gave President Barrack Obama six months to roll-out his doomed
Keynesian policies, twelve months to discover they were flawed and
eighteen months to realize that the solution to America’s problems
must lie within a different economic framework. I had hoped by the end
of twenty-four months to see new policies closer to an Austrian
economic philosophy emerge. I was wrong.
Though, even the Wall Street Journal recently featured an article on the
re-emergence of the Austrian School of Economic philosophy, it would
appear that President Obama’s administration still neither gets it, nor I
am afraid ever will.
Key defections by his leading economic advisors, talk of the need for QE
II and a Stimulus II, and a political collapse in public confidence
suggests a growing awareness that Keynesian policies are not working, as
many predicted they wouldn’t. Obama's exciting rhetoric of Hope and Change
has left myself and the majority of recent polled Americans disillusioned
and disappointed. What I see the administration failing to grasp is
I-America has a Structural problem, not a cyclical business cycle problem.
Though the cyclical business cycle was greatly worsened by the financial
crisis, I would argue that the structural problem facing the US is
actually a contributor to what caused the financial crisis.
II- America has a Credit demand problem, not a Credit supply problem. It
isn’t that the banks won’t lend, but rather that few can any longer afford
or qualify (on any reasonably and historically sound basis) to borrow.
economic news has turned decidedly negative globally and a sense of
‘quiet before the storm’ permeates the financial headlines. Arcane
subjects such as a Hindenburg Omen now make mainline news. The retail
investor continues to flee the equity markets and in concert with the
institutional players relentlessly pile into the perceived safety of
yield instruments, though they are outrageously expensive by any
proven measure. Like trying to buy a pump during a storm flood, people
are apparently willing to pay any price. As a sailor it feels
like the ominous period where the crew is fastening down the hatches
and preparing for the squall that is clearly on the horizon. Few crew
mates are talking as everyone is checking preparations for any
eventuality. Are you prepared?
What if this is not a squall but a tropical storm, or even a hurricane?
Unlike sailors the financial markets do not have the forecasting
technology to protect it from such a possibility. Good sailors before
today’s technology advancements avoided this possibility through the use
of almanacs, shrewd observation of the climate and common sense. It
appears to this old salt that all three are missing in today’s financial
Looking through the misty haze though, I can see the following clearly
looming on the horizon.
Since President Nixon took the US off the Gold standard in 1971 the
increase in global fiat currency has been nothing short of breath taking.
It has grown unchecked and inevitably became unhinged from world
industrial production and the historical creators of real tangible wealth.
“Americans are expecting to take a double whammy on
the chin soon; Europe’s debt crisis and a double dip
recession. The tension is clearly palatable. Americans
are worried and scared about what’s coming next and
that’s on top of the near universal recognition that
we are mired in a pretty deep recession already.
Bradley Honan, Vice President of StrategyOne
StrategyOne conducted 1,050 online interviews among a
representative sampling of Americans between June 25 and 27, 2010.
Perceptions of the Current
There is near universal agreement (92%) that the US is still in a
recession, and a strong majority, 79%, disagree with experts’
characterization that the recession is over.
Additionally, more than half of the public (57%) believes the U.S.
economy is either in a deep recession (48%) or in a 1930s style
economic depression (9%). Only 4% say the economy is doing fine
and 39% say the economy is in a “mild recession”.
Impact of the Recession on Americans:
Significant numbers of Americans have experienced hardship as a
result of the recession.
o 42% say that they or their spouse has
had wages or salary reduced
o 34% say they or their spouse lost
their job or has been laid off
o 33% have taken on more hours or
another job to try and make ends meet
o 28% dipped into a planned retirement
account like an IRA or 401K because they needed the money
o 14% say they have been forced to sell
or liquidate a major asset like their car or home
o 9% have had their house foreclosed on
o 8% had their child delay college (or
graduate school) or drop out to save money
o In terms of their own personal
finances, 2 in 10 expect say they will recover by the end of 2011
(20%), 3 in 10 say after the end of 2011 (27%), and a quarter say
their personal finances won’t ever fully recover (24%).
One would think that New Jersey teachers might have the ability to learn.
However, judging from repeated powder puff softball questions by teachers that
governor Chris Christie can hit out of the ballpark, I have to wonder.
Please consider this creampuff question and Christie's answer.
Governor Chris Christie was straight, direct, and correct in his response to a
union teacher in New Jersey who complains about teacher layoffs. Clearly the
teacher's union is to blame. Moreover, it is the same in every state. How
teachers cannot see this is a wonder to behold.
Earlier today, the Basel Committee on Banking
Supervision committee released Basel III guidelines, which
are expected to have a material impact on curbing bank
risk appetite... when they are fully implemented in July
of 2019. Luckily by then the last thing on people's minds
will be whose bank's Tier 1 capital (which includes such
intangible "capital" items as mortgage servicing rights
and preferred stock) was being misrepresented for the past
9 years, as real cap ratios are discovered to have had a
decimal comma following the zero. In the meantime, here is
the summary of the proposed changes to bank capitalization
requirements, which apparently were so "stringent" that
the Fed issued a Sunday afternoon press release patting
itself, and the entire financial system on the back, for
pulling off another multi-trillion toxic debt David
Copperfield disappearing act. So for the next several
years, banks will need to demonstrate a stringent
4.5% Common Equity cap ratio, in other, will be
allowed leverage over 20x. And this is the "stringent
requirement" that has forced Deutsche Bank to
sell over $12 billion in new stock to raise capital.
Furthermore, the coincident take over of Post Bank will
surely allow DB to terminally confuse its investors as to
what its final pro forma numbers are supposed to
represent, and, more importantly, what the unadjusted
actuals really are... Surely this example of just how
woefully undercapitalized European banks are (consider the
DB action a stark refutation of the "all is clear"
statement proffered by the Stress Test farce from July)
will be enough to get the EURUSD back to 1.30 overnight.
A. Tier 1 Capital A1. BASEL
II: Tier 1 capital ratio = 4% Core Tier 1
capital ratio = 2%
The difference between the total
capital requirement of 8.0% and the Tier 1 requirement can
be met with Tier 2 capital.
A2. BASEL III:
Tier 1 Capital Ratio = 6%
Core Tier 1 Capital Ratio (Common Equity after
deductions) = 4.5%
Core Tier 1 Capital Ratio (Common Equity after
deductions) before 2013 = 2%, 1st January 2013 = 3.5%, 1st
January 2014 = 4%, 1st January 2015 = 4.5%
The difference between the total capital requirement
of 8.0% and the Tier 1 requirement can be met with Tier 2
B. Capital Conservation Buffer
B1. BASEL II: There is no capital
B2. BASEL III:
Banks will be required to hold a capital conservation
buffer of 2.5% to withstand future periods of stress
bringing the total common equity requirements to 7%.
Capital Conservation Buffer of 2.5 percent, on top of
Tier 1 capital, will be met with common equity, after the
application of deductions.
Capital Conservation Buffer before 2016 = 0%,
1st January 2016 = 0.625%, 1st January 2017 = 1.25%, 1st
January 2018 = 1.875%, 1st January 2019 = 2.5%
The purpose of the conservation buffer is to ensure
that banks maintain a buffer of capital that can be used
to absorb losses during periods of financial and economic
stress. While banks are allowed to draw on the buffer
during such periods of stress, the closer their regulatory
capital ratios approach the minimum requirement, the
greater the constraints on earnings distributions.
C. Countercyclical Capital Buffer
C1. BASEL II: There is no Countercyclical
C2. BASEL III: A
countercyclical buffer within a range of 0% – 2.5% of
common equity or other fully loss absorbing capital will
be implemented according to national circumstances.
Banks that have a capital ratio that is less than 2.5%,
will face restrictions on payouts of dividends, share
buybacks and bonuses. The buffer will be phased in from
January 2016 and will be fully effective in January 2019.
Countercyclical Capital Buffer before 2016 =
0%, 1st January 2016 = 0.625%, 1st January 2017 = 1.25%,
1st January 2018 = 1.875%, 1st January 2019 = 2.5%
D. Capital for Systemically Important
D1. BASEL II: There
is no Capital for Systemically Important Banks
D2. BASEL III: Systemically important banks should
have loss absorbing capacity beyond the standards
announced today and work continues on this issue in the
Financial Stability Board and relevant Basel Committee
The Basel Committee and the FSB are
developing a well integrated approach to systemically
important financial institutions which could include
combinations of capital surcharges, contingent capital and
Total Regulatory Capital
Ratio = [Tier 1 Capital Ratio] + [Capital Conservation
Buffer] + [Countercyclical Capital Buffer] + [Capital for
Systemically Important Banks]
Large American corporations are going global as fast as they
can. That’s good for their shareholders. But in a Washington ever
more susceptible to their money and influence, it’s not
necessarily good for American workers.
QUESTION: What will
happen to the tax shield that interest payments provide?
Assume a scenario where a company with $X in debt manages to
refiance all of it at near-zero interest rates. This will simply
make pretax net income jump substantially, and provide for a much
greater tax provision owed to the government. As everyone is
aware, the number one prerogative before CFOs and corporate
strategists, is how to minimize tax payments, which, in our
opinion, means that soon companies, even Investment Grade, will
lever over and above the level of debt suitable for their business
model, with dividend recap deals coming down the line, all in the
pursuit of recapturing a debt interest-based tax shield. After
all, a company (and most definitely its Board of Directors) would
certainly prefer to pay a dividend to its shareholders, than to
give away 40% of its profits to the government, even if this means
a sudden and abrupt deterioration of debt ratios across levered
corporate America. And once interest rates do pick up, and the
next refi/maturity wave hits in 5-7 years, then it will be really
game over. But that is a topic for another day. (We are also
confident that the tax code's Section 382 NOL Limitations will
also soon have to be adjusted to facilitate the M&A boom which
everyone expects yet never happen, as there are thousands of
companies with huge NOL "assets" that could be acquired if Sec.
382 were to be changed... and it will be).
The still-high ratios of debt and debt service to disposable income suggest that
the household sector and the private sector more broadly will need to continue
running financial surpluses in coming years. Unless fiscal and monetary policy
provide a strong counterweight, this is likely to imply only sluggish growth,
with risks tilted to the downside.
As more and more pundits realize that looking at debt burdens in nominal terms
is erroneous, and that one has to apply deflation expectations to projections of
real debt burdens, look for the feedback loop of lack of confidence in the
economy to become ever more acute, as consumers further retrench in the saving
mode so very abhorred by the Fed. And as more and more money finds its way to
the mattress and precious metals, look for some incendiary decisions out of the
government that seek nothing less than to devalue the dollar directly.
The far greater implication is that the Fed continues
to be stuck with no recourse of how to fix the system in
the long-run, once the toxic spiral of deflationary
deleveraging accelerates. And yes, the only option will
soon be the nuclear one, which is QE on top of QE on top
of QE, all with the hope of spurring inflation, yet
leading to the unfortunate outcome of loss in the US
While the debt/income ratio shown in Exhibit 1 is hardly the
end of the story, we believe that Exhibit 2 leaves out an
important factor, namely that debt service is defined in
nominal rather than real terms. The calculation does
not take into account the rate at which inflation erodes the
real value of household debt over time. This erosion will
confer a bigger benefit on indebted households in a
high-inflation environment such as the early 1980s than in a
low inflation environment such as now.
Retail investor has whip-sawed from substantially
pessimistic to substantially optimistic in the course of just
a few weeks according to a survey from the American
Association of Individual Investors (AAII).
Trader's Narrative: This level of overall bullishness is the highest since late April 2010 and the
highest percentage of bulls since mid April, just as the market made an
important top. The nominal level of bullishness isn’t the only thing that
concerns me. It is also the fact that retail investors have a very short
attention span and are willing to forgive and forget at the drop of a hat. Until
we see true capitulation (with continuing reluctance to jump aboard an ensuing
rally) it is difficult to see a way out of this choppy malaise.
In my view the AAII survey isn't very robust given how often it fluctuates
between extremes, but perhaps says something relevant for short-term trading.
Note that the survey simply asks people whether they are bullish or bearish on
the market for the next six months, which probably explains its volatility.
Generally, I much prefer fund flow data, such as that from the Investment
Company Institute, since it shows not what people say, but what they do. Still, what's nice about the AAII survey is that it comes out quickly and often.
Zero Hedge Commentary on CNBC Interview: For some, this
week's incident on CNBC where Michael Pento was kicked off CNBC
for daring to question the basic assumption that his host Erin
Burnett presented as fact, was perplexing (to others, who are well
aware of the modus operandi of the TV station is, not so
much). In a follow up interview that was uninterrupted by
commercial breaks and octoboxes, with King World News, Michael
Pento gives a post-mortem of just what transpired: "I looked at it
4 times and I don't when I went off the rails, I thought it was a
bit unwarranted. All I was doing was being very passionate about
an issue I feel very strongly about." The core of the disagreement
of course, is the underlying assumption which CNBC takes as
gospel, which is that no matter what, interest rates will not, are
not allowed to rise (which together with a failed treasury
auction, will be the key indicators of the "beginning of the
end"). And Pento is completely right to question this as the
underlying "factual basis" of any rhetorical question: "We as
Americans have no right to believe that interest rates on the 10
year, which are far below their historic 49 year average, 7.31%,
are now on 2.7%, so the onus is not on me that interest rates will
rise. The onus is on other people to convince me and the investing
public that the US bond market will always be in a perpetual
bubble that will never burst. And if you look at the data, it
shows that this can not be a sustainable situation." Pento then
goes on to highlight all the facts that certainly make his case,
but that ultimately all collapse into one thing: that the Fed will
be able to continue to control, and frankly, manipulate the rate
market for perpetuity. This is a flawed assumption and sooner or
later Ben Bernanke will lose control as with every system which is
in disequilibrium, the snapback to a sustainable balance will
occur, and the longer it is kept away from its natural state, the
more violent the snapback will be.
One point that Pento discusses that bears further attention, is
his argument that governmental investment in the economy should
decline and the private sector should be encouraged to pick up the
slack. Of course, with the
of Payments equation which is now on the forefront of public
attention, this means that unless the Current Account goes
positive, the private sector is unlikely to be able to pick up the
slack from a collapse in endless governmental stimulus (and thus
constant debt creation). Which goes to the crux of the
Keynesian-Austrian debate. Many would say here that instead of
having funded the government apparatus, which as even
Mort Zuckerman points out is beyond unwieldy and has grown
excessively, the government should have instead have focused on
making the US competitive from an international trade standpoint,
a topic even
Warren Buffett lamented in his non-corrupt days, when he was
actually a voice of reason, and not just unbridled, government
captured greed. Alas, that would mean a total break from the
current Chinese trade surplus hegemony and realigning the US
economy in a way that would result in a dramatic shock to millions
of people who realize they are simply uncompetitive in the global
picture (and thus redundant in the job market) but which would
serve as another much needed reset to get America off on a way to
long-lost prosperity with an attempt to reincarnate the American
manufacturing sector while gradually phasing out the service
sector (and especially its "financial innovation" component) . Yet
Gorgon T. Long also pointed out a few days ago, America is now
dead set on repeating the destructive Keynesian mistakes of the
past, and will continue to fund a broken model until one day, as
Michael Pento all too correctly points out, it all snaps, and the
"shocking" death of Keynesianism,
as described a month ago by Eric Sprott, catches all so many
Of course to explain all this to Erin Burnett, who still
believes that the government has done a great job with the
"fastest" recovery in the past 20 years, which would be correct if
one could eliminate those little pesky things known as "facts", is
beyond folly. All those who are invited to CNBC, and dare to
explain the truth: you have been warned.
QUOTE OF THE WEEK
To paraphrase Oscar Wilde
know the price of everything but the value of nothing.
In therapy, you have to accept a mistake to move on.
At times, this realization will be painful but in the end
it is better for you. Right now Wall Street is in
complete denial and trying to pretend all is well.
Their profits are up but all that is happening is a wealth
transfer from taxpayers to this unproductive group.
Gordon T Long is not a registered advisor and
does not give investment advice. His comments are an expression of opinion
only and should not be construed in any manner whatsoever as
recommendations to buy or sell a stock, option, future, bond, commodity or
any other financial instrument at any time. While he believes his
statements to be true, they always depend on the reliability of his own
credible sources. Of course, he recommends that you consult with a
qualified investment advisor, one licensed by appropriate regulatory
agencies in your legal jurisdiction, before making any investment
decisions, and barring that, we encourage you confirm the facts on your
own before making important investment commitments.ont>
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Gordon T Longfont>
is not a registered advisor and does not give investment advice. His comments
are an expression of opinion only and should not be construed in any manner
whatsoever as recommendations to buy or sell a stock, option, future, bond,
commodity or any other financial instrument at any time. While he believes his
statements to be true, they always depend on the reliability of his own
credible sources. Of course, we recommend that you consult with a qualified
investment advisor, one licensed by appropriate regulatory agencies in your
legal jurisdiction, before making any investment decisions, and barring that,
we encourage you confirm the facts on your own before making important