A quote from Bloomberg news, and a chart. Here's the link to the entire article. From Bloomberg:
"Less than three months ago the European Banking Authority said Dexia SA (DEXB) had passed its so- called stress test with ease. The French-Belgian lender’s July 15 news release carried this headline: “2011 EU-wide Stress Test Results: No Need for Dexia to Raise Additional Capital.”
"Then last weekend, 86 days after getting its clean bill of health, Dexia took a government bailout to avoid collapsing. Nobody was surprised this happened. Nor should anyone have been.
"The stress-test exercise was a charade, just as it was a year earlier when Bank of Ireland Plc and Allied Irish Banks Plc passed their tests and collapsed soon after. Once again the rules were rigged so only a handful of unimportant banks would flunk. Everyone who was paying attention understood this.
"The European Union’s banking authority went through with the farce anyway, presumably aware that in all likelihood some big bank was bound to get a passing grade and quickly implode, the same as last year, causing embarrassment for everyone involved. All of which leads to the important question: Why?"
Here's the chart showing Europe's most vulnerable banks. The leverage is staggering. These are financial institutions, upon which rest the stability of a continent and threaten the financial stability of the world. I can't imagine leverage of 50 to 1! As a futures trader, I use leverage of 10 or 12 to 1! Leverage is a double-edged sword that cuts both ways. If a bank uses 50 to one leverage, then a loss of just 1 to 1 1/2% entirely wipes out the bank's capital base! It is insolvent with just a small loss! it is beyond comprehension to me that officials allow that kind of leverage for banks! TANG EQ = tangible equity
source: John Hussman, Phd.
Note in the above chart that some of Europe's largest banks are exposed to catastrophic losses with heavy leverage. Dexia, which just collapsed, was Europe's STRONGEST bank in the stress tests just 3 months ago. Deutche Bank, the German megabank, and Credit Agricole, one of France's largest banks, are also heavily leveraged for implosion. This list reads like the largest banks in the Eurozone: UBS, Commerzbank, Barclays, BNP Paribas, Credit Suisse, Societe Generale, Lloyds of London, and Royal Bank of Scotland are all some of the largest banking institutions in the world! For perspective, in 2008, many large U.S. banks had leverage of only about 12 to 1. These Eurobanks have leverage of 53 to 1! It begs the question why banking officials and regulators would allow such leverage that almost guarantees a global financial catastrophe! They were either supremely stupid, incompetently ignorant, or criminally complicit with a broader agenda of intentional destruction! Take your pick!
In commenting on the above-linked Bloomberg article, Dr. John Hussman said yesterday: "Weil ends his piece with a simple sentence: "Dexia's demise is only the start." We couldn't agree more. "
Here is a link to his article. Be forewarned that his writing is very recondite and quite abstruse, but it is very educational as well. In this week's market commentary, he writes about the fraud that is Europe's banking system, and how Europe's supposedly-strongest banks in the recent "stress tests" a few months ago were in reality Europe's most VULNERABLE institutions! Hussman is a brilliant man. (I'd like to nominate him to be the next Treasury Secretary or Fed Chairman. We're going to need the best to get us out of this black hole of debt and destruction. Prepare yourself, John! )
Tuesday, October 18, 2011
A quote from Bloomberg news, and a chart. Here's the link to the entire article. From Bloomberg:
Monday, October 17, 2011
Empire State Fed index disappoints the market:
"Future indexes generally indicated an expectation that conditions would improve in the months ahead, but the level of optimism remained relatively low. The future general business conditions index fell six points to 6.7, its lowest level since February of 2009."
German Finance Minister Wolfgang Schaeuble said the EU summit "would not present a definitive solution to the euro zone debt crisis."
German Prime Minister Angela Merkel echoed the sentiment with this statement: "dreams that are taking hold again now that with this package everything will be solved and everything will be over on Monday won’t be able to be fulfilled.”
This statement today from Goldman Sachs', a surprisingly skeptical view considering the Goldman always seems to be predicting good times.
"To some extent it is remarkable that markets continued to rally last week and that Eurozone-related risk premia declined, because at the surface, there has been very little concrete progress regarding the Eurozone fiscal crisis. The extent of Greek haircuts, the details of bank recapitalisations, the use of leverage in the EFSF or not – all these and many other issues remain basically unresolved at the moment. Only one thing is clear, policymakers continue to work overtime while trying to find solutions."
Sunday, October 16, 2011
"By a continuing process of
inflation, government can confiscate, secretly and unobserved, an important
part of the wealth of their citizens.
But first, let me quickly call to your attention a speaking engagement that I'm doing November 9 in Atlanta. It is for Hedge Funds Care, and it's a wonderful event for a children's charity. If you can make it, I hope to see you there. You can learn more and register at http://www.hedgefundscare.org/event.asp?eventID=74.
An Encore Presentation
But economic stagnation continued and so did the money growth. They kept making money more available. No reaction. Then, suddenly prices began to explode unbelievably (but, perversely, not business activity).
So, on this day government officials decided to bring figures in line with market realities. They devalued the mark. The new value would be 2 billion marks to a dollar. At the start of World War I the exchange rate had been a mere 4.2 marks to the dollar. In simple terms you needed 4.2 marks in order to get one dollar. Now it was 2 billion marks to get one dollar. And thirteen months from this date (late November 1923) you would need 4.2 trillion marks to get one dollar. In ten years the amount of money had increased a trillion fold.
Numbers like billions and trillions tend to numb the mind. They are too large to grasp in any "real" sense. Thirty years ago an older member of the NYSE (there were some then) gave me a graphic and memorable (at least for me) example. "Young man," he said, "would you like a million dollars?" "I sure would, sir!" I replied anxiously. "Then just put aside $500 every week for the next 40 years." I have never forgotten that a million dollars is enough to pay you $500 per week for 40 years (and that's without benefit of interest). To get a billion dollars you would have to set aside $500,000 dollars per week for 40 years. And a…..trillion that would require $500 million every week for 40 years. Even with these examples, the enormity is difficult to grasp.
Let's take a different tack. To understand the incomprehensible scope of the German inflation maybe it's best to start with something basic….like a loaf of bread. (To keep things simple we'll substitute dollars and cents in place of marks and pfennigs. You'll get the picture.) In the middle of 1914, just before the war, a one pound loaf of bread cost 13 cents. Two years later it was 19 cents. Two years more and it sold for 22 cents. By 1919 it was 26 cents. [Double in value, or a "mere" 12% compound inflation –JM.] Now the fun begins.
In 1920, a loaf of bread soared to $1.20, and then in 1921 it hit $1.35. By the middle of 1922 it was $3.50. At the start of 1923 it rocketed to $700 a loaf. Five months later a loaf went for $1200. By September it was $2 million. A month later it was $670 million (wide spread rioting broke out). The next month it hit $3 billion. By mid month it was $100 billion. Then it all collapsed [as if a roughly 8 billion times rise in cost wasn't already collapse! Hint of irony here. – JM]
Let's go back to "marks". In 1913, the total currency of Germany was a grand total of 6 billion marks. In November of 1923 that loaf of bread we just talked about cost 428 billion marks. A kilo of fresh butter cost 6000 billion marks (as you will note that kilo of butter cost 1000 times more than the entire money supply of the nation just 10 years earlier).
[Side note: So convinced were the bond markets that war was not possible that bonds were still selling at normal prices. War was simply inconceivable. Bad call. - JM]
The German General Staff thought the war would be short and sweet and that they could finance the costs with the post war reparations that they, as victors, would exact. The war was long. The flower of their manhood was killed or injured. They lost and, thus, it was they who had to pay reparations rather than receive them.
Things did not go badly instantly. Yes, the deficit soared but much of it was borne by foreign and domestic bond buyers. As had been noted by scholars….."The foreign and domestic public willingly purchased new debt issues when it believed that the government could run future surpluses to offset contemporaneous deficits." In layman's English that means foreign bond buyers said – "Hey this is a great nation and this is probably just a speed bump in the economy." (Can you imagine such a thing happening again?)
When things began to disintegrate, no one dared to take away the punchbowl. They feared shutting off the monetary heroin would lead to riots, civil war, and, worst of all communism. So, realizing that what they were doing was destructive, they kept doing it out of fear that stopping would be even more destructive.
People's savings were suddenly worthless. Pensions were meaningless. If you had a 400 mark monthly pension, you went from comfortable to penniless in a matter of months. People demanded to be paid daily so they would not have their wages devalued by a few days passing. Ultimately, they demanded their pay twice daily just to cover changes in trolley fare. People heated their homes by burning money instead of coal. (It was more plentiful and cheaper to get.)
The middle class was destroyed. It was an age of renters, not of home ownership, so thousands became homeless.
But the cultural collapse may have had other more pernicious effects.
Some sociologists note that it was still an era of arranged marriages. Families scrimped and saved for years to build a dowry so that their daughter might marry well. Suddenly, the dowry was worthless – wiped out. And with it was gone all hope of marriage. Girls who had stayed prim and proper awaiting some future Prince Charming now had no hope at all. Social morality began to collapse. The roar of the roaring twenties began to rumble.
All hope and belief in systems, governmental or otherwise, collapsed. With its culture and its economy disintegrating, Germany saw a guy named Hitler begin a ten year effort to come to power by trading on the chaos and street rioting. And then came World War II.
That soul-wrenching and disastrous experience with inflation is seared into the German psyche. It is why the populace is reluctant to endorse the bailout. It is also why all the German proposals have each country taking care of its own banks. (It gives them more control.) The French plans tend to socialize the bailout. There's more disagreement in these plans than the headlines would indicate.
To celebrate have a Jagermeister or two at the Pre Fuhrer Lounge and try to explain that for over half a century America's trauma has been depression-era unemployment while Germany's trauma has been runaway inflation. But drink fast, prices change radically after happy hour.
http://www.amazon.com/endgame). Let me quote a few paragraphs.
"We know that the world is drowning in too much debt, and it is unlikely that households and governments everywhere will be able to pay down that debt. Doing so in some cases is impossible, and in other cases it will condemn people to many hard years of labor in order to be debt-free. Inflation, by comparison, appears to be the easy way out for many policy makers.
"Companies and households typically deal with excessive debt by defaulting; countries overwhelmingly usually deal with excessive debt by inflating it away. While debt is fixed, prices and wages can go up, making the total debt burden smaller. People can't increase prices and wages through inflation, but governments can create inflation and they've been pretty good at it over the years. Inflation, debt monetization and currency debasement are not new. They have been used for the past few thousand years as means to get rid of debt. In fact, they work pretty well.
"The average person thinks that inflation comes from 'money printing.' There is some truth to this, and indeed the most vivid images of hyperinflation are of printed German Reichmarks being burnt for heat in the 1920s or Hungarian Pengos being swept up in the streets in 1945.
"You don't even have to go that far back to see hyperinflation and how brilliantly it works at eliminating debt. Let's look at the example of Brazil, which is one of the world's most recent examples of hyperinflation. This happened within our lifetimes. In the late 1980s and 1990s it very successfully got rid of most of its debt.
"Today Brazil has very little debt as it has all been inflated away. Its economy is booming, people trust the central bank and the country is a success story. Much like the United States had high inflation in the 1970s and then got a diligent central banker like Paul Volcker, in Brazil a new government came in, beat inflation, produced strong real GDP growth and set the stage for one of the greatest economic success stories of the past two decades. Indeed the same could be said of other countries like Turkey that had hyperinflation, devaluation, and then found monetary and fiscal rectitude.
"In 1993 Brazilian inflation was roughly 2,000%. Only four years later, in 1997 it was 7%. Almost as if by magic, the debt disappeared. Imagine if the US increased its money supply which is currently $900 billion by a factor of 10,000 times as Brazil's did between 1991 and 1996. We would have 9 quadrillion USD on the Fed's balance sheet. That is a lot of zeros. It would also mean that our current debt of thirteen trillion would be chump change. A critic of this strategy for getting rid of our debt could point out that no one would lend to us again if we did that. Hardly. Investors, sadly, have very short memories. Markets always forgive default and inflation. Just look at Brazil, Bolivia, and Russia today. Foreigners are delighted to invest in these countries.
"The endgame is not complicated under inflation/hyperinflation. Deflation is not inevitable. Money printing and monetization of government debt works when real growth fails. It has worked in countless emerging market economies (Zimbabwe, Ukraine, Tajikistan, Taiwan, Brazil, etc.). We could even use it in the US to get rid of all our debts. It would take a few years, and then we could get a new central banker like Volker to kill inflation. We could then be a real success story like Brazil.
"Honestly, recommending hyperinflation is tongue in cheek. But now even serious economists are recommending inflation as a solution. Given the powerful deflationary forces in the world, inflation will stay low in the near term. This gives some comfort to mainstream economists who think we can create inflation to solve the debt problem in the short run. The International Monetary Fund's top economist, Olivier Blanchard, has argued that central banks should target a higher inflation rate than they do at present in order to avoid the possibility of deflation. Economists like Paul Krugman, a Nobel Prize winner, and Olivier Blanchard argue that central banks should raise their inflation targets to as high as 4%. Paul McCulley argues that central banks should be 'responsibly irresponsible.'
"Peter Bernholz wrote the bible on inflation and hyperinflation, called Monetary Regimes and Inflation: History, Economic and Political Relationships. He writes about 29 periods of hyperinflation. What causes such a spectacular increase in prices? Bernholz has explained the process very elegantly.
"Bernholz argues that governments have a bias towards inflation. The evidence doesn't disagree with him. The only thing that limits a government's desire for inflation is an independent central bank. After looking at inflation across all countries and analyzing all hyperinflationary episodes, the lessons are the following:
1. Metallic standards like gold or silver standard show no, or a much smaller, inflationary tendency than discretionary paper money standards
2. Paper money standards with central banks independent of political authorities are less inflation-based than those with dependent central banks.
3. Currencies based on discretionary paper standards and bound by a regime of a fixed exchange rate to currencies, which either enjoy a metallic standard or, with a discretionary paper money standard, an independent central bank, show also a smaller tendency towards inflation, whether their central banks are independent or not.
"Bernholz examined twelve of the twenty-nine hyperinflationary episodes where significant data existed. Every hyperinflation looked the same. 'Hyperinflations are always caused by public budget deficits which are largely financed by money creation.' But even more interestingly, Bernholz identified the level at which hyperinflations can start. He concluded that 'the figures demonstrate clearly that deficits amounting to 40 percent or more of expenditures cannot be maintained. They lead to high inflation and hyperinflations….' Interestingly, even lower levels of government deficits can cause inflation. For example, 20% deficits were behind all but four cases of hyperinflation.
"Stay with us here, because this is an important point. Most analysts quote government deficits as a percentage of GDP. They'll say, 'The US has a government deficit of 10% of GDP.' While this measure makes some sense, it doesn't tell you how big the deficit is relative to expenditures. The deficit may be 10% the size of the US economy, but currently the US deficit is over 30% of all government spending. That is a big difference."
The US Federal Reserve system is different from most central banks, whether it is independent or not. It is composed of 12 separate regional banks, each of which has its own board, which appoints its regional president. The regions each get a certain number of rotating votes in the FOMC meetings, along with the appointed Fed governors. But they all get to participate in FOMC meetings and offer opinions. And the presidents certainly talk with each other. The last two meetings have seen the unusual circumstance of three dissenting votes.
These regional boards comprise local business leaders, some academics, and community leaders. They have to go back and work and live in their communities. They don't get to retire to an ivory tower and tenure, like many Fed governors. They see the real world, or at least their parts of it, and the boards have become very diverse over time.
Hyperinflation requires a central bank to willingly commit economic suicide. Typically, that happens at the behest of an authoritarian government. Under our current system, I can't see that happening. The hue and cry would be very loud and long and early. If you think Fisher et al. are vocal today, think about their response to really aggressive printing. I am not talking about something on the order of QE2, a BB gun as compared to a bazooka. I am talking about real printing.
It is not just a few vocal regional Fed presidents, of whom Fisher is the most eloquent. Even Bernanke has been talking about the limits of monetary policy and the need for the fiscal house to be put in order.
If Bernanke and his fellow Keynesians could whip up 4-5% inflation for a few years, would they do it? I think so, although they would publicly demur. But that is a far cry from 10% and even further from the 50% that would be needed to really ignite hyperinflation. I doubt they have the stomach for that, even in the face of a serious recession. The memories of the '70s are still part of our genetic make-up.
But could they print a whole lot more than one can imagine now, without unleashing the inflation demon? The simple answer is yes, and for that rationale we go back to the '30s and Irving Fisher, who gave us the classic equation of the link between money supply and inflation and the velocity of money (how fast money moves through an economy).
Inflation is a combination of the money supply AND the velocity of money. In short, if the velocity of money is falling, the Fed can print a great deal of money (expanding its balance sheet) without bringing about inflation. Remember the above instance, where workers wanted to get paid twice a day? That was a case of both rising money supply and rising velocity of money, a deadly combination. I have written several e-letters about the velocity of money, if you want more in-depth analysis. If this is something you do not understand, I suggest you take the time; otherwise you will not get the background of the argument. Here are a couple links to letters where I explain the velocity of money:
When do we see a seriously falling velocity of money? At the end of debt supercycles, where deleveraging is the order of the day. Which is where we are today in the US. Look at the graph below (from my friend Lacy Hunt at Hoisington Asset Management). Notice that the late '70s saw a rising money supply and rising velocity of money. And voila, we got inflation in the US. Notice that now velocity is falling and, as Lacy points out, the velocity is mean reverting over very long periods of time, so we can expect it to go lower. Also remember that the US government (at the federal level) has yet to really begin to get its fiscal house in order. (Although state and local government have combined to cut deficits $200 billion a year through a combination of spending cuts and tax increases, or over 1% of GDP, which has been a serious headwind with more cuts and tax increases to come.)
What could change my mind? If the (how to say this politely?) ill-conceived (stronger words come to mind) proposal by Financial Services Committee ranking member Barney Frank (D-Mass) were to see the light of day, I would get very concerned. According to Bloomberg and The Hill, Frank plans to submit a bill that would remove the votes of the five regional Federal Reserve presidents from the 12-member Federal Open Markets Committee (FOMC), which sets interest rates, and replace them with five appointees that would be nominated by the President and confirmed by the Senate.
Frank says "he is concerned that the process is undemocratic because the regional Fed presidents are not elected or appointed by elected representatives, and he believes that regional Fed presidents are overly likely to focus on guarding against inflation at the expense of more adequately tackling the country's unemployment crisis." (US News and World Report)
Basically, he wants the Fed to be subservient to the politicians. Under his proposal, the FOMC could lose what independence it has in a short time. This is part of a strain of thought that suggests that the decisions that affect all of us should be made by a few elite people who purport to understand what is going on, which coincidentally are government insiders and the academics who foster their agendas.
How did Weimar and other hyperinflation incidents occur? When power was in the hands of a few well-intentioned elites who did not understand the long-term consequences, or were acting in self-interest without transparency or any check on their decisions. The Fed is designed to be a system of checks and balances, with no one president getting to appoint all the governors (they have 14-year terms), in order to try to remove the process as much as possible from political interference. That does not mean they will make the right decisions, but in this I agree with the alarmists: history suggests that without some constraint (gold standards as an example) hyperinflations may occur.
A repeat of the '70s? That is within the realm of possibility, but it's certainly not a base-case scenario. Hyperinflation under our current system? I just don't see it.
The far more interesting question is what will happen when we reach the point of "won't happen." Will that be something we recognize before it happens and act proactively to avoid a cataclysmic event? Will we wait until the bond market jerks our chain about the fiscal crisis, which is massively stagflationary? Yes, the Fed can print to some degree, but not dealing with the crisis will ultimately force a huge restructuring of spending and taxes which, if not caught early enough, will propel us into a certain Second Great Depression. Which is why I think we will deal with it proactively in 2013, because to not do so would be folly of the worst sort. The consequences are unimaginable for the US and for the world. Think Greece, and then go downhill. All over the world.
I think more and more political leaders are beginning to understand that point. They are not happy about it. But I remain hopeful that in 2013 we can actually deal with the deficit and the debt in an orderly manner. If we do not, God help us all.