Guest Post: Project “End Up Like Japan” Continues To Advance Well In The West

"Having considered for some time the most appropriate metaphor for the current market environment, we think this may be it: one may be doomed, but one can still party on.

Having already hit the iceberg, one major problem we see is the common perspective for both investors and the asset management industry to view debt and equity as the entire universe of investor choices available.

The reality is (a) that investors can pursue other distinct types of assets (we would single out real assets as an obvious and relevant alternative), and (b) that there can and will be times when both debt and equity markets together underperform, in both relative and absolute terms (the relative benchmark being cash since developed government debt can in no way now be considered a risk-free asset class).

We may be fast approaching a macro environment that threatens conventional portfolios with exactly that outcome– a bear market in both stocks and bonds simultaneously. In other words, the authorities could attempt to throw a bull market party for both bonds and common stocks, but nobody would show up. The ticket to entry is simply too expensive.

Having long exhausted the armory of conventional policies to keep the unsustainably indebted show on the road, increasingly desperate politicians are doing increasingly desperate things, be that gifting money to the IMF in a brazen display of fiscal denial that we can ill afford (US, UK) or simply stealing from other sovereigns (Argentina).

Project ‘End Up Like Japan’ continues to advance well throughout the western economies. The euro zone continues to perform like a group of drowning men lashed together for buoyancy..."

at http://www.zerohedge.com/news/guest-post-project-%E2%80%9Cend-japan%E2%80%9D-continues-advance-well-west

Guest Post: There Will Never Be A Failed US Treasury Auction... Until There Is

"And there's your trade. Everyone is betting on this one idea - that the Fed will never lose control of interest rates and the US Treasury will never have a failed auction. The same way nearly every major financial player on the planet was willing to bet that US real estate could never fall for an extended period of time.

And we all know how that trade worked out.

Timing, please?

Of course, the big question for most Zero Hege readers is not if this will happen, but when.

Who knows? Not me. Not Paul McCulley. Not the Bernank. Not Timmy G. Not any financial pundit or TBTF economist. No one knows..."

at http://www.zerohedge.com/news/guest-post-there-will-never-be-failed-us-treasury-auction-until-there

READ MORE

GOLDMAN: BUY GOLD

"There's a fresh note out this morning from Goldman Sachs urging traders to buy gold.

Under our gold framework, US real interest rates are the primary driver of US$-denominated gold prices. However, after being remarkably strong in the first half of 2011, this relationship broke down last fall, with gold prices falling sharply in the face of declining US real rates, as tracked by 10-year
TIPS yields. While gold prices have returned to trading with a strong inverse correlation to US real rates since late December, at sub-$1,700/toz they remain below the level implied by the current 10-year TIPS yields.

We believe that despite last fall’s decline in 10-year TIPS yields, the gold market may have been expecting that real rates would soon be rising along with better economic growth, leading to a sharp decline in net speculative length in gold futures. Accordingly, a simple benchmarking of real rates to
US consensus growth expectations suggested a level of +40 bp by year end. Our models suggest this higher level of real rates would be consistent with the current trading range of gold prices. As we look forward, our US economists expect subdued growth and further easing by the Fed in 2012, which should push the market’s expectations of real rates back down near 0 bp and gold prices back to our 6-mo forecast of $1,840/toz.

Goldman isn't the only bank to go bullish on gold lately."

at http://www.businessinsider.com/goldman-buy-gold-2012-3#ixzz1qQN3yeRb

Illusion of Cheap Money; Major Promises in Europe But No Real Reform; Does the Bond Market Have it Wrong? 30 years of Japanisation?

"Steen Jakobsen, chief economist at Saxo Bank in Denmark discusses the illusion of cheap money, bond market yields, and the lack of European reform in his latest email.

In Spain, things are going from bad to worse. Last weekend's local election in Andalucia, where Spain’s centre right People’s Party failed to secure an outright majority, left Prime Minister Rajoy without a mandate to carry on with tough austerity.

It was a bad start to week where we on Thursday will see a major general strike aimed at… Yes, you guessed it: Austerity measures.

Spain 10-Year Bonds and 5-Year CDS



Illusion of Cheap Money

The European story remains one of major promises and no actual reforms. A low interest rate and an extreme sense of “security” created by the illusion of easy money and low interest rates won't last forever.

As I wrote in Interest rates: the market has it all wrong, we could be on route to an exit strategy from central banks which at a bare minimum will be a goodbye to “unconventional measures” and if so, the low in interest rate cycle is in place.

30 years of Japanisation?

The only way central banks can create a proper exit from unconventional is to hand over the torch to reforms from governments and politicians. Unlikely, yes, needed?

Absolutely, otherwise we are doomed to 30 years of Japanisation..."

at  http://globaleconomicanalysis.blogspot.com/2012/03/illusion-of-cheap-money-major-promises.html

Financial repression: Then and now

"Rich nations worldwide have a problem with debt. In the past, such problems have been dealt with by several tactics, including 'financial repression'. This column explains how the tactic works and documents its resurgence in the wake of the global and Eurozone crises.

In light of the record or near-record levels of public and private debt, debt-reduction strategies are likely to remain at the forefront of policy discussions in most of the advanced economies for the foreseeable future (Reinhart and Sbrancia 2011).
Throughout history, debt-to-GDP ratios have been reduced by:

• Economic growth.
• Fiscal adjustment and austerity plans.
• Explicit default or restructuring of private and public debt.
• “Surprise” inflation.
• Steady financial repression accompanied by steady inflation.

As coined by Ronald McKinnon (1973), the term “financial repression” describes various policies that allow governments to “capture” and “under-pay” domestic savers. Such policies include forced lending to governments by pension funds and other domestic financial institutions, interest-rate caps, capital controls, and many more. Governments have typically used a mixture of these to bring down debt levels, but inflation and financial repression typically only work for domestically held debt (the Eurozone is a special hybrid case). In the current policy discussion, financial repression comes under the “macroprudential regulation” rubric.
Most governments would only contemplate default or surprise inflation in truly desperate economic conditions. In Europe, austerity is being pursued but in the countries that need it most, falling growth tends to offset much of the progress. Little wonder, then, that financial repression is back on the policy menu.
Financial repression, teamed with a steady dose of inflation, cuts debt burdens from two directions:

• Low nominal interest rates reduce debt servicing costs.
• Negative real interest rates erode the debt-to-GDP ratio (it is a tax on savers).

Here, inflation need not take market participants entirely by surprise and, in effect, it need not be very high (by historic standards).
Financial repression also has some interesting political-economy properties. Unlike other taxes, the “repression” tax rate (or rates) is determined by financial regulations and inflation performance that are opaque to the highly politicised realm of fiscal measures. Given that deficit reduction usually involves highly unpopular expenditure reductions and/or tax increases of one form or another, the relatively “stealthier” financial repression tax may be a more politically palatable alternative for authorities faced with the need to reduce outstanding debts..."

at http://www.voxeu.org/index.php?q=node/7767

Twin Deficits, Public Debt and Interest Rates

Public debt, fiscal deficit and current account deficit do not create problems for the U.S. economy for now. But if interest rates start to increase, interest expenses may suddenly become a heavy burden.

Despite Gains, This is the ‘Weakest Recovery Ever’: Rosenberg

"Recent economic gains have been primarily illusory, driven by weather-related factors that are not sustainable, economist David Rosenberg told CNBC.

“Is it growing? How could it not be growing,” Rosenberg said. “We’ve got four years of trillion-dollar-plus deficits, we have a Fed balance sheet that’s tripled in size, zero policy rates for three years. Of course you’re going to get some growth.”

“If you want to take a big-picture perspective, this goes down as the weakest economic recovery ever, despite all the ramp up in government stimulus, and that really tells you something,” he said.

“Employment data were affected by the seasonal adjustments,” he said. “It felt like March in February, and if you apply the March seasonal factors to February, employment would have actually declined.”

“As you look at the US economy over the next two years, is the US economy going to improve more or less than other economies around the world?” said Richard Bernstein, head of Richard Bernstein Advisors and a former colleague of Rosenberg’s at Merrill Lynch. “We are in the early stages of a long-term period of US asset outperformance.”

at http://www.valuewalk.com/2012/03/despite-gains-this-is-the-weakest-recovery-ever-rosenberg/

WALL STREET CONFIDENCE TRICK: How "Interest Rate Swaps" Are Bankrupting Local Governments

"Far from reducing risk, derivatives increase risk, often with catastrophic results. — Derivatives expert Satyajit Das, Extreme Money (2011)

The “toxic culture of greed” on Wall Street was highlighted again last week, when Greg Smith went public with his resignation from Goldman Sachs in a scathing oped published in the New York Times. In other recent eyebrow-raisers, LIBOR rates—the benchmark interest rates involved in interest rate swaps—were shown to be manipulated by the banks that would have to pay up; and the objectivity of the ISDA (International Swaps and Derivatives Association) was called into question, when a 50% haircut for creditors was not declared a “default” requiring counterparties to pay on credit default swaps on Greek sovereign debt.

Interest rate swaps are less often in the news than credit default swaps, but they are far more important in terms of revenue, composing fully 82% of the derivatives trade. In February, JP Morgan Chase revealed that it had cleared $1.4 billion in revenue on trading interest rate swaps in 2011, making them one of the bank’s biggest sources of profit. According to the Bank for International Settlements:

[I]nterest rate swaps are the largest component of the global OTC derivative market. The notional amount outstanding as of June 2009 in OTC interest rate swaps was $342 trillion, up from $310 trillion in Dec 2007. The gross market value was $13.9 trillion in June 2009, up from $6.2 trillion in Dec 2007.

For more than a decade, banks and insurance companies convinced local governments, hospitals, universities and other non-profits that interest rate swaps would lower interest rates on bonds sold for public projects such as roads, bridges and schools. The swaps were entered into to insure against a rise in interest rates; but instead, interest rates fell to historically low levels. This was not a flood, earthquake, or other insurable risk due to environmental unknowns or “acts of God.” It was a deliberate, manipulated move by the Fed, acting to save the banks from their own folly in precipitating the credit crisis of 2008. The banks got in trouble, and the Federal Reserve and federal government rushed in to bail them out, rewarding them for their misdeeds at the expense of the taxpayers..."

at   http://www.globalresearch.ca/index.php?context=va&aid=29907

How Long Can We Finance the Debt?

"Everyone should know by now that the Treasury Department can borrow money at historically low rates. That is a major reason why some very smart economists think that the federal government should borrow more money in the short term (i.e., this year and next) and use that money to boost economic growth.
In the medium term (say, the next decade), however, the big question is how long we will be able to finance new government borrowing at such low rates. Today’s low rates are a product of several factors. One is certainly the slow rate of economic growth, in particular the depressed housing market, which has reduced demand for credit. But another factor is the Federal Reserve’s aggressive moves to keep long-term interest rates down; another is foreign central banks’ appetite for Treasuries.
John Kitchen and Menzie Chinn have written a new paper (pre-publication version here) that attempts to disentangle these factors, which Kitchen summarized in a blog post. They show the large and growing role in the Treasury market played by the foreign official sector:



Kitchen and Chinn also measure the impact of purchases by foreign central banks on interest rates. They estimate that as those central banks increase their holdings of Treasuries by 1 percentage point of potential GDP, long-term interest rates (measured as the spread between 10-year and 3-month rates) fall by 0.33 percentage points. Since the Federal Reserve is expected to reduce its balance sheet as the economy recovers, if foreign holdings of U.S. government debt simply remain at current levels (as a share of GDP), they expect that 10-year yields would climb to 7.9 percent by 2020—rather than 5.4 percent as forecast in the CBO’s baseline..."

at http://baselinescenario.com/2012/03/20/how-long-can-we-finance-the-debt/#more-10000

The Simple Problems Of Too Much US Debt

"In a succinct and chart-laden presentation, Professor Antony Davies, of Duquesne, offers a simple perspective on just how bad things are for the US (in terms of debt or obligations). Putting the interest cost in the context of war-spending, his analysis is interesting given the recent and dramatic rise in interest rates. Current interest payments, given the US Government's lowest ever 3% interest cost, are $440 billion, or three times the annual operating expenses of the Iraq and Afghanistan wars. While his discussion of a market-set interest rate is perhaps a little off-the-mark given the extent of QE programs and their reach-around prime-dealer duration-reducing effects, it is nevertheless true that the more money the government is spending on interest, the less money is available to provide services and his punchline on what happens should rates rise even modestly from here sums the real problem the US faces (even as a currency issuer as opposed to a currency user - given the inherent instability that making totalitarian use of the reserve status would incur)..."

at http://www.zerohedge.com/news/simple-problems-too-much-us-debt

Guest Contribution: “Financing U.S. Debt”

"...With the outlook for continued U.S. budget deficits and growing debt -- and the uncertainties regarding their financing -- we examine the role of foreign official holdings of U.S. Treasury securities in determining Treasury security interest rates, and the resulting implications for international portfolio allocations, net international income flows, and the U.S. net international debt position. ... Although relationships suggest that the world portfolio could potentially accommodate financing requirements over the intermediate horizon, substantial uncertainty surrounds the likelihood of that accommodation and the associated effects on interest rates and adjustments in international portfolios. Notably, unprecedented levels and growth of foreign official holdings of U.S. Treasuries will be required to keep longer-term Treasury security interest rates from rising substantially above current consensus projections..."

at http://www.econbrowser.com/archives/2012/03/guest_contribut_14.html

Is There a Bubble in Treasuries? Both Sides of the Case; Explaining the 2011 Treasury Rally (It's Not What You Think); Where to From Here?

"People have been calling a bubble in treasuries for at least a decade. The shocking result, especially to hyperinflationists, has been a stair-step decline in yields for 30 years. That's quite a long time.

Here is a chart going back 20 years from Steen Jakobsen at Saxo bank in Denmark.

Click on Any Chart in this Post for Sharper Image

$TYX 30-Year Long Bond




Operation Print-Money-Like-a-Madman

Via email, Steen writes

I think higher interest rates are for real, and not a fluke.

The move down in US yields below its long-term channel was an unusual move - as can be seen in the above chart - 30 year US has been in solid down-ward slopping channel since 1980s. There have now been two breaks to the down-side: One in 2009 when the stock market crashed to 666 in the S&P - and now since 2011, when Fed initiated Operation Print-Money-Like-a-Madman with QE, QEII and Operation Twist plus “low rates forever”.

These moves were the exception not the norm, a function of the “unconventional measures” all the central banks has been pointing to forever.

We are entering an extremely dangerous period. Valuations are stretched, even my internal bull, Peter Garnry is getting conservative. The divergence is bigger and bigger – actually to me this is beginning (on charts) to look at lot like end of 2007 into 2008.
Let’s hope I am wrong, again, and this is merely a pause before the world is saved and we can all believe that more debts creates growth and reforms..."

at  http://globaleconomicanalysis.blogspot.com/2012/03/is-there-bubble-in-treasuries-both.html

Sovereign Crisis from Economic Stimulus to Debt Austerity Snowball Effect

"A blockbuster draft report from the European Commission saw the light of day recently, thanks to some reporting from Bloomberg. It highlights an incredibly dangerous Catch-22 facing many sovereign nations — the “Snowball Scenario.”
Let me give you an example how this works …

Suppose country A’s economy goes into the tank. The government responds by borrowing boatloads of money and spending like mad on stimulus packages.
The markets allow it to go on for a while. But then investors start to get antsy about all the debt being added to the government’s balance sheet. So they start dumping its bonds, driving prices lower and rates higher. That, in turn, forces the country to implement austerity measures to get its debt and deficit under control.
The problem?
Those moves send the economy BACK into the crapper! Government spending has to rise yet again to pay for things like unemployment insurance, new stimulus packages, and so on … at the same time tax revenues fall. That drives debts and deficits even higher.
The end game in this snowball scenario? A sovereign default!
And that’s not just a theory. In fact …
Snowballs Are Already Rolling Downhill in Spain, Greece, and Portugal"