Hmmm

A walk around the fringes of finance

ALFreD HItCHCOCK

THINGS THAT MAKE YOU GO

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Im full of fears and I do my best to avoid difficulties and any kind of complications. I like everything around me to be clear as crystal and completely calm.

Dialogue should simply be a sound among other sounds, just something that comes out of the mouths of people whose eyes tell the story in visual terms
Alfred Hitchcock

Always make the audience suffer as much as possible

Alfred Hitchcock

There is no terror in the bang, only in the anticipation of it

Alfred Hitchcock

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Alfred Hitchcock are movie makers. The men were born in different centuries, on different continents and applied their talents to vastly different styles of film-making, yet both became legends in their chosen field. the two men developed styles all of their own that have spawned many imitators throughout the years and both developed techniques that would change movie making forever. In 1951, the English auteur released Strangers on a train which began a run of movies that culminated in 1960 with perhaps Hitchcocks greatest film; Psycho (though personally, I prefer 1959s North by Northwest which I must have watched a hundred times in my life and it still never gets old). In 1958, however, Hitchcock released a movie starring James Stewart and Kim Novak that was based upon the French novel Dentre les Morts by the wonderfully-named Boileau-Narcejac. Hitchcock titled his film Vertigo. The film was a psychological thriller that centred around a former police detective John Scottie Ferguson who had been forced into early retirement due to clinical depression and vertigo. Upon its release, Vertigo received mixed reviews, but, over time, it has come to be widely regarded as one of the finest pieces of work of Hitchcocks long carer and is a fixture on just about every Best 100 Films list. Burns, born in Brooklyn, NY, chose a less-dramatic oeuvre but his accomplishments have been equally impressive as he has helmed a series of documentaries that have become part of the fabric of American society.

Ken Burns and

From his first solo project after an apprenticeship served, of all places, at the BBC, Burns set about adapting David McCulloughs book The Great Bridge about the construction of the Brooklyn Bridge for a documentary feature. Burns debut project earned him an Academy Award nomination and set him on his way to a career filled with such landmark documentary projects as The Civil War, Baseball and The War (all of which were multi-part television documentaries that garnered record ratings). The cinematographic techniques that the two men pioneered were wildly different and yet they became synonymous with the men who popularized them (even though neither man laid claim to inventing that which ultimately bore their name); The Ken Burns Effect and the Hitchcock Zoom Anyone with a video camera, an iMac and some time on their hands is probably familiar with the Ken Burns Effect. It is a panning and zooming technique whereby the director inserts still photographs into a movie and by zooming in, focuses the attention of the viewer on a certain isolated piece of the full picture. The technique is designed to keep the viewer occupied and entertained by material that would otherwise look a little staid and to ensure that attention is paid to the precise piece of the picture that the director wishes to be the centre of focus rather than what he has decided is the extraneous material cluttering up the edge of the view. The Hitchcock Zoom is an altogether different technique that is aimed at unsettling the viewer through a dramatic change in perspective. It was first developed by a cinematographer named Irmin Roberts, but was popularized by Hitchcock when used extensively in Vertigo to convey..... well, you can probably figure that out all by yourself.

As I sat

ruminating about the muchvaunted Draghi plan this week ahead of thursdays announcement by the head of the ECB, I

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Google Trends Searches For Grexit

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couldnt help but let my mind wander to the devices employed by Messrs. Hitchcock and Burns to either unsettle their viewers or make them focus on a specific part of the whole, rather than the big picture itself. For the last eighteen months, we, the viewers, have been manipulated by a seemingly never-ending procession of Eurocrats, bureaucrats, technocrats and who-said-thats to look at a very precise part of the economic picture rather than be allowed to step back and try to take in the wider situation. Techniques have been consistently deployed that, like the Hitchcock Zoom, are designed to unsettle and unbalance us in order to keep us disorientated enough to question what is real in our surroundings. Accordingly, I thought this week I would take a step back, ignore where the Ken Burns Effect of Draghis words were pointing my attention, turn a blind eye to the conflicting rhetoric emanating from the various actors in the Theater of the Absurd and concentrate on the big picture - to try and make sense of the broader reality. It damned near gave me vertigo. So lets take a look at the Ken Burns Effect, the Hitchcock Zoom and then step back and try to see the reality of three parts of the dynamic currently confronting us in Europe. And where better to start than the cradle of kleptocracy democracy; Greece.

SOURCE: GOOGLE TRENDS

In late-August, Asmussen was asked to comment on the possibilities and consequences of a Grexit (a loathsome portmanteau, coined by Willem Buiter of Citigroup, that only came into existence in February and into the public conscious in May as you can see from the above graph. Hopefully it will disappear just as quickly): (RT): A Greek exit from the eurozone would be manageable but very expensive, not only for the crisis-troubled country, but for the whole region, European Central Bank policymaker Joerg Asmussen said ahead of the German and Greek foreign ministers meeting. Firstly, my clear preference is that Greece should remain in the currency union, Asmussen said in an interview to Germanys Frankfurter Rundschau daily. Secondly, it is in Greeces hands to ensure that. Thirdly, a Greek exit would be manageable. However, Asmussen warned that a so-called Grexit would not be as painless as it seems. It would be associated with a loss of growth and higher unemployment and it would be very expensive in Greece, Europe as a whole and even in Germany, he pointed out. Two weeks earlier, another familiar Eurocrat had offered his thoughts on the <gulp> Grexit: (Pan-European Networks): The Prime Minister of Luxembourg and the leader of the Eurogroup, Jean-Claude Juncker, has suggested that a Greek exit or Grexit from the euro-

The Ken Burns Effect: Greece

The gentlemen on the left is Joerg Asmussen. Asmussen is an economist and Germanys representative on the ECB governing board as well as a high-ranking member of the Social Democratic Party of Germany.

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zone could be managed. Speaking on Monday Juncker said: From todays perspective, it would be manageable but that does not mean it is desirable because there would be significant risks, especially for ordinary people in Greece. Michael Fuchs, deputy parliamentary leader of Angela Merkels Christian Democratic Union party, had this to say on August 17: (UK Daily Telegraph): ... A theoretical exit for Greece would be manageable, he said, adding that the exposure at this stage is about 17bn if Im not mistaken, virtually all of it in the public sector. Clearly, the part of the picture that we, as viewers, are being very deliberately pointed towards focussing on is a manageable Greek Exit or, as I shall hereinafter refer to it in protest at the awfulness of Buiters term, a Hellboy (which is a portmanteau of Hellas and Boycott). Either way, the script is set. Greece leaving the Eurozone is nothing to worry about. By concentrating investors minds on the fact that the exit of Greece from the Eurozone is manageable, the Eurocrats are attempting to reduce the volatility that the uncertainty surrounding the Hellenic Republic engenders in a world where volatility and uncertainty reign supreme. Fortunately for them, the breadth of attention that markets seem to be able to summon up currently is sufficiently narrow that a certain degree of success is possible with even the flimsiest of smokescreensafter all, its virtually impossible to keep track of the hundreds of different statistics and metrics that form the sum of the financial mosaic in which we find ourselves.

possibly going to ask for a softening of the bailout terms, the reaction suggested that was not about to happen any time soon. Greek finance minister, Yannis Stournaras, deflated the trial balloon put the rumours to rest in no uncertain terms: (FT): The programme is off-track and we cant ask for anything from our creditors before we get it back on course, Mr Stournaras told the Financial Times. There is light at the end of the tunnel but it is a long tunnel, he added A mere 40 days later, on a taxpayer-funded Summer tour of European capitals, Greek PM, Antonis Samaras held meetings with Francois Hollande and Angela merkel as well as our old friend Jean-Claude Juncker, Luxembourgs Prime Minister by day (a role he has somehow held since 1995) and, by night, avenging President of the Eurogroup. At each stop there were pictures of the smiling leaders embracing and shaking hands after productive talks had been held and, it was readily apparent to the viewing public, that the programme had to somehow be miraculously back on track. Surely? (RFI): Greece is in the eurozone and Greece must stay in the eurozone, Hollande said at a joint press conference with Samaras at the Elysee palace. But it still has to demonstrate the credibility of its programme and the willingness of its leaders to go the whole way, while doing it in a way that is bearable for the population. Translation: Greece must do something which is essentially impossible, but it will be done because it must be done. Yes, folks, in the Eurozone, it really is that simple. Hollandes enthusiasm (or perhaps the richness of the lunch menu) seemed to suffuse Samaras, who was even more upbeat: I also think that we can achieve our goals and our commitments, reduce deficits, our debt, complete the structural change we have begun, he said

The Hitchcock Zoom: Greece

The most recent wobble in the Greek situation (or the Grituation) was back in July when, after government-sponsored leaks to the press popular opinion seemed to suggest the Greeks were

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So... Were back where we started, right?

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Fantastic! Oh.... There was, as the late Steve Jobs would have said, one more thing: Samaras is reported to want an extra two years to put through the next stage of the package 11.5 billion euros-worth of cuts that are currently supposed to be made in 2013-2014. No matter though, because that old favourite the person with knowledge of the discussions had this to say: (FT): The prime minister stressed his commitment to accelerating structural reforms, especially privatisation, in order to turn the economy around and start creating jobs, one such person said. It went well, there was a good atmosphere, another aide said. An IMF official said: We dont have any comment on the talks at this point. When Samaras reached the German capital a few days later, however, the Hitchcock Zoom was used to full effect: German Chancellor Angela Merkel on Sunday warned that every day counts in efforts by debt-wracked Greece to comply with its commitments and safeguard its euro zone membership. In this context, every day counts now to really strengthen efforts and apply what has been promised, Ms. Merkel told ARD public television when asked about how confident she was in Prime Minister Antonis Samaras. Ms. Merkel said that much confidence had been lost over the past two and a half years and reiterated the need to now wait for a progress report, due next month, by Greeces international creditors. Like others I have said to the Greek prime minister that there is still a lot to do, she said.

Certainly, the headlines on Bloomberg on August 25 would seem to have thrown markets off balance through several dramatic changes in perspective: HOLLANDE: PEOPLE SHOULD STOP ASKING IF GREECE WILL STAY IN EURO HOLLANDE SAYS GREECE HAS TO DEMONSTRATE CREDIBILITY SAMARAS SAYS GREECE WILL STAY IN THE EURO ZONE Alexander Dobrindt, general secretary of the Christian Social Union, said he sees no way around Greece leaving the euro area, Bild am Sonntag reported, citing an interview. Dobrindt sees Greece out of the euro in 2013 Greece should receive EU support when it leaves the currency union and have the option of returning: Dobrindt Enough of the selective focus and dizzying perspective changes folks. Its Reality time.

REALITY: Greece
When we ignore the various misdirection devices being used to confound, confuse and selectively focus the markets and simply step back far enough to take in the whole picture, things are very stark, but at the same time actually remarkably simple indeed. Greece is broke. Not only is Greece broke, but it has absolutely no chance whatsoever of either paying back the first tranche of 110 billion granted to it under stringent conditions on May 2, 2010a bailout that meant the imposition of severe austerity for Greeks and elicited a response that could hardly be described as surprising: (NYT): The new austerity package was met with great anger by the Greek public, leading to massive protests, riots and social unrest throughout Greece. On 5 May 2010, a

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national strike was held in opposition to the planned spending cuts and tax increases. In Athens some protests turned violent, killing three people. ...or the portion of the second bailout (a further 130 billion agreed in June 2011just 13 months after the initial sum had been granted) advanced so far. In fact, in early August the Greeks had to pay back 3.2 billion to the ECB and it was clear that there was no way they could raise the money so, in a perfect example of the Bizarro World in which we live, the ECB announced that it would raise the amount of short term Greek government bonds allowed to be posted with it as collateral thus enabling Greece to raise the money to pay them back through such a short-term bond issuancean issuance 60% that could be immediately pledged back to the Bank of 50% Greece by the buyers (read Greek banks) in exchange 40% for cash. Dont believe me? Ask Wolf Richter:
Number Unemployed (%) 30%

If Greece defaults in September, these T-bills in the hands of the Bank of Greece will remain in the Eurosystem, and all remaining Eurozone countries will get to eat the loss. 3.5 billion or more may be printed in this manner. The cost of keeping Greece in the Eurozone a few more weeks Greek unemployment is now spiraling out of control and, as can be seen in the graph (below) almost one-in-four Greeks are out of work and, amongst the under-25s that number is a staggering 53.8%. The Troika are now back in Greece to prepare a report on how the country is doing in its attempts to comply with the tough conditions put
Greek Unemployment (% Total and Under-25)

53.8%

23.13% 20% (via ZeroHedge): [The ECB}...allowed Greece 10% to sell worthless treasury bills with maturities of three and six months 0 June 04 June 05 June 06 June 07 June 08 June 09 June 10 June 11 June 12 to its own bankrupt and Quarter Unemployed (Under-25) SOURCE: BLOOMBERG bailed out banks. Under Unemployed (Total) the Emergency Liquidity Assistance (ELA), the upon it when the second bailout was approved banks would hand these T-bills to the Bank in June of 2011 and that report is currently due of Greece (central bank) as collateral in exto be released on October 6th at which point the change for real euros, which the banks would next tranche of bailout funds will be released then pass to the government. Thus, the Bank assuming of course everything is back on track. of Greece would fund the Greek government. It wont be, because it cant be. Precisely what is prohibited under the treaties that govern the ECB and the Eurosystem Not only do the maths simply not work (and, of central banks. But voila. Out-of-money once again Ill reiterate the fact that the laws of Greece now prints its own euros! The ECB mathematics cant be subverted), but Greece approved it. The ever so vigilant Bundesbank has neither the ability nor the desire to impleacquiesced. No one wanted to get blamed for ment reforms as draconian as those required Greeces default. while it is still shackled to the Euro and unable to default, devalue and begin the process of re-

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building its economy. The other reality surrounding the Hellboy lies within the Target2 system, the SMP and a little something called Lex Monetaebut more of those little realities a little Later. For now, lets move on to Spain, shall We?

The New York Times outlined what the creation of the Bad Bank would do: (NYT): The move is meant not only to let Spanish banks eventually begin to receive money from the 100 billion, or $126 billion, reserve that European finance ministers have approved, but also to restore market confidence in the countrys banking system. While Reuters explained the mechanism through which it would be effected: (Reuters): The Spanish Treasury will inject 6 billion into the states bank rescue fund to beef up its firepower... The FROB fund will receive both state debt and cash, the source said, adding that the operation would boost its capital base to 15 billion euros from 9 billion. The source also said the move should not impact Spains liquidity position in a substantial way. The Spanish government injects debt into the States banking rescue fund to help shore it up and the rescue fund will absorb the sectors toxic assets so they can move on. Focus people! The problems have gone away.

THE KEN BURNS EFFECT: Spain

The selective focus point towards which we are being directed when Spain moves front and centre lies at the heart of a banking sector that is riddled with both unacknowledged non-performing loans as well as toxic assets that, were they marked to anywhere near market value would torpedo the entire Spanish banking sector. Of course, those problems are going to be repaired instantly by the ring fencing of anything bad that lies within it through the use of an old favourite strategy - the bad bank. Lets selectively focus on how great things are going to be in the Spanish banking sector once everything is fixed, shall we? The problem presented by the Spanish banking system is easily resolved; you simply set up a bad bank, transfer all the bad assets to it and, Hey Presto, no more banking sector problems. (BBC): The Spanish government is creating a bad bank into which all the toxic property assets of its debt-laden banking sector can be off-loaded. The move is aimed at helping the countrys troubled banks draw a line under the debt crisis and move on. The Bank of Spain will assess the value of the assets being transferred into the banco malo and the banks will receive cash, debt or shares in return, said economy minister Luis de Guindos. The bad bank could last 10 to 15 years. The rotten assets being off-loaded must have a value that allows the bad bank to make a profit in the long-term, said Mr de Guindos after a cabinet meeting.

THE HITCHCOCK ZOOM: Spain

Spain is one dizzying perspective change after another, but this week saw Spanish finance minister Louis de Guindos throw everybody for a loop when he threatened mentioned in passing that perhaps Spain wouldnt accept a bailout after all if the terms were too harsh for their liking: (UK Daily Telegraph): In an escalating game of brinkmanship, Spanish finance minister Luis de Guindos said his country is not yet willing to sign a Memorandum giving up fiscal sovereignty to EU inspectors. First of all, one must clarify the conditions, he told German newspaper Handelsblatt. Mr de Guindos said the crisis engulfing the region is larger than any one country and

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end of the month.

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warned north Europe not to scapegoat Spain. My colleagues are aware that the battle for the euro will be fought in Spain. Spain is right now the breakwater for the eurozone, he said, adding that solidarity would be welladvised. De Guindos message, roughly translated is this: This isnt Spains problem, its Europes problem. Or, as JP Getty famously put it: If you owe the bank $100 thats your problem. If you owe the bank $100 million, thats the banks problem. Spain is very much the banks problem.

Once the thin end of the wedge had been inserted, the hammer was brought down: (Yahoo! Finance):A bailout for Spains teetering banks, once requested by Madrid, could amount to as much as 100 billion euros, two senior EU sources told Reuters on Saturday. Spain has not yet made a formal request for European aid but it could come during a conference call of euro zone finance ministers, the sources, who were both on an earlier call to discuss the technicalities of a rescue, said. A decision on Spain will only be taken ... by the ministers (in a second call). Madrid has not officially asked for help yet, one of the officials said. The statement will mention 100 billion euros as an upper limit. From no bailout to 30 billion to 100 billion in the space of a week. Pretty impressive. The reality is likely to be far morehundreds of billions more. In fact, a little under two months later,we are already at 300 billion: (UK Daily Telegraph): The warning [from de Guindos] comes as German Chancellor Angela Merkel leaves for Madrid for talks with premier Mariano Rajoy to thrash out the conditions of a full sovereign rescue of up 300bn (238bn), beyond the 100bn bank rescue already agreed. There is a very good reason why Seor Rajoy is refusing to submit to a programme in order to get a bailout and that is because if any outside observer were to be given a look at Spains finances, the true scale of the disaster would become apparent. The signs have been there for all to see in recent weeks as, one-by-one the Spanish regions have stepped forward with their hands out: (UK Guardian): Andaluca, Spains most populous region, has said it needs a 1bn (800m) advance to pay its bills... it comes as Catalonia, the second most populous region,

Reality: Spain
In December 2010, seven regional savings banks (Cajas) were consolidated into what was, effectively a Bad Bank. This had the effect of creating the fourth largest bank in Spain with 12 million customers and 328 billion in assets. That bank was called Bankia. Seventeen months later, Bankia requested a bailout of 19 billionthe largest in the nations historyafter a previously-reported 328 million profit was restated as a 4.3 billion loss. Seventeen months. In June of this year, the subject of a bailout for the entire Spanish banking sector was first raised. The initial amount that would be needed, it was estimated, would be 30 billion. (Channel News Asia): Eurozone finance ministers agreed Tuesday to offer Spain 30 billion euros this month to help its distressed banks as they raced to stay ahead of market scepticism. After nine hours of talks, Jean-Claude Juncker, the Luxembourg premier who also heads the Eurogroup , said a memorandum of understanding for Spain would be formally signed in the second half of July, with 30 billion euros (US$37 billion) available by the

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warned that if it does not get rescue money by the end of the month, it will be in serious trouble and must seek a bridging loan. Catalonia has asked for 5bn from the rescue fund to cover debt-rollovers and deficit spending this year. Regional finance boss Andrea Mas-Colell has warned it may have to apply yet another round of spending cuts before the end of the year. But this is just the tip of the iceberg. Spanish unemployment is now in a similar state to that of Greece (chart below, left) as the construction sectorwhich at its peak in 2007 employed more people than any of the 27 EU nationsimplodes (chart below, right). A Eurostat report demonstrates perfectly the problem with the Spanish construction sector: (Eurostat): In terms of the number of persons employed, the construction sector in Spain was the largest among the Member States in 2007; the 2.9 million persons employed in these activities represented a little less than one fifth (19.5 %) of the construction workforce in the EU-27. In terms of value added generated, however, the construction sector in the United Kingdom was largest (19.2 % of EU-27 value added), despite having a workforce that was about half the size of that in Spain. Meanwhile, the government has started tapping its social security fund in order to pay its bills:

(UK Daily Telegraph): It emerged today that Spains social security system has raided a rainy-day fund to cover state pensions for the first time as deepening recession erodes contributions. Tomas Burgos, social security minster, said the government had drained 4.4bn from the Fondo de Prevencion financed from workers illness insurance to the meet the shortfall in July, reducing the account to just 400m. Mr Burgos said Madrid may have to use all mechanisms at our disposal to meet payments, revealing that the next step may be a raid on the pension systems 67bn Reserve Fund. The pension system has been losing contributors as unemployment soars to 25pc. It shed a further 137,000 jobs in August. But it is the capital flight out of the country which is truly breathtaking. A recent Goldman Sachs report highlighted the massive acceleration in deposit outflows from Spain in 2012 (chart, top, next page): To put this into perspective, in July alone 74 billion, or 4.7% of the entire deposit base of the country was withdrawn. A report this week from Nomura laid out the reality of Spain with painful clarity: (FT): The main conclusion from looking at the details of the country-specific balance of payments within the eurozone is that Spain is in
Spanish Construction Sector Employment Index

3000
60 Spanish Unemployment (% Total and Under-25)

50

52.3%

2500

40 Number Unemployed (%)

2000
30

Workers (000s)
24.90%

20

1500

10

1000
0 30/6/04 30/6/05 30/6/06 30/6/07 30/6/08 Quarter 30/6/09 30/6/10 30/6/11 30/6/12

Unemployed (Under-25) Unemployed (Total)

500 Sep 02

Sep 03

Sep 04

Sep 05

Sep 06

Sep 07

Sep 08

Sep 09

Sep 10

Sep 11

SOURCE: BLOOMBERG

SOURCE: BLOOMBERG

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There are three main pillars of the capital flight. First, foreigners are large sellers of Spanish securities. In the latest quarter, this generated an outflow of 19.4% of GDP. Second, there is a large outflow from Spanish residents accumulating foreign bank claims. In the latest quarter, the outflow from this source was 16.7% of GDP.
SOURCE: ECB/GOLDMAN SACHS

a category of its own. While there are some outflows in countries like Portugal and Italy, the size of these outflows is not nearly as large as in Spain. On a 3-month rolling basis, Italys outflows represent about 15% of GDP currently, while they represent about 50% of GDP for Spain. In Italys case, both portfolio outflows and other investment outflows represent a touch more than 5% of GDP. For Spain, both sources of outflows are much larger; about 20% of GDP in the case of portfolio outflows and about 30% in the case of other investment outflows (chart, below). The report explains who is pulling money out of Spain at such a frenzied pace but, apart from foreigners and Spanish residents it seems as though everything is hunky dory:
% of GDP 40 30 20 10 0 -10 -20 -30 -40 -50 -60 2006 2007 2008 2009 2010 2011

Third, there is a large outflow from foreigners liquidating banking claims in Spain. In the latest quarter, this was 15.3% of GDP.

I could go on, but time and space are short so Ill summarize thus; Spain is going to need a fullscale, all-singing, all-dancing bailout. Soon. By soon, I mean within several weeks which could mean it will be requesting aid at almost exactly the same time as the Troika report on Greece is issued. The Eurocrats will then be faced with a situation wherein they are being asked for several hundred billion euro in aid for one of the largest members of the Eurozone and must decide whether to throw an additional 20 billion down the black hole that is Greece at the same time knowing full well that it is money they have zero chance of ever seeing again. 20 billion to keep the ponzi scheme going might seem an insignificant amount of money to them at that point, but I suspect, after seeing the Draghi Plan unveiled this week, Greece is about to be made an example of to prove to the German electorate world that there are consequences of not being good Europeans. The fact that seniority concerns were addressed for the OMT (Outright Market Transactions) this week but not for the SMP into which billions of euros of Greek bonds were siphoned is telling indeed.

2012

SOURCE: BOS/BOI/NOMURA

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Oh, did I mention that Spain currently owes the Target2 system 408 billion(40% of GDP)? No? Well well get to Target2 shortly, but before we do, its time to focus our attention on one more topic.

This last pointhardly covered by a press corps focussed on the u-wordis likely to end up being the single worst thing to happen to the citizens of Germany since the invention of the mullet. Watch this space.

THE KEN BURNS EFFECT: The Draghi Scheme

The use of the Ken Burns Effect this past week by Mario Draghi was worthy of an Academy Award nomination for cinematography. With a carefully orchestrated leak (via his old pals at Goldman Sachs) of just about every detail of his upcoming plan, Draghi successfully managed to focus the attention of the markets on one specific piece of his cleverly-crafted scheme (hereinafter referred to as the Dreme. Hey, Willem, this is easy!). Granted, he had help in that the piece he wanted focus to be on was exactly the piece everybody had been waiting (and, frankly, hoping desperately) to hear. One little word; unlimited. By using the u-word, Draghi ensured that the minor details of his proposal to conduct unlimited sterilized buying of bonds were passed by as his camera panned smoothly across a bunch of confused faces to settle on the word unlimited. It was beautiful. Incidentally, how many of you even spotted that I just used the words unlimited and sterilized in the same sentence? Thought so. By focusing us all on what we wanted to hear, Draghi managed to generate an impressive bounce in markets on Thursdayafter all, he just promised essentially unlimited intervention, but outside of the warm, fuzzy comfort of unlimited bond buyingsterilized, of coursethe questions remained. Almost lost in the hoopla was the fact that the ECB has now lowered its collateral requirements to the point where they will loan cash against essentially any old junk that isnt nailed down in a banks headquarters.

THE HITCHCOCK ZOOM: The Dreme

Its hard to explain how markets could have been caught off balance and dizzied by The Dreme after all, what he said had appeared almost verbatim on every major newswire in the days immediately prior to Thursdays press conference, but dizzied they were. In the lead-up to the big event, the usual perspective changes were evident as a stream of headlines hit the tape that were guaranteed to generate just the right amount of angst: MERKEL TELLS LAWMAKERS SHE OPPOSES UNLIMITED ECB BOND PURCHASES MERKEL CAN ACCEPT TEMPORARY ECB BOND BUYING, BARTHLE SAYS MERKEL CAN ACCEPT ECB BOND BUYING OF SHORT MATURITIES: BARTHLE ECBS DRAGHI DOESNT HAVE TOO MUCH SUPPORT FROM MERKEL, MERKEL BACKS WEIDMANN ECB CAN ONLY BUY BONDS ATTACHED TO CONDITIONALITY The Germans are out... no, wait, theyre in but only temporarily... yes, theyre in but only if the purchases are at the short end... no, wait, Merkels backing Weidmann and he threatened to resign over this last week so that must mean the Germans are out... hold it...as long as theres conditionality The Dreme can go ahead unchallenged... Dizzy yet? Then Thursday came and The Dreme was laid out in all its glory. European banks soared (in some cases as much as 15%) as Super Mario

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REALITY: The Dreme

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promised to take all their risky bonds off their hands at a nice fat profit and stick them on the taxpayers of Northern Europes his own balance sheet. This generated perhaps the most dizzying of all the effects of The Dreme which was to be seen in the short end of the Spanish and Italian sovereign bond curves which have now retreated from 6% and 5% respectively to sit comfortably below 3%.
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Spanish & Italian Government 2-Yr Bond Yields

Draghi has gone all-in in his efforts to save the Euro and, in doing so, he has set the stage for one last political battle which will be fought against an immediate backdrop of the German Constitutional Court ruling on the validity of the ESM and the Dutch elections (both taking place on Wednesday and both with the propensity to throw up a shock or two) as well as the Troikas upcoming report on Greece. Economic data right across Europe suggests a recession is imminent for most countries and that will undoubtedly roil the political status quo. Throw in the inevitable riots in Greece and Spain as tensions over increased austerity flare, the burgeoning North South divide and you have anything but a stable environment under which The Dreme can be implemented. No sooner had Draghis checkbook been taken out, than the power players of Europe began chirping at one another (including the usual references to WWII): (UK Daily Telegraph): Former Spanish premier Jose Maria Aznar said the EMU crisis had poisoned relations between North and South. We have a situation where one country has become the hegemon, and that is Germany. This is the first time we have seen anything like this since the Second World War, he said in Cernobbio. The bitter clash was all too evident in press headlines on Friday. Germanys Die Welt ran with Markets Cheer Death of the Bundesbank, playing on deep-seated German fears over the loss of monetary control. Italys Il Giornale - owned by the family of expremier Silvio Berlusconi - splashed with ECB slaps Bundesbank in the face. Its lead story highlighted the risks for Italy if it accepts the Faustian Pact of an ECB bond rescue. States have to renounce sovereignty and hand over the keys to the house to European bankers, who will obviously impose heavier sacrifices, it said.

Italy 2-Yr Yield Spain 2-Yr Yield

July

August

September

SOURCE: BLOOMBERG

Now, this is obviously good for Spain and Italy (particularly Italy whose primary surplus has meant that its biggest problem has just been gaining access to cheap moneythough in recent months the economic picture in the country has deteriorated dramatically), but, as is always the case in Europe, there is a certain amount of dizziness inherent in the situation. Under the strict conditionality rules surrounding the OMT (Outright Market Transactions) announced by Draghi, anyone making use of the programme must request a formal bailoutand that means its Troika Time. Thus far, without buying a single bond under OMT, The Dreme has had a strong effect on markets, but those markets are just front-running what they see as the inevitable bailout request from Spain. However, as long as Spain can fund itself at the short end at these levels, the pressure is off them to request a bailout at all which means their debt will inevitably be sold off. And round and round it goes.

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Draghi has temporarily released the pressure on Europes peripherals, but he has had to go beyond to the very edge of his mandate. What happens next is open to debate but the Eurocrats are bound to find a way to ensure we have no more than a few days of relative calm ahead of us. The simple reality is this: The Eurozone is absolutely unworkable in its present form and, if those in charge of it dont decide on their own that it needs to be reworked, then markets will make that decision for them. If and when they do, it will be anything but manageable. Spain will need a bailout that will dwarf those given to Ireland and Greece, the Greeks will have to be cut loose and forced to return to the Drachma and governments will fall right across the continent before this is settled, bringing the kind of political instability and strength amongst extreme parties that hasnt been seen since the dark days of the 1930sa return to which the Eurozone was ironically designed to specifically prevent. Yes, I know this has run a little longer than usual, but weve just got one more thing to deal with:

of the Eurozone. Currently, the claims and liabilities that have been allowed to build up have reached the point where they are binding the countries of Europe together right as the boat steams full speed towards the iceberg. To recap: TARGET2 is the European System of Central Banks (ESCB) balance of payments mechanism. The acronym stands for Trans-European Automated Real-time Gross settlement Express Transfer system. The purpose of TARGET2 is to provide a mechanism for the real-time gross settlement of cross-border interbank and customer payments. The system allows for intra-day finality, which insures that transactions will not be unwound if one of the parties fails to settle. As you can see from the chart below, left, these balances have steadily climbed and, beginning in July 2011, German claims on the system have skyrocketed to almost 750 billionthe vast majority of which is the liability of Italy and Spain. Going back to where we left our friends in Spain a few pages ago, we can see that Seor Rajoy and co. currently owe 408 billion which pretty much makes them Germanys problem because, if they were, to leave the Eurozone Lex Monetae would apply. Whats Lex Monetae? (Morgan Stanley): Lex Monetae is an internationally recognized legal concept. It requires that no party may default on a contract if a government alters its national currency, using a particular conversion rate. Amounts specified in the contract will simply be redenominated to the new currency by using the specified conversion rate. I may not know much, but I do know that 408 billion will be an awful lot of pesetas.

REALITY: Target2
We have spoken at length about Target2 in these pages previously and it really is the Achilles Heel

Until next time...

SOURCE: ECB

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Contents
Fate Of Eurozone Rests In The Hands Of German Judges What If Spain Refuses To Play Mario Draghis Game? Goodbye Doha, Hello Bali Iran May Be Successfully Smuggling Oil, Avoiding Customs Russia To Produce Electricity With Former Nukes The Rise Of Inflation Nations How Do We Measure Debt? Spencer Dale: QE Could Harm The Economy Charts That Make You Go Hmmm..... Words That Make You Go Hmmm..... And Finally.....

09 September 2012

The Gonnie, Gonnie Banks

# 41 Bank First Commercial Bank, Bloomington, MN Total Cost to FDIC Deposit Insurance Fund Assets ($m) 215.9 Deposits ($m) 206.8 Cost ($m) 63.9 63.9

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potential to throw the stock exchange into turmoil, trigger frenzy on bond markets and bring down the German government. So the eyes and ears of the eurozone will be on the eight red-robed judges of Germanys highest court this week when they deliver a long-awaited verdict over whether a financial rescue fund considered crucial to the future of the euro gets the green light. The constitutional court is under international pressure to rule in favour of the European stability mechanism and fiscal pact. A dissenting ruling from the court, based in Karlsruhe, southwestern Germany, would probably cause havoc on money markets and cast doubt on the future of Europes single currency.

They have the

The poll was released a day after the European Central Bank president, Mario Draghi, divulged plans for making unlimited bond purchases to lower borrowing costs for crisis countries in the eurozone. The announcement unleashed a wave of condemnation across much of Germanys media and among a growing band of eurosceptics, who said the scheme would stoke inflation. German fears of a repeat of its 20th-century experiences of hyperinflation and the catastrophic consequences run deep. A black day for the euro, and for all of us! a headline in the tabloid Bild said last week. It said the ECB had effectively written a blank cheque to indebted states by offering to buy their bonds. Jens Weidmann, head of the Bundesbank, issued a statement calling the Draghi decision tantamount to financing governments by printing bank notes and accusing the Italian banker of breaking ECB rules.

The German constitutional court cannot afford to be seen as not being independent, but it also cannot afford to be seen as ... The German constitutional the court that brought down Analysts noted that the the government, said Con- court cannot afford to be seen once mighty Bundesbank stanze Stelzenmller, a se- as not being independent, but had been sidelined. Gernior transatlantic fellow at it also cannot afford to be seen mans feel utterly deserted the German Marshall Fund as the court that brought down and mocked by the fact that in berlin. theyre going to their Bundesbank has been have to try to square the the government so completely isolated, as circle; in other words, not has Germany, said Gunnar bring down the government at the same time as Beck, a specialist in EU law at Londons School asserting their independence. of Oriental and African Studies.While this looks The ruling, due on Wednesday, is expected to give the go-ahead to the ESM, a permanent bailout mechanism, and the fiscal pact, but with caveats such as constraints on future decisionmaking or a ruling that Germanys basic law has to be rewritten if there is to be further EU integration. A government insider told the Observer, on condition of anonymity, that the court is very independent and always good for a surprise. Nobody knows what will happen on 12 September. A poll published on Friday on Spiegel Online showed that 54% of Germans were in favour of the court blocking the legislation, reflecting the degree to which public opposition to bailouts is increasing. like an attractive solution in the short term, in the long term its disastrous, as it takes away any incentive for reform from the countries in crisis.
O O O

UK GUARDIAN / LINK

So Super Mario

did it. the European Central Bank president on Thursday announced unlimited bond buying to tame profligate eurozone members borrowing costs. Under appropriate circumstances, we will have a fully effective backstop to avoid destructive scenarios with potentially severe challenges for price stability, Draghi told an expectant world. The ECB, then, is still referring to price stability, pretending its actions are designed with its

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regular inflation target in mind. We are, patently, a long way beyond that point. Draghis plan is the latest ECB attempt perhaps the most serious yet to prevent the break-up of the single currency. Be aware, though, that perhaps is the operative word. Draghi insists it is impossible any country might leave the eurozone. Yet some of the stronger European governments have admitted theyre preparing for it and, crucially, bond markets have been betting on it for months. Indeed, the reason Draghi has spent the entire summer administering the behind-the-scenes political arm-twisting that made Thursdays words possible is because he knows that unless the European authorities pull an elephantine rabbit out of the hat, then at least one, and possibly several, of the peripherals will be forced by the markets to exit.

Stoxx Europe 600 surging 1.9pc on Thursday, the gains pretty much across the board. Americas S&P 500 was 1.5pc up, hitting its highest close since 2008. Yet the devil, as always, is in the detail. And the detail strongly suggests that the ECBs bond-buying, far from being unlimited, will very much be conditional. Possibly, for that reason, it may even be non-existent. Almost certainly, it wont be in the immediate future.
O O O

LIAM HALLIGAN / LINK

So desperate was the world for relief that Draghis words were like an elixir. In Italy and Spain, not the worst eurozone fiscal offenders but currency. Be aware, though, the ones big enough to matThe aims of the Doha round, ter most, 10-year govern- that perhaps is the operative launched by the World Trade ment yields dropped sharply word. Organisation (WTO) in 2001, after he spoke, by around 20 were laudable. It deliberand 40 basis points respectively. ately put poor countries first, placing particular priority on improving the access of their farmers Sovereign debt prices rose because Draghi said to rich-country markets. It was ambitious too, the ECB would buy unlimited bonds, meaning covering not only trade in manufactured goods, that deeply distressed Club Med debt markets agriculture and services, but also a host of things can theoretically be propped up to an extent more indirectly related to trade (antitrust, intelgoing way beyond the eurozones two bail-out lectual property and foreign-investment rules, funds. Thats good, because one of funds has for example). According to the Peterson Inspent most of its money and the second doesnt stitute, a think-tank, the potential gains were legally exist. around $280 billion a year. Its failure is a tragedy. Draghi also confirmed the ECB will forego the seThe villains are powerful lobbies, notably in agniority status it insisted on during previous purriculture, such as Americas cotton and sugar inchases under the Securities Markets Programme dustries and Japans rice farmers and fishermen. (SMP). So investors thinking about further bankBut there were also two structural problems rolling the eurozone profligates can worry less with Doha. One was the number of countries. about being shoved to the back of the creditor At the end of the first world-trade talks in 1947, queue if the bonds default. 23 countries were involved. When Doha startEquity markets were also euphoric, with the

go hand in hand. When the economic crisis first hit in 2008, world trade and growth collapsed together. In 2009 both recovered, and did reasonably well until this year, when both slipped again (see article). Cutting tariffs and red tape would boost trade, and support the fal... Draghis plan is the latest tering recovery. This should spur efforts to replace the ECB attempt perhaps the failed Doha trade talks with most serious yet to prevent a new effort to do a multilatthe break-up of the single eral deal.

Trade and growth

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ed, 155 were. Second, the idea was to achieve a grand bargain in which agriculture, manufacturing and services would all be liberalised. But reaching agreement on some areas was so difficult that the WTOs mantra Nothing is agreed until everything is agreedproved fatal. After many missed chances to conclude a deal, an absolute deadline was set for December 31st 2011. That too, was missed. Since then, protectionism has been intensifying. In the past two weeks Argentina has lodged complaints against America over lemons and beef and against Spain over biofuels. Altogether, tit-for-tat actions mean that new restrictions cover 4% of global trade, more than Africas exports. On the plus side, disputes over these are being adjudicated by the WTO system. With Doha paralysed, regional alternatives to a multilateral deal are springing up. They are not all bad, but regional deals tend to benefit insiders at the expense of outsiders, so that global gains will be achieved only if they can be fitted together. And the small deals often enshrine rulessuch as electrical and emissions standardswhich vary from region to region, so they make global deals harder to forge.
O O O

Bloomberg: - Irans tanker fleet is the busiest since February as fewer vessels store unsold oil at sea and more switch to transporting cargoes that most crude carriers are barred from hauling, said EA Gibson Shipbrokers Ltd. The number of very large crude carriers operated by Tehran- based NITC in use for floating storage fell to 10 by the end of August, Steve Christy, director at London-based Gibson, said by phone today. That was a six-month low, he said. More of these ships are being used to move crude sales into the international market, rather than to store unsold cargoes in the Middle East region, which is what was happening in 2010, Christy said. This seems to indicate that in spite of the official export numbers hitting new lows, Iran may be successfully bypassing customs registration and smuggling crude to some buyers - likely at a discount to the market. Of course Iranian authorities and companies would never admit to the part about the discount. The smuggling part however is another story. Iran has recently all but admitted to smuggling, and may now be in fact using this export capability as a propaganda tool.

ECONOMIST / LINK

Irans oil output

hit a new low recently as sanctions, particularly those from the eU took hold. the chart below points to an unprecedented collapse in production. And it is estimated that Irans oil exports are now down some 66% YoY. But are the official export numbers right or is Iran finding ways to get around the sanctions? According to Bloomberg, Irans tanker fleet is now on the move. Since February Irans tankers have been used for storage of excess oil that could not be sold into the market because of the sanctions. These ships were kept stationary. But now Iranian crude carriers seem to be on the move.

Irans crude oil production (Bloomberg/OPEC; 1000 barrels/day)

SOURCE: SOBER LOOK/BLOOMBERG

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Tehran Times: - ... Oil Minister Rostam Qasemi said that although the West has imposed sanctions on Irans oil sector with the goal of toppling the Islamic establishment, the countrys oil exports will never be halted because oil consuming countries need Iranian crude. There are many ways to easily sell oil, one of which is to take advantage of businessmen and the private sector, Qasemi added.
O O O

every country on Earth considers this technology barely controllable. Yet this small 600-megawatt reactor in the woods of the Urals has been generating power for 32 years, and has done so largely without event. Its currently the only commercial fast reactor online at full capacity anywhere in the world. Now a fourth unit is being built in Beloyarsk, also a fast reactor. Its a facility with global political significance: Beloyarsk 4 is being built in the service of global peace. On July 13, 2011, a treaty between Russia and the United States came into effect, one that US President Barack Obama praised as a step toward making the world safer and more secure. Under the Plutonium Management and Disposition Treaty, the two nuclear superpowers resolved to destroy 68 metric tons of plutonium, enough to fill 17,000 nuclear warheads. Obama declared that the plutonium could be used to generate power for people in both countires. Russias plan for disposing of its share of the plutonium involves a fast reactor, a variation on the fast breeder reactor design but without a breeding blanket. That alteration gives the power station the capability to destroy plutonium. Operating this sort of fast reactor with weaponsgrade plutonium, though, is a risk no one have has ever taken yet, but this is the plan stipulated in the Russian-American treaty, also known as the 123 Agreement. The Obama administration, on the other hand, prefers to fulfill its side of the disarmament treaty with a more time-tested method: The US share of 34 tons of weaponsgrade plutonium will be used in traditional nuclear power plants. At the same time, though, the US will contribute at least $300 million (240 million) to the construction of the new disarmament reactor at Beloyarsk.

SOBERLOOK / LINK

a picture of smiling children heralds the arrival of a new nuclear age. Zarechny -- Our Nuclear City is the sign that greets drivers entering this town 50 kilometers (30 miles) east of the Russian city of Yekaterinburg along a country road through a wooded landscape. Flowerbeds line the streets of Zarechny. There is a fresh wreath laid at the Tomb of the Unknown Soldier, and the town square draws children with its moon bounces and carousels. The only major street in this city of 30,000 forms a straight line leading to the premises of Beloyarsk, the nuclear power plant that has been providing crisis-proof jobs for local residents for over half a century. Russia is proud of Beloyarsk. The plants third unit is a fast reactor, a reactor type thats similar to the infamous fast breeder reactor. Following various spectacular breakdowns, nearly

A billboard with

CLICK TO ENLARGE

SOURCE: DER SPIEGEL

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This is going to lead to problems! says Yevgeny (name changed), who is involved in the construction of the new Beloyarsk reactor. You shouldnt build a nuclear reactor under time pressure, and certainly not such a complicated one!

future inflation. The justification is that a central bank like the Fed is smart enough to take back the excess money supply before inflation hits, though there is little evidence that this is true.

Bernanke calls the U.S. economy far from satA fast reactor is not your standard power plant, isfactory. This is the right characterization. The he continues indignantly. All it takes is one slopcurrent unemployment rate is 8.3 percent. This pily welded seam, and thats figure understates the diffithat! The reactor will be ... Breathing in just a few mil- culties in the labor market. cooled not with water, but ligrams of plutonium dust is The current ratio of employwith liquid sodium, a liquid ment to population over 16 fatal to humans metal that ignites the mois 58.4 percent compared to ment it comes into contact 62.9 percent five years ago. with the air. The current total employment is 4.2 million less than five years ago. Considering that the labor What makes the new reactor a particularly deliforce normally grows by over 1 million per ancate case, though, is its fuel. num, there must be a lot of discouraged workers who have stopped looking for jobs and are not Of all the bequests of the atomic age, the heavy counted as unemployed anymore. metal that takes its name from Pluto, god of the underworld, is considered the most dangerous. Monetary stimulus works through decreasing A nuclear chain reaction initiated with six kiloborrowing cost or devaluing currency. The forgrams (13 pounds) of the material over Nagamer works if there are borrowers who respond saki, Japan, on Aug. 9, 1945, immediately killed to lowering the interest rate. the U.S. household 80,000 people. Breathing in just a few milligrams sector suffers high indebtedness. Its debt apof plutonium dust is fatal to humans. petite is low. The U.S. corporate sector is sitting O O O DER SPIEGEL / LINK on a record cash level and isnt likely to borrow and invest just because the interest rate is a little lower. The U.S. government suffers a high fisJackson Hole gathcal deficit and cannot increase it due to politiering, Ben Bernanke defended his case for furcal deadlock. The dollar is strong due to the euro ther monetary stimulus to help the economy. It debt crisis and growth recession in emerging appears that QE3 is coming soon, possibly this economies. QE3 may cheapen the dollar a bit, month. I always believed that QE3 would come but wont be enough to make a significant difthis year. The reasoning was based on how the ference because Europe is in recession and the Fed would react according to its dual mandate growth rates in emerging economies are being of price stability and employment maximization. halved. Short-term inflation data drives the Feds inflaQE3 will merely exaggerate bubbles that have tion concerns. As a weakening global economy emerged in some areas. The S&P 500 is close to has recently driven down commodity prices such an all-time high despite a weak U.S. and global as oil, steel, etc., and the weak demand forces economy. Internet stocks, for example, have valsuppliers to discount, the current inflation picuations in the stratosphere. Manhattan flats are ture looks benign. Even though these factors are surging in price again. If QE3 makes a difference, short-term in nature, the Fed has at least an exit is through making bubbles. While there may cuse to ignore the inflation risk. While there is be some gain in the short term, it will lead to bigusually an 18-month lag between monetary polger problems down the road. icy and its inflationary consequence, most central banks tend to emphasize current rather than Mario Draghi, the president of the European

At last weeks

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Central Bank (ECB), promised to do whatever it takes to preserve the euro. His statement turned around sentiment in the Italian and Spanish bond markets. There is little doubt that the ECB has to support these markets to hold the euro zone together. And Draghis commitment works only if it is open-ended, i.e., it is willing to buy an unlimited amount to cap the bond yields for Spain and Italy. The ECB purchases are likely to be in the trillions of euros. As the ECB purchases such bonds from investors, a portion of the money would be diverted out of the euro zone. The resulting euro weakness will be the immediate transmission mechanism for inflation to hit the euro zone. Of course, the net increase in global money supply will inflate goods and services that have low price elasticity. Food and oil are good examples.

a major cause of further declining credibility, and because it is so intensively reinforcing it is a major warning signal. This matters for China for at least two reasons. First, a worsening Europe will make it harder than ever for China to rebalance growth away from investment, and second, China itself is experiencing capital flight. To address the first, any sustained increase in the growth rate of Chinese consumption if indeed this occurs, which in my opinion is very doubtful will not only have to compensate for a reduction in the growth rate of Chinese investment, but might also have to compensate for a reduction in Chinas current account surplus. What is more, the crisis in Europe will only make the global trade environment tenser and nastier.

The ECB bond purchases, if big enough, can hold Notice already what is happening in commodithe euro zone together. It ty-exporting countries like works through inflation to ... Flight capital is both a Indonesia. According to an lower the real cost of social major result of declining cred- article in Thursdays Wall welfare in the crisis coun- ibility and a major cause of Street Journal: tries, like Italy and Spain. further declining credibility, Indonesias trade deficit Cutting nominal expendiand because it is so intensively hit an all-time high in June tures has proven too hard as exports from Southeast to do. The main point is that reinforcing it is a major warnAsias largest economy fell ECB intervention works only ing signal sharply, a sign that weaker if it creates inflation. While demand from China and the the ECB mandate is price West is affecting some of the stability only, the Draghi promise has put holding few countries still growing at a considerable the euro zone together ahead of price stability. clip. This is probably the path for the euro zone in the coming years. A third straight month of trade deficits in one O O O ANDY XIE / LINK of the worlds biggest commodity producers bodes ill for Indonesia, which had become a darling of foreign investors looking for fresh issue of my newsletter much opportunities, but has struggled to contain of the first half was dedicated to a discussion of the damage from a sharp fall in its currency recent events in Spain and Italy and why they rein recent months that has rattled investors. inforce the argument that several countries will be forced to leave the euro and restructure their Countries whose growth depends either on growth in Chinese investment or growth in eudebt. The most worrying, but expected, fact was ropean demand are going to see significant the amount of capital fleeing the afflicted coundeterioration in their trade accounts. This will tries. I cited an article in Spiegel that claims that almost certainly lead to even more trade interin the past year an amount equal to nearly 30% vention, currency wars, and all the other beggarof Spains GDP had left the country. Flight capital thy-neighbor polices typical of a global demand is both a major result of declining credibility and

In the last

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contraction. I think we should expect to see a lot more articles like this. In addition China itself is seeing noticeable capital outflows as business owners and other wealthy people begin disinvesting and withdrawing deposits. Capital flight from China began surging in early 2010, and it seems to be getting worse, with some monthly withdrawal estimates as high as $40-50 billion, and this cant help but put increasing pressure on Chinas ability to finance the infrastructure, manufacturing and real estate bubbles that have driven the economy. Over the long term, and in the name of rebalancing, this is probably a good thing for China. The sooner liquidity-driven overinvestment stops, the less debt will pile up and the less painful the deleveraging process will be. But in the short term it will aggravate the slowing down of the economy.
O O O

to leave the amount un- changed but was outvoted. Economists now expect the committee to add another 50bn in November, despite opposition from pensioner groups whose incomes have been devastated by low interest rates. In his speech, Mr Dale said economists should not assume QE was a benign policy option. Prolonged and aggressive monetary accommodation, combined with increasingly unconventional policy tools, also comes with potential costs and risks, he said. If the weakness in the economy was down to our impaired financial system and the sustained period of tight credit conditions, for example, further demand stimulus [QE] may largely result in higher inflation. If the handbrake on your car is stuck, putting your foot further and further down on the accelerator wont get you very far before the car starts to overheat, Mr Dale said. High inflation has been blamed for dragging the economy back into recession by eroding household incomes.

MICHAEL PETTIS / LINK

tomatically resort to printing money if growth remains weak because it might do more harm than good, the central banks chief economist warned. Speaking at Trinity College, Dublin, Spencer Dale warned that more quantitative easing (QE) could store up problems for the future without solving current ones.

The Bank of england should not au-

Aside from the risk of rising inflation, he said, low rates and QE may be encouraging investors to shift their portfolios to... Monetary policy should wards increasingly risky asprovide short-term support in sets. This could store up times of need, but it must avoid problems for the future, he added.

How effective it was as a policy depended on what had caused the economic weakness, he said, giving the example that simply pressing on the accelerator did not do much good to a car if the handbrake was on. If the problems were misdiagnosed, rather than boosting growth, QE might just lead to higher inflation, he added.

becoming a long-term crutch obstructing the required rebalancing of our economy,

Accommodative monetary policy may also be damaging Britains long-term potential by allowing inefficient firms [to] remain in business for longer and so slow the reallocation of capital and labour to more productive uses. Monetary policy should provide short-term support in times of need, but it must avoid becoming a long-term crutch obstructing the required rebalancing of our economy, Mr Dale said.
O O O

His comments came in the wake of the Monetary Policy Committees decision in July to increase QE by 50bn to 375bn. Mr Dale had wanted

UK DAILY TELEGRAPH / LINK

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we looked at monthly Chinese imports of gold from Hong Kong in 2012, the comparable country in question was Portugal (whose citizens, if not central bank, incidentally have run out of gold to sell), because that is whose total gold holdings (at 382.5 tons) Chinese imports had just surpassed. Fast forward a month later, and the update is even more disturbing. In July, Chinese gold imports from HK, after two months of declines, have picked up once more and hit a 3-month high of 75.8 tons. While it is notable that this number is double the 38.1 tons imported a year prior, and that year-to-date imports are now a record 458.6 tons, well over four times greater than the seven month total in 2011 which was 103.9 tons, what is far more important is that in the first seven months of 2012 alone SOURCE: ZEROHEDGE CLICK TO ENLARGE China has imported nearly as much gold as the total holdings of the hedge fund at the heart of the Eurozone, elsewhere known simply as the European Central Bank, and just as importantly considering the import run-rate has hardly slowed down in August, which data we will have in a few weeks, it is now safe to say that in 2012 alone China has imported more gold than the ECBs entire official 502.1 tons of holdings.
O O O

The last time

ZEROHEDGE / LINK

pig for a huge graphic that takes the NFP report apart in minute detail (via The Big Pigture)

Click on the

CLICK TO ENLARGE

SOURCE: RITHOLTZ/BANK OF THE INTERNET

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crisis, the Fed has increased its balance sheet from $900 billion to $2.9 trillion (red line in chart, top left). The difference is $2 trillion (or 13% of GDP). When the asset side of the Feds balance sheet grows, so must liabilities. The Feds liabilities consist mostly of money in circulation. So we can assume that $2 trillion in additional money has been pumped into the economy. Or has it? When the Fed buys bonds, it does so from Primary Dealers (21 global financial institutions). They hand over the bonds and get a corresponding credit on their account with the Fed. The Primary Dealers might then purchase some other securities with that money (which then gets credited to another banks account with the Fed). And thats where the buck stops. Three quarters of the money printed never make it into the economy. They remain as excess reserves (reserves in excess of banks minimum reserve requirements, blue line) in accounts at the Fed. Hence, of $2 trillion additional money, only $500 billion (yellow line) ended up outside the Fed. Why? Banks could use those reserves for lending, but there is no demand for additional loans (from customers with sufficient debt bearing capabilities)...
O O O

Since the financial

ZEROHEDGE / LINK

CLICK TO ENLARGE
09September2012

SOURCE: ZEROHEDGE

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Official recession calls are the responsibility of the NBER Business Cycle Dating

Committee, which is understandably vague about the specific indicators on which they base their decisions. This committee statement is about as close as they get to identifying their method. There is, however, a general understanding that there are four big indicators that the committee weighs heavily in their cycle identification process. They are: Industrial Production Real Income (excl. transfer pmts) Employment Real Retail Sales The weight of these four in the decision process is sufficient rationale for the St. Louis FRED repository to feature a chart four-pack of these indicators along with the statement that the charts plot four main economic indicators tracked by the NBER dating committee. In his July 10th Bloomberg TV interview, ECRIs Lakshman Achuthan cites these four at about the 2:05 minute point in his remarks. He says, and I quote When you look at those four measures, they are rolling over. Are they really rolling over? The first chart [left] graphs the period from 2000 to the present, thereby showing us the behavior of the four indicators before and after the two most recent recessions ...[bottom, left] heres a cluttered chart from 1959 to the present. That is the earliest date for which all four indicators are available. The main lesson of this chart is the diverse patterns and volatility across time for these indicators.
O O O

DOUG SHORT / LINK

CLICK TO ENLARGE

SOURCE: DSHORT

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is never one to pull his punches and in this interview he continues that trend as he tackles The Dreme (yep, Im sticking with it), monetary printing easing, the possible confiscation of gold, inflation, capital misallocation, China and, of course, intellectually dishonest, incompetent central bankers.

Dr. Marc Faber

CLICK TO LISTEN

Jim Puplava looks at the deteriorating fiscal situa-

tion in the US and the potential of more QE from Ben Bernanke. In his first topic, Sixteen Trillion and still counting Jim explains why we are headed into the fiscal abyss unless we change course, and soon. In Big Ben is at it againwhy Im so bullish on gold stocks, Jim looks at the potential for more QE from Ben Bernanke and the Fed, perhaps even open-ended QE, and how this will be bullish for gold and gold stocks.

CLICK TO LISTEN

CLICK TO WATCH

vacation with Mickey and Minnie, CNBCs Rick Santelli is back and mind-blown at the total cognitive dissonance of the fact that we just broke through $16tn debt. The relaxed Chicagoan summarizes, in words and tables that any Disney-princess-loving 6 year old girl could comprehend, why a trillion is a big number and while not dissing the first ladys speech, he notes that unlike her moneys not important to Barack comment, when the number gets this big, it better matter to someone. (via Zerohedge)

Fresh from his

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and finally

Hmmm
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THINGS THAT MAKE YOU GO HMMM..... 2012

COMMENTS

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Grant Williams
Grant Williams is a portfolio and strategy advisor to Vulpes Investment Management in Singapore - a hedge fund running over $250million of largely partners capital across multiple strategies. The high level of capital committed by the Vulpes partners ensures the strongest possible alignment between us and our investors. In Q4 2012 we will be launching the Vulpes Agricultural Land Investment Company (VALIC), a globally-diversified agricultural land vehicle which will provide truly diversified exposure to the agricultural sector through a global portfolio of physical farmland assets. Grant has 26 years of experience in finance on the Asian, Australian, European and US markets and has held senior positions at several international investment houses. Grant has been writing Things That Make You Go Hmmm..... since 2009. For more information on Vulpes please visit www.vulpesinvest.com

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Follow me on Twitter: @TTMYGH YouTube Video Channel: http://www.youtube.com/user/GWTTMYGH California Investment Conference 2012 Presentation: Simplicity: part I : part II

As a result of my role at Vulpes Investment Management, it falls upon me to disclose that, from time-to-time, the views I express and/or the commentary I write in the pages of Things That Make You Go Hmmm..... may reflect the positioning of one or all of the Vulpes funds - though I will not be making any specific recommendations in this publication.

Grant

www.vulpesinvest.com

09September2012

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