1.1 billion, according to the Peterson Institute for International Economics. That amounts to over $900,000 for each of the 1,200 jobs that were “saved”.

Openness delivers other benefits. Migrants improve not just their own lives but the economies of host countries: European immigrants who arrived in Britain since 2000 have been net contributors to the exchequer, adding more than £20 billion ($34 billion) to the public finances between 2001 and 2011. Foreign direct investment delivers competition, technology, management know-how and jobs, which is why China’s overly cautious moves to encourage FDI disappoint.

What have you done for me lately?
None of this is to deny that globalisation has its flaws. Since the 1840s advocates of free trade have known that, though the great majority benefit, some lose out. Too little has been done to help these people. Perhaps a fifth of the 6m or so net job losses in American manufacturing between 1999 and 2011 stemmed from Chinese competition; many of those who lost jobs did not find new ones. With hindsight, politicians in Britain were too blithe about the pressures that migration from new EU member states in eastern Europe brought to bear on public services. And although there are no street protests about the speed and fickleness in the tides of short-term capital, its ebb and flow across borders have often proved damaging, not least in the euro zone’s debt-ridden countries.

As our special report this week argues, more must be done to tackle these downsides. America spends a paltry 0.1% of its GDP, one-sixth of the rich-country average, on policies to retrain workers and help them find new jobs. In this context, it is lamentable that neither Mr Trump nor Mrs Clinton offers policies to help those whose jobs have been affected by trade or cheaper technology. On migration, it makes sense to follow the example of Denmark and link local-government revenues to the number of incomers, so that strains on schools, hospitals and housing can be eased. Many see the rules that bind signatories to trade pacts as an affront to democracy. But there are ways that shared rules can enhance national autonomy. Harmonising norms on how multinational firms are taxed would give countries greater command over their public finances. A co-ordinated approach to curbing volatile capital flows would restore mastery over national monetary policy.

These are the sensible responses to the peddlers of protectionism and nativism. The worst answer would be for countries to turn their backs on globalisation. The case for openness remains much the same as it did when this newspaper was founded to support the repeal of the Corn Laws. There are more—and more varied—opportunities in open economies than in closed ones. And, in general, greater opportunity makes people better off. Since the 1840s, free-traders have believed that closed economies favour the powerful and hurt the labouring classes.

They were right then. They are right now.

How Trump Happened

Joseph E. Stiglitz

NEW YORK – As I have traveled around the world in recent weeks, I am repeatedly asked two questions: Is it conceivable that Donald Trump could win the US presidency? And how did his candidacy get this far in the first place?

As for the first question, though political forecasting is even more difficult than economic forecasting, the odds are strongly in favor of Hillary Clinton. Still, the closeness of the race (at least until very recently) has been a mystery: Clinton is one of the most qualified and well prepared presidential candidates that the United States has had, while Trump is one of the least qualified and worst prepared. Moreover, Trump’s campaign has survived behavior by him that would have ended a candidate’s chances in the past.

So why would Americans be playing Russian roulette (for that is what even a one-in-six chance of a Trump victory means)? Those outside the US want to know the answer, because the outcome affects them, too, though they have no influence over it.

And that brings us to the second question: why did the US Republican Party nominate a candidate that even its leaders rejected?

Obviously, many factors helped Trump beat 16 Republican primary challengers to get this far.

Personalities matter, and some people do seem to warm to Trump’s reality-TV persona.

But several underlying factors also appear to have contributed to the closeness of the race. For starters, many Americans are economically worse off than they were a quarter-century ago. The median income of full-time male employees is lower than it was 42 years ago, and it is increasingly difficult for those with limited education to get a full-time job that pays decent wages.

Indeed, real (inflation-adjusted) wages at the bottom of the income distribution are roughly where they were 60 years ago. So it is no surprise that Trump finds a large, receptive audience when he says the state of the economy is rotten. But Trump is wrong both about the diagnosis and the prescription.

The US economy as a whole has done well for the last six decades: GDP has increased nearly six-fold. But the fruits of that growth have gone to a relatively few at the top – people like Trump, owing partly to massive tax cuts that he would extend and deepen.

At the same time, reforms that political leaders promised would ensure prosperity for all – such as trade and financial liberalization – have not delivered. Far from it. And those whose standard of living has stagnated or declined have reached a simple conclusion: America’s political leaders either didn’t know what they were talking about or were lying (or both).

Trump wants to blame all of America’s problems on trade and immigration. He’s wrong. The US would have faced deindustrialization even without freer trade: global employment in manufacturing has been declining, with productivity gains exceeding demand growth.

Where the trade agreements failed, it was not because the US was outsmarted by its trading partners; it was because the US trade agenda was shaped by corporate interests. America’s companies have done well, and it is the Republicans who have blocked efforts to ensure that Americans made worse off by trade agreements would share the benefits.

Thus, many Americans feel buffeted by forces outside their control, leading to outcomes that are distinctly unfair. Long-standing assumptions – that America is a land of opportunity and that each generation will be better off than the last – have been called into question. The global financial crisis may have represented a turning point for many voters: their government saved the rich bankers who had brought the US to the brink of ruin, while seemingly doing almost nothing for the millions of ordinary Americans who lost their jobs and homes. The system not only produced unfair results, but seemed rigged to do so.

Support for Trump is based, at least partly, on the widespread anger stemming from that loss of trust in government. But Trump’s proposed policies would make a bad situation much worse. Surely, another dose of trickle-down economics of the kind he promises, with tax cuts aimed almost entirely at rich Americans and corporations, would produce results no better than the last time they were tried.

In fact, launching a trade war with China, Mexico, and other US trading partners, as Trump promises, would make all Americans poorer and create new impediments to the global cooperation needed to address critical global problems like the Islamic State, global terrorism, and climate change. Using money that could be invested in technology, education, or infrastructure to build a wall between the US and Mexico is a twofer in terms of wasting resources.

There are two messages US political elites should be hearing. The simplistic neo-liberal market-fundamentalist theories that have shaped so much economic policy during the last four decades are badly misleading, with GDP growth coming at the price of soaring inequality. Trickle-down economics hasn’t and won’t work. Markets don’t exist in a vacuum. The Thatcher-Reagan “revolution,” which rewrote the rules and restructured markets for the benefit of those at the top, succeeded all too well in increasing inequality, but utterly failed in its mission to increase growth.
This leads to the second message: we need to rewrite the rules of the economy once again, this time to ensure that ordinary citizens benefit. Politicians in the US and elsewhere who ignore this lesson will be held accountable. Change entails risk. But the Trump phenomenon – and more than a few similar political developments in Europe – has revealed the far greater risks entailed by failing to heed this message: societies divided, democracies undermined, and economies weakened.

Deutsche Bank: Get Ready For A Bail-In

by: Daryl Montgomery
- A proposed U.S. fine of $14 billion dollars against Deutsche Bank may push the bank into insolvency.

- The bank has already paid billion dollar fines for LIBOR manipulation and has thousands of legal complaints against it.

- Deutsche's capital ratio is extremely thin and it has massive derivatives exposure.

With an election next year, a government bailout is not tenable. Instead, a bail-in will have to take place.
Deutsche Bank (NYSE:DB) is frequently in the news, and the news about it is just as frequently bad. On Monday, September 26th, its stock was down over 7% in New York trading (at a price being reported as a record low) after Angela Merkel said over the weekend that the German government wouldn't support state aid for the bank in relationship to a $14 billion U.S. fine involving the sale of defective mortgage products. The bank claims, however, that at no point did it ask Merkel to intervene. A government spokesman said it was a non-issue. It's not the first fine that Deutsche Bank has received a fine, although this is the biggest one by far, nor is it the only problem the bank is facing.
Deutsche Bank Trading 2016 Year-to-Date
While Deutsche Bank has said it will fight the U.S. Justice Departments levy, considering its record, it may not get far. Deutsche Bank has paid large fines before. In relation to accusations of LIBOR manipulation, it paid almost $1 billion in December 2013 and $2.5 billion in April 2015 (with 29 employees potentially facing criminal charges based on comments by the U.K.'s Financial Conduct Authority). In February 2014, Deutsche paid $1 billion for contributing to the collapse of the Kirsch Media Group. As for fines against Deutsche Bank that have been in the mere millions, they are too numerous to mention.
The problem with expenses for fines was already so bad by 2013, that in February of that year, the bank had to postpone issuing its annual report and call a special shareholder meeting dealing with the company's legal problems. The situation seems to have only become worse since than with the bank currently involved with 7,000 legal complaints against it (according to the Guardian). The bank has approximately $5 billion set aside for litigation, but this doesn't appear to be nearly enough. Since Deutsche Bank's market capitalization is only $18 billion (based on reports in the Financial Times), the upcoming legal costs could be as much as this amount.
It would be serious enough if massive regulatory fines were Deutsche's only problems, but they aren't. Deutsche's capital ratio if often described as "thin." A banking analyst in 2014 privately described it to me as, "statistically indistinguishable from zero." In March 2015, Deutsche Bank failed the Fed's stress test and it did so again in 2016 (one of only two banks to do so). Despite ranking in the bottom 10 of 51 European banks, Deutsche Bank passed the EU's less demanding stress tests this July (the bar is set very low compared to bank stress tests conducted in the U.S.). In mid-September, FDIC Vice Chairman Hoenig stated that Deutsche's status as the riskiest bank among its peers was worsening. The ratio of its lender's capital to its assets was the lowest of the world's major Banks.
Deutsche's capital ratio is not only thin, but the bank also has a problem with derivatives. According to its 2015 annual report the notational amount of derivatives on its books was 41.9 trillion euros (more recently reported as 52 trillion euros). This is one reason that the IMF in late June called it the greatest risk to the global financial system. While the derivatives exposure should be considered serious, it man not be as bad as it appears because EU bank derivatives reporting is different from that of U.S. banks.
The biggest critic of Deutsche Bank, however, is the stock market itself. The stock is trading at least as low as it has since 1983, although some claim it is at an all-time low. The stock has dropped precipitously this year. It is trading well below its lowest point during the 2008-09 Credit Crisis. One source lists its price to book value as 0.22. This is especially indicative of a potential failure in the near future as explained in "Zombie Banks: Low Price/Book Ratios Characterize The Walking Dead".
Deutsche Bank Trading Lower Than It Did During the Credit Crisis
Financial institutions can only operate if other financial institutions are willing to do business with them. They fail once that is no longer the case, and that can happen in a very short period of time.
Bear Stearns failure in March 2008 is a case in point. Deutsche Bank is currently in the zone where something like this can happen. It has been on the edge of this zone for at least two years now. The recent massive fine from the U.S. could easily push it over that edge. Right now, the market is hopeful that the bank will be able to reduce that fine substantially. If that hope disappears, Deutsche Bank may go with it.
Since there is a major election in Germany next year, a government bailout of Deutsche Bank is not a tenable solution. Therefore, there will have to be a bail-in. Stockholders, bondholders and large depositors will likely all have to pay for to resurrect this too big to fail bank. It is not a good idea to be in any of these groups at the moment, at least not on the long side. There is simply too much risk of a major loss. Agressive traders can consider shorting both the stock and bonds.

Norway’s global fund

How to not spend it

It is tough for a small democracy to run the world’s biggest sovereign-wealth fund

TWO decades after Norway’s government paid a first deposit into its sovereign-wealth fund, the country is learning how to manage a behemoth. The vehicle, which is used to invest abroad the proceeds of Norway’s oil and gas sales, has amassed a bigger fortune than anyone expected, thanks to bumper oil prices. As the direct benefits of oil decline—around 46% of Norway’s expected total haul of oil and gas is gone—the relative importance of the fund will grow. The annual revenues it generates now regularly exceed income from oil sales.

This week the “Pension Fund Global” was worth Nkr7.3 trillion ($882 billion), more than double national GDP. No sovereign-wealth fund is bigger. It owns more than 2% of all listed shares in Europe and over 1% globally. Its largest holdings are in Alphabet, Apple, Microsoft and Nestlé, among 9,000-odd firms in 78 countries.

In designing the fund, Norway got a lot right. Its independence is not constitutionally guaranteed, but it is protected as a separate unit within the central bank, overseen by the finance ministry and monitored by parliament. It is run frugally and transparently; every investment it makes is detailed online.

Other funds might copy those structures, but would struggle to mimic the Nordic values that underpin them. Yngve Slyngstad, the fund’s boss, says growth came “faster than anyone had envisaged”, and that a culture of political trust made it uncontroversial to save as much as possible. A budgetary rule stops the government from drawing down more than the fund’s expected annual returns (set at 4% a year). The capital, in theory, is never touched. Martin Skancke, who used to oversee the fund’s operations from the finance ministry, attributes the trust the institution enjoys to relatively high levels of equality and cultural homogeneity. It also helps that many rural areas recall poverty just two generations ago.

Yet expectations of the fund may change as Norway itself does. Tesla-driving Norwegians are now less shy about flaunting their wealth. Those under 50 have known only a world in which the 5.2m Norwegians are among its wealthiest people. Immigration is higher than ever, especially after an influx of Syrian refugees.

Progress, a populist, anti-immigrant party, has long wanted more oil cash spent at home. As a junior coalition partner since 2013, in charge of the finance ministry, it has curbed its urge to splurge. But in the first half of this year the government for the first time took more from the fund than it deposited from its oil revenues: a net withdrawal of Nkr45 billion. Recent low returns meant that the fund’s capital fell slightly, too.

It is too early to see any long-term trend, but some are worried. “It is very hard to have a huge sum of money at the bedside and to tighten your belt at the same time,” says someone close to the fund. Mr Slyngstad is sanguine but acknowledges that few democracies sustain sovereign-wealth funds: politicians always prefer higher spending and lower taxes. He denies ever feeling political pressure.

But others’ appetites are evidently growing—if not to spend more, then to use the fund differently.

One complaint is that relatively modest dollar returns on investments (5.5% a year since 1998) reflect too much caution among those who guide the fund’s strategy.

Sony Kapoor, a leading critic of the fund, argues that it “screwed up” in the past decade by failing to invest in emerging markets that were hungry for capital, and by ignoring unlisted assets, such as infrastructure. He says the fund missed out on “$100 billion to $150 billion” as a result. Worse, he says, its supposed caution in fact exposed it to high risk by concentrating its assets in rich economies.

Defenders of the fund’s strategy dismiss this criticism, arguing that poorer countries often offer too few suitable, big investment opportunities. But this is not the only criticism from Mr Kapoor and others. In a democracy, morality counts. The ethics of investment are debated ever more hotly. Politicians, NGOs and others increasingly say moral concerns should outweigh others, and even profits.

The fund refuses to invest in firms with products deemed unethical, such as tobacco or many sorts of weapons. It is also becoming more activist in the approach to its portfolio, divesting from those seen as grossly corrupt and flagging concerns over companies’ misuse of water and energy, or any risk that they benefit from child labour.

It is also getting more outspoken on subjects like high executive pay. It has said it will join class-action lawsuits against Volkswagen over the firm’s fiddling of fuel-emissions results. The fund has been instructed by parliament to help fight climate change. So 1% of its portfolio is in firms deemed to be green. It has divested from heavy polluters, firms involved in deforestation and, this year, from coal companies.

Such restrictions create dilemmas. The fund still invests in oil, for example: Royal Dutch Shell is one of its biggest holdings. Its ethical advisers argue that it can achieve more by promoting good practices within oil firms. But a former adviser admits the fund’s climate-change brief makes such investments a “paradox”.

In effect, the fund is exporting Norwegian values as well as capital. In the future it could turn against more products—sugar and fast-food, say, because of obesity. So far the fund’s managers see no serious financial cost from blacklisting 100 or so companies. But they do not deny that some ethical decisions do entail trade-offs. Their own shareholders, the Norwegians themselves, may not always let them do what is right rather than what pays.

Autonomous vehicles

Who’s self-driving your car?

The battle for driverless cars revs up

But can it fly?

WITH its successful test of robo-taxis on the streets of Pittsburgh last week, Uber has dominated recent headlines on autonomous vehicles. But behind the scenes three groups—technology giants such as Uber, carmakers and a whole fleet of autoparts suppliers—are in a tight race. Each is vying to develop the hardware and software that make up the complex guts of a self-driving vehicle.

A couple of years ago tech firms appeared well ahead in this battle. But, Uber aside, they have dabbed the brakes of late. The recent departure from Google of Chris Urmson, the company’s figurehead for autonomous vehicles and the man who once promised it would put self-driving cars on the road by 2017, is a significant reversal. The recent slimming of the team at Apple that is devoted to building an autonomous electric car, also shows that tech firms are not having it all their own way (though Apple’s possible tie-up with McLaren, a British maker of sports cars and Formula 1 racing team, would be one way to put its carmaking ambitions back on track).

Carmakers, meanwhile, are making more of the running after a slow start. Despite recent safety concerns, Tesla, an electric-car maker, is making progress with its Autopilot system. In 2017 Volvo, which is also working with Uber to get cars to drive themselves, will test self-driving cars by handing them for the first time to a select group of ordinary motorists. And in August, Ford said it would launch a fully-autonomous car, without steering wheel or pedals, for car-sharing schemes by 2021.

All parties recognise that the biggest profits from autonomy will come from producing an “operating system”—something that integrates the software and algorithms that process and interpret information from sensors and maps and the mechanical parts of the car. Tech firms probably have the edge here. But carmakers and suppliers are not giving up easily. So they are involved in a bout of frenzied activity to keep control of the innards of self-driving cars. In July, for example, BMW, Mobileye, an Israeli supplier that specialises in driverless tech, and Intel, the world’s biggest chipmaker, said they were joining forces.

Another strategy for carmakers is to develop autonomous driving in-house. They are hoovering up smaller firms that have useful self-driving technology, notes Andrew Bergbaum of AlixPartners, a consulting firm. Ford has put money into a lidar company (lidar is a type of remote-sensing technology), and into another that sells mapping services. It has also acquired two other firms that specialise in machine-learning and other artificial-intelligence technology.

The losers in this race look likely to be the big parts-makers, whose relationship with their main customers could become strained. Over time carmakers have largely ceded to them the job of developing new technology. If they turn back the clock and reintegrate vertically that may leave less business for the suppliers.

The tech giants still have huge advantages. As well as their financial resources, they are in the best spot to claim the big profits from the operating system. Apple’s plans to build a car may be swiftly revived if it buys McLaren. And Google is ahead in machine-learning, the vital element in developing algorithms that will eventually replace drivers. But carmakers are coming up surprisingly fast on the inside lane.

The Free Market Always Prevails

By: Michael Pento

The global securities market got a surprise recently when U.S. core consumer price inflation crept up to 2.3% year over year in the month of August. This closely followed core measure, which strips out the more volatile food and energy costs, increased 0.3%; this was the biggest rise in core CPI since February.

According to the government, while the costs associated with food and energy decreased, price increases came primarily from medical care commodities and medical care services. According to the Bureau of Labor Statistics (BLS), the prices for medicine, doctor appointments, and health insurance rose the most since 1984.

Unfortunately, it doesn't appear that consumers will have any relief from the rising cost of health care. According to Freedom Partners the average state increase for health insurance premiums under the Affordable Care Act was 15.1% from 2015, as the promised premium reductions from Obamacare circles the drain.

The rise in health care costs stands as another glaring example of the negative consequence of supplanting free-markets with government control. Demonstrating once again how flawed Keynesian economic policies inevitably lead to stagflation.

Unprecedented debt levels, massive money printing and intractable asset bubbles have failed to produce viable growth. And with the "stag" firmly in tow, it's only a matter of time before the "flation" kicks into full gear.

But once inflation targets are finally achieved, central banks will be forced to either rapidly raise interest rates, or sit back and watch the free market take charge and do it for them.

In our current low growth and incipient inflation environment, central banks have embraced the role as master to the subservient financial markets. And for the past eight years, equity prices and bond yields have moved in Pavlovian fashion to every dovish or hawkish utterance out of a central bankers' mouths.

But let's not forget, at the height of the 2008 financial crisis these same markets were nobody's lackey. The stock market dropped over 50% despite the fact that the Fed was busy slicing interest rates from 5.25%, down to 0%. The truth is that governments and central banks only have the ability to control markets for a relatively brief period of time and eventually market forces always prevail.

Therefore, ultimately inflation will supersede central banks in their ability to control the yield curve.

This will be especially shocking to people like Haruhiko Kuroda, the Head of the Bank of Japan (BOJ), who recently had the audacity to proclaim he can peg long-term rates at 0%, despite having an inflation target that will now be allowed to rise above 2%,

Recently, we received a small taste of how this may play out when a handful of individuals on the FOMC a.k.a. (the Federal Open Mouth Committee) and the President of the European Central Bank, Mario Draghi, forced markets to consider there may someday be limits to their monetary policies.

This caused the Dow to shed nearly 400 points in one day and pushed long-maturity Treasury yields much higher.

Bond yields in developed markets also rose in tandem. In Japan, yields rose from -0.28%, to 0% and in Germany yields jumped from minus 0.19%, to 0.01%.

But more importantly, commodities, bonds and stocks all dropped together--for a few volatile days markets gave investors nowhere to hide. This is a small preview of what lies in store for financial markets once the thin veil is removed on this artificial and tenuous global economy.

Just imagine the shock to bond prices once Mr. Kuroda is successful in creating his newly espoused "overshoot" on the 2% inflation target in Japan; especially after pegging the 10-year at less than or equal to 0% for so very long. Yields will spike aggressively in an attempt to price in rising inflation, an insolvent government and the mandatory removal of the BOJ's bid. That means yields will surge 100's of basis points in a relatively short period of time. And since the bond market is global in nature the end of the Japanese bond bubble will send yields soaring worldwide.

Manipulated markets can't last forever and never end well. Currently, every market on the planet is extensively mispriced because every asset's value is a function of sovereign debt yields that are now under the control of world central bankers. However, such an ability to dominate markets is temporary. And once yields normalize the entire economic charade, which has been based on a global artificial wealth effect, will come crashing down.