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Stage 1 Comes to an End!
A Matter of National Security
A Guide to the Road Ahead 
Confirming the Flash Crash Omen
It's Either RICO Act or Control Fraud
Shifting Risk to the Innocent
Uncle Sam, You Sly Devil!
Is the US Facing a Cash Crunch?
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Manufacturing a Minsky Melt-Up
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POSTS: Tuesday, 02-22-2011
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TIPPING POINTS

Process of Abstraction

Research Process

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

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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).

If the U.S. dollar is being devalued so rapidly, then why does it sometimes increase in value against other global currencies? Well, it is because everybody is recklessly printing money now. The 6 charts which you are about to see below prove this.

At this point, every nation on earth (to the best of my knowledge) uses a fiat currency.  All of the major global currencies are being continually devalued.  In fact, there are times when counties will purposely devalue their currencies even more rapidly in order to gain a competitive advantage in world trade.

This is why so many investors now have such an aversion to paper currency.  It starts losing value the moment you take possession of it.

In some areas of the world, "gold fever" is absolutely exploding.  For example, China imported five times as much gold in 2010 as it did in 2009.  On the Shanghai Gold Exchange, trading volume soared 43 percent during the first 10 months of 2010.

AN OPEN LETTER TO TREASURY SECRETARY O'NEILL
AND FEDERAL RESERVE CHAIRMAN ALAN GREENSPAN

Why Does the IMF Prohibit Gold-Backed Currency for its Member States?

(Congressman Ron Paul sent this letter to both the Treasury and the Federal Reserve Bank in April.  Neither has responded)

Dear Sirs:

I am writing regarding Article 4, Section 2b of the International Monetary Fund (IMF)'s Articles of Agreement. As you may be aware, this language prohibits countries who are members of the IMF from linking their currency to gold. Thus, the IMF is forbidding countries suffering from an erratic monetary policy from adopting the most effective means of stabilizing their currency. This policy could delay a country's recovery from an economic crisis and retard economic growth, thus furthering economic and political instability.

I would greatly appreciate an explanation from both the Treasury and the Federal Reserve of the reasons the United States has continued to acquiesce in this misguided policy. Please contact Mr. Norman Singleton, my legislative director, if you require any further information regarding this request. Thank you for your cooperation in this matter.

Ron Paul
U.S. House of Representatives

 

Ron Paul

www.house.gov/paul

A week ago, when we reported on a move by the Dutch central bank that ordered a pension fund to forcibly reduce its gold holdings, we speculated that "this latest gold confiscation equivalent event is most certainly coming to a banana republic near you." And while we got the Banana republic right, the event that we are about to describe is not necessarily identical. It is much worse. A bill proposed in the State of Washington (House Bill 1716), by representatives Asay, Hurst, Klippert, Pearson, and Miloscia, whose alleged purpose is to regulate secondhand gold dealers, seeks to capture "the name, date of birth, sex, height, weight, race, and address and telephone number of the person with whom the transaction is made" or said otherwise, of every purchaser of gold in the state of Washington. Furthermore, if passed, Bill 1716 will record "a complete description of the property pledged, bought, or consigned, including the brand name, serial number, model number or name, any initials or engraving, size, pattern, and color or stone or stones" and of course price. But the kicker: if a transaction is mode for an amount over $100, which means one tenth of an ounce of golds, also required will be a "signature, photo, and fingerprint of the person with whom the transaction is made." In other words, very soon Washington state will know more about you than you know about yourself, if you dare to buy any gold object worth more than a C-note. How this proposal is supposed to protect consumers against vulture gold dealers we don't quite get. Hopefully someone will explain it to us. We do, however, get how Americans will part with any and all privacy if they were to exchange fiat for physical. And in a police state like America, this will likely not be taken lightly, thereby killing the gold trade should the proposed Bill pass, and be adopted elsewhere.

While we are confident that representatives Asay, Hurst, Klippert, Pearson, and Miloscia have no clue why they are even proposing this bill, we would also be delighted to find out which moneyed interests they represent, and what happens to precious metal trading in America should Bill 1716 become a legal precedent which is effectively the first step before the final implementation of Executive Order 6102 version 2.

 

Washington Gold Biometrics  

 

Five days before his inauguration, President-elect Barack Obama told the Washington Post that entitlement reform could no longer be kicked down the road. He then spent the next two years kicking — racking up $3 trillion in new debt along the way — on the grounds that massive temporary deficit spending was necessary to prevent another Great Depression. To prove his bona fides, he later appointed a deficit-reduction commission. It made its report last December, when the economy was well past recession, solemnly declaring that “the era of debt denial is over.”

That lasted all of two months. The president’s first post-commission budget, submitted Monday, marks a return to obliviousness. Even Erskine Bowles, Obama’s Democratic debt-commission co-chair, says it goes “nowhere near where they will have to go to resolve our fiscal nightmare.”

The budget touts a deficit reduction of $1.1 trillion over the next decade.

Where to begin? Even if you buy this number, Obama’s budget adds $7.2 trillion in new debt over that same decade.  

But there’s a catch. The administration assumes economic-growth levels higher than private economists and the Congressional Budget Office predict. Without this rosy scenario — using CBO growth estimates — $1.7 trillion of revenue disappears and U.S. debt increases $9 trillion over the next decade. This is almost $1 trillion every year.

Assume you buy the rosy scenario. Of what does this $1.1 trillion in deficit reduction consist? Painful cuts? Think again. It consists of $1.6 trillion in tax hikes, plus an odd $328 billion of some mysterious bipartisan funding for a transportation trust fund (gas taxes, one supposes) — for a grand total of nearly $2 trillion in new taxes.

Classic Obama debt reduction: Add $2 trillion in new taxes, then add another $1 trillion in new spending and, presto, you’ve got $1 trillion of debt reduction. It’s the same kind of mad deficit accounting in Obamacare: It reduces debt by adding $540 billion in new spending, then adding $770 billion in new taxes. Presto: $230 billion of “debt reduction.” Bialystock & Bloom accounting.

And what of those “painful cuts” Obama is making to programs he really cares about? The catch is that these “cuts” are from a hugely inflated new baseline created by the orgy of spending in Obama’s first two years. These were supposedly catastrophe-averting, anti-Depression emergency measures. But post-recession they remain in place. As a result, discretionary non-defense budget levels today are 24 percent higher than before Obama — 84 percent higher if you add in the stimulus money.

Which is why the supposedly painful cuts yield spending still at stratospheric levels. After all the cuts, Department of Education funding for 2012 remains 35 percent higher than in the last pre-emergency pre-Obama year, 2008. Environmental Protection Agency: 18 percent higher. Department of Energy: 22 percent higher. Consider even the biggest “painful cut” headline of all, the 50 percent cut in fuel subsidies for the poor. Barbaric, is it not? Except for the fact that the subsidies had been doubled from 2008 levels. The draconian cut is nothing but a return to normal pre-recession levels.

Yet all this is penny-ante stuff. The real money is in entitlements. And the real scandal of this budget is that Obama doesn’t touch them. Not Social Security. Not Medicaid. Not Medicare.

What about tax reform, the other major recommendation of the deficit commission? Nothing.

How about just a subset of that — corporate tax reform, on which Republicans have signaled they are eager to collaborate? The formula is simple: Eliminate the loopholes to broaden the tax base, then lower the rates for everyone, promoting both fairness and economic efficiency. What does the Obama budget do? Removes tax breaks — and then keeps the rate at 35 percent, among the highest in the industrialized world (more than twice Canada’s, for example).

Yet for all its gimmicks, this budget leaves the country at decade’s end saddled with publicly held debt triple what Obama inherited.

A more cynical budget is hard to imagine. This one ignores the looming debt crisis, shifts all responsibility for serious budget-cutting to the Republicans — for which Democrats are ready with a two-year, full-artillery demagogic assault — and sets Obama up perfectly for re-election in 2012.

Obama fancies his happy talk, debt-denial optimism to be Reaganesque. It’s more Louis XV. Reagan begat a quarter-century of prosperity; Louis, the deluge.

Moreover, unlike Obama, Louis had the decency to admit he was forfeiting the future. He never pretended to be winning it

 

Mervyn King, the Governor, said inflation was likely to return to the Bank's official target of 2 per cent 'on the assumption that the Bank Rate increases in line with market expectations'. 

The market takes this as confirmation that the Bank will raise the rate by a series of quarter-point increases, starting in May. The ultra-low interest rate policy was a response to the 2008 panic; it had never happened before and it will be a long time before it happens again.

Apart from the evidence of the Consumer Prices Index, there have been significant increases in food and petrol costs. Now we know there will be higher interest rates on mortgages, there will inevitably be pressure on consumer spending in the High Street. It will not be a comfortable time for anybody.

My description last month of inflation being a global threat is borne out by the rise in prices in the major national economies.

- Britain's Consumer Prices Index has now reached the forecast rise of 4%;

- The wholesale price index in the United States has risen to 4.1%;

- The consumer price index in China has risen to 4.9%; and in

- The eurozone, consumer prices have risen by 2.4% in the last 13 months.

The two commodities which provide the best indicators of the long-term prospect for inflation are oil and gold. The price for a barrel of Brent Crude has risen to more than $100, and has been very firm at that level. The price of gold has risen above $1,350 per troy ounce and has been reasonably firm at that level.