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POSTS: Friday, 01-28-2011
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TIPPING POINTS

Process of Abstraction

Research Process

1- Sovereign Debt Crisis
2- EU Banking Crisis
3- Bond Bubble
4- State & Local Government
5 - Risk Reversal
 
6 - Residential Real Estate -
Phase II
7 - Commercial Real Estate
8 - Central & Eastern Europe
9 - Chronic Unemployment
10 - US Banking Crisis II
11 - Pension - Entitlement Crisis
12 - North & South Korea
 
13 - Public Policy MIscues
14 - Rising Interest Pressures
15 - Food Price Pressures
16 - US Stock Market Valuations
17- Finance & Insurance Balance Sheet Write-Offs
18 - Japan Debt Deflation Spiral
19 -Credit Contraction II
 
20 - US Reserve Currency
21 - US Fiscal, Trade and Account ImBalances
22 - China Bubble
23- Government Backstop Insurance
24 - Corporate Bankruptcies
25 - Slowing Retail & Consumer Sales
26 - Public Sentiment & Confidence
27 - Shrinking Revenue Growth Rate
28 - US Dollar Weakness
29 -Global Output Gap
30 - Oil Price Pressures
31 -Natural Disaster
32 - Pandemic
33 - Iran Nuclear Threat
34 - Crisis Programs Expiration
35 - Terrorist Event

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TIPPING POINTS

"The moment of critical mass, the threshold, the boiling point"

The tipping point is the critical point in an evolving situation that leads to a new and irreversible development. The term is said to have originated in the field of epidemiology when an infectious disease reaches a point beyond any local ability to control it from spreading more widely. A tipping point is often considered to be a turning point. The term is now used in many fields. Journalists apply it to social phenomena, demographic data, and almost any change that is likely to lead to additional consequences. Marketers see it as a threshold that, once reached, will result in additional sales. In some usage, a tipping point is simply an addition or increment that in itself might not seem extraordinary but that unexpectedly is just the amount of additional change that will lead to a big effect. In the butterfly effect of chaos theory , for example, the small flap of the butterfly's wings that in time leads to unexpected and unpredictable results could be considered a tipping point. However, more often, the effects of reaching a tipping point are more immediately evident. A tipping point may simply occur because a critical mass has been reached.

The Tipping Point: How Little Things Can Make a Big Difference is a book by Malcolm Gladwell, first published by Little Brown in 2000. Gladwell defines a tipping point as "the moment of critical mass, the threshold, the boiling point." The book seeks to explain and describe the "mysterious" sociological changes that mark everyday life. As Gladwell states, "Ideas and products and messages and behaviors spread like viruses do."

The three rules of epidemics

Gladwell describes the "three rules of epidemics" (or the three "agents of change") in the tipping points of epidemics.

  • Connectors are the people who "link us up with the world ... people with a special gift for bringing the world together." They are "a handful of people with a truly extraordinary knack [... for] making friends and acquaintances". He characterizes these individuals as having social networks of over one hundred people. To illustrate, Gladwell cites the following examples: the midnight ride of Paul Revere, Milgram's experiments in the small world problem, the "Six Degrees of Kevin Bacon" trivia game, Dallas businessman Roger Horchow, and Chicagoan Lois Weisberg, a person who understands the concept of the weak tie. Gladwell attributes the social success of Connectors to "their ability to span many different worlds [... as] a function of something intrinsic to their personality, some combination of curiosity, self-confidence, sociability, and energy."
  • Mavens are "information specialists", or "people we rely upon to connect us with new information." They accumulate knowledge, especially about the marketplace, and know how to share it with others. Gladwell cites Mark Alpert as a prototypical Maven who is "almost pathologically helpful", further adding, "he can't help himself". In this vein, Alpert himself concedes, "A Maven is someone who wants to solve other people's problems, generally by solving his own". According to Gladwell, Mavens start "word-of-mouth epidemics" due to their knowledge, social skills, and ability to communicate. As Gladwell states, "Mavens are really information brokers, sharing and trading what they know".
  • Salesmen are "persuaders", charismatic people with powerful negotiation skills. They tend to have an indefinable trait that goes beyond what they say, which makes others want to agree with them. Gladwell's examples include California businessman Tom Gau and news anchor Peter Jennings, and he cites several studies about the persuasive implications of non-verbal cues, including a headphone nod study (conducted by Gary Wells of the University of Alberta and Richard Petty of the University of Missouri) and William Condon's cultural microrhythms study.

 

RESEARCH METHODOLOGY

 

PROCESS OF ABSTRACTION

 

 

SOVEREIGN DEBT & CREDIT CRISIS

 

Inverted chart of 30-year Treasury yields courtesy of Doug Short and Chris Kimble. As you can see, yields are at a "support" area that's held for 17 years.

If it breaks down (i.e., yields break out) watch out!

The state budget crisis will continue next year, and it could be worse than ever. That's part of what's freaking out muni investors, who last week dumped them like they haven't in ages.

States face a $112.3 billion gap for next year, according to the Center on Budget and Policy Priorities. If the shortfall grows during the year -- as it does in most years -- FY2012 will approach the record $191 billion gap of 2010. Remember, with each successive shortfall state budgets have become more bare.

Things could be especially bad if House Republicans push through a plan to cut off non-security discretionary funding for states, opening an additional $32 billion gap. 

MUNI BOND OUTFLOWS

RISK REVERSAL

 

RESIDENTIAL REAL ESTATE - PHASE II

 

COMMERCIAL REAL ESTATE

2011 will see the largest magnitude of US bank commercial real estate mortgage maturities on record.

2012 should be a top tick record setter for bank CRE maturities looking both backward and forward over the half decade ahead at least.

Will this be an issue for an industry that has been supporting reported earnings growth in part by reduced loan loss reserves over the recent past? In 2010, approximately $250 billion in commercial real estate mortgage maturities occurred. In the next three years we have four times that much paper coming due.

Will CRE woes, (published or unpublished) further restrain private sector credit creation ahead via the commercial banking conduit?

Wiil the regulators force the large banks to show any increase in loan impairment. Again, given the incredible political clout of the financial sector, I doubt it.

We have experienced one of the most robust corporate profit recoveries on record over the last half century. We know reported financial sector earnings are questionable at best, but the regulators will do absolutely nothing to change that.

So once again we find ourselves in a period of Fed sponsored asset appreciation. The thought, of course, being that if stock prices levitate so will consumer confidence. Which, according to Mr. Bernanke will lead to increased spending and a virtuous circle of economic growth. Oh really? The final chart below tells us consumer confidence is not driven by higher stock prices, but by job growth.

9 - CHRONIC UNEMPLOYMENT

There are 3 major inflationary drivers underway.

1- Negative Real Interest Rates Worldwide - with policy makers' reluctant to let their currencies appreciate to market levels. If no-one can devalue against competing currencies then they must devalue against something else. That something is goods, services and assets.

2- Structural Shift by China- to a) Hike Real Wages, b) Slowly appreciate the Currency and c) Increase Interest Rates.

3- Ongoing Corporate Restructuring and Consolidation - placing pricing power increasingly back in the hands of companies as opposed to the consumer.

FOOD PRICE PRESSURES

RICE: Abdolreza Abbassian, at the FAO in Rome, says the price of rice, one of the two most critical staples for global food security, remains below the peaks of 2007-08, providing breathing space for 3bn people in poor countries. Rice prices hit $1,050 a tonne in May 2008, but now trade at about $550 a tonne.

WHEAT: The cost of wheat, the other staple critical for global food security, is rising, but has not yet surpassed the highs of 2007-08. US wheat prices peaked at about $450 a tonne in early 2008. They are now trading just under $300 a tonne.

The surge in the FAO food index is principally on the back of rising costs for corn, sugar, vegetable oil and meat, which are less important than rice and wheat for food-insecure countries such as Ethiopia, Bangladesh and Haiti. At the same time, local prices in poor countries have been subdued by good harvests in Africa and Asia.

 

- In India, January food prices reflected a year-on-year increase of 18%t.

- Buyers must now pay 80%t more in global markets for wheat, a key commodity in the world's food supply, than they did last summer. The poor are especially hard-hit. "We will be dealing with the issue of food inflation for quite a while," analysts with Frankfurt investment firm Lupus Alpha predict.

- Within a year, the price of sugar on the world market has gone up by 25%.

US STOCK MARKET VALUATIONS

 

WORLD ECONOMIC FORUM

Potential credit demand to meet forecast economic growth to 2020


The study forecast the global stock of loans outstanding from 2010 to 2020, assuming a consensus projection of global
economic growth at 6.3% (nominal) per annum. Three scenarios of credit growth for 2009-2020 were modelled:


• Global leverage decrease. Global credit stock would grow at 5.5% per annum, reaching US$ 196 trillion in 2020. To
meet consensus economic growth under this scenario, equity would need to grow almost twice as fast as GDP.
• Global leverage increase. Global credit stock would grow at 6.6% per annum, reaching US$ 220 trillion in 2020.
Likely deleveraging in currently overheated segments militates against this scenario.
• Flat global leverage. Global credit stock would grow at 6.3% per annum to 2020, tracking GDP growth and reaching
US$ 213 trillion in 2020 – almost double the total in 2009. This scenario, which assumes that modest
deleveraging in developed markets will be offset by credit growth in developing markets, provides the primary credit
growth forecast used in this report.

Will credit growth be sufficient to meet demand?


Rapid growth of both capital markets and bank lending will be required to meet the increased demand for credit – and it is
not assured that either has the required capacity. There are four main challenges.


Low levels of financial development in countries with rapid credit demand growth. Future coldspots may result from the
fact that the highest expected credit demand growth is among countries with relatively low levels of financial access. In
many of these countries, a high proportion of the population is unbanked, and capital markets are relatively undeveloped.


Challenges in meeting new demand for bank lending. By 2020, some US$ 28 trillion of new bank lending will be
required in Asia, excluding Japan (a 265% increase from 2009 lending volumes) – nearly US$ 19 trillion of it in China
alone. The 27 EU countries will require US$ 13 trillion in new bank lending over this period, and the US close to US$
10 trillion. Increased bank lending will grow banks’ balance sheets, and regulators are likely to impose additional capital
requirements on both new and existing assets, creating an additional global capital requirement of around US$ 9 trillion
(Exhibit vi). While large parts of this additional requirement can be satisfied by retained earnings, a significant capital gap in
the system will remain, particularly in Europe.

The need to revitalize securitization markets. Without a revitalization of securitization markets in key markets, it is doubtful
that forecast credit growth is realizable. There is potential for securitization to recover: market participants surveyed by
McKinsey in 2009 expected the securitization market to return to around 50% of its pre-crisis volume within three years.
But to rebuild investor confidence, there will need to be increased price transparency, better data on collateral pools, and
better quality ratings.


The importance of cross-border financing. Asian savers will continue to fund Western consumers and governments:
China and Japan will have large net funding surpluses in 2020 (of US$ 8.5 trillion and US$ 5.7 trillion respectively), while
the US and other Western countries will have significant funding gaps. The implication is that financial systems must
remain global for economies to obtain the required refinancing; “financial protectionism” would lock up liquidity and stifle
growth.

 

US$ RESERVE CURRENCY

SocGen crafts strategy for China hard-landing

Société Générale fears China has lost control over its red-hot economy and risks lurching from boom to bust over the next year, with major ramifications for the rest of the world.

Société Générale said China's overheating may reach 'peak frenzy' in mid-2011

- The French bank has told clients to hedge against the danger of a blow-off spike in Chinese growth over coming months that will push commodity prices much higher, followed by a sudden reversal as China slams on the brakes. In a report entitled The Dragon which played with Fire, the bank's global team said China had carried out its own version of "quantitative easing", cranking up credit by 20 trillion (£1.9 trillion) or 50pc of GDP over the past two years.

- It has waited too long to drain excess stimulus. "Policy makers are already behind the curve. According to our Taylor Rule analysis, the tightening needed is about 250 basis points," said the report, by Alain Bokobza, Glenn Maguire and Wei Yao.

- The Politiburo may be tempted to put off hard decisions until the leadership transition in 2012 is safe. "The skew of risks is very much for an extended period of overheating, and therefore uncontained inflation," it said. Under the bank's "risk scenario" - a 30pc probability - inflation will hit 10pc by the summer. "This would cause tremendous pain and fuel widespread social discontent," and risks a "pernicious wage-price spiral".

- The bank said overheating may reach "peak frenzy" in mid-2011. Markets will then start to anticipate a hard-landing, which would see non-perfoming loans rise to 20pc (as in early 1990s) and a fall in bank shares of 50pc to 75pc over the following 12 months. "We think growth could slow to 5pc by early 2012, which would be a drama for China. It would be the first hard-landing since 1994 and would destabilise the global economy. It is not our central scenario, but if it happens: commodities won't like it; Asian equities won't like it; and emerging markets won't like it," said Mr Bokobza, head of global asset allocation. However, it may bring down bond yields and lead to better growth in Europe and the US, a mirror image of the recent outperformance by the BRICs (Brazil, Russia, India and China).

- Diana Choyleva from Lombard Street Research said the drop in headline inflation from 5.1pc to 4.6pc in December is meaningless because the regime has resorted to price controls on energy, water, food and other essentials. The regulators pick off those goods rising fastest. The index itself is rejigged, without disclosure. She said inflation is running at 7.6pc on a six-month annualised basis, and the sheer force of money creation will push it higher. "Until China engineers a more substantial tightening, core inflation is set to accelerate.

- The longer growth stays above trend, the worse the necessary downswing. China's violent cycle could be highly destabilising for the world." Charles Dumas, Lombard's global strategist, said the Chinese and emerging market boom may end the same way as the bubble in the 1990s. "The basic strategy of the go-go funds is wrong: they risk losing half their money like last time."

- Société Générale said runaway inflation in China will push gold higher yet, but "take profits before year end".

- The picture is more nuanced for food and industrial commodities. China accounts for 35pc of global use of base metals, 21pc of grains, and 10pc of crude oil. Prices will keep climbing under a soft-landing, a 70pc probability. A hard-landing will set off a "substantial reversal". Copper is "particularly exposed", and might slump from $9,600 a tonne to its average production cost near $4,000. Chinese real estate and energy equities will prosper under a soft-landing,

- The bank likes regional exposure through the Tokyo bourse, which is undervalued but poised to recover as Japan comes out of its deflation trap. If you fear a hard landing, avoid the whole gamut of Chinese equities. It will be clear enough by June which of these two outcomes is baked in the pie.

SocGen crafts strategy for China hard-landing Pritchard

PUBLIC SENTIMENT & CONFIDENCE

 

 

SHRINKING REVENUE GROWTH RATES

PIMCO'S NEW NORMAL: According to PIMCO, the coiners of the term, the new normal is also explained as an environment wherein “the snapshot for ‘consensus expectations’ has shifted: from traditional bell-shaped curves – with a high likelihood mean and thin tails (indicating most economists have similar expectations) – to a much flatter distribution of outcomes with fatter tails (where opinion is divided and expectations vary considerably).” That is to say, the distribution of forecasts has become more uniform (as per Exhibit 1).

Food inflation more important than oil price rises

History is adamant on the risks. While much has been made of oil prices as drivers of global inflationary spurts since the 1970s, recent work of ours (Catão and Chang 2010) provides evidence that food price pressures have been no less important. The data in fact suggests that food tends to have stronger predictive power on global inflation cycles than oil.

As Figure 1 illustrates, every single inflation upturn over the past four decades has been preceded (with a one to two-year lag) by an uptick in world food prices; this causality relation is confirmed by formal econometric tests. To be sure, one could arguably blame such past slippages on the looser monetary regimes of the 1970s and 1980s. Yet, later experience indicates that this transmission mechanism remains quite alive in the more recent era of inflation targeting too.

This is portrayed in Figure 2, which plots the IMF global indices of food and oil prices (measured along the left vertical axis) against the cross-country median of percentage deviations from the central inflation targets (measured along the right vertical axis) for all countries that have formally adopted inflation targeting. Clearly, the large swings since 2006 in deviations of actual from targeted inflation have coincided with attendant swings in world food prices. Further, Figure 2 also confirms that food prices are better predictors of global inflation than oil prices. While oil prices began to climb up in earnest from 2003, significant deviations from targeted inflation only materialised after food prices took off from late 2006. In short, there is substantial evidence – both recent and well-past – that food prices lurk behind large international swings in inflation rates.

 

Here It Comes: US Suspends New Issuance Under Supplementary Financing Program, $200 Billion Liquidity Gusher Imminent

Earlier this week we predicted that the US Treasury would wind down its SFP program, unleashing $200 billion in 56-day non-rollable "Fed bonds" on the market. We predicted this would occur by mid-February. As of a few minutes ago, the Treasury has just confirmed that starting February 3, this will be precisely the case. Per the Treasury, supplementary financing account to fall to USD 5bln, with the reason being the traditional explanation: decreasing funds in account as country nears debt ceiling.

As the revised table below shows, each Thursday beginning February 3 we will now see an incremental $25 billion in extra liquidity as the maturing 56-Day CMB is not rolled.

From the US Treasury:

Treasury Issues Debt Management Guidance on the Supplementary Financing Program

1/27/2011

WASHINGTON – The U.S. Department of the Treasury’s Assistant Secretary for Financial Markets, Mary Miller, today issued the following statement on the Supplementary Financing Program:
 
“Beginning on February 3, 2011, the balance in the Treasury's Supplementary Financing Account will gradually decrease to $5 billion, as outstanding Supplementary Financing Program bills mature and are not rolled over. This action is being taken to preserve flexibility in the conduct of debt management policy.”?

Here is what we predicted on January 24:

Here Comes Another $25 Billion In Excess Weekly Liquidity To Ramp Up Stocks

Frequent readers may recall that 11 months ago, when the economy was falsely rumored to be doing better, and the Fed was expected to take baby steps in withdrawing liquidity (only to end up having to inject another $900 billion shortly... and probably much more soon), one of the key mechanisms used was the Treasury's Supplementary Financing Program, whereby the Treasury would issue 56-Day Cash Management Bills each week with a $200 billion ceiling. In addition to funding the Treasury with a $200 billion debt ceiling buffer, the program was supposed to extract a fifth of a trillion in liquidity which would be locked into the rolling of each 56 day bill (each one amounting to $25 billion) up to a total of $200 billion, as disclosed each day in the Treasury's DTS SFP Table 1 open cash balance. Well, not even 11 full months later, it is now time to unwind the program. The immediate catalyst for the unwind of the SFP is that the Treasury will most certainly breach the debt ceiling by the end of March unless it gets the benefit of the $200 billion buffer, which counts toward the total debt issued by the UST. However, what that also means is that the US stock market is about to become awash with another $25 billion in suddenly free cash every single week, until the entire $200 billion SFP buffer is depleted. In other words, take the liquidity impact of POMO, which is roughly $25-30 billion a week, and double it! We are confident the US Treasury will announce that beginning with the week of February 14, it will no longer roll maturing 56-Day Cash Management Bills, which means that for the ensuing 8 weeks, one on every single Thursday, there will be a total of $200 billion in incremental liquidity flooding the market, and probably sending stocks, commodities, and everything else that is not nailed down into the stratosphere all over again.

Below is a table laying out our estimated weekly liquidity boost. We believe the starting date for the SFP winddown will be the week of February 14, although we could be off by one week in either direction. (Zero Hedge update: February 3 seem just about right).

This makes sense, especially when considering of our expectation that the Fed will force the market to do a repeat performance of 2010, whereby it goes parabolic through mid-April and then it is smashed in another flash crash like event due to some exogenous variable, opening up the path for further Quantitative Easing. That said, it is likely that the PDs and the Fed's OMO will now orchestrate the perfect market boil up over the next 2 months as more than ample liquidity chases stocks at increasingly ridiculous multiples until the point where everything goes bidless just like on May 6.

 

Today the Financial Crisis Inquiry Commission releases its full report on the crisis. Already the minority GOPers on the panel have come out with their own rebuttal, and the centerpiece is this chart, which shows that the housing bubble in the US was mirrored all around the world. Thus, any attempt to pin this to The Fed, or Wall Street's control of Washington, or Fannie and Freddie, fails on the ground of the global nature of the crisis.

 

The Diamond Market and Bank Closures

January 27, 2011
Mr. B in the Far East

Steve:

We talk gold all the time, now let's have a look at the diamond market for a moment. I am working in the mainstream of diamond sales with a remarkable sale of a ominous large black stone called the BLACK OBAMA and it's 824 carats of super large translucent purity (photo attached) appraised at about 160,000,000 usd. Price tag is $55 mio USD.

While working to sell this stone we came across a leading Diamond Purveyor, Professional in Israel, who commented, "I would be taking interest in this, but we have no time for these matters now" and he just hung up. We knew that the diamond market is very slow at the moment with Buyers outstripping Sellers of rough diamond collections 520 to 10! We also learned that the Israelis are preparing for war and are downsizing the diamond cutters activities there. In other words the Diamond Giants are slowing down distribution of the large rough diamond collections and cutting into the use of diamonds as money!

So what can be done with existing ownership of diamonds rough or polished? What is interesting is that the BIS has allowed diamonds to be put into trade. This will allow diamonds rough or polished to be avalled and used in PPP programs. (see attached overview for your eyes only) This means that banks are loading up to create positive balance sheet figures using real assets to include bullion, diamonds and bank instruments. As the Banks now are more and more aware of what they will be doing in an upcoming world war, they are getting prepared. Corporations and institutions are organizing new agendae based on a synergy between the 'secret government' and the falseness of shortages.

The current inside line is that it's the calm before the storm. This is a reference to the disquieting action of "cheaper" gold allowing governments everywhere to keep printing up their currency to match the amount of listed au in registered supply. Gold is being sold quietly at the bank level, or when gold is coming out of trade and has to be sold.

Consider then a bank holiday that will inflict a real change in the oil-backed dollar and the USD as the commodity driver. Currencies will take on new value based on how much gold they have on book. If gold's value has to go up to 2000 USD per ounce one week and 4000 USD per ounce the next, it's all because a leading currency will have to own up to what paper is printed against what is existing against it's bullion reserves. If you printed too much, then your currency is out or renamed into the new unit of measure. And guess what, the Rouble and the Remimbi will not be in that drain pipe scenario.

There are some owners of bullion out of Asia that have to create cash-streams to pay off high interest fees on bullion storage or basically come out of hiding. You can move billions of dollars of bullion without the FED noting what is going on. And so all the bullion that is in the system is being accounted for until. This means eventually if a gold sale happens and the FED does not want the cash to reach it's buyer, then they will freeze it. So 200 Metric tonnes worth 3 Billion USD will go into hyper space with a weaker USD having to cough up three or four times the paper to buy.

The "secret government" agenda has it's financial streams that will operate in it's etheric state without impunity and will keep an apparent downturn of the markets in a lower cloud formation which most of humanity will have to eat of that sandwich.

Mr. B