News from Londongrad

The news that UK prime minister David Cameron wants to urge the EU to exclude Russia from the SWIFT system is a few days old by now. As an aside, we note the rebels in the Eastern Ukraine and by implication their “surplus military hardware store” next door apparently aren't worried overly much, as the rebels just attacked two Ukrainian military vessels in the Sea of Azov, one of which was reported to have gone up in flames as a result (see also brief video below).

Anyway, here is what Bloomberg reported regarding Cameron's proposal:

 

“The U.K. will press European Union leaders to consider blocking Russian access to the SWIFT banking transaction system under an expansion of sanctions over the conflict in Ukraine, a British government official said.

The Society for Worldwide Interbank Financial Telecommunication, known as SWIFT, is one of Russia’s main connections to the international financial system. Prime Minister David Cameron’s government plans to put the topic on the agenda for a meeting of EU leaders in Brussels today, according to the official, who asked not to be named because the discussions are private.

“Blocking Russia from the SWIFT system would be a very serious escalation in sanctions against Russia and would most certainly result in equally tough retaliatory actions by Russia,” said Chris Weafer, a senior partner at Moscow-based consulting firm Macro Advisory. “An exclusion from SWIFT would not block major trade deals but would cause problems in cross-border banking and that would disrupt trade flows.

 

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AfD Gains 10% of Vote in Saxony

The Free State of Saxony, Germany's 10th-largest state by area and 6th largest by population, has elected its regional parliament over the weekend. The result was quite a surprise, to say the least.

As a backgrounder: the Free State of Saxony is on former GDR territory in the East of Germany. The cities of Dresden, Leipzig and Chemnitz are located there. Here is its location on the map:

 

592px-Deutschland_Lage_von_Sachsen.svg


Free State of Saxony in dark green

 

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Gold Stocks Reach New High Relative to Gold

As we have mentioned in previous updates on the gold sector, few things are more important for its likely future performance than how gold stocks are performing relative to gold. The action in the stock market this year is in many ways increasingly reminiscent of the final phase of the technology bubble of the late 1990s. Concurrently, the recent action in gold, silver and gold stocks is also exhibiting similarities to the lows that were made at the time.

To elaborate a bit on this: the action in the stock market and the fundamental backdrop are of course only similar to the 1999/2000 period in certain respects; no two historical periods are ever completely similar. From a technical perspective, the parallels are the following: relative weakness in small cap stocks, an increasingly narrow advance driven by fewer and fewer stocks during each new rally leg over recent months, new all time highs in the Rydex bull/bear asset ratio and a noticeable increase in volatility in the ratio, multiple intra-market divergences over recent months with strength focused on the tech sector, and extremely lop-sided bullish sentiment readings in both positioning and survey data over recent months.

Fundamentally, the main similarity is a tightening of policy by the Fed. Note here that even though the Federal Funds rate remains pegged at the 0-0.25% corridor (and due to the mass of excess reserved held by banks effectively trades just below 0.1%), the so-called “tapering” of QE still amounts to a tightening of monetary policy. However, while the Fed has reduced its monetization activities, commercial banks have stepped up their inflationary lending. As a result, y/y money supply growth (TMS-2) has oscillated around the 8% mark since mid 2013. This is still quite brisk, and as such is a fundamental datum that can be considered as supportive for the market. Note though that it represents a sharp slowdown from the peak growth rates recorded in 2010 (approx. 17%) and 2011 (approx. 16%) and that the willingness of banks to continue to expand credit greatly depends on the economy's performance (there is a feedback loop between the two).

 

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Fiscal Policy – The Real Difference

That leaves fiscal policy as the real difference between an independent Scotland and the rest of the UK. But what a huge difference that can mean. This is where choice, responsibility and independence of mind and spirit enter the equation. As Austrians, we would probably make very different choices from those set out in Scotland’s Future but, there again, we would make very different choices from those made in the UK, the US, Europe and elsewhere. (At the same time, we believe that we would have more opportunity to influence these decisions in a smaller administrative unit than we do today.)

We have a philosophical problem with the Scottish government’s commitment to policies such as “free medical prescriptions”, “free university education” and the retention of public ownership of the Health Service. But our issue is with terminology and blind faith, not with the choices. In fact, these are good examples of the priorities that Scots in general espouse relative to the rest of the UK. Provision of medical treatment for all people in society, a commitment to education for the young and a functioning medical care system. These are all strongly supported public services in Scotland. As Hayek would put it, an awareness of what our neighbors want – who are we to argue?

 

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A Cold Summer in Europe …

The summer is slipping away. In the morning, mists hang over the fields. The chestnut trees have already turned a rust color. We start a fire in the kitchen fireplace to keep our mother warm.

 

Helikopter-geld

It wasn’t much of a summer in Europe this year. Still, we’re sorry to see it go. This weekend we will pack up the house… turn off the water… close the shutters … and head for the airport.

We’re headed to China first. Stay tuned …

 

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A Jumble of Memes

It has recently become quite fashionable to drag up the old Luddite argument that technological progress will destroy jobs, which is to say, destroy them on a net basis. Allegedly, the “rise of the Robots” will accomplish what centuries of economic and technological progress in the capitalist market economy have failed to do.

As you will see in the video below, the purveyors of this idea assure us that “this time, it's different”. Allegedly, humans are now in the same position that horses found themselves in when the automobile was invented. If you are not groaning inwardly by the time this argument is proposed, then you urgently need to brush up on your knowledge of economics (the same obviously goes for the makers of the video).

Closely associated with this idea is the meme of a “basic income for everyone”, to be provided by the State. People arguing in favor of such a program have apparently forgotten that nothing really comes for “free”.  Not only must this redistribution be funded by others who produce real wealth and the State would have to forcibly expropriate them in order to provide this basic income, but we may rest assured that this “gift” will come with strings attached. A crypto-communist State  providing basic incomes to all citizens will strip them not only of the incentive to work, it will inevitably also abridge their freedom in many other spheres of life. The State never provides something for “free”.

 

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The Credit Gradient

The United States, and every country, is subject to a monetary authority and legal tender laws. Here in the U.S. we have the Federal Reserve, a central bank that plans money and credit. The Fed thought they had perfected their planning (but of course it cannot be perfected). They thought they had ended the boom and bust cycle, and brought us into a brave new era, their so-called great moderation that ended in 2008. All they really did was manage the banking system to the brink of insolvency.

Let’s try a thought experiment. Suppose the monetary central planner attempts to fix the problem of insolvency by massive injections of liquidity. The central bank buys bonds. It dictates rates near zero on the short end of the yield curve, and promises not to raise rates for years to come. What perverse outcome would we expect?

Arbitrageurs see a green light, telling them that they can safely borrow short to buy long bonds. As the price of a bond goes up, the rate of interest goes down—it’s a rigid mathematical inverse. This is how suppression of short-term rates causes suppression of long-term rates.

 

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Angry Young Roofers

It is another cool, cloudy day in Poitou. The whole summer has been like this – like a winter in Georgia, with hardly a single warm day. Vacationers head back to Paris with the same white skin they came with. Beach resorts empty out… embarrassed at the way they treated their loyal customers.

But the roofers have liked it. No hot sun has beat down on them. We are redoing the roof of one of the barns. Alas, it is a slate roof, which costs a fortune. But at least you only have to replace it once a generation. Slate roofs last for 60 to 70 years.

 

Flag_of_France.svg_

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The Currency – Sterling or Not?

For those of us living and working abroad, and especially in the world of finance, one of the most perplexing features of the debate on Scotland’s post-independence currency has been the misconception that somehow the successor state to the United Kingdom can stop Scotland using sterling as the medium of exchange. This has been the mantra repeated by leaders of all the major UK parties.

Sterling is a freely-convertible, internationally-traded currency. It shares those features with a limited number of other currencies – the US dollar, the euro, the Australian dollar, the Canadian dollar and the yen (to name most). As such, sterling is available to any country in the world as a transactions and reference currency. So, unless the UK successor state intends to make sterling non-convertible (with dire consequences for the City of London) we can safely say that ‘sterlingization’ is not only a viable option but an attractive one given Scotland’s strong trading relationship with other parts of the UK, and vice versa. In this sense, Scotland would be making the same choice as the independent Irish government did post-1923 (Ireland operated a currency board arrangement with sterling between 1927 and 1979).

 

ScotlandPNew-50Pounds-TRBoS-2005-dml_fPT: A 50 pound note issued in Scotland. Currently, Scottish banks have to deposit an equivalent amount with the Bank of England if they want to issue notes – about £3.6bn pound sterling notes issued in Scotland are in circulation at present.

(Image source: The Royal Bank of Scotland)

 

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It’s NOT All about Pounds and Oil

 

“We shall not rebuild civilization on a large scale. It is no accident that on the whole there was more beauty and decency to be found in the life of small peoples, and that among the large ones there was more happiness and content in proportion as they had avoided the deadly blight of centralization. Least of all shall we preserve democracy or foster its growth if all the power and most of the important decisions rest with an organization far too big for the common man to survey or comprehend. Nowhere has democracy ever worked well without a great measure of local self-government, providing a school of political training for the people at large as much as for their future leaders. It is only where responsibility can be learned and practiced in affairs with which most people are familiar, where it is the awareness of one’s neighbor rather than some theoretical knowledge of the needs of other people which guides action, that the ordinary man can take a real part in public affairs because they concern the world he knows. Where the scope of the political measures becomes so large that the necessary knowledge is almost exclusively possessed by the bureaucracy, the creative impulses of the private person must flag. I believe that here the experience of the small countries like Holland and Switzerland contains much from which even the most fortunate larger countries like Great Britain can learn. We shall all be the gainers if we can create a world fit for small states to live in.”

 

Friedrich Hayek, The Road to Serfdom (1944), Chapter 15 (emphasis added)

 

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Waiting Until 2158

All over the world stocks are rising. In the US, the S&P 500 rose over the 2,000 mark for the first time in history. The Dow is over 17,000. And if you want to buy a share of online TV network Netflix, Inc. (NASDAQ:NFLX), you will pay $144 for every dollar the company earned over the last 12 months.

 

world

 

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The Death of Goodwill

 

This is the first piece in what I intend to be a series, on the theme I think of as the Death of Goodwill. There was (and still is) a huge difference between the attitudes of people in America and the attitudes of those in third-world countries. I use the word goodwill for this difference. For centuries, Americans have been helping one another raise barns, live through hard times, and get up when they fall in the street. Unfortunately, goodwill is being strangled. There are numerous mechanisms for this, though all have bad governance at the core.

With the death of goodwill will come the collapse of civil society, and its twin sister law and order.

 

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Planned Bond Exchange Declared Illegal

You bet it is illegal – in its continued attempt to welsh on its creditors, Argentina's  government has attempted to move its debt out of the reach of US courts by swapping its debt for new debt issued under local law. The problem is of course that “local law” can be made up to the government's liking. Simply put, investors would never have lent the government money in the first place if these bonds had not been issued under US law. By entering clauses that determined that New York would be the relevant jurisdiction, Argentina's government enticed investors to lend a lot of money to it at what were then quite favorable terms.

Obviously, for the government to attempt to alter these clauses retroactively by means of a swap makes a complete mockery of these contractual agreements. Hence, judge Griesa's determination that such action would be illegal is perfectly justified and correct (for details on the legal backdrop, we refer you to our previous article  “Argentina – Deadbeat State Goes on the Attack”). In the interest of achieving a settlement, the judge wisely refrained from issuing a contempt of court finding (he can't very well throw Argentina into jail anyway). It is obvious that judge Griesa just wishes the issue would go away, but to his credit, he continues to stand firm on the law.

According to a recent Bloomberg report:

 

“Argentina’s plan to pay its restructured debt beyond the reach of U.S. courts is illegal, said the judge overseeing litigation stemming from the nation’s 2001 default, while declining to hold the country in contempt.

U.S. District Judge Thomas Griesa said in Manhattan federal court today that the proposal, announced Aug. 19 by Argentina President Cristina Fernandez de Kirchner, is “invalid, illegal and in violation of current court orders and injunctions.”

Griesa declined a request by lawyers representing investors holding Argentina’s defaulted bonds that he find the nation in contempt of court. The judge told lawyers for both sides that a contempt finding wouldn’t add to the prospects of a settlement between Argentina and its creditors.

“The thing that is of paramount necessity is to have a settlement,” Griesa said. “There must be a settlement.”

 

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Buying Stuff One Doesn't Need With Money One Doesn't Have

Still in those lazy, not-so-hazy days of summer. August 15 marked the 43rd anniversary of that fateful decision by the Nixon administration to end the direct convertibility of the US dollar to gold. It came and went without much fanfare. Nobody cares.

Thanks largely to this new easy-money regime, credit creation replaced capital accumulation as the main driver of economic growth. Credit in the US expanded 50 times between 1964 and 2007, far more than the economy that supports it.

 

printedmoneyUncut 32-subject sheet of $2 Federal Reserve Notes.

(Photo by Christopher Hollis for Wdwic Pictures)

 

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Montebourg Gives a Speech – to Unexpected Effect

It all started harmless enough. The economically illiterate French “industrial renewal” minister Arnaud Mounteba…sorry, Montebourg, delivered one of his usual fiery addresses on the alleged evils of non-existent “austerity” imposed by the stingy and small-minded Germanic tribes across the river Rhine.

As a brief reminder: France's economy has entered a downward spiral as a result of its sclerotic body of regulations, overly high taxation and the imposition of a quasi-Zwangswirtschaft by president Hollande and his socialist buddies. As a result, the country continues to be unable to deliver on its promises with respect to the EU's stability pact, the rules of which were tightened in reaction to the euro area's sovereign debt crisis.

Here is what Montebourg had to say:

 

“The time has come for France to resist Germany's "obsession" with austerity and promote alternative policies across the euro zone that support household consumption, firebrand French Economy Minister Arnaud Montebourg said on Sunday.

Deficit-reduction measures carried out since the 2008 financial crisis have crippled Europe's economies and governments need to change course swiftly or they will lose their voters to populist and extremist parties, Montebourg told a socialists' meeting in eastern France.

"France is the euro zone's second-biggest economy, the world's fifth-greatest power, and it does not intend to align itself, ladies and gentlemen, with the excessive obsessions of Germany's conservatives," Montebourg said. "That is why the time has come for France and its government, in the name of the European Union's survival, to put up a just and sane resistance [to these policies]."

Montebourg said consensus was growing among economists and politicians worldwide on the need for growth-oriented policies and mentioned his German socialist counterpart Sigmar Gabriel and Italy's premier Matteo Renzi as potential allies. He cited former president Charles de Gaulle and former British prime minister Margaret Thatcher as having effectively spoken up to change the course of EU policies they opposed.

Montebourg said he had personally asked President Francois Hollande for "a major re-direction of our economic policy". The government should now focus less on cutting debt than on supporting households to revive consumption, a traditional economic driver, he said.

Montebourg, who makes no secret of his own presidential ambitions, is known for his frequent attacks on austerity, but his latest comments are likely to embarrass Hollande, who despite mounting pressure said just days earlier he would not back away from his policy based on spending cuts and corporate tax breaks.

Hollande's business-minded policies have alienated many left-wing lawmakers and voters already frustrated with his failed pledge to curb unemployment. He is now the most unpopular president in over half a century, with an approval score of 17 percent in the latest Ifop poll.

Hollande's office declined to comment on what Montebourg said. A source close to Prime Minister Manuel Valls said Montebourg had gone too far.

 

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