Stock Markets Fall Around the World

On Friday, the carnage suffered by the SPX on Thursday was transmitted across the world, as stocks in Asia and Europe fell sharply. One thing that has been evident for quite some time is that the performance of various stock markets had become very uneven well before this recent rout.

Shanghai has been going nowhere since it made a high in late 2009 – over  two years ago. The European stock markets of the countries at the center of the sovereign debt crisis all have been in downwardly sloped trading ranges since 2009/2010 (this includes the stock markets of the entire 'PIIGS' stable), driven mainly by the the sharp decline in bank stocks. Brazil's Bovespa has been in a downtrend all year long, with the decline accelerating  last week.



Spain's IBEX falls below its 2010 low – click for higher resolution.



Italy's MIB index fares even worse – this is the lowest level since late March 2009 – click for higher resolution.



The bear market in Brazil's Bovespa accelerates – click for higher resolution.



The Shanghai stock index has been the first to top out in 2009 and has been going nowhere for months – click for higher resolution.



In short, there were numerous warning signs well before the market rout of the past two weeks gripped the 'better performing' stock markets as well.

In Europe, the German DAX Index was one of the best performing markets heretofore, mainly due to the combination of low interest rates and an economic boom in Germany. This index has now also plummeted to new lows for the year.



Germany's DAX plunges. As often happens when the trend turns down, the advance of many months is given back within days – click for higher resolution.



With regards to the US stock market it should be noted that last week's break of lateral support also created a break of the uptrend line from the 2009 low and was accompanied by a Dow theory sell signal. This means that from a technical perspective, the cyclical bull market from the 2009 low must be regarded as being over until clear evidence to the contrary emerges.

If it is indeed over, then a new cyclical bear market within the secular bear market has begun. This is actually quite likely – as we have noted on many occasions, indicators that are important yardsticks for the medium to long term market outlook have been on 'red alert' for quite some time. Especially noteworthy are the all time low in the mutual fund cash-to-assets ratio and the  second highest level of margin debt in history.

In the short term the market now looks very oversold, but this does not necessarily mean that an upturn is imminent. Last week's move certainly constitutes a mini-crash, but sometimes a 'mini-crash' turns into a big crash.

It is not possible to forecast the near term outcome with any certainty, but last week's rout has certainly left the market in a position where a rebound becomes increasingly probable.  In the less likely, but not impossible event that the market plunges further, a strong rebound can nonetheless be expected to eventuate fairly soon (this is to say, we are close in time, but not necessarily in price just yet).

Medium to longer term we are struck by the nonchalance with which last week's rout has been met by many market observers. While some of the 'fear gauges' we are watching show now an elevated level of concern, the signals are uneven and have been at far bigger extremes in the past. Of concern to us is inter alia that speculative net long positions in stock index futures remain fairly large, that speculation in options has yet to fully turn toward expressing fear and that from an anecdotal standpoint, too many strategists remain bullish (see this report by Mish for some details on this particular point as well as the excerpt from Bloomberg further below).

The main reason for this barely shaken bullish consensus seem to be current earnings forecasts. We would point out to this that if the economy has entered a recession over the summer – which is a strong possibility – then these forecasts will turn out to be worthless.



The S&P 500 Index – after falling through the neckline of its head & shoulders top, it proceeded to violate another support level, but managed to rebound off a third, ending the week between the two levels with an 'uncertainty' type candle closing out the week on big trading volume. Whether this will produce a short term low remains to be seen, but the probability of a rebound is certainly growing – click for higher resolution.



A close-up of the SPX with two possible near term paths drawn in – a tentative 'if it bounces right here, this might happen' idea in orange, and a 'further crash move, and then the bounce' in green. As noted in the volume section, volume has been strong on Friday, but not convincingly so – click for higher resolution.


As noted above there is now a 'Dow Theory' sell signal in force, as can be seen below:



The Dow Transportation vs. the Industrial Average – at the high, the two averages diverged and now they have both broken below their previous low. This amounts to a DT sell signal – click for higher resolution.



Some comments from a Bloomberg article on the sanguine view adopted by Wall Street strategists are worth quoting – our remarks are interspersed:

“It’s unlikely I will change my view because we had a bad week or get really excited because we had a good week,” Tobias Levkovich, Citigroup Inc. (C)’s chief U.S. equity strategist in New York, said in an Aug. 3 phone interview. “That’s not a well- reasoned market outlook,” said Levkovich, who forecasts the S&P 500 will end the year at 1,400. “That’s a reactive trader mindset, but that’s not what I’m supposed to be doing.”

Translation: I won't listen to the market.

The combination of falling prices and rising profits has driven the S&P 500’s price-earnings ratio down 17 percent since Feb. 18, data compiled by Bloomberg show. At 13.2 times profit, the valuation is 20 percent below the average since 1954.

Following the drop in valuations, “our view is growth picks up, and like last summer/fall as the data turn up, they will take the equity market up with it,” Binky Chadha, Deutsche Bank’s chief U.S. equity strategist in New York, said in an Aug. 2 e-mail. He said the index will reach 1,550, the highest projection in the Bloomberg survey.

The only 'average' of valuation worth considering is the Shiller p/e in our opinion – today more so than ever, as it smoothes out the earnings cycle. In recent years profit margins have pushed to the upper end of their historical envelope relative to total economic output several times. This is not an 'average' situation, it makes therefore no sense to compare current valuations to an average of the past without the cycle smoothing provided by the Shiller method. Moreover, secular bear markets have historically tended to eventually produce single-digit trailing p/e ratios. If earnings were to remain unchanged and the market were to fall to a trailing p/e of 6 or 8 as it has done in the 1940's and early 1980's respectively, there could still be a huge decline ahead. As to why 'growth will (supposedly) pick up', this is not quite clear from the above, but to our mind it amounts largely to 'hoping'.

The S&P 500 bottomed in 2010 at 1,022.58 on July 2. Gross domestic product expanded at an annual rate of 2.5 percent and 2.3 percent in the third and fourth quarters. The stock index rallied 10 percent to 1,127.79 through Aug. 9, before slipping 7.1 percent to 1,047.22 by Aug. 26.

At the time, strategists said the index would rise to 1,234 through the end of 2010, according to the average estimate. Three days later, Bernanke said the central bank would “do all that it can” to sustain growth, foreshadowing the bond-purchase program revealed two months later. The August announcement helped catapult the S&P 500 to 1,257.64 as of Dec. 31 and 1,343.01 by Feb. 18, a 28 percent advance.

In other words, the market's rise was the result of yet another round of massive money supply inflation. How many more times will that trick work? More on this further below.

Laszlo Birinyi, one of the first investors to recommend buying stocks when the bull market began in March 2009, said this week that stocks shouldn’t be abandoned.

“It’s like all these times when you second-guess yourself, and you probably wake up a little earlier than you’re used to, and maybe you put an extra finger of scotch in the glass,” Birinyi said in an Aug. 2 telephone interview. “It’s probably a good idea to have a gut check once in a while, because it makes you review and rethink your process. Our view is that this is still a market of some duration.”

Mr. Birinyi has to our knowledge never been bearish. The only reason why he is always 'the first to pick a low' is because he only gives buy recommendations, i.e., he's simply a stopped clock. That is by the way the by far safest attitude for a stock market forecaster to have – since due to the inflationary fiat money regime the market rises about 67% of the time on average, so someone who is always bullish will have a two thirds hit rate, which isn't bad. Besides, bullish opinions are generally more popular than bearish ones. However, anyone who bought this market 11 years ago is still waiting to break even (in the case of tech stocks, many won't live long enough). Even during secular bear markets there are of course rallies worth playing – but the 'buy and hold' approach will generally underperform the return from t-bills over the duration of the secular bear market – even if they yield next to nothing, as is the case right now.

The S&P 500 had the second-best performance in 2011 among the world’s 10 biggest stock markets through yesterday, even after the 12 percent slump since April 29 brought the year-to- date decline to 4.6 percent. China’s Shanghai Stock Exchange Composite Index did best with a 4.4 percent drop. Japan’s Topix lost 8.1 percent, while the FTSE 100 Index (UKX) of U.K. stocks dropped 8.6 percent.


“Doing this 22 years, to me this has to be the type of bottoming that the U.S. needed to just clean the slate,” Brian Belski, the New York-based chief investment strategist at Oppenheimer & Co., said in a telephone interview yesterday. “A year ago, we were only a couple quarters into the rebound, now we’re further in. There was less belief a year ago because nobody really believed forward earnings growth. Now they’ve proven themselves.” He estimates the S&P 500 will reach 1,325.

Translation: the future will look exactly similar to the recent past. This type of extrapolation is typical for sell-side analysts and strategists, which is why they never tend to catch important turns. As a good example of how useless their belated recognition of what is going on often is, consider that a brokerage downgraded shipping stock FRO to 'sell' last week – after a 78% decline in the stock. If you wait for these people to tell you to sell, you're probably just about ready to move into a cardboard box under the bridge.

Barry Knapp, the New York-based chief U.S. equity strategist at Barclays, said that it’s unlikely the economy will contract even though data show a slowdown. The Citigroup Economic Surprise Index has averaged negative 95.05 since sinking on June 3 to negative 117.20, meaning reports were missing the median estimate in Bloomberg surveys by the most since January 2009.

“If you sell stocks at 1,250, that’s a bet we’re going back to a recession, and we don’t buy that,” Knapp said in a telephone interview yesterday. His year-end projection is 1,450. “The probability of the U.S. going back into a recession is low. These things have a way of running their course.”

Why is it held that the probability of a recession low? No-one is really saying – it is apparently just assumed that this must be so. However, during secular debt-deflationary contractions recessions occur actually quite frequently, and at the moment the probability of another recession appears in fact quite high.

All that said, the strategists quoted by Bloomberg could still turn out to be correct of course. There have been examples of uptrends that were clearly violated (the 1998 decline is a pertinent example), and yet the bull market remained ultimately intact. One possibility is that yet another episode of monetary pumping will resurrect the trend by rapidly devaluing the money unit  further. In fact, money supply growth in the US remains very strong thus far, so while the market is pulled down by fears of recession it also receives a degree of support from ongoing monetary inflation.

We would however note that hoping for monetary and/or fiscal authorities to take actions to manipulate market prices higher very often turns out to be a mug's game. The crisis in the euro area is a great recent example and so was the 2007/8 crisis. This misguided faith in the powers of the authorities is the 'potent directors fallacy', an error in judgment that is as old as the stock market itself. In literally every major downturn in history people liked to believe that a central authority would be able to stop a negative trend from unfolding (in 1998, economist Rudi Dornbusch announced that there would never be a recession again 'because the Fed doesn't want one'. In late 2007 economist Gregory Mankiw praised the 'dream team at the Fed and treasury' that would surely keep us out of recession). It never works.

The rules of the game would obviously change in a hyper-inflationary crack-up boom, but we are far from that point (though it can not be ruled out that we will experience something of this sort at some point in the future).

What puzzles us about the consensus demonstrated above is that it has turned out to be so deeply ingrained in spite of a clear slowdown in economic activity and a very weak stock market. This is not exactly a 'wall of worry'.


Waiting for Jack-In-The-Box

Given the fact that Standard & Poors saw fit to downgrade US treasury debt from AAA to AA+ on Friday after the market close, a flurry of activity by various official bodies has taken place over the weekend. There was a G7 meeting where inter alia 'concerted central bank action' was apparently discussed, euro area central bank chiefs were scrambling to get the Italian situation under control after a less than inspiring press conference by Silvio Berlusconi on Friday, and all of all of this will be followed by an FOMC meeting on Tuesday. So everybody is essentially waiting for this to happen:



Jack will come out of his box and make everything alright again – or so it is hoped.



Regarding the lack of specifics revealed during the hastily convened Berlusconi/Tremonti press conference on Friday, it was a bit of a surprise that Italian yields actually declined a few basis points in its wake. As Reuters reports:

Opaque pledges and a lack of detail on measures to speed up deficit reduction plans risk undermining Italy's hopes of winning a reprieve from financial markets that have pushed the country to the brink of crisis.

Desperate to stop market panic that has sent Italian bond yields soaring to 14-year highs, Italian Prime Minister Silvio Berlusconi hastily announced plans on Friday to speed up reforms and balance the budget by 2013, a year ahead of schedule.

Initial reaction from analysts and the European Union's top economic official was positive, but whether the pledges convince the European Central Bank to bolster Italy by buying its bonds, or calm market tensions, may hinge on the specifics of the plan.

So far, few seem to know what the plan will include. Indeed it is unclear if the government itself knows.

"The decision to bring forward the balancing of the budget is a positive step but we need a lot more detail," said Raj Badiani of IHS Global Insight, warning that the promised reforms are unlikely to happen overnight. "The problem is Italy doesn't have time right now and the reforms they announced are easier said than done."

Economy Minister Giulio Tremonti said on Friday there would be no new austerity measures beyond those announced in a 48 billion euro package passed last month which contained cuts to local government funding, health charges and vague plans for a mix of welfare cuts and tax measures. That programme was widely criticised for delaying the bulk of measures until after elections in 2013 and Tremonti said it would be accelerated but offered no specifics about a plan which in any case still had to be fleshed out in important areas.

ECB sources say the bank — which is due to discuss later on Sunday whether to buy Italian bonds — remains divided on the issue and even some of those who favor the move want Italy to do more to frontload its austerity measures. Some proposals, like a fee for non-urgent medical visits and tests, quickly sparked a popular backlash and prompted talk of alternatives. Even without any such backtracking, the funding cuts make up only a relatively small portion of the plan.

For the bulk of the savings, the government will ask parliament to approve a so-called "delega fiscale" or "tax delegation law" and "delega assistenziale" or "welfare delegation law" — something of a political blank cheque. The laws allow parliament, which is delaying its summer break to continue sitting next week, to "delegate" to government the job of drawing up tax and welfare measures worth, in this case, up to about 20 billion euros, within a certain time. Only after that, would the government nail down the measures and get them approved by parliament.

In a sign that nothing concrete has been finally settled, daily Corriere della Sera on Sunday said government experts had decided the welfare system could not contribute the additional funds needed and were now eying the pensions system.”


(emphasis added)

This is not exactly confidence inspiring. Alas, perhaps the following band-aid will prove helpful – as in the meantime, the governors of the euro-system's central banks have held emergency talks over the possibility of the ECB intervening in Italian and Spanish bond markets. As Bloomberg relates:

European Central Bank officials held emergency talks today as governments pressured them to buy Spanish and Italian bonds to stem the worsening debt crisis.

The central bank chiefs met by conference call, said a euro-area central bank official who declined to be identified because the talks are confidential. A spokesman for the ECB declined to comment. Officials from the Group of 20 held a call earlier today and G-7 finance chiefs, including U.S. Treasury Secretary Timothy Geithner, are set to confer later today.

The flurry of talks comes as the first U.S. credit-rating cut in history by Standard & Poor’s threatens to further derail efforts to stop the debt crisis from engulfing the euro area’s third and fourth-largest economies.

“Europe is in an incredibly dangerous situation,” Nick Kounis, head of macroeconomic research at ABN Amro in Amsterdam, said in an interview by telephone yesterday. “The risk is that the U.S. downgrade is just going to unsettle everyone even more. It’s a unique situation in that we are essentially in the heart of a European sovereign debt crisis, which has reached its meltdown phase.”


(emphasis added)

It sounds like we're getting closer to the point where the 'only way out' will be the printing press, so we imagine that this emergency conference call was quite lively. Indeed, the ECB has later announced it is now prepared to intervene more forcefully. The central bank issued a statement promising to throw gobs of liquidity at the problem:

“After a rare Sunday night conference call, the ECB welcomed announcements by Italy and Spain of new deficit cutting measures and economic reforms as well as a Franco-German pledge that the euro zone's rescue fund will take responsibility for bond-buying once it is operational, probably in October.

"It is on the basis of the above assessments that the ECB will actively implement its Securities Markets Programme," an ECB statement said.

The statement marked a watershed in the ECB's fire-fighting efforts after modest bond-buying last week failed to stem contagion to the currency bloc's larger economies. It did not explicitly say that effort would now include buying Spanish and Italian paper, but the fact that last week's purchases were confined to Irish and Portuguese paper drove Italian and Spanish 10-year paper to a 14-year high.

Last Friday's downgrading of the United States' AAA credit rating by Standard & Poor's added urgency to efforts to control euro zone turmoil by raising the risk of global financial meltdown, driving global policymakers into a frenzy of weekend telephone consultations.

"The Euro system will intervene very significantly on markets and respond in a significant and cohesive way," a euro zone monetary source said, speaking shortly before the statement was released.

Germany and France earlier said in a joint statement that the EFSF bailout fund would soon be able to buy government bonds of debt strugglers Italy, Spain, Greece, Portugal and Ireland.

ECB President Jean-Claude Trichet called the Sunday meeting of the policy-setting Governing Council to decide on buying Italian paper after Prime Minister Silvio Berlusconi announced new measures on Friday to speed up deficit reduction and hasten economic reform.

One ECB source said the council would also discuss possible emergency liquidity measures to prevent money markets freezing.


(emphasis added)

In the meantime, the above mentioned G7 emergency meeting has concluded as well and the statement consists of a mixture of decidedly unwarranted back-patting for the various deficit cutting measures announced thus far, and a promise to support financial markets in every way imaginable. The complete statement can be read here. Of course the only thing that can potentially 'support financial markets' (i.e., artificially hold up share and bond prices) is a good dose of money printing. The passages from the G7 statement to this effect are:

“We are committed to taking coordinated action where needed, to ensuring liquidity, and to supporting financial market functioning, financial stability and economic growth.”


“We reaffirmed our shared interest in a strong and stable international financial system, and our support for market-determined exchange rates. Excess volatility and disorderly movements in exchange rates have adverse implications for economic and financial stability. We will consult closely in regard to actions in exchange markets and will cooperate as appropriate.”


Read: we'll print as much money as it takes to prop up the markets, and hope that the effects of inflation will continue to be confused with 'economic growth'. As to our commitment to 'market-determined exchange rates', like Dick Cheney,  it is neither man nor beast, but has elements of the twain.

Of interest to us was also the following statement that was included in the G7 communique:

“The Euro Area Leaders have stated clearly that the involvement of the private sector in Greece is an extraordinary measure due to unique circumstances that will not be applied to any other member states of the euro area.”


This seems to be a blank check declaration that henceforth, all and sundry shall be bailed out, no matter what. With what, exactly? You have one guess…



Good thing these days it takes just a few key-strokes on a computer keyboard. Imagine printing up trillions on this Gutenberg original.



The FOMC meeting on Tuesday – as far as we know the August meeting is a one day affair, so the announcement should come on Tuesday afternoon –  is also likely to give some indication of the Federal Reserve's willingness to engage in some more monetary pumping.

So we have no shortage of jack-in-the-boxes suddenly popping up and promising us that most elusive of commodities – the luxury miracle (the first ever luxury miracle in history was provided by Jesus, in his role as the central wine-bank of Cana – see this account by Pastor Duane Broome – starting at 2:50 in the video. Here is Rowan Atkinson's account of the event).

Whether any of this works remains to be seen, but given how oversold the stock markets look, it might eventually do the trick temporarily. However, at the time of writing, Asian markets have just opened sharply lower once again, with stocks in Singapore and Hong Kong especially hard hit. US stock futures were also down heavily, with DJIA futures down some 300 points.  So the 'let's all calm down' exhortations appear not to have had the desired effect just yet.


 A Few Additional Market Observations

Going through the charts of various stock markets, we noticed that some charts look better than others – often the markets that show relative strength during a decline will turn out to be the strongest markets in the subsequent rebound – the same is generally also true of individual stocks or sectors, although one must take care to filter out the 'defensive' sectors in this exercise.

As an example, the weekly chart of the KOSPI still looks strong – so far anyway. It has yet to violate any important support levels.



South Korea's stock market is a relative strength leader – the recent sell-off has yet to violate any important supports – click for higher resolution.



Japan's Nikkei has been a weak performer for some time and a brief period of outperformance earleir this year was cut short by the tsunami. However, it has so far also been reluctant to give a lot of ground in the recent decline. This may of course just be a function of the head start it has had.



The Nikkei has been going nowhere for months, but so far has held up better than many other markets in the most recent decline – click for higher resolution.



Meanwhile, the US bond market reversed in Friday's trading, as apparently rumors of the impending debt downgrade by S&P began to swirl. Given that the bullish consensus in this market has recently become rather pronounced, it may be time for a rebound in yields.



The level from which the 10 year t-note yield reversed on Friday has been home to two previous reversals. A rebound could take the 10 year note yield back to retest the  recently broken support – click for higher resolution.



Gold has become one of the 'go to markets' for money seeking a safe haven, and with a cloud hanging over US treasury debt following the debt downgrade, it may well become the 'only game in town'. At the time of writing, gold was up nearly $40 in Asian trade. This may well change again by the time trading begins in Europe and at the COMEX, but for now it appears as though a great many people are trying to buy insurance – insurance of which only a strictly limited amount exists above ground (all the gold in the world would fill only about 2.7 Olympic-sized swimming pools). Gold has an advantage one must not underestimate: it requires no promises from increasingly confused and often squabbling government officials to hold its value. As we have often mentioned, it is the only currency that is not born of debt or reliant on anyone's vague 'promise to pay'.



Gold has been a major beneficiary of the crisis – this time around is behaving very differently compared to what happened during the 2008 crisis. The difference is in the nature of the respective crises. While in 2008 there was a banking crisis that created a major deflation scare, we now have a sovereign debt crisis, which the markets rightly expect to be 'solved' with the help of more inflation. Furthermore, the crisis strikes at the very heart of the monetary system, as government debt securities represent the  main asset on central bank balance sheets. As shown above, the negative divergence between gold and gold stocks has grown even larger lately, as gold stocks have been depressed by the weak stock market – click for higher resolution.



It is probably time now to keep a close eye on the gold futures curve. Gold normally never goes into backwardation – should it begin to do so, it would likely represent a major warning signal for the monetary system. It would signify, as Dr. Fekete once noted, that traders are no longer sure whether it will be possible to receive delivery on further out futures contracts. While in the normal course of business only a small fraction of the outstanding futures stand for delivery, the theoretical possibility of standing for delivery is an important psychological underpinning of the futures market and by extension the entire system. Dr. Fekete argues that 'gold is the ultimate extinguisher of debt', a thought we are sympathetic to (even though we disagree with him on many other things). Consider in this context that the fiat money system ultimately rests on confidence. If this confidence evaporates, then what will be left? The answer obviously can only be: 'the commodity that has originally been chosen as money by the free market' – i.e., gold.

Note here that this has nothing to do with so-called 'intrinsic value' – a concept that is often thoughtlessly used by 'gold bugs' when referring to the innate superiority of gold as a medium of exchange. All value judgments are ultimately subjective, there is no such thing as an 'intrinsic value' that lies outside the value judgments of human beings. The decisive difference between fiat money and gold money is that the former is a creature of the State the supply of which can be expanded at will and at little cost, while the latter has been chosen as money by the voluntary exchanges of economic actors in the marketplace and can only experience a very slow expansion of supply (at present about 1.5% are added to the world's stock of gold per year).

One more remark regarding gold stocks: while they have suffered in the latter half of last week's sell-off in the stock market, they have nonetheless actually outperformed the broader market on a short term basis, as can be seen below.



The HUI-SPX ratio – since early July, the gold stocks have actually outperformed the SPX, though obviously not every day. On Thursday and Friday they sold off more than the SPX, but this hasn't materially dented the picture yet – click for higher resolution.



After the Berlusconi press conference on Friday, there was also a small rebound in European bank stocks. It may not mean much yet and whether it continues will likely depend on whether the upcoming interventions by the ECB in euro area bond markets are deemed successful. Judging from what ultimately happened to the peripheral bond markets of the 'GIP' trio one shouldn't expect too much, although a short term effect seems likely.



After hitting a new low in Friday's trading, shares of Italy's largest bank Unicredito rebound and end the day slightly up. Of course these short term bounces have been quite meaningless to date – click for higher resolution.



The same happened with the second-largest Italian bank Intesa Sanpaolo. Note that these bounces happened concurrently with a slight decline in Italy's government bond yields, which suggests that there is a strong connection between euro area government bond yields and bank stock prices.  In other words, the banks have been selling off so much precisely because the sovereign debt crisis represents a growing threat to their dwindling capital – click for higher resolution.



We mentioned the Swiss franc's enormous ascent several times recently, and note that there has been a bit of hesitation in its surge last week, following intervention by the SNB (Swiss National Bank) designed to bring it down.

As interventions go, it hasn't been particularly successful yet, but the franc is now so overbought and overloved (the bullish consensus is as stretched as it gets) that a correction appears ever more likely.

It should be pointed out that while the Swiss currency is regarded as a 'safe haven', it is a fiat currency as well (it once used to be fully backed by gold, but this is no longer the case; note also that the SNB governors are apparently mostly card-carrying Keynesians, judging from their published speeches and papers). Furthermore, although Switzerland is in principle an economically and fiscally sound place, its banking system is a fractionally reserved system as well and some of its biggest banks are of the 'too big to bail' category and their current share prices look none too reassuring. This seems to have been conveniently forgotten recently, but one would do well to keep it in mind. 



The Swiss franc – so far interventions have not been able to put a dent into its advance – click for higher resolution.



A Blast From the Past?

As a final remark we would like to point out that the current crisis is not really a 'new crisis', but an extension of the crisis that began in 2008. The intervening expansion was largely an inflationary mirage. If one considers the evolution of the crisis – from a major private sector credit crisis to a sovereign debt-cum-banking crisis – it has so far followed the crisis of the early 1930's fairly closely. The main difference as far as we can tell is that our modern day policymakers assert that they have 'learned the lessons of the 1930's' and are therefore employing a different approach. Really? Between 1929 and 1933, the Federal Reserve pumped up its balance sheet, increasing free bank reserves by over 400%.

Admittedly today's policymakers have achieved what the Fed did not achieve in the 1930's: they have managed to grow the money supply at fantastic rates, in spite of a private sector credit crunch. This is probably the main reason why the stock market is plunging against gold, while holding up quite well in nominal terms by comparison – so far anyway.

We were quite astonished last week when references to 1931 were suddenly popping up in research published by European banks.

The seminal event in Europe in 1931 was the failure of Austria's then largest bank, Creditanstalt. Creditanstalt had previously merged with another bank close to failure, the agricultural bank Bodenkreditanstalt.

When it turned out that this would drag Creditanstalt over the edge as well, Austria's government found itself unable to bail the bank out, as it was in financial troubles itself (sound familiar?). When Creditanstalt went under  following a run on the bank, the crisis spread to Germany, where the giant Danat Bank went bankrupt, taking countless smaller banks with it. A bank holiday was declared and in the end millions lost their life savings. France then decided to support Austria's government financially, under the precondition that it cancel a planned customs union with Germany. This destroyed a major chance at producing some badly needed economic growth. Political radicals had a field day, chief among them Adolf Hitler.

You will be interested to learn that Creditanstalt was resurrected in modern times and this time it ended up being taken over by a larger rival, Bank Austria. Guess what happened next? Bank Austria was taken over by Italy's Unicredito. It is eerie that Italy's largest, and obviously troubled bank houses the modern-day Creditanstalt. 

Let's just hope the parallels stop right there.



The SPX-gold ratio – the stock market's secular descent against gold continues – click for higher resolution.




Charts by:, Bigcharts



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7 Responses to “Praying For A Luxury Miracle”

  • mc:

    “Good thing these days it takes just a few key-strokes on a computer keyboard. Imagine printing up trillions on this Gutenberg original. ”

    It isn’t that hard, you just have to get the denomination right.

    Of course, printing $100T notes didn’t do Zimbabwe all that much good….

  • amun1:

    “The rules of the game would obviously change in a hyper-inflationary crack-up boom, but we are far from that point ”

    That does seem to be a fairly universal opinion, but I wonder if we are so far from that point. The last 60 years since Bretton Woods have been a unique monetary environment, in which the entire world agreed to hold the currency and debt of a single country, and essentially tied their own monetary policy to that country. They used the dollar for all of their international trade and they used dollar debt to manipulate foreign exchange. They allowed the US to run budget and trade deficits for decades on end, piling their own currency excess on top of ours in order to maintain a semblance of stability. Can we expect that this global fiat experiment will follow the same trajectory as historical currency failures?

    Previous episodes of hyperinflation, for which Weimar Germany is the model, started with a gradually increasing level of inflation which eventually reached escape velocity, aided by a government that refused to stop printing. But this time we have a long, long build up of excess debt and money, coupled with extreme overcapacity for producing retail consumer goods. I could foresee a case where inflation looks very well contained until a single incident, like an oil shock, spikes global hyperinflation almost overnight.

    • I actually agree that one must at least consider this possibility. When the markets are calmer than they are now, I often write about the monetary system and the situation that currently pertains. In one or even several of those articles I have discussed the possibility that central bankers may be underestimating the amount of inflation that is already in the system when they smugly assert that they could ‘bring inflation under control in 15 minutes’. The one variable that they have absolutely no control over is the demand for money. If the demand for money should – for whatever reason – fall sharply, then a hyperinflation type situation could conceivably develop very quickly. Alas, it is my impression from the data that at present the demand for money remains fairly high. As you say though, it is impossible to forecast with certainty how quickly that may change.

  • Thanks, good read as always.

    Pardon my naivety, but what exactly is meant by the ‘double divergence’ written on the Dow Theory sell signal chart? Is it referring to the third time that the Industrials index touched the blue line?

    • First of all, I must apologize for not replying to comments for over a week – but as you can probably imagine, I was unusually busy.
      What I mean is that first, one of the averages made a new high and the other one didn’t, and the same happened later again, only vice versa.
      In fact, a similar divergence appeared in early 2008.
      The current divergence is ALSO a ‘double divergence’ in a second sense, namely, a divergence with 2007, when the DJIA reached a new ATH, while the DJTA reached a new ATH this year, not confirmed by the industrials.

  • davidb1:

    Pop goes the weasel.

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