Silver is getting pummelled:
What does this mean?
Hedge funds and speculators who were long gold are trying to get a buffer of cash to soak up hits from the coming default cascade.
What does that mean for gold’s long term fundamentals?
So Bernanke announced a twist operation, shifting the weight of bonds toward the long-end of the maturity spectrum, and a program to roll maturing mortgage backed securities. This means that the Fed’s balance sheet will remain largely unchanged — in other words, very bloated.
But in the immediate term there will be no QE3, no drop on interest in excess reserves, no purchases of equities, commercial paper, foreign debt or any of the wackier theories about Bernanke surprising the economy into recovery. What does this mean for projections on the US economy? Very little — without an artificial updraft of stimulus, and with the ongoing global pressures, it seems inevitable that equities — Bernanke’s metric of choice — will sooner or later end up in the ditch by the wayside.
From the Guardian:
The Fed said the economy faced “significant downside risks”; one of those risks being the volatility in financial markets around the world. US stock markets reacted badly to the move. The Dow Jones Industrial Average closed down 283.82 points, or 2.49%, at 1124.84. The Dow has fallen two of the last three trading days following fears that Europe’s financial woes will spread to the US.
Bernanke’s policy since 2007 as Governor of the Federal Reserve has been to pump money to reflate the rest of the economy to catch up with swollen debts acquired during the bubble — debts, especially in real estate, that would otherwise be defaulted upon as post-crash deflation took hold, leading to bank failures, credit retraction and a huge deflationary spiral to the bottom. That was his thesis in 1983 in regard to the 1930s, and he has been particularly lucky (or unlucky) to be able to test his thesis through policy. The real question is — what is supporting asset prices now? Is it real, new organic growth in America? No — growth is low, stagnant, and led by corporate profits, not small business or industrial output. Is it a booming real estate sector? No — confidence and prices are as low as 2009. Is it lower dependence on foreign oil, and a booming energy sector? No — America is more dependent on Arab oil than at any time in history, and the Arabs are wealthier than ever. Is it deeper, wider and burgeoning consumer demand? No — consumer demand for all but the rich is stagnant, burnt out by crippling food and fuel inflation, and rampant unemployment especially among the young.
He will print eventually — perhaps not this week or month, but he will — no matter how clear Wen Jiabao has been that QE3 should not happen.
Some interesting commentary comes from Peter Tchir of TF Market Advisors
Disappointment With The Fed
There are lots of things out there that once they have been done, can never be undone. Ben just disappointed the market for the first time. Whether he knew it or not he failed to beat expectations. He has been so good at managing expectations and using that as a policy tool he lost sight of how far ahead of itself the market had gotten. Everyone expected twist and seriously, what’s a 100 billion in size between friends in this crazy market.
He downgraded the economy but didn’t use that as an excuse to do more. There was no new, ingenious idea. If anything they tried to clarify the commitment to hold rates low til 2013 is dependent on economic conditions remaining weak. Yet there were still 3 dissenters.
Ben has been a fan of making markets dance to his tune based on expectations. By disappointing some people I expect his ability to keep the market up by talking will be reduced as investors will need to see action rather than being told vaguely that there could be action. That will take time to play out and even I have to admit he gave us something today, just not enough.
The conclusion is very simple: intervention breeds expectation of more intervention, which breeds dependency.
Hedge fund manager Jim Chanos (among others, including Nouriel Roubini) says that China is a giant wreck due a hard landing.
From Zero Hedge:
On the Chinese government’s balance sheet:
“The Chinese government’s balance sheet directly does not have a lot of debt. The state-owned enterprises of the local governments and all the other ancillary borrowing vehicles have lots of debt and its growing at a very fast rate. The assumption is that the state stands behind all this debt. We see that the debt in China, implicitly backed by the Chinese government, probably has gone from about 100% of GDP to about 200% of GDP recently. Those are numbers that are staggering. Those are European kind of numbers if not worse.”
On how a Chinese property bubble will play out:
“I think that will be the surprise going into this year, and into 2012 – that it is not so strong. The property market is hitting the wall right now and things are decelerating. The CEO of Komatsu said last week that he is having trouble getting paid for his excavator sales in China. Developers are being squeezed. They’re turning to the black market for lending, this shadow banking system that is growing by leaps and bounds like everything in China.
“Regulators over there are really trying to get their hands around the problem. In the meantime, local governments have every incentive to just keep the game going. So they will continue with these projects, continuing to borrow as the central government tries to rein it in.”
Chanos on his long and short positions:
“We are short Chinese banks, the property developers, commodity companies that sell into China, anything related to property there is still a short.”
“We are long the Macau casinos. It’s our long corruption, short property play. We feel that there’s American management and American accounting. They are growing at a faster rate even than the property developers.”
On the IMF lowering growth estimates for China:
“A lot of people are assuming that half of all new loans in China are going to go bad. In fact, the Chinese government even said that last year relating to the local governments. If we assume that China will grow total credit this year between 30% to 40% of GDP, and half of that debt will go bad, that is 15% to 20%. Say the recoveries on that are 50%. That means that China, on an after write off basis, may not be growing at all. It may be having to simply write off some of this stuff in the future so its 9% growth may be zero.”
Is he right?
China has a property bubble, resulting from excess supply. It is also the world’s greatest industrial behemoth, controlling the world’s supply chains in many key components, and is becoming an increasingly powerful player in energy markets thanks to its buy-out of Venezuela and its close ties to authoritarian Eurasian energy powers like Russia, Iran and Pakistan. This means that it’s probably not the best place for Westerners to park capital in the short term. But it has no bearing on China’s strategic standing in the medium to long term.
A comparison with America is inevitable. The United States destroyed its industrial productive capacity, has a zombified financial system , a stagnating labour market, stagnating infrastructure, a clueless establishment, and its currency is about to lose global reserve currency status.
America needs the global resource and trade infrastructure. That’s why America is in Iraq, Afghanistan, Yemen, Pakistan. That’s why there are hundreds of bases around the world and why America spends trillions policing the world.
The counter-argument I often hear is “but America has nukes, America can order other countries to do things and they will do it”. But ever since mutually-assured destruction that hasn’t been true.
If you don’t control your supply chains, you have a geostrategic problem. China grasped the importance of supply chains, and through cunning use of long-term planning has made itself the spider at the centre of the web of global trade. America grasped they could get a free lunch with US treasuries and that free lunch destroyed their productive capacity.
China has a cold. America has congential haemerrhoids, restless legs syndrome, diabetes, and autism.
And what might put Europe and the global financial system to the sword? Recrimination. It’s not my fault it’s everyone else’s fault. Now former ECB policy-maker and Euro-hawk Jurgen Stark has weighed in to tell Euro-hopping U.S. Treasury Secretary Geithner (in less direct language) to shut up and go home.
From Zero Hedge:
Finger-pointing in the direction of Europe shouldn’t prevent others from putting their budgets in order and doing their homework before handing out advice to Europeans.
Of course, Stark has a point. Europe is a complete mess, European policy makers are stumbling and slumbering forward to the gates of Hades. But America? The American economy is a jaundiced sham; where Europe has maintained a sliver of its former industrial might (i.e. supply chains, heavy & light industry, consumer manufacturing) in Germany, Scandinavia and the Netherlands, America prefers to ship a significant majority of its consumption (and even a lot of its infrastructure) from China (and subsidise the shipping costs through massive military deployment).
So the European Monetary Union is (slowly failing). Nations are reaching ever-closer to default, bringing about the prospect of shockwaves and turmoil throughout the region and the world. Why can’t nations just default? Well — they can. But policy-makers fear the consequences of blowing holes in the balance sheets of too-big-to-fail megabanks. Sovereign default would lead to the same problems as in 2008 — margin calls on banks’ highly leveraged positions, fire sales, a market crash, and the deaths (and potential bailouts) of many global financial institutions.
From Lawrence Kotlikoff:
Sovereign defaults are only the proximate cause of this euro-killing nightmare. The real culprit is bank leverage. If the lenders had no debt, sovereign defaults would reduce the value of their equity, but wouldn’t shut them down, thereby destroying the financial-intermediation system.
Non-leveraged banks are, effectively, mutual funds. If appropriately regulated, mutual funds don’t make promises they can’t keep and never go bankrupt. Yet they can readily handle all manner of financial intermediation as 10,000 of them in the U.S. make abundantly clear.
Countries get into trouble, just like households and firms. Similarly, nations should be permitted to default without threatening the global economy. Forcing the banks to operate with 100 percent equity by transforming them into mutual funds – – as I have advocated in my Purple Financial Plan – is the answer to Europe’s growing sovereign-debt crisis.
In a nutshell, the ECB tells the banks: “No more borrowing to buy risky assets, including sovereign debt, and forcing taxpayers to take the hit when things go south. You’re now limited to marketing mutual funds, including ones that hold nothing but cash and will constitute our new payment system.”
Now I don’t doubt that this is a very good idea that could potentially restore meritocracy — allowing good businesses to succeed and bad ones to fail. But would it solve the problems at the heart of the Eurozone?
In a word — no. As was noted at the Eurozone’s inception, the chasm opened up between a nation’s fiscal policy (as determined by a nation’s government), and its monetary policy (as determined by the ECB) necessarily leads to crisis, because monetary policy cannot be tailored to each economy’s individual needs. Kotlikoff’s suggestion would reduce systemic risk to the banking system (largely a good thing), but would merely postpone the choice that European policy makers will have to make — integration, or fracture.
A few days ago Solyndra, a Bay Area maker of industrial solar panels, announced plans to file for bankruptcy.
It wasn’t just a blow for the company’s 1,100 laid-off employees or the investors who have pumped millions into the venture. It called into question the Obama administration’s entire clean-energy stimulus program.
Two important questions are raised by Solyndra’s failure: Should the government be in the business of picking winners and losers by providing loan guarantees to risky energy ventures? And is Obama using stimulus funds to reward his political contributors?
Now — to be clear — this isn’t solely Obama’s problem. George W. Bush, Bill Clinton, and many other administrations both in America and overseas have had lots of troubles with crony capitalism. Obama is by no means the worst next to twenty years of subsidised Japanese zombification.
So just what is the problem with crony capitalism, and with Solyndra in particular? Personally, I am the biggest supporter of solar technology out there. In my view, transitioning to solar energy is potentially the best thing that could happen to the US economy for reasons of energy independence, minimising carbon emissions, long-term sustainability, decentralisation and so forth. So I have no problem with solar energy, and I have no problem with the government supporting research into solar energy. But I still think this was a bad investment. It wasn’t supporting basic research, only a manufacturing process that was unviable in the market.
When it comes to marketable products, only the people out in the economy know what they want, and what they want to spend their money on. That’s why when government tries to pick winners and losers, it very often gets it totally and stupendously wrong.
Solyndra was touted by the Obama administration as a prime example of how green technology could deliver jobs. The President visited the facility in May of last year and said “it is just a testament to American ingenuity and dynamism and the fact that we continue to have the best universities in the world, the best technology in the world, and most importantly the best workers in the world. And you guys all represent that.”
And why wasn’t Solyndra a winner.
All told, Solyndra raised $1.1 billion from private sources. The extra federal support ended up having the well-intended but unfortunate effect of letting Solyndra ramp up manufacturing in a hurry, even as evidence was emerging that the company had badly misread the changing economics of the solar panel market. A few years ago, prices for the silicon wafers used in most flat solar panels were soaring. Solyndra proposed building an entirely different panel, using cylindrical tubes coated with thin films of copper-indium-gallium-selenide that would pick up light from any direction.
In funding documents, Solyndra insisted that its tubes would be far cheaper than the silicon alternative. No such luck. Silicon prices have plunged nearly 90 percent from their peak in 2008, making conventional panels the better bargains.
So the government backed the wrong player, whose business model wasn’t economically viable. For the system to work, economically viable ideas have to succeed, and unviable ones have to be allowed to fail, and with government favouritism in the market, that just doesn’t work. Now that doesn’t mean to say that I don’t believe in some government role. In my view, the role of government is to create a level playing field for a free market to exist. Supporting basic research is the right role for the government in solar, so that solar efficiencies can be increased to a level where solar can compete on a level playing field with coal and oil.
Let’s move away from Solyndra (which is really a very small example), and onto the main target: the global financial system.
Would you give money to a compulsive gambler who refused to kick the habit? In essence, that’s what the world’s biggest banks are asking taxpayers to do.
Ahead of a meeting of the Group of Seven industrialized nations’ finance ministers in Marseilles this week, bankers have been pushing for a giant bailout to put an end to Europe’s sovereign-debt troubles. To quote Deutsche Bank Chief Executive Officer Josef Ackermann: “Investors are not only asking themselves whether those responsible can summon the necessary willpower … but increasingly also whether enough time remains and whether they have the necessary resources available.”
Unfortunately, he’s right. As Bloomberg View has written, Europe’s leaders — particularly Germany’s Angela Merkel and France’s Nicolas Sarkozy — are running out of time to avert disaster. Their least bad option is to exchange the debts of struggling governments for jointly backed euro bonds and recapitalize banks. European banks have invested so heavily in the debt of Greece and other strapped governments, and have borrowed so much from U.S. institutions to do so, that the alternative would probably be the kind of systemic financial failure that could send the global economy back into a deep recession.
But the problem is the destructive and failed nature of the financial system itself. If government doesn’t allow banks that made bad decisions to be punished by the market, then the bailed-out zombie banks can rumble on for years, parasitising the taxpayer in the name of ever-greater bonuses for management, while failing to lend money, create new employment, or help the economy grow.
The global financial system isn’t working because there are fundamental structural problems with the global economy. These include over-leverage, the agency problem, trade deficits, failed economic planning, massive debt acquisition, Western over-reliance on foreign oil and goods, military overspending, systemic corruption, fragility and so forth. Stabilising the global financial system merely perpetuates these problems. The market shows that it needs to fail — preferably in a controlled way so that real people don’t get hurt — so that we can return to experimental capitalism, where sustainable ideas prosper, and unsustainable ideas don’t.
I’ve talked a lot recently about reindustrialisation. Now, I’m fairly certain David Cameron hasn’t been reading what I write. But I’m also fairly certain we have been looking at the same statistics: Manufacturing has shrunk from nearly 40 percent of Britain’s gross domestic product in the late 1950s to not much more than 10 percent now. And while Cameron might not put it this way, that has left Britain as a shrivelled husk of an economy: overly reliant on services, foreign oil, Chinese manufacturing, junk food, corporate handouts, and too-big-to-fail-too-big-not-to-fail financials. So it’s no surprise that Cameron has been talking up manufacturing. From Bloomberg:
Prime Minister David Cameron has latched on to manufacturing as a cure for Britain’s economic hangover and its 7.9 percent jobless rate. U.K. Business Secretary Vince Cable says that for sustainable, long-term growth, “manufacturing is where we need to be.”
“One of the main growth sectors of the economy in recent years has been banking,” Cable said in an interview. “For reasons that are blindingly obvious, that’s not going to be so important in future.”
Angela Merkel says that Europe won’t issue Eurobonds, presumably heeding the warning that handing over 133% of German GDP to bailing out PIGS may not go down so very well with the German taxpayer. From Bloomberg:
German Chancellor Angela Merkel attempted to shut the door on common euro-area bonds as a means to solve the debt crisis, saying that she won’t let financial markets dictate policy.
Joint euro bonds would require European Union treaty changes that would “take years” and might run afoul of Germany’s constitution, Merkel said. While common borrowing might arrive at some point in the “distant future,” bringing in euro bonds at this time would further undermine economic stability and so they “are not the answer right now.”
“At this time — we’re in a dramatic crisis — euro bonds are precisely the wrong answer,” Merkel said in an interview with ZDF television in Berlin yesterday. “They lead us into a debt union, not a stability union. Each country has to take its own steps to reduce its debt.”