The "Currency War" that EWFF discussed in October and again in the most recent issue has expanded to new fronts, as world central banks fought to remain economically competitive by trying to push down the value of their currencies. Singapore became at least the ninth nation to "jump on the easing bandwagon" in January, employing loose monetary measures designed to reduce the value of the Singapore dollar.
Our long term bullish forecast for the U.S. dollar remains on track, and this month the Dollar Index jumped to 95.527, retracing 50% of its decline from 121.020 in July 2011 to 70.700 in March 2008. Short term, the rally is stretched like a taut piece of rope: prices have closed higher for 30 out of the past 39 weeks. Recently, a 10-day average of a poll of currency traders (courtesy trade-futures.com) showed 93.7% dollar bulls, an all-time record high. Also, Large Speculators in futures and options, who are generally trend-followers, now hold an all-time record net-long position of 72,897 contracts, as shown on the chart on the above. The extreme in these measures shows the strength of the rally but also reflects a trend that is ripe for a correction. The U.S. Dollar Index is at or near the end of Intermediate wave (3), which started in May 2014. Wave (4) will be a multi-month pullback that alleviates the aforementioned sentiment extremes and sets up the dollar for another wave of advance.
Finally, with the U.S. dollar rallying together with gold and U.S. Treasury bond prices, it is clear that investors are seeking money havens, assets they perceive will hold value the best in an increasingly risky environment. As deflationary forces intensify, it will become harder to find stable assets other than outright cash.
Will the US Dollar Crash Stocks Like It Did in 2008?Graham Summers 02-18-15 Phoenix Capital Research
For 30+ years, Western countries have been papering over the decline in living standards by issuing debt. In its simplest rendering, sovereign nations spent more than they could collect in taxes, so they issued debt (borrowed money) to fund their various welfare schemes.
This was usually sold as a “temporary” issue. But as politicians have shown us time and again, overspending is never a temporary issue. This is compounded by the fact that the political process largely consists of promising various social spending programs/ entitlements to incentivize voters.
In the US today, a whopping 47% of American households receive some kind of Government benefit. This type of social spending is not temporary… this is endemic.
The US is not alone… Most major Western nations are completely bankrupt due to excessive social spending. And ALL of this spending has been fueled by bonds.
This is why Central Banks have done everything they can to stop any and all defaults from occurring in the sovereign bonds space. Indeed, when you consider the bond bubble everything Central Banks have done begins to make sense.
Central banks cut interest rates to make these gargantuan debts more serviceable.
Central banks want/target inflation because it makes the debts more serviceable and puts off the inevitable debt restructuring.
Central banks are terrified of debtdeflation (Fed Chair Janet Yellen herself admitted that oil’s recent deflation was economically positive) because it would burst the bond bubble and bankrupt sovereign nations.
So how will all of this play out?
The first real sign of trouble has already emerged. That sign pertains to the US Dollar.
Globally, the world is awash in borrowed money… most of it in US Dollars. The US Dollar carry trade is north of $9 trillion… literally than the economies of Germany and Japan COMBINED.
When you BORROW in US Dollars you are effectively SHORTING the US Dollar. So when the US Dollar rallies… you have to cover your SHORT or you blow up.
And the US Dollar has been rallying… HARD. Indeed, the move that began in July is already on par in scope with that which occurred during the 2008 meltdown:
This first wave imploded the price of Oil, numerous other commodities, and several emerging markets equities, most notably in Russia and Brazil.
However, the US markets are not immune to the move.
Some 87% of companies have guided below consensus expectations for next quarter. The stronger US Dollar is hurting profits… which are the single biggest driver of stock prices.
What happened the last time that stocks were strongly disconnected from reality… and the US Dollar began to rally hard?
The real trade-weighted exchange rate index against major currencies has reached its highest level at the end of January since April 2003. The broader index is currently at a 69-month high. The major currency index includes six currencies (Euro, Yen, Canadian Dollar, Pound Sterling, Swedish Krona, and Swiss Franc). The broader definition includes 26 different currencies. The currency weights are based on yearly trade data. In order to calculate a "real" (i.e inflation-adjusted) exchange rate, the nominal exchange is multiplied by the ratio of US CPI index to the foreign currency CPI index.
The nominal trade-weighted exchange rate index by major currencies is at its highest level since May 2004, while the broader index is at its highest level since March 9th, 2009 (the infamous start to the current bull market).
Lastly, our purchasing power parity diffusion index has fallen to 0 for the first time since 2009. This means that on a purchasing power parity basis, nine currencies are currently overvalued versus the USD and nine currencies are undervalued versus the USD.
Did the Fed Just Enter the Currency Wars? BL
Policy makers pointed to the dollar’s rising value as ‘persistent source of restraint’ on exports in a surprisingly dovish set of meeting minutes published Wednesday
MOST CRITICAL TIPPING POINT ARTICLES THIS WEEK - Feb. 15th, 2015 - Feb. 21st, 2015
MACRO RISK - Changing Landscape
Even UBS itself admitted last week that a "dislocation" in the market (which is "underestimating Grexit Risks") is necessary in order to overcome the Greek impasses.
Question: What could go wrong?
As we have highlighted many times before, markets respond well to moderate growth, low inflation and supportive monetary conditions, as is now the case. But the global recovery also remains fragile and hence vulnerable to shocks. Here's what could go wrong:
Renewed political uncertainty. Fragile growth, particularly in the Eurozone, remains at risk to bouts of political uncertainty. Last year’s midyear slowdown mostly stemmed from unease over the growing conflict in the eastern Ukraine. With no solution to the latest re-escalation of the conflict in sight (at the time of writing) and with the impasse between Greece, the troika and virtually all other Eurozone member governments threatening to usher in a new chapter in the Eurozone crisis, Europe’s ‘green shoots’ of recovery could quickly wilt again. And note that, as Europe goes, so go global growth impulses. The Eurozone is the world's largest economic aggregation and biggest export destination for many emerging economies, which are increasingly reliant on (net) exports for growth.
Rapid and disruptive Fed tightening. As noted above, we expect a faster pace of Fed tightening than is now priced into markets. Typically, 'carry' positions are most vulnerable when the Fed initiates unexpected rate hikes. In macroeconomic and market terms, those most exposed to the unwinding of 'carry' include countries financing external deficits via short-term portfolio inflows, such as Brazil, South Africa or Turkey. Credit fixed income markets are also potentially vulnerable, particularly given their susceptibility to illiquid trading conditions.
Excessive dollar strength. Thus far, broad-based dollar appreciation has not been particularly problematic. But further gains might become disruptive. At some point, political pressure against dollar strength may build in Washington, particularly as the 2016 elections approach. But vulnerability to dollar strength is arguably greater outside the US, including in commodity-producing industries and countries, where a strong dollar tends to depress output prices. Countries and corporates reliant on dollar financing, but with revenues derived in weaker currencies (e.g., in many emerging economies) could also feel the pinch in a stronger US dollar environment.
And a bonus point from UBS on rates:
when looking further over the horizon and assuming that major policy, political and currency shocks can be avoided, investors may have to consider the next iteration of the 'new-normal'—low discount rates. One by-product of the ECB's QE is its impact on global bond yields, including US Treasuries. If, as seems likely, the ECB pursues QE for longer, Fed rate hikes may not lift US and global yields by as much as in past such cycles. The by-product would be much flatter yield curves and lower long-term interest rates than in prior episodes of US full employment, non-inflationary growth. Accordingly, at some point style shifts could dominate equity returns, with investors taking advantage of unusually low discount rates to bid up the prices of assets with annuity-like and attractive long-term cash flows.
This supposedly excludes the #Ref! P/E Nasdaq, which is on pace to surpass its dot com 1.0 nominal record in a few weeks at most.
The 2008 Crisis was largely a banking crisis focused on securities. The REAL Crisis will hit when the bond bubble collapses.
The current global monetary system is based on debt. Governments issue sovereign bonds, which a select group of large banks and financial institutions (e.g. Primary Dealers in the US) buy/sell/ and control via auctions.
These financial institutions list the bonds on their balance sheets as “assets,” indeed, the senior-most assets that the banks own.
The banks then issue their own debt-based money via inter-bank loans, mortgages, credit cards, auto loans, and the like into the system. Thus, “money” enters the economy through loans or debt. In this sense, money is not actually capital but legal debt contracts.
Because of this, the system is inherently leveraged (uses borrowed money).
Consider the following:
1) Total currency (actual cash in the form of bills and coins) in the US financial system is little over $1.2 trillion.
2) If you want to include money sitting in short-term accounts and long-term accounts the amount of “Money” in the system is about $10 trillion.
3) In contrast, the US bond market is well over $38 trillion.
4) If you include derivatives based on these bonds, the financial system is north of $191 trillion.
Bear in mind, this is just for the US.
Globally the bond bubble is north of $100 trillion. And this $100 trillion has been used as collateral for a derivative market that is well north of $555 TRILLION.
Again, debt is money. And at the top of the debt pyramid are sovereign bonds: US Treasuries, German Bunds, Japanese Government Bonds, etc. These are the senior most assets used as collateral for interbank loans and derivative trades. THEY ARE THE CRÈME DE LA CRÈME of our current financial system.
So, this time around, when the bubble bursts, it won’t simply affect a particular sector or asset class or country… it will affect the entire system.
The coming crisis will not be another 2008. It will be something much much worse. The 2008 Crisis was caused by an implosion of the Credit Default Swap market. At that time, the entire CDS market was roughly $50-60 trillion in size.
The interest rate based derivatives market is TEN TIMES larger in size: north of $555 trillion.
UNSUSTAINABLE EQUILIBRIUM - The Damage of Sustained Excess Credit
Excess Credit Has Lead to a 70% Consumption Economy with:
Unsustainable Excess Consumption and
Excess Global Supply RUN RATES
When you run a business you quickly learn that everything is about run rates and the sustainablility of those run rates. Any deterioration in the rate and actions are quickly taken by business leaders.
An Economy is no different except there is no responsible CEO.
A SUSTAINABLE EQUILIBRIUM
Money is a Store of Value Without Distortions (like Inflation),
Capital Comes from Savings
Consumer Savings - Money in excess of expenses & obligations,
Corporate Savings - Profits and Free Cashflow
No Debt Financing Burdens
Demand matches Productive Supply
A UNSUSTAINABLE EQUILIBRIUM
Money is NO LONGER a Store of Value by being DEBASED,
Capital Comes from Credit Creation
Credit Credit and Debt is bringing future demand forward
A Consumption driven economy is a 'Buy Now, Pay Later" Equilibrium
Consumer - Cheap Money Elevates Consumption without correpsonding increases in cashflow to match,
Corporate Production - Increases with cheap money to match increased demand,
Debt burden grows from both consumers and producers,
If 'unchecked' it leads to economies Consuming more than they produce,
Supply EVENTUALLY Overpowers Demand at elevated consumption levels leading to price competition,
DEMAND GROWTH SLOWS
Money borrowed (principle) comes due which slows along with real disposable income,
EXCESS CREDIT CREATION
Governments are forced to create larger levels of credit to sustain consumption by bringing even more demand forward,
The required credit creation goes up parabolically as forward demand is brought forward from further out years,
Excess credit leads to cheaper money, excess leverage, mispricing of risk, lack of price discovery,malinvestment , moral hazard and unintended consequences.
One of the greatest costs of the credit bubble that has enveloped the world the past 15 years is that it has allowed the price of most assets and services to skyrocket. In a sustainable equilibrium, available capital to fund investment comes from savings. But when as now, the banking system is flooded with credit on credit from a recklessly levered financial sector, for a time it makes capital plentiful and therefore less valuable. Since less valuable, capital is rewarded with lower and lower yields.
Using borrowed money, more people have the ability to buy, and hence the price of most services and assets rises with the demand. Until finally we reach the end point of borrowing capacity, the end of debt service ability (ie., no matter how low rates are, repayment ability is ultimately finite because it is tethered to one’s available cash flow collected through sales or wages). At the end point, credit slows and the inevitable payback period exacts its pound of flesh: years of reduced consumption courtesy of servicing costs, defaults, write-downs, bankruptcies and of course, mean reverting prices for assets and services. All of a sudden, reality reveals that few people actually have liquid savings, and hence few can afford to be buyers. And if at all, only at much lower prices.
A present example of these forces at work, is in post-secondary education. Education costs have skyrocketed because students have been able to access seemingly endless credit and so schools have been able to dramatically jack up costs and still find customers. But the end point of this ‘virtuous cycle’ seems to upon us. Students are increasingly already in debt by the time they reach college (car loans and credit cards) and then even after graduating, many are not able to earn enough to payback their loans and start a household–for years–as the debt weight of past consumption stifles new.
Student loans continue to pile up, now totaling $1.16 trillion in outstanding balances, one of the main reasons researchers have cited for the low levels home ownership among young adults. Here is a direct video link.
But it’s not just students or Greeks who are now suffering the paralyzing effects of impossible debt levels. It’s worldwide:
Despite widespread talk of “deleveraging” after a global credit bubble burst in 2008, the world continues to pile on more debt. According to a new study by McKinsey, the world ended last year some $57 trillion deeper in debt than it was in 2007.
The total tab—owed by governments, companies and households—is now more than twice the value of the world’s total economic output.
The biggest chunk of new borrowing since 2007—some $25 trillion—has come from governments going deeper into hock. Of the nearly 50 countries included in the analysis, only five—Argentina, Egypt, Israel, Romania and Saudi Arabia—have paid down some of their debt.
Here is the McKinsey Study Parks refers to above : REPORT
11 - Shrinking Revenue Growth Rate
MACRO News Items of Importance - This Week
GLOBAL MACRO REPORTS & ANALYSIS
US ECONOMIC REPORTS & ANALYSIS
CENTRAL BANKING MONETARY POLICIES, ACTIONS & ACTIVITIES
TECHNICALS & MARKET ANALYTICS
STUDIES - MACRO pdf - THE 'MORAL HAZARD RISK' OF CENTRAL BANK INTERVENTION
FLOWS - The impact of a liquidity bubble on Price and Risk
The following chart, courtesy of Citigroup, demonstrating the liquidity cliff i.e., the impact of a liquidity bubble on price and risk, is so mindbogglingly simple, it is no wonder that virtually nobody gets it.
As Citi observes, all a liquidity tsunami does for credit, as well as for equity, is to perpetuate the illusion of maximum pricing while shifting the risk curve to the point where any deviation from "perfection" - or loss of faith in the liquidity or its providers (as in central banks who in 2015 are finally going "all in") will ultimately lead to an instantaneous waterfall in price.
Which also explains why lately the exchanges have all been practicing how to most efficiently shut down when the "waterfall" moment arrives. Because if there is no market, one simply can't sell.
THEMES - FLOWS
DEFINITION OF 'ALPHA'
1. A measure of performance on a risk-adjusted basis. Alpha takes the volatility (price risk) of a mutual fund and compares its risk-adjusted performance to a benchmark index. The excess return of the fund relative to the return of the benchmark index is a fund's alpha.
2. The abnormal rate of return on a security or portfolio in excess of what would be predicted by an equilibrium model like the capital asset pricing model (CAPM).
INVESTOPEDIA EXPLAINS 'ALPHA'
1. Alpha is one of five technical risk ratios; the others are
The Sharpe ratio.
These are all statistical measurements used in modern portfolio theory (MPT). All of these indicators are intended to help investors determine the risk-reward profile of a mutual fund. Simply stated, alpha is often considered to represent the value that a portfolio manager adds to or subtracts from a fund's return.
A positive alpha of 1.0 means the fund has outperformed its benchmark index by 1%. Correspondingly, a similar negative alpha would indicate an underperformance of 1%.
2. If a CAPM analysis estimates that a portfolio should earn 10% based on the risk of the portfolio but the portfolio actually earns 15%, the portfolio's alpha would be 5%. This 5% is the excess return over what was predicted in the CAPM model
RISK - Derivatives Now Used For "Alpha Generation"
Maybe the pervasive “this time is always different” meme has been perpetuated to the point that the market actually believes it, or maybe it’s just old fashioned greed, but whatever the case, market participants (and this means central banks, retail investors, and everyone in between) have an extraordinary inclination towards Einsteinian insanity.
Never mind, for instance, that the Fed’s attempts to “smooth out the business cycle” (breaking it in the process) have everywhere and always served only to create bigger and bigger bubbles that have led, invariably, to crashes that are ever more spectacular/devastating - what we need is more intervention by central planners bankers. Forget the fact that throughout the course of human history, minting endless amounts of fiat currency always fails - in the words of new BOJ board member Yutaka Harada, “we just need to print more money.”
And certainly pay no attention (despite the tendency for these types of discrepancies to self-correct) to the divergence between the S&P and trivial things like the U.S. macro picture and/or forward earnings estimates...
... the U.S. economy is the cleanest dirty shirt and Jeremy Siegel is probably contemplating Dow 40K as we speak, so just hold your nose and buy.
Given this steadfast refusal to learn from yesterday’s mistakes, it isn’t any wonder that when Citi recently surveyed 43 banks, 29 asset managers, and 31 hedge funds regarding their outlook for the credit derivatives market in 2015, the consensus was that “there seems to be plenty of room and enthusiasm to use derivatives to take leveraged risk." Phew: for a minute there it looked like leveraged risk taking with derivatives might go the way of the Dodo in the post-crisis world, making Bruno Iksil the last great example of how much fun one can have stomping around in off-the-run CDS indices with depositors’ money.
It’s also comforting to know that among those Citi surveyed, the general consensus was that
"...there seems to have been a shift from using derivatives as a hedging tool, to using them more for alpha generation [as] most products are now used more for adding risk and directional views."
So investment professionals and sophisticated market participants are quite eager to take leveraged risk with derivatives with an eye not towards “hedging” (i.e. mitigating risk), but towards “alpha generation” and expressing “directional views” (i.e. gambling). In fact, nearly two-thirds of those surveyed listed either “alpha generation” or “adding risk” as the primary reason for trading single-name and index CDS:
For credit tranches, the combined figure was 82%:
The takeaway: banks and “sophisticated” investors are increasingly eager to take leveraged risk with derivatives in order to make directional bets on credit spreads. That certainly sounds like a pre-crisis mentality to us and it naturally won’t end well if the (re)proliferation of risk-taking via these instruments manages to embed an outsized amount of counterparty risk in the system.
Finally, in what surely was an effort to furnish readers with a bit of comic relief, Citi asked respondents if they “were concerned about investors taking more levered risks using derivatives” (here’s where one can gauge the extent to which those we entrust with our investments took the lessons of 2008 seriously). The results:
* * *
Bonus chart: Other types of structured products are making a comeback as well, with ABS issuance (backed by everything from car loans to student debt) hitting its highest level since 2008:
RISK - Risk Ratios Tell Us things Are Not As They Appear
Headline: Equity Risk Is Increasingly Non-Existent…By The Numbers
The concept of risk for hedge fund managers is a constant concern.
The only real metrics I care to focus on are
Total returns and
Risk adjusted returns.
Most clients could not care less about risk adjusted returns…but I sure do. And, as many are aware, the holy grail of risk metrics is the Sharpe Ratio [as calculated according to the title of this post]. The most interesting precept of the Sharpe Ratio, in my opinion, is that it treats volatility as random…both upside and downside volatility. No way to predict it in either direction so both directions are assigned the same discounting value. Basically, according to Bill Sharpe, all volatility is a penalty against your performance. I get it.
Still, in a perfect world, what if most of the volatility experienced by a portfolio of equities was actually favorable? So rare…if not impossible…but still at least worthy of consideration. And so the Sortino Ratio [or as I refer to it as the Gain/Pain Ratio] was born…essentially, it is exactly as the Sharpe Ratio but stratifies favored and un-favored volatility. Favorable volatility is not penalized. Unfavorable volatility is scored as a legitimate demerit. It has always seemed fairer to me.
Naturally, both ratios are relevant and higher values for both measurements reflect better risk-adjusted returns. And portfolio managers realize that, no matter the ratio, both need to positive…or you are losing money. However, given full investment of capital, the Sharpe Ratio can be strongly positive yet still not offer high absolute returns. Conversely, if your Sortino Ratio is high, you are probably delivering very strong absolute returns…again, assuming full investment of capital.
Given all of this…What is a good numerical value for both ratios? Generally, over time, any value > 1.5 is pretty good and numbers > 2.0 are stellar. Be advised the data may vacillate, a little bit, based on the time frame used in your calculation i.e. weekly or monthly.
Recently I constructed a model that required one, three and five year Sharpe Ratios for the S&P 500. I also decided to include the Sortino Ratio. Prior to the results I hypothesized that the numbers ought to be pretty impressive given the endless equity “bull” since March 2009 but I was still curious to get the exact data. Plus, a weekly price chart of the S&P 500, since 2009, visually reflects the anomaly of very limited draw-downs in the context of extremely strong returns. The calculations are as follows and as Mrs. Doubtfire once said…“Effie…Brace Yourself”.
1 Year = 1.37
3 Year = 1.86
5 Year =1.0
1 Year = 2.65
3 Year = 3.41
5 Year = 1.69
Collectively, these numbers are clearly impressive but even more so in that they are calculated from a passive, long only strategy. This is a hedge fund manager’s worst nightmare as, for five years, most “hedging” has proved to be only performance degrading.
Furthermore, the Sortino Ratio data are nothing short of staggering.
What they really say = Plenty of Gain with Very Little Pain.…and it really is unsustainable if only because it has become much too easy to generate positive returns with very little effort, pain or savvy.
It actually seems, at times, as though there is this mysteriously large buyer that suddenly appears whenever the equity market most “needs it”... and the subsequent buying is so aggressive and so desperate... not the style of the mostly steady “hands” I personally know.
It just seems too good to be true and the Sortino Ratio numerically reflects that belief. Plus, we all know that the economic fundamentals are not as smooth as the weekly or monthly charts of the S&P 500 would suggest.
Remember that equities typically offer the most risk of any asset class... not the lowest risk as the above data set suggests. Nevertheless, Yellen and Bernanke must be “psyched” as their “wealth effect” model has been so effective…actually too effective as the market distortions grow ever larger…and more market bears become contorted “road-kill”.
To be sure these distorting effects may be entirely assigned to The Fed... the debt monetizing, interest rate suppressing “Masters of the Universe” who always GET WHAT THEY WANT while answering to nobody.
They’ve literally trounced and expectorated on the concept of “MORAL HAZARD” and, it seems, purposely reconfigured and redefined its meaning into: WE HAVE NO ECONOMIC MORALS AND THIS POSES AN ENORMOUS HAZARD TO THE PERFORMANCE OF HEDGED MONEY MANAGERS. THE SPOILS GO TO THE IGNORANT ONLY…THE FED’S TRUE HEROES.
RISK - Debt increases Risk, and Risk increases Volatility
A question to begin today's discussion... Which is riskier: corporate or public debt?
If I lend $1,000 to my neighbour and take his bicycle worth $1,000 as collateral, which is what pawn brokers do, I have a quantifiable risk. I also have collateral which I can trust. I can see, feel and touch the bicycle.
When you lend money to a business in most instances you actually have a lien over the business and its assets. Even if the business is insolvent, as a bond holder you stand in line ahead of any creditors.
When you lend money to a sovereign and that sovereign finds it difficult to pay the loan back will they allow you to seize their assets in default? Can you take the president's bicycle?
Which is riskier?
I believe that the world in general is riskier today than at the height of the GFC.
In our report on global debt we detail both household as well as sovereign debt around the world. The report provides a stark reminder of the global credit bubble and its consequences.
Recently a colleague asked me why did the Swiss break the peg? The answer to that in one simple word is debt. All pegs break eventually because a peg allows for market participants to rely on an underwriter of risk. And when risk is underwritten by someone else then leverage is used, and when leverage is used risk rises. Like spirits, these two bedfellows make for a great party but a terrible hangover.
So how is the world riskier today? McKinsey Global Institute recently published a report on the topic. They mention, and I quote:
Seven years after the bursting of a global credit bubble resulted in the worst financial crisis since the Great Depression, debt continues to grow. In fact, rather than reducing indebtedness, or deleveraging, all major economies today have higher levels of borrowing relative to GDP than they did in 2007. Global debt in these years has grown by $57 trillion, raising the ratio of debt to GDP by 17 percentage points
Think about that for a minute and while you're thinking about that consider that the central banks are very, very close to running all out of bullets. Their predominant weapon has been manipulating the cost of capital via the interest rate market and now we have negative interest rates in Europe. I can't think of a time when the risk to capital has been greater!
Now I want you to think about all this debt and consider volatility because this is where we profit from moronic bureaucrats...
Debt and Volatility
Debt increases risk, and risk increases volatility. As such increases in debt typically cause increases in volatility. Six months ago we were yelling from the rooftops that volatility was at extreme lows. This, on the back of understanding that at the global macro level debt was rising, and while volatility should have been rising alongside it this wasn't the case. Instead we've had a divergent relationship whereby as debt has continued to expand, volatility continued to fall. In this gap lies huge asymmetry.
At the time we received many emails from readers saying things like "Don't you understand how much debt the US is in?" and that "The dollar can't rally and is going to collapse".
Let me be clear. Firstly, we're not apologists for the clowns running policy at central banks. I think they're all idiots and I wouldn't take a job at a central bank unless I was allowed to blow it up. More importantly though, the USD and quite frankly every other currency cannot be viewed in isolation. Context is everything in order to understand global capital flows and why the USD is rallying.
When in Hong Kong recently my suspicions were confirmed about the capital flowing out of China. Hong Kong is the conduit for mainland money which is also why the banks there are so flush with cash.
Consider that China's debt has quadrupled from $7 trillion in 2007 to over $28 trillion. This debt has been fueled largely by real estate and shadow banking. China’s total debt now stands at 282 percent of GDP, higher than that of the United States. If I was on the mainland looking around me I'd be moving cash out as well. This, amongst other reasons, is why we're short yuan.
We are entering a period of increased volatility. That volatility is going to be amplified by the gargantuan debts staring down at us. This is a topic which Brad will be discussing in depth just a few weeks from today at our next meet-up. You can get more details on nabbing one of the last remaining spots here.
"In economic life and history more generally, just about everything of consequence comes from black swans; ordinary events have paltry effects in the long term." - Nassim Nicholas Taleb
.... why would anyone put up with a government that brazenly steals, cheats, sneaks, spies and lies, not to mention alienates, antagonizes, criminalizes and terrorizes its own citizens and then justifies it in the name of safety, security and the greater good?
Why would anyone put up with militarized police officers who shoot first and ask questions later, act as if their word is law, and operate as if they are above the law?
Why would anyone put up with government officials, it doesn’t matter whether they’re elected or appointed, who live an elitist lifestyle while setting themselves apart from the populace, operate outside the rule of law, and act as if they’re beyond reproach and immune from being held accountable?
Unfortunately, not only do we put up with a laundry list of tyrannies that make King George III’s catalogue of abuses look like child’s play, but most actually persist in turning a blind eye to them, acting as if what they don’t see or acknowledge can’t hurt them.
The sad reality, as I make clear in my book A Government of Wolves: The Emerging American Police State, is that life in America is no bed of roses. Nor are there any signs that things will get better anytime soon, at least not for “we the people,” those of us who belong to the so-called “unwashed masses”—the working class stiffs, the hoi polloi, the plebeians, the rabble, the riffraff, the herd, the peons and the proletariats.
Not only is the government unapologetic about spying on its citizens, but government agencies are using their collective surveillance data to carry out Orwellian pre-crime programs that attempt to nab “criminals” before they ever commit a crime. To do so, they have to study our social media posts, our buying habits, and where we travel to and from, and on and on.
We’re still being treated like serfs working for an overlord, with little actual rights when it comes to our property, our bodies, our children or our welfare. It doesn’t really matter what the justifications are for such taxes, regulations, prohibitions and fines if they result in us having little-to-no control over how we live our lives. In Seattle, for example, even one’s trash is subject to government regulation. Residents who fail to separate out their food waste for composting are fined for each violation.
We’re still being fooled into thinking that politics matter and that there’s a difference between the Republicans and Democrats, when in fact, the two parties are exactly the same. As one commentator noted, both parties support endless war, engage in out-of-control spending, ignore the citizenry’s basic rights, have no respect for the rule of law, are bought and paid for by Big Business, care most about their own power, and have a long record of expanding government and shrinking liberty.
Our communities are still being held hostage by militarized police. Despite the fleeting attention paid to the transformation of community police into extensions of the military, the transfer of military equipment from the federal government to localities continues unabated, with more than $28 million worth of tactical equipment distributed in the last quarter of 2014. The federal government, in conjunction with local police, has created a standing army on American soil—something those who drafted our Constitution believed would devastate our freedoms.
Every once in a while, we get tossed a bone to satisfy that gnawing, nagging hunger for something that looks and tastes like freedom, democracy and free enterprise. Political elections, town-hall meetings, awards ceremonies, sports spectacles, high-dollar lotteries, reality TV shows, morning news programs and patriotic-themed blockbuster movies: these are all the trappings of a so-called free nation without the substance (what Shakespeare referred to as a “tale told by an idiot, full of sound and fury, signifying nothing”). Indeed, Big Business, in conjunction with Big Government, have become very adept at distracting the citizenry so that “we the people” often have no clue as to the real nature of the political game being played.
Temporarily assuaged, easily distracted and suffering from an appalling case of public amnesia, we fall right back into our complacency and compliance, content to turn a blind eye to blatant abuses, forgive past transgressions, and forget all of the reasons why we should be mad as hell about the state of our nation.
So why do I stay? Why do any of us continue to put up with the gut-wrenching, soul-sucking, misery-drenched, demoralizing existence that is America today?
Perhaps I stay because I was raised to believe that anything worth having is worth fighting for, and I believe with every fiber of my being that freedom matters. In fact, I come from a long line of Americans who understood that there is a price to be paid for freedom, whether that means standing up to the British military, sitting down in a bus seat reserved for “whites only,” or pushing back against corporations who pollute our waters and pillage our lands for profit.
Perhaps I soldier on because I remember what it was like to grow up at a time when the only surveillance I had to worry about were the neighbors who reported back to my mother whenever I did something wrong, and I desperately want my grandchildren to experience that kind of carefree existence. I want them to know that there’s more to life than metal detectors, lockdowns, random searches and pre-crime units trying to nab them for a crime if they dare step out of line.
Perhaps I persevere because I know that there are genuinely concerned Americans out there, including some good cops, honest politicians and pragmatic idealists, who want to pitch in and turn things around for the better. As long as there is this small but vocal minority who cares enough to stand up and speak out, then all is not completely lost.
Gentlemen may cry, peace, peace — but there is no peace. The war is actually begun! The next gale that sweeps from the north will bring to our ears the clash of resounding arms! Our brethren are already in the field! Why stand we here idle? What is it that gentlemen wish? What would they have? Is life so dear, or peace so sweet, as to be purchased at the price of chains and slavery? Forbid it, Almighty God! — I know not what course others may take; but as for me, give me liberty or give me death!
Obama will unleash his latest executive order, one which will set the stage for "information sharing and analysis organizations" (ISAOs) - or, in political jargon "hubs where companies share cyber threat data with each other and with the Department of Homeland Security." In regular parlance, what Obama will do is merely codify the second coming of the Patriot Act, which as Reuters put it, is "legislation to require more information-sharing and limit any legal liability for companies that share too much." In other words, the Kiss You Privacy Forever order. But don't worry: it is for your own protection.
(By clicking on the play button you agree to have your information shared with not only the NSA but Apple, AT&T, Verizon, T-Mobile, Cisco, Google, and well... everyone else)
Here come the "information sharing and analysis organizations", or ISAOs.
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In the aftermath of the Snowden whistleblowing scandal which has now all but been forgotten, there was a brief period when it seemed the growth of the US spying apparatus would be halted if not put into reverse. Those days are long forgotten and later today Obama is expected to to sign an executive order "that aims to make it easier for the government to share classified cyberthreat information with companies."
The spin, as proposed by the WSJ, is that "this will be effort designed to spur collaboration and deter hackers, the White House said." In reality what Obama's latest executive order will do, is expand the universe of entities that has access to the trove of private confidential data contained in the vast government spying apparatus, which as has been made all too clear now focuses as much on US citizens as it does on legitimate foreign threats, and further eviscerate the concept of individual privacy in the US.
The order sets the stage for new private-sector led "information sharing and analysis organizations" (ISAOs) - hubs where companies share cyber threat data with each other and with the Department of Homeland Security.
It is one step in a long effort to make companies as well as privacy and consumer advocates more comfortable with proposed legislation that would offer participating companies liability protection, the White House said.
"We believe that by clearly defining what makes for a good ISAO, that will make tying liability protection to sectoral organizations easier and more accessible to the public and to privacy and civil liberties advocates," said Michael Daniel, Obama's cyber coordinator, in a conference call with reporters.
Obama will sign the order shortly during a conference on cybersecurity at Stanford University in the heart of Silicon Valley.
As the WSJ adds, "much could depend on whether intelligence agencies such as the National Security Agency and the Central Intelligence Agency participate in any arrangement that allows classified information to be shared with companies." Sadly, if history is any guide, the NSA, whose "safekeeping" of private US citizen data has a woeful track record, will be quite instrumental in spearheading an effort which many have dubbed the Patriot Act for the digital age.
Ironically, this latest move comes as as big Silicon Valley companies "prove hesitant to fully support more mandated cybersecurity information sharing without reforms to government surveillance practices exposed by former National Security Agency contractor Edward Snowden."
Cybersecurity industry veterans said Obama's anticipated order would be only a modest step in one of the president's major priorities - the defense of companies from attacks like those on Sony and Anthem Inc.
Obama has proposed legislation to require more information-sharing and limit any legal liability for companies that share too much. Only Congress can provide the liability protection through legislation.
The bottom line is that all Obama is really doing is not only promoting data sharing between the government and key private corporations - and one wonders just how reciprocal such sharing will be - but effectively indeminifes them from obtaining and processing such data. "Businesses are unlikely to share a lot of timely and "actionable" cyber intelligence without liability relief, said Mike Brown, a vice president with the RSA security division of EMC Corp."
"Until that gets resolved, probably through legislation, I'm not sure how effective continued information-sharing will be," said Brown, a retired Naval officer and former cyber official with the Department of Homeland Security.
Senator Tom Carper, the top Democrat on the Senate Homeland Security committee, introduced a bill this week that incorporates much of Obama's plan. But Republicans control Congress, and they have yet to sign on to the idea.
"This is an urgent matter and we are working with anyone that we can up on the Hill to make that happen," said Daniel, who had not yet reviewed Carper's bill.
Getting a bill through Congress will require at least the support of big Silicon Valley companies such as Google Inc and Facebook Inc.
Curiously one company which has no qualms about collaborating with the US government also happens to be the largest company in the world currently by market cap:
Obama also will meet privately with some executives on Friday. They are expected to press again for surveillance reform and support for strong encryption, which some in the administration have faulted recently on the grounds that it enables criminals and terrorists to hide their activity.
Google, Facebook and Yahoo are not sending their chief executives to the Stanford conference because of the rift, according to an executive at a major technology company. Apple Inc Chief Executive Tim Cook will give an address.
Many questions, but one thing is clear: America's relapse into the second coming of the Patriot Act is coming fast and furious, which as some also say is par for the course for the president who, just like Bush, has now been given a blank check to send US troops not only to Iraq but any place where "ISIS operates", if only at the discretion of the Pentagon.
So to summarize:
the good news: no more North Korean "hacks" of Sony straight to YouTube comedy flops.
the bad news: the trade off will be even less personal privacy for those who feel the urge to be constantly on their smartphones and otherwise connected to the grid.
Apple and Exxon Mobile are the two most profitable US corporations. Apple earned $39.5 billion last year. Exxon Mobile earned $32.5 billion. The Federal Reserve, however, earned more than both of them put together: $101.5 billion.
As I have said before, it’s amazing how much money you can make when you make the money!
And what did the Fed do with all that money? It gave it to the American taxpayers. Well, more precisely, it gave it to the US Treasury Department. The Fed handed over $99 billion to the Treasury. That payment alone reduced the government’s budget deficit by 16%. The actual deficit was $506 billion. It would have been $605 billion without the Fed’s contribution.
Nor was this a one-off event. Any way you look at it, the Fed is a money-making machine (pun intended). The US central bank has given the government $500 billion since 2008, as you can see in the chart below.
Where do all these profits come from? They come from the Fed’s huge bond portfolio. The Fed owns $2.5 trillion worth of US government bonds and another $1.7 trillion bonds backed by the Government Sponsored Enterprises (a.k.a. Fannie Mae and Freddie Mac). The central bank earned $116 billion of interest income on those bonds last year.
OK. So those bonds represent $4.2 trillion of assets on the Fed’s balance sheet. But, balance sheets must balance. So what’s on the liabilities side of the Fed’s books? The main items are $1.3 trillion of Federal Reserve Notes (i.e. dollar bills, also known as currency in circulation) and $2.6 trillion of deposits placed at the Fed by banks. The Fed does not pay any interest on the Federal Reserve Notes and it only pays 0.25% (or 25 basis points) on the banks’ deposits. Consequently, it paid only $6.9 billion in interest expenses. Therefore, even after deducting various miscellaneous expenses, the Fed still ended up with a profit of more than $100 billion last year. That just might make it the most profitable organization in history!
What’s more, there’s no end in sight for this earnings bonanza. As long as the Fed continues to own those bonds, it will continue to reap fabulous returns – and, it will continue to hand them over the to government, thereby reducing the government’s budget deficit year after year.
The Fed is not alone. Other central banks are getting in on this game. The Bank of England owns 26% of all UK government debt. The Bank of Japan owns Japanese government bonds equivalent to 22% of Japan’s GDP. Next the European Central Bank will begin buying the debt of the Eurozone governments, and by September 2016, it will own nearly 10% of the total.
How can this be? Surely this is too good to be true. How can the central banks print money, buy government bonds and earn enormous profits without causing high rates of inflation or even hyperinflation? It’s possible because Globalization is extremely deflationary. By pushing down wages in the developed economies, the deflationary pressures from Globalization are offsetting, even more than offsetting, all of the inflationary forces that should have resulted from the vast creation fiat money by the central banks.
Fiat money creation and Globalization have never before occurred at the same time. Consequently, this is a unique moment in history that presents both great dangers and extraordinary opportunities. Yesterday, I uploaded a new Macro Watch video that explains the massive profits of the world’s major central banks and discusses their implications for economic policy in the US, the UK, Japan and the Eurozone. The video is called “QE Is Debt Cancellation”.
If you are a subscriber to my video-newsletter, Macro Watch, log in and learn how the crisis in the global economy will affect you. If not, join here:
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. 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.
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