Guest Post: The Real Story Of The Cyprus Debt Crisis (Part 2)

Perfectly timed given the Cypriot President's call for better terms, we look at what really went on to crush this tiny island nation...

Submitted by Charles Hugh-Smith of OfTwoMinds blog,

Not only is the bail-in a direct theft of depositors' money, the entire bailout of Cyprus is essentially a wholesale theft of national assets.

Here is Part 2 of our comprehensive account of the banking/debt crisis in Cyprus. As noted yesterday, the debt crisis in Cyprus and the subsequent "bail-in" confiscation of bank depositors' money matter for two reasons:
1. The banking/debt crisis in Cyprus shares many characteristics with other banking/debt crises.
2. The official Eurozone resolution of the crisis may provide a template for future resolutions of other banking/debt crises.
It also matters for another reason: not only is the bail-in a direct theft of depositors' money, the entire bailout is essentially a wholesale theft of national assets. This is the inevitable result of political Elites swearing allegiance to the European Monetary Union.
I am honored to present Part 2 of Cyprus resident John H. Morgan's report.

The Cyprus Bank Deposit Bail-in

On 16 March 2013, the noose was tightened around Cyprus. Emergency Liquidity Assistance (ELA) was cut off. Banks remained closed while the Government negotiated with the Eurogroup of European finance ministers to save the Cyprus banking system. President Anastasiades announced the first proposal to the nation: he would tax all bank deposits in Cyprus to fund the recapitalisation of Laiki Bank. This plan was rejected by the Cypriot Parliament as it infringed the guarantee on all insured deposits up to €100,000. The Minister of Finance visited Russia to ask for financial assistance, to no avail.

On 25 March 2013, as Greece celebrated Independence Day, it was announced that Laiki Bank would be wound up and Bank of Cyprus would be restructured. All Cypriot depositors in Laiki Bank and Bank of Cyprus who held more than €100,000 would be forced to pay for Cypriot bank losses and withdrawals, mostly sustained in Greece (the so-called “bail-in” of depositors). Bank of Cyprus would be responsible for paying back Emergency Liquidity Assistance provided by the European Central Bank to Laiki Bank. It would also assume liability for all Laiki insured deposits up to €100,000.

The value of uninsured deposits over €100,000 held by Cypriot Banks came to €38bn (billion) out of a total €68bn in deposits. The governor of the Central Bank of Cyprus stated that 70% of all uninsured deposits were held by foreigners. There are an estimated 60 000 British citizens, 30,000 Russian citizens and 10,000 other European nationals living in Cyprus. Together with Cypriot-domiciled foreign firms (such as German shipping companies), they had deposited €30bn in Cypriot banks.

Cypriot Banks were closed for 10 days to prevent a bank-run. Their overseas branches stayed open to preserve a semblance of normality and avoid triggering a bank-run on Greek banks. Cash was rapidly withdrawn from the British, Greek and Russian branches of the Cypriot banks. The value of the assets held by the Greek branches of the Cypriot Banks was €23bn. These assets received huge haircuts as they were traded for €9.2bn of Emergency Liquidity Assistance (ELA). The ELA was provided by the European Central Bank to replace money withdrawn from Cypriot Banks via their Greek branches. To prevent further losses in Greece, the Central Bank of Cyprus was ordered to sell the Greek operations of the Cyprus Banks in a fire-sale.

Piraeus Bank of Athens paid €524m (million) for the remaining Greek assets of Laiki Bank, BoC and Hellenic Bank. The purchase was funded by the European Central Banks’ European Financial Stability Fund (EFSF), using Piraeus shares as collateral. The boards of Laiki Bank and BoC resigned immediately as they had been kept out of negotiations. The governor of the Central Bank of Cyprus confirmed that the deal was stitched together by the Cypriot and Greek governments and the Eurogroup of finance ministers. Piraeus Bank of Athens was even awarded a €3.1bn write-back on the purchase price for buying impaired assets. It recorded its first profit in years.

This massive mark-down of assets owned by Cypriot bank shareholders and bondholders (worth 75% of Cyprus’ annual GDP), was hushed up. Once again, Cyprus banks had been forced to make crippling sacrifices to support Greece’s ailing economy. Within weeks of the deal, the CEO of Piraeus Bank of Athens was in Cyprus touting for business.

In a radical departure from accepted practice, two major groups of creditors, financial institutions and government agencies, were exempted from the bail-in haircuts. This meant that Central Banks were refunded their liabilities ahead of uninsured depositors. The ECB would get 100% of its €9.2bn ELA and the Bundesbank would get 100% of its €7bn TARGET2 liability.

These loans had been given to Cypriot Banks to replace the cash withdrawn when depositors moved their money elsewhere, especially to Germany. Technically, ELA is no different from a bank bailout, apart from costing 4% interest compared to 2.5%. The TARGET2 component of the Eurosystem shifts Euros back to European banks whose deposits have been depleted by interstate transfers, in effect giving them a loan.

Under the Troika deal, the liquidity provided by the European Central Bank and Bundesbank would be refunded first. Uninsured depositors would receive worthless bank shares to replace the cash and assets confiscated to cover Central Bank liabilities. It would have caused massive scandal in the EU if Cyprus commercial banks defaulted on the liquidity assistance provided by European Central Banks. Politically, it was much easier to raid the uninsured deposits of Cyprus account-holders after accusing them of money-laundering.

This ruthless action by the Eurogroup reassured taxpayers of Germany, Finland, Netherlands and Austria, who saw Northern economies carrying ever-increasing risks of default by Southern European banks and governments. Currency controls were put in place to staunch the movement of capital out of Cyprus. Nevertheless, billions of Euros are leaving Cyprus on a monthly basis.
As a reward for its compliance with the conditions set by the Troika of lenders, the government of Cyprus was granted a soft loan of €10bn by the European Stability Mechanism and IMF. €4.1bn was made available to roll over Cyprus external sovereign debt; €3.4bn was given to President Anastasiades to spend on governance; €2.5bn could be used to re-capitalize Cyprus’ smaller banks, Hellenic Bank and the Co-op Bank.

The Cyprus government must start repaying the loan and interest back after 10 years. The interest bill will exceed €3bn. This will be enough time to fund loan repayments from offshore gas revenues, expected to be earned from 2018 onwards.

External bond-holders of Cypriot Government debt will be repaid 100% of their investment, courtesy of Cypriot taxpayers. This vindicates the promise made by EU Economic and Monetary Affairs Commissioner Olli Rehn of Finland. In a January 2013 interview with Handelsblatt daily, Rehn reassured financial markets that there would be no haircuts on Cyprus Government Bonds.
However, President of the European Central Bank, Mario Draghi, announced in May 2013 that Cyprus banks may use Cyprus Government Junk Bonds “guaranteed by the Cyprus Government, with the agreed haircuts” as collateral for ECB funding.

This means that uninsured depositors will pay off much of the Cyprus Government debt as the value of Cyprus Government Bonds has been written down. The ECB has agreed to accept lower quality Asset-Backed Securities as collateral. Uninsured depositors will lose yet more of their funds in order to pay out the billions of Euros of insured deposits that are being painstakingly withdrawn within the constraints of capital controls.

Slowly, brick by brick, the last remaining wealth of Cyprus is being wrung from its soil and auctioned off. Central banks are extracting every ounce of gold from an island that was once renowned for its copper in Roman times.


Economic Effects of the Cyprus Bank Deposit Bail-in

Cypriot businesses have seen their working capital plundered. The country is increasingly reverting to a cash-economy with a consequent dive in tax revenues. Provident funds, including those of bank-employees, have been severely impaired.

Most companies have cut wages, leading to severe distress among families who are paying off housing loans. This is intended to achieve the Troika’s goal of “internal devaluation”. By cutting labour costs, it is hoped to make Cyprus as competitive as countries like Germany.

Cyprus Airways is undergoing restructuring. Half of its staff have been retrenched. €20m in severance pay will be paid out of future airline revenues as the European Commission has barred the state from subsidising a commercial airline. The three Lufthansa consultants in charge of the restructuring are set to receive €1.3m. The remaining staff will suffer a 25% salary cut.

Even charities have not been spared a deposit haircut. Soup-kitchens for the legions of unemployed rely on constant donations of food from the public. The Cyprus Olympic Committee has lost €600,000 from the bail-in.

In an act that beggars belief, the Cypriot Parliament has levied a 30% tax on the interest earned from bank deposits. This has made Cypriot banks totally uncompetitive and deposits are tapering off. Money is being deposited offshore and ELA requirements of the Bank of Cyprus are increasing. The Central Bank of Cyprus announced that €6.34bn or 9.96% of deposits were withdrawn from domestic banks in April 2013. Deposits had dropped by €14.23bn or 19.87% since April 2012. (This fall, in one year, is equivalent to 80% of Cyprus’ annual GDP.)

In another measure which defies logic, a property tax was insisted on by the Troika of international lenders. The government aims to extract maximum tax revenue by inflating property prices by the annual rate of consumer price inflation since 1980. Currently, property prices are at an all-time low. This tax will further depress the property market and withdraw large amounts of liquidity from the battered economy.

The reasons are not hard to fathom. A week after the Memorandum of Understanding was signed with the country’s lenders, President Anastasiades apologised to State employee unions that he had been forced to cut their salaries and pensions. He assured them that there would be no further cuts. The Minister of Finance assured government employees that their benefits would be maintained by reducing state expenditure on infrastructure. The opening of a new medical faculty at the University of Cyprus, costing €100m, would be funded, as it formed part of an election pledge.

Between January and May 2013, unemployment in the Cyprus private sector increased from 52,000 (11.8%) to 71,000 (16.1%), the steepest increase in the European Union. The EU has warned that Cyprus runs the greatest risk of social upheaval of all European countries.


Economic and Political Prospects for Cyprus post-2013

Unable to devalue its currency to remain competitive, unable to print money to buy its citizens’ assets and stimulate its moribund economy, the Republic of Cyprus has come to realise that membership of the Eurozone is a poisoned chalice. The island has been cast adrift from Europe and left to sink or swim.

NATO continues to frame the geopolitical agenda of the Eastern Mediterranean, as it did when Turkey was allowed to invade the island in July 1974. In May 2013, two months after the Cypriot government had ceded control of its economy to the Troika of international lenders, Prime Minister Erdogan of Turkey listed 5 demands to President Barack Obama of the USA. One of those demands was that none of the estimated €200 billion of Cyprus offshore oil and gas reserves be sold to Russia. A week later, the Secretary General of NATO, Anders Fogh Rasmussen, warned the leaders of Cyprus that the island must settle the Cyprus Problem before it drills for oil and gas.

There is no need to bribe NATO member Turkey with trillions of cubic feet of hydrocarbons from the Levantine Basin to facilitate settlement of the Cyprus Problem. Turkey can use its military superiority to seize the island and its gas reserves. Despite reassuring noises that America will defend American energy companies drilling for hydrocarbons off the Cyprus coast, it is likely America would support its strategic ally Turkey, rather than side with insignificant Cyprus. In a display of solidarity, NATO allies in Europe have moved Patriot missiles to Turkey’s border with Syria.

Europe and Turkey are about to sign the aptly named “European Readmission Treaty” whereby Turkey has agreed to become a dumping ground for illegal migrants who have entered the EU through Turkey from countries to its east. This goes a long way towards reassuring German and French voters that the European Empire is spreading eastwards, rather than the Ottoman Empire spreading westwards.

During 2013, in a sign of Europe’s softening stance on Turkey, the European Court of Justice accorded Turkish Law primacy in settling all land restitution claims on the island of Cyprus.
Greek and Turkish speaking Cypriots have been promised a €200 billion bonanza from the discovery of hydrocarbons off the Cyprus coast. The use of most of the gas revenues to bankroll multinational energy conglomerates and to offset State “borrowings” will go largely unnoticed: a drop in the vast ocean of political corruption.

copyright 2013 by John Henry Morgan; all global rights reserved in all media

John Morgan is the director of a company based in Larnaca, Cyprus. He owns property in Cyprus and has lived there since 2004. He comes from the United Kingdom. He has also worked in Europe, Africa and the Middle East.


The 2013 Cyprus Deposit Bail-in: POSTSCRIPT

"I run a Cypriot marine & diving company operating in the UAE in the Middle East. We have had €400,000 (a 90% retention) frozen by the Bank of Cyprus which was all the money we had to finish mobilizing for the final stage of a project. We desperately need that money to finish our mobilization and complete the project. We must finish the project in order to receive payment for all the work we have already done. We are now without funds in an Arab country that imprisons debtors and we have debts. We can't pay the salaries and wages of our people, and soon won't have enough money to feed them. We stand to lose our marine and equipment assets if we can't pay our debts. We are in very serious trouble and all the pleading and demands that at least some of our funds are released are ignored. We are desperate. We are the only company in this sort of trouble according to the Cypriot Ambassador. There is no protection for foreign nationals in this country. We need our money, we need help. Can you help us please by investigating or publishing our story?"Christopher M Penny

Bank of Cyprus starts process of turning uninsured deposits into stocks

Dubai Business Directory Listing for COMBINED DIVING & INSPECTION SERVICES

Guest Post: The Core-Periphery Model

Submitted by Charles Hugh-Smith of OfTwoMinds blog,

What assets will the core/Empire protect? Those of the core. What will be sacrificed? The periphery.

In periods of crisis, scarcity and instability, key resources flow from the periphery to the core. We can witness this in plants, which respond to drought by sacrificing peripheral foliage (that fueled growth in times of abundance) to save the core functions necessary to surviving the drought.

This core-periphery model has a number of interesting dynamics. One is that expanding the periphery yields diminishing returns, and so these high-cost, low-yield assets are jettisoned first just as a matter of prudent risk/asset management.
One example is a farming community based in a narrow valley served by a river. Crop production can be increased by carrying water up the sides of the valley to irrigate new high-maintenance terraced fields, but the farther the water must be carried, the lower the net energy gain of the crop.
In eras of scarce water, the marginal upland fields will be abandoned. In other words, systems shrink (or in the worst-case scenario, fail) from the periphery to the core.
We can see this dynamic is the Eurozone credit/debt crisis: the core-nation banks in Germany, the Netherlands and France feasted in times of plenty on periphery nations' sovereign debt and housing bubbles, reaping enormous profits by extending credit to periphery countries and their banking/housing sectors.
When collateral suddenly declined/became scarce and the yield on expanding debt reversed from positive to negative, the core Eurozone nations protected their banks at the expense of the periphery countries' banks and sovereign debt.
I covered this in depth (thanks to correspondent David P.) earlier this year:
Put another way: credit panics start in the periphery because that's where the risk and overshoot of debt to collateral are highest.
There is another overlay to the core-periphery model: neocolonialism. I explained this in The E.U., Neofeudalism and the Neocolonial-Financialization Model (May 24, 2012). The classic colonial model is a simple core-periphery dynamic: the core nation extracts commodities and low-cost labor from its colonies (the periphery) and sells its own high-margin manufactured goods to the captured-markets of its colonies.
It's tough to beat this wealth-accumulation scheme, but as overt colonization fell into disfavor/became too costly to profitably maintain, the model shifted to a financialization-neocolonial model in which credit from the core nation establishes a very real financial/political dominance in periphery nations.
In the Eurozone, we see how the assets and income streams of the periphery nations are transferred to the core nations' banks by one means or another--in the Eurozone, the European Central Bank and its proxies are being used as intermediaries.
American hegemony of the global financial system creates political, diplomatic and "soft" power. No wonder the stock markets of financial core countries such as the U.S., Germany, France and Japan have risen: global capital is exiting high-risk periphery nations and seeking the relative safety of dollar and euro-based assets.
In our pastoral valley analogy, it boils down to this: where do you want to control arable land--next to the river, or halfway up the mountainside?
The Pareto Distribution also plays a role in the core-periphery model. As I noted way back in 2007 at the height of housing bubble 1.0 (bubble 2.0 is now playing in housing markets everywhere), the core-periphery model of extending credit to skim ever-riskier returns leads to increasing vulnerability to Pareto-distribution effects: Can 4% of Homeowners Sink the Entire Market? (February 21, 2007)
The 4% of subprime homeowners who defaulted not only popped the housing bubble, they also triggered a meltdown in the global financial system. This dynamic can shuffle the core-periphery rings in a disconcerting fashion: countries that considered themselves securely in the core (for example, Spain and Italy) discover they're now in the inner ring of the periphery--still too valuable to sacrifice but no longer core.
We also see the core-periphery model in urban-suburban demographics. The efficiencies and amenities of city centers are more attractive to younger households than distant exurbs with expansive yards and long commutes. Even if gasoline were less costly, the time and hassle factor of commuting, multiple-auto ownership, etc. makes the core more attractive than the periphery.
Cash-strapped cities faced with difficult decisions on where to trim services inevitably choose to protect services to the high-density core and cut them in the lower-density periphery.
Proximity to the core lowers costs and risks: where do you want to control arable land--next to the river, or halfway up the mountainside? Yes, your land adjacent to the river may get flooded from time to time, but that risk is more than offset by the benefits in times of water scarcity.
What assets will the core/Empire protect? Those of the core. What will be sacrificed? The periphery.

The ECB’s Forked-Tongue Policy To Save The Euro

Wolf Richter

In theory, Germany’s Federal Constitutional Court could throw a monkey-wrench into the efforts to keep the Eurozone duct-taped together; it could rule against the ECB’s money-printing and bond-buying mechanism, lovingly dubbed Outright Monetary Transactions. It was launched with fanfare last September. Actually, not with fanfare but with a few vague words, uttered by ECB President Mario Draghi himself, including the magic one, “unlimited.”

A word so powerful that it would bail out speculators and banks that had bought crappy Spanish and Italian debt at steep discounts. Bonds and stocks surged – as did unemployment and other problems, but what the heck, OMT wasn’t about curing sick economies. It was about a central bank promising to bail out speculators.

During oral arguments on Tuesday and Wednesday, the Court weighs if OMT violates the constitution’s requirement that budget matters be controlled by Parliament, but a ruling will be delayed until after the general elections on September 22. If the Court, which has no authority over the ECB, rules that aspects of OMT are unconstitutional in Germany, it could forbid the Bundesbank from participating in the one measure that has kept the Eurozone together. The Eurozone as we know it would unravel.

In practice, the Court would never do that. Given how it has ruled on euro-related issues so far, it will find a way out of the debacle, regardless of what it says in the constitution. And if it really wants to throw the book at the ECB, it could nod with an impish frown, impose some stipulations, and rubberstamp the rest.

But that hasn’t kept the mess from ballooning beautifully out of control in Germany where the ECB’s efforts to save the euro and itself – without euro there would be no ECB – are viewed with a decided lack of enthusiasm: 48% of the Germans side with the 37,000 plaintiffs, believing that the Court should stop the ECB’s whatever-it-takes-to-save-the-euro approach; only 31% believe that the plaintiffs are wrong; and despite the dense coverage in the media and in every corner of the internet, 21% still have no opinion.

Bundesbank President and ECB board member Jens Weidmann lambasted OMT from day one as “equivalent to funding governments by printing money,” warned of the risks of these measures, and questioned their legality under German law. He claimed that the ECB had overstepped its mandate by promising to fund the deficits of teetering countries, ultimately exposing German taxpayers to the risks and costs of bailing out speculators in foreign debt.

At the hearing, Weidmann faces a former associate and now antagonist, Jörg Asmussen, member of the ECB’s executive board, who’d praised OMT last week as “probably the most successful monetary policy measure undertaken in recent times.” Then, just before the hearings, he counter-attacked in the mass-circulation tabloid Bild:

"When we announced the program, the Eurozone was near uncontrolled disintegration. Important companies and banks began to prepare for it. At that time, the ECB was the only European institution capable of taking action, and it had to make clear to every speculator, ‘Do not mess with the ECB.’ The euro will be defended. The markets have learned the lesson.”

Draghi and his ilk must be getting cold feet. Over the last few days, a 52-page document that the ECB submitted to the Court in defense of its policies surfaced. In it, the ECB declared that its “unlimited” purchases of debt were suddenly not unlimited at all, but were in fact limited to €524 billion!

It had to do with internal limits. The OMT program could only purchase debt that would mature in 1-3 years. As of December 2012, Spain had €143 billion of this type of debt outstanding, a mere 26% of its total debt, and Italy €343 billion, or 32% of its debt. The ECB assured the court that it actually wouldn’t even go that far.

The message should have been a deafening alarm for the market; it should have sent speculators scrambling for the exits. Well, some scrambled alright. But the slick calculus wasn’t meant for them. It was meant for the justices of the Court, perhaps to fool them, perhaps to offer them a fig leaf. And market participants already know that the ECB doesn’t have to stick to these internal limits, or any limits; it has already figured out how to get around treaty limitations against buying sovereign debt.

And on Monday, Draghi said in an interview on German TV that the ECB would suddenly not use its OMT program to save bankrupt countries – or as he said more politely, “we will not intervene to ensure the solvency of the countries if they are profligate.” So profligate countries would be allowed to go bust. But – and there his tongue split in two again – “if there is a confidence crisis in the euro which is threatening the solvency of the countries not beyond what their fundamentals are, then we are ready to intervene.”

The plaintiffs, who want to keep the Bundesbank from participating in these interventions, were not impressed. Eternal euro-critic and Member of Parliament Peter Gauweiler (CSU) assured his fellow citizens that OMT would turn the ECB into an “uncontrolled power.” In exchange for giving up control, Europeans could live “in a brave new Huxley-world of the unlimited debt,” a world where “money is no longer earned but printed.”

So the Eurozone debt crisis remains “solved,” and there is nothing to worry about, other than a few cosmetic details, for example that the ECB, in order to keep the monetary union glued together, has one message for the Court and another for the markets – based on its forked-tongue policy.

Just when you thought the concept of universal justice was dead, a courageous Spanish judge did what no other judge in the Western world, bar Iceland, dared to do. Read.... The Unthinkable Happens: A Former TBTF Bank Chief Goes to Jail

India Involuntarily Enters Currency Wars Alongside Usual PenNikkeiStock Acrobatics Out Of Japan

Japan goes to bed with another absolutely ridiculously volatile session in the books following a 5%, or 637 point move higher in the PenNIKKEIstock Market closing at over 13514, which if taking the futures action going heading to Sunday night into account was nearly 1000 points. With volatility like this who needs a central bank with price stability as its primary mandate. The driver, as usual, was the USDJPY, which moved several hundred pips on delayed reaction from Friday's NFP data as well as on a variety of upward historical revisions to Japanece economic data, but not the trade deficit, which came at the third highest and which continues to elude Abenomics. Fear not: one day soon consumers will just say no to Samsung TVs and buy Sony, or so the thinking goes.

Will rekindled Japan optimism be enough to offset what was an absolutely disastrous weekend of data from China remains to be seen.

Perhaps the most interesting news out of Asia was the spreading of FX vol tremors to a new participant India, which is the latest entrant into the currency wars, even if involuntarily, where the Rupee plunged to 58, the lowest ever against the dollar. The reason for this latest vol casualty - central banks of course. According to Standard Chartered, INR’s decline due to domestic growth disappointing paired with “stubbornly high” inflation, slowing portfolio capital and expectations of Fed ’tapering’ QE programme "sooner rather than later." Scotiabank’s Senior Currency Strategist Sacha Tihanyi added in an interview that the market is "getting spooked" by new USD/INR high, which could mean this INR depreciation “feeds on itself.”

The plunge led to the usual warning headlines from Bloomberg:


Just like the BOJ wants Yen stability.

There was little news out of Europe, where Italy reported Industrial Production which slid -0.3% on expectations of an unchanged number. The continent is focused on Germany where the top court will decide if the ECB's OMT program is constitutional. Expect lots of posturing and jawboning from Mario and his henchmen as they try to wiggle the OMT which still has no defined legal framework, into anything they want it to be so it passes with flying colors and, ironically, continues to not exist.

In the US the Monthly Budget will be disclosed on Wednesday followed by Retail sales and Jobless claims on Thursday. The preliminary June reading of the UofM Consumer Confidence on Friday should make an interesting read given the recent market volatility and weakness. US industrial production and PPI data hit on Friday. For the US bond market, focus will probably be on the $66bn in Treasury auctions across 3s, 10s, 30s on Tuesday, Wednesday and Thursday, respectively.

The remaining overnight news bullets via Bloomberg:

Treasuries little changed as JPY weakened against USD, Japanese stocks surged; BoJ 2-day meeting underway with board divided whether to extend maturity of liquidity provisions to market by up to 3yrs

Japanese GDP grew 4.1% in 1Q compared with preliminary 3.5% estimate; nominal GDP rose 0.6% vs revised 0.4%

China’s new leaders face a test of their resolve to forgo short-term stimulus for slower, more-sustainable growth after May trade, inflation and lending data trailed estimates, signaling weaker global and domestic demand

36 provincial and city governments in China owed 3.85 tln yuan in total at the end of 2012, the National Audit Office said in a statement today on its web site

Germany’s top court probably won’t intervene in the ECB’s plan to buy bonds of crisis-torn countries, in line with previous cases involving the country’s integration with the EU; Constitutional Court reviewing OMT and ESM this week

Sovereign yields mixed. Nikkei +4.9%; China closed for holiday. European stock markets, U.S. equity index futures gain. WTI crude, metals fall

* * *

The main macro catalysts from SocGen

The US jobs report did not provide the Fed with any new information. Consequently, the Fed will not be prompted to speed up the end of its asset buying nor postpone it. However, the Fed’s monetary policy remains a major influence on financial markets. US 10Y Treasuries yields  moved away from their peak of 2.23% reached on 29 May, pulling back to 2.10%. They should thus consolidate around the latter level until Thursday’s publication of retail sales.

The beginning of the week also looks to be calm in the eurozone, even if the economic calendar is slightly busier here. Today’s publication of industrial production data in France and Italy is not however expected to trigger any major change in trends. As a reminder, last week the ECB downgraded its GDP growth forecast for 2013 (from -0.5% to -0.6%). But that is still better than what SG expects (-0.8%). The question is when the trough will be hit in terms of eurozone activity and if the ECB will have to act again in the meantime.

Overall, the financial markets are expected to start the week by continuing to consolidate. The US 10Y rate trend remains a major determining factor, for eurozone rates as well as for the EUR/USD and USD/JPY. For 10Y rates, follow the support in the 2.00% zone for Treasuries and 1.45% for Bund. On the forex market, the EUR/USD should find a resistance zone around last week’s peaks, at 1.3307 in the short term, while the USD/JPY should encounter support in the 95 zone.

* * *

Deutsche's Jim Reid summarizes the main events over the weekend and sentiment

Expect the will they/wont they tapering debate to continue to ebb and flow for the next few days/weeks. On Friday there was relief that the number was relatively healthy but not one that forces the Fed's hands. The S&P 500 closed +1.28%. However the number was firm enough to push 10yr UST 10bp higher to 2.17%. Interestingly the recent rise in 10yr yields has coincided with declining inflation expectations (as measured by US 10yr breakeven rates). The combination of higher nominal yields and lower inflation expectation has seen real yields risen sharply in the recent weeks to close in positive territory (0.0195%) for the first time since January last year. The success of financial repression relies heavily on keeping bond yields below inflation and nominal growth so this recent move is a worry. Things like this and the fact that the recovery is still only steady, means that we think the Fed will have to keep QE going for longer than current expectations suggest even if they do reduce purchases. However this realisation will take a fairly long-time to materialise and the debate will continue to rage on for some time over future Fed policy.

It’s also difficult for them to act in a vacuum and this weekend's Chinese data was interesting and generally weaker-than-expected. If China is slowing it is possible that the Fed may have to do more heavy lifting than they would like. In terms of the weekend data, Chinese exports in May only grew 1% yoy versus consensus of 7.4% and down sharply from the controversial +14.7% reading in April which was reportedly driven up by artificial invoicing. Indeed DB’s Jun Ma believes that this sharp deceleration reflects largely the impact of the government crackdown on hot money inflows via fake trade activities, and the underlying export growth, after adjusting for the base effect, remains steady at around 8-9% yoy in May. Imports also shrank 0.3% in May versus a year ago, whilst the market was expecting a +6.6% increase. Some disinflationary pressure was also evident in China. The latest May CPI rose 2.1% yoy vs 2.4% in April and consensus of 2.5%. Similarly, PPI fell more than expected at -2.9% vs consensus of -2.5%. Jun Ma thinks the weaker inflation suggests that monetary policy should stay relaxed. IP growth also decelerated marginally to 9.2% yoy in May from 9.3% in Apr, and was a tad lower than market expectation of 9.4% and DB's forecast of 9.3%. FAI growth slowed by 0.2ppts to 20.4% yoy and marginally below consensus of 20.5% but retail sales was in line with market estimates at 12.9% yoy.

The other major global story at the moment is clearly Japan and tomorrow wraps up an important BoJ policy meeting which will be followed by a media conference by Kuroda. Interestingly Kuroda's post-meeting conference in May marked the recent peak on the Nikkei (15,627) and the index is now just over 14% off those highs! The market will be looking for a bit more confidence and clearer communication from Kuroda this time. His comments last month where he played down the rise in JGB yields, and bond market volatility, probably spooked a market that were of the understanding that BoJ QE was aimed at keeping yields low.

Elsewhere, PM Abe’s cabinet is said to be likely to approve the growth strategy that is the final piece of his three-part plan on Friday so there's plenty to keep Yen and Nikkei watchers going this week. Overnight Asian equities are following Friday's positive US lead to trade mostly higher as we type. The Nikkei is nearly 4% higher on the day while the Hang Seng is up 0.4%. An upward revision to Japan’s Q1 GDP (to 4.1% from 3.5% previously) is offering a boost to sentiment and perhaps cushioning some of the disappointing weekend data from China. In credit markets, Asian IG CDS spreads are about 6bp tighter and outperforming bonds as cash credit continues to trade on a heavy note. Elsewhere, the UST 10yr yield is steady at 2.171% while the Dollar index is slightly stronger.

Moving on to Europe, the Der Spiegel reported over the weekend that the IMF is increasing its pressure on Eurozone member states to get a further haircut on Greece's sovereign debt underway this year (source: MNI). The IMF believes that without a haircut, Greece’s funding gap of EU4.6bn next year cannot be closed which complicates the IMF’s participation as the fund can only be involved in rescues where there is financing certainty over the next 12 months. This follows IMF’s admission of its ‘errors’ around Greece’s first bailout programme in relation to its over optimistic economic projections.

Taking a look at the week ahead we have the usual post-payrolls data lull in the US. Indeed it won't be until Wednesday before we get the Monthly Budget followed by Retail sales and Jobless claims on Thursday. The preliminary June reading of the UofM Consumer Confidence on Friday should make an interesting read given the recent market volatility and weakness. We’ll also get US industrial production and PPI data on Friday. For the US bond market, focus will probably be on the $66bn in Treasury auctions across 3s, 10s, 30s on Tuesday, Wednesday and Thursday, respectively.

On the other side of the pond, we will get industrial production data across various Euro countries during the first half of the week followed by the Euroland CPI report on Friday. Elsewhere, the German Constitutional Court is scheduled to hold hearings on the ESM and ECB’s OMT on Tuesday and Wednesday. Our European economists noted that the Court’s line of questioning could be revealing and if the ECB has overstepped its competencies, the case could be referred to the European Court of Justice. In their view, the ECJ would most likely be supportive of the ECB. In Japan all eyes will be on monetary and government policies this week. In other parts of Asia, Chinese markets will be closed from Monday to Wednesday for the Dragon Boat Festival while Hong Kong markets will be shut on Wednesday.

2013: Stock Market Crash!

They predicted it was going to happen long ago.

Are we talking about Nostradamus or even anything remotely as cheesy as him? We all know that was a load of baloney. Just hot air and wind! Right? The Mayans might have got it right after all. Remember, the end of the world for them didn’t necessarily mean the end of the world it just meant the end of a cycle. A new cycle might begin, just different, opening up a whole new world. So maybe that cycle did begin as the door closed on 2012. January came and went and we are still here.

But, there are people who are in-the-know and who are able to predict (or think they can) what’s going to happen even years ahead of when it actually does. Yet, we only look back and then it’s too late for the ‘if-only’ statements and weeping over the milk that got spilt. There’s no point looking back and regretting anything. Might as well listen to the people that have correlated the ups and downs in the financial markets. For once! What else have you got to lose?

If we are to believe what they said, then this is the year. 2013! It’s going to happen according to them. The stock-market is ready to crash yet again this year and this time it’s going to be a big one. Let’s take a look at what was said, when, why and by whom.

1.       Charles Nenner 

Claimed in December 2010 that the crash would occur sometime either in 2013 or just after. Although, we might ask if that is called hedging one’s bets. Nenner is a stock market analyst, right? But three years ago he developed a correlational theory that expressed the stock market moves as being influenced by sunspots.

Anyone that wants to predict the downturn in the market will be able to consult the predictions of the sunspot cycle via That means, in fact, that sunspot cycles are predictions that will enable us to make further predictions about the economic cycle of the world. Yeah!

2.       Peter Schiff

Predicted that the bang would occur this year too. This is the guy, you will surely recall, that was poo-pooed because he said in 2007 that the stock market crash of 2008 would occur. We were told that the economy back then had never looked so good. Now, he’s predicting the crash of 2013. Can we afford to turn a blind eye to this one? There will be a huge US Dollar drop and Treasury bond crisis. He says that the banks won’t hold up this time. They have been shored up once before, and they have passed Federal-Reserve tests regarding their ability to cope in the event of a crisis. But, he adds that they are not ready to pass any stress test for viability over a Treasury bond crisis like the one that is lurking behind the Fed’s door this year. Shiff is one of the few that believes it’s 2013 and that things are nowhere near the happy-go-lucky mark that people are spouting on about.

3.       Jeffrey Gundlach

Predicted the 2008 financial crisis too. Now, he is also one of the few telling us to prepare for the time-bomb that is about to explode. In January of this year, he said that the market was ready to implode. That’s all because we have been living on debt that has been piling up for thirty-odd years now. In the first decade we got hooked on debt. We must have been candy-flipping back then. We really jacked up, didn’t we? The second decade saw all of that go pear-shaped as we walked right into the sticky mess of the sovereign debt crises and the foreclosures. Our debt had become too big to be anything more than a big burden weighing us down. The third decade is just starting. It will involve rampant inflation that we’ll obviously try to control, but that we’ll make worse, debt defaulting on repayments as well as corruption galore. Lovely! Gundlach suggests that we should be moving elsewhere right now. Only problem is he doesn’t tell us where!  Does it all sound familiar, though?

4. Robert Weidemer

Robert Weidemer tried to get his video interview banned, but you can see it at:

Weidemer predicts that unemployment will hit 50% in the USA. 90% of the stock market will be wiped out and there will be inflation of 100%. Too over the top? Well, Weidemer predicted the failings of the housing market and the catastrophic result on the world’s economies. The unsinkable USA almost sank because of it. Probably best to jump ship now.

5. David Stockman

David Stockman predicted a few months ago that we were on the next train to stock-market hell and there were no tickets left for a return journey. That’s because, according to him, the Federal Reserve has been dishing out too much monopoly money. There are no real gains in the economy, just phony spoof-like patchwork. But that’s ready to pull apart. How can you not believe Stockman with a name like that?

The bursting of the dot com bubble cost us in the region of $5 trillion from 2000 to 2004 as it bust in our faces and brought the world down. That was even bigger in 2007, when it cost $7 trillion and perhaps we are still notching up the cost even today. How much is it going to cost this time?

Believe it or refute their claims as drunken beer-talk down the local pub. But, when (or if) it happens, no point telling anyone that you didn’t know. You can lay off the ‘what-ifs’ now. They won’t wash. I’ll just say “I told you so”. Maybe the Mayas got it right after all. The new cycle might begin this year. Just have to figure out what that new cycle will include, don’t we? The death of the dollar? The Death of our economies? A new cycle? But, hey, if the predictions were as worthy as all that, we wouldn’t be doing much all day, would we? I wouldn’t, at least. We would be acting on them, wouldn’t we? Or maybe we are just non-believers.


What do you think? Are we F***ed?


Originally posted 2013: Stock Market Crash!

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Peak Collateral

Originally posted at Golem XIV's blog (author of The Debt Generation),

I wonder if we are reaching what we might call ‘Peak Collateral’?  That state when the creation of assets, which the market will accept as collateral, is insufficient to sustain the demand for credit.

It’s funny isn’t it, how the terms we use, or are encouraged to use, have such an influence on how an analysis unfolds. So much of the eventual conclusion is already encoded in them. Especially the terms we are encouraged to choose as our starting place. Our leaders and the bankers have been so very concerned that every analysis begin and end with liquidity. But I think it is becoming clearer by the month that collateral is a more revealing term.

When Lehman Brothers and AIG collapsed was it just a shortage of liquidity? No of course not. That’s like saying a man with the plague died of a high temperature. Certainly he had a temperature when he died but it was a symptom not a cause. Both Lehmans and AIG were running out of collateral and without collateral for the oxygen of repo and short term funding, they began to suffocate. Once those two began to choke, the money ran out for others. The collapse of Depfa and Hypo in Germany/Ireland, for example, was a direct result of them not being able to get the funding they relied upon from their sugar-daddy funder, AIG. That created a domino effect. AIG had run out of assets that it could pledge as collateral. It could not raise money that it could then use to lend to HYPO/Depfa. Hypo in turn had such poor assets they too had little or no chance of anyone accepting them as collateral.

It seems to me we are moving back to a similar situation.  You might ask, out of sheer exasperation, how it could be, given all the tough talk and all the new requirements for capital and risk management? How, after all the bailing outs and now ins, all the endless and global QE, all the new rules and capital buffers, that we do not seem to have really got anywhere?

The image that comes to my mind is of the strange attractors which govern the lives of any non-linear system. And global finance is certainly made of many such non-linear systems.

This is the Lorenz attractor that governs convection in liquids and is thus one of the attractors which makes our weather both unpredictable and relatively stable. And it is this unpredictability within parameters which is one hall-mark of non-linearity.

Within an attractor, trajectories appear to jump around, taking hair-pin turns, reversing and re-reversing without warning, or rhyme or reason. Yet for all their unpredictability they are always orbiting within the shape of the attractor. The attractor is simply a map of all the possible states the system can be in. Each point on the attractor is the state of the entire system at one moment.

It turns out that non-linear systems which are massively unpredictable from moment to moment, are nevertheless still bounded. Map all the possible states the system can be in, and you find a shape. That shape is the attractor. All the system’s many states exist within its bounds. Every trajectory, no matter how alarming in its twists and turns, collapses and recoveries, is some complex orbit within this shape – this attractor. And this, I think, is what we have been following for the last 5 years since that first set of dislocations occurred - another orbit of the attractor we have never left nor attempted to alter or escape from.

Our political leaders and their financial masters have made it clear that they will not really countenance any real change to the system. They were always willing to talk of ‘better’ rules or ‘tighter’ regulations but never of systemic changes. And thus, I would argue, nothing that has been done has changed the underlying nature of the global financial system nor, therefore, of the attractor or coupled attractors which govern it. We, therefore, have been careening round the same attractor as before, mistaking the gyrations and permutations inherent in it, for  signs of change.

Every attractor has a central region where the non-linearity resides. In the Lorenz attractors it is on the central saddle. For the last 5 years we have simply been passing through this region and being flung about as we did so.

Of course a system like the financial one is not governed by a single attractor. There are surely many. I am interested in the role and trajectory of ‘collateral’.

There are conflicting forces pushing and pulling at the route collateral takes.

On the one hand everyone is desperate for yield. They want assets which give as high a return as they can find and that generally means assets that are unsafe and full of risk. Such assets are lucrative but, because they are risky, are not easily pledged as collateral themselves, and in fact require a lot of regulatory capital (other assets) held against them.

On the other hand, the same people who want risky assets,  also want assets which are as AAA safe as possible. These are not lucrative themselves but can be used as collateral for short term funding and/or as regulatory capital against the riskier assets.

The more risky the assets you have, the higher your VaR (Value at Risk) and your Counterparty Risk ( the risk that you may lose money because the  businesses to whose fortunes you are linked, via you assets, may themselves lose money)  which are two of the main things that determines how much regulatory capital you need to find and hold.

You may well look at these two conflicting desires and wonder what the problem is. Surely it is just a matter of a prudent balance which can be adjusted as times and needs change? And of course you are right. In the ‘normal’ course of events one person wants to re-balance in one direction, another the other way and the market is there to facilitate.

Two problems arise however when times are not normal. And ours are not.

That neat notion of the market facilitating people wanting to re-balance one way or another presupposes that people’s needs are evenly distributed. Some need more risk others less, some more collateral others less. But what happens to this happy picture if everyone has too many risky assets and wants fewer, all at the same time? Or when everyone wants solid assets to hold as collateral all at the same time? The market is useless at those times because the market is only the pairing of seller and buyer. If there is no balance then there is no market. The invisible hand becomes palsied.

What people really want is assets that are both high yielding and safe enough to pledge as collateral. And where there is a desire the market will provide. And what it provides, seen from the outside, is a bubble. A bubble of unreasoning and unreasonable exuberant make-believe that something that is risky is also safe.

In 2007, risky and lucrative but still safe and pledge-able was mortgage backed securities. Today the same role is played by sovereign debt. Our lords and master did nothing to alter the system and the desires and distortions it demands/creates, they have merely found a new way of satisfying and sustaining the system. That it has jerked and convulsed back to life, they are keen to call ‘fixed’ and ‘recovered’. Re-animation is perhaps better. Nothing has been fixed. Certainly nothing changed.

Where ratings agencies rated any old securitized tat as AAA, today governments and international bail out funds make extravagant claims of being willing to do ‘whatever it takes’ to ensure that government debt is risk free.  This has opened a wonderful world where nations can be kept in a state of permanent poverty and panic, forcing yields on their debt up to very lucrative levels, while also allowing them to be held as risk free and therefore perfect collateral.  How quickly do you think the banks want to see those nations ‘fixed’? I would hazard that they would prefer that nations are held in this perfect state of fiscal impotence for as long as it takes to arrange the fire sale of its real assets.

All of which, to my mind, describes where we are. A seeming victory for the banks and financial class.

And yet…

As I have written before, the real risk of assets cannot be magicked away. It can be traded, as it is being, in magic sounding new trades to new people, who assure you they can contain and manage the risk in your assets in return for a fee. You keep the assets, they take the risk.

Believe the soothsayers of regulatory arbitrage, and the risk which used to weigh upon your balance sheet, disappears out of sight out of mind. Gone to some mathematical null space from which we are told it cannot escape. But we all know it can and will.

Where is this regulatory capital trade putting the risk really?  As far as I can trace it, it is being bought by hedge funds. And who owns those hedge funds (owns their shares)? Pension funds. Ooops! Once again the market’s answer to those who say too much risk is systemically suicidal, is not to reduce risk but to put it where the regulators are not looking.

At the same time as risk is once again accumulating out of sight and mind, collateral too is once again becoming a problem. The problem is no one is creating new assets which really are safe and solid. They aren’t because everyone is labouring under such an overhang of debt and bad debt that the organic growth of wealth producing activity (researching and developing and then making and selling stuff) is too slow.

Everyone wants yield now, if not sooner. And when I say everyone, I mean the financial world and those Treasury parts of businesses which are more a part of the financial world than they are a part of the manufacturing company whose name they carry.  Think of the financial arm of GE or GM.

Everyone wants collateral. They want it in order to pledge to central banks in order to get those AAA rated sovereign bonds. They want it to pledge for short term funding so they can keep breathing at night. They need it in order to be declared safe with adequate capital held against their loans.

But no one wants it really, not from the yield point of view. Better to say they are forced to ‘want’ it. If they can find a way to have collateral that is somehow also high yielding they would much rather have that. Which is at least part of why Cypriot and Greek banks held so much Greek debt and why MF Global kept buying Greek and Italian debt rather than safe German debt, till it all blew up and everyone but Joe Corzine got hurt.

Collateral is getting scarce. What truly is safe, has long ago been pledged mainly to the central banks. The rest has been ring-fenced into covered bonds and other super-safe investments. None of it also pledged elsewhere or re-hypothecated onwards to prop up other loans – honest! Even the central banks have had to relax and further relax their rules about what they  will accept as safe enough to act as collateral for a central bank loan. Once it was genuinely AAA rated assets. Now if you have a beach towel from a Club Med holiday you once took, it’ll do.

Once we had fiat money. Today we have super fiat, ultra fiat and super ultra zero-content fiat.

Why do you think China is buying more and more gold? I wonder if China isn’t preparing for a contingency of a currency implosion and is making sure it has the necessary gold reserves to market the Yuan as the only ‘gold’ backed global currency.  Just a thought.


Peak collateral is just a notion. The notion that at the time we want yield and growth we are running out of collateral which is supposed to underpin the high yielding assets and loans. Such a shortage would cause the ponzi-like growth that is necessary to sustain a bubble, to stall and then implode. I think our lords and rulers know this and have decided that it must not be allowed. And this – the need for collateral – is the reason for the endless QE. If this is even close to the mark, then recent murmurings about the Fed tailing off its bond buying will prove to be hollow. The Fed will quickly find it cannot exit QE without precipitating precisely the disorderly collapse, to which it was supposed to be  the solution.

The replacement for AAA rated, yet very risky/lucrative mortgage backed securities is AAA yet junk sovereign debt that can never default but sometimes does.

What all this is enabling is the looting of those nations that are already upon the debt rack. Will it sustain? No of course not. But what does that matter to those enriching themselves in the mean time.

Guest Post: The Microeconomics Of Inflation (Or How We Know This Ends In Tears)

Submitted by Martin Sibileau of A View From The Trenches blog,

A week later and everyone is a bit more nervous, with the speculation that US sovereign debt purchases by the Federal Reserve will wind down and with the Bank of Japan completely cornered.

In anticipation to the debate on the Fed’s bond purchase tapering, on April 28th (see here) I wrote why the Federal Reserve cannot exit Quantitative Easing: Any tightening must be preceded by a change in policy that addresses fiscal deficits. It has absolutely nothing to do with unemployment or activity levels. Furthermore, it will require international coordination. This is also not possible. The Bank of Japan is helplessly facing the collapse of the country’s sovereign debt, the European Monetary Union is anything but what its name indicates, with one of its members under capital controls, and China is improvising as its credit bubble bursts.

In light of this, we are now beginning to see research that incorporates the problem of future higher inflation to the valuation of different asset classes. One example of this, in the corporate credit space was Morgan Stanley’s “Credit Continuum: Debt Cost and the Real Deal” published on May 17th, 2013. Upon reading it, I was uncomfortable with the notion that inflation is the simple reflection of the change in a price index, which implies the thesis of the neutrality of money. For instance, the said research note discusses how standard financial metrics compare vis-à-vis a rate of inflation.

Why is this relevant? The gap between current valuations in the capital markets (both debt and credit) and the weak activity data releases could mistakenly be interpreted as a reflection of the collective expectation of an imminent recovery. The question therefore is: Can inflation bring a recovery? Can inflation positively affect valuations?

I am not going to comment on others’ views or recommendations, but on the underlying method. A price index is a mental tool that has no relation to reality. In the real world, we trade driven by relative prices. To infer economic behaviour off changes in a price index is a mistake. The impact of inflation is more complex. For this reason and in anticipation of future debates on this topic, I offer you today a microeconomic analysis of such impact, on value.


I suggest that a good way (but certainly not the only one) to assess the impact of inflation on the valuation of a firm is to think of the same within the typical free-cash flow approach. After all, what matters is not how inflation can affect a certain component of its capital structure, but how the entire value of a firm is impacted, before the same can be shared among the different contributors to the said capital structure (i.e. equity, debt holders, etc.)

Simplifying, as far as I can recall from the times when I worked in the area of Private Equity,  the way to calculate the free cash flow of a firm for a determined period is to obtain its operating margin, add to it depreciation & amortization costs and subtract capital expenditures, changes in net working capital and taxes. I show the formula below:


– Operating Costs

Operating margin


+ Depreciation & Amortization

- Capital Expenditures

- Change in net working capital

- Operating tax

Free Cash flow



What follows is a discussion on the impact of inflation on each of the components of the valuation formula above:

Revenues (= unit price x volume sold)

Under inflation, only those firms that have pricing power can defend the value of their production. At the same time and because inflation brings unemployment and the destruction of purchasing power, in general (not for all firms, of course), sales volume drops too. This backdrop encourages consolidation, where big players get bigger and small ones disappear. With it, the bigger firms obtain oligopolistic to monopolistic pricing power which assures two things: The currency zone where this development takes place loses in innovation and prices become less flexible. This inflexibility, when fully unfolded, directly leads to indexation, which is the stepping stone for any hyperinflationary process. If the consolidating firms are public, it is likely that during the consolidation process they become private via leveraged deals, as long as credit is still available.

Operating costs (=unit cost x volume bought + factors)

With regards to direct inputs, the same pricing problem described above arises. There are those firms that have leverage with their suppliers and can force these to delay price increases (i.e. margin contraction) and those that can’t. Consolidation therefore pays off on this front too, carrying the same consequences mentioned above. From an accounting perspective, when inflation is high, firms can’t even measure the cost of their inputs and are forced to take a Schrodinger approach, with either Last in-First Out (LIFO) or First in – First Out (FIFO) accounting.

With regards to indirect inputs, these can be segmented into labour and capital. Labour intensive firms will struggle with a unionizing work force and inflation always nourishes the growth of unions, to renegotiate labour contracts. All things equal, this context simultaneously encourages higher unemployment and illegal immigration, because while credit is available at negative real rates (i.e. the nominal interest rate is lower than the inflation rate), firms will find more convenient to replace labour with capital. This takes place during the lower stages of an inflationary process. In later stages, credit disappears and the higher interest rates make refinancing debts unfeasible, bankrupting those firms that dared to invest in capital expenditures.

Where the required labour is low skilled but expensive due to social security legislation, firms will also replace it with illegal immigration, whenever possible.


The impact of inflation on operating margins (i.e. revenues – operating costs) is to drive consolidation, the replacement of labour by capital, indexation, price rigidity and the loss of competitiveness. The loss of competitiveness is the natural result of an environment that favours oligopolistic/monopolistic structures and short-term investment opportunities. It is very common to blame entrepreneurs or management for this outcome. However, the conditions that drive firms to adopt these survival strategies are the exclusive responsibility of politicians.

Depreciation & Amortization

“…Both depreciation and amortization (as well as depletion) are methods used to prorate the cost of a specific type of asset to the asset’s life…these methods are calculated by subtracting the asset’s salvage value from its original cost…” (Investopedia)

It is clear that any attempt to accurately portray the value and life cycle of fixed or intangible assets under inflation becomes irrelevant. What if due to high inflation the salvage value of an asset is higher than its original cost?

Under inflation there is uncertainty on the true cost of maintaining the fixed resources involved in the operation of a business. This uncertainty forces firms to cut back on capital expenditures. Investment demand and economic growth therefore collapse

Capital expenditures

Because nothing can be reasonably forecasted under inflation and growth and efficiencies are better served via consolidation and without innovation, capital expenditures can only be of a very short nature, if any.

Change in net working capital

This item is perhaps the most neglected and yet, most relevant, in my view. For valuation purposes, an increase in net working capital means that a higher amount of capital is tied to the operations of a firm. Therefore, a lower amount of cash is available to the contributors of capital to the firm (i.e. debt and equity holders). For this reason, the change in net working capital is subtracted in the valuation formula above.

What is net working capital? In simple terms:

Accounts receivable

+ Inventory

-  Accounts payable

Net working capital

If from one period to another the time necessary to collect on accounts receivable increase and/or the inventory turnover necessary to run an operation decreases, the value of the firm falls, as less cash is available to the contributors of capital. Alternatively, if the firm manages to increase the time necessary to honor accounts payable –all things equal- more cash is available.

What is the impact of inflation on net working capital? Complete! Under inflation, firms seek to delay any cash outflow. The higher their accounts payable, the more debt they dilute. At the same time, bank lending quickly shrinks. At high inflation levels, even working capital lending disappears. At this stage, vendor financing is key and only those companies that demonstrate a steady commitment to their suppliers can obtain credit from them. Suppliers, on the other side, often go bankrupt precisely because they cannot collect on their receivables. One of the painful ironies of inflation is that under it, liquidity evaporates!

With regards to inventory, this is counter intuitive, but firms will try to maximize its amount, as long as they can get vendor financing. The accumulation of inventory allows firms to lock in a cost of production that would otherwise be uncertain. This is very inefficient. Just-in-time production models become totally unfeasible. The accumulation of 

inventory is more understandable when one realizes that inflation is the destruction of the medium of indirect exchange, which forces us to barter. Under barter, inventory is not a burden.

Just as much as firms seek to delay cash outflows, they will want to collect as quickly as possible. Those firms that operate at the end of the distribution chain and can sell to a granular, cash-paying public will be at an advantage over those that operate at earlier links of the chain (and have a concentrated customer base which demands vendor financing). Inflation therefore leads to consolidation on this basis too, towards the end of a distribution chain.

An example of a firm that would fit this profile, benefitting from an inflationary context would be Costco Wholesale Corp. (and no, this is not an investment recommendation, but a hypothetical example). As Costco sells in bulk, its customer base would grow, since the public that seeks to escape from a devaluing currency and lock the price of necessary staples would see an advantage in purchasing the same in quantities, at a discount. Simultaneously, the company would be in a privileged position to exert pricing power over its suppliers and grow via acquisitions. As an extreme (but illustrative) example, I recall that during the ‘80s in Argentina, when employees were paid their salaries, many took the day off (and parents left their kids with nannies) to go shopping. They were simply ensuring that not one day would pass with them holding depreciating currency, which had to be exchanged as fast as possible for all the goods that were going to be consumed until the next wage payment. They set off in a hurry and bought, when possible, in bulk!


Operating tax

Tax payments are simply one more cash outflow. Even without inflation, one tries to minimize and delay this outflow. Under high inflation, delaying its payment is a matter of survival and represents and additional source of financing. Because all hyperinflations took place before the internet era, we don’t know how easy it will be to delay tax payments when the next hyperinflation arrives. I imagine it will be much harder in the digital era.


The inflationary policies carried out globally today, if successful will have a considerably negative impact on economic growth. The microeconomic impact described above brings the following unintended and unnecessary macroeconomic consequences:

-Oligopolistic/ Monopolistic structures

-Loss of innovation, competitiveness

-Indexation, price rigidities

-Unionization of labour force and higher unemployment

-Illegal migratory flows

-Destruction of public capital markets

-Higher fiscal deficits

If this analysis is correct, the record asset values we see today cannot be interpreted as the omen of an imminent recovery. I am not saying that these nominal values are not justified. What I am saying is that they should not be interpreted as an indication that economic growth is on the way

Four Signs That We’re Back In Dangerous Bubble Territory

Submitted by Chris Martenson of Peak Prosperity blog,

As the global equity and bond markets grind ever higher, abundant signs exist that we are once again living through an asset bubble or rather a whole series of bubbles in a variety of markets. This makes this period quite interesting, but also quite dangerous.

With equity and bond markets at or near all-time record highs, with all financial assets consistently shrugging off bad or worse news as the riskiest of assets continue to find consistent upward bids, we find ourselves in familiar and bubbly territory.

I can summarize my thoughts in one sentence:  How could this be happening again so soon?

In times past, it took one or more generations between bubbles for people to financially recover and forget the painful lessons before they would consider doing it all again. Yet here we are, working our way through our third set of bubbles in less than two decades, which must be some sort of world record.

I will confess to my biases right up front: I have always been deeply skeptical of both the practice of running up debts at a faster pace than income (the common practice of the entire developed world over the past several decades) and the idea that the solution to too much debt is more debt, enabled by cheaper money courtesy of thin-air money printing.

In short, instead of seeing central banks as sophisticated stewards of intricate monetary policies, I view them as serial bubble-blowers and reckless debt-enablers whose only response, when confronted with the inevitable consequences of their actions, is to serve up more thin-air money at an even cheaper rate. And when that doesn't work, then they simply try even more of the same, but in larger quantities.

While I think central banks are populated by earnest people with impressive credentials who have rationalized their actions as being necessary and in service of the greater good, I also think that the biggest ones hold an entrenched set of institutional views that are dogmatic, fail to incorporate the idea of economic and resource limits, and are seemingly immune to healthy introspection.

Somewhere along the way, I would have hoped they might have noted that each new crisis is larger than the one before necessitating an even larger response that begets an even larger crisis next time, etc., and so on. A corporate bond hiccup in 1994 led to monetary loosening that enabled the development of the Long Term Capital Management (LTCM) fiasco of 1998, which was followed by the tech bubble, and then the housing bubble, and here we are with a now global equity and bond bubble that is larger than all the prior bubbles combined. Much larger.

It was famously said that the market can remain irrational longer than you can remain solvent. And if the trading maxim, don't fight the Fed, is worth heeding, then surely one should absolutely not take on all of the central banks at once, either. So, the risk I run here in seeing things through my 'common sense' filter is that perhaps this time the Fed, et al., have got it right, and a true and lasting recovery is at hand.

With that caveat, in this report I lay out the five most worrisome signs that horrific market losses await the unwary, the careless, the reckless and those who possess all three characteristics (i.e., your average central bank).

These are not normal times. The degree of separation between reality and today's financial markets is extreme, which means they have a tremendous degree of potential energy stored up that could erupt in a downward cascade at any time.

While we can’t predict the exact time or trigger of a market avalanche back down to reasonable levels, I can definitely advise that you do not want to be standing in the valley when it happens.

Four Signs That We're Bubbling

Here are the four things that convince me that we are in truly bubbly territory:

Sign #1: Junk Bond Prices at Record Highs

The Fed, et al., have been buying up all of the 'safe' bonds, with the twin intents of driving down interest rates and chasing investors into riskier assets. With lower yields comes (hopefully) more borrowing; and when investors move towards riskier assets, this drives up the equity markets which, as the thinking goes, will paint a rosier picture of the economy plus boost consumer confidence and spending.

Along with this, however, we find speculators and investors, starved for yield, chasing the junkiest of the junk.

Indeed, the prices of these "assets" have recently been driven to all-time record highs, which means that their yields have hit record lows.

And not just "low" prices, but a brand new record low in all of financial history.

Sign #2: Junk Sovereign Debt Being Chased to New Highs

It was just over a year ago when Greece ten-year debt was yielding a whopping 30%, reflecting the poor economic fundamentals of the country and concern that the European Central Bank (ECB) might stop loaning Greece the principal and interest payments needed to prevent another default.

Oh yes, and let's not forget that just a year prior, more than $130 billion had been lost by Greek bond investors, which created a ripple effect across Europe, including recently crippling Cyprus' key banks.

Today? Greek ten-year debt is under 10%.

Greece Bulls Charge Into Corporate Bonds

May 15, 2013


Investors are returning to Greece, lured by receding fears that the troubled country will leave the euro and the high returns offered by many of its battered assets.


It is a remarkable turnaround. Only a year ago, Greece was toxic territory for investors. A debt restructuring had just wiped out more than €100 billion ($130 billion) in government bonds. The stock market stood at one-tenth its 2007 levels. A political earthquake had the country poised for a chaotic election.


But now the markets have turned. Months of relative calm in Europe and the pressure to go somewhere, anywhere, for yield in a low-interest-rate world—has investors taking another look. The Athens stock market has rallied more than 80% in the past 12 months, with the Athex Composite Index rising 0.8% on Tuesday. Greek government bonds have been on a tear since June.


The real story here, about speculators not ‘investors’ returning to Greece, is that the world is so utterly starved for yield that even Greek debt seems reasonable now. In Greece, even as the trend towards buying Greek debt was building, the country's economy (as measured by unemployment and GDP) deteriorated sharply.

As compared to 2008, Greek GDP in 2012 shrank by 20%, and current trends continue to show 5%-6% shrinkage in 2013:


In what sort of a world does serious economic contraction, spiking unemployment, extremely high levels of debt-to-GDP, and falling bond yields go together? A bubbly world, that's where.

Sign #3: It's Not Official Until It's Denied

The poster child for a bubble market has to be Japan, where the main stock index of the island nation, the Nikkei, is up an astonishing 70% in the past six months (!) in a vertical index rise that is well outside of our personal experience:

This isn't some penny stock, but the entire stock index for the world's third largest economy. Of course, the 'reason' for this rise centers on the actions the Bank of Japan is taking to debase its currency. The people of Japan are realizing that they cannot trust their cash and had better put it to use somewhere besides their bank accounts before its purchasing power is drained away.

After such an obviously unstable spike in the market, what's left to do but officially deny that it's in a bubble?

Stock Boom Isn't a Bubble, Says BOJ's Kuroda

May 15, 2013


TOKYO—The Bank of Japan's governor played down worries that the stock-market boom is a bubble and that a weak yen will stir cost-push inflation, signaling his resolve to press ahead with the bold monetary easing that has fueled stock prices and driven down the currency.


Grilled by lawmakers during a session of the upper-house budget committee, Haruhiko Kuroda flatly rejected an opposition-party member's argument that the recent rapid rise in the Tokyo stock market is out of line with Japan's real economy.

"At this moment I do not think they are in a bubble," Mr. Kuroda said.

Driving this bubble is the determined resolve of the BoJ to make the yen worth less, perhaps even someday worthless. For a major world currency, the chart below is quite startling.

If something is not official until it's denied, then the Japanese stock market is most definitely in a bubble. It should be noted that there are similar examples of stock indexes making new highs on bad news and weak fundamentals the world over, so we're not just picking on Japan alone here.

Sign #4: Making Up Crazy Excuses

My final sign of that we are in bubble territory is when the folks who consider it their job to make sense of the high and spiking prices offer up thin, sometimes stretched-to-the-breaking-point, rationalizations for why the current price action make sense.

In the late 1990s, when the third most recent Fed bubble was cooking along, stratospherically valued technology shares were justified with strange metrics such as 'impressions' and 'eyeballs' and other contorted valuations contained in no standard finance methodologies.

In the 2000s, when the second most recent Fed bubble was cooking along, housing prices were justified with trite slogans such as "they're not making any more land, you know" and bizarro claims that housing had never gone down in price over time which it most certainly had.

Today is no different. We're seeing the same sorts of 'explanations' to justify high prices fueled by central bank printing. Perhaps the central cheerleader for the benefits of perpetuating central banking policy errors is Paul Krugman, who recently swept aside arguments for an equity bubble by saying something that Irving Fisher might recognize:

O.K., what about stocks? Major stock indexes are now higher than they were at the end of the 1990s, which can sound ominous. It sounds a lot less ominous, however, when you learn that corporate profits— which are, after all, what stocks are shares in — are more than two-and-a-half times higher than they were when the 1990s bubble burst.


Also, with bond yields so low, you would expect investors to move into stocks, driving their prices higher.


This sounds reasonable until you consider the context of this argument about corporate profits, of which an economist like Krugman ought to be fully aware. Corporate profits are in very, very unusual territory (one could even say record territory), and to say that equities are fairly valued now because of their relationship to corporate profits is to argue that such profitability is a new and permanent feature of life.

The economist Irving Fisher somewhat famously and regrettably opined in 1929 (right before the stock market crashed) that a new corporate model and economic era was in play that had led to a "permanent plateau of prosperity." The rest is history.

In life and investing, there's nothing quite so powerful as reversion to the mean, which in the case of corporate profits is nearly 50% lower than where they currently are. By the time that economists are dismissing the notion of an equity bubble by pointing out heightened corporate profits, without providing any of the necessary context, we are in full-blown rationalization mode which is another bubble indicator.

Also, the fact that Mr. Krugman is citing "low bond yields" as a justification for moving into stocks rather delightfully skips over the reality that it is the central banks themselves that are responsible for those low bond yields. Krugman presents the information as if such intervention were a normal market condition to which investors were rationally reacting, rather than a completely fake circumstance engineered by central banks conducting the biggest monetary experiment in human history.

Next, we have this tidy explanation from Goldman Sachs, groping for reasons to explain why stocks always seem to go up no matter what:

"while equity prices respond more to dovish surprises than hawkish surprises, the results suggest that equity prices typically go up regardless of whether the Fed policy surprise is positive or negative (“good news is good for equities, and bad news is good for equities”). But it is not at all clear why the equity market should systematically buy into this pattern."


(Source - Zero Hedge)

This is at least as honest an appraisal of the situation as I can find. Goldman Sachs is basically waving its hands in the air and saying that it's somewhat puzzling why markets should be acting this way. An even more honest statement would continue by noting that such periods of irrational exuberance are quite often found during bubbles, and that bubbles have a bad habit of destroying wealth.

As is common in life, such justifications merely expose the 'human factor' of bubbles. Bubbles require a belief system to be installed in the beholder, and two things that beliefs are exceptionally good at are gathering supporting data and rejecting contradictory data (if such data is even seen in the first place).

The human mind does this all the time with respect to our own level of ability, our luck, our good looks, our children's performance you name it this is just part of our innate mental programming.

The really odd part in this story is that once upon a time, bubbles were separated by a generation or more, so that the lessons (and pain) of the prior one could be culturally forgotten before the next one could take hold. Yet here we are, working on our third bubble in a row larger than the prior two that just happened within the past 15 years. (Of course, with a wide enough lens, we might say that each bubble was just a subset of the largest credit bubble in all of history that began building some 40 years ago).

For some reason, we are forgetting the lessons of the past faster than ever before. Such willful ignorance invites a series of reality-based reversions more punishing than ever before, too.

My advice: Keep a journal. These are interesting times; possibly not to be repeated in many, many generations.

Conclusion to Part I

There are abundant signs that the world's equity and bond markets are ignoring risk and chasing yield to dangerous extremes. Various denials and justifications are being offered to rationalize these behaviors as sensible or prudent. Taken together, this tells me we are once again in bubble territory, and that, as with all bubbles, this one will end badly. Or rather, these bubbles (plural) will end badly together.

I'm sure that most market participants have it in their minds to dance as long as the music is playing and to be among the first to reach the exits when the music stops. However, everybody is thinking this, and given that only the most well-connected of market players have the opportunity to exit first (literally in the blink of an eye), very few will actually make it through the doorway unscathed.

As is always true in life, the point of a bubble is to separate the most people from the most wealth. The wealth doesn't actually vanish; it's just simply transferred from the last purchasers to those who sold before the bursting.

I truly have no idea how much longer all this craziness can continue. I suspect the answer is a lot longer than anybody suspects, myself included. But I also know that reversals tend to happen quite quickly, all on their own, with very little warning. This leads to my personal motto: I'd rather be a year early than a day late.

In Part II: Protect Your Wealth in Advance of the Bubble's Bursting, we detail our rationale that all this ends in a wrenching market crash (Phase I), which will be followed by even larger, more desperate, and unusual central bank actions (Phase II) that will initially set the stage for what seems like a recovery but ultimately terminates in the largest currency crisis of modern times, if not human history (Phase III).

The difficulty will be avoiding being whipsawed throughout, losing wealth at every step. After all, the primary outcome of every attempt at money printing in the past has been a massive wealth transfer from a very large proportion of the afflicted society to a much smaller one.

Click here to access Part II of this report (free executive summary; enrollment required for full access).

In the meantime, trade safe. My advice here is to use extreme caution whether investing or speculating, whichever you are involved in.

Guest Post: The Coming Collapse Of The Petrodollar System

Authored by Andrew McKillop,


The theory of Petrodollar Warfare can be attributed to US analyst and author William R Clarke, and his 2005 book of that title which interpreted the US-UK decision to invade Iraq in 2003. He called this an "oil currency war", but the concept of the petrodollar system and petrodollar recyling dates back to the eve of the first Oil Shock in 1973-1974. The role of the petrodollar system as a driving force of US foreign policy is explained by analysts and historians as basic to maintaining the dollar's status as the world's dominant reserve currency - and the currency in which oil is priced.

The term "petrodollar warfare" as used by William R. Clark says that major international war, legal or not, was seen as justified to protect the petrodollar system. Over and above the loss of human life, the combined costs of the Afghan and Iraq wars for the US are controversial like the interpretation of these wars as "oil wars", but analysts like Joseph Stiglitz and Linda Bilmes put the total combined war cost at above $4 trillion. This can be compared with - and totally dwarfs - the annual cost of US oil imports, which are now sharply declining on a year-in year-out basis as domestic shale oil output ramps up, and US oil demand stagnates.

Clarke's theory, like the explanation of the role and power of the "petrodollar system" depends on two basic drivers. Most major developed countries rely on oil imports, which are purchased using dollars, so they are forced to hold large stockpiles of dollars in order to continue importing oil. In turn this also creates consistent demand for dollars, and prevents the dollar from losing its relative international monetary value, regardless of what happens to the US economy.


Variants of the Petrodollar War concept include the role of oil currency conflicts and rivalry, notably concerning US relations with Iran, Venezuela and Russia, and possibly with Europe concerning the gradual replacement of US dollars with the euro, for oil transactions. More important, the entire petromoney system and the potential for Petrodollar War hinges on global oil import demand and the oil price. Both of these have to hold up. When or if they do not, foreign oil importer nations who formerly found it beneficial to hold dollars to pay for oil, would have to find some other (unexplained) reason for huge holdings of dollars, when their oil imports decline and-or oil prices also decline.

The "currency war" variant of the petrodollar system theory, holding that a shift to notably euros or gold for oil payments would undermine the system, is unrealistic when given any serious analysis, because all world moneys are interchangeable or convertible, and gold is priced in US dollars.



These are easy to define.

1974-1986 The first phase. The 1972 start of "petrodollar recycling" initiated by Nixon and Kissinger  just before the fivefold rise in oil prices of 1973-74, set the process of US-Saudi Arabian cooperation for the near-exclusive benefit of these two players. The US dollar was "backstopped" by the transfer of Saudi liquidities to the US Federal Reserve system banks, especially the Federal Reserve Bank of New York.  A small number of other chosen central banks, especially the Bank of England, and the central banks of Germany, France, Italy and Japan also benefitted.

1986-1999 The second phase. This also featured US and Saudi control, but under Clinton's two mandates the focus radically changed to the controlled deflation or reduction of both oil prices and the world value of the US dollar. While the US continued to benefit from "petrodollar recycling", Saudi Arabia was the major loser, undoubtedly changing its perceptions of the system's utility to KSA.

2000-2013 The third and last phase. This period featured a major longterm rise in oil prices and the entry not in force, but progressively of the euro currency into the now enlarged "petromoney recycling" process. Euros now cover about 25% of global oil transactions, for an annual value of around €700 billion, with about the same amount of back-to-back additional lquidities. The massive growth of QE and central bank "easing", from 2008, has heavily reduced the role of "petromoney recycling".

Among the major changes of the petromoney system during these 3 phases, the first phase set the basic political concept among US deciders that "petrodollar recycling" could at one and the same time enable the US to run huge trade and budget deficits, low or very low interest rates, and prevent the collapse of the dollar's value due to the forced need of all world buyers of oil to hold US dollars to make purchases of oil. By the second phase, this underlying concept shaded to including non-oil assets as the focus of value manipulation, controlled inflation and controlled deflation of value. In the third phase, massive increases of the oil price to 2008 played a major role in enabling the continued depreciation of the dollar's world value as US sovereign debt also massively increased, but since 2008 and the start of central bank QE the need for, and role of the petrodollar system have heavily contracted.



Estimates of the exact size and role of petrodollars and petroeuros in the international money system, finance system, and economic system are varied. Many analysts however say the minimum role of the petrodollar system is to create, back-to-back, liquidities at least equivalent to the transaction value of the world oil trade, which for crude and products is about $3.4 trillion-a-year. Combined, the approximate minimum total $6.8 trillion annual value of oil trade plus the petromoney system is about 10% of world annual GNP, equivalent to about 45% of US annual GDP. This may appear as still large and important but has to be compared with, for example, the exposure of national private banks only in Europe in relation to national GDPs, which is often 300% - 400%.

Only QE can "plaster over" these liabilities.

Petromoney recycling is still treated by "the elites" as a critical prop to monetary system integrity, and explains why the USA is far from the only country depending on the system holding up. All oil producers, even smaller-sized, are beneficiaries the same way as all major developed nations' central banks, but the US is still the prime beneficiary. However, the basic supports for the system's operation - continuing high oil demand, high oil prices, and oil priced in dollars -  have all weakened or are threatened, today. In particular when global oil demand declines or stagnates, and when oil prices decline, the dollars that will no longer be needed for global purchases of oil will return in massive amounts back to their country of origin, the USA. The consequences can only be dramatic, and threaten the start of a process completely unlike the Clinton-era controlled devaluation of the dollar's value along with the decline of oil prices consented by Saudi Arabia.

The now-menaced "petrodollar system" is also weakened because of worldwide change in the perception of oil and oil energy. From the dawn of the petroleum age to its accelerating twilight, today, geopolitical strategies concocted by developed nations featured the maintenance of secured access to world oil supplies. This was believed to be a win-win strategy for developed nation policy makers, and especially for US policy makers. From the 1970s and the first Oil Shock of 1973-1974, the only "morph' in this policy and strategy was to substitute expensive oil, for cheap oil.

For the USA's ability to run deficits and the petrodollar system, much higher oil prices were a major gain, not a loss, and this is almost surely still the perception of the Obama administration today.

In its first phase and last phase, the economic and political incentives for ensuring national access to oil supplies, and the existence of the petrodollar system as a monetary and finance tool - unrelated to the economy - worked better with higher oil prices. Today however, with the major and massive changes of oil resource availability revealed by the shale energy revolution, rising global oil production capabilities, stagnating oil demand, and rising renewable energy supplies in all major developed countries, and the constantly declining role of oil in the economy, the Petrodollar System's days are surely numbered, like the notion that $100-oil prices are "normal".

The impact of this will be massive.

Guess Who Is A Shocking Fan Of Austrian Economics

The statement below, coined by Friedrich Hayek in his 1931 "Prices and Production", is well-known by any fans of the Austrian school of economics (and by implication, loathed by all Keynesians):

“There can be no doubt that besides the regular types of the circulating medium, such as coin, notes and bank deposits, which are generally recognised to be money or currency, and the quantity of which is regulated by some central authority or can at least be imagined to be so regulated, there exist still other forms of media of exchange which occasionally or permanently do the service of money. Now while for certain practical purposes we are accustomed to distinguish these forms of media of exchange from money proper as being mere substitutes for money, it is clear that, other things equal, any increase or decrease of these money substitutes will have exactly the same effects as an increase or decrease of the quantity of money proper, and should therefore, for the purposes of theoretical analysis, be counted as money.”

One may usually find it in letters of the few renegade hedge fund managers who dare to call out the Chairsatan for his utter bubble pumping insanity, in the writings of those who have not been indoctrinated into the fallacies of the Keynesian pseudo-religious dogma, and generally discussed by those who actually do understand real credit and thus, monetary creation.

One will certainly not find it in the mecca of Keynesian ideology - the US Treasury - where the dominant thought paradigm these days appears to be that sovereign debt is, in fact, an asset, that record debt will be cured with more record debt, and that the only thing that matters when accounting for money is M1, maybe M2, but certainly not M3, and where nobody has even heard of shadow money (the same reason why we predicted - correctly - over a year ago why the Fed will continue to monetize debt long before QEternity was announced).

Or won't one?

We were quite shocked to find precisely this fragment in its entirety not in some fringe economics department of the Sorbonne, but on page 86 (of 126) in this quarter's refunding presentation by the Matt Zames (JPMorgan)-chaired Treasury Borrowing Advisory Committee to the US Treasury, specifically in the appendix to the presentation we showed last week explaining just why the US has an $11.2 trillion asset shortage, why Bernanke has trillions more of monetization left to go, and why all conventionally-based understanding of monetary theory - any that ignores shadow money - is and has always been 100% wrong.

That's right: it would appear that the long hand of Austrian economics has penetrated deep into the narrative offered by the JPM and Goldman-chaired TBAC.

But... if that is the case, and if indeed the Treasury's advisors are fundamentally at heart, Austrian, then that would diametrically change the entire ballgame. Simply because it would mean that whoever wrote the TBAC's most recent slideshow understand perfectly well that the path the US has set off on is not only not going to have a happy ending as the Keynesian borg Kolhoz claims (courtesy of the endless monetization of debt), but will, naturally, end in tears.

So, one wonders: is that precisely what JPM and Goldman (the two heads of the TBAC) have had in mind all along?

And if so, one also wonders just how they really feel about gold...

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