If you have come across this page seeking info on the Swedish rock band and its 1986 hit, I must disappoint you. While Joey Tempest and band might be a more interesting subject than finance, this post is limited to the tempest that is about to intensify in Europe. Sorry.
The cracks within the EU
When the Euro was created in thought in 1992 in Maastricht, Holland, the European Union was looking forward to crown its union with a common currency. Having come of age at that point I was also enthusiastic about this prospect. The treaties signed by all participating countries stated rules in order to ensure the stability/credibility of the future currency. Governments were not allowed to borrow beyond 60% of GDP and above 3% of GDP per year. By 2007, only Luxembourg and Finland had played by the rules. http://en.wikipedia.org/wiki/Maastricht_Treaty Needless to say, the faith in the currency union has been shattered and no consequences for rule violations were enforced. Furthermore, European banks are now in trouble because they bear the burden of governments borrowing out of control(holding their bonds as reserves). While I am critical of many financial institutions, blaming European banks for the obvious violations of the Masstricht treaties by public servants is unjust. Assuming that the perpetrators(national governments) of the banking crisis in Europe are now supposed to solve the banking crisis they created is naive at best. What has become clear is that the under capitalization of European banks needs to be addressed yet how to do so is the contentious debate behind closed doors of the European powers that be.
Solutions
Herman Van Rompuy (here with the Irish Finance Minister Michael Noonan) knows where the money for the European banking bailout is, in Germany. (Foto: consilium) (Photo: Consilium)
German led surplus countries would prefer to confiscate savings over 100,000 Euros of bank customers in order to replenish bank capital levels across Europe. While no sane politician would come out and admit so publicly, the wheels are in motion: http://translate.google.com/translate?sl=de&tl=en&js=n&prev=_t&hl=en&ie=UTF-8&eotf=1&u=http%3A%2F%2Fdeutsche-wirtschafts-nachrichten.de%2F2013%2F05%2F16%2Feu-setzt-masterplan-um-enteignung-der-sparer-kommt%2F As for government debt levels, German conservatives would prefer austerity over deficit spending. France and the deficit countries’ governments believe that this would lead to a prolonged depression within Europe and has suggested that the ECB should print money as in Japan and America. Furthermore, European governments should stop austerity immediately and increase deficit spending. http://globaleconomicanalysis.blogspot.ca/2013/05/hollande-asks-ecb-to-engage-in-japanese.html After all, America is supposedly back on track and Abenomics is deemed to be a success according to Bloomberg news http://www.bloomberg.com/news/2013-05-16/japan-becomes-most-favored-nation-in-poll-showing-abe-optimism.html
Leaders in Europe finally agree on one thing. Europe is in recession. http://money.cnn.com/2013/05/15/news/economy/europe-recession/index.html Congratulations on this revelation.
As readers of this blog know I have no faith in money printing resolving any economic problems in the long run but apparently, world markets assume that this course of action is the best option right now. Regardless of what I think, it is clear that Europe is not unified in its approach regarding its common currency. The clock is ticking. The capital- and resulting social issues in Europe are intensifying and unless consensus is reached the days of the Euro are numbered. The construct of a single currency run by seventeen independent financial governments with different philosophies behind it has always been a rather naive concept. In my opinion, European leaders need to decide whether to form a financial union or not.
On the one hand, I understand the disciplined approach by the German government as it is trying to reign in excessive spending and return the continent to a sustainable economic model. However, many deficit countries are in such desperate economic conditions that a serious depression has started under German austerity plans. Already, we see Southern Europeans flocking north in order to find employment or at least, German social services guaranteed by the EU to all EU citizens. http://translate.google.com/translate?sl=de&tl=en&js=n&prev=_t&hl=en&ie=UTF-8&eotf=1&u=http%3A%2F%2Fdeutsche-wirtschafts-nachrichten.de%2F2013%2F05%2F10%2Feu-alle-europaeer-haben-anspruch-auf-sozial-leistungen-in-deutschland%2F Obviously, there are social repercussion with this felt all over Europe.
The number of Spaniards who came to Germany in 2012, has over 2011 increased by 45 percent (Photo: Flickr / abdallahh).
“A triumph of hope over experience”
In England, the UK Independence party has recently won a stunning 26% of popular vote. In their opinion, the UK should leave the EU altogether as it appears to be in disarray. Listen to MEP Bloom’s two minute speech in front of the European parliament in Brussels.
The Final Count Down
With German elections in September, the fate of Europe will be very much dependent on their outcome. If Mrs. Merkel wins relection Europe will likely continue to push for austerity and structural reform. http://translate.google.com/translate?sl=de&tl=en&js=n&prev=_t&hl=en&ie=UTF-8&eotf=1&u=http%3A%2F%2Fwww.n-tv.de%2Fwirtschaft%2FDeutschland-spaltet-seine-Banken-article10663041.htmlhttp%3A%2F%2Fwww.n-tv.de%2Fwirtschaft%2FDeutschland-spaltet-seine-Banken-article10663041.html If the Social Democrats take over power in Germany, expect a European version of Abenomics and massive QE. After all, according to Mr. Bernanke and Mr. Kuroda the printing press solves economic problems. Interesting times ahead… What does Joey Tempest think?
Have you read the famous ancient book “Art of War” by Sun Tzu? It seems that many of the wise words in this revered military text hold true in the financial markets. My favorite quote:
“If you know the enemy and know yourself, you need not fear the result of a hundred battles. If you know yourself but not the enemy, for every victory gained you will also suffer a defeat. If you know neither the enemy nor yourself, you will succumb in every battle”
Keep this in mind before making any trade/investment decisions. Emotions tend to override judgment when reason is limited.
One of my favorite legends in the business, Bill Fleckenstein, gave an interview on Yahoo Finance. When he speaks, one should listen. After all, he nailed both Nasdaq and housing bubble, not only the top but also the aftermath at the bottom. It is a delight to listen to his views on the markets and his conclusions are similar to the those by Sun Tzu.
Have you ever wondered if the cost of living is truly rising at 1.5% a year as reported by the BLS? http://www.bls.gov/news.release/cpi.nr0.htm While everybody intuitively knows that this number is pure fantasy I have found myself trying to explain the reality behind the numbers in many conversations. It is true that the extreme inflation many economists have expected has not occurred so far and here is the reason why. In classic economics, inflation is measured by the rise in money supply and rising prices are the symptoms thereof. Below you can see the monetary base on a 25 year chart. Inflation anyone?
However, in modern economics velocity of money was added to explain the actual rise in prices as the turnover in money reflects the increased demand due to rising inflationary expectations. In other words, as long as the extra money created does not find its way into the economy, price inflation remains subdued. This is the reason why many economists say that inflation is low and why inflationary expectations are “massaged” lower by the powers that be. Velocity is decidedly low at the moment but it is only a matter of time until people figure out the true cost of living increases and act accordingly(pushing up velocity). Decide for yourself if the central bankers will be able to balance money supply and velocity indefinitely or if there will be an inflationary accident down the road. Do you think the Federal Reserve or any other central bank will be able to unwind its balance sheet and raise interest rates or will inflation get out of hand?
For a rather animated yet short, inflationary debate revolving around the Big Mac, please watch below. As so often, I agree with Peter Schiff.
For those of you who read my post today on Abenomics it may be of interest how the G7 finance ministers have responded to the stated goal of Japanese currency debasement. I quote the Financial Times
“G7 reaffirms commitment not to devalue currencies for domestic gain
By Chris Giles in Aylesbury
May 11, 2013 4:14 pm
Finance ministers and central bank governors of the Group of Seven rich economies have reaffirmed a commitment not to seek to devalue their currencies for domestic gain.
After an informal two-day gathering in a country house hotel outside London with no communiqué, participants said on Saturday they were reassured by Japan that its revolutionary new economic strategy was not intended to weaken the yen….” http://www.ft.com/intl/cms/s/0/2d194414-ba4a-11e2-a564-00144feab7de.html
In case you don’t have a subscription to the FT, here another link that may be helpful http://www.forexlive.com/blog/2013/05/11/g7-re-assured-that-japan-is-not-deliberately-attempting-to-weaken-yen/
Either way, this statement by the G7 finance ministers and central bankers is anything but the truth and an insult to our intelligence. Judge for yourself if you feel represented by your official.
As I have written several times this year about Japan’s radical economic plan referred to as “Abenomics” http://rpreschern.wordpress.com/2013/01/05/dancing-on-mount-fuji-japan-in-2013/ , Japan has found its way into the headlines once again. On Thursday, the Yen breached the 100Yen/$ mark and has lost over 20% since the new prime minister took office half a year ago. For those of you that don’t remember what Abenomics stands for, here a quick explanation on my part followed by two fitting cartoons.
Prime Minister Abe appointed a central bank governor who has agreed to double the supply of yen within two years. Crushing the exchange rate should give Japanese exporters an advantage over their foreign competitors and thus, reignite economic growth. Of course, the chain reaction this causes on the global stage as well as the fact that anyone holding yen and Japanese bonds is losing their purchasing power is of seemingly less importance today.
Two further graphic explanations can be found below…
It is certainly true that lowering the value of one’s currency makes domestic products more attractive to foreign markets but it is really a subsidy paid for by currency/bond holders of Japan. After all, Japan imports practically all of its natural resources and those have gone up 20% in price in recent months as well. Furthermore, foreign competitors feel cheated and pressure their governments to retaliate.
Currency Wars
Until globalization became a respected concept of modern-day economics via the WTO, there have always been protective measures against foreign competition. In the old days, trade wars were conducted via tariffs and import quotas/bans/embargos whereas today, we all claim to live in a free global world yet we choose to let/urge central banks to conduct currency devaluations to gain global market share rather than the old subsidies. Of course, there is absolutely no difference in the end result: higher prices for all imported goods. Furthermore, the policy of doubling the money supply in two years has caused all other central banks to follow suit by either lowering interest rates, printing money or intervening in the currency markets to lower domestic currencies. Five central banks alone lowered interest rates in the last week, New Zealand intervened in the market to lower its currency and the ECB is considering negative interest rates to lower the Euro.
Undoubtedly, destroying the purchasing power of practically all currencies is not a panacea to structural economic problems. However, as the hungry dog in the cartoon, it is very pleasant in the short run as all this liquidity finds itself pouring into the financial markets which then boom. The Federal Reserve and the Bank of Japan now create a combined $155 billion a month out of thin air. Since interest rates have practically been abolished, any risk asset with a yield is now invested in no matter what the criteria. After all, when your borrowing costs are zero, anything looks better than zero yielding cash that loses purchasing power.
Race to debase
This “race to debase” works in the short run in nominal terms but in my opinion this policy will lead to an inevitable counter reaction whereby all financial assets drop at once. While we hear about exit strategies once the economy improves it is clear to me that there can be no graceful exit. Look at the Federal Reserve in America for example. It now sits on over $3 trillion of highly interest sensitive Treasuries and mortgage securities. If it were to exit its stimulus it would have to sell that portfolio. Can anyone tell me who would be willing(and able) to buy $3 trillion of Treasuries and mortgage securities at current interest rates from the Federal Reserve? This is impossible to do without crashing the bond markets and consequently, stock and currency markets.
On the other hand, if the Fed were to raise interest rates it would destroy its own balance sheet and bankrupt the federal government through higher interest payments. Remember, for every percentage in interest, the federal government currently would have to pay an additional $170 billion a year to service its debt, on top of the trillion-dollar deficit it currently produces and finances via Fed money printing.
A good friend of mine and expert pointed out that the Fed could just let the balance sheet mature and not renew its purchases. In theory, this is a nice idea but in reality, who would then step in and purchase the debt that the government needs to roll over at maturity? In other words, what private capital entities would be willing and able to lend $3 trillion to the US government and mortgage holders at current interest rates? It won’t happen and that’s why all major central banks have their backs to the wall at this point. Unless there is structural reform and growth, this party will end badly. Printing more money postpones the day of reckoning and should work until a currency goes into free fall. Let’s watch Japan and see what happens. After all, they are “winning” the race at the moment and are most likely to reach the finish line first.
The yellow brick road
How do you protect yourself from the possibility of an eventual demise of our current monetary system? Real assets. Anything that can’t be printed and has lasting value should weather the storm. High quality equities come to mind. As long as the company you own shares in stays in business you should be ok. Farm land can’t be printed and it even yields food every year. As for currencies, gold and to a lesser extent, silver, platinum and palladium serve the same purpose as stores of value.
Coincidentally the currency wars are being conducted in gold as well(see below)
Ask yourself which party you would rather be in the end. The one with all the gold or the one with all the paper money?
In my article “Quantitative easing. Economic stimulus or folly?”http://rpreschern.wordpress.com/2012/11/30/quantitative-easing-economic-stimulus-or-folly/ I explained my point of view regarding current global monetary policy. To assume that solving a problem of too much debt and consumption can be solved with more debt and consumption(financed by printed money) defies any logic, mildly speaking. To be fair we should listen to central bankers explain their goals and ideas. I found this fairly balanced 20 minute documentary in which the journalist was able to sit down and ask several central bankers questions regarding monetary policy. Decide for yourself if money creation is a panacea for our economic problems. You know my answer…
This past week has given us many headlines in the financial world. It started with central bank meetings and subsequent statements worth discussing and ended in new highs in the US stock markets after a supposedly strong jobs number. As financial markets continue their divergence from economic reality I think it is worthwhile analysing the growing dangers to our portfolios and find a way to make the best of the situation we are in.
Central bank review
On Wednesday, the US Federal Reserve released a statement that met expectations promising to continue its strong support for the economy as growth is modest. A day later, the head of the European central bank, Mario Draghi, lowered Europe’s leading interest rate by 0.25% to the historic low of half a percent. Citing a weak economy in the euro area, Mr. Draghi also considered negative interest rates in case the economy were to deteriorate further. http://www.cnbc.com/id/100697205 This was big news indeed as any bank account holder would then be paying banks interest to lend them their money, quite a crazy proposition if you think about it. Would you lend somebody money, accept their credit risk and be willing to pay him/her? In trader’s lingo this has come to be known as “return free risk”.
Lorenzo Bini Smaghi(above)
Paul Krugman and unknown feline advisor(above)
Another (Italian) ex-ECB governor and now Harvard professor, Lorenzo Smaghi issued a statement this week in which he wondered if central bankers “weren’t flying blind”. Furthermore, he stated that “We don’t fully understand what is happening in advanced economies.”. http://krugman.blogs.nytimes.com/2013/04/20/the-non-secret-of-our-non-success/ In fact, my good friend, Paul Krugman strongly criticized Mr. Smaghi regarding the ECB’s failed policies. I have to pinch myself over and over again but I actually agree with Krugman on this one.
JOBS
On Friday morning, the US Labor Department issued a supposedly positive jobs report and fireworks in the stock markets went off again leading to all time highs in equity markets. While the jobs number was ok in my opinion it was really nothing to be excited about. If you don’t understand my reservations, kindly read the article below.
http://www.marketwatch.com/story/dark-side-to-jobs-report-big-drop-in-hours-worked-2013-05-03
GLOBAL ECONOMY
Rather than take the extreme side of negativity or euphoria, I believe that the global economy overall is stagnant and on a slight downward trend. The best way for me to gauge economic activity is via the PMI’s around the world. For those of you that aren’t immersed in economic terminology, below is a good definition.
Purchasing Managers’ Index is an index that is read on a monthly basis to gauge how manufacturing activity is performing. This index is a true snapshot of how manufacturing and corresponding businesses are performing for a given month. A reading of 50 or above is considered a positive reading. Anything below 50 is considered to indicate a decline in activity. Readings of the index have the ability to shift the day’s trading session one way or another based on the results. http://www.investorwords.com/8256/Chicago_PMI.html#ixzz2SGgEgcS5
In short, it measures real productivity and corresponding movement of output, a true gauge of economic strength or weakness. Below the chart that backs my point:
http://m.financialsense.com/sites/default/files/users/u163/images/2013/0502/04-pmi.jpg
As you can see, the global economy is teetering along. Considering the insane amount of money printing and deficit spending this is a rather weak indicator for future growth and consequently, future earnings. Equities are nothing but participation certificates of future earnings. What will happen when unsustainable monetary and fiscal policy are scaled back? Unless there is some sort of economic revolution about to be revealed these curves will probably point down in the not too far future.
Knowing this, experts in the media have now resorted to rather strange reasons for stocks to keep climbing.
Bob Doll, chief equity strategist at Nuveen Asset Management said “Stock markets don’t want a strong economy, since a resurgence in growth would mean the end of cheap money and heighten worries about inflation.” http://www.cnbc.com/id/100700717 Is this an investable idea? Basically, what Mr. Doll is implying is that bad economic news means more money printing which in turn should lift stock prices. This may be a short-term trade but definitely not a sane long-term strategy for investment.
Art Cashin, head of UBS floor operations at the NYSE points out that it’s all about the “TINA” trade(there is no alternative) when it comes to stocks. http://video.cnbc.com/gallery/?video=3000165111 Think about that statement for a second. Since interest rates have practically been abolished and government bonds provide negative real yield you should buy stocks as nothing else will provide you with a positive return. Again, this makes sense as a trade in the short run but hardly in the long run.
Gordon Gekko returns
As there are no definitive fundamental economic reasons to assume global earnings will grow in the future, why is the stock market rallying like this? Aside from cheap money and TINA, the answer can be found in the resurgence of greed in the stock market. Fear and greed are the main driving forces of all markets and override rational judgment most of the time. Trading on margin is the perfect bench mark to assess a greed or fear level in a stock market. Borrowing money to buy a volatile asset requires a strong conviction that the risk is worth taking. Unlike a house, stocks are not a necessity of life and margin interest is not tax-deductible as mortgage interest is in the US. A fearful investor would not dare to take out a loan to buy stocks, a greedy one would certainly take the chance. Check out the chart below regarding current levels of margin and compare them to the previous stock market highs.
As you can see, we find that both the Tech Bubble highs in 2000 as well as the 2007 highs were accompanied with record levels of margin debt. We all know how these two scenarios turned out. Evidently, margin debt is once again reaching record territory and I lead the obvious conclusions up to the reader.
WHAT NOW
Nobody knows how long or high this irrational greed driven rally will last as the future of the world is uncertain. Mathematically speaking, it does not matter whether this market rallies for another year or 20% and then falls that much further or if it drops now and less so. What does matter is how the individual chooses to participate or stay away. If you want to trade this market (on margin), there is no advice from me as I have no clue where the stock market will be in one week, month or year. I suspect it will climb another 10% or so and then take an epic fall but that is merely a guess on my part and subject to change as events unfold. If you choose to trade the market remember your competition these days is tough…
Should you select to trade on margin and the market reverses you could easily see a crash like scenario as all margin players must exit at the same time accelerating the down trend. Caveat emptor.
INVESTING
If you are an investor in equities like most people are, this is a great time to look at your portfolio and decide what you would like to do. Personally, I assign a fixed percentage of my net worth to equities and when that percentage changes(currently larger due to higher prices) I sell high and lock in profits to get back to the predetermined percentage. If the market drops substantially from here I will be able to reenter at lower prices while I will not miss out on a continued rally if the market goes higher from here. I believe that this approach fits my investment style best. Please decide for yourself what strategy works for you.
Finally, I wanted to share an interesting chart regarding risk allocation with you. It is truly stunning how different investment cultures are around the world. Whether individuals or countries, we are all unique and need to individually find a way to keep our personal fear and greed in check. Good luck!
While the financial world eagerly awaits the US Federal Reserve’s and ECB’s “monetary outlook” tomorrow and Thursday, I wanted to share a fascinating article with you that Mr. Taibbi wrote for Rolling Stone magazine. The author took the time to research and reveal the inner workings of the largest financial institutions in the world. Anyone with a bank account and a conscience should read this powerful article and……. reflect.
This past week was rather quiet in the financial markets. Stocks and bonds moved marginally while currencies were steady. Gold retraced half of its recent “plunge” as physical buyers globally are scrambling to take advantage of the discount. A false tweet by AP managed to upset the Dow for a few minutes before returning the markets to slumber.
On Monday, I wrote about the upcoming GDP changes in the US that will increase our economy by approximately 3%. http://rpreschern.wordpress.com/2013/04/22/gdp-about-to-get-bigger/ On Friday, the actual US GDP numbers came out for the first quarter and were calculated at 2.5% growth on an annualized basis. Of course, this is nominal GDP not real GDP. The difference is very important because only measuring growth in dollars and cents without measuring the inputs and the change in dollars and cents is an incomplete assessment of reality.
Currently, US GDP runs at about $16 trillion per year meaning that a 2.5% increase would add $400 billion in growth to GDP this year. Divide this number by four and the quarterly increase was $100 billion for the first quarter of 2013. Unfortunately, in the same time period, the Federal Reserve “added” 3*$85 billion to the economy equaling $255 billion while the federal government ran a deficit of about $293 billion* http://thehill.com/blogs/on-the-money/budget/276103-first-quarter-deficit-was-293-billion-cbo-says. In fact, we printed $255 billion and borrowed $293 for a total of $548 billion in the first quarter of 2013 to achieve $100 billion of growth. My understanding of accounting would mandate that we subtract $548 billion of printed/borrowed funds from the generated $100 billion in growth which would show a net real growth of -$448 billion for this quarter, a stunning -11.2% real GDP number annualized. While I do understand that GDP itself is a flawed economic indicator as much as my accounting is simplified I would like to point out that current economic numbers are anything but positive. At some point we need to have structural growth to justify our reported numbers or reality will catch up with us in a very rapid manner.
As for the markets, take a look at the overlay of stocks and bonds below.
As you can see the equity market clearly calls for a stronger economy while the bond market is fearful. Ask yourself whether the markets reflect reality or whether artificial/record stimulus into both stocks and bonds have created gigantic misallocation into both assets. Personally, I hope for the former but the evidence points to the latter.
Bloomberg reported this week that central banks around the world are on an equity buying spree. http://www.bloomberg.com/news/2013-04-24/central-banks-load-up-on-equities-as-low-rates-kill-bond-yields.html Aside from the questionable practice of (quasi) government entities becoming owners of particular companies, what will happen if this stimulus ever ends? How can private/small business compete with corporations that are subsidized by central banks?
Evidently, there are different views on this monetary policy of central banks buying equities. Jim O’Neill, chairman of Goldman Sachs asset management opined this week that “I don’t think people should worry about that.”….”Frankly, it makes a huge amount of sense in a world of floating exchange rates and such incredible opportunity, why should central banks keep so much money in very short-term, liquid things when they’re not going to ever need it?” O’Neill said. “To help their future returns for their citizens, why would they not invest in equity?” http://www.businessinsider.com/jim-oneill-on-central-banks-buying-stocks-2013-4 Is it possible that he applauds this policy for other reasons than the common good?
Paul Volcker, former Federal Reserve chairman and my true monetary hero for helping end the inflationary problems in the late 1970′s-1980′s came out this week with a rather different assessment on current central bank intervention in all asset markets. http://money.cnn.com/2013/04/08/news/economy/volcker-central-banks/index.html Mr. Volcker stated “Central banks are no longer central banks,” said Volcker. “I think it gets dangerous when they lose sight of the basic function of the central bank…” Volcker said that rather than trying to stay out of the market as much as possible and simply tinker from the sidelines, central banks have been aggressively trying to influence economic growth and even inflation. “The central bank is not an all-powerful tool….The Federal Reserve is the world’s largest financial intermediary”
I clearly side with Mr. Volcker on this issue. Assuming that we can have central banks indefinitely prop up asset prices and not experience a future back lash is naive. As for the ethical ramifications of central banks picking winners and losers I would like to remind you of the following quote.
“Fascism should more properly be called corporatism because it is the merger of state and corporate power.” – Benito Mussolini
Let us hope that this dark chapter of human history remains in the books and does not become reality.
Finally, I have listened to this excellent interview with Bud Conrad from Casey Research. He is quite the expert on macroeconomic analysis and presents a rather balanced view on the global economy. Enjoy.
* I understand that the first fiscal quarter of 2013 for the federal government ended on Dec.31 2012. Federal figures for the first quarter of 2013 are not available yet but should not deviate substantially from the previous quarter.
In case you have not heard, as of July of this year, GDP will be calculated differently. The changes are outlined in the article below. Please be careful regarding the effects of the new calculations. It is estimated that the new model will show an increase in GDP by 3% in July which may distract from economic reality if neglected in reporting. Enthusiasm regarding the future has me very concerned at this point and artificial boosts to the perception of the economy may feed the greed that blinds the bulls and turns them into pigs. You know what they say about markets? Bulls make money, bears make money and pigs get slaughtered…
Data Shift to Lift US Economy by 3%
As for the type of animal spirits currently present in the markets please review the following chart and judge for yourself what “animal” you are.
http://hussmanfunds.com/wmc/wmc130422.htm
