We are becoming increasingly concerned with a turn in the US Business Cycle. The Surprise Index along with other indicators is suggesting that the business cycle has peaked and is headed lower. Small Business Sentiment shows slowing planned hiring as we additionally notice increased levels of announced layoffs and store closings. The US Retail sector is under increasing pressures (which we feature this month in a Special 162 page Supplement) as US Consumption feels the pains of reduced real income.
We are equally concerned about the US Muni Financial market as fiscal problems at the state and local level are becoming increasingly evident such as in Puerto Rico, Illinois and Chicago. Infrastructure spending has all but stopped to pay for debt servicing costs and public service employees pensions & benefits. Rating downgrades spell potentially serious financial problems for fiscal funding going forward. A slowing business cycle and turndown may be something many state and local governments will not be able to handle in 2015.
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WAR ON CASH - Is the War on Cash Just an Extension of the War on Gold?
Martin Armstrong warns: "The only way to prevent the banking collapse is to prevent people from withdrawing cash. Hence, we see this trend is surfacing in all the mainstream press to get the people ready for what is coming – the elimination of cash. We are starting to even see this advocated in parts of Germany. We will not be able to buy or sell anything without government approval. That is where we are going ..."Martin Armstrong
Supporting this we additionally read:
* Italy made cash transactions over €1,000 illegal;
* Switzerland has proposed banning cash payments in excess of 100,000 francs;
* Russia banned cash transactions over $10,000;
* Spain banned cash transactions over €2,500;
* Mexico made cash payments of more than 200,000 pesos illegal;
* Uruguay banned cash transactions over $5,000; and
* France made cash transactions over €1,000 illegal, down from the previous limit of €3,000.
So what is going on?
This chart tries to put some perspective on the changes we have been living through.
Fear has brought changes that have systematically impacted our personal control of our bank deposits, transfers, withdrawals and even usage.
The bottom right of this chart, as you will soon see, has become so exhaustive as to be make the chart difficult to draw.
There is a serious shortage of bonds which are needed to support collateral lending.
1- REGULATORY RULES
First of all we have new regulatory rule which are slowly seizing up the liquidity in the $100T bond market.
New Basel III bank capital requirements made it too expensive for banks to hold certain inventories of securities on their books.
The Volcker Rule under Dodd-Frank prohibited certain proprietary trading that was an important adjunct to customer market making and provided some profits to make the customer risks worthwhile.
Fed and Treasury bank examiners were looking critically at highly leveraged positions in repurchase agreements that are customarily used to finance bond inventories.
2- FROM MARKET MAKERS TO AGENTS
Taken together, these regulatory changes meant that banks were no longer willing to step up and make two-way customer markets as dealers. Instead, they acted as agents and tried to match buyers and sellers without taking any risk themselves. This is a much slower and more difficult process and one than can break down completely in times of market distress.
3-HFT COMES TO BOND MARKET
In addition, new automated trading algorithms, similar to the high-frequency trading techniques used in stock markets, were now common in bond markets. This could add to liquidity in normal times, but the liquidity would disappear instantly in times of market stress. The liquidity was really an illusion, because it would not be there when you needed it. The illusion was quite dangerous to the extent that customers leveraged their own positions in reliance on the illusion. If the customers all wanted to get out of positions at once, there would be no way to do it and markets would go straight down.
4-HIGH QUALTIY SWAPS COLLATERAL
Another factor that Mr. Bond and I discussed over dinner was the shortage of high-quality collateral for swap and other derivatives transactions. This was the flip side of money printing by the Fed. When the Fed prints money, the do it by purchasing bonds in the market and crediting the seller with money that comes out of thin air. This puts money into the system, but it takes the bonds out of circulation. But banks need the bonds to support collateralized transactions in the swap markets.
A SHAKEY SHADOW BANKING SYSTEM
The importance of the bond issue must be put in perspective within the REPO market which underpins the Shadow Banking System and was at the root of the financial crisis in 2008 when the Asset Backed Commercial Paper (ABCP) market seized up. Today REPOS have replaced ABCP as the short term leveraged lending tool through Rehypothecation and Collateral Transformations.
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