29th November 2011: Economic Excerpts In The Cold November Rain – Kyle Bass

Quote of the Day:

The spending idiocy of the World is gonna catch up with itself and that’s where we are today.

Kyle Bass – Hedge Fund Manager

Macro Overview

• Much of what I needed to say on the Eurozone has been said and I’ll update you if things change… if you’d like a quick refresher here are some links to the most popular key articles on the Eurozone:
  • Greek Sovereign Debt Crisis, Part 1
  • Greek Sovereign Debt Crisis, Part 2
  • The Art of Political Deception, Part 1 – Evolution of the Greek Debt Crisis
  • EFSF = The Mother Of All Sub Prime CDOs

 

Kyle Bass

• I’m taking a few days off writing extensive opinionated material and will choose instead to provide you with a few choice excerpts/videos/links which I think have shaped my views this year and will shape my forecasts into next year.
• Today – interview with Kyle Bass Part 1

• Today – interview with Kyle Bass Part 2

28th November 2011: Navigating The EU Minefield

Quote of the Day:

When our perils are past, shall our gratitude sleep?

George Canning

Macro Overview

The Long March To European Union

• It’s hard to have a thankful spirit in this, the most depressing of Thanksgivings for the market since 1932, but we must be grateful for what we have. The perils are far from past and there is indeed much sorrow in the World… but not all is bad. Indeed, beyond all the hysteria and market volatility one could argue, philosophically, that Europe has never been this close to achieving its ultimate goal: a harmonious, economically sustainable family union. We now know that the European Union in its original form is most certainly not sustainable – surviving the most economically and geopolitically benign 15 years from 1993 to 2007 is hardly a rigorous testing ground for such an ambitious project. Let’s face it the global recession was a bad one but it was not centered in Europe, the wheels fell off the Euro-cart at the first speed bump we hit. I know it sounds crazy to say such a thing at such a time, but, with talk of Treaty change, moral hazard (especially vis-à-vis ECB money-printing) and political compromise; Europeans are genuinely giving themselves a chance of achieving greatness. Out of great destruction comes great opportunity.
• I’ve had a skeptical view of this global recovery since it began. In fact, I’ve been skeptical of the global economy for about 15 years, if I’m brutally honest. I guess that puts me in the gloom and doom column. But I think it’s important to decipher the real risk convections from just the momentum of the media hype.
• Loyal readers of mine will know that I suggested that 3 things needed to happen in order to sort out the EU crisis (the main headwind to the global economy today). I called them the short, medium and long term solutions. The critical issue I had stressed was a need for a change in the very fabric of the EU foundation, the treaties. I even suggested ways which the treaties could be adjusted to enforce fiscal consolidation via democratically punitive triggers and yes this would imply a loss of sovereignty. But in my mind if you embrace a European political union and single Euro monetary union then you, de facto, embrace a loss of sovereignty. In fact I’m actually surprised it took so long to get to this point.
• Things are far from fixed, not by a long way… but a journey of a thousand miles begins with one step.

 

Market Overview

Stocks Bounce On General Optimism

• Forget the headlines, the markets are correctly pricing in what is a more optimistic scenario for the entire Global Economy. Although I still think much of the developed world will endure a pretty hefty recession (or growth recession), I think that the worst case scenario (disorderly collapse) is getting less and less probable. Stocks, bonds, volatility markets should all be pricing this in … and they are doing.

 

Caution Is Still Justified In The Financial Sector

• My Chart of the Day is just a reminder that all is not well in Europe. I think there is massive significance in the political changes that are being suggested. But remember they are just suggestions not actions. Will Italians be comfortable with a “loss of sovereignty” to other Germany, Austria, Netherlands and other European states. Indeed, will Germans be happy with the new supra-national layer above them? Who knows… and due to entirely to 18 months of political dithering, the political challenge is significantly greater than it would have been if this discussions had occurred 18 months ago, or even 6 months ago, for that matter. The chart below shows that there is still a huge amount of fear and friction in the European inter-bank lending markets – it shows the LIBOR-OIS spread.

 

Chart of the Day

Euro LIBOR-OIS (Source: Bloomberg)

 

 

Events

Macro Events:

Update:

• Nothing Significant

Alerts:

• South Africa GDP
• Switzerland GDP
• Sweden GDP

 

Corporate Events:

Results:

• Nothing Significant

Dividends:

• Nothing Significant

 

Reading, Links:

Nothing Significant

27th November 2011: EU Politicians Must Strive To Be Eagles, Not Turkeys

 

European Parliament ?

Quote of the Day:

Avoid being a Turkey and avoid the obvious risk!

Eric Fry – Daily Reckoning

 

Macro Overview

Thanksgiving Turkeys

• Eric Fry of the esteemed Daily Reckoning (I recommend you subscribe to this service) simplifies economic arguments eloquently.
• With respect to the sovereign debt crisis epicentred in Europe Eric Fry says:

At the end of the day you’re gonna end up with a far worse situation (you already are) than if you’d simply let a bankrupt government fail.

• Dithering in the Eurozone at such a crisis point is making European politicians look more like a gang of squabbling turkeys. At some point a leader will emerge, perhaps it will be Merkel, perhaps it will be Super Mario Draghi… or perhaps someone we do not expect at all. The expedition of leadership matters at times like this, but, as they say: it must be hard to soar with eagles when one is surrounded by turkeys.

Market Overview

Stocks Have Another Wretched Week

• Another wretched week in the markets last week. Media is trying to put on a positive spin on the situation and in a normal situation they would not need to. I mean the biggest black Friday spending spree in history and finally the Europeans do look as though they’re making some sort of progress on the debate. But these are not normal times…  who knows where the markets will close next week but I would not be surprised to see a relief rally.

The “least bad” currency is the Dollar – for now…

• The Dollar is on a tear, as I’ve mentioned before, we need to watch the situation very carefully inEuropein the build up to Christmas. Some very important decisions could be made which seriously affect the Dollar and the Euro’s status. Chart of the Day: Dollar Index.

Chart of the Day

Dollar Index (Source: Bloomberg)

 

 

Events

Macro Events:

Update:

• German Inflation

Alerts:

• Mexican Inflation Numbers

 

Corporate Events:

Results:

• Nothing Significant

Dividends:

• Nothing Significant

 

Reading, Links:

Nothing Significant

24th November 2011: The Eurozone Endgame is Nigh: “Treaty Change” – At Last A Substantive Debate

 

Light At The End of the Euro-Tunnel ?

Quote of the Day:

With (Chancellor Angela) Merkel, we will soon make proposals on modifying the treaties to prevent countries from diverging in the budgetary, economic and fiscal areas,

 

Nicholas Sarkozy – French President

 

Macro Overview

“Treaty Change” is on the Table in Europe – hate to say I told you so… but I told you so

• 12 weeks is a long time in this market. But 12 weeks ago I remember explicitly stating that the way to solve this Eurozone crisis was to change the very fabric of the glue holding it together… namely CHANGE THE TREATIES that were agreed long ago (Maastricht Treaty, Stability and Growth Pact, EU Treaty)… I’ve since referred to this many times in my comments. Here is a quote:

They’re missing the most obvious solution in my opinion which is what Donovan calls the confederation of Europe. I’ll go one stage further and say I think the best solution would be to reform the Maastricht Treaty and Stability and Growth Pact. Let’s call it “The Eurozone Consolidation Treaty”.

• Then I set aside specific actions which would change the treaties should be changed – namely to STRUCTURALLY enforce more fiscal discipline and economic management of the region (not leaving it to vague “guidelines”) where automatic punitive measures come into play for countries which do not adhere to the limits.

• Listen, it’s all here http://theinternationalperspective.wordpress.com/2011/09/08/ read it for yourself…
• At the time this was regarded as politically impossible, outlandish, perhaps even fool-hardy, insane, idiotic… right?
• OK… I now forward you the headline in Reuters just hitting the tape…

 

French President Nicholas Sarkozy has embraced a German campaign for treaty change that could give European authorities intrusive powers to intervene in the national budgets of countries sharing the euro currency.

France and Germany will soon propose amendments to the European Union treaty in response to the bloc’s sovereign debt crisis, Sarkozy said on Tuesday.

“With (Chancellor Angela) Merkel, we will soon make proposals on modifying the treaties to prevent countries from diverging in the budgetary, economic and fiscal areas,” he told an Asian forum inParis.

“We will do everything not just to defend Europe but also to consolidate it.”

• You know where you heard it first, dear reader, and I believe we may have entered the end game here. It’s been a long time coming but I actually see light at the end of the euro-tunnel – especially if Germany and France revamp the EFSF with something tangible.
• The Dollar has rallied hard since I called an end to my bearish stance which was great, but it may be time to resume the Dollar short again and perhaps even buy Euros again (!?). Let’s see how all this pans out – it’s only a headline so far and much more needs to happen. But, in my opinion, EU leaders may have just cleared the path for a relevant debate and perhaps even some action towards a sensible solution.

 

Market Overview

Thanksgiving – Give Thanks You’re Not a Fixed Income Broker

• Markets quiet due to US Thanksgiving but I was just just talking to a friend of mine who told me fixed income volumes were down 75% according to some independent data providers. Ouch! Nobody wants to put money to work it would seem – no bottom fishing this month. It seems everyone is mesmerized by European CDS prices and Angela Merkel’s lips.
• But as is so often the case the media, obsessed with money-printing as a solution to all things (not, coaxed by the banking sector, who don’t want any more write-downs – honest!) ignored the most important and fundamental change that Merkel and Sarkozy had finally agreed upon: Treaty Change. For those who think this is not substantive enough – bear in mind that’s all the Euro is… one big Treaty. This is a plee to find a fundamental solution to what is a fundamental problem.

Thanksgiving – Give Thanks You’re Not Shareholder of: GRPN, AIG or RIM

• What can I say, Groupon lost almost 40% of its value in 3 days and now trades well below IPO price. I can’t say I’m particularly sympathetic with shareholders, but it does point to the nature of the IPO market and just how poor sentiment is out there – and, given the amount of front-loaded “investment” Groupon management put into the company, this was definitely a sentiment driven stock. Chart of the Day: Groupon share price.

• We shouldn’t be so hard on Groupon – afterall it’s only been trading a few days, but AIG and RIM – now that’s a different story. These two behemoths are pretty much the only big non-bank names which have lost over 60% of their value this year. Fighting it out for the supreme prize of worst performing stock of 2011 – still one month to go but it looks like RIM is gonna “win” though. Chart of the Day: AIG and RIM YTD charts.

 

Chart of the Day

Groupon's Fall from Grace (Source: Bloomberg)

 

AIG YTD (Source: Bloomberg)

RIM YTD (Source: Bloomberg)

 

Events

Macro Events:

Update:

• German GDP in line at +0.5% QoQ (+2.5% YoY)
• UK GDP in line at +0.5% QoQ (+0.5% YoY)

Alerts:

• Mexican Inflation Numbers

 

Corporate Events:

Results:

• Genting [GENTMK],

Dividends:

• Johnson & Johnson [JNJ], Loews [L], Marriott [MAR]

 

Reading, Links:

Nothing Significant

23rd November 2011: Don’t Let the Inflation Dog off the Leash – FENTON! FENTON!!!!

Quote of the Day:

…over the next few quarters, the MPC’s most important judgment call will be put to the test … we will all discover whether inflation declines rapidly

Paul Tucker – BoE Deputy Governor

Macro Overview

Don’t Let the Inflation Dog off the Leash – FENTON! FENTON!!!

• Inflation is fine so long as you expect it to happen, some say. Yeah, try telling that to a German back in the 1930’s. Not only did they expect inflation they were prepared for it, they yearned for it, prayed for it… but when they let the genie out of the bottle they realized they had no control over it. It was like letting an excitable dog off the lead in a field full of deer… you just don’t know what will happen next or if indeed you will have the tools to contain it. FENTON!!! FENTON!!! I have to say this video made me laugh, Fenton is a dog after my own heart. But this irate guy running after his dog is a good metaphor for how much control authorities truly have over inflation expectations once they lose credibility leash.

• UK BoE is beginning to realize the consequences of runaway inflation. Despite showing a pretty graph to the press on how they expect CPI to drop considerably from its unthinkable 5% YoY level the BoE has been quick to quell any speculation over more stimulus – at least in the short term (although they did unanimously agree to maintain the existing QE plan). The bank has lurched so far to the “stimulus” side of the stimulus/credibility trade-off that it risks losing so much credibility that it lets go of the dog lead… FENTON!!! FENTON!!!

Market Overview

German Bond Auction Disaster

• Markets were left reeling after a German (yes that’s right a German) bond auction failed quite spectacularly to fill its books. These were supposed to be the bonds everybody wanted. That’s a bit like turning up to a kiddie’s party with ice cream and finding out that they’d rather eat broccoli.
• But it’s not just Germany– bond investors are willing to buy almost everything other than European debt (see Chart of the Day for Greek CDS) even US Treasuries!
• As we watch French yields rise to a level which shows that the market already thinks that France has lost its AAA status, Stephen Gallo thinks that, were it not for QE this would be happening in money-printing countries like the UK and the US. Which begs the question: what would happen to Dollar assets if (when?) Europe sorts itself out?

Waiting for QE

• I have to say I’m a little surprised by the US market reaction today. Sure Chinese HSBC PMI was down but who, in all honesty, takes this number seriously. Well I supposed it may not be as manipulated as the official statistics – that’s one thing going for it. But less money flow into Europe should be good for US assets and the GDP deflator was so low that it left the door open to more speculation over QE. But the German bond auction seemed to dwarf everything – the market is really worried about a messy end to the European saga. You can’t take your eyes off this – we are literally right into the crunch time which could change everything… forever!

Chart of the Day

Greek 5 Yr CDS (Source: Bloomberg)

Events

Macro Events:

Update:

• US PCE Core Deflator – in line at (+0.1% MoM)

Alerts:

• German GDP
• Taiwanese GDP
• UK GDP

Corporate Events:

Results:

• Nothing Significant

Dividends:

• Nothing Significant

Reading, Links:

Nothing Significant

22st November 2011: Why The Germans Understandably Hate Inflation

Sweeping up Bank Notes - When Cash Becomes Trash

Quote of the Day:

There is no way it will work, at least not for a longer period — because, of course, following massive buying … as a political solution to this crisis, after a while people would realize that what is on the European Central Bank’s books has to be recapitalized by someone,

Angela Merkel – speaking on ECB participation

Macro Overview

Why the Germans Hate Inflationary Policies

• It’s not hard to see where German hatred of inflationary policies come from. WWII arose out of hyper-inflation in the Weimar Republic which saw Germany at the epicenter of the most expansive war in the history of mankind.
• Remember, Germany is a massive and growing exporter outside of Europe and, as the European consumer hits the skids, this is only likely to increase as a proportion of total exports. ECB money-printing would likely lower the exchange value of the Euro boosting their exports. The fact that Germany campaigns against ECB participation gives you an idea of just how petrified they are of unruly inflation expectations.
• If you look at the chart below it shows how the Paper Deutsche Mark rose against the Gold Mark from 1 to 1 Trillion in the six years from 1918 to 1924 – quite a remarkable feat. Imagine how disruptive this is on a highly productive economy like Germany’s. This is a chart engrained onto the soul of every German – they are not going there again.

German Hyper-Inflation

Why the Germans Hate ECB Monetization

• Well, monetization is inflationary policy, so it stands to reason, why they’d hate it doesn’t it? True, but so many historians and pro-print pundits point to the fact that WWII was caused primarily by the oppressiveness of the Versailles Treaty in the aftermath of the first World War. But this misses the point, the economic reality was that, for whatever reason, there was a sovereign debt problem in Europe (and debt takes many guises). The Germans felt they had no alternative but to inflate their way out of this debt and the rest, as they say, is history.
• Since the painful aftermath of the Second World War, Germany’s Bundesbank has been modeled on a strict mandate of price stability and, under this resolute stewardship of inflation, the German economy has indeed flourished. The ECB is a central bank crafted (correctly in my view) in the same mold of this stoic, uncompromising Bundesbank. With monetary authority over a wide variety of cultures it was even more imperative that the ECB had a simple, pure mandate, unpolluted by political influence, untainted by conflict. Employment distractions and a bias towards monetization and money-printing are highly charged political hot-potatoes for any central bank, never mind a supra-national central bank, to contend with.

Why the Germans Will Not Tolerate Even A Temporary Direct ECB Participation

• This was really well explained in a WSJ Blog yesterday. A typical modern western central bank can print the heck out of its fiat paper currency and can simultaneously cohesively suppress inflation statistics while making the argument that, as soon as inflation “appears”, they’ll be extremely pro-active in reversing the inflationary policies. But, ironically, the ECB is actually more inherently righteous than this as, due to its structure, it finds this argument is much more difficult convey.

• Firstly because, once the bank loses sight or control of inflation, within a culturally broad region of independent fiscal authorities, the dispersion of inflation risk increases greatly. Some cultures within the Eurozone could be in outright deflation (periphery) while other parts are getting cooked by rampant inflation (Germany).
• Secondly, and more importantly, the ECB (arguably the last bastion of supra-national credibility within the EU) immediately loses credibility by overtly stepping over the strict mandate line enforced on it. Additionally, if the ECB makes the decision to monetize peripheral debt, it must do so assertively and with a communicated long term objective (we’ve already seen that the market does not buy half-measures, and the market will test the ECBs resolve on anything like this). By making a heavy and almost indefinite commitment to purchase peripheral debt, the inflationary effects will be felt inGermanyalmost immediately and the Euro will probably tank – exasperating the problem. The ECB and the whole of Europe would then have a gargantuan problem. As German inflation careers out of control, the ECB, having just vaporized most of its credibility, must:

1. Continue with its monetization until peripheral economies are safely out of their debt trap – meanwhile the most productive economy in the Eurozone will have hit the self-destruct button. Good luck managing the fallout from that.
2. If it tries a U-turn and begins a sudden tightening policy, what little credibility it has, will finally desert it – you now have a central bank with no credibility trying to fight runaway inflation in what was the old Weimar Republic. Good luck managing the fallout from that.

Sympathy For The Germans (For a Change)

• I have criticized the way Germany has positioned itself forcefully within the Eurozone and I’ve noted how they have benefited from the weaker Euro and I’ve criticized them for actually being the protagonists who discredited the fiscal framework of the Stability and Growth Pact in the first place (see the excerpt from the Guardian in this piece).
• That said; I do sympathize with their argument with respect to inflationary monetary policies. Not only is there inherent moral hazard to money printing in general, ECB direct involvement with sovereign debt purchases will likely expose more, not less, flaws within the Eurozone framework. I believe treaty change, as I’ve commented on many times (see here for suggestions I made long before it was on the tip of Merkel’s tongue) to be imperative if the Eurozone is to survive. This is because it is fiscal accountability and the very foundations upon which the EU was constructed are the root causes of many of the fractures within the Eurozone.
• Germany is as much to blame as all the other countries for this crisis, as I said in my piece Brokeback Europe:

…there is little fiscal discipline within the EU and therefore little credibility. This is not an opportunity to point nationalistic fingers; this is a fault within the constitutional framework itself. The EU was a collective creation, this gaping policy hole is a collective, European mistake.

• But just because Germany is as much at fault as every other nation, does not mean we should ignore their suggestions for a solution. The southern European states should accept that direct participation by the ECB in the debt markets is out of the question, they should grant Germany this but in return they should demand that German taxpayers put up a significant amount of collateral into the EFSF to draw a line under this once and for all. That is where the negotiation process should be – at the moment Europeans are arguing about which argument they want to have! We’re a long way from finding and implementing a solution, it would seem.

Market Overview

Persistent Volatility

• The 30 day moving average of the VIX has been over 30 for 3 months now – outside of the Great Recession the last time we were at this elevation for this long was in the quarters directly proceeding the September 11^th Terrorist Attacks.

Group-Off!

• I’ve chosen to show Groupon chart today in my Chart of the Day. Stock hit $20. It opened at $26 yesterday, so at one point that stock had lost 25% of its value.

Chart of the Day

Groupon (Source: Bloomberg)

Events

Macro Events:

Update:

• US GDP worse than expected at +2.0% (+2.5% expected)
• Eurozone Consumer Confidence – bad but roughly in line with expectations (-20.4)

Alerts:

• US PCE Core Deflator (should give us more insight into that GDP number)
• South African GDP

Corporate Events:

Results:

• Deere [DE],

Dividends:

• HSBC [HSBA LN],

Reading, Links:

Nothing Significant

21st November 2011: The Super (US) Committee vs The Super (EU) Commission – Western Politicians Hit Rock Bottom… Then Started To Dig

Quote of the Day:

A committee should consist of three men, two of whom are absent.

Herbert Beerbohm Tree
Macro Overview

The Super Bad Committee are Super Bad

• Capitol Hill’s finest were assembled into and elite, crack-pot, collection of super-brains, locked into a room and told to “sort out the budget”. Now, as the deadline approaches, it seems to be a Herculean effort just to get them in the same room. The West is at it again, snatching poverty from the jaws of prosperity.
• Check this video out from Peter Schiff a few choice excerpts:

…instead of [the ECB] buying the bonds that nobody wants how about making the bonds attractive to investors…

… it’s not going to monetize its way out of a crisis, it will just monetize its way into an even deeper crisis…

… the increase in US interest rates is gonna start when we get some kind of short term resolution to the European crisis. I think, contrary to what a lot of American politicians claim, the problems in Europe are not hurting the US economy, they’re actually helping this phony US economy sustain itself. Because so many people are worried about the Euro, they’re buying the Dollar, they’re buying treasuries…

Market Overview

The “Giffen Behaviour” of Treasuries – look at the yield curve shape not the absolute yield

• Well American’s can’t complain. They’ve had at least 2 months of respite as Europeans strained every fibre in their collective body to snatch poverty from the jaws of prosperity.
• If I had a dollar for every time some media pundit said “people are ignoring the problems withAmerica’s budget once again because they’re buying treasuries” I’d be a rich man. Let’s be clear, people are not buying treasuries because they are optimistic about the state of the Global or US economy or the state of the budget or political progress. Nor are they ignoring these factors, they are buying treasuries because they are fearful of the economic outlook.
• It is like PIMCO’s Kashkari said;, if you feel a building is going to collapse in an earthquake you run down the stairs, towards the origin of the tremor. Lower and lower treasury yields over the past 5 years are not a sign that people are happier with the state of America’s finances. Do they honestly think, with anemic growth expectations, people are more optimistic now about the state of America’s fiscal position than they were in 2006?
• You see Treasury price-dynamic work on a similar psychology to “Giffen Behaviour” – the less attractive the price is for the product, the more demand there is for it. If you want a better indicator of sentiment in the treasury markets, look at the yield of the 10 year note in relation to the 2 year note, or in other words, the yield curve steepness (see Chart of the Day).

Chart of the Day

US Yield Curve Steepness (Source: Bloomberg)

Events

Macro Events:

Update:

• Nothing Significant

Alerts:

• Nothing Significant

 

Corporate Events:

Results:

• Nothing Significant

Dividends:

• Hershey [HSY],

Reading, Links:

Nothing Significant

20th November 2011: Short, Medium and Long Term Solutions to the Euro-crisis

20^th November 2011: Short, Medium and Long Term Solutions to the Euro-crisis

Quote of the Day:

Gaining credibility is a long and laborious process… but losing credibility can happen quickly.

Mario Draghi – ECB President

Macro Overview

How to Solve the European Crisis: Short, Medium and Long Term Solutions

• Back to the economic problems at hand. To be honest not much has changed economically with the EU – perhaps that is why European indices are closing in on their lows of the year. In some cases (Italy, Greece) it’s a case of same problem, different personnel.
• I’ll suggest how the economic problems in the EU may be addressed. It may surprise you to note that I actually err in favor of a German-style solution (amendments to the Treaties) not a Fed-esque: “print first, ask questions later” approach. Never-the-less one cannot embrace a central bank structured to dance to the tune of a German economy without Germans taking some ownership of the fallout. Here, humbly, are my short, medium and long term solutions to the crisis and there is no order of priority here. Because the can cannot be kicked any further, it is just as imperative that we implement long term solutions immediately:
1. Short Term (to secure the days and weeks ahead) – unfortunately, either by flawless design or comical ineptitude, politicians have succeeded in procrastinating so long that the credibility of the ECB is already in freefall. The ECB now has little choice but to put its foot on the gas with respect to direct money printing/monetization of peripheral debt in order to avoid the falling chips of a collapsing financial system  dictating how Europe is finally structured. However, the ferocity of short term actions depend largely on how the medium and long term actions are implemented. However, much though I hate to say it, looking at the EU’s record thus far it’s likely that the only short term solution would be: ECB must print money (the French way).
2. Medium Term (to secure the months and quarters ahead) – No gimmicks or fancy tricks. The EFSF must be funded with real collateral, real capital and real commitment by the European core to a degree which puts the security of the financial system of the Eurozone beyond doubt. Notice, I did not use the word “cash” – Italy, France and Germany, for instance, have a lot of Gold reserves. It does mean, though, that tax-payers from the European core must put their hands in their pockets, metaphorically – there is simply no other way. So the medium term solution would be: front the capital for the EFSF (the financial way).
3. Long Term (to secure the years and generations ahead) – political structural reform with respect to the fabric of the European Union. Treaty changes and changes in legislation, strip it back and start again from first principles. So the long term solution would be: political reformation of the EU (the German way).

• It’s an interesting game of cat and mouse within the EU. The Germans have the economic power and therefore impose that they have the political power. The French have the political power and therefore impose that they have the economic power. You see, if the German’s could implement #3 immediately, there would be much less need for #1 and #2. But the more the process is delayed, the more the markets will enforce #1 upon them, irrespectively. As time goes on, the decision-tree sways toward the French side of the debate. Time is on France’s side of the debate, not Germany’s. One could almost say that this is a subtle game of brinkmanship, but it’s all very interesting, I have to say – who knows how this will turn out?

The UK Referendum Debate – Leaders Need to Lead

• So much talk about how “undemocratic” the EU has become, how sovereign states are sacrificing their sovereignty to an “elite” in Brussels (indeed within their own governments). How the political class have rebuked demands from their own people and endeavored to rape them, the people, of their democratic rights. Which begs the question: when should the government authoritatively govern and when should political power be abdicated by the minority that is government and released temporarily to the vast majority that is the electorate. These are the elastic boundaries of modern democracy and they are being tested today in Europe at full stretch.
• Remember The European Commission is the nuts and bolts of the EU – this is where legislation which directly affects Europeans is drafted. With responsibility for a $16Trillion economy and a population of 500 million people, it is perhaps astonishing that so much power has been granted to a European political body whose representatives are not directly voted for by the public. The European Parliament, of course, is a democratically established institution but its role is a little administrative, by comparison. The forefront of all government is expressed in the creeping political evolution through the constant creation of new legislation – but it is the European Commission which has this power not the European Parliament.
• If you are confused, then don’t worry, so are the half a billion Europeans in the Union – it’s not hard to see why many Europeans are skeptical of senior pro-Euro politicians (even within their own government, never mind other people’s governments) and just how much of their/our collective interests they truly have at heart. The reality is; many iconic and tectonic shifts in political landscapes happen in Brussels without democratic ratification that the public can truly relate to. The argument being that: political development is always with our “collective interest” at heart. But the politicians work for us: the onus is on them to convince us that this truly is the case and, if they cannot, then they must not do anything and leave the critical decisions to us.
• The UK referendum debate is just as interesting as the proposed vote itself. Indeed, it would appear the dissenting back-benchers emanating from all parties are pounding the table for a referendum in the UK. So this is not a partisan issue. Instead, the divide seems to have occured between those at the very top of government (perhaps the so-called “elite”) and those much closer to the electorate – what I would call “on-the-beat constituent representatives” and back-benchers, who seem to think the EU “decision” is so important to the future of Britain,  it should unquestionably be embodied in a much purer democratic process.
• Is this a good time for democratic purism? I don’t know. Is this a good  for political authoritativeness? I don’t know. What I do know is that the idea of membership of a European Monetary Union, indeed a European Union, has never had greater attention among everyday Europeans, including the British. We are at a cultural inflection point, the debate has never been so important, so poignant, so visible nor has so much ever been at stake.
• This is a definitive time for Europe and huge decisions are about to be made which will affect every one of its 850 million people – even those not in the EU. If Britain values its own self-interest, it must be a part of the decision-making process – even if it decides to exit the Union and the decision-making process altogether. If David Cameron and our senior politicians do not have the spine to make these massive decisions for Britain, then it is imperative that they should allow the public to do so for Britain.
• Skeptics would say that these are terrible times in Europe, but I’m more optimistic. With great turbulence comes great opportunity – these are exciting times in Europe, but we do need our leaders to lead.

Market Overview

“What Does This Button Do?” – The Last Words Said in European Parliament

• Poor Europeans, they try to come up with solutions but keep hitting the self-destruct button. If only Europe wasn’t so complicated. If only everyone had the same agenda, the same ideals, the same persuasion… but then it would not be European would it? Greek CDS rose again to new highs (see Chart of the Day)… so much for a new unified leadership.
• Same problems, different personnel.

Chart of the Day

Greek CDS (Source: Bloomberg)

Events

Macro Events:

Update:

• Nothing Significant

Alerts:

• Nothing Significant

Corporate Events:

Results:

• Nothing Significant

Dividends:

• Nothing Significant

Reading, Links:

Nothing Significant

17th November 2011: The ECB Conundrum: Sarkozy wants Merkel to “Swear in Church”

Quote of the Day:

I am convinced that only political solutions can resolve the situation

If politicians think the ECB can solve the euro crisis, then they are mistaken.

Angela Merkel

Macro Overview

Merkel and Sarkozy Clash As The Clock Runs Down

• “Time is running out” said Buiter, Citi’s Chief Economist. That’s an understatement but Buiter also mentioned the main spanner in the works, the Germans liken purchasing government bonds to “swearing in church” – for the Germans, it’s just not done.
• Reuters reports today that France andGermany are clashing over ECB crisis role.

1. Germanyfavours a political and fiscal revolution re-writing the treaties to hardcode political union
2. France favours a monetary revolution – with the ECB playing a greater role as the “lender of last resort” either directly monetizing or indirectly by re-engineering the EFSF as a bank which can borrow from the EFSF.

• I’ve been a little critical of the way Germany has positioned its authority within EU thus far, but, in this sense, I actually prefer the German solution. In many ways the ECB is the finest central bank in the World – not that this is saying much. But the problems with the dysfunction of the Great European Experiment do not lie with the ECB, the flaws are not monetary flaws, they are political flaws – in particular in the way the treaties were constructed. Working within that political framework, the ECB has got a pretty good record, it has to be said (and I hate talking up central bankers of fiat currencies, you should know that!). So trying to solve fiscal imbalances with monetary activism only exacerbates the problem, in my opinion – political miscalculations need political solutions.
• Of course, loyal readers are fully aware of my thoughts on this – I have written extensively about it in previous comments. But, what I believe should happen and what I believe will happen are two separate arguments. In my view, the ECB may be coaxed into playing a more prominent role in the EU drama, perhaps covertly or “by stealth” as Niall Ferguson put it.

Market Overview

Risk Apathy In the Markets

• I couldn’t even tell you why stocks are selling off today… all I know is they are – the data wasn’t all that bad (UK Retail sales up, US Jobs data slightly better than expected). It’s one of those days where the market just seems to have given up trying to convince themselves thatEuropewill sort itself out.
• Chart of the Day shows how despondent the market is, investors buying 10 year treasuries at just over 2% because they don’t know what else to buy, so theUSyield curve gets flatter still.

Chart of the Day

US 2s-10s Steepness (Source: Bloomberg)

Events

Macro Events:

Update:

• Nothing Significant

Alerts:

• Brazilian Inflation
• Canadian Inflation

Corporate Events:

Results:

• Heinz [HNZ],

Dividends:

• Prudential [PRU],

16th November 2011: China Risk is Front and Centre (again)

Currency Wars

Quote of the Day:

…the Eurozone crisis is not just closely related to the unstable recovery of the global economy against the backdrop of the international financial crisis but was also a result of the long term accumulation of internal problems…

Wen Jiabao’s barbed retort to European Council’s Van Rompuy after he failed to turn up to his appointment to meet the Chinese Premier.

Macro Overview

China: Geopolitical Risk From The West

• Obama gave China a public verbal beating the other day telling the World’s growth engine to start behaving like an economic “grown up”. Hmpht! Talk about the pot calling the kettle black. Chinese officials must be laughing at this for sure – who are the Americans to start lecturing people over financial prudence? “Ah, that’s the problem with these democracy-junkies“, they’ll scoff, “as soon as an election appears around the corner they’ll say any old claptrap to get a few votes – even if it is not constructive to the future of the country!“
• But you can feel the uneasiness of a relationship under strain as the US announced that it would station more troops in the Pacific Rim today and ups the ante on the protectionist debate and anti-China rhetoric. I think relationships between the two symbiotic powers of the World are now as tense as they were two years ago when Obama ignored China’s pleas not to meet the Dalai Lama. Remember that day Chinese admirals subsequently refused the customary ceremonial tours as the USS Nimitz in the Hong Kong harbour. As I wrote at the time in my piece, Geopolitical Chess-Moves Between China and the US: “a move which Americans are playing down but are a little shocked by, I think”.
• Never-the-less, attacks on China are coming from many quarters. Europe views China a little more cautiously (perhaps with a little more respect) after they embarrassingly failed to get the so-called “dumb money” to buy into the basket-case that was the EFSF. As Van Rompuy found out (see Quote of the Day above), China is quite prepared to stamp its authority, now that it actually has some.

Christine Lagarde’s New IMF Holds No Punches on Chinese Financial Sector Risk

• Also, after berating Europe and its lack of discipline, the IMF turned East, issuing a stark warning to the Chinese about the precariousness of its banking system. A lot of people have the misconception that China has a limitless amount of cash at its disposal. That is simply not true when you consider the obligations of its own, and if you have to bail out an entire banking system those dollar bills (already being systematically debased) will disappear quicker than an iphone4S in a Central Hong Kong Apple Store – just ask the Europe, hell… just ask the Americans!
• Of course, dear reader, we know the nature of investment risk in China, indeed I wrote in my extensive piece: Prepare for The Dragon’s Fat Tail Risk.

Some of my friends in closer dialogue with Greater China businesses think that magnitude of bank losses due to NPLs may be greater than book equity of the banking sector as a baseline case. Don’t ask what the worst case scenario is, it’s too horrific to put into print.

• IMF also sounded the recession alarm bell for Hong Kong. The Telegraph cited:

Rampant lending since the 2008 financial crisis has left many companies and local governments in China with huge debts, while a recent slowdown in economic growth and falling property prices have fuelled fears of an explosion in defaults.

While China’s financial sector was “robust overall”, inefficient credit allocation and other weaknesses needed to be addressed, said Jonathan Fiechter, deputy director of the IMF Monetary and Capital Markets Department.

• But, again, the IMF is not telling us things we didn’t already know, dear reader. Over the months, I’ve made it quite clear that, while leverage and NPL problems in Greater China are bad, if you’re looking at NPLs (and comparing them to equivalent levels of sub prime debt in the US banking system, for instance) then you’re missing the point. The point about having massive state interjection of influence into an allocation process best suited to capitalism is more to do with the, almost entirely immeasurable, latent inefficiencies of capital. Not long ago I sounded a  cautionary tale…

• Breakneck Growth in China hides a lot of cracks beneath the surface. I’m not just talking about NPLs it’s the entire nature in which capital is allocated in a business society used to persistently high growth and relatively low inflation.
• This has been touched upon by Peking University Professor, Michael Pettis, in particular in a couple of pieces:

1. Small Companies Feel the Pain in China – Pettis
2. China Incentives and Debt – Pettis

• To quote a couple of sentences from the second piece:

In all previous cases of countries following similar growth models, the dangerous combination of repressed pricing signals, distorted investment incentives, and excessive reliance on accelerating investment to generate growth has always eventually pushed growth past the point where it is sustainable, leading always to capital misallocation and waste.  At this point – which China may have reached a decade ago – debt begins to rise unsustainably.

• I leave you with a quote from Michael Pettis, which I have used before, from a talk which you really must listen to if you care about investing in Asia, or anywhere for that matter (click here: Pettis on China Risk)…

If there is massive mis-allocation [of investment/capital] then you would also expect that which ever sector of the economy is effectively paying for this misallocation, their share of economic wealth should be declining.

Is there such a sector in China? Yes, of course there is: it’s called the household sector…

• I’m not saying that the Chinese growth story will come crashing to an abrupt halt – indeed only yesterday I mentioned the long term growth considerations for China and paraphrased that, eventually, the sun will rise in the East and set in the West. But nothing goes up in a straight line and, if you’re unprepared, the down-shocks can be so violent and persistent it won’t matter what your long term view is. These capital misallocations appear superfluous most of the time and lie dormant as just minor frictional business costs of an economy growing at lightening speed. Until the day they don’t… then all hell breaks loose.

Market Overview

Japan stumbles to new low

• I suppose I should let you know that the Topix – Japan’s equity index closed at a 1.5 year low today at 724 (yes that’s even below the Fukushima/Tsunami close). If we go through 700 that’ll be below the 2008/9 recession levels and the lowest level since (wince!)… 1984 – YIKES!  See Chart of the Day.

European Credit Market In Turmoil (still)

• I’m not going to talk about the European markets too much today (its too depressing) I’ll just show you the updated French-German 5 Yr CDS Spread – see Chart of the Day.

Oil Prices – Inflation is back – just when we didn’t need it

• After disappointingly persistent inflation data out of Europe and the US it really looks like the central bankers’ hands are tied. But we know their hands are never tied, they’ve been pretty adept at conjuring excuses to print more up until now. But it’s hard to ignore the facts as we look at light crude bursting through $100 like its on a mission – see Chart of the Day.

Chart of the Day

Tragic Topix (Source: Bloomberg)

France-Germany 5 yr CDS Spread (Source: Bloomberg)

Sweet Light Crude Back Above $100 (Source: Bloomberg)

Events

Macro Events:

Update:

• Spanish GDP Growth – stalled (0.0%)
• Eurozone CPI – persistent (3.0% YoY)

Alerts:

• Bank of Japan– Rates
• Spain GDP
• US Inflation (CPI)
• US Industrial Production

Corporate Events:

Results:

• Pernod-Ricard [RI FP], SAB Miller [SAB LN], San Miguel [SMB PM]

Dividends:

• Capital One [COF], Singapore Airlines [SIA SP],

Reading, Links:

China Risk:

• China Risk #1
• China Risk #2
• China Risk #3