zondag 9 september 2018

Dozens Killed In Five Days Of Riots In Southern Iraq's Basra

Riots have continued for five days in Basra, Iraq's second largest city, in southern Iraq. Protesters have attacked or set fire to nearly every government building, including the headquarters of the Iran-linked ruling Dawa Party and the offices of the state-run Iraqiya TV station, as well as the Iranian consulate. They also attacked almost every office belonging to the Iran-backed Shia militias known as the "Popular Mobilization Forces" or "Hasheed." At least 15 people have been killed in the riots in the last week. On Saturday, assailants fired Katyusha rockets at Basra airport. There have been occasional anti-government protests in Basra for years. The latest protests were triggered by brownish water coming out of the water taps, making people sick who try to drink it, and by a crippling electricity shortage at a time when temperatures are reaching 120 degrees Fahrenheit during the day. By Saturday afternoon, Iraqi security forces and troops began deploying in the center of Basra and on street intersections. Dozens of gun-mounted black pick-up trucks belonging to the Interior Ministry and carrying masked security forces in combat fatigues were seen. Iraqi News and AP and Vox and CNN
# Riots in Iraq's Basra evoke fault lines of 1980s Iran-Iraq war; Basra is home to some of the largest oil fields in Iraq. These oil fields are contributing enormously to Iraq's economy, but none of the money seems to help Basra. Basra used to be called the "Venice of the East" because of its network of waterways and canals, which should be providing it with plenty of fresh water. But the canals were bombed by Iran during the 1980s Iran-Iraq war, and have not been repaired since then. Most Iraqis are Shia Muslims, with Sunni Muslims in the minority. After the war, Saddam Hussein, a Sunni Muslim, neglected and marginalized the mostly Shia Basra population, causing considerable dissent. When Saddam was deposed by the 2003 American invasion, an Iran-linked Shia government came to power, and they have also largely neglected and marginalized the Basra population. The Basra Shias have returned the favor by forcing the few Sunnis living in Basra to leave. Although the split between Sunni and Shia Muslims is a defining feature of the Mideast, there are also ethnic alliances that override the sectarian fault lines. Iraq had two generational crisis wars during the last century, the 1920 Iraqi Revolution and the 1980s Iran-Iraq war. In both of those wars, the Iraqi Sunnis and Shias united behind the war effort against the enemy,- the British colonists in 1920 and the Iranians in the 1980s.
So even those the Muslims in Basra are Shia Muslims, they have bitter memories of the atrocities committed by the Iranians in the 1980s. Those bitter memories are revived every time someone is killed by a land mine planted by Iran during the 1980s war. So the current riots in Basra are about more than drinking water and electricity. There is a great deal of fury directed at Iran's "meddling" in the current government, which is in a state of chaos anyway. Politicians in Baghdad have not agreed on a government following inconclusive elections in May. The new parliament met for the first time on Monday, but failed to elect a speaker, much less name a prime minister, so the former prime minister, Haider al-Abadi, continues in power. Parliament convened an emergency session on Saturday to discuss the crisis in Basra, but no action was taken. Another interesting fact is that there are differences between Shia theology in Basra and Shia theology in Iran. When Ruhollah Khomeini set up his Islamic Revolutionary government after Iran's 1979 civil war, he reinterpreted centuries of Shia theology to include a doctrine called Wilayat al-Faqih, which means Guardianship of the Jurist. The effect of this doctrine was that the Supreme Leader was considered to be as infallible as the 12 infallible Imams that had led Shia Islam over a millennium ago. This meant, of course, that Khomeini was the infallible leader of all Shia Muslims. Needless to say, Shia Muslims in Iraq do not accept Khomeini or the current Supreme Leader, Seyed Ali Hosseini Khamenei, as infallible leaders. So the doctrine of Wilayat al-Faqih (Guardianship of the Jurist) is rejected by Iraq's Shias in Basra, and so Iran's Shiism and Iraq's Shiism are effectively two different sects. This difference goes to the core of the protests, as the government in Baghdad is linked with Iran and Iranian Shiism. This will have to be settled as part of the resolution to the current riots.... Reuters and Al Monitor and Middle East Eye (16-July)

zaterdag 8 september 2018

Trump Tariff Threat Trounces Tech Turnaround, Tesla Tattered

It was supposed to be a blockbuster day for stocks, if not so much for bonds, and it started off well. One hour after the BLS reported the strongest growth in average hourly earnings in 9 years...


Stocks started off strong, even if the performance through mid-day left something to be desired...


The early rebound was driven by tech stocks, with a rebound in the battered semis and chip sector...


Helping FANGs reverse two days of sharp declines, at least in early trading...


Treasury yields showed more enthusiasm, with a sharp bond selloff after the bell sending 10Y yield to 2.95%, after opening at 2.88%. The move was matched across the curve, even if yield curve remained perfectly flat intraday and was last seen fractionally lower...


However the pleasant mood in the market was promptly spoiled just around noon, when Bloomberg carried over comments from Trump aboard Air Force 1, in which the president threatened to impose an additional $267BN in tariffs on China imports, in addition to the $200BN already contemplated, capturing virtually all Chinese exports. The latest salvo from Trump in the trade war rattled U.S. stocks a day after top American executives made a last-minute push to convince the president to not impose fresh tariffs. The result in the Dow Jones was instant, sending the multi-national heavy index tumbling by 100 points. At its low point, the Dow was down nearly 180 points...


Although as the day progressed, and as traders realized that the big "risk-off" event of the day, Trump's announcement of $200BN in new Chinese tariffs, would be delayed, stocks recouped much of their losses, and the Nasdaq was virtually unchanged after peeking into the green on a few occasions...


The dour mood returned shortly after 3:30pm however, when Apple announced that it would likely be hit by the Chinese sanctions:
- APPLE: PROPOSED TARRIFS AFFECTS WATCH, AIRPODS, APPLE PENCIL
- APPLE SAYS PROPOSED TARRIFS ALSO AFFECT MAC MINI, SOME CABLES
Although even fears that Apple margins would be impacted failed to put too much pressure on stocks, and the S&P never really moved too far below the unchanged line. Earlier in the session, dollar weakness helped emerging-market stocks snap seven days of declines while a gauge of currencies also rose...


The rebound, however, will be brief as today's surge in the dollar which guarantees at least two more rate hikes this years, and potentially more in 2018, means that the pain for EMs will return as soon as Monday...


In summary, another day of whiplashes, in which Trump proved that with one phrase he can crush sentiment on a moment's notice. Meanwhile, as LPL Financial 's Ryan Detrick tweeted this morning, it's been a tough start to the month of September for the S&P 500, which has fallen for the fourth day in a row. This is notable, because as he notes, "going back to the Great Depression, only two times did it start down the first four days. 1987 and 2001." And, as Bloomberg shows, a 20-year seasonality chart bears that out, with "2018 a far cry from recent history"...


Which is troubling for hedge funds, because as Nomura showed earlier in the week, September has traditionally been a month of two-halved: a strong first half, and then a slide in the second...


It may be the case that have decided to skip the first half and go straight to the selloff. Finally, it's worth noting that just hours after Elon Musk gave a controversial interview in which he showed off his flamethrower and smoked pot, first Tesla's Chief accounting officer quit after just one month on the job, followed immediately by an announcement that Tesla's head of HR would not be returning to the company. The news sent TSLA stock plunging as much as 10%, its biggest one day drop in 2 years...


While Tesla bonds plunged to the lowest on record...


Is the long-overdue bursting of the Tesla bubble emblematic of the sentiment shift in the market in general? Tune in next week and find out....

Playing With Dominoes

The Great “Recession” was never a recession. It was a monetary event first and foremost, and it continues to be eleven years later. That means by and large it has been a failure of imagination. Central bankers say they’ve done this and that, but what they’ve never done, apart from actually succeed, is examine the way money actually works in this modern world. Greenspan said it in June 2000, this “proliferation of products.” What might happen if they no longer proliferate? You’d have to imagine an answer because they have none. In the spirit of imagination, use yours to mentally draw in below DXY or some other equivalent eurodollar signal like repo or even EFF...


None of our economic problems are really that difficult. They just don’t fit in the narrow box Economists have constructed so that their DSGE models can be free from singularities. It’s nice, I suppose, eliminating infinities from certain equations (“rational” rather than adaptive expectations) but at the expense of macro competence? It takes very little imagination, actually, to see how they really have no idea what they are doing....

Ethereum Plummets After Co-Founder Buterin Says Days Of Explosive Growth Are Over

The pain for ethereum fans has been relentless in 2018, with the cryptocurrency sliding more than 80% from its January highs. Then, moments ago even more pain was unleashed by an unlikely source after Vitalik Buterin, Ethereum's 24 year old co-founder, said that "the days of explosive growth in the blockchain industry have likely come and gone now the average person is aware of its existence." 
* Vitalik Buterin...

In an interview with Bloomberg at an Ethereum and blockchain conference in Hong Kong, Buterin said that "the blockchain space is getting to the point where there’s a ceiling in sight. If you talk to the average educated person at this point, they probably have heard of blockchain at least once." What this means is that "there isn’t an opportunity for yet another 1,000-times growth in anything in the space anymore." Commenting on the first six or seven years of growth of Bitcoin and other cryptocurrencies, Buterin said that it was dependent on marketing and trying to get wider adoption, but "that strategy is getting close to hitting a dead end." Instead, the co-founder of the second most valuable cryptocurrency said that the next growth phase will be getting people who are already interested in cryptocurrencies to be involved in a more in-depth way: "Go from just people being interested to real applications of real economic activity", a point he has made regularly in the past even as he frequently slammed the stratospheric growth observed in cryptocurrencies in 2017, if not so much 2018.
Ethereum has tumbled more than 80% in the past 9 months, with losses accelerating last month as some start-ups paid in the digital currency during their Initial Coin Offerings cashed out to cover expenses, and on concern about broader price declines among virtual currencies, according to industry watchers cited by Bloomberg. Following Buterin's commentary, Ethereum plunged another 8%, dropping as low as $200, with the comments by its billionaire founder making him 8% poorer in a matter of minutes...

Marko Kolanovic: This Is What The Next Crisis Will Look Like

As part of an extensive, cross-asset effort summarizing JPMorgan's views in a 168-page report issued to commemorate a decade of the Lehman failure, and titled appropriately "Ten Years After the Global Financial Crisis: A Changed World", JPMorgan head quant has published a section in which he lays out his thought on "What the next crisis will look like." To frequent readers of Kolanovic, the report is very similar to a similar effort he put together last October, in which he also previewed the "next crisis, which he dubbed the Great Liquidity Crisis - and said would be defined by severe liquidity disruptions resulting from market developments since the last including
i) decreased AUM of strategies that buy value assets;
ii) Tail risk of private assets;
iii) Increased AUM of strategies that sell on “autopilot”;
iv) Liquidity-provision trends;
v) Miscalculation of portfolio risk
vi) Valuation excesses.
Fast forward to today when despite his recently optimistic shift, Kolanovic reiterates many of the same underlying apocalyptic themes, making one wonder just how "tactical" his recent bullish bias has been. Echoing what he said last October, Kolanovic writes that "the main attribute of the next crisis will likely be severe liquidity disruptions resulting from market developments since the last crisis". A key feature of this market transformation, is the shift from active to passive investment, and the prevalence of trend-following investors and market makers, which "reduces the ability of the market to prevent large drawdowns." In some bad news for the risk-parity crowd, Kolanovic writes that "in multi-asset portfolios, the ability of bonds to offset equity losses will be reduced" while PE firms won't be spared either as private assets that are less frequently marked to market may understate the true risk exposure of portfolios. Combining these views with his core competency, market volatility, Kolanovic writes that "these factors may lead to a miscalculation of true risk due to a reliance on recent volatility as the main measure of portfolio risk." Which is an odd statement for Kolanovic to make considering the just two weeks ago, he was pushing the lack of market vol as a key support pillar for his continued bullish outlook on the market. Cognitive dissonance aside, it is a breath of fresh air to glimpse a return of the old, "skeptical" Kolanovic, even if it is in the context of a strategic piece, while he maintains his bullish facade when it comes to his periodic tactical reports. In any case, here is what Kolanovic thins the next crisis will looks like, as excerpted from the broader JPMorgan report.
# What will the next crisis look like? This year marks the 10th anniversary of the 2008 Global Financial Crisis (GFC) and also the 50th anniversary of the 1968 global protests. Currently, there are financial and social parallels to both of these events. Leading into the 2008 GFC, some financial institutions underwrote products with excessive leverage in real estate investments. The collapse of liquidity in these products impaired balance sheets, and governments backstopped the crisis. Soon enough governments themselves were propped by extraordinary monetary stimulus from central banks. Central banks purchased ~US$10 trillion of financial assets, mostly government obligations. This accommodation is now expected to reverse, starting meaningfully in 2019. Such outflows (or lack of new inflows) could lead to asset declines and liquidity disruptions, and potentially cause a financial crisis. We will call this hypothetical crisis the “Great Liquidity Crisis” (GLC). The timing will largely be determined by the pace of central bank normalization, business cycle dynamics, and various idiosyncratic events such as escalation of trade war waged by the current U.S. administration. However, timing of this potential crisis is uncertain. This is similar to the 2008 GFC, when those that accurately predicted the nature of the GFC started doing so around 2006. We think the main attribute of the next crisis will be severe liquidity disruptions resulting from these market developments since the last crisis:
# Shift from Active to Passive Investment. We have highlighted the growth in passive investment through ETFs, indexation, swaps, and quant funds over the past decade, transforming equity market structure and trading volumes. For instance, as of May 2018, total ETF assets under management (AUM) reached US$5.0 trillion globally, up from US$0.8 trillion in 2008. We estimate that Indexed funds now account for 35-45% of equity AUM globally, while Quant Funds comprise an additional 15-20% of equity AUM. With active management declining to only one-third of equity AUM, we estimate that active single-name trading accounts for only 10% of trading volume. We estimate 90% of trading volume comes from Quant, Index, ETFs, and Options. The shift from active to passive asset management, and specifically the decline of active value investors, reduces the ability of the market to prevent and recover from large drawdowns. Figure 1 illustrates the trend in passive assets, showing the growth of passive equity fund AUM as a % of total equity fund assets since 2005...


The US$2 trillion rotation from active and value to passive and momentum strategies since the last crisis eliminated a large pool of assets that would be standing ready to buy cheap public securities and backstop a market disruption. Figure 2 highlights the inflows into passive equity funds since 2010 compared to outflows from active equity funds...


# Increased AUM of strategies that sell on “autopilot.” Over the past decade there was strong growth in Passive and Systematic strategies that rely on momentum and asset volatility to determine the level of risk taking (volatility targeting, risk parity, trend following, option hedging, etc). A market shock would prompt these strategies to programmatically sell into weakness. For example, we estimate that futures-based strategies grew by US$1 trillion over the past decade, and options-based hedging strategies increased their potential selling impact from 3 days of average futures volume to 7 days of average volume.
# Trends in liquidity provision. The model of liquidity provision changed in a close analogy to the shift from active/value to passive/momentum. In market making, this has been a shift from human market makers that are slower and often rely on valuations (reversion) to programmatic liquidity that is faster and relies on volatility-based VAR to quickly adjust the amount of risk taking (liquidity provision). This trend strengthens momentum and reduces day-to-day volatility, but it increases the risk of disruptions such as the ones we saw on a smaller scale in May 2010, October 2014, and August 2015. Figure 3 highlights the decline in S&P 500 e-mini futures market depth following a volatility spike, measured against VIX. S&P futures represent the largest liquidity pool for broad equity market exposure...


# Miscalculation of portfolio risk. Over the past two decades, most risk models were (correctly) counting on bonds to offset equity risk. At the turning point of monetary accommodation, this assumption will most likely fail. This increases tail risk for multi-asset portfolios. An analogy is with the 2008 failure of endowment models that assumed Emerging Markets, Commodities, Real Estate, and other asset classes were not highly correlated to DM Equities. In the next crisis, Bonds likely will not be able to offset equity losses (due to low rates and already large CB balance sheets). Another risk miscalculation is related to the use of volatility as the only measure of portfolio risk. Very expensive assets often have very low volatility, and despite the downside, risks are deemed perfectly safe by these models.
# Tail risk of private assets: Outflows from active value investors may be related to an increase in Private Assets (Private Equity, Real Estate, and Illiquid Credit holdings). Over the past two decades, pension fund allocations to public equity decreased by 10%, and holdings of Private Assets increased by 20%. Similar to public value assets, private assets draw performance from valuation discounts and liquidity risk premia. Private assets reduce day-to-day volatility of a portfolio but add liquidity-driven tail risk. Unlike the market for public value assets, liquidity in private assets may be disrupted for much longer during a crisis.
# Valuation excesses. Given the extended period of monetary accommodation, many assets are at the high end of their historical valuations. This is visible in sectors most directly comparable to bonds (e.g., credit, low volatility stocks), as well as technology and internet-related stocks. (Sign of excesses include multi-billion dollar valuations for smartphone apps or for initial cryptocurrency offerings that in many cases have very questionable value). Following the large U.S. fiscal stimulus, strong earnings growth reduced equity valuations to long-term average levels. Valuations came down in other pockets of excess such as Cryptocurrencies and several hyper growth stocks. Despite more reasonable valuations, equity markets may not hold up should monetary tightening continue, particularly if it is accompanied by toxic populism and business disruptive trade wars.
# Rise of populism, protectionism, and trade wars. While populism has been on the rise for several years, this year we have started to see its significant negative effect on financial markets as trade tensions have risen between the U.S. and numerous countries. The great risk of trade wars is their delayed impact. The combination of a delayed impact from rising interest rates and a disruption of global trade have the potential to become catalysts for the next market crisis and economic recession.
# Kolanovic' conclusion: We believe that the next financial crisis will involve many of the features above, sparking the Great Liquidity Crisis (GLC), and addressing them on a portfolio level may mitigate their impact. It remains to be seen how governments and central banks will respond in the scenario of a great liquidity crisis. If the standard interest rate cutting and bond purchases do not suffice, central banks may more explicitly target asset prices (equities). This may be controversial in light of the potential impact of central bank actions in driving inequality between asset owners and labor. Other “out of the box” solutions could include a negative income tax (one can call this “QE for labor”), progressive corporate tax, universal income, and others. To address growing pressure on labor from artificial intelligence, new taxes or settlements may be levied on technology companies (for instance, they may be required to pick up the social tab for labor destruction brought about by artificial intelligence, in an analogy to industrial companies addressing environmental impacts). While unlikely, a tail risk could be a backlash against central banks that prompts significant changes in the monetary system. In many possible outcomes, inflation is likely to pick up.
The next crisis is also likely to result in social tensions similar to those witnessed 50 years ago in 1968. In 1968, TV and investigative journalism provided a generation of baby boomers access to unfiltered information on social developments such as Vietnam and other proxy wars, civil rights movements, income inequality, etc. Similar to 1968, the internet today (social media, leaked documents, etc.) provides millennials with unrestricted access to information on a surprisingly similar range of issues. In addition to information, the internet provides a platform for various social groups to become more self-aware, polarized, and organized. Groups span various social dimensions based on differences in income/wealth, race, generation, political party affiliations, and independent stripes ranging from liberal to alt-right movements to conspiracy theorists and agents of adversary foreign powers. In fact, many recent developments such as the U.S. presidential election, Brexit, independence movements in Europe, etc., already illustrate social tensions that are likely to be amplified in the next financial crisis. How did markets evolve in the aftermath of 1968? Monetary systems were completely revamped (Bretton Woods), inflation rapidly increased, and equities produced zero returns for a decade. The decade ended with a famously wrong Businessweek article “the death of equities” in 1979.
# To summarized: financial apocalypse with a dash of civil war thrown in for good measure. But there's time. Until then, don't forget to BTFD.

ING Busted For €775 Million In Money Laundering

Dutch bank ING Groep, the latest financial services provider in the Netherlands, admitted on Tuesday that criminals had been able to launder money through its accounts and agreed to pay €775 million ($900 million) to settle the case. It was hardly a surprise: in fact, ING was warned as early as a decade ago that its money laundering controls were lax, the Dutch prosecutor said, in the latest case highlighting failures in European Union money laundering controls from Latvia to Denmark. ING admitted to shortcomings which had allowed clients “to use their bank accounts for money laundering practices for years” and its chief executive Ralph Hamers said it had taken “drastic measures” to prevent a repetition. Now, thanks to Reuters, we find just how pervasive money laundering has been using what is traditionally seen as one of Europe's sleepiest banks. Consider this: when Dutch prosecutors trawled through ING’s books they found a “women’s underwear trader” had been able to launder €150 million through the bank’s accounts without ringing alarm bells. “It should have been clear to the bank that the monetary flows had little to do with the lingerie trade,” the prosecutors said on Tuesday after imposing a 775 million euro penalty on the Dutch bank for its failings, Reuters reported...


Commenting on Europe's latest money laundering scandal, and its settlement, Ana Gomes, a Portuguese member of the European Parliament, said: "I fear that countries in Europe are oblivious to fighting financial crime." ING’s penalty coincides with European regulators considering whether to tighten regional controls of financial crime and one official with knowledge of the matter said money laundering may be raised at a meeting of EU finance ministers this week. Several months ago, Latvia - which had styled its banks as a financial bridge between Russia and the west, was forced to close one of its banks after it was accused by the United States of money laundering and breaking sanctions. Denmark’s Danske Bank has also been in the spotlight: it has admitted to flaws in its anti-money laundering controls in Estonia and a year ago launched its own inquiry, the results of which are expected this month. “The system is now designed to allow money laundering. It is full of holes. We need serious European rules with pan-European powers of enforcement,” Gomes added. The crackdown on illegal money flows has escalated all the way to the ECB:
* Europe has made some reforms, requiring countries to set up centralised bank account registers, but cooperation across borders remains poor and the European Parliament has asked the European Central Bank (ECB), which monitors the bloc’s big banks, to step up its anti-money laundering checks. 
In response, the ECB has long claimed that its AML powers are limited, but fresh new laws are unlikely until a new European Parliament takes office after elections next year. Meanwhile, in the case of ING, Dutch prosecutors highlighted a series of lapses that they said followed years when it put profit ahead of controls, leaving the compliance department understaffed and able only to investigate the “tip of the iceberg”. It goes without saying that the targets of the laundering crackdown were mostly Russian entities: the prosecutors said that $55 million had been paid by telecoms group VEON, formerly VimpelCom, out of an account at ING via a Gibraltar-based company to Gulnara Karimova, the daughter of the former president of Uzbekistan. And despite being alerted, ING took years to pass the information to the authorities, they added in their report. The Uzbek Prosecutor General’s office said last year that Karimova was in custody following a conviction for embezzlement. Her Swiss lawyer Gregoire Mangeat said she had been “detained arbitrarily”, adding it was not possible to talk to her. It wasn't just Russia though: in another case highlighted by Dutch prosecutors, two companies importing fruit and vegetables from South America ran up cash deposits of more than a half a million euros, before ING was alerted by police. It then closed the accounts. Prosecutors said that the Netherlands’ central bank (DNB) had warned ING as early as 2008 that its procedures were insufficient, but lead prosecutor Margreet Frohberg told Reuters that it had failed to act in earnest until 2016. A DNB spokesman said that Dutch banks had begun improving their controls as early as 2008, but moved too slowly:
* “A minimalist interpretation and a mechanical implementation of the laws is insufficient. More really has to happen. The financial sector knows this, but we’re still far from where we need to be,” he said, adding that the Netherlands was increasing penalties and demanding tighter controls. 
As for ING, it said it was impossible to estimate how much money was laundered through its accounts, but lead prosecutor Margreet Frohberg told Reuters “hundreds of millions of euros” were involved. The fine is not ING’s first for failing to prevent illegal transactions. In 2012 it paid a penalty of $619 million for facilitating billions of dollars worth of payments through the U.S. banking system on behalf of Cuban and Iranian clients....

Charles Hugh Smith; After 10 Years Of "Recovery," What Are Central Banks So Afraid Of?

If the world's economies still need central bank life support to survive, they aren't healthy--they're barely clinging to life. The "recovery"/Bull Market is in its 10th year, and yet central banks are still tiptoeing around as if the tiniest misstep will cause the whole shebang to shatter: what are they so afraid of? The cognitive dissonance / crazy-making is off the charts: On the one hand, central banks are still pursuing unprecedented stimulus via historically low interest rates, liquidity and easing the creation of credit on a vast scale. Some central banks continue to buy assets such as stocks and bonds to directly prop up the "market." (If assets don't actually trade freely, is it even a market?) On the other hand, we're being told the global economy is in synchronized growth and this is the greatest economy ever in the U.S. and China. Wait a minute: so the patient has been on life-support for 10 years and authorities are telling us the patient is now super-healthy? If the patient is so healthy, then why is he still on life support after 10 years of "recovery"? If the global economy is truly healthy, then central banks should end all their stimulus programs and let the market discover the price of credit, risk and assets.
If the economy is truly expanding organically, under its own power, then it doesn't need the life-support of manipulated low interest rates, trillions of dollars in central bank asset purchases, trillions of dollars in backstopping, guarantees, credit swaps, etc. If the economy were truly recovering, wouldn't central banks have tapered their stimulus and intervention long ago? Instead, central bank stimulus skyrocketed to new highs in 2015-2017 as global markets took a slight wobble. That little slide triggered a massive central bank response, as if the patient had just suffered a cardiac arrest...


As for China's economy being so healthy--then why are Chinese authorities expanding credit in such manic desperation? Healthy economies growing organically don't need authorities pumping trillions of yen, yuan, euros and dollars into credit and asset markets...


So what are central banks so afraid of? Why are they still tiptoeing around in fear after 10 years of unprecedented stimulus? The answer is as obvious as the emperor's buck-naked body: central banks know the global economy is so brittle, so fragile and so dependent on cheap credit for its survival that the slightest contraction in credit will collapse the entire system. If the world's economies still need central bank life support to survive, they aren't healthy, they're barely clinging to life. The idea that central banks can wean a sick-unto-death global economy off life support is magical thinking, and central banks know it. If the patient isn't getting well after 10 years on life support, he isn't going to get well. And so we have the travesty of a mockery of a sham of "tapering", a gimmicky PR charade of reducing the trillions of life support by a few drops, as if the patient will leap off the gurney and run a marathon as soon as we reduce the stimulus by a few more drops. It would be laughable if it wasn't so delusional. It's one or the other: if the patient is healthy, then withdraw all stimulus and let interest rates go wherever market participants take them. If the patient is actually extremely ill, then maybe we should look beyond central banks propping up a rotten, corrupt, exploitive, venal, parasitic, predatory status quo to systemic transformation....

Fed Said to Be Less Prepared For Crisis Than 10 Years Ago

A group of current and former policymakers and academics in the financial industry that comprise the "Group of 30" - a financial industry working group that includes names like Mario Draghi and Mark Carney and which is the "who's who" of economists and experts that led the world into the last financial crisis - has come to the same conclusion that the many in the "fringes of economic thought" have been warning about for the last decade: the Fed is going to be in worse off shape to fight the next major crisis than they were in 2008. “Some of the tools to fight the hopefully rare but extreme crises in the future have been weakened,” Tim Geithner, a distinguished Group of 30 member, told Bloomberg.
While many of our readers have likely arrived at that same conclusion on their own, the reasoning by the Group of 30 seems to differ somewhat from conventional skepticism. More importantly, how could the world be "unprepared" nearly a decade after the great recession, and with new reforms being put into place as a result of the financial crisis? According to Geithner, new reforms are actually part of the problem. Geithner tells Bloomberg the unease is a partially a result of "Congress limit[ing] the ability of the Federal Reserve and the Federal Deposit Insurance Corp. to provide emergency support to the financial system". Mexico’s former central bank head Guillermo Ortiz started to hint at the right idea when he told Bloomberg that "The next financial crisis will likely come from a new source". But that new source, according to Ortiz, is not the biggest debt load ever seen in the history of the world, but will be due to cybercrime. "Central banks and supervisors may not be placing enough emphasis on preparing," he continued telling Bloomberg. Meanwhile, as policymakers confirm that they believe the next crisis is going to be "different", it still doesn’t seem as though anybody has considered the idea of the alarm going off from inside the U.S. as a result of a potential hyperinflationary or currency based crisis. Au contraire, these grizzled experts believe that the problem is that they won’t be able to inject dollars into the system fast enough, just the opposite. Further, policymakers believe that the enhanced regulation on banks has likely simply left them playing whack-a-mole and pushing much of the nefarious behavior to the shadow banking system...


"If you apply constraints on risk taking to only part of the financial system, say just the banks, and allow other types of financial institutions to operate outside those constraints then you will leave the overall financial system less resilient. Banks themselves may look more stable but their role in the system will shrink over time," Geithner continued. For once, he's right: just ask China and its years-long attempt to rein in China's giant shadow banking system without causing a financial crisis in the process. Yet for some reason these "smartest people in the room" continue to believe that if we can’t govern all of the institutions that deal in finance, somehow the better option is only to govern some of them, instead of letting them all do business under a free market scenario (that outcome would require the end of central banking and modern economics which may explain their skepticism). Even more amusing is the fact that much of the camaraderie formed by international regulators over the financial crisis as a result of them coming together to solve the problem also looks like it could be on its deathbed. G-30 member Axel Weber says that confidence between regulators may not last another decade "In a world where inward-looking policies are starting to emerge, and where economic and trade tensions are starting to become the day-to-day in politics." In other words, for those who believe that the biggest scourge on the face of the ear are central banks and glorified academics running the world, the collapse of globalization may just be the white knight they have been waiting for. Perhaps in retrospect, something good will come out of Trump's presidency after all....

Trump Does 180 Shift On Syria: Regime Change Back On The Table

Will the war in Syria never end? Will the international proxy war and stand-off between Russia, the United States, Iran, and Israel simply continue to drift on, fueling Syria's fires for yet more years to come? It appears so according to an exclusive Washington Post report which says that President Trump has expressed a desire for complete 180 policy shift on Syria. Only months ago the president expressed a desire "to get out" and pull the over 2,000 publicly acknowledged American military personnel from the country; but now, the new report finds, Trump has approved "an indefinite military and diplomatic effort in Syria". The radical departure from Trump's prior outspokenness against militarily pursuing Syrian regime change, both on the campaign trail and during his first year in the White House, reportedly involves "a new strategy for an indefinitely extended military, diplomatic and economic effort there, according to senior State Department officials". This even though one of the Pentagon's main justifications for being on Syrian soil in the first place, the destruction of ISIS, has already essentially happened as the terror group now holds no significant territory and has been driven completely underground...


But most worrisome about the Post report is that sources said to be close to White House policy planning on Syria suggest that Trump has made a commitment to pursuing regime change as a final goal. Crucially, the report describes that "the administration has redefined its goals to include the exit of all Iranian military and proxy forces from Syria, and establishment of a stable, nonthreatening government acceptable to all Syrians and the international community." Of course, there's the glaringly obvious issue of the fact that the most powerful top competing "alternatives" to the current government in Damascus include groups like Hay'at Tahrir al-Sham, which currently holds Idlib and is under direct allegiance to al-Qaeda chief Ayman al Zawahiri (as recently confirmed in the US State Department's own words).
# Donald J. Trump (@realDonaldTrump President Bashar al-Assad of Syria must not recklessly attack Idlib Province. The Russians and Iranians would be making a grave humanitarian mistake to take part in this potential human tragedy. Hundreds of thousands of people could be killed. Don’t let that happen!
The shift stems from the White House's re-prioritizing the long held US desire for the complete removal of Iranian forces from Syria. There's reportedly increased frustration that Russia is not actually interested in seeing Iran withdraw, despite prior pledges as part of US-Russia largely back channel diplomacy on Syria. However, the Post report quotes a top Pompeo-appointed official, James Jeffrey, who is currently "representative for Syria engagement" at the State Department, to say that U.S. policy is not that “Assad must go” but that immense pressure will be brought to bear, and in terms of future US troop exit, “we are not in a hurry”. “The new policy is we’re no longer pulling out by the end of the year,” Jeffrey said while noting the mission would largely shirt ensuring Iranian departure. He also indicated to that Trump is likely "on board" on signing off on "a more active approach" should there be direct confrontation with either Iran or Russia. It goes without saying that such a significant policy shift makes the possibilities of just such a confrontation, or perhaps "provocation", over Idlib all the more dangerous considering it now appears Trump may now be looking for an excuse to act, which would provide the usual convenient distraction from problems at home....

Russia’s Huge Natural Gas Pipeline To China Nearly Complete

Gazprom’s Power of Siberia natural gas pipeline from Russia to China is 93 percent complete, the Russian gas giant said in an update on its major projects. A total of 2,010 kilometers (1,249 miles) of pipes are laid for the Power of Siberia gas pipeline between Yakutia and the Russian-Chinese border, or on 93 percent of the route’s length, Gazprom said in a statement. The natural gas pipeline is expected to start sending gas to China at the end of 2019 and its completion is among Gazprom’s top priorities. The two-string submerged crossing of the Power of Siberia pipeline under the Amur River is 78 percent complete, and the Atamanskaya compressor station adjacent to the border is also under construction, the Russian company says. Gazprom has a 30-year contract with CNPC for the supply of an annual 1.3 trillion cu ft of natural gas via the infrastructure. This year, Gazprom plans to invest nearly US$3.2 billion (218 billion Russian rubles) in the pipeline project, up from the US$2.3 billion (158.8 billion rubles) investment last year, according to Russia’s TASS news agency...


Gazprom and CNPC have also discussed another pipeline from Russia to China via the western route, the so-called Power of Siberia 2 pipeline, that would source gas from Western Siberian gas fields, but little progress has been made regarding the specifics of this project. Gazprom is dominating gas supplies to many European markets while it vies to meet the surging Chinese natural gas demand as the country is in the middle of a massive switch from coal-fired to gas-fired heating in millions of homes. Although Chinese companies are looking to boost domestic natural gas production, local production won’t come even close to meeting surging demand, and China is expected to increasingly rely on gas imports. According to the Gas 2018 report by the International Energy Agency (IEA), China will become the world’s largest natural gas importer by 2019. The share of imports in China’s natural gas supply is seen rising from 39 percent to 45 percent by 2023, the Paris-based agency forecasts.

Simon Black; The Pension Crisis Is Bigger Than The World’s 20 Largest Economies

If your retirement plans consist entirely of that pension you’ve been promised, it’s time to start looking elsewhere. As you probably know, pensions are giant pools of capital responsible for paying out retirement benefits to workers. And right now many pension funds around the world simply don’t have enough assets to cover the retirement obligations they owe to millions of workers. In the US alone, federal, state, and local governments, pensions are about $7 TRILLION short of the funding they need to pay out all the benefits they’ve promised. (And that doesn’t include another $49 trillion in unfunded Social Security obligations).  America’s private pensions are in bad shape too, a total of around 1400 corporate pensions are a combined $553 billion in the hole. Plus, 25% of those funds are expected to go broke in the next decade. But the pension problem is much bigger than just what’s happening (though the US problems are SEVERE). In 2015, the total worldwide gap in pension funding was $70 TRILLION according to the World Economic Forum. That is larger than the twenty largest economies in the world combined. And it’s only gotten worse since then. The WEC said that the worldwide pension shortfall is on track to reach $400 trillion by 2050. And what solutions did they suggest?
# “Provide a ‘safety net’ pension for all.” You know, sort of like Social Security, which as we mentioned is $49 trillion in the hole. Not exactly a sound solution. Another solution the WEC offered was to increase contribution rates, in other words, forcing current workers pay more to support retired workers. Only one problem with that, global demographics are awful. There just aren’t enough young people being born to pay out benefits for retirees. And that problem is coming to a head in South Korea, where about 13% of the population is currently of retirement age: 65 or older. By 2060, 40% of the population will be over 65. And, you guessed it, there aren’t close to enough people being born to burden that load. This is a nightmare scenario for pensions (in addition to fact that low interest rates have made the returns pensions need to break even basically unachievable). But worry not, South Korea has an answer for the problem. The government spent $113 billion over the past 12 years trying to get people to have more kids (I’m curious what this money was spent on, removing condom dispensers from bathrooms?). But more importantly, this should give you a hint of how the government views you. Much like a dairy cow. Not enough milk? Breed more cows!


But for all the money and effort, South Koreans are actually having FEWER babies, a decline of 1.12 babies per woman in 2006, to just 0.96 this year. So when you look a few decades out, South Korea clearly isn’t going to have enough workers paying into the pension system to support all the retired beneficiaries. Even the government acknowledges this. And they’ve already started managing expectations. One of the government’s proposals is to slash retirement payments by 10%. At the same time, the government wants to increase current contributions (i.e. payroll TAX) by almost 50%. These people have been planning their futures based on promises the government has been making for decades. Unfortunately, those promises have no basis in reality. And if you think higher pension contributions and lower payouts are contained to South Korea, you’re nuts. Earlier this year, the US Office of Personnel Management proposed $143.5 billion worth of pension cuts for current AND already retired federal workers. But that’s a band-aid on a bullet wound. It won’t actually come even close to solving the problem. You know more cuts will come. Remember, US government pensions are $7 TRILLION in the hole. And the demographics are just as bad (the US currently has the lowest fertility rate on record).
I’m not trying to be alarmist. These are just the cold hard facts that everyone needs to understand. We’re talking about long-term challenges to retirement. But it’s retirement… ergo we’re SUPPOSED to think long-term about retirement: years, decades out. Retirement requires having a plan. Or, in this case, a Plan B as anyone depending on a pension or social security for retirement is out of luck. Governments have lulled hundred of millions of people into a false sense of security based on financial promises they are not going to be able to keep. It’s not a political problem. It’s an arithmetic problem. And one they’re unable to solve. But you can. While you might not be able to fix the pension gap in your home country, you can definitely secure your own retirement. There’s no need to rely on empty promises and broken pension funds. With some basic planning, education, and a bit of early action, you can safely sidestep the consequences of this looming financial crisis that is larger than the world’s 20 largest economies combined....

Chris Whalen; Rising Interest Rates Are Not Always Good For Banks

It is axiomatic among investors that rising interest rates are good for banks in terms of enhancing earnings. But this is not necessarily true. In fact, banks make money on widening interest rate and credit spreads, namely the different between the cost of money and the return on loans and investments. Rising rates can be a mixed blessing. In the 1980s, sharply higher interest rates during the term of Federal Reserve Chairman Paul Volcker essentially destroyed the housing finance sector in the US. Fixed rate mortgages and rising interest expenses led to widespread insolvencies in the savings & loan sector that cost US taxpayers hundreds of billions in losses. Today the situation facing banks in the US is equally dire yet is largely unrecognized by the financial markets and policy makers.
Since the 2008 financial crisis, the Fed, ECB and Bank of Japan have suppressed the cost of funds, providing an enormous subsidy to bank equity holders and debtors at the expense of individual savers and bond investors. In 2015, for example, the cost of funds for the $15 trillion in US bank assets fell to just $11 billion per quarter. Prior to 2008, that number for quarterly interest expense was close to $100 billion. In Q2 ’18, the US banking industry reported net interest income of $161 billion vs a cost of funds of just $27 billion. The latter figure showing interest expense is almost doubling every 12 months. With the Fed now tightening policy, both by raising the target for short-term interest rates and by allowing its balance sheet to shrink, US banks are facing the prospect of rising interest expense and shrinking net interest margins. At the end of the second quarter of 2018, the larger US banks saw their cost of funds rising by more than 55% year-over-year while interest earnings were increasing by about 1/10th that amount. By Q4 ’18, interest expense will be around $40 billion per quarter and rising faster in dollar terms than interest earnings for all US banks...


Based upon projections by Whalen Global Advisors, net interest income for all US banks will cease growing by year end and will be visibly declining in Q1’19. In the event, the superficial narrative parroted by Wall Street pundits that rising interest rates are good for banks and other leveraged investors will be shown to be a complete nonsense. Bank profits since 2008 have been supported by cheap funding, not robust asset returns, a situation that is rapidly changing. Will Chairman Powell wake up before we run the good ship Lollipop aground? Indeed, one reason that the ECB is reluctant to follow the example of their counterparts in the US by raising interest rates is because EU banks could never withstand such a change in funding costs. As one ECB official told this writer in June, “we intend to reinvest the proceeds of quantitative easing indefinitely.” BTW, the decision by Chinese conglomerate HNA to exit its incredible equity stake in Deutsche Bank now begs the question with respect to DB and the broader question of prudential supervision in Europe. Adding to the dilemma facing Fed Chairman Jerome Powell and his colleagues on the Federal Open Market Committee is the fact that the trillions of dollars worth of securities purchased by the Fed, ECB, BOJ and other central banks since 2008 has effectively capped asset returns. Central bank action to lower interest rates drove the return on earning assets for US banks down from well over 1% to just 70bp last year. The gross spread, before funding costs, of the top 100 US banks is just 4%. Margins for loans and securities are brutally tight.
As interest expenses for banks rise at double-digit rates, asset returns are barely moving, as illustrated by the sluggish response of the benchmark 10-year Treasury to Fed rate moves. For the largest US banks, gross yields on their loan portfolios are below 3%, a reflection of the still tight credit spreads visible in the bond and debt markets. Competition for assets is intense, effectively making it impossible for banks to grow their profit margins on loans even as short-term rates rise. So long as the Fed and other central banks retain their nearly $9 trillion in securities, the effective return on loans and securities will be muted. Central banks do not hedge their positions or even trade regularly, thus there is no selling pressure on long-dated securities. While the FOMC under Chair Janet Yellen was perfectly content to manipulate long-term interest rates downward via “Operation Twist,” when the Fed purchased long-term securities and sold shorter duration bonds, now the Fed sits by and does nothing as the Treasury yield curve threatens to invert. The strange asymmetry in Fed interest rate policy threatens the soundness of the US banking industry and, with it, the growth prospects of the US economy. Just as a mismatch between rising interest rates and fixed-rate mortgages destroyed the S&L industry in the 1980s, US banks today face a market environment where funding costs are rising, but the returns on loans, securities and other assets are not increasing commensurately.
Indeed, the dearth of duration in the market continues to put downward pressure on spreads. Simply stated, banks in the US are about to get caught in an interest rate squeeze of gigantic proportions. In order to avoid this approaching calamity, the Fed needs to start outright sales of longer term securities, essentially the reverse of Operation Twist. They might also have a chat with the Treasury about issuing longer dated paper, as we recently discussed in The Institutional Risk Analyst. Even sales of long-dated swaps and futures would be helpful to manage the transition back to “normal” that Chairman Powell has professed to be the goal of the US central bank. Given Powell’s previous statements in 2012 about the duration of the Fed’s bond portfolio, one wonders what he is waiting for when it comes to managing this dangerous situation. By law the Fed is responsible for managing interest rates and employment, but in fact the yardsticks used by the American political class to measure the job performance of Chairman Powell and his colleagues on the FOMC are the debt and equity markets. Should the Fed continue its “do nothing” approach to monetary policy normalization, then we are likely to see an inverted yield curve, then a selloff in global equity markets led by financials and finally shrinking profits in the US banking system early next year. These three eventualities may very well ensure that 2019 is a recession year in the US....

Catalyst For A US Dollar Collapse And Gold Blastoff In Play?

Is it possible that the US Dollar could be creating a multi-year topping pattern, while Gold is creating a multi-year bottoming pattern? I would understand if the majority feels it is almost “impossible,” as the long-term trend for Gold is down and the long-term trend for King Dollar is up! This chart looks at Gold and the US Dollar on a monthly basis over the past 20-years. It is possible that both could be creating major reversal patterns over the past three years! To prove that major reversals are in play, Gold would need to rally above $1,357 and the US Dollar would need to break below 88...

Don Quijones; Credit-Cardholders And Bank Customers Burned Again As New IT Chaos Breaks Out In The UK

The payments industry deplores it, but cash is starting to look pretty good, and central banks agree: “We do not foresee a totally cashless society”.  This has not been a good year for IT systems in the UK. First there was TSB Bank’s botched IT migration in April, which resulted in millions of customers being blocked from their online accounts. The problems at the bank continue to fester even to this day, 22 weeks later. Then there was the Visa outage in June, which caused chaos across much of Western Europe, but particularly in the UK where consumers are far more reliant on contactless Visa cards. And now there’s British Airways and Lloyds Banking Group. On Thursday, British Airways announced that up to 380,000 card payments on both its website and app had been compromised during a 15-day data breach. BA says the breach affected bookings made between 10.58 pm on August 21 and 9.45 pm on September 5. The compromised data included the personal and financial details of the passengers that booked during that period. BA says it was not a breach of the airline’s encryption. “There were other methods, very sophisticated efforts, by criminals in obtaining our data,” BA’s chief executive, Álex Cruz, said. Some customers have complained of having to cancel cards as a result of the breach while others are considering changing their online passwords.
BA launched a massive charm offensive assuring customers who lose out financially that they will be compensated. That didn’t stop the shares of BA’s Anglo-Spanish multinational holding company, International Consolidated Airlines Group, S.A., from falling 5% between Thursday and Friday. And on Wednesday, Lloyds Banking Group reported that about 5% of transactions on card machines run by Cardnet, a joint venture between Lloyds Bank and First Data, were duplicated on 29 August. Most of the cards affected were Visa Debit cards, and thousands of British card holders had been charged twice. This resulted in chaos for both cardholders and merchants. “My initial reaction was horror and then when I found out there was nothing Mercedes could do until the Monday, I felt lost,” said Francesca Brady, who was charged twice for an £18,000 second-hand Mercedes. She and her mother were left thousands of pounds overdrawn over the weekend until Mercedes reimbursed them. Cardnet claims that all affected customers were refunded by Tuesday, September 4. But even if each duplicate charge is indeed refunded, there will still be a loss incurred by the merchants that have to waive each transaction fee due to the bug. Then there are the victims who fail to realize they’ve been overcharged because their blind reliance on convenient payment technologies has left them psychologically unaccustomed to keeping track of their spending. This episode was the second major glitch affecting Visa cards this summer, but it’s unlikely to dim Visa’s determination to “put cash out of business” for its own profits.
For companies like Visa and MasterCard, which provide the technical infrastructure for digital money transfers all over the world, cash is arguably their biggest competitor. It is also a huge barrier preventing credit card companies and IT-firms from collecting valuable personal and financial information on consumers and to monetize this data. This is precisely why Visa, MasterCard and their allies are running huge global marketing campaigns to remind consumers how absurd and antiquated it is to pay with cash and how much more modern and convenient it is to make all your payments digitally. They even offer to bribe restaurants and retailers into refusing to accept cash, all in the name of “educating merchants and consumers alike on the effectiveness of going cashless.” But each time a major glitch occurs, consumers and retailers are reminded of the risks of depending purely on digital payments, as well as one of the great benefits of physical cash: it is accepted just about everywhere and does not suddenly fail on you.
Even the ECB recently warned that a wholly cashless economy would heightens the risk of IT failures, systemic hacking and rampant financial exclusion, as more vulnerable members of society would be unable to make payments. “Increasingly, central banks insist that cash will also play a role. We do not foresee a totally cashless society,” said Ewald Nowotny, member of the ECB’s Governing Council, at a recent conference in Brussels. “If there is for instance an energy blackout, cash is the only surviving way of payment.” Even in the UK’s “less cash” economy, people are beginning to sit up and pay attention, according to a survey by GoCompare Home Insurance: In the wake of the Visa outage in the summer, as well as the unending chaos at TSB, a quarter of the survey’s respondents said they now keep more cash in their house in case similar payment system failures happen again. And the IT chaos continues at TSB Bank. Last Friday the lender scheduled a four-hour shutdown of the online platform so that it could carry out maintenance work, warning customers in advance. But then the system crashed in time-honored fashion, leaving many customers unable to access mobile, online or telephone services for the whole weekend....

Fed’s QE Unwind Hits $250 Billion

Here’s my math when this “balance sheet normalization” will end. In August, the Federal Reserve was supposed to shed up to $24 billion in Treasury securities and up to $16 billion in Mortgage Backed Securities (MBS), for a total of $40 billion, according to its QE-unwind plan, or “balance sheet normalization.” The QE unwind, which started in October 2017, is still in ramp-up mode, where the amounts increase each quarter (somewhat symmetrical to the QE declines during the “Taper”). The acceleration to the current pace occurred in July. So how did it go in August?


# Treasury Securities; The Fed released its weekly balance sheet Thursday afternoon. Over the period from August 2 through September 5, the balance of Treasury securities declined by $23.7 billion to $2,313 billion, the lowest since March 26, 2014. Since the beginning of the QE-Unwind, the Fed has shed $152 billion in Treasuries. The step-pattern of the QE unwind in the chart above is a consequence of how the Fed sheds Treasury securities: It doesn’t sell them outright but allows them to “roll off” when they mature; and they only mature mid-month or at the end of the month. On August 15, $23 billion in Treasuries matured. On August 31, $21 billion matured. In total, $44 billion matured during the month. The Fed replaced about $20 billion of them with new Treasury securities directly via its arrangement with the Treasury Department that cuts out Wall Street, the “primary dealers” with which the Fed normally does business. Those $20 billion in securities were “rolled over.” But it did not replace about $24 billion of maturing Treasuries. They “rolled off” and became part of the QE unwind.
# Mortgage-Backed Securities (MBS); The Fed is also shedding is pile of MBS. Under QE, the Fed bought residential MBS that were issued and guaranteed by Fannie Mae, Freddie Mac, and Ginnie Mae. Holders of residential MBS receive principal payments as the underlying mortgages are paid down or are paid off. At maturity, the remaining principal is paid off. To keep the balance of MBS from declining after QE had ended, the New York Fed’s Open Market Operations (OMO) kept buying MBS. The Fed books the trades at settlement, which occurs two to three months after the trade. Due to this lag of two to three months, the Fed’s balance of MBS reflects trades from the second quarter. In August, the cap for shedding MBS was $16 billion. But at the time of the trades reflected on the August balance sheet, the cap was $12 billion. Over the period from August 2 through September 5, the balance of MBS fell by $11.5 billion, to $1,697 billion, the lowest since October 8, 2014. In total, $73 billion in MBS have been shed since the beginning of the QE unwind. The QE unwind is scheduled to reach cruising speed in October, when the unwind is capped at $50 billion a month. The plan calls for shedding up to $420 billion in securities in 2018 and up to $600 billion a year in each of the following years until the Fed deems its balance sheet adequately “normalized”, or until something big breaks. Based on current discussions, as part of this “normalization,” the Fed is likely to get rid of all its MBS and retain only Treasury securities...


# Total Assets on the Balance Sheet; The balance sheet also reflects the Fed’s other activities. Total assets for the period from August 2 through September 5 dropped by $47 billion. This brought the decline since October 2017, when the QE unwind began, to $252 billion. At $4,208 billion, total assets are now at the lowest level since March 12, 2014...


# When will this Balance Sheet Normalization end? It took the Fed about six years to pile on these securities. It’s going to take a number of years to shed them. But the balance sheet will never go back to where it had been before QE for the simple reason that as the economy grows, the Fed’s balance sheet expands along with it. The chart below shows this relationship as it existed before the Financial Crisis. It depicts the total assets on the Fed’s balance sheet (black line) and nominal GDP seasonally adjusted annual rate (red line). All data is quarterly...


There is no telling what the Fed will do in terms of its balance sheet. But by looking at the past and extrapolating into the future, we can a least get a feel for the lower range, the level below which the Fed will certainly not go.
- GDP: Since 2008, nominal GDP has grown 38% from $14.8 trillion to $20.4 trillion.
- Balance sheet: In 2008, just before the Fed’s gyrations started, total assets amounted to $892 billion. If the Fed’s balance sheet had grown since then at the same rate as nominal GDP, it would be $1.23 trillion today. That’s sort of a base line.
# The Future: If nominal GDP (not adjusted for inflation) grows at 5% per year (slightly below the current rate), it will reach $24.8 trillion in Q2 2022. If the Fed’s balance sheet had not experienced QE, and if it had grown since 2008 at the same rate as nominal GDP, it would reach about $1.5 trillion in Q2 2022. So, if the QE unwind proceeds at $550 billion a year (below the cap of $600 billion), the Fed’s total assets will drop to about $2 trillion by Q2 2022. This range between $1.5 trillion and $2 trillion will mark the absolute low end of the Fed’s balance sheet by the time normalization ends in 2022. And most of those assets will be Treasury securities. What little MBS will be left on its balance sheet by then will be shed in future years. This is my math, and I’m sticking to it....

“Gradual” Rate Hikes Start To Add Up: US Treasury Yields Up To Three Years, Hit 10-Year Highs!

An entire generation working on Wall Street has never seen Treasury yields this high. The one-month treasury yield rose to 2.0% yesterday at the close and is at about the same level today, the highest since June 10, 2008. It is starting to price in a rate-hike at the Fed’s September 25-26 meeting. This rate hike, the Fed’s third this year, would bring its target to a range between 2.0% and 2.25%. The three-month yield, currently at 2.14%, has reached the highest level since February 26, 2008. Back then, as the Financial Crisis was taking its toll, yields were going through enormous volatility, as the chart below shows. During that volatile period in mid-2008, the three-month yield spiked for a day to 2.07% on June 16, but never got back to the 2.14% in February that year...


It hasn’t been exactly a whirlwind rate-hike cycle with one-percentage-point rate hikes per meeting, à la Paul Volcker in the early 1980s, but in their “gradual”, as the Fed never tires to point out, easy-to-digest, no-surprises manner, the rate hikes are starting to add up. There is an entire generation working in the finance industry and on Wall Street who has never seen Treasury yields this high. They’re in for a learning experience.
# The one-year yield rose to 2.49% at the close yesterday, and remains at about the same level today, beating the 2.48% on June 25, 2008...



The two-year yield closed at 2.66% yesterday and trades at the same level today, the highest since July 25, 2008 (when it closed at 2.70%)...


The three-year yield, at 2.73% yesterday, and edging down just a tad at the moment, is at the highest level since August 14, 2008...


All US Treasury yields through three-year maturities are now at 10-year highs. But the yields of Treasuries with maturities longer than three years still have not reached 10-year highs. For example, the five-year yield at 2.77% today is still way below the 4.16% on September 5, 2008. The 10-year yield has risen as well so far this week. It closed at 2.90% yesterday and trades at the same level at the moment. On September 5, 2008, the 10-year yield was 3.66%. So it will take a while before it hits a 10-year high. But note the two surges in this rate-hike cycle, each took the 10-year yield up by over one percentage point. The 10-year tends to move in these surges. And in this scenario, “surge 3” would push it over the 10-year high...


The yield curve has been on “inversion” watch since last year, where long-term yields would be lower than short-term yields, a phenomenon that in the past has been followed by a recession or worse. In recent days, the yield curve has steepened a tiny bit, and everyone is expelling an equally tiny sigh of relief. In that spirit, the spread between the two-year yield and the 10-year yield widened to 24 basis points, a smidgen off the 18-basis-point spread on August 27, a low not seen since before the Financial Crisis...


When QE 3 was announced, Wall Street called it “QE Infinity” to create the hype that the Fed would never end QE. And those folks also said that the Fed could never raise interest rates again. When the Fed tapered and then stopped QE, those folks said that the Fed could never unwind QE and could certainly never raise rates. When the Fed raised its target range by 25 basis points in December 2015, those folks said that the Fed could never raise its target range over 1%. And in the first three quarters of 2016, the Fed flipflopped and these folks seemed to be right. But then in December 2016, the Fed raised again, and has since been raising with clockwork regularity. Late last year, the Fed started unwinding QE. And the Fed’s rhetoric has become increasingly hawkish....

Theory About Gold And Silver For Long-Term Investors

# Why are these trends so long and so big, both, up and down? My early experience with silver gave rise to decades of observations that have formed my theory about the price cycles of gold and silver versus the US dollar. My first big loss, “big” only in percentage terms since I was just starting out, was with silver in the early 1980s. I did all the right things: I researched it; I bought physical silver; and I bought after it had crashed 70% from its spike. The spike had been caused by the Hunt brothers’ efforts to corner the silver market, manipulation of precious-metals prices being as old as the precious-metal trade itself. Silver had spiked to over $45 an ounce. After it collapsed, I saw an opportunity. I bought at $14 an ounce in early 1981. Then I learned the meaning of “catching a falling knife.” Silver continued plunging to around $5/oz, for me a 65% paper-loss. It then experienced a surge of nearly 200%, to where I was, briefly, in the black, and euphoria set it. After which I learned the meaning of “dead-cat bounce” as silver plunged again. In 1984, I sold at $7 an ounce, my first-ever 50% loss. I annotated those events in this chart...


The red horizontal line denotes my purchase price in 1981 of $14 an ounce. Today, nearly four decades later, silver is at $14.15 an ounce. The blue horizontal line denotes the price at which I sold in 1984. Silver continued to fall, hitting $5 an ounce in 1986. And after another dead-cat bounce in 1987, silver fell below $4 an ounce, and stayed below $7/oz until 2005. For me to come out even, I would have had to sell at the peak of the dead-cat bounce in February 1983. The next chance to sell at break-even came in early 2007. Then came the epic rally that mirrored the handiwork of the Hunt brothers. After its collapse, silver is back where it had been when I bought after its collapse in early 1981. This trade is denominated in US dollars, which has lost 65% of its purchasing power since 1981. So if I had held on to my stash of silver and sold today, in real terms, adjusted for the 65% loss of the dollar’s purchasing power. Well, you see where this is headed.
The $14/oz I’d get today would buy only a small fraction of the $14/oz I put into the metal in 1981. In addition, I would have never collected a dime in interest to compensate for the loss of purchasing power. The only way I could have come out ahead is hang on to my silver until early 2011, then with perfect timing, sell at near its peak. Gold has gone through similar motions. After a blistering 650% surge from 1976 to early 1980, it plunged, had a 50% dead-cat bounce into October 1980, and then fell off the wagon entirely, dropping below $300/oz in 2001. But then began another surge of over 600% to exceed $1,900/oz in August 2011. At which point the price began to re-collapse. Currently at $1,193/oz, the price of gold is down about 38% from its peak seven years ago...


There are important and valid reasons to hold precious metals (PMs). Some of these reasons have little to do with PMs as a profitable investment or trade, but they’re beyond the scope of this discussion. Why are these enormous price movements, up and down, special, why they last so long, and how a long-term investor might look at them. It boils down to time, a long time. As evident in the charts above, the large price movements take place over many years. There are huge brief bounces on the way down, and big brief drops on the way up. PMs are very volatile, and so there is a lot of money to be made betting short-term in both directions, a very risky game. But for long-term investors, there is a different story: Uptrends are glorious and can last a decade. But once the downtrend sets it, it can outlast a normal investor’s time horizon. Gold stayed below its 1980 peak for 20 years years of pain and suffering, until 2001. The subsequent surge lasted a decade and was breath-taking and intoxicating. Then it all re-collapsed. Now we’re only seven years into the downtrend.
# Why are these trends so long and so big? PMs are not commodities like oil or wheat that get burned, eaten, or used in industrial processes and products. In typical commodities, when prices surge, producers produce more to make hay while the sun shines, so to speak. When the price surges past a certain point, demand falls off and a glut sets in. Prices plunge below the cost of production for long enough to where some producers go under. Others cut back. Production drops. This happens even as the collapsing price causes demand to rise. Falling production and rising demand work through the glut, the market tightens, and prices recover. But this mechanism doesn’t work with gold at all and works only in a limited manner with silver. The metals are not (generally) eaten or burned. There is little industrial demand for gold; and what little gold is used for industrial purposes is often recycled. There is more industrial demand for silver, but only part of the production goes into industrial demand, and some of that gets recycled. The rest is hoarded. Much of the gold and silver that has been mined over the past thousands of years is still above ground in form of gold bars, gold and silver coins, jewelry, utensils, decoration, art, sarcophagi, and what not. The term “consumption” is used a lot in gold-and-silver lingo, but it’s a misnomer for gold.
When investors buy gold, they’re not consuming it. They’re hoarding it. Same principle applies when investors buy silver to hoard it. So even when the price collapses below the cost of production for the lowest-cost mines, and subsequently production collapses, the massive stash of gold that is already above ground doesn’t go away. And with silver, the supply being hoarded as PMs gives the market a lot of supply and flexibility. This changes the pricing dynamics and lengthens the price cycles of gold and silver. It is why prices can soar beyond all wildest dreams. There are no “rational levels” for the price of gold. Sky-high gold prices don’t impact the real economy: People are rebelling in the streets if they cannot afford to buy bread; but no one is rebelling when gold hits $2,000/oz. At the same time, there is no rational minimum price for gold, and the cost of production is irrelevant on the way down. As we have seen from the example of the Hunt brothers, price manipulations are rampant in the PM markets. But they’re rampant in every other market as well, and in no market as rampant as in the vast credit markets, particularly the government bond markets, where central banks with the tools of monetary policy, such as interest rate policies and QE, openly manipulate yields and therefore prices.
# So for investors who buy and sell gold and silver to make a profit, there is a rule: Buy low and sell high. I tried to do this the first time and failed. If you fail to sell high, and you get sucked into the subsequent crash, you might have to wait a decade or two decades just to get back where you were in nominal terms. But in the interim, there is no yield to compensate you for the loss of purchasing power of the dollar. You’ll get screwed by two factors: The drop in price of PMs and by not being compensated for the loss of the purchasing power of the dollar! Traders can benefit from the volatility. But for long-term investors, it boils down to years and decades. They need to wait long enough for the downturn to play out and not grab a falling knife. The current downturn is only seven years into the down cycle. The last downturn in gold lasted from the end of 1980 to 2001. That’s 20 years! And if long-term investors manage to buy close to the low, and after that glorious multi-year ride toward the sky, they need to sell just when they’re the most euphoric about the price, at the very moment everyone is talking about gold and silver and how great they are. Just when everything says that they should never-ever sell, and that they should buy more now, and that they should convert everything they have into gold and silver, that’s precisely when they need to sell. But this is very hard to do....

Turkey Fails To Prevent Russia And Iran From Mass Slaughter In Idlib, Syria

The leaders of the three countries in the so-called "Astana Group" met in Tehran on Friday with to decide the fate of Syria's Idlib province. No Syrians participated in the meeting. Representatives of the three countries, Russia, Turkey and Iran, have met several times in Astana, the capital city of Kazakhstan. Russia, Syria and Iran have been preparing for weeks, massing troops and tanks, for an assault that will create a massive humanitarian disaster among the 3.5 million civilians in Idlib. At the summit meeting, Turkey's president Recep Tayyip Erdogan argued for a ceasefire, and no invasion at all. Daily Sabah (Turkey)
# Rouhani, Erdogan and Putin, the three amigos, hold hands prior to their meeting...

Rouhani, Erdogan and Putin, the three amigos, hold hands prior to their meeting (Reuters)

At the press conference following the meeting, he said, "We don’t want Idlib to turn into a bloodbath," and said: "Idlib is not only about the future of Syria, it is also about the peace of the whole region. Any attack launched or to be launched on Idlib will result in a disaster, massacre and a very big humanitarian tragedy. "If we can declare a cease-fire here, it will be one of the most important steps of the summit, and it will relieve the civilians." Iran's president Hassan Rouhani rejected Erdogan's plea, saying that the fighting in Syria must continue until all "terrorists" are "uprooted," especially in Idlib. He added, "fighting terrorism in Idlib is an unavoidable part of the mission of restoring peace and stability to Syria." Russia's president Vladimir Putin also rejected the plea, saying that "the legitimate Syrian government has a right and must eventually take control of its entire national territory". BBC and Vox
# Turkey prepares for massive refugee problem; Idlib has a population of about 3.5 million people, including several tens of thousands of jihadists belonging to al-Qaeda linked Hayat Tahrir al-Sham (HTS), or less than 2% of the population. Many of the jihadists are hiding out in the same homes as the civilians. There are reports that many civilians are demanding that the jihadists leave the homes and go elsewhere, though that's unlikely to happen. Bashar al-Assad intends to kill all "terrorists," but he's made it clear in the past that he considers the entire population of Idlib to be "terrorists," meaning that he will be targeting the entire population. In a sense, Turkey has the most at stake in the Astana Group decision about Idlib. In the press conference on Friday, Erdogan said that there are already 3.5 million Syrian refugees hosted by Turkey, and: "Idlib's population is now 3.5 million. We do not have power and facilities to host another 3.5 million." Bashar al-Assad's regime, along with Russia, will be using missiles, barrel bombs, chlorine gas and Sarin gas to kill the "terrorists" in Idlib following Vladimir Putin's "Grozny Model." Entire neighborhoods will be flattened, and schools, markets and hospitals will be particularly targeted in order to kill as many women and children as possible, as part of Bashar al-Assad's genocidal campaign. This means that hundreds of thousands or even millions of civilians will be abandoning their homes, trying to flee the violence.
When al-Assad was conducting a similar slaughter on Aleppo, Ghouta and Daraa, many thousands of civilians fled to Idlib. Now, there's no Idlib for Idlib, meaning that people who want to flee have no place to go. Idlib borders Turkey, and undoubtedly many of them will try to flee across the border into Turkey. It's possible that millions of refugees will succeed in reaching Turkey, and a few hundred thousand of them may then travel to Europe. According to Turkey's Red Crescent, this would be the beginning of a "new immigration wave" into both Turkey and Europe. One thing that's clear is that Russia and Vladimir Putin are in charge now. Putin can delay the assault, or launch it immediately. He can also use the threat of an assault to get leverage. For example, Putin has been demanding that the US and EU pay billions to rebuild Syria, after Russia played the biggest part in destroying Syria. Russia could use the Idlib assault in a negotiation that says, "Pay up or else!" Anadolu (Turkey) and Yeni Safak (Turkey)
# Syria and Russia launch a big, new disinformation campaign; There have been reports that Syria and Russia have been launching a new disinformation campaign, to hide al-Assad's use of chemical weapons and other atrocities. My personal experience is that the article that I wrote three days ago generated a much higher level of troll attacks than I've been seeing recently. So it may well be that Russia's troll factory, the Internet Research Agency in St. Petersburg, is on the march again. The trolls generally try to paint Bashar al-Assad as a sweet, gentle opthamologist (his college major), a sensitive guy who now runs a country and is trying to bring peace, justice and stability to Syria and the world. But Bashar al-Assad is not a sweet opthamologist. He's a perverted, depraved, sociopathic monster who is running a country with the intention of inflicting the same depraved, sociopathic acts on millions of people. So for trolls and for those readers with short memories, here's an article from last year from the London Guardian, summarizing a report by Amnesty International... Guardian (London, 7-Feb-2017)