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.




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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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Update on Global High Yield Debt Issuance Volumes

Here is a small addendum to our recent articles on the corporate debt bubble (“A Dangerous Boom in Unsound Corporate Debt”) and the associated derivatives-berg, which is intended to hedge both the credit and interest rate risk this credit boom has given rise to (“A Perilous Derivatives-Berg”).

We recently combed through John Hussman's weekly commentaries, one of which contained an up-to-date chart of global high yield debt issuance per quarter from Q1 2006 to Q2 2014. Both global issuance volume and the number of deals are depicted on the chart. As you can see, we have long left all previous records in the dust.


hi-yieldGlobal high yield debt issuance in USD billion per quarter, plus the number of offerings, via John Hussman.


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Diagrams and Forecasts

We’re still in the lazy days of August, with little going on in the stock market. So let’s use this time to look at deeper trends. We left off last time with discouraging words.



(Photo by Eddie S.)


First, we noted that, according to Washington’s own budget people, Social Security is going broke 20 years sooner than forecast. It’s already $15 trillion in the hole, with a deficit that’s up 300% (mistakenly reported as 400%) in the last five years.


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Islamist Militias Take Tripoli

We have previously reported on the conflict no-one was really watching, in that interventionist “success story” Libya. After weeks of fighting between Islamist militants and the Zintan nationalists under former general/warlord Khalifa Hiftar, Tripoli has finally fallen to the Islamists.

Meanwhile, the internationally recognized government is holed up in Tobruk in the country's East, and evidently powerless to alter the situation. Apparently Tripoli is no longer the capital of Libya, or rather, there are now two competing capitals actually. The arc of instability becomes ever more unstable (as an aside, ISIS has reportedly kicked out the last remainder of Assad's forces from Raqqa province in Syria over the weekend).

The Guardian reports:


Libya has lurched ever closer to fragmentation and civil war this weekend after Islamist-led militias seized the airport in the capital, Tripoli, proclaimed their own government, and presented the world with yet another crisis. Operation Dawn, a coalition of Islamist and Misrata forces, captured the airport on Saturday in fierce fighting against pro-government militias after a five-week siege that battered parts of the capital.

Television images from the scene showed jubilant, bearded, militias dancing on wrecked airliners, firing machine guns in the air and chanting "Allah O Akbar" ("God is great"). On Sunday, they set airport buildings ablaze, apparently intending to destroy rather than hold the site.

The victory, which secures Islamist control over Tripoli, was a culmination of weeks of fighting triggered by elections in July, lost by Islamist parties.

Rather than accept the elections result Islamist leaders in Libya accused the new parliament of being dominated by supporters of the former dictator Muammar Gaddafi, and have sought to restore the old national congress.

"The general national congress will hold an emergency meeting in Tripoli to save the country," said Omar Ahmidan, a congress spokesman.

Libya's official parliament, the house of representatives, in the eastern city of Tobruk, denounced the attack as illegal, branding Dawn a "terrorist organisation" and announcing a state of war against the group. The move leaves Libya with two governments, one in Tripoli, and one in the east of the country, each battling for the hearts and minds of the country's myriad militias.


Fighting is continuing to the west of Tripoli, while Islamist brigades in Benghazi, 400 miles east, are battling with army units and nationalist militias of the former general Khalifa Hiftar.

The weekend's developments threaten to tilt the country across the line from troubled post-Arab spring democracy to outright failed state.


Many Libyans think fragmentation is now inevitable, with Islamist-led forces strong in Tripoli, and tribal and nationalists dominant in the east of the country.

"It's gone into complete madness," said Hassan el Amin, a Libyan politician who fled to Britain after receiving death threats from Misrata militias. "There's another battle coming up, between east and west."


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The Nature of the Latest Rally Leg

Keeping in mind that a number of important historical market peaks have been recorded in late August/early September, here is a brief look at how the most recent rally leg stacks up in terms of its internals. It can definitely be stated that the technical condition of the market has weakened further (the same happened already on the preceding rally leg, but it has become even more pronounced now).

Specifically, it can be seen that the market is carried higher by fewer and fewer stocks. The underperformance of the small cap vs. the big cap sector has continued, but that is not the only evidence of narrowing we have.

Whenever a stock market rally becomes narrower, it essentially conveys the information that market liquidity is becoming less ample. There is no longer enough additional liquidity entering the market to enable the tide to lift all boats concurrently. Given the fact that most indexes are capitalization-weighted, their performance can easily mask underlying deterioration. It makes therefore sense to keep an eye on the market's innards.

Small caps on average sport higher valuations than big caps, and generally need more plentiful liquidity to rally. Moreover, they tend to be more economically sensitive, as smaller companies are likely to largely depend on the performance of the domestic economy.


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A Mathematical Gangster Strikes

Normally we think of natural sciences as being empirical sciences first and foremost, but even so, the experimental falsification or verification of hypotheses is still preceded by rational conception.

This is especially true in physics, where theory is way ahead of the ability to experimentally verify all the concepts that have been created. Even Einstein had to wait four years before the first empirical proof of general relativity could be obtained in 1919 by observing the position of stars during a solar eclipse (which showed that the mass of the sun bent the light rays coming from said stars, altering their relative position in the sky). This was notwithstanding the fact that general relativity could explain the anomalous rate of precession of the perihelion of Mercury's orbit, which was first recognized as posing a problem for Newtonian mechanics in 1859. Even though the 1919 observations were reconfirmed in 1922 as well as by later observations, sufficiently precise measurements to remove all remaining doubt could only be performed in the 1960s. 


Leonhard Euler by Handmann“Mathematical gangster” Leonhard Euler (1707-1783), in a famous painting showing him wearing rather odd Prussian headgear made from silk. While Napoleon became a cognac, Euler eventually became a Swiss banknote.

(Pastel by Jakob Emanuel Handmann)


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Treasured Delusions

First, we check in with the markets. What’s new? Not much. The Dow crossed the 17,000 mark on Friday. Janet Yellen is supposed to address the world today from Jackson Hole, Wyoming.

It is hard to imagine that she will say anything surprising… or even meaningful. Commentators all over the planet are waiting to analyze each word… hoping for a hint of what is coming.

They want to know when we will be leaving this wacky world of price fixing by central banks. They want to know when we will get back to more normal interest rates and a more neutral monetary policy. We think we have the answer already: Only when we have no other choice.

The world’s largest economy, and its capital markets, depend on cheap credit. Take it away, and asset prices will collapse … and the economy will go into a recession/depression.

Yellen can’t allow that. It goes against all her training, her convictions, and her most treasured delusions. She will fight the inevitable downturn with more liquidity and more free credit … until the whole shebang blows up. Then, and only then, will things go back to normal …


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Immigration For Republicans


This essay is not intended to address a crisis that may be occurring on the border at this time. I make no comment on that. Nor does it discuss the issues around war, such as how to deal with citizens of enemy nations. This essay is not a policy proposal, it does not set out, for example, when an immigrant can become a citizen and attain the vote or what to do to immigrants who commit crimes. It has but one purpose: to enumerate and respond to the common arguments used in favor of an impenetrable and guarded border fence to shut down immigration.


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Derivatives and the Credit Bubble

In principle, there is absolutely nothing wrong with derivatives. They serve a valuable function, by transferring risk from those who don't want to be exposed to it to those who are willing to take risk on in their stead for a fee. However, since the adoption of the pure fiat money system, credit growth has literally gone “parabolic” all over the world. This growth in outstanding credit has been spurred on by interest rates that have been declining for more than three decades.

Larger and larger borrowings have become feasible as the cost of credit has fallen, and this has in turn spawned an unprecedented boom in financial engineering.

When critics mentioned in the past that this had created systemic dangers, their  objections were always waved away with two main arguments: firstly, the amount of net derivatives exposure is only a fraction of the outstanding gross amounts, as so many contracts are netted out (i.e., things are not as bad as they look). Secondly, the system had proven resilient whenever financial system stresses occurred. Perhaps not as resilient as it seemed, considering that these crises as a rule required heavy central bank interventions and/or bailouts in various shapes and forms. Would the system have been as resilient if those had not occurred? We have some doubts with regard to that.


total_derivativesSince the crisis, derivatives growth has stalled, but the notional amount has returned to its record highs as of the end of 2013 – click to enlarge.


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WGC Continues Not to Understand Gold Market

The WSJ recently reported on the latest gold supply-demand report issued by the World Gold Council. It isn't really a surprise to us, but it is nevertheless astonishing that an organization that is supposedly focused on gold can get the market's most fundamental aspects so utterly wrong. The WSJ article is entitled Global Gold Demand Down 16%”. That sounds like a lot, right? Here are excerpts from the article:


“Global demand for gold slumped in the second quarter as Chinese and Indian buying returned to more stable levels following a record-breaking quarter a year earlier, the World Gold Council said Thursday.

"This is a gold market that is returning to balance," Marcus Grubb, managing director of investment strategy at the World Gold Council said in an interview. "These figures reflect the exceptional quarter that was second quarter last year where we had large outflows in exchange-traded funds on the one hand and a very significant increase in physical buying on the other."


China and India, which together account around half of global gold demand, purchased 193 tons and 204 tons of gold, respectively, in the second quarter—a sharp drop from a year earlier.


Total demand for gold was 964 metric tons in April to June, down 16% compared with 1,148 tons during the same period in 2013, the industry body said in a quarterly report. Demand for gold used in jewelry dropped by almost a third to 510 tons in the second quarter, from a year before.

The World Gold Council expects India to buy between 850 and 900 tons of gold this year, down from 975 tons last year. China is expected to buy between 900 and 1,000 tons, down from the record 1,275 tons of demand last year.

Central banks, meanwhile, bought up a net 118 tons of gold in the second quarter, a 28% jump from the year before. The main buyers were the central banks of Russia and Kazakhstan, reflecting the appetite of emerging-market countries for a hedge against dollar exposure in their reserves.

After the sharp selling in the second quarter of 2013, investments in the latest quarter rose by 4% in the three months through June, to 235 tons, reflecting more stable demand for exchange-traded funds, the WGC said.

"Investors are now comfortable owning gold again in the form of ETFs and we've seen a very significant stabilization," said Mr. Grubb.

Overall supply of gold to the market—including mine supply, recycling and producer hedging—rose 10% in the second quarter to 1,078 tons, while mine production rose 4% to 765 tons, according to the WGC.


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THE GOLD CARTEL: Government Intervention on Gold, the Mega Bubble in Paper and What This Means for Your Future