Category: Deflation


End of the Road…

June 30th, 2015 — 12:43pm

I wrote this in response to a friend complaining about Greek irresponsibility.

The other angle is the corruption of the banking system as it’s currently structured and the complicity of the EU so called creditors i.e. Merkel, (where Germany is the main beneficiary of the Euro) in conjunction with the ECB’s Draghi and Lagarde of the IMF.

There is no tangible value backing ‘money’ in the current fiat banking system. Banks create money when they make loans; all money is loaned into existence. This is confirmed in the BofE Quarterly bulletin from just over a year ago here.

This is done at no material cost to the bank, and yet the payment of the interest requires the investment of intellectual or physical labour of the borrower, which is a material cost. Furthermore, the charging of interest (for risk ?) where the bank can suffer no loss and is not being temporarily deprived of the funds extended as credit (since they didn’t exist prior to the inception of the ‘loan’) means that in reality the entire transaction is utterly inequitable. Fraudulent even, notwithstanding its being legally sanctioned.

At the time the ‘money’ is created, they don’t also create the ‘money’ required to pay the interest, so bankruptcies are an absolute inevitability. It’s musical chairs.

Most of the bailout money ‘given to Greece’ has actually gone to the banks because these loans count as assets on the bank balance sheets and if they get wiped out, bank capital will get reduced, which would cause a deflationary spiral and collapse the entire Eurozone banking system. When you consider that the derivatives exposure of Deutsche Bank is $75 trillion, a 20x multiple of German GDP, this will probably happen anyway, eventually. It’s just a bubble in search of a pin.

Bank balance sheet write downs will be the result of any hard default, whereas QE on the other hand is the way to conduct a silent default and is avidly being pursued by the ECB. So default is not a moral issue for them. But basically the EU has attempted to sacrifice the Greek people in order to keep the banking system afloat and allow them to conduct their own soft default while continuing to extract the output of Greek labour to pay the banker’s salaries. OK, I know that’s a bit of a crude characterisation of the situation.

This entire situation is entirely of the making of the collusion of a large number of players, not least the ECB. By preventing a Greek currency devaluation, the Euro itself is ultimately responsible.

Here’s some more light reading.

http://www.zerohedge.com/news/2015-06-29/good-you-alexis-tsipras-part-1

http://www.zerohedge.com/news/2015-06-29/french-economy-dire-straits-worse-anyone-can-imagine-leaked-nsa-cable-reveals

http://www.zerohedge.com/news/2015-06-25/forget-grexit-madame-frexit-says-france-next-french-presidential-frontrunner-wants-o

http://www.zerohedge.com/news/2015-06-12/deutsche-bank-next-lehman

:)

Comment » | Deflation, EU, EUR, Greece, Macro, PIIGS, QE, The Euro

Credit Crunch

April 19th, 2015 — 3:38pm

From Zero hedge – Originally published by Michael Snyder via The Economic Collapse blog,

Get ready for another major worldwide credit crunch. Today, the entire global financial system resembles a colossal spiral of debt. Just about all economic activity involves the flow of credit in some way, and so the only way to have “economic growth” is to introduce even more debt into the system. When the system started to fail back in 2008, global authorities responded by pumping this debt spiral back up and getting it to spin even faster than ever. If you can believe it, the total amount of global debt has risen by $35 trillion since the last crisis. Unfortunately, any system based on debt is going to break down eventually, and there are signs that it is starting to happen once again.

For example, just a few days ago the IMF warned regulators to prepare for a global “liquidity shock“. And on Friday, Chinese authorities announced a ban on certain types of financing for margin trades on over-the-counter stocks, and we learned that preparations are being made behind the scenes in Europe for a Greek debt default and a Greek exit from the eurozone. On top of everything else, we just witnessed the biggest spike in credit application rejections ever recorded in the United States. All of these are signs that credit conditions are tightening, and once a “liquidity squeeze” begins, it can create a lot of fear.

Over the past six months, the Chinese stock market has exploded upward even as the overall Chinese economy has started to slow down. Investors have been using something called “umbrella trusts” to finance a lot of these stock purchases, and these umbrella trusts have given them the ability to have much more leverage than normal brokerage financing would allow. This works great as long as stocks go up. Once they start going down, the losses can be absolutely staggering.

That is why Chinese authorities are stepping in before this bubble gets even worse. Here is more about what has been going on in China from Bloomberg…

China’s trusts boosted their investments in equities by 28 percent to 552 billion yuan ($89.1 billion) in the fourth quarter. The higher leverage allowed by the products exposes individuals to larger losses in the event of stock-market drops, which can be exaggerated as investors scramble to repay debt during a selloff.

In umbrella trusts, private investors take up the junior tranche, while cash from trusts and banks’ wealth-management products form the senior tranches. The latter receive fixed returns while the former take the rest, so private investors are effectively borrowing from trusts and banks.

Margin debt on the Shanghai Stock Exchange climbed to a record 1.16 trillion yuan on Thursday. In a margin trade, investors use their own money for just a portion of their stock purchase, borrowing the rest. The loans are backed by the investors’ equity holdings, meaning that they may be compelled to sell when prices fall to repay their debt.
Overall, China has seen more debt growth than any other major industrialized nation since the last recession. This debt growth has been so dramatic that it has gotten the attention of authorities all over the planet…

Wolfgang Schaeuble, Germany’s finance minister says that “debt levels in the global economy continue to give cause for concern.”

Singling out China in particular, Schaeuble noted that “debt has nearly quadrupled since 2007″, adding that it’s “growth appears to be built on debt, driven by a real estate boom and shadow banks.”

According to McKinsey’s research, total outstanding debt in China increased from $US7.4 trillion in 2007 to $US28.2 trillion in 2014. That figure, expressed as a percentage of GDP, equates to 282% of total output, higher than the likes of other G20 nations such as the US, Canada, Germany, South Korea and Australia.
This credit boom in China has been one of the primary engines for “global growth” in recent years, but now conditions are changing. Eventually, the impact of what is going on in China right now is going to be felt all over the planet.

Over in Europe, the Greek debt crisis is finally coming to a breaking point. For years, authorities have continued to kick the can down the road and have continued to lend Greece even more money.

But now it appears that patience with Greece has run out.

For instance, the head of the IMF says that no delay will be allowed on the repayment of IMF loans that are due next month…

IMF Managing Director Christine Lagarde roiled currency and bond markets on Thursday as reports came out of her opening press conference saying that she had denied any payment delay to Greece on IMF loans falling due next month.
Unless Greece concludes its negotiations for a further round of bailout money from the European Union, however, it is not likely to have the money to repay the IMF.
And we are getting reports that things are happening behind the scenes in Europe to prepare for the inevitable moment when Greece will finally leave the euro and go back to their own currency.

For example, consider what Art Cashin told CNBC on Friday…

First, “there were reports in the media [saying] that the ECB and/or banking authorities suggested to banks to get rid of any sovereign Greek debt they had, which suggests that maybe the next step will be Greece exiting,” Cashin told CNBC.
Also, one of Greece’s largest newspapers is reporting that neighboring countries are forcing subsidiaries of Greek banks that operate inside their borders to reduce their risk to a Greek debt default to zero…

According to a report from Kathimerini, one of Greece’s largest newspapers, central banks in Albania, Bulgaria, Cyprus, Romania, Serbia, Turkey and the Former Yugoslav Republic of Macedonia have all forced the subsidiaries of Greek banks operating in those countries to bring their exposure to Greek risk — including bonds, treasury bills, deposits to Greek banks, and loans — down to zero.
Once Greece leaves the euro, that is going to create a tremendous credit crunch in Europe as fear begins to spread like wildfire. Everyone will be wondering which nation will be “the next Greece”, and investors will want to pull their money out of perceived danger zones before they get hammered.

In the past, other European nations have been willing to bend over backwards to accommodate Greece and avoid this kind of mess, but those days appear to be finished. In fact, the finance minister of France openly admits that the French “are not sympathetic to Greece”…

Greece isn’t winning much sympathy from its debt-wracked European counterparts as the country draws closer to default for failing to make bailout repayments.
“We are not sympathetic to Greece,” French Finance Minister Michael Sapin said in an interview at the International Monetary Fund-World Bank spring meetings here.
“We are demanding because Greece must comply with the European (rules) that apply to all countries,” Sapin said.
Yes, it is possible that another short-term deal could be reached which could kick the can down the road for a few more months.

But either way, things in Europe are going to continue to get worse.

Meanwhile, very disappointing earnings reports in the U.S. are starting to really rattle investors.

For example, we just learned that GE lost 13.6 billion dollars in the first quarter…

One week following the announcement that it would dismantle most of its GE Capital financing operations to instead focus on its industrial roots, General Electric reported a first quarter loss of $13.6 billion.

The results were impacted by charges relating to the conglomerate’s strategic shift. A year ago GE reported a first quarter profit of $3 billion.
That is a lot of money.

How in the world does a company lose 13.6 billion dollars in a single quarter during an “economic recovery”?

Other big firms are reporting disappointing earnings numbers too…

In earnings news, American Express Co. late Thursday said its results were hurt by the strong U.S. dollar, which reduced revenue booked in other countries. Chief Executive Kenneth Chenault reiterated the company’s forecast that 2015 earnings will be flat to modestly down year over year. Shares fell 4.6%.

Advanced Micro Devices Inc. said its first-quarter loss widened as revenue slumped. The company said it was exiting its dense server systems business, effective immediately. Revenue and the loss excluding items missed expectations, pushing shares down 13%.
And just like we saw just before the financial crisis of 2008, Americans are increasingly having difficulty meeting their financial obligations.

For instance, the delinquency rate on student loans has reached a very frightening level…

More borrowers are failing to make payments on their student loans five years after leaving college, painting a grim picture for borrowers, according to the Federal Reserve Bank of New York.

Student debt continues to increase, especially for people who took out loans years ago. Those who left school in the Great Recession, which ended in 2009, had particular difficulty with repayment, with many defaulting, becoming seriously delinquent or not being able to reduce their balances, the New York Fed said today.

Only 37 percent of borrowers are current on their loans and are actively paying them down, and 17 percent are in default or in delinquency.
At this point, the American consumer is pretty well tapped out. If you can believe it, 56 percent of all Americans have subprime credit today, and as I mentioned above, we just witnessed the biggest spike in credit application rejections ever recorded.

We have reached a point of debt saturation, and the credit crunch that is going to follow is going to be extremely painful.

Of course the biggest provider of global liquidity in recent years has been the Federal Reserve. But with the Fed pulling back on QE, this is creating some tremendous challenges all over the globe. The following is an excerpt from a recent article in the Telegraph…

The big worry is what will happen to Russia, Brazil and developing economies in Asia that borrowed most heavily in dollars when the Fed was still flooding the world with cheap liquidity. Emerging markets account to roughly half of the $9 trillion of offshore dollar debt outside US jurisdiction.

The IMF warned that a big chunk of the debt owed by companies is in the non-tradeable sector. These firms lack “natural revenue hedges” that can shield them against a double blow from rising borrowing costs and a further surge in the dollar.
So what is the bottom line to all of this?

The bottom line is that we are starting to see the early phases of a liquidity squeeze.

The flow of credit is going to begin to get tighter, and that means that global economic activity is going to slow down.

This happened during the last financial crisis, and during this next financial crisis the credit crunch is going to be even worse.

This is why it is so important to have an emergency fund. During this type of crisis, you may have to be the source of your own liquidity. At a time when it seems like nobody has any cash, those that do have some will be way ahead of the game.

Comment » | Deflation, EU, Geo Politics, Greece, The Euro

Dollar Pegs

February 19th, 2015 — 6:56am

The Dollar Pegs are Next
Posted on January 18, 2015 by Martin Armstrong
Dollar-Peg

The next crisis will be the currency pegs against the dollar. Here we have pegs from Hong Kong to the Middle East. We will have the same problem for as the dollar is driven higher, thanks to the implosion in the Euroland, these nations will import DEFLATION from a rising dollar. This will break their backs and force pegs to collapse around the world. Keep in mind that this will unfold probably after September 2015 and help to spiral the world economy into the worst depression in centuries. Start preparing for a rainy day.

These idiots are raising taxes when they should be lowering them as even Keynes suggested. Unfortunately, we are in a major crisis because of their insane mismanagement of the economy. There is nothing they will not steal. They are the type of people who are pocketing soap on the cart of the maid as they leave the hotel room. This level of corruption is turning into a feeding frenzy, which is our doom.

The rise in the dollar, will be the key to breaking the post-war economy. It was the flight of capital from Euroland into the Swiss that broke that peg. We will see in the months ahead the same crisis unfold in the Middle East and in Asia. This will be accelerated by the emerging economies who have issued $6 trillion in dollar debt since 2007. As the dollar rises, they will be forced into the same position as Greece – unable to pay their debts because the debt keeps rising in cost.

Comment » | Asia, Deflation, General, Geo Politics, Macro, US denouement, USD

Even The BIS Is Shocked At How Broken Markets Have Become

December 8th, 2014 — 3:02pm

Originally posted here

Not a quarter passes without the Bank of International Settlements (BIS) aka central banks’ central bank (also the locus of some of the most aggressive manipulation of gold and FX in human history) reiterating a dire warning about the fire and brimstone that is about to be unleashed upon the global economy.

It started in June of 2013, when Jaime Caruana, certainly the most prominent doom and gloomer at the BIS (who also was Governor of the Bank of Spain from 2000 to 2007 when this happened) asked if “central banks [can] now really do “whatever it takes”? As each day goes by, it seems less and less likely… [seven] years have passed since the eruption of the global financial crisis, yet robust, self-sustaining, well balanced growth still eludes the global economy…. low-interest policies have made it easy for the private sector to postpone deleveraging, easy for the government to finance deficits, and easy for the authorities to delay needed reforms in the real economy and in the financial system. Overindebtedness is one of the major barriers on the path to growth after a financial crisis. Borrowing more year after year is not the cure…in some places it may be difficult to avoid an overall reduction in accommodation because some policies have clearly hit their limits.”

The BIS’ preaching did not end there, and hit a new crescendo in June of 2014, when in its 84th Annual Report, the BIS slammed “Market Euphoria”, and found a “Puzzling Disconnect” between the economy and the market”:

“it is hard to avoid the sense of a puzzling disconnect between the markets’ buoyancy and underlying economic developments globally”, that “despite the euphoria in financial markets, investment remains weak. Instead of adding to productive capacity, large firms prefer to buy back shares or engage in mergers and acquisitions” and that “the temptation to go for shortcuts is simply too strong, even if these shortcuts lead nowhere”… “Particularly for countries in the late stages of financial booms, the trade-off is now between the risk of bringing forward the downward leg of the cycle and that of suffering a bigger bust later on.”

“The global economy continues to face serious challenges. Despite a pickup in growth, it has not shaken off its dependence on monetary stimulus. Monetary policy is still struggling to normalise after so many years of extraordinary accommodation. Despite the euphoria in financial markets, investment remains weak. Instead of adding to productive capacity, large firms prefer to buy back shares or engage in mergers and acquisitions. And despite lacklustre long-term growth prospects, debt continues to rise. There is even talk of secular stagnation.

Financial markets are euphoric, but progress in strengthening banks’ balance sheets has been uneven and private debt keeps growing.

It did not end there either. In September of 2014, the warnings continued:

… the search for yield – a dominant theme in financial markets since mid-2012 – returned in full force. Volatility fell back to exceptional lows across virtually all asset classes, and risk premia remained compressed. By fostering risk-taking and the search for yield, accommodative monetary policies thus continued to support elevated asset price valuations and exceptionally subdued volatility.

The spell of market volatility proved to be short-lived and financial markets resumed their rally soon afterwards. By early September, global equity markets had recouped their losses and credit risk spreads once again consolidated at close to historical lows. While geopolitical worries kept weighing on financial market developments, these were ultimately superseded by the anticipation of further monetary policy accommodation in the euro area, providing support for asset prices.

The warnings continued. Earlier today, the BIS released its latest Quarterly Review report, where the most prominent warning this time revolves around the inverse Plaza Accord surge in the US Dollar whose dramatic, concentrated surge in recent months is unparalleled in history. In a nutshell, in “Currency movements drive reserve composition”, BIS’ McCauley and Chan warn that, in Ambrose Evans-Pritchard’s words, “off-shore lending in US dollars has soared to $9 trillion and poses a growing risk to both emerging markets and the world’s financial stability.”

From the full report:

The appreciation of the dollar against the backdrop of divergent monetary policies may, if persistent, have a profound impact on the global economy, in particular on EMEs. For example, it may expose financial vulnerabilities as many firms in emerging markets have large US dollar-denominated liabilities. A continued depreciation of the domestic currency against the dollar could reduce the creditworthiness of many firms, potentially inducing a tightening of financial conditions.

Or it may not: because this is essentially a carbon copy of the warnings that were issued after Bernanke first hinted at tapering in May of 2013, leading to the Taper TantrumTM, which led to some short-term volatility which were promptly soothed by even more central bank liquidity flooding what’s left of the capital “markets.”

AEP has more:

A chunk of China’s borrowing is disguised as intra-firm financing. This replicates practices by German industrial companies in the 1920s, which hid their real level of exposure as the 1929 debt trauma was building up. “To the extent that these flows are driven by financial operations rather than real activities, they could give rise to financial stability concerns,” said the BIS in its quarterly report.

“More than a quantum of fragility underlies the current elevated mood in financial markets,” it warned. Officials are disturbed by the “risk-on, risk-off, flip-flopping” by investors. Some of the violent moves lately go beyond stress seen in earlier crises, a sign that markets may be dangerously stretched and that many fund managers do not really believe their own Goldilocks narrative.

“Mid-October’s extreme intraday price movements underscore how sensitive markets have become to even small surprises. On 15 October, the yield on 10-year US Treasury bonds fell almost 37 basis points, more than the drop on 15 September 2008 when Lehman Brothers filed for bankruptcy.”

“These fluctuations were large relative to actual economic and policy surprises, as the only notable negative piece of news that day was the release of somewhat weaker than expected retail sales data for the US one hour before the event,” it said.

The BIS said 55pc of collateralised debt obligations (CDOs) now being issued are based on leveraged loans, an “unprecedented level”. This raises eyebrows because CDOs were pivotal in the 2008 crash.

“Activity in the leveraged loan markets even surpassed the levels recorded before the crisis: average quarterly announcements during the year to end-September 2014 were $250bn,” it said.

BIS officials are worried that tightening by the US Federal Reserve will transmit a credit shock through East Asia and the emerging world, both by raising the cost of borrowing and by pushing up the dollar.

But it’s best to leave it to the BIS itself, where this time Claudio Borio picks up the torch left by Jaime Caruana. What is notable is that none other than the BIS slams the infamous, and now legendary intervention by James “QE4″ Bullard to assure the S&P’s levitation continues without a hitch!

To my mind, these events underline the fragility – dare I say growing fragility? – hidden beneath the markets’ buoyancy. Small pieces of news can generate outsize effects. This, in turn, can amplify mood swings. And it would be imprudent to ignore that markets did not fully stabilise by themselves. Once again, on the heels of the turbulence, major central banks made soothing statements, suggesting that they might delay normalisation in light of evolving macroeconomic conditions. Recent events, if anything, have highlighted once more the degree to which markets are relying on central banks: the markets’ buoyancy hinges on central banks’ every word and deed.

Wait, so the central banks’ central bank is openly chastising one of its own now and for what: for stabilizing the market and preserving the unstable euphoria that the BIS has been warning about for so long?

Does this mean that the BIS is now openly calling for a crash? Perhaps, what is clear is that even the BIS, or the “good cop” (if only for the middle-class, certainly bad cop for the 0.01%-ers) is now shocked by just how broken the markets have become as summarized in the following line:

The highly abnormal is becoming uncomfortably normal. Central banks and markets have been pushing benchmark sovereign yields to extraordinary lows – unimaginable just a few years back. Three-year government bond yields are well below zero in Germany, around zero in Japan and below 1 per cent in the United States. Moreover, estimates of term premia are pointing south again, with some evolving firmly in negative territory. And as all this is happening, global growth – in inflation-adjusted terms – is close to historical averages. There is something vaguely troubling when the unthinkable becomes routine.

So yes, thank you for confirming – years after most who still follow the farce that is the “market” with an open mind – just how absolutely broken it is thanks to central bankers.

And here is the rub, because for the BIS to be complaining about broken markets is nothing short of peak hypocrisy.

Why? Exhibit A: the BIS board of directors.

So, dear BIS thinkers, philosophers, and commentators: the next time you wish to warn the general public about how fucked up everything has become, maybe you can throw some of these “rational” ideas around your next Board meeting first and ask the economist sociopaths who are sitting on the CTRL-P buttons at printing presses around the globe to maybe take it a little easier with the wholesale, worldwide destruction of not only fiat currency but every single “market”.

Oh, and while you are at it, please tell Benoit Gilson to slam paper gold to triple (and, if possible, double) digits ASAP: unlike the world’s chasers of momentum who only buy an asset if it becomes more expensive on hopes greater fools will buy it back from them, there are those who actually know a good deal that won’t last when they see it.

Comment » | Deflation, General, Macro, QE

Deflation again

February 22nd, 2014 — 8:22am

From AEP in the telegraph here

French President François Hollande must now pay the price for kowtowing to the contraction polices of the eurozone. His country is sliding into deflation.

French prices fell 0.6pc in January from a month earlier, and would have fallen even further without one-off tax rises.

Manufactured goods fell 3pc, and clothing fell 15.4pc as retailers slashed prices to offload stock.

France’s core prices have been dropping for months, even if the core CPI index is still just positive at 0.1pc on a year-to-year basis.

This outcome is exactly what the Observatoire Economique predicted a year ago would happen under the eurozone’s contractionary policy structure, that is to say under a triple squeeze of fiscal austerity, passive monetary tightening, and draconian bank deleveraging.

Surprise, surprise, the eurozone M3 money supply has been contracting since March.

People laughed at the Observatoire. Nobody is laughing any more. As the IMF said last night, Europe is one external shock away from a lurch into outright deflation.

“A new risk to activity stems from very low inflation in advanced economies, especially the euro area, which, if below target for an extended period, could de-anchor longer-term inflation expectations. Low inflation raises the likelihood of a deflation in case of a serious adverse shock to activity. In the euro area, low inflation also complicates the task in the periphery where the real burden of both public and private debt would rise as real interest rates increased.”

It is no mystery where that shock might come from. The Fed and the Chinese central bank are tightening into an emerging market storm that is turning more serious by the day.
A long list of countries are having to raise interest rates to defend their currencies, creating a further tightening bias. Some of these countries are coming off the rails altogether.

Optimists have a touching faith in the German locomotive that is supposed to pull the eurozone out of the swamp, but the latest data shows that German wages fell 0.2pc in 2013. Germany too is in wage deflation.

Which raises the question: how on earth are France, Italy, Spain, Portugal, and Greece supposed to claw back lost labour competitiveness against Germany by means of “internal devaluations” if German wages are falling?

This forces these countries to go into even steeper wage deflation to narrow the gap, and that in turn causes debt dynamics to spin out of control as the denominator effect does its worst.
There is a technical solution to this. It is called QE. The European Central Bank can lift the entire EMU system off the reefs by launching a monetary blitz to meet its own M3 growth target of 4.5pc.

Unfortunately, the German constitutional court has just raised the political bar for QE to such a high level that the ECB will have to wait until the shock hits before reacting, and by then it will be too late.

Contrary to widespread belief, there is no treaty prohibition against QE. Mario Draghi has said explicitly that it is “not illegal” and remains an option in extremis.
Maastricht prohibits the financing of budgets but not open market operations (QE) needed to maintain monetary stability.

The alleged constraint is entirely political and ideological, and driven by fear that German Eurosceptics will fight it in the courts.

So we have an impasse. What now happens if the damp kindling wood of eurozone recovery fails yet again? It has Japanisation written all over it.

Comment » | Deflation, EU, France, Macro, PIIGS

Global Economic Recovery..

April 28th, 2013 — 6:55pm

HG

bellwether verdict suggests not…

Comment » | Deflation, General, Macro

Japan

April 15th, 2013 — 4:22pm

Ex-Soros Advisor Sells “Almost All” Japan Holdings, Shorts Bonds; Sees Market Crash, Default And Hyperinflation

From zerohedge here

Previously, we have pointed out why Japan’s attempt at reincarnating its economy, geared solely at generating a stock market-based “wealth effect”, and far less focused on boosting the country’s trade surplus or current account, is doomed to failure, namely due the drastically lower equity participation by the general population and financial institutions in the country’s stock market. Sure, foreign investors will come and go renting each rally for a period of time, but unless the local population participates in the “reflation attempt” (which has already sent the price of luxury goods, energy and food through the rood), or in other words change the behavioral patterns of two generations of Japanese in under two years, the inflationary shock will simply leads to a loss of faith in the government and ultimately Abe’s second untimely demise. Not surprisingly, 4 months after Japan set off on the most ludicrous economic experiment in history, and one week after the BOJ announced its plans to double its balance sheet, Abe’s approval rating has already begun sliding with a poll by Asahi just reporting that popular support of Abe’s cabinet is already down to 60%, down from 71% a month ago.

The reflationary reality has finally started to get official recognition with the very Goldman Sachs (who like in Europe and the US is behind this epic experiment in hidden taxation of consumers) asking how popular inflation would be in Japan, and answers:

How popular will inflation be in Japan? Assuming the BoJ is successful and inflation rates rise, one interesting dynamic will be the political support for ‘super-easy’ monetary policy. The majority of financial household assets sit in deposits, which until now have earned a positive real rate. While long-term inflation expectations move higher, the Yen and equities re-price rapidly but the negative impact on deposit returns from negative real rates will only be felt once inflation has actually started to materialise. This is clearly not an immediate concern as the government’s approval ratings remain high ahead of the Upper House elections this Summer. Still, PM Abe’s policy aim of beating deflation may become less popular at some stage because the implied distributional choices of higher inflation may become clearer for voters. For example, higher inflation would re-distribute real income from (older) savers to (younger) wage earners. But again it is worth thinking about the exact sequencing. By the time inflation in Japan becomes settled in positive territory the Fed may well be on the verge of hiking rates. In essence, any concerns about inflation in Japan and debate about a BoJ policy response will likely arrive at a stage when Fed tightening and JPY carry trades have already become the dominant theme.

In short, yes, Japanese inflation will destabilize the economy, and almost certainly lead to yet another political upheaval, but by then Japan will have served its purpose and injected some $1 trillion into the US stock market, thus supposedly allowing the US economy to become self sustaining. Or not. As to the consequences that the demographically-challenged Japanese population has to face as it suddenly finds itself holding worthless pieces of paper… who cares.

Which means that Abenomics will ultimately fail to fix Japan, but at least there is some hope it will last long enough to send the S&P to even more ridiculous highs – which, when one cuts out all the noise, it really what the whole experiment is all about.

For Japan, there is still some hope that the country will stop this ludicrous experiment merely serving to feed US risk assets before it is too late. Luckly, we are not the only ones seeing the writing on the wall. A month ago, it was “Mr. Yen”, former finmin Eisuke Sakakibara, himself, saying “Abenomics” is going to fail.

“In terms of two percent inflation, it [‘Abenomics’] will fail. Deflation is structural. Even at the time, when Japan was in the upward [growth] swing between 2002 and 2007, prices went down. It will be extremely difficult to get out of deflation,” said Sakakibara, also known as “Mr. Yen” for his efforts to influence the currency’s exchange rate through verbal and official intervention in the forex markets in the late 1990s.

According to Sakakibara structural deflation in the world’s third largest economy is largely a result of the integration between the Japanese and Chinese economies and hence near impossible to move away from.

“Cheap Chinese goods come into Japan and push down the prices. And a lot of Japanese companies go to China to manufacture goods — so it’s not going to change,” said Sakakibara, who is currently a professor at Aoyama-Gakuin University in Tokyo.

According to Sakakibara, dollar-yen between 90 and 95 would be most favorable for the economy.

“I remember in 1998, 1999 — it [dollar-yen] did go to 150 — I was at that time in the government, I was terrified,” he said.

Moments ago, it was none other than Takeshi Fujimaki, Soros’ former advisor on all matters Japanese, who tripled down on the warnings, and told Bloomberg that the Bank of Japan’s “huge bet” by boosting quantitative easing won’t turn the economy around and is instead sending the nation toward default.

“By expanding the monetary base to 270 trillion yen, the BOJ is making a huge bet which I think it will ultimately lose,” Fujimaki said in an interview in Tokyo on April 11. “Kuroda’s QE announcement is declaring double suicide with the government. The BOJ will have to share the country’s fate and default together.”

Why? Same reason we have been pointing out every day for the past week, the same reason the Japanese bond market is now essentially broken with daily trading halts becoming an expected feature:

“The volatility in the JGB market as well as the fact that there is large selling represent fear among investors,” Fujimaki said. “They are early signs of a larger selloff and we should continue to monitor the moves in the long-term bonds.”

Fujimaki said he recently bought put options for Japanese government bonds of various maturities, without elaborating. He continues to hold real estate in Japan and options granting the right to sell the yen against the greenback expiring in less than five years. He also holds assets in U.S. dollars and currencies of other developed nations.

“Japan’s finance is sinking into the ocean,” Fujimaki said. “There’s no escape from a market crash in the future when you have such enormous debt.”

And the punchline:

“By expanding the monetary base to 270 trillion yen, the BOJ is making a huge bet which I think it will ultimately lose,” Fujimaki said in an interview in Tokyo on April 11. “Kuroda’s QE announcement is declaring double suicide with the government. The BOJ will have to share the country’s fate and default together.”

“Shirakawa did more than enough and he had good reasons to not do any more,” said Fujimaki. “There will be tremendous side effects from monetary stimulus. QE doesn’t work and has no exit.”

“Things may look rosy for now as stocks rise, but should we see hyper-inflation, JGBs will see a huge selloff, leading to a stock market crash,” said Fujimaki, adding that he sold “almost all” of his Japanese stock holdings some time ago.

Wow.

And people thought Kyle Bass was bearish.

Comment » | Deflation, Japan, USDJPY

The Road to Serfdom

October 12th, 2012 — 3:43pm

originally posted here and here

Authored by Detlev Schlichter; originally posted at DetlevSchlichter.com,

We are now five years into the Great Fiat Money Endgame and our freedom is increasingly under attack from the state, liberty’s eternal enemy. It is true that by any realistic measure most states today are heading for bankruptcy. But it would be wrong to assume that ‘austerity’ policies must now lead to a diminishing of government influence and a shrinking of state power. The opposite is true: the state asserts itself more forcefully in the economy, and the political class feels licensed by the crisis to abandon whatever restraint it may have adhered to in the past. Ever more prices in financial markets are manipulated by the central banks, either directly or indirectly; and through legislation, regulation, and taxation the state takes more control of the employment of scarce means. An anti-wealth rhetoric is seeping back into political discourse everywhere and is setting the stage for more confiscation of wealth and income in the future.

War is the health of the state, and so is financial crisis, ironically even a crisis in government finances. As the democratic masses sense that their living standards are threatened, they authorize their governments to do “whatever it takes” to arrest the collapse, prop up asset prices, and to enforce some form of stability. The state is a gigantic hammer, and at times of uncertainty the public wants nothing more than seeing everything nailed to the floor. Saving the status quo and spreading the pain are the dominant political postulates today, and they will shape policy for years to come.
Unlimited fiat money is a political tool

A free society requires hard and apolitical money. But the reality today is that money is merely a political tool. Central banks around the world are getting ever bolder in using it to rig markets and manipulate asset prices. The results are evident: equities are trading not far from historic highs, the bonds of reckless and clueless governments are trading at record low interest rates, and corporate debt is priced for perfection. While in the real economy the risks remain palpable and the financial sector on life support from the central banks, my friends in money management tell me that the biggest risk they have faced of late was the risk of not being bullish enough and missing the rallies. Welcome to Planet QE.

I wish my friends luck but I am concerned about the consequences. With free and unlimited fiat money at the core of the financial industry, mis-allocations of capital will not diminish but increase. The damage done to the economy will be spectacular in the final assessment. There is no natural end to QE. Once it has propped up markets it has to be continued ad infinitum to keep ‘prices’ where the authorities want them. None of this is a one-off or temporary. It is a new form of finance socialism. It will not end through the political process but via complete currency collapse.

Not the buying and selling by the public on free and uninhibited markets, but monetary authorities – central bank bureaucrats – now determine where asset prices should be, which banks survive, how fast they grow and who they lend to, and what the shape of the yield curve should be. We are witnessing the destruction of financial markets and indeed of capitalism itself.

While in the monetary sphere the role of the state is increasing rapidly it is certainly not diminishing in the sphere of fiscal policy. Under the misleading banner of ‘austerity’ states are not rolling back government but simply changing the sources of state funding. Seeing what has happened in Ireland and Portugal, and what is now happening in Spain and in particular Greece, many governments want to reduce their dependence on the bond market. They realize that once the bond market loses confidence in the solvency of any state the game is up and insolvency quickly becomes a reality. But the states that attempt to reduce deficits do not usually reduce spending but raise revenues through higher taxes.
Sources of state funding

When states fund high degrees of spending by borrowing they tap into the pool of society’s savings, crowd out private competitors, and thus deprive the private sector of resources. In the private sector, savings would have to be employed as productive capital to be able repay the savers who provided these resources in the first place at some point in the future. By contrast, governments mainly consume the resources they obtain through borrowing in the present period. They do not invest them in productive activities that generate new income streams for society. Via deficit-spending, governments channel savings mainly back into consumption. Government bonds are not backed by productive capital but simply by the state’s future expropriation of wealth-holders and income-earners. Government deficits and government debt are always highly destructive for a society. They are truly anti-social. Those who invest in government debt are not funding future-oriented investment but present-day state consumption. They expect to get repaid from future taxes on productive enterprise without ever having invested in productive enterprise themselves. They do not support capitalist production but simply acquire shares in the state’s privilege of taxation.

Reducing deficits is thus to be encouraged at all times, and the Keynesian nonsense that deficit-spending enhances society’s productiveness is to be rejected entirely. However, most states are not aiming to reduce deficits by cutting back on spending, and those that do, do so only marginally. They mainly replace borrowing with taxes. This means the state no longer takes the detour via the bond market but confiscates directly and instantly what it needs to sustain its outsized spending. In any case, the states’ heavy control over a large chunk of society’s scarce means is not reduced. It is evident that this strategy too obstructs the efficient and productive use of resources. It is a disincentive for investment and the build-up of a productive capital stock. It is a killer of growth and prosperity.
47 percent, then 52 percent, then 90 percent…

Why do states not cut spending? – I would suggest three answers: first, it is not in the interest of politicians and bureaucrats to reduce spending as spending is the prime source of their power and prestige. Second, there is still a pathetic belief in the Keynesian myth that government spending ‘reboots’ the economy. But the third is maybe the most important one: in all advanced welfare democracies large sections of the public have come to rely on the state, and in our mass democracies it now means political suicide to try and roll back the state.

Mitt Romney’s comment that 47% of Americans would not appreciate his message of cutting taxes and vote for him because they do not pay taxes and instead rely on government handouts, may not have been politically astute and tactically clever but there was a lot of truth in it.

In Britain, more than 50 percent of households are now net receivers of state transfers, up 10 percent from a decade ago. In Scotland it is allegedly a staggering 90 percent of households. Large sections of British society have become wards of the state.

Against this backdrop state spending is more likely to grow than shrink. This will mean higher taxes, more central bank intervention (debt monetization, ‘quantitative easing’), more regulatory intervention to force institutional investors into the government bond market, and ultimately capital controls.
Eat the Rich!

In order to legitimize the further confiscation of private income and private wealth to fund ongoing state expenditure, the need for a new political narrative arose. This narrative claims that the problem with government finances is not out-of-control spending but the lack of solidarity by the rich, wealthy and most productive, who do not contribute ‘their fair share’.

An Eat-the-Rich rhetoric is discernible everywhere, and it is getting louder. In Britain, Deputy Prime Minister Nick Clegg wants to introduce a special ‘mansion tax’ on high-end private property. This is being rejected by the Tories but, according to opinion polls, supported by a majority of Brits. (I wager a guess that it is popular in Scotland.) In Germany, Angela Merkel’s challenger for the chancellorship, Peer Steinbrueck, wants to raise capital gains taxes if elected. In Switzerland of all places, a conservative (!) politician recently proposed that extra taxes should be levied on wealthy pensioners so that they make their ‘fair’ contribution to the public weal.
France on an economic suicide mission

The above trends are all nicely epitomized by developments in France. In 2012, President Hollande has not reduced state spending at all but raised taxes. For 2013 he proposed an ‘austerity’ budget that would cut the deficit by €30 billion, of which €10 billion would come from spending cuts and €20 billion would be generated in extra income through higher taxes on corporations and on high income earners. The top tax rate will rise from 41% to 45%, and those that earn more than €1 million a year will be subject to a new 75% marginal tax rate. With all these market-crippling measures France will still run a budget deficit and will have to borrow more from the bond market to fund its outsized state spending programs, which still account for 56% of registered GDP.

If you ask me, the market is not bearish enough on France. This version of socialism will not work, just as no other version of socialism has ever worked. But when it fails, it will be blamed on ‘austerity’ and the euro, not on socialism.

As usual, the international commentariat does not ‘get it’. Political analysts are profoundly uninterested in the difference between reducing spending and increasing taxes, it is all just ‘austerity’ to them, and, to make it worse, allegedly enforced by the Germans. The Daily Telegraph’s Ambrose Evans-Pritchard labels ‘austerity’ ‘1930s policies imposed by Germany’, which is of dubious historical and economic accuracy but suitable, I guess, to make a political point.

Most commentators are all too happy to cite the alleged negative effect of ‘austerity’ on GDP, ignoring that in a heavily state-run economy like France’s, official GDP says as little about the public’s material wellbeing as does a rallying equity market in an economy fuelled by unlimited QE. If the government spent money on hiring people to sweep the streets with toothbrushes this, too, would boost GDP and could thus be labelled economic progress.

At this point it may be worth adding that despite all the talk of ‘austerity’ many governments are still spending and borrowing like never before, first and foremost, the United States, which is running the largest civil government mankind has ever seen. For 5 consecutive years annual deficits have been way in excess of $1,000 billion, which means the US government borrows an additional $4 billion on every day the markets are open. The US is running budget deficits to the tune of 8-10% per annum to allegedly boost growth by a meagre 2% at best.
Regulation and more regulation

Fiscal and monetary actions by states will increasingly be flanked by aggressive regulatory and legislative intervention in markets. Governments are controlling the big pools of savings via their regulatory powers over banks, insurance companies and pension funds. Existing regulations already force all these entities into heavy allocations of government bonds. This will continue going forward and intensify. The states must ensure that they continue to have access to cheap funding.

Not only do I expect regulation that ties institutional investors to the government bond market to continue, I think it will be made ever more difficult for the individual to ‘opt out’ of these schemes, i.e. to arrange his financial affairs outside the heavily state-regulated banking, insurance, and pension fund industry. The astutely spread myth that the financial crisis resulted from ‘unregulated markets’ rather than constant expansion of state fiat money and artificially cheap credit from state central banks, has opened the door for more aggressive regulatory interference in markets.
The War on Offshore

Part and parcel of this trend is the War on Offshore, epitomized by new and tough double-taxation treaties between the UK and Switzerland and Germany and Switzerland. You are naïve if you think that attacks on Swiss banking and on other ‘offshore’ banking destinations are only aimed at tax-dodgers. An important side effect of these campaigns is this: it gets ever more cumbersome for citizens from these countries to conduct their private banking business in Switzerland and other countries, and ever more expensive and risky for Swiss and other banks to service these clients. For those of us who are tax-honest but prefer to have our assets diversified politically, and who are attracted to certain banking and legal traditions and a deeper commitment to private property rights in places such as Switzerland, banking away from our home country gets more difficult. This is intentional I believe.

The United States of America have taken this strategy to its logical extreme. The concept of global taxation for all Americans, regardless where they live, coupled with aggressive litigation and threat of reprisal against foreign financial institutions that may – deliberately or inadvertently – assist Americans in lowering their tax burden, have made it very expensive and even risky for many banks to deal with American citizens, or even with holders of US green cards or holders of US social security numbers. Americans will find it difficult to open bank accounts in certain countries. This is certainly the case for Switzerland but a friend of mine even struggled obtaining full banking services in Singapore. I know of private banks in the UK that have terminated banking relationships with US citizens, even when they were longstanding clients. All of this is going to get worse next year when FATCA becomes effective – the Foreign Account Tax Compliance Act, by which the entire global financial system will become the extended arm of the US Internal Revenue System. US citizens are subject to de facto capital controls. I believe this is only a precursor to real capital controls being implemented in the not too distant future.

When Johann Wolfgang von Goethe wrote that “none are more hopelessly enslaved than those who falsely believe they are free” he anticipated the modern USA.

And to round it all off, there is the War on Cash. In many European countries there are now legal limits for cash transactions, and Italy is considering restrictions for daily cash withdrawals. Again, the official explanation is to fight tax evasion but surely these restrictions will come in handy when the state-sponsored and highly geared banking sector in Europe wobbles again, and depositors try to pull out their money.
“I’ve seen the future, and it will be…”

So here is the future as I see it: central banks are now committed to printing unlimited amounts of fiat money to artificially prop up various asset prices forever and maintain illusions of stability. Governments will use their legislative and regulatory power to make sure that your bank, your insurance company and your pension fund keep funding the state, and will make it difficult for you to disengage from these institutions. Taxes will rise on trend, and it will be more and more difficult to keep your savings in cash or move them abroad.

Now you may not consider yourself to be rich. You may not own or live in a house that Nick Clegg would consider a ‘mansion’. You may not want to ever bank in Switzerland or hold assets abroad. You may only have a small pension fund and not care much how many government bonds it holds. You may even be one those people who regularly stand in front of me in the line at Starbucks and pay for their semi-skinned, decaf latte with their credit or debit card, so you may not care about restrictions on using cash. But if you care about living in a free society you should be concerned. And I sure believe you should care about living in a functioning market economy.

This will end badly.

Comment » | Deflation, Fed Policy, General, Geo Politics, Gold, Macro Structure, QE

We’re doomed

July 26th, 2012 — 6:06pm

This is from Graham Summers of Phoenix Capital Research via zerohedge here

As noted in yesterday’s piece concerning how and why Europe could bring about systemic risk, EU banks are likely leveraged at much, much more than 26 to 1.

Indeed, considering how leveraged and toxic US banks’ (especially the investment banks’) balance sheets became from the US housing bubble, the chart I showed you should give everyone pause when they consider the TRUE state of EU bank balance sheets.

This fact in of itself makes the possibility of a systemic collapse of the EU banking system relatively high. Let me give you an example to illustrate this point.

Let’s assume Bank XYZ in Europe has a loan portfolio of €300 million Euros and equity of €30 million Euros. This means the bank is “officially” leveraged at 10 to 1 (this would be a great leverage ratio for a European bank as most of them are leveraged to at least 26 to 1 or worse).

So… let’s say that 10% of the bank’s loans (read: assets) are in fact worth 50% of the value that the bank claims they’re worth (not unlikely if you’re talking about a PIIGS bank). This means that the bank’s actual loan portfolio is worth €285 million (10% of 300 is 30 and 50% of 30 is 15).

With equity of only €30 million, the bank, at some point, will have to take writedowns or one time charges on its loan portfolio that would erase HALF of its equity. At this point, the bank becomes leveraged at 19 to 1 (€285 million in assets on €15 million in equity).

This announcement would result in:

Depositors pulling their funds from the bank (thereby rendering it even more insolvent)
The bank’s shares plunging on the market (raising its leverage levels even higher as equity falls further).

Thus, at a leverage ratio of 10 to 1, even a 50% hit on 10% of a bank’s loan portfolio can result in the bank needing a bailout or even collapsing.

Now, what if that €300 million in loans is actually the amount the bank’s in-house risk models believe to be “at risk” and the REAL loan portfolio is around €800 million?

Immediately, we realize that the bank is in fact leveraged at 26 to 1. At this level even a 4% drop in asset prices erases ALL equity rendering the bank insolvent.

And yet, based on Basel II requirements, this bank can claim in all public disclosures that it is only leveraged at 10 to 1. With this in mind, you should understand why the banks lobbied so hard against a rapid implementation of Basel III capital requirements (which would require equity and capital equal to 10.5% of all of risk-weighted assets.)

Indeed, Basel III requirements which were meant to go in effect at the end of 2012 will now gradually begin to be implemented in 2013. And banks will have until 2015 to adjust to the new capital requirements and until 2019 conservation buffers in place.

With that in mind, take my XYZ bank example, apply it to all of Europe, assume leverage ratios of 26 to 1 at the very minimum (Lehman blew up when it was leveraged at 30 to 1), and take another look at the housing bubbles in the above chart.

In simple terms Europe’s entire €46 trillion banking system is in far worse shape than even the US investment banks were going into 2008. And this is based on their leverage ratios alone.

Comment » | Deflation, EU, EUR, Geo Politics, Gold, Macro, The Euro

The War for Spain

April 15th, 2012 — 4:13am

From John Mauldin’s free weekly letter. Posted here

In my book Endgame, co-author Jonathan Tepper and I wrote a chapter detailing the problems that Spain was facing. It was obvious to us as we wrote in late 2010 that there really was no easy exit for Spain. The end would come in a torrent of misery and tears. Tepper actually grew up in a drug rehab center in Madrid – as a kid, his best friends were recovering junkies. (For the record, he has written a fascinating story of his early life and is looking for a publisher.) His Spanish is thus impeccable, and he used to get asked to be on Spanish programs all the time. Until the day came when the government created a list of five people, including our Jonathan, who were basically named “Enemies of Spain,” and pointedly suggested they not be quoted or invited onto any more programs.

As it turns out, the real enemy was the past government. We knew (and wrote) that the situation was worse than the public data revealed, but until the new government came to power and started to disclose the true condition of the country, we had no real idea. The prior government had cooked the books. So far, it seems it even managed to do so without the help of Goldman Sachs (!)

In about ten days I will be sending you a detailed analysis of all this, courtesy of some friends, but let’s tease out some of the highlights. True Spanish debt-to-GDP is not 60% but closer to 90%, and perhaps more when you count the various and sundry local-government debts guaranteed by the federal government, most of which will simply not be paid. Spanish banks are miserably underwater, and that is with write-offs and mark to market on debts that totals not even half of what it should be. If Spanish housing drops as much relative to its own bubble as US housing has so far (and it will, if not more), then valuations will drop 50%. The level of overbuilding was stupendous, with one home built for every new every person as the population grew. We know that unemployment is 23%, with youth unemployment over 50%. Etc, etc. We could spend 50 pages (which is what I will get you access to) detailing the dire distress that is Spain.

Which brings us to this week. It was only a few weeks ago that most everyone, including your humble analyst, thought that the ECB had bought a little time with its “shock and awe” €1-trillion LTRO. Lots of analysis said there would now be at least a year to put programs in place to deal with the coming crisis.

Yet we may now be fast approaching the Bang! moment when the markets simply refuse to believe in the firepower that whatever governmental entities can muster. It happened with Greece, as it has in all past debt crises. Things go along more or less swimmingly until, as Ken Rogoff and Carmen Reinhart so articulately detail in This Time is Different, we wake up one morning to find that Mr. Market has seemingly lost all interest in funding a country at a level of interest rates that is credibly sustainable. When interest rates ran to 15% for Greece, even arithmetically challenged European politicians could understand that Greece had no hope of ever paying off its debt.

When rates rose last year to almost 7% for Italy and 6% for Spain, before the ECB let loose the hounds of monetization, they were approaching the limits of sustainability. Rates came back down as the ECB either bought directly or engineered the purchase of the bonds of the two countries. But now the LTRO effect appears to have worn off, and yesterday interest rates for Spanish ten-year bonds climbed again to 5.99%. There is a large auction for ten-year Spanish bonds next week, which the market is clearly anticipating with a bit of concern. Meanwhile, Italian interest rates are not rising in lock step, which shows that the anxiety is now clearly directed at Spain. Ho-hum, move along folks, nothing to see here in Rome.

(What follows now is a mix of the facts as I read them and speculation on my part. I admit I may be reading more into the information, as I squint at it at 3 AM, than is justified. But then again, there is a substantial amount of history that suggests I am not totally off base…)
Spain Goes “All In”

I came across this tidbit from typicallyspanish.com, and my antennae started to twitch (hat tip Joan McCullough). The key is the second paragraph. (Hacienda is the common name of the Spanish tax ministry, otherwise known as the Agencia Estatal de Administración Tributaria.)

“Spain led the loss in the number of self-employed workers in Europe in 2011. One in two of the self-employed to lose their jobs in the EU over the year was Spanish. Seven out of ten self-employed in Spain do not employ anyone else. Over 2011 Europe lost a total of 203,200 self-employed workers, 0.6% fewer than in 2010.

“Following the news that cash business transactions over 2500 € are to be banned, Hacienda has said they will not fine anyone who admits that they have been making payments of more than 2,500 € over the previous three months. The cash limit is part of the Governments anti-fraud plans which have been approved today, Friday. Those Spaniards who have a bank account outside the country now face the legal obligation of having to inform Hacienda about the account. The Government hopes its anti-fraud measures will bring in 8.171 billion €.”

My fellow US citizens will be saying to themselves, “So what? We have to report our foreign bank accounts, and any large cash transactions are flagged.” But gentle reader, this is much different. This is new law for Spain, basically currency control writ large, and bells have to be going off all over Europe.

First of all, note that Greece never tried to require its citizens to report cash transactions or to list foreign deposits. This is the new Spanish government revealing serious desperation. The government’s back is to the wall. They have to know they will not collect the taxes they need to generate, but are going to try anyway to demonstrate to the rest of Europe (read Germany) that they are doing everything they can.

In a side note, on Wednesday, Spain’s interior minister introduced new measures to thwart plots using “urban guerrilla” warfare methods to incite protests. And the local papers are printing op-eds by economists talking about how the effort to comply with German austerity demands will just make the economy worse, and that the government is not taking into account the resolve of labor unions to oppose them. “Germany is the problem.” It pains me to say this (truly it does), but this is what we were writing about Greece, not all that long ago. We are seeing footage of demonstrations, verging on riots. It is a familiar pattern.

Second, let’s review what I wrote a month ago. I noted that the LTRO money was being used by Spanish banks to buy Spanish government debt (and Italian banks were buying Italian government debt, etc.). The intention was to help the two countries specifically and Europe in general to finance their debts and allow banks to shore up their capital as part of that effort. But what that does is yield the unintended consequence of making a breakup of the eurozone easier, as it helps get Spanish and Italian debt off the books of German and French banks.

The only reason Germany and France, et al., cared about Greece is that their banks had so much Greek debt on their balance sheets, in many cases more than enough to render them insolvent. Bailing out the banks directly would have been costly, so better (thought the European leaders) to do it with bailouts from funds created with guarantees from the various governments (which is a backdoor way to get it from taxpayers) and the European Central Bank. A crisis was avoided and there was a more or less orderly Greek default – which anybody who bothered to look at the math saw coming well in advance.

A further side note: Spanish-bank borrowing from the European Central Bank doubled last month, “revealing a dangerous dependence on emergency funding that on Friday triggered renewed turmoil in financial markets.” (The Telegraph) And the Spanish stock market is down some 30% over the past year.)

So, in the effort to make sure that everyone pays their taxes and to stop tax fraud, the Spanish government is going to find out which of its citizens have moved their money out of Spain. And let’s be clear, money has been flying out of the banks of Spain and Portugal (and to some extent Italy) as it did, and still is, in Greece.

And it will be easier to track that offshore money than you think. Some people, I am sure, moved their money into cash and then out of the country. But others simply wired the money, thus leaving a trail. Spanish banking regulators can easily require they be given that information, and what bank will say no to the regulators? Spain does not collect taxes from its citizens if they are residents of a foreign country (as the US does), but it can tax everyone who lives in Spain. And if you live in Spain and decide to diversify your risk among a few other countries? I am not sure of Spanish tax law, but I reasonably assume you are supposed to report all your income from whatever source. (Otherwise there would be no one investing with Spanish banks, brokerages, and investment advisors –if it were legal not to report foreign investments, then everyone would invest outside of the country.)

Let me hazard a modest prediction: We will see a rather sudden and substantial need for physical cash in certain other “peripheral” countries, as now their citizens may not want to leave trails as they go about opening foreign bank accounts. What is to keep Italy from doing as Spain has done? Or Portugal? Or France? Or Germany?

Let me be clear about something. I am not suggesting that people should not pay their taxes. If you choose to live in a country, you should pay the taxes that are required. What Spain is trying to do is simply make sure that all their citizens pay the proper amount of taxes. If there was already 100% compliance, there would be no need for new regulations like Spain’s. And the same goes for the US. Our penalties are rather stiff for not paying taxes, more so, I’m guessing, than in most of Europe. I have on more than one occasion noted that the national sport of Italy is tax avoidance.

My friends in Spain tell me a lot of business is done in cash. But that is the case in the US and almost everywhere I go. There are a lot of (ahem) “independent” taxi drivers, services, etc. that do not take anything but cash. Maybe they report everything, but I do not bother to ask. (When I was a waiter in college, did I report all of my tips? I was required to report a minimum amount of income for each hour worked, but did I report everything? Since it has been 40 years and the statute of limitations has run out by now, I might admit to missing a few dollars here and there.)

I imagine there are quite a few Spanish citizens who are not sleeping well this weekend. And more than a few people tossing and turning in other countries as well. If the next month comes and goes without any sign of unusual cash movement in Europe, then I will owe the peoples of peripheral Europe a big apology for doubting their willingness to pay their taxes. Or maybe it will turn out that they were better at “avoidance” than your average American, and planned their movements far in advance…

Let’s get back to the central point. Spain is too big to fail and too big to save. The bond markets are clearly getting nervous, much sooner than was planned. Spain is clearly attempting to demonstrate that it will do everything in its power to comply with the new European austerity rules. Yet Prime Minister Mariano Rajoy has warned that the situation has created “a vicious circle that strangles Spain.”

Rajoy delivered a strongly worded speech to parliament, insisting that it was “as clear as day” that Spain would not need a Greek-style bailout. But in recognition that the country is losing market confidence, he appealed to other European leaders to be “careful with their comments” and remember that “what is good for Spain is good for the eurozone.” (The London Telegraph)

One can look at the amount of money Spain will need to refinance in the coming year and look at their financial ability, then look at how much can possibly be raised by the European community, even under the proposed new structures, and readily come to the conclusion that there is simply not enough money to save Spain if the market goes Bang!

The only possible solution I see is for the European Central Bank to step in with some new program. ECB President Mario Draghi has demonstrated a marked ability to come up with new, creative ways to kick the can down the road. Finding the money to bail out Spain is hopefully in his book of tricks. As fellow central banker Ben Bernanke has noted, Mario has a printing press. And the LTRO showed he knows where it is and how to use it.
“We Are Not Greece”

The German Bundesbank is saying as loudly as it can, “QE? Nein!!” But I count only two German votes among the 23 that compose the board of the ECB. Spain is demonstrating to its European brothers and sisters that it is doing all it can. “We are not Greece” is the clear statement. And “We need and deserve your help.” Yesterday, Rajoy pointedly noted again that “What is good for Spain is good for the eurozone.”

One should not underestimate the willingness of politicians who are viscerally committed to a certain action (in this case European unity) to spend someone else’s money in the pursuit of that action. Especially if that money is a hidden tax in the form of debt monetization.

The markets are moving up the time table on the next large monetization of Spanish (and eventually Italian?) debt. Germans will shout that this is inflationary, and for them it probably will be. But much of the rest of Europe is in the grip of deflation. Spain is clearly in a classic Keynesian liquidity trap. This is what can happen when you have very different economies operating under one monetary roof. This is not simply a banking or sovereign-debt crisis, it is about a massive trade imbalance and huge differences in the productivity of labor. The trade imbalance between the south – Portugal, Spain, Italy, and Greece – and the north (mostly Germany) must be solved before there can be any resolution of the economic crisis. This is Economics 101, which European politicians seem to have slept through.

There will be the attempt to create some sort of fund to buy Spanish debt, but it will prove to not be enough. And given recent market movements, it may not be able to happen fast enough. It will not surprise me if the ECB uses the promise of such a fund as a pretext for acting sooner.

And yes, this will lower the value of the euro. We will have to see how far Europe is willing to push the process. Greece will soon default again (they are in a depression and have a national election in early May), Portugal is still moving toward being bailed out, and the Irish are growing tired of having to repay the British, French, and Germans for bailing out their failed banks. Think bailout fatigue isn’t growing among European voters? Stay tuned…

Comment » | Deflation, EU, Macro, PIIGS, Spain, The Euro

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