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The Latest Bubble?

Subsidies encourage the type of behaviour they are subsidising.

And the Federal Reserve’s QE Infinity is subsidising the market for mortgage backed securities by taking them out of the market at a price floor.

Unsurprisingly, the market for mortgage-backed securities is near all-time highs:

And Wall Street is doing some wild and wacky things.

UBS has just launched a 16-times-leveraged MBS ETN. The ETN, called the ETRACS Monthly Pay 2x Leveraged Mortgage REIT, offers double the return of the Market Vectors Global Mortgage REITs Index – itself an investment vehicle 8x leveraged to mortgage-backed securities.

The idea appears to be that with the Fed acting as a buyer-of-last-resort that prices will take a smooth upward trajectory and that 16:1 leverage makes sense for retail investors as a bet on a sure thing.

Of course, back in the real world, there is no such thing as a sure thing. As Pedro Da Costa recently noted, banks are sitting on the proceeds of MBS purchases, rather than passing on the money to customers in the form of lower interest rates. As the New York Fed’s William Dudley recently noted:

The incomplete pass-through from agency MBS yields into primary mortgage rates is due to several factors—including a concentration of mortgage origination volumes at a few key financial institutions and mortgage rep and warranty requirements that discourage lending for home purchases and make financial institutions reluctant to refinance mortgages that have been originated elsewhere.

Those leveraging up on MBS might want to consider the implications if the Fed were to change its QE3 transmission mechanism — a transmission mechanism that William Dudley is willing to admit is broken — and buy other assets instead of MBS. Without a buyer of last resort with a printing press, prices would seem to be at current levels unsustainable. And those junk MBS products that the market is leveraging up on now in the hope that the Fed will buy them all will be left out in the cold. Such an event would bad news for anyone leveraged 16:1 on MBS.

But such an event would be an ingenious pump and dump, shifting the burden of junk MBS off Bulge Bracket balance sheets and onto the books of not only the Fed — which has already sucked up huge swathes of toxic junk — but also small-time speculators looking to book leveraged gains, but who end up taking the hit. 

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This is Blowback

The YouTube video depicting Mohammed is nothing more than the straw that broke the camel’s back. This kind of violent uprising against American power and interests in the region has been a long time in the making. It is not just the continuation of drone strikes which often kill civilians in Pakistan, Yemen, Somalia and Afghanistan, either. Nor is it the American invasions and occupations of Iraq and Afghanistan. Nor is it the United States and the West’s support for various deeply unpopular regimes such as the monarchies in Bahrain and Saudi Arabia (and formerly Iran). Nor is it that America has long favoured Israel over the Arab states, condemning, invading and fomenting revolution in Muslim nations for the pursuit of nuclear weapons while turning a blind eye to Israel’s nuclear weapons and its continued expansion into the West Bank.

Mark LeVine, Professor of Middle Eastern history at U.C. Irvine, writes:

Americans and Europeans are no doubt looking at the protests over the “film”, recalling the even more violent protests during the Danish cartoon affair, and shaking their heads one more at the seeming irrationality and backwardness of Muslims, who would let a work of “art”, particularly one as trivial as this, drive them to mass protests and violence.

Yet Muslims in Egypt, Libya and around the world equally look at American actions, from sanctions against and then an invasion of Iraq that killed hundreds of thousands of Iraqis and sent the country back to the Stone Age, to unflinching support for Israel and all the Arab authoritarian regimes (secular and royal alike) and drone strikes that always seem to kill unintended civilians “by mistake”, and wonder with equal bewilderment how “we” can be so barbaric and uncivilised.

All of these things (and many more) have contributed to Muslim and Arab anger toward the United States and the West. Yet the underlying fact of all of these historical threads has been the United States’ oil-driven foreign policy. Very simply, the United States has for over half a century pursued a foreign policy in the region geared toward maintaining the flow of oil out of the region at any cost — even at the cost of inflaming the irrational and psychopathic religious elements that have long existed in the region.

This is not to defend the barbaric elements who resort to violence and aggression as a means of expressing their disappointment with U.S. foreign policy. It is merely to recognise that you do not stir the hornet’s nest and then expect not to get stung. 

And the sad thing is that stirring the hornet’s nest is totally avoidable. There is plenty of oil and energy capacity in the world beyond the middle east. The United States is misallocating capital by spending time, resources, energy and manpower on occupying the middle east and playing world policeman. Every dollar taken out of the economy by the IRS to be spent drone striking the middle east into the stone age is a dollar of lost productivity for the private market. It is a dollar of productivity that the market could have been spent increasing American energy capacity and energy infrastructure in the United States — whether that is in oil, natural gas, solar, wind or hydroelectric.

And this effect can spiral; every dollar spent on arming and training bin Laden and his allies to fight the Soviet Union begot many more thousands of dollars of military spending when bin Laden’s mercenaries turned their firepower onto the United States, and the United States chose to spend over ten years and counting occupying Afghanistan (rightly known as the graveyard of empires). It is likely that the current uprisings will trigger even more U.S. interventionism in the region (indeed it already has as marines have already been dispatched to Yemen) costing billions or even trillions of dollars more money (especially if an invasion of Iran is the ultimate outcome). This in turn is likely to trigger even fiercer resistance to America from the Islamist elements, and so the spiral continues on.

The only way out of this money-sucking, resource-sucking, life-sucking trap that is very literally obliterating the American empire is to swallow pride and get out of the middle east, to stop misallocating American resources and productivity on unwinnable wars.

But neither major Presidential candidate is interested in such a policy. Perhaps it is because war is a great profit source for the military-industrial complex, the force to which both the Democratic and Republican parties are beholden?

In any case, we should expect to see much more of this:

Source: Reuters

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Chinese Instability?

Some commenters have noted that it is not necessarily a good idea to buy equities in a nation that is about to become a global superpower. And so it was following the 1929 crash as Britain descended, and America — encumbered by a historic depression — ascended. Certainly, investors buying equities in 1929 might never have recovered their purchasing power until the 1960s:

So while China is ascendant, and arguably — on the strength of being the spider at the web of global trade, the biggest consumer of oil, its huge foreign exchange reserves, and (most importantly) the globe’s major productive base — already pulling ahead, things might well still be volatile for China. Certainly, it seems a volatile time for many Chinese; the nation lacks a public healthcare system, workers are frequently injured or killed in industrial accidents, air quality is often poor, pollution is still rampant and free speech is still an utterly alien concept. But on the other hand, they are blessed with very high rates of growth backed by very high rates of growth in real productivity, high levels of saving, and low levels of net debt.

And it seems like a recent schism in China’s leadership could worsen matters.

From the Washington Times:

U.S. intelligence agencies monitoring China’s Internet say that from March 14 to Wednesday bloggers circulated alarming reports of tanks entering Beijing and shots being fired in the city as part of what is said to have been a high-level political battle among party leaders – and even a possible military coup.

The Internet discussions included photos posted online of tanks and other military vehicles moving around Beijing.

The reports followed the ouster last week of senior Politburo member and Chongqing Party Secretary Bo Xilai, who was linked to corruption, but who is said to remain close to China’s increasingly nationalistic military.

Chinese microblogging sites Sina Weibo, QQ Weibo, and the bulletin board of the search engine Baidu all reported “abnormalities” in Beijing on the night of March 19.

The comments included rumors of the downfall of the Shanghai leadership faction and a possible “military coup,” along with reports of gunfire on Beijing’s Changan Street. The reports were quickly removed by Chinese censors shortly after postings and could no longer be accessed by Wednesday.

While it is impossible and foolish to try and draw larger conclusions from these snippets of information, it is fairly safe to say that if true, Western leaders — spooked by the various authoritarian Eurasian and pro-Chinese governments who have ditched the dollar for bilateral trade — will be keen to see some of the spirit of the Arab Spring on the streets of Beijing. Of course, American commentators may not be so happy if a radical protectionist anti-American faction of the military — intent on defending Iran from Israel, and exporting less goods and components to the United States — takes control of the nascent superpower. 

But such a military coup seems very unlikely. The likeliest view is that this is simply the inevitable ouster of a Communist Party figure who simply didn’t fit in, in a country where for the political class fitting in is still exceedingly important.

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Why the Republican Party Needs Ron Paul

From the Washington Post:

Simply, Ron Paul is just too popular to ignore. Republicans will find it very hard to win with him running as an Independent. If anything, a three-way split might play out even more strongly for Paul, as he can bash both the incumbent and the Republican as emblematic of the establishment — an establishment that more and more is failing America.

Of course, many forces are deeply opposed to Ron Paul, because for better or worse, his small-government anti-Federalist policies are a drastic change from the status quo, and embarrass big-government Republicans like Newt Gingrich, Rick Perry and George W. Bush who claim they want to balance the budget and end up spending a heck of a lot more.

So Paul supporters can expect a deluge of negative claims: claims that he is a racist, claims that his foreign policy is dangerous, claims he wants to return to segregation, claims that he cannot win and is unelectable.

Ultimately, everyone knows that it is the status quo that is more unsustainable than anything else. America is now the most indebted nation in the history of our planet, bogged down in expensive wars and its role as global policeman, and increasingly in denial of her constitution and the principles of her founders. Congress and Obama — as well as extending the reactionary and unconstitutional Patriot Act — have recently signed some of the most reactionary and illiberal legislation ever in the NDAA of 2011, which allows for the indefinite detention of American citizens without due process. Americans voted for Obama hoping for change from the big-spending interventionist corporatism of George W. Bush, and got much more of the same.

Paul’s non-interventionist foreign policy, his civil libertarianism, his strict adherence to the constitution, his rejection of banking bailouts and his willingness to cut spending are not what every voter is looking for, but are a tonic to the disastrous policies of the status quo that are sucking down the American economy.

Of course, many Americans fear radical change. That’s why establishment contenders like Cain, Gingrich, Bachmann and Perry have rapidly risen in the polls and fallen, as voters scrabble around hunting for a viable alternative to the status quo. Paul’s gains have been slow, steady and consistent. This has been in spite of an earlier campaign of media ignorance, and now a campaign of media smears, including the charge that he is either or a racist, or has associated himself with racists.

These media attacks will prove ineffective. Voters are turning to Paul because of his policies, and the fact that he represents a radical departure from what to many Americans is a disastrously failed status quo. He could be the Grand Wizard of the KKK, a shapeshifting Reptilian from Alpha Draconis, or a cross-dressing drug addict, and that would not change a thing because Ron Paul will ultimately be judged on the content of his policies, not superficial smears that have nothing whatever to do with policy.

Voters — middle class voters, poor voters, factory workers, the unemployed — like the idea that the President will cut the debt. Voters like the idea that the President will respect a strict interpretation of the constitution, instead of passing authoritarian legislation like the NDAA, SOPA and the Patriot Act. Voters like the idea that the President will end wars, close foreign bases, and defend America, instead of practicing expensive nation building in the middle east and central Asia. Voters like the idea of not pledging future tax dollars to bailing out badly managed and corrupt banks.

While some of his stances are unpopular with some segments of the population, there is no other declared candidate from either of the major parties who offers any of the above. None. Ron Paul’s rise is just a symptom of the establishment not delivering to the people what they want, need and deserve.

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Scientists Map The Rulers of the Financial Universe

It’s long been clear to some of us in the financial kingdom that a small clique of powerful companies control vast swathes of the global economy.

Now that mythos has been given some scientific credibility.

From New Scientist:

The idea that a few bankers control a large chunk of the global economy might not seem like news to New York’s Occupy Wall Street movement and protesters elsewhere (see photo). But the study, by a trio of complex systems theorists at the Swiss Federal Institute of Technology in Zurich, is the first to go beyond ideology to empirically identify such a network of power. It combines the mathematics long used to model natural systems with comprehensive corporate data to map ownership among the world’s transnational corporation.

The work, to be published in PloS One, revealed a core of 1318 companies with interlocking ownerships (see image). Each of the 1318 had ties to two or more other companies, and on average they were connected to 20. What’s more, although they represented 20 per cent of global operating revenues, the 1318 appeared to collectively own through their shares the majority of the world’s large blue chip and manufacturing firms – the “real” economy – representing a further 60 per cent of global revenues.

When the team further untangled the web of ownership, it found much of it tracked back to a “super-entity” of 147 even more tightly knit companies – all of their ownership was held by other members of the super-entity – that controlled 40 per cent of the total wealth in the network. “In effect, less than 1 per cent of the companies were able to control 40 per cent of the entire network,” says Glattfelder. Most were financial institutions. The top 20 included Barclays Bank, JPMorgan Chase & Co, and The Goldman Sachs Group.

As the world learned in 2008, such networks are unstable.

Or, as I put it this week:

One thing is clear:

A huge mountain of interlocking, interconnected debt is a house of cards, and a monetary or financial system based upon such a thing is prone to collapse by default-cascade: one weak link in the chain breaks down the entire system.

 

 

 

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The Housing Bubble Priced in Gold

In the United States, the post-sub prime housing crash has meant that consumer spending has stagnated. People are simply not remortgaging their homes to buy boats or other such consumer goods anymore, because there is no longer the expectation that price rises will pay for the boat. This is because prices are slumping due to excess supply built during the peak years. For people who don’t own property in the United States, this price crash has allowed them to get a foot on the property ladder, which is broadly a good thing. Keynesians might argue that the slump in consumer spending is broadly a bad thing, but it’s not: it was never sustainable in the first place. Boosting GDP through unsustainable spending is a short recipe for bubbles.

In the United Kingdom, the story is different. Property prices haven’t really crashed:


 Continue reading →

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China is Not Ready to Pull the Plug on America

A very interesting article on alt-market asks a question I have been contemplating these past few weeks. In my view, America’s economic health is totally dependent upon two things: the flow of dollars to the middle east in exchange for oil, and the flow of dollars to China for consumer goods. Any disruption to either or both of these flows would result in sustained and significant disruption to America’s economy. That’s why America — absent of any real plan to move its energy generation, and its supply chains back to America — spends so much money policing the world.

So, that brings us onto the question: What would happen if China liquidated its dollar and bond holdings and moved its wealth into harder assets? And is China on the verge of doing just that?

From alt-market:

There are two mainstream market assumptions that, in my mind, prevail over all others. The continuing function of the Dow, the sustained flow of capital into and out of the banking sector, and the full force spending of the federal government are ALL entirely dependent on the lifespan of these dual illusions; one, that the U.S. Dollar is a legitimate safe haven investment and will remain so indefinitely, and two, that China, like many other developing nations, will continue to prop up the strength of the dollar indefinitely because it is “in their best interest”. In the dimly lit bowels of Wall Street such ideas are so entrenched and pervasive, to question their validity is almost sacrilegious. Only after the recent S&P downgrade of America’s AAA credit rating did the impossible become thinkable to some MSM analysts, though a considerable portion of the day-trading herd continue to roll onward, while the time bomb strapped to the ass end of their financial house is ticking away.

The debate over the health and longevity of the dollar comes down to one very simple and undeniable root pillar of economics; supply and demand. The supply of dollars throughout the financial systems of numerous countries is undoubtedly overwhelming. In fact, the private Federal Reserve has been quite careful in maintaining a veil of secrecy over the full extent of dollar saturation in foreign markets in order to hide the sheer volume of greenback devaluation and inflation they have created. If for some reason the reserves of dollars held overseas by investors and creditors were to come flooding back into the U.S., we would see a hyperinflationary spiral more destructive than any in recorded history. As the supply of dollars around the globe increases exponentially, so too must foreign demand, otherwise, the debt machine short-circuits, and newly impoverished Americans will be using Ben Franklins for sod in their adobe huts. As I will show, demand for dollars is not increasing to match supply, but is indeed stalled, ready to crumble.

We know from insiders in the Chinese government that China are looking at “liquidating more of our holdings of Treasuries once the US Treasury market stabilizes”, and “buying stakes in Boeing, Intel, and Apple and these types of companies… in a proactive way”, and of course gold. But does that mean China will be liquidating as soon as possible? After all Bernanke won’t stop printing, the dollar won’t stop being devalued, and America won’t stop burning through its productive capital on military spending.

I don’t believe they will. Wen Jiabao’s subtle and supportive public remarks during Joe Biden’s recent visit suggests that China wants a controlled and managed transition away from the dollar as the global reserve currency. Withdrawing support for the dollar right now would send China’s remaining dollar pile crashing into the earth.

From the Council on Foreign Relations:

China has accumulated a massive stock of U.S. dollar reserves in recent years. Statements of concern from China regarding the risk that U.S. economic policy might undermine the future purchasing power of these assets has fuelled the market’s concern that China may shift away from dollar purchases. Yet in the 12 months ending in July 2009 China accumulated more dollar-denominated assets, mainly U.S. Treasuries, than foreign assets in total. Despite its rhetoric, China has thus far taken no actions to wean itself off of the dollar.

And as I have noted numerous times, China has no interest in upsetting the global balance — under the current circumstances it is very rapidly strengthening, whilst America falters. And why change something that is working for China?

So when will China pull the plug? There are a few relevant pictures to watch:

  1. China’s gold reserves: currently at 1,000 tonnes, these would have to go significantly higher.
  2. China’s acquisitions of American industry: this would signify Chinese dollar-outflows.
  3. China’s holdings of U.S. debt: if Bernanke keeps printing, these would have to remain stable, or more likely tip-toe lower.
  4. Flotation of the yuan: if China wishes to curb domestic inflationary pressures, they will float the yuan on global markets. A successful yuan flotation would cut the relative value of China’s dollar holdings, lessening the incentive to hang onto U.S.-denominated assets

I expect all of these developments to take place over years, not months. And, in my view, the greatest threat to the dollar’s status as global reserve currency is a global oil shock, triggered by a new middle eastern war, or some black swan. And it is an oil shock that is precisely the event that might force China to accelerate offloading its dollar hoard.

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On Solyndra

A few days ago Solyndra, a Bay Area maker of industrial solar panels, announced plans to file for bankruptcy.

From the L.A. Times:

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.

From NBC:

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.

From BusinessWeek:

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.

From Bloomberg:

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.