FedUpUSA

Archive for June 8th, 2010

Financial Jenga

During the current economic crisis, most of the major countries have tried to spend their way out – either with government programs funded with new debt or by forcing debt directly into the private economy through guarantees, regulations and action by quasi-government bodies. We discussed the implications for China in Command and Control and for the US in The Federal Funhouse. These initiatives were based on Keynesian economic theory – that government should make up for any shortfall in private demand by spending (likely
incurring deficits) sufficient to stabilize aggregate demand.

This is a temporary band aid at best and the governments and central banks were hoping to buy time and convince everyone that things were OK so they should go out and spend. This was doomed to fail as prior private demand was based on nearly universal lending at suicidal risk levels. One of the key objectives of Financial Jenga was to document the extent of the madness in credit. Enough people have seen through the wishful thinking so that there will be greater caution on the part of both borrowers and lenders for the foreseeable future.

The massive deficits that various governments have run can only be sustained as long as there are lenders out there willing to finance them. Several bond auctions have failed or nearly failed in the last several weeks. Now we see the appetite for debt drying up and some key nations beginning to talk about austerity. A good example is this statement from the G-20 Meeting Communique:

The recent events highlight the importance of sustainable public finances and the need for our countries to put in place credible, growth-friendly measures, to deliver fiscal sustainability, differentiated for and tailored to national circumstances… We welcome the recent announcements by some countries to reduce their deficits in 2010 and strengthen their fiscal frameworks and institutions.

Clearly, the finance ministers are signaling a new mood of fiscal responsibility here – in sharp contrast to the “stimulus” measures that have previously reigned. This change in emphasis is further reinforced by the recent statements from two key European governments. From the UK we have (Prime Minister) “Cameron warns of painful cuts to tackle debt” as a headline. In Germany, Chancellor Merkel is cutting the budget by nearly $100 billion according to Bloomberg. This is not only a sharp contrast with the Keynesian program here in the US, it is a direct slap in the face of Tim Geithner at Treasury and the entire Obama Administration:

German Chancellor Angela Merkel’s Cabinet approved levies on banks, air travel and nuclear-power plants as part of what she called an “unprecedented” round of budget cuts, rejecting U.S. calls to spur growth.

Bux Populi

Austerity is the new watchword and it is showing up first in places where governments either have their backs to the wall or are less under the influence of the banks. Yet even here in the US, where we have the best government the bankers’ money can buy, things are starting to change. Actual voters concerned about the rapidly growing deficit seem to be a stumbling block to Congressional spending with less than 6 months until the elections. Web-based My Way News reports:

Obama’s proposed $250 bonus payment to Social Security recipients was killed by the Senate. Also gone is an $80 billion-plus Senate plan that promised money to build roads and schools, help local governments keep teachers on the payroll and stimulate hiring in the home improvement industry with rebates for homeowners who make energy-saving investments.

Just last month, deficit concerns killed $24 billion in fiscal relief to prevent state workers from being furloughed. It was a measure that earlier had won initial votes in both the House and Senate.

The battle over extending jobless benefits for up to 99 weeks for the long-term unemployed typifies how the Democrats’ jobs agenda has foundered. What originally was a $200 billion measure combining the jobless benefits with renewing popular business and family tax breaks was cut to $115 billion by House leaders after moderate Democrats who are particularly vulnerable in November refused to support it.

The Federal Government has been able to finance large deficits so far. Partially this results from capital flight as Europe’s problems become more apparent. Part of the equation is an increased preference for Treasury bonds over stocks and lower-grade private bonds. Finally, there is the large-scale purchases of MBS by the Fed, which has indirectly funded Treasury auctions by putting more money into the hands of bond buyers and Primary Dealers. Despite a very favorable environment for Treasury bond demand, huge issuance pushed yields upward until the recent resurgence of Europe’s problems.

The difficulty financing our debt led the Obama Administration to float several proposals for major tax increases in an effort to convince bond buyers that there would be enough tax revenue to support the debt. This included a VAT. Notice how little we have heard about that and other taxes since the Euro crisis made the dollar and Treasuries the only game in town. Even so, the easy period of debt finance is coming to an end – even for the US government. Washington had best not expect to fund large deficits easily into the indefinite future.

A lot of bankers have to be asking themselves a question. If governments are cutting back, who is going to bail me out? 

By Katrina Nicholas

June 8 (Bloomberg) — Europe’s 750 billion euro ($900 billion) aid package might fail to save the 11-year-old monetary union and usher in an “extended period” of market stress and disorder, according to Royal Bank of Scotland Group Plc.

“Maybe we reach the point where this Herculean effort works and enough policy stimulus is provided so countries can fly again,” David Simmonds, global head of research and strategy at RBS, said in Singapore today. “However I do not subscribe to this view because one cannot treat a debt-fuelled over-consumption problem with a lot more debt.”

European finance ministers yesterday put the finishing touches on a rescue fund designed to combat the region’s fiscal woes and end speculation the euro area might break apart. The crisis is threatening to slow global economic growth, pushing the euro down 17 percent against the dollar this year.

The benchmark Stoxx Europe 600 Index has retreated 11 percent from this year’s high on April 15 as Spain, Portugal and Greece had their credit ratings downgraded. The region’s economy expanded 0.2 percent in the first quarter, strained by the highest unemployment in the euro’s history, and spending cuts.

“The buck stops with the sovereign,” said Simmonds, who is based in London and is visiting the city-state to meet with clients. “There isn’t going to be some intergalactic force that comes to bail out sovereigns, and that nervousness will weigh on the market for some time.”

Financial institutions globally have combined exposure to Portugal, Spain and Greece of more than 2 trillion euros, about half taken up by banks, Simmonds said.

“About 500 billion euros or so is held by French and German banks, so the point to stress is there will be a Herculean effort to hold this thing together,” he said.

–Editors: Ed Johnson, Tom Kohn

To contact the reporter on this story: Katrina Nicholas in Singapore at knicholas2@bloomberg.net

To contact the editor responsible for this story: Will McSheehy at wmcsheehy@bloomberg.net

Bloomberg Businessweek

By Monty Pelerin

There is no question that we are in for a massive change in our lifestyles. As I wrote in Worse than a Depression:

We are witnessing the death of democratic socialism. No politician wants it to happen, but none can prevent it. We are at the point where the Ponzi concept of “extend and pretend” has been extended beyond social commitments and banking systems to entire economies. We are approaching what Ludwig von Mises described as “the crack-up boom”:

There is no means of avoiding the final collapse of a boom brought about by credit [debt] expansion. The alternative is only whether the crisis should come sooner as the result of a voluntary abandonment of further credit (debt) expansion, or later as a final and total catastrophe of the currency system involved.

Mr. Denninger and I are in agreement that we are headed into a Depression. There may be disagreement regarding the route we take to get there, but, if there is, that is understandable. The Depression forecast is relatively simple, albeit it politically incorrect. It is simple because it is based on mathematics. It is politically incorrect in the sense that Washington does not want you to understand how badly they have mucked things up.

The route that leads to the Depression is not deterministic because it involves behavior variables that are beyond forecasting with any high degree of probability. These behavioral variables primarily involve politicians. Specifically, how will they react as events begin to spin out of control?

From my reading, and I hope I am not misinterpreting Mr. Denninger, he seems to suggest the politicians will halt the stimulus at some point. That would put us into an economic downturn almost immediately, as he points out. My understanding of Mr. Denninger’s view of the political class, however is such that it is difficult for me to accept that he believes that politicians would do the right thing. Thus, if I am misinterpreting him somewhat, I apologize. From a substance standpoint, it really has little bearing.

At this point, there are only two options for the political class: stop the stimulus immediately and face the music, or try to bluff through one more time. The best thing for the country, especially if it were accompanied by necessary cut-backs in government at all levels (unlikely until markets force it) would be the first option.

The second option is clearly not possible, but “possible” is no deterrent to politicians. We have passed the tipping point where additional debt can be either useful or possibly even obtained. Per Mr. Denninger:

This is unavoidable, and no amount of bleating will change it.  I wish there was a solution to this problem, but there is not.  The promises made cannot be kept, not due to lack of political will but inability to continue to compound debt upon debt upon debt any longer.

Thus, I expect us to end with a hyperinflationary Depression. This ending is more damaging than entering a Depression with a functioning price system. It is so because hyperinflation causes markets to fail. More importantly, it wipes out all savings (read the middle-class).  

Monty Pelerin at www.economicnoise.com

By Karl Denninger

You want to know where the spikes in the Euro came from today?

Try here:

That’s “official intervention” by the Swiss National Bank and if they don’t cut this crap out they’re going to cause an equity and credit market collapse.

These jackasses now have double the Euros they held just a short while ago from these “operations”, and as you can see, they’re pissing into a hurricane on even a daily basis, say much less on anything more consequential:

Congress does not have the right to get involved in the affairs of a foreign sovereign. 

But Congress has every right to demand that Bernanke close his goddamn swap lines right now until this shit stops, lest The Fed be the one who is on the hook when the entire ECB structure comes apart and WE THE TAXPAYERS are on the hook.

This sort of tampering, performed by a private party, is illegal.  Of course it’s routine and “expected” in the FX space for sovereigns to interfere, but much of the instability that we have seen of late has been caused by this sort of “intervention.”  Specifically, today it was responsible for a sixteen point, or 1.5%, jackrabbit move in both directions in the stock market in the space of less than two hours.

There is absolutely no excuse for The United States to support this sort of garbage with our taxpayer backstops.  These instabilities in the foreign exchange markets make it impossible for real companies to hedge costs and profits in foreign nations and do severe and irrevocable damage to these firm’s operations.

It is also reflecting into the US Commercial Paper markets and driving spreads wider there as well.  This is the very same market that locked up in 2008 and triggered the equity market collapse.

The SNB’s “interest” in doing this is clear: Half of European banks are stuffed full of debt written in Swiss Francs – in nations where the currency is the Euro!  These idiots (both the borrowers and the banks that offered these “products”) have now seen the principal balance of these loans represented in Euros rise by 11% in the last year.

This sort of idiocy, incidentally, is one of the reasons two years ago that I said there was no chance we could possibly “inflate our way out” or play the “Keynesian game” any more and get away with it.  These instabilities can and will come to the fore and force defaults and there is literally nothing that can be done about it.  The more the ECB intervenes in the bond market the weaker the Euro gets and the more damage is done to debtors holding Swissy-denoted notes!

We made a critical error in 2007 and compounded it in 2008 and 2009 by building in structural deficits as a supposed “sop” to the banksters who got us into this mess – both here and abroad.  We have continued to refuse to force them to eat their own cooking and close those firms that were responsible for doing this and both were and are insolvent, both here and abroad.

Now we have CENTRAL BANKS flailing around trying to stop that which is inevitable, expending tens of billions that have effective time periods measured in minutes, and yet we STILL refuse to wake up and smell the coffee.

There is no durable economic stability or recovery possible until these imbalances are forced out of the system in their entirety.  This means forcing those who are insolvent to admit it and swallow their medicine. 

The extreme volatility will continue so long as their jackassery by entities like Bernanke and the SNB continue, and as more and more investors and traders give up on any sort of longer-term holding due to the volatility and head to the sidelines liquidity in both equities and credit will contract until there is an all-on no-bid circumstance one day – a full, all-on crash – and this one will NOT retrace.

If you thought the “Flash Crash” was bad I hope you’re prepared for what’s coming, unless we find a leader somewhere in the world who will pull these jackasses into the dock and demand that they stop it – right now.

I’ve been warning people now for three years about snipping the fuse before it goes inside the box. 

It appears it may have now done so, in which case it’s too late.

The Market-Ticker