What Will Cause The Collapse?

Bear markets only end when price reaches a gut wrenching low. When speculators have been beaten down so much that mere mention of their favorite stock or commodity induces nausea and they do not want to touch it in their life time, ever. By that token the bear markets in the US stock markets will reach its nadir when S&P will be near 400, Dow near 3000. At these levels, 2008 will sure look like a trailer. At that level, there will be no safe haven except cash. That will be the ultimate collapse that the mega bears are hoping for.

Will that happen? If that were to happen, when will that happen? The global economy seems to be lurching from one crisis to another and still S&P has not breached 1000 yet. What we are seeing, is that a normal correction in a bull market or beginning of a bear market ? 

The Western civilization has modeled itself on the Keynesian theory where higher government spending has created an illusion of growth. In reality, there has been no wage growth in the USA in the last 20 years. The macro story is same in the USA or Greece or Japan. Only difference is, some countries can print their own money, some cannot. But printing money does not give the solution to the problem of solvency. If you do not believe, ask Robert Mugabe of Zimbabwe. With 200% debt to GDP ratio, Japan is trying for the last 20 years to bring in prosperity. And yet, the Nikkei is down from 38000 to 9000. 

The ZRIP and easy money policy that are being followed by the Fed or JCB indicates that the Central Bankers of the world are worried about deflation, not inflation. With the Balance Sheet contraction upon us, all the central banks are trying to inject as much liquidity in the financial system as possible. Their only hope of survival is to re-float the financial markets. 

What QE1 and QE2 did was just that. It helped re-inflate the collapsed bubble. There were no growth then, there is no growth now. So why then the markets are not collapsing, given that there is no QE3, there are sovereign default threats and GDP is barely moving. What is holding up the support level? 

The answer can possibly be found in the last G20 meeting. With the world economies so inter connected, it is a kind of MAD world. (Mutual Assured Destruction). Therefore, China wants to keep the markets going in the USA and in Europe so that it can keep its millions of rural poor employed and keep a lid on social unrest. US of A provide dollar swap lines to virtually dead European banks because not keeping them alive will de-stabilize the world economy big time. SNB pegs its currency to sick Euro so as to keep the Swiss Franc low. Every country is doing what it can to keep the music going.

Under such a situation, the world economy will lurch from one crisis to another, only to be propped up by more money. Volatility will be high. Even safe havens like gold swing between 2% to 7% in one market session. But TPTB (The Powers That Be) will not let the bottom fall off. The world markets are pushing on a string.

Only thing that can destroy this equilibrium is going to be something which is beyond the control of the CB and TPTB. A true black swan event. I do not think that the coming black swan event will be financial. Even if Greece defaults, it will not cause the system collapse. It has now been almost two years and the default has been priced in. The only black swan event I can imagine is going to be Geo-Political. For e.g. Israel Iran conflict. 

When the markets know that the governments are watching their back, they keep gambling. And they are doing exactly the same thing. Today, the US markets went up by 2% on no good news. Nothing fundamentally changed from last week. It is as if, yes they can. Right now, it is money moving from the pocket of one hedge fund and bank to another. Ordinary investors are not a part of it. The gamblers will continue to do so till such an external shock crashes the system. What will force that is anybody’s guess. Till that time, keep the good times rolling.

I will be travelling for the next two weeks and the posts will be somewhat irregular. But if I come across something interesting, I will do my best to bring it to your attention.

Hugh Hendry on the importance of social mood & failure

"I'd say 80% of my activity is engaged in the interpretation of social mood." - Hugh Hendry. 

That quote taken from this September 2010 BBC Hardtalk interview with Hugh Hendry. 

When asked about the need for regulatory control of financial markets and curtailing of risk, Hugh replies, "The best form of regulation is, 'If you mess things up, you fail.'".  

Hat tip: Kevin Kaiser at Hedgeye.

A New Wrinkle

The latest scheme out of the European political class is the idea of creating an SPV (Special Purpose Vehicle) that will "leverage up" the $ 400 billion fund that had been previously put in place to "stabilize" the sovereign debt crisis. How will this work?

The idea is that you create this SPV (think Fund) and put $ 400 billion into it in the form of equity capital. The SPV then borrows $ 1.2 Trillion from willing bond buyers. That gives you $ 1.6 Trillion to buy up Greek, Spanish, and Italian debt and stave off disaster. So, the theory goes.

So who provides the $ 1.2 trillion in debt capital? That is, who are the willing bond buyers who think investing in a vehicle that buys trash will be a winner? If you thought Wall Street cooked up outrageous schemes, try this one on for size.

This idea will not work. It is not the magic elixir. No one in his right mind would provide the debt financing for this vehicle. The US, no doubt, will volunteer to put money into this. (We love throwing money away). But, the rest of the world will balk at this silly idea. The Chinese will not fall for this.

What this scheme shows is that the politicians still haven't figured out that defaults are inevitable. Only defaults have any real shot of turning the situation around in Europe. Politicians can only make things worse by these kinds of dreams and schemes.

Hope Is Eternal and Futures Are Up

The futures are up in the morning and possibly we will see a gap-up opening. But I do not think we should jump back in the markets yet. Most likely this rally will be short lived. It is more of a dead cat bounce after a big sell off week. The EU has not yet come up with any definitive solutions and we can expect the volatility to continue well in October. I think SPX will have trouble going past 1150.

Corrections in Gold and Silver continue.  Silver can reach around $22 level or below. I am not sure about Gold and hence staying away from it for now. The funny thing is, historically, gold has performed better in a deflationary environment. If anyone cares to remember that gold was in a 20 year bear market when the stock markets were going up and inflation was much higher than it is today. So if we see a yearend rally from end of October, we might see a sharp selloff of gold.

For now, it is better to be in cash and wait for a good low in October before any buying opportunity comes up.

P.S; The markets opened gap up but now some are in red and some are struggling to keep the opening gain. In the mean time, I hear Cramer in CNBC that he is buying gold. Hmmmm. If the snake oil salesman is now pushing gold, may be it is time to seriously short gold.
This one is from Kitco at 10.45 AM on 26th Sept. 2011;

Did gold really go down 62.90?

Yes. The stronger US Dollar was responsible for 3.50 of that drop.

Gold price Change due to Strengthening of USD

-3.50

Gold price Change due to Predominant Sellers

-59.40

Gold Price: Total Change

-62.90

Mind The Gap

The so-called income gap between rich and poor is growing we are told. The rich are "sharing disproportionately" in the economic gains we are told. What does this mean? Should we do something about it? If so, what should we do?

Imagine, that adopting "Policy A" would double the income of the poorest sixty percent of the population, but, at the same time, quadruple the income of the richest forty percent of the population? Suppose that there was simply no other feasible way to double the income of the poorest sixty percent? Would you favor implementing "Policy A?" After all, "Policy A" increases inequality. The dreaded "income gap" widens under "Policy A."

One way to eliminate income inequality -- eliminate the income gap -- is to force the entire citizenry to live at the edge of starvation. This is, more or less, the experiment that the Soviet Union embarked upon in 1917. How did that turn out? The Soviet Union successfully eliminated the "income gap."

Suppose "taxing millionaires and billionaires" meant that unemployment for the rest of us would rise to double digits and stay there for the next thirty years. Is it still worth it, so that we can make "the rich pay their fair share," even if such a policy would guarantee that large numbers of people cannot find jobs?

Why does anyone care about the income gap? The issue is not how to divide a fixed pie after all. The issue is how to grow the pie. Suppose our only concern is with people whose income and wealth puts them in the bottom 50 percent of the pile. It might be necessary to enrich a few folks in order improve the lot of the bottom 50 percent. Who cares if the rich get richer?

Isn't it the right policy to try to improve the lot of the poorest 50 percent of our population regardless of how rich the rest of the folks get? It just might turn out that income inequality is a by-product of improving the lot of the poorest folks in society and that deliberate policies to reduce inequality damage the economic prospects of the poorest half of the population. So, why the interest in the income gap?

What we should be concerned about are policies that improve the economic prospects of the half of the population with the lowest income and least amount of wealth. If improving the prospects of the less fortunate increases income and wealth inequality, so be it.

Correction in Gold & Silver And Coming Year End Rally.

In my last post I wrote; “I am not sure if the corrections are over or we shall see renewed weakness again. …….. The weakness in the market may continue till October.”  That was after the markets rallied for a week and people were hoping for a trade-able bottom and there were talks of new Bull Run.  However Euro did not live up to the hype and came down couple of hundred pips.  I said that the big money is leaving Europe and they want to keep that flight low key and orderly and the correction in precious metal may have just started.

Right on cue, price of gold came down by over 5% in the week. Everyone is speculating why the price of gold and silver came down. The easy answer that is being talked about is that CME hiked the margin. But that is not the complete answer. Yes, margin hike deter additional position taking and sometimes forces the weak speculators to liquidate. But the more compelling reason was the position liquidation and margin call by the Mutual Funds and Hedge Funds. I think most funds were caught by surprise by the violent plunge in the stock market.  So when the sell orders came in, they held on to their loss positions and liquidated the position in precious metal which was in profit. Moreover, there were widespread disappointments with the Fed action.  Again, in the last post I said that the rally was “in anticipation of Santa Clause coming early on September 21st. There may be some disappointments and we might see some selling the news.”

I would like to show two charts. First the gold chart.

If gold falls below $1550 by next week, the next support is around $ 1050 / $ 1100. But even that kind of correction would keep gold on a long term bull run. Whether that will happen or not, is anybody’s guess. But the chances of the continued correction are high.

The 2^nd chart is of Silver. 

Silver has already broken the trend line big time and the next support is around $ 25. I think even that support will be broken. By the same token, gold may also suffer. My favourite chartist Chris Kimble has this Eiffel Tower chart for gold. So make your own conclusion.

Coming back to the stock markets, I expect the weakness to continue in October, till the Europeans show some guts and political will to throw more good money after the bad. The Obama administration is pushing Germany hard and want a trillion euro rescue fund. The problem is that Madam Markel is losing the political capital and the German population is becoming sick of supporting Greece.  But the cost of not supporting Euro is very high and Germany may just want to buy more time. That Greece will default is given. The European banks, particularly the French Banks are going to suffer the most. The most important question is, is Greece going to be the only sovereign default? The Euro Zone may be able to handle Greek default but if Ireland and Portugal and Spain are added to the equation, then it is a different ball game.

I do not expect the markets to fall much below from here onward. My short term downside target is around 1125 in SPX.  If that is broken, the next support level is around 1050 in SPX. A close below that would mean big trouble. However I do not expect the bottom to fall off yet and most likely we would see a bounce of the lows.

The central bankers and the world governments are missing the woods for the trees. For them everything is a liquidity problem when in fact the problem facing the world is solvency problem. The only way they are trying to solve the crisis is by pumping in more money in the banking system. But it s a giant black hole sucking the life out of the world economy. The balance sheet contraction is on us, however much the central bankers and governments may try. Remember the QE2? After $ 600 billion, the US stock markets are now below the level of QE2. The desperate fight is on to save the system and for a while PTB (Powers That Be) will succeed. I am expecting a yearend rally to start from end of October which may well take the stock markets to a new high in 2012 before the game is over.

For now, let us see how low gold goes.

Precious metals take a hit as dollar moves higher

Gold and silver have really taken it on the chin this week, with gold down 5% Friday and silver down a whopping 15% in today's trading (as of 4pm Chicago time). 

For the week, Finviz shows gold and silver down 8.7% and 23.6%, respectively (see performance chart below). 

The sell-offs in the futures markets have, of course, impacted the share prices of metals ETFs, GLD and SLV similarly.

The leading gold and silver mining indices, XAU and HUI, also took a dive over the last few days. 

Meanwhile, the US dollar index continued its climb this week. Having bottomed near 72.70 in early May, and following its consolidation around the 73.50 mark in August, the index (which measures the US dollar against a basket of other paper currencies) is up strongly in September. 

 

So were there any technical price signals or sentiment changes that hinted at these latest shifts in the dollar and in the precious metals market?

Sounding prescient on the gold trade is Phil Pearlman, discussing his decision to sell gold in this August 24th interview on CNBC (looking sharp, buddy). 



We'll continue watching gold, silver, and the dollar in the weeks ahead. Keep up with our real-time updates on Twitter and stay tuned to the blog feed for more.

If You Want Jobs, The Micro Environment Must Change

The regulatory and litigation environment virtually guarantees that job growth in the US will be anemic for years to come. No macro activities (or short term tax gimmicks) will change the employment picture.

The truth is: employers are scared to expand payrolls. They don't want to get sued; they don't want to take on future health care and retirement liabilities that are limitless; they don't want to deal with all of the extra costs that government has imposed on employers. The motives for all of this employee protection were no doubt noble.

The latest wrinkle is that Obama's "Job's Plan" permits the unemployed to sue a business that has the temerity to hire someone who already has a job elsewhere instead of hiring an unemployed person. Laws like that make employers leave the playing field. Who wants to hire anyone when the very act of taking on a new hire can trigger litigation that can put you out of business? Why can't the Obama folks get this?

Until the micro conditions of the labor market change (and no one is really discussing making these changes), the poor, the minorities, the less-educated have no real future in this economy other than collecting welfare checks and entitlement payments. Working for a living is increasingly not a likely possibility.

Obama and the liberal elite don't get this because they know nothing about hiring and why businesses hire people. None of the Obama people have any experience at all with business or with unemployment.

The Obama folks think that the solution is to have government build roads and patch up airports and transfer money to public employees. That is not the answer. The only people that benefit from stuff like that are highly paid union employees with rich retirement plans and generous health plans. They really don't need the government's help. They are riding high in this economy. Obama and his gang are riding high as well.

But, Americans that are least able to defend themselves -- lower middle income, minorities, the lower-skilled work force -- have no real chance in the economy that Obama and his crowd have created. Businesses are not going to hire employees that are "lawyered up" and ready to sue them. Why should they? The alternative is to outsource and to substitute capital for labor. That will continue.

We need micro changes. Even if the economy grows, the beneficiaries will not be the unemployed. Obama has seen to it that these folks have no real shot.

So, Why the Selloff?

Other than Obama's new(?) tax plan to tax "millionaires and billionaires," there wasn't much news to point to for an explanation of the nearly 8 percent drop in world equity markets from Tuesday at 2 PM until Thursday afternoon's market close.

Greece is old news and so is the weakness in the American economy. Nothing new on this front was announced prior to the selloff.

The equity markets seem to be stuck in a very wide trading range since early August. If so, the market probably rallies from here. My own guess continues to be that this is buying time for long term investors. This is not a time to be exiting equity markets, but a time to be planting a large foot into these markets.

It is scary. Government policies in western countries have been so absurd for so long that one despairs that things can ever be turned around. But, they can be and, I think, will be. Most Eurozone countries are going to default on their debt and a number of high-profile European banks have no hope of survival. Once these things happen, then we have a real chance for an economic revival.

As long as western politicians think there is some magic and painless solution to the debt crisis that avoids defaults, then economic stagnation will continue. But, the clock is ticking. Defaults will come whether politicians like it or not. The sooner the better.

So, it still makes sense to own equities -- perhaps more now than ever. Markets can see into the future and past unpleasant events. We will get there and get past all of this.

Long bonds flying on Operation Twist - $ZB_F $TLT

Earlier this afternoon on Twitter, I noted that the long bond ETF, TLT was up over 10% (then quoted near $114.60) since S&P downgraded the USA's debt rating to AA+ on August 5, 2011.

Well, it looks like we'll have to update those stats already, thanks to the pop in 30 year bonds (ZB_F) and in TLT on news of Operation Twist, the Fed's telegraphed scheme to sell $400bn of short maturity bonds and reinvest in longer (6 to 30 year) bonds by June 2012. 

Here's how the market reacted to that news. Note the flagpole move up in TLT and the 30 year Treasury futures, ZB_F on the intraday charts. 

 Above: 5 minute chart of the 30 year Treasury futures, via Finviz.com.

Here's an intraday chart of TLT, courtesy of freestockcharts.com.

The updated daily chart of the TLT, marking the August 5th closing price to today's action on the Twist announcement. Chart via freestockchats.com.

So in the space of 20 minutes, we had to recalculate that 6 week return figure (post S&P debt downgrade): the long bond ETF TLT is now up 13% since its close on August 5th, based on an intraday price of $117.70

What a difference a day makes...

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The Obama Tax Plan

Obama will announce his new tax plan today -- more than $ 1.5 trillion in new taxes. Even a Democratically-controlled Congress wouldn't pass something like this in the middle of a recession. You have to wonder if Obama really cares at all. He is wasting everyone's time with proposals like this. He should go back to Martha's Vineyard.

It Won't Be Long Now

Goodbye Greece. We are getting into the fourth quarter on the Greece situation. The Germans are increasingly unlikely to continue the bailout game for domestic political reasons. Ditto for Greece. The Greeks are more likely to roll back their existing "austerity" measures than enact new ones. The game is just about over. Default is coming soon.

Then we look to Spain and Italy and watch that story unfold in much the same manner.

As If Things Weren't Bad Enough

Here comes the President -- one more time: "Tax the Millionaires and Billionaires." Same ole, same ole.

Hidden in his tax-the-rich proposal is the virtual elimination of the current municipal bond market, because the Obama proposal essentially eliminates tax exempt interest on municipal bonds. That should help our cities and states!

If the Obama package could pass, it would nail the coffin shut on any future American economic progress. We would become the new Japan with no real prospect for economic growth in the next half century. (That may happen anyway. Obama has done a lot of damage already).

Fortunately, no one is listening to Obama anymore and new taxes are not in the cards with a Republican House of Representatives.

All Obama signifies with the package to be released on Monday is his irrelevance. He doesn't understand the private sector, he doesn't understand the dynamics of the entitlement programs, and he doesn't seem to care anyway.

He's still having a good time in the White House. There are still a lot of parties to attend and fun things to do. That the country is collapsing economically is not something that Obama seems much bothered about.

Nothing new there.

Geithner and "Catastrophic"

Tim Geithner is an embarassment. He spent Friday in Poland lecturing European leaders on the necessity to increase the bailout fund for the bankrupt states of Greece, Spain, and Italy. According to Geithner, failure to expand the bailout fund and, implicitly, to let Greece (and Spain and Italy) to balloon their national debts to even greater heights, would be "catastrophic." Great idea! Add to the debts of Greece, Spain, and Italy! That's a novel way to solve the European debt crisis -- make it bigger.

Well, Geithner might respond, that's what we did in the US and look how wonderfully things are going there!

This is what happens when politicians think they can solve problems. They make the problems much bigger. This way when things collapse down the road, they won't be around to face the music. Europe will eventually implode. Geithner just doesn't want it to happen on his watch.

Unfortunately for the US, we are on "his watch" and the results are there for all to see -- economic stagnation.

It is embarrassing that the Obama Administration is still trying to pretend that more and more debt and more and more economic stagnation is the way to go. It makes one wonder what the real motive is here.

Geithner Selling His Failed Ideas to Europe

Tim Geithner will be in Poland tomorrow to sell his failed US 2008 program to Europe. Heck, maybe it will work this time. It certainly didn't work in the US, unless you think our situation is a good outcome.

All these folks can ever say is that it would been worse. Really? What makes you think that? Letting nature take its course without government interference has worked in every other situation. Only when the government intervenes to "fix things" such as the 1930s in the US and 1990s in Japan,and now the US in the Obama era, have economies failed to recover.

Europe is so far gone, it won't matter anyway. All Geither will be able to do is make certain that when the defaults start, Germany and France can be added to the list, because they are the ones that will have to underwrite this stupidity.

Oh, by the way, the Federal Reserve is stepping up too. That means the US, which is reeling from massive indebtedness, is now adding to its own woes by helping to backstop the idle Greeks. What a great idea!

You just couldn't make this stuff up. The idiots are running the asylum!

Corrections In Gold?

Markets are playing exactly according to the script. Stocks rallied for 4^th day straight on the news of European fix. I have been writing for a while that CBs( Central Bankers of the world) have learned their lesson from the 2008 crisis and they would prevent such a crisis from developing again. So we see that the ECB, BOE, SNB, BOJ, BOC and of course the FED has come together to provide liquidity to the market.  Once again, I have been writing that the only thing the CBs know is how to pump in money in the system and although such an action will only delay the inevitable balance sheet contraction, it will provide some much needed time for the speculators and too big to fail banks to make some more money.

The CBs have set up US Dollar swap lines for the “Zombie European Banks” who survive on leverage and are actually dead men walking. That has resulted in the short squeeze in the world stock markets.  This should lead to further decline in US Dollar and a rally in Equities.

However, I am not sure if the corrections are over or we shall see renewed weakness again. It seems that the “Big Banks” are buying all that their clients are selling. Again, this is in anticipation of Santa Clause coming early on September 21^st. There may be some disappointments and we might see some selling the news. The weakness in the market may continue till October. But the bottom-line is, the mega bears are going to be disappointed that world has not ended as predicted and Zero hedge will go ballistic with different conspiracy theories. For the next three months, we will see these dooms day soothsayers go rabid with froth in the mouth. They may still be vindicated at a later date sometime in 2012, but for entirely different reasons. More on that later.  

The new trade now is “Buy Euro and Sell Gold”.  In fact, the corrections in precious metal may have just started.  Let me show you the chart from Chris Kimble.

Both the precious metals have broken multiple support lines and from technical perspective, it may be time to short them with a tight stop.

From fundamental perspective, once again, the big money is leaving Europe but they want that flight to be low key and orderly. So on the superficial level, there will be show of strength of Euro and with the help of the CBs, sell gold.  Precious metals should be considered as insurance to inflation and break down of fiat currency. I do not see US Dollar going out of fashion any time soon. In fact, with the balance sheet contraction looming over the global economy, brake-up of Euro zone and a possible Geo-political clash in Middle East, the flight to safety will be towards US Dollar.

It is going to be an interesting time.

A Clueless White House

The White House released the following statement on Wednesday (Amy Brundage, White House spokesman):

"As the president has consistently said, he does not believe that Social Security is a driver of our near and medium term deficits."

How can the President of the United States be this misinformed on perhaps the most important issue facing the country?

Geithner to the Rescue

Tim Geithner wasted a little more taxpayer money -- why not? -- going to Europe this week to have an important meeting with Germany's Angela Merkel to "convince" her how important it is that the Greek situation be contained. You really have to wonder about Tim Geithner. Does he really believe Greece is not going to default? How disconnected is this guy from reality? He still thinks his stimulus plan worked?

The lack of understanding of Economics in this White House is without parallel in American history. This White House not only doesn't know what to do, it doesn't even look like they care about whether the economy recovers or not. The so-called "Jobs Plan" is little more than transfer payments to Obama allies paid for, he says, by taxing "millionaires and billionaires," which apparently includes everyone who makes over $ 200,000 per year.

The sad fact is the folks below the median income are hit hardest by this White House. Those with protected jobs -- public school teachers, public employees, government bureaucrats of all stripes -- they're pretty happy. Their income hasn't fallen a bit. In fact their income has risen, while folks in the bottom half of the income spectrum have been savaged. Obama's war on lower middle incomes is bearing fruit -- massive long term unemployment, massive short term unemployment, and massive under-employment.

Maybe we should increase some of the old standards to get this economy going: 1) Raise the minimum wage to $ 100 per hour...that should raise living standards; 2) Why not let folks get six months a year paid sick leave...they might need it; 3) How about 100 days a year mandated family leave with pay; etc. etc. Heck if $ 7.25 is a good minimum, think how great $ 100 an hour would be. I can just imagine these kind of discussions going in the Obama White House.

Why not outlaw all pollution starting today? Why not mandate that all cars have to get 200 mpg starting next week? These are merely extensions in degree of the current Obama EPA actions. Heck, why not go for it, since we don't care one way or another about American jobs or the economy?

What about raising tax rates to 80 percent for all those rich people who make more than $ 75,000. That should bring in a lot of money. Lets eliminate corporate tax loopholes and raise corporate rates to 70 percent. That will solve our deficit problem.

All of these discussions are the kind that I suspect go on regularly in the Obama White House. They may seem extreme now, but we have gotten use to a lot of Obama stuff that would have seemed extreme ten years ago. Now we have nine percent unemployment; maybe we can double that number in two or three years. Why should people work anyway?

As goofy as all this sounds, it doesn't sound any goofier than what Obama and Geithner say regularly on the stump. No wonder the economy is moribund.

European Union. Win of Hope Over Commonsense

In continuation of the analysis of the crisis in Europe, here is a beautiful and well researched article from "Startfor". Startfor provides the best Geo-political analysis ever and is an invaluable tool for understanding the global macro economics. It cuts through the noise and presents the clear picture. Read on;


Before 1492, Europe was a backwater of small nationalities struggling over a relatively small piece of cold, rainy land. But one technological change made Europe the center of the international system: deep-water navigation.

The ability to engage in long-range shipping safely allowed businesses on the Continent’s various navigable rivers to interact easily with each other, magnifying the rivers’ capital-generation capacity. Deep-water navigation also allowed many of the European nations to conquer vast extra-European empires. And the close proximity of those nations combined with ever more wealth allowed for technological innovation and advancement at a pace theretofore unheard of anywhere on the planet. As a whole, Europe became very rich, became engaged in very far-flung empire-building that redefined the human condition and became very good at making war. In short order, Europe went from being a cultural and economic backwater to being the engine of the world.

At home, Europe’s growing economic development was exceeded only by the growing ferocity of its conflicts. Abroad, Europe had achieved the ability to apply military force to achieve economic aims — and vice versa. The brutal exploitation of wealth from some places (South America in particular) and the thorough subjugation and imposed trading systems in others (East and South Asia in particular) created the foundation of the modern order. Such alternations of traditional systems increased the wealth of Europe dramatically.
But “engine” does not mean “united,” and Europe’s wealth was not spread evenly. Whichever country was benefitting had a decided advantage in that it had greater resources to devote to military power and could incentivize other countries to ally with it. The result ought to have been that the leading global empire would unite Europe under its flag. It never happened, although it was attempted repeatedly. Europe remained divided and at war with itself at the same time it was dominating and reshaping the world.

……………..The tensions underlying Europe were bought to a head by German unification in 1871 and the need to accommodate Germany in the European system, of which Germany was both an integral and indigestible part. The result was two catastrophic general wars in Europe that began in 1914 and ended in 1945 with the occupation of Europe by the United States and the Soviet Union and the collapse of the European imperial system. Its economy shattered and its public plunged into a crisis of morale and a lack of confidence in the elites, Europe had neither the interest in nor appetite for empire.
Europe was exhausted not only by war but also by the internal psychosis of two of its major components. Hitler’s Germany and Stalin’s Soviet Union might well have externally behaved according to predictable laws of geopolitics. Internally, these two countries went mad, slaughtering both their own citizens and citizens of countries they occupied for reasons that were barely comprehensible, let alone rationally explicable. From my point of view, the pressure and slaughter inflicted by two world wars on both countries created a collective mental breakdown.

………………Paradoxically, it was the United States that gave the first shape to Europe’s future, beginning with Western Europe. World War II’s outcome brought the United States and Soviet Union to the center of Germany, dividing it. A new war was possible, and the reality and risks of the Cold War were obvious. The United States needed a united Western Europe to contain the Soviets. It created NATO to integrate Europe and the United States politically and militarily. This created the principle of transnational organizations integrating Europe. The United States also encouraged economic cooperation both within Europe and between North America and Europe — in stark contrast to the mercantilist imperiums of recent history — giving rise to the European Union’s precursors. Over the decades of the Cold War, the Europeans committed themselves to a transnational project to create a united Europe of some sort in a way not fully defined.

………………..The European Union was designed not simply to be a useful economic tool but also to be a means of European redemption. The focus on economics was essential. It did not want to be a military alliance, since such alliances were the foundation of Europe’s tragedy. By focusing on economic matters while allowing military affairs to be linked to NATO and the United States, and by not creating a meaningful joint-European force, the Europeans avoided the part of their history that terrified them while pursuing the part that enticed them: economic prosperity. The idea was that free trade regulated by a central bureaucracy would suppress nationalism and create prosperity without abolishing national identity. The common currency — the euro — is the ultimate expression of this hope. The Europeans hoped that the existence of some Pan-European structure could grant wealth without surrendering the core of what it means to be French or Dutch or Italian.

Yet even during the post-World War II era of security and prosperity, some Europeans recoiled from the idea of a transfer of sovereignty. The consensus that many in the long line of supporters of European unification believed existed simply didn’t. And today’s euro crisis is the first serious crisis that Europe has faced in the years since, with nationalism beginning to re-emerge in full force.

In the end, Germans are Germans and Greeks are Greeks. Germany and Greece are different countries in different places with different value systems and interests. The idea of sacrificing for each other is a dubious concept. The idea of sacrificing for the European Union is a meaningless concept. The European Union has no moral claim on Europe beyond promising prosperity and offering a path to avoid conflict. These are not insignificant goals, but when the prosperity stops, a large part of the justification evaporates and the aversion to conflict (at least political discord) begins to dissolve.

Germany and Greece each have explanations for why the other is responsible for what has happened. For the Germans, it was the irresponsibility of the Greek government in buying political power with money it didn’t have to the point of falsifying economic data to obtain eurozone membership. For the Greeks, the problem is the hijacking of Europe by the Germans. Germany controls the eurozone’s monetary policy and has built a regulatory system that provides unfair privileges, so the Greeks believe, for Germany’s exports, economic structure and financial system. Each nation believes the other is taking advantage of the situation.

Read more: The Crisis of Europe and European Nationalism | STRATFOR 
Republished with permission of STRATFOR.

Bruce Kovner retires: a Market Wizard's career

Bruce Kovner is stepping down as chairman and CEO of Caxton Associates, the hedge fund he founded in 1983. 

Bloomberg has the details on the transition that will see CIO Andrew Law take over at Caxton: 

"...“After 34 years in the trading business and more than 28 years leading Caxton, the time has come to hand the leadership of the company to a new generation,” Kovner, 66, wrote in the letter. “I do so knowing that I will miss the adrenalin rush of confronting markets every day but also confident that new leadership will carry on the traditions, style and substance of Caxton’s successful history.”...

...Kovner is attempting a rare handover of power in the $2 trillion hedge-fund industry, where some of the most successful managers, including Stanley Druckenmiller and George Soros, chose to transform their firms into family offices rather than put another trader in charge. A family office usually oversees money for a wealthy individual and their relatives." 

And a note on Kovner's successor Law, who offers up some interesting comments on lessons learned from Bruce Kovner and similarities in their trading styles:

"...Law’s trading style has always been similar to Kovner’s, he said in an interview in his office on Park Avenue in Manhattan. Yet the older man drove home some important lessons.

“I’ve learned to listen to the markets more,” said Law, meaning that he pays close attention to how markets move relative to one another, and how they react to events. He depends on these observations, rather than what he calls “abstract fundamental preconceptions,” to forecast future price movements.

Law also embraces Kovner’s practice of cutting risk when he doesn’t understand what’s going on in markets, something that Law did in May and June of this year. “Bruce has done this many times in his career,” he said."

Kovner is a true trading legend whose trading career really took off once he joined Commodities Corporation in late 1976. On his performance as a hedge fund manager, Financial Times sums up his 28 years thusly: "An investment of $1,000 in Caxton made when the firm began trading in 1983 would today be worth $168,000.".  

Kovner sat down for a rare interview with Jack Schwager in 1989. The resulting chapter on "Bruce Kovner - The World Trader" can be found on page 31 of this Market Wizards ebook. Check it out.

Schwager, Jack D. - Market Wizards 1989

Related articles and posts: 

1.  Bruce Kovner interview with AR magazine - Absolute Return.

Europe -- A Case Study in Why Government Is Not The Answer

So, where are we now in fixing the Greek debt crisis. Greek government debt maturing in March of 2012 is trading in the open market at 55 cents on the dollar, according to today's Wall Street Journal. The yield on two year Greek debt is now 75 percent, on 10 year paper 20 percent. So, the default has really already occurred. The fiscal deficit for Greece through the first eight months of the year is 22 percent higher than last year. Meanwhile, real GDP is likely to drop 10 percent this year as compared to a fall of 5 percent last year. So, where does it end? -- where it should have ended two years ago when Greek sovereign debt was a lot lower and European banks were in far, far better shape.

This impending disaster is a direct result of government policy. Merkel and Sarkozy in cahoots with the ECB (European Central Bank) have served up the myth that somehow they could avert a Greek default through politics. We now see the results of their efforts -- economic disaster for Greece and the weakening of the entire European financial structure. So much for bailouts.

Think of how regulation is faring. Why would European banks be in trouble if they are marking their positions to market, as liberal politicians claim regulators will force them to do. Actually, liberal politicians are forcing these banks to mis-mark their positions so as to foster the illusion that they are in good shape. Yesterday, these European banks shed between four and ten percent of their value in a single trading session and most are down more than sixty percent in value value this year. Way to go regulators!! If you have properly marked your bond positions, then why not just sell them? That shouldn't change your net worth at all since you have already marked them to market. But, no. The regulators know best. Now, they are forcing the banks to publicly lie about the value of their holdings. Wow! Isn't that great. Good to see the regulators doing their job.

But, meanwhile, the markets are not fooled by the regulators and the politicians. The markets are showing the way and the way is down for European sovereign debt and down for the European banking system. Had the market simply been permitted to work its will two years ago and let Greece default, we would have only minor problems today with the Euro and with European banking. But, no, politicians and central bankers had to take center stage, repeating the same mistakes that American policy makers made in the fall of 2008. These folks never learn.

Take a lesson from the Asian Crisis of 1997, which was first and foremost a debt crisis. What happened? Fortunately, the IMF was unable to be a backstop or a bailout source for that crisis. So what happened? The crisis ended naturally by 1998 and by 2000 Asia was back and roaring ahead. Why didn't Asia stagnate like the US did after 2008 and Europe is now? Because no one bailed them out. Three cheers for "no policy." "No policy" works.

What doesn't work is government policy. It doesn't work in the US and we are watching government policy turn a minor crisis in European sovereign debt into a major conflagration. When will we learn?

Sell Everything? Not Yet.

Following the crisis in Euro zone, one would be tempted to sell everything. But we should have sold and got out of equity in April itself. Now it is little late in the season because, we might be reaching a bottom soon, or at least by October. In the mean time enjoy the following clip;

To Be or Not To Be.

The markets are betting that Greece will default anytime now. The one year Greek bond yield is at 91%!

 If anyone is expecting a different outcome, then s/he is living in denial.  The debt to GDP ratio is well over 140% now and Greece is well behind all projections of deficit reduction. What else would you expect? Even in the best of times, the tax collection system in Greece was a joke. Now, with austerity, the GDP has gone down further and the tax collection along with it.

There is a general air of acceptance of the inevitable about the Greek default and with that, the non-PIIGS countries are trying to shore up their banks and insurance companies, which will have severe haircut, from 50% to 90% on their sovereign bond holdings and contagion effect. So now Germany is putting money in its financial institutions instead of putting in more money in the black hole that is Greece.

Last week, UBS published a research report on how solving the Euro problem will be expensive but not solving it will be even more expensive. For whatever it is worth, such a report should be taken with a large pinch of salt because if the Euro goes, UBS also goes under. Their conclusion, save Euro whatever the cost otherwise there will be war. It seems Paulson has found his match in Europe.

The European Union has only two choices:
1. Either save the Euro at the cost of the Sovereigns
2. Or, Save the Sovereigns and destroy the Euro in its present form.
But sometimes things do not go as planned and so it might be that both the Euro and the Sovereigns are destroyed.

Let us analyze the options.

The Euro at its current form can be saved only if Germany and other rich North European countries continue to provide unlimited funding and guarantees for the debts of the PIIGS countries. The public opinion and the political maneuver room is becoming narrower for this option.  They cannot force Greece out of the union. Only way possible is for Greece to leave voluntarily.  But Greece will not leave voluntarily because going forward; nobody will touch their new "Drachma". Apart from showing their ruins to the tourists, Greece does not have much to sell to earn money.  They import 70% of their energy, so energy cost will be prohibitive. Food will be so expensive that it will cause street riots. Banking will be dead. Business will suffer and unemployment will be sky high.  So Greece will continue to drain the Euro and suck Germany dry.

But how long before Germany says enough? If Germany is to leave Euro, its new "Mark" will be expensive like Swiss Franc. That will surely hurt the export driven economy of Germany. In addition, they will lose market access to the rest of the Europe. German banks that have lent money to other European countries, will be massive losers and will need Government bailouts.

In the first scenario, ECB will have to print money like the FED to continue to buy bonds of the PIIGS countries and that is not acceptable to Germany. In the second scenario, there will be huge disruption of trade and commerce and a depression is sure to follow.

In fact a depression is sure to follow in either way. The G7 countries are trying to solve the problem by injecting more liquidity. That serves to prop up the sick banks and financial institutions at the cost of the ordinary voters. And sooner or later, voters will respond with their boot. In worst case, with blood on the road. How far the political class will go to save the oligarchy is the moot question.

From John Hussman of Hussman Fund: “The global economy is at a crossroad that demands a decision - whom will our leaders defend? One choice is to defend bondholders - existing owners of mismanaged banks, unserviceable peripheral European debt, and lenders who misallocated capital by reaching for yield and fees by making mortgage loans to anyone with a pulse. Defending bondholders will require forced austerity in government spending of already depressed economies, continued monetary distortions, and the use of public funds to recapitalize poor stewards of capital. It will do nothing for job creation, foreclosure reduction, or economic recovery.
The alternative is to defend the public by focusing on the reduction of unserviceable debt burdens by restructuring mortgages and peripheral sovereign debt, recognizing that most financial institutions have more than enough shareholder capital and debt to their own bondholders to absorb losses without hurting customers or counterparties - but also recognizing that properly restructuring debt will wipe out many existing holders of mismanaged financials and will require a transfer of ownership and recapitalization by better stewards. That alternative also requires fiscal policy that couples the willingness to accept larger deficits in the near term with significant changes in the trajectory of long-term spending.”
More from Mr. Hussman: ” Presently, the global economy is in a low-level Nash equilibrium where consumers are reluctant to spend because corporations are reluctant to hire; while corporations are reluctant to hire because consumers are reluctant to spend. Unfortunately, simply offering consumers some tax relief, or trying to create hiring incentives in a vacuum, will not change this equilibrium because it does not address the underlying problem. Consumers are reluctant to spend because they continue to be overburdened by debt, with a significant proportion of mortgages underwater, fiscal policy that leans toward austerity, and monetary policy that distorts financial markets in a way that encourages further misallocation of capital while at the same time starving savers of any interest earnings at all.
We cannot simply shift to a high-level equilibrium (consumers spend because employers hire, employers hire because consumers spend) until the balance sheet problem is addressed. This requires debt restructuring and mortgage restructuring (see Recession Warning and the Proper Policy Response ). While there are certainly strategies (such as property appreciation rights) that can coordinate restructuring without public subsidies, large-scale restructuring will not be painless, and may result in market turbulence and self-serving cries from the financial sector about "global financial meltdown." But keep in mind that the global equity markets can lose $4-8 trillion of market value during a normal bear market. To believe that bondholders simply cannot be allowed to sustain losses is an absurdity. Debt restructuring is the best remaining option to treat a spreading cancer. Other choices are fatal.”
You can read the entire article here: http://hussmanfunds.com/wmc/wmc110905.htm

The smart money of Europe know that the situation is dire and money is leaving the shores of Europe like never before. In fact the Banks in the USA are now charging interest to accept short term deposit. That is why yield of 10 year US Notes are falling to ridiculous level. What do they know that we are missing?

Even if the USA  can manage to muddle through, events in Europe will surely push US and global economy in recession or worst still, in depression.  In short term, we can expect the weakness in the US markets to continue till October.  May be a tradable bottom will be available around Sept. 21st when the FED is expected to come out with QE3. As I continue to say, the world governments are better prepared than they were in 2008, but even then their hands are tied behind their back with the massive debt level.  There will be one last push up before the melt down. I do not believe that we shall see the S&P 500 below 1000 in 2011 but the fair value of SPX is around  400 to 600. That will be reached during the coming balance sheet contraction. May be it is time to listen to Napier again.

The Beginning of The Age of Default

There have been many famous epochs in European history and we are now about to witness the dawn of the latest -- the Age of Default.

Greece is verging on financial collapse (this week) and there is no longer any viable way to prevent that collapse. Whatever they may call it, default is on the way and soon, certainly before the year is out perhaps much sooner.

But, that will just be the beginning, as we move swiftly from country to country throughout the Eurozone. There is some chance, but it is slim, that Germany can itself avoid default. The reason for pessimism on Germany is that Germany will end up absorbing the obligations of its major banks, much as Ireland did two years ago. When the bailer bails out too many bailees, then the bailer needs a bailer. Who will bail out Germany?

It will be interesting how this plays out in the US. California, Illinois, and New York have no hope of avoiding bankruptcy. They will, no doubt, appeal to the federal government for relief, which, if given, would only prolong the inevitable.

The question is not whether California, Illinois and NYS will go bankrupt, the question is when. To the extent the federal government absorbs the obligations of these states, such activity will hasten the collapse of the US federal debt market.

None of this involves the losses that you might think. While Greek's nominal debt is $ 450 billion, it's current market value is probably half of that. The market has already dictated a 50 percent default, so that there is only another $ 225 billion left for investors to lose. Ditto for Spain and Italy with corrections for market conditions.

The problem is going to be: most folks have simply assumed that the ECB had some magic formula to avoid a Greek default. The ECB doesn't have such a formula. A Greek default will shock the markets and awaken the markets to the prospect of further defaults both in Europe and in the US. That is the main significance of the Greek default -- the loss of $ 225 billion to bond holders is a relatively minor problem.

For some reason, financial commentators have bought in to the "we can bail out everyone" song that is sung by European politicians and the Obama White House. It's not so and the Greek default will be the first bell that rings to show that it is not so.

Tough Road Ahead for US and Europe

Bad policy has a way of surviving, even though the results of bad policy may be plain for all to see. The US and the Western countries have managed, by government policies (political policies) to destroy the vibrancy of their economies. Perverse incentives and irrational agency costs so pervade these economies that real economic growth of the kind seen in the nineteenth and twentieth century is not likely to ever return.

Many in the Western world applaud the collapse of their own economies. They see economic growth as damaging to the well being of the population. Those who take this view are usually pretty well insulated from the downside of stagnant economic growth. But most of the citizenry are not insulated from that downside. Unemployment and under-employment mostly afflict folks that have no real way to protect themselves. In the US, minorities suffer the most from the collapse of the economy; white college graduates suffer the least.

John Maynard Keynes was, in my opinion, the greatest economist in history. Strangely, what passes as "Keynesianism" is an absurd, foolish set of doctrines that are routinely taught to undergraduates that suggest that wasteful government spending can lead to wealth. Keynes never believed anything of the sort as a perusal of his work would suggest. But, who reads Keynes these days? If you read Keynes, you will quickly run across the notion of "animal spirits" that motivate entrepreneurs to do the things that spur real economic growth. Where is that taught in the modern academic establishment?

In his classic "Treatise on Money," Keynes used the term inflation to mean mostly growth in the money supply. He was certainly no believer in the so-called trade-off between unemployment and inflation. He was aware of what happened in the 19th century when powerful economic growth carried Britain and the US to the pinnacle of power amidst more or less constant deflation (how can that be?). Keynes saw "pyramid building," which he cited in his 1935 work "The General Theory of Employment, Interest and Money" as a device to encourage business, not as Obama and his advisers see it, as a substitute for the private economy.

The media labels the Obama Administration as Keynesian. Nothing could be further from the truth. The Obama Administration basically believes in transfer payments to their political allies and throwing money down rat holes. Keynes would have been appalled. He probably would have joined the Tea Party.

The truth is that no amount of government spending or targeted tax cuts can do any good. They simply waste (future) taxpayers money and make things worse. Government is stifling entreneurial activity in the US and in Western Europe. It is that simple. Incentives do matter, contrary to what Obama and his folks think. Businesses are not the enemy, contrary to what Obama and his folks think. Until policies change, the future lies with Asia and parts of the world not bent on destroying private enterprise, but bent on encouraging it.

Just attend a movie in the Western world and you can see the stereotypes. Businessmen are always crooks and left-leaning lawyers and college professors and students are always the good guys. Businesses are portrayed constantly in the media as instruments of environmental destruction and unfeeling masters of downtrodden employees. Our modern literature portrays the same images. Pick up a college newspaper, anywhere in the country, you get the same message. College, student-run, newspaper columns spend most of their time counting up ethnic and social noses to see if they are all represented properly and if there are enough centers and resources sucking up tuition money to promote their agendas. Most of these latter efforts simply create divisions and animosities amongst people where there previously were none.

In short, the culture no longer believes in free enterprise. If you are rich enough or comfortable enough or have enough job security, then what do you care about people that can't find work or are in danger losing their job. In a sense, it is the preoccupation with pipedreams, that enables the liberal elite to ignore the economic plight of the average American or Western European. The average guy is pummelled by the government-only approach to the economy. But, what do Obama and his group care, except for their interest in re-election.

The controversy over the Boeing plant in South Carolina typifies the way this game is cynically played. The Obama Administration could care less if thousands of jobs are shipped out of the country so long as no non-union employees get hired in South Carolina by Boeing. It is not enough to be an American citizen to merit Obama's interest, you have to be a prospective union member as well. Obama could stop the travesty going on in the Boeing plant dispute, but he chooses not to. That tells us a lot about Obama.

In the end, you have to decide what kind of economy you want. China and Asia are choosing to have a dynamic economy with rising standards of living and increasing economic power. The US and the West have thrown in the towel and prefer political theater to economic progress. Not a pretty picture for those that need jobs and a future in the Western world.

Keynesian Capitalism

The USA is the bastion of free market or so we are told. The animal spirit of capitalism encourages innovation and improves standard of living of ordinary people. or so we are told. So we cheer when the profits of the big companies go up and S&P 500 goes higher. ( Forget the small business, they do not have money to spare for lobbying to Congress). Will it be surprising then to note that in this era of super growth of corporate profits, the share of wages in GDP is the lowest?

Unfortunately the chart shows that most of the profit growth has come at the expense of wages. But wait, if there is no wage growth, how come people are buying stuff? Sale of ipods and ipads are going through the roof even when food stamp usage is at record number. Where the money is coming from? Well, apart from not paying the mortgage, most of the money is coming from Government transfer payments:

In fact, 22% of every dollar of the US personal consumption is coming from Uncle Sam. So in effect, The government transfer payments are keeping the corporate profits healthy. Capitalism for the mass indeed.

Have you ever wondered, why the Government and the Fed are so keen to keep the asset values ( read stock markets) high? May be the following chart will help in understanding.

 Do we still need more narratives?