Submitted by Pater Tenebrarum of Acting-Man blog,

Full Court Press

Not a day passes without the financial media denouncing gold as an investment option and hailing the bureaucrats heading the world's monopolist monetary central planning agencies as superheroes. It began prior to gold's recent breakdown, with widely cited bearish reports on gold published by Credit Suisse and Goldman Sachs, among others. Never mind that most of their arguments were easily unmasked as spurious. It should be no wonder though: gold's rise was the most conspicuous evidence of faith in central banking being slowly but surely undermined. The banking cartel relies on the fiat money system remaining intact; the legal privilege of fractional reserve banking provides it with what is an essentially fraudulent profit center unparalleled by any other in the world (fraudulent in terms of traditional legal principles, but not in terms of the current law of course). Not surprisingly, ever since the completely unrestrained fiat money system became operational in the early 1970s, the financial sector's share of corporate profits has inexorably risen and finally eclipsed all other sectors of the economy.

 

The share of financial profits of total corporate profits – a direct result of the fractional reserve banking privilege and the central bank monopoly on money (via Ed Yardeni) – click to enlarge.

 

In other words, the banks have to protect a major franchise. It is a good bet that if gold had continued to rise in the face of money printing being accelerated all over the world, the inevitable loss of faith in central banks would have happened sooner rather than later. That it will eventually happen is unavoidable – the modern monetary system was fated to self-destruct the moment it was conceived. This is so because central planning and price controls cannot work in the long run, even though central banks are socialistic institutions adrift in a capitalist sea, so to speak. They can to some extent observe prices in the market, but the problem is that the market price most relevant to them – namely the ratio of future against present goods as expressed in interest rates on the credit markets – is not independent of their actions. There is therefore nothing that can tell them whether their administered interest rates are too high or too low. It is a system that is condemned to fail at some point (unfortunately with grave consequences for the economy at large).

The fact that a great many people ostensibly believe in its viability is not proof that it is viable; most of those who are most vocal about retaining the central bank money monopoly are directly profiting from its existence after all. That the commercial banks only want to protect a source of large profits and an invaluable backstop in case their speculations go wrong is clear, but the same is true of most academics in the economics profession. The great bulk of them derives its income from the State, and the central bank is at the forefront of supporting the livelihood of its apologists.

Among commercial banks, Credit Suisse has been a leader in the recent rhetorical onslaught against gold, and has just published a follow-up, duly repeated by Bloomberg under the non-too-subtle title: 'Gold Seen Crushed'.

“Gold, down 17 percent since January, is poised to lose 20 percent in a year as inflation fails to accelerate and with the worst risks to the global economy waning, Credit Suisse Group AG said.

 

Gold will trade at $1,100 an ounce in a year and below $1,000 in five years, according to Ric Deverell, head of commodities research at the bank. Lower prices are unlikely to lure more central-bank buying, said Deverell, who worked at the Reserve Bank of Australia for 10 years before joining Credit Suisse in 2010.

 

“Gold is going to get crushed,” Deverell told reporters in London today. “The need to buy gold for wealth preservation fell down and the probability of inflation on a one- to three-year horizon is significantly diminished.”

 

Investors are losing faith in the world’s traditional store of value even as central banks continue to print money on an unprecedented scale. Bullion slumped into the bear market last month after a 12-year bull market that saw prices rise as much as sevenfold. Gold is a “wounded bull,” Credit Suisse said in a Jan. 3 report.

(emphasis added)

Color us unsurprised that the main author of the report is an ex-central banker. As regards inflation, below is a chart we have recently shown, US money TMS-2. The good people at Credit Suisse neglect to mention in their report that official 'CPI inflation' has rarely risen beyond the central bank's 'target' of 2% during the entire gold bull market to date. It was completely irrelevant to the gold market thus far, so why should the outlook for the government's 'inflation' data suddenly become relevant now? Monetary inflation has been higher over the past five, 10 and 15 years than at any time since the end of WW2 in a comparable period – and it continues to accelerate.

It is therefore erroneous to claim that 'the probability of inflation on a one to three year horizon is diminished' – the exact opposite is the case. As noted above, Credit Suisse's argumentation has been spurious in its first bearish gold report already and it continues to be so. It seems more likely that a concerted public relations campaign against gold is underway, while parallel to that, a pro-central banking campaign is in full swing. We're not really big fans of conspiracy theories, but in this case, everything points to this being the case; it is just as transparent as the pro-war campaign prior to the Iraq war was.

 

Monetary inflation in the US since the year 2000. Money TMS-2 has more than tripled – click to enlarge.

 

Success! Gold Now Seen as 'Worst Performing Asset' by Investors

The gold market is of course complying so far, as the clients of the banks issuing bearish reports are bailing from their gold positions. Skeptical voices like Elliott Capital Management's Paul Singer have been drowned out by the incessant barrage of propaganda. Gold continues to decline in the near term and its chart has begun to look rather ominous.

 

Gold over the past week (most active futures contract) – down every day of the week – click to enlarge.

As Credit Suisse incidentally also reported, its campaign has been crowned with success: not only has the gold price declined sharply, gold has now become the 'most hated asset class' with the 'worst outlook among commodities' according to a recent CS survey among institutional investors:

“Gold has the worst 12-month outlook among commodities and will trade below $1,400 an ounce in a year, according to an investor poll by Credit Suisse Group AG.

 

Sixty percent of respondents named bullion as having the worst outlook, 18 percent picked copper and 16 percent selected corn, the bank said in an e-mailed report today. Fifty-one percent predicted gold will fall under $1,400 in 12 months, it said. The bank polled 185 investors including hedge funds, pension funds and family offices on May 15 in London.

 

“Bearishness for gold was a very clear consensus,” said Kamal Naqvi, the head of commodities sales for Europe, Middle East and Africa at Credit Suisse. “It’s not about just not buying gold, it’s about shorting it,” or wagering on a drop.

 

Gold slumped into a bear market last month as investors lost faith in the metal as a store of value. Bullion is down 17 percent this year, compared with the 2.9 percent drop for the Standard & Poor’s GSCI gauge of raw materials.

 

Fifty-three percent of investors expect commodity prices to stay near current levels, Credit Suisse said. Most were underweight raw materials or had zero exposure, while they expected to be overweight or neutral in 12 months, the bank said. Investors named relative value trades, fundamentally based directional trades and volatility as the best ways to extract value from commodities.”

(emphasis added)

The general bearishness on commodities jibes with what we have seen in the recent Merrill Lynch fund manager survey. The bearishness on gold is in keeping with what we have seen in the Barron's 'Big Money' survey and other polls. Apparently though the people who write the gold reports at Credit Suisse are oblivious to the contrarian implications of their own survey.

As we have recently pointed out, just before Japan's stock market embarked on a 75% rally in the space of a few months, fund managers absolutely hated Japan (they love it now!). As we wrote in our October 30 review of the Barron's Big Money poll:

“However, what we really love is that they hate Japanese stocks even more! As it were, we are busy writing an article on Japan that will be entitled 'Reconsidering Japan' and should be published sometime this week. There are quite a few reasons to believe that Japanese stocks will finally do the unexpected and come back to life.”

At the time, a full 76% of the 'big money' fund managers surveyed declared themselves bearish on Japan. Currently, 69% of the managers surveyed in the most recent Barron's poll are bearish on gold. One must of course admit that from a technical perspective gold currently looks weak. That is undeniably the case and there could therefore be more near to medium term downside. However, the most important fundamental data as well as the sentiment backdrop clearly remain bullish. In fact, the skepticism of investors regarding commodities in general and gold in particular in the face of the biggest money printing orgy of the modern age is what we would call an 'extreme long term bullish dichotomy'. It seems highly likely to us that a year from now or maybe even earlier,  the conversation will have profoundly changed.

    

Amid the sound and fury of yesterday's IRS hearing were a few small tidbits which raise significant questions about who knew what and when within the Obama administration. While getting the answer (the real honest truth) is highly unlikely, as the Wall Street Journal notes, the IRS's watchdog told top Treasury officials around June 2012 (when Republican lawmakers were complaining publicly about alleged IRS targeting of tea-party groups) he was investigating allegations the tax agency had targeted conservative groups, for the first time indicating that Obama administration officials were aware of the explosive matter in the midst of the president's re-election campaign. The revelation nonetheless raised a fresh set of questions about who was aware of the problem within the Obama administration. However, the hearing left numerous other fundamental questions unanswered, including who ordered the targeting and why it continued so long, pointing to a protracted investigation ahead as Rep. Paul Ryan exclaimed, "how can we not conclude that you misled this committee?" As Doug Ross' full timeline below suggests, this is fascism on the part of the IRS and White House...

 

Via Doug Ross of Director Blue blog,

Reading this timeline, I have come to three conclusions:

 

  1. Steve Miller lied to Congress
  2. Lois Lerner lied to Congress
  3. Barack Obama lied to the American people

This scandal has the fingerprints of Axelrod, Jarrett and/or the Chicago Machine all over it.

This is fascism on the part of the IRS and the White House. It is fascism, straight up.

Or, as I call the IRS: Organizing for Revenue.

 

Via The Wall Street Journal,

The Internal Revenue Service's watchdog told top Treasury officials around June 2012 he was investigating allegations the tax agency had targeted conservative groups...

 

...

 

The revelation nonetheless raised a fresh set of questions about who was aware of the problem within the Obama administration.

 

...

 

the agency had taken "absolutely inappropriate" actions in targeting conservative groups seeking tax-exempt status for often heavy-handed scrutiny.

 

...

 

The hearing left numerous other fundamental questions unanswered, however, including who ordered the targeting and why it continued so long, pointing to a protracted investigation ahead. Mr. Miller conceded the agency likely disciplined the wrong employee in one effort to address the problem.

 

...

 

House Ways and Means Committee Chairman Dave Camp (R., Mich.), "I think the most interesting revelation was the overall arrogance of the IRS and the lack of information from somebody who was in charge,"

 

...

 

White House officials say they learned about the targeting of conservative groups from the report, and not before. President Barack Obama on Thursday said, "I can assure you that I certainly did not know anything about the IG report before the IG report had been leaked through the press."

 

...

 

At the hearing, lawmakers of both parties expressed anger that IRS officials didn't reveal the problems to them in 2012.

 

...

 

then-commissioner Douglas Shulman about that in March 2012. He testified before the Ways and Means committee then that there was "absolutely no targeting,"...

 

...

 

"Throughout this time, the IRS leadership has demonstrated a total disregard for the oversight role of the Congress and this committee," said Rep. Sander Levin

 

...

 

"How was that not misleading this committee?" said Rep. Paul Ryan (R., Wis.) to Mr. Miller. "How can we not conclude that you misled this committee?"

 

...

    

Excerpted from Jacob Steen's Chronicle blog at Tradingfloor.com,

The mystique of the Bermuda Triangle has caught the imagination and interest of generations. In much the same way it has also caught my attention and I feel that now there is a Bermuda Triangle of economics - a space where everything tends to disappear without radar contact, a black hole in which rationality and science is replaced by hope, superstition and nonsense pundits like myself pretending to understand the real drivers of the economy.

The Bermuda Triangle in real life runs from Bermuda to Puerto Rico to Miami. The economic one runs from high stock market valuations to high unemployment to low growth/productivity. Just like the real Bermuda Triangle, in the Bermuda Triangle of economics there is plenty of scientific evidence that can explain most, if not everything, of what is going on. But that does not suit Hollywood, sorry, the US Federal Reserve.

Neither does it suit mainstream banking analysis or the media in dealing with reality and facts: the mystique simply sells better! After all, there is a reason why people leave science education for PhDs in apps and virtual reality.

There is a myth that the sunken Atlantis could be in the middle of this triangle. It has been renamed Modern Monetary Theory (MMT) to make it suit the black hole's main premise of ensuring there is a fancy name for what is essentially the same economic recipe: print and spend money, then wait and pray for better weather.

The economic Bermuda Triangle, or EBT, is getting harder and harder to justify - if for nothing else because the constant reminders of crisis keep us all defensive and non-committed to investing beyond the next quarter. We all naively think we can exit the "risk-on" trade before anyone else. A less cynical person than me could think that some things in life need to be experienced - not talked about.

Where to from here?
A long time ago, policymakers entered a one-way street where reversing is, if not illegal, then impossible. Enough though about the polices. What is more important is what is next?

If a political scientist should create a simple model for how this Bermuda Triangle works, the first action point would be to test the premise of the policy. No theory is better than its premise - clearly.

The Federal Reserve version of the premise is to create a positive wealth effect that ultimately leads to better sentiment and investment. The barometer of success is the stock market, but does the stock market really correlate to wealth? Clearly the stock market has been on a tear, but is everyone, including the average Joe, benefitting? Clearly not. Ownership of stocks is almost exclusively for the top 10 percent of the population. Social divide is much higher today than it was before the crisis. 

In Japan, they are more open - they simply want to create a bubble. I repeat, a bubble. That is interesting when policymakers for years have said it is impossible to figure out when there is a bubble! I guess - proactively wanting a bubble makes it more transparent? Confused? Certainly I am, but then again Abenomics is "double Dutch" to me anyway.

So the premise does not hold, but how will the policymakers deal with failure? Change course? Never! It would be worse than blasphemy! A one-way street means cars can only go one way - not in reverse. Optionality is for democracies and capitalistic systems, not for a time of crisis. In times of crisis, we need the foresight of our great supreme leaders, sorry, politicians and central bankers, to guide us. Their divine insight will lead us safely ashore to the beaches of Lalaland, where the sun always shines.

No, the response is to do more. Take the Bank of Japan's quantitative easing (QE) infinite released on April 4. One month into the experiment and Japanese Government Bond (JGB) yields are higher, not lower.

The yield curve is steeper, inflation expectations are flat but the Nikkei and USDJPY are higher. A success? Yes, except in the one area you wanted to impact: the yield and the yield curve!

The other part is that for this to work, the stock market needs to keep outpacing the fall in JGBs. The Government Pension Fund manages more than USD 1 trillion. Its allocation? Sixty-five percent in JGBs and less than 11 percent in stocks. Hence, the present scoreboard would read: 

USD 650 billion x (146.50 - 143.50) = 2% =  - USD 13bn.  USD 110bn  x 40% =  USD 48bn. A net gain of USD 35bn but...

What if the Nikkei comes off 10 percent - then USD 48bn becomes USD 37bn and the new equilibrium price of 138.50 is only five figures away.

A price point that will make Japan less well off, not better, plus it would have increased the funding price of the 240 percent debt-to-GDP ratio. Some strong macro fund managers think that a collapse in Japan is less than 12 to 18 months away, among them Mr. Kyle Bass stands out. Maybe Japan should be careful about what it wants. My conclusion on Japan is:

1. The Japan scenario is neither black nor white, but a continuous gradual process. Japan is notoriously slow in changing its political process and ultimately nothing will have changed materially one year from now. Yes, the Nikkei could be the start of a secular bull market as Stanley Druckenmiller recently said in New York, but it is already up 60 percent from the low. And with China and Europe slowing, it is likely to see a major correction and probably soon.

 

2. The unintended consequence of QE Infinite in Japan is so far (as shown above) a higher yield - even higher than the recent rise in US rates - USDJPY becomes vulnerable for a major correction down to 95/96.

 

3. Japan will not go bankrupt inside 12 months or even 12 years, but the hope of a recovery will wane and soon. Watch how the Upper House election in the Diet in July becomes the final destination for Abenomics. Prime Minister Shinzo Abe needs to secure 63 and 100 new seats; 63 seats to maintain momentum behind his economic policy and 100 to secure the majority to change the constitution.

 

 

Delivering "cheap money" is the easy part of his three pillar strategy, which got him elected. Using stimulus correctly and working on the supply side of the economy will be impossible due to structure, lack of immigration, health care and ageing costs. I wish Japan well, but nothing will be saved by using the economic Bermuda Triangle. Of all countries, Japan should know - it invented the economic version of it!

Another key event will be the German election.

In Germany,  Chancellor Angela Merkel will win the battle (the election), but will probably lose the war: she needs to step up. Europe expects it. The market wants it. The problem is, she can't afford it.

Bailing-in will mean a loss of rating for Germany, while staying austere will cost exports and long-term growth. Which scenario to choose? I personally think she will fail - fail to reconcile. She is already short of a Chancellor's majority and after the election, the Greens and SPD will hold her hostage. Staying in power will mean giving in. Simply. 

That, however, will be the end of the honeymoon for Europe. Germany cannot save Europe. Each country in Europe needs to realise that its recovery comes from its own political willingness to reform and eat reality pills. Europe is destined to repeat the history of Japan, unless an even more severe crisis makes us wake-up. 

This means we see the July to October period as a very important time frame for this experiment. We firmly believe the German election will be the game changer, but we could get a surprise in July unless Mr Abe gets JGB yields under control.

Policy conclusion

The Federal Reserve is testing the waters with its "tapering", but Fed chief Ben Bernanke is financing the budget deficits via his QE. Hence, he will continue less aggressively, but QE is not ending.

The Bank of England gets a new boss in July. This will kick-start American-style policies, which sits right in the middle of the economic Bermuda Triangle, with GBP being the main casualty.

The Bank of Japan will soon correct its maturity in buying - buying longer and deeper - as the July election looms.

The European Central Bank is close, very close to doing something that smells and feels like QE. Selling the sick man of Europe - France - makes a lot of sense here.

Strategy

We are entering the realisation part of this global slowdown. Unlike three months ago, policymakers now realise that growth is not coming back in six months' time as they all love to estimate at their press conferences. So over the summer, the Federal Reserve, Bank of England, Bank of Japan, International Monetary Fund and European Central Bank will all go back to their drawing boards and... do more of the same.

The policy is not wrong; clearly, it is only the amplitude of it. I agree with Jeff Gundlach, who believes QE is here to stay for a long, long time, but also that the only thing that will get us out of this funk is innovation and reality. How do I reconcile this?

By allowing the 70 percent likelihood for Extend-and-Pretend Season 4 through to the July to October period (German and Japanese elections), which will lead us to Japanisation (dis-inflation, no growth and productivity plus an ageing population).

There is a 30 percent chance of failing before July - failing as in the market collapsing or social tensions rising, governments falling and the financial system under pressure.

We are due for a new crisis. We have governments and central banks proactively pursuing bubbles. Hence, the probability of bursting one of those bubbles will need to have risen by the same magnitude as the desperate moves of policymakers.

    

Despite 'crashes' in the market, the demand for physical silver continues to rise. "Buyers are already outpacing sellers by a stunning 50-to-1 ratio. We are seeing the beginning of shortages; but this will only accelerate if Western governments continue with this raid on paper gold and silver."

 

 

The Silver Squeeze – An infographic by the team at The Silver Squeeze Free Infographic

    

Submitted by Lance Roberts of Street Talk Live,

There have been quite a few bold predictions, since the beginning of the year, that the dollar was set to soar and that the great "bond bull market" was dead.  The primary thesis behind these views was that the economy was set to strengthen and inflation would begin to seep its way back into the system.  Furthermore, the "Great Rotation" of bonds into stocks, on the back of said economic strength, would push interest rates substantially higher.  

While I have no doubt that at some point down the road that inflation will become an issue, interest rates will rise and the dollar will strengthen - it just won't be anytime soon.  A wave of "disinflation" is currently engulfing the globe as the Eurozone economy slips back into recession, China is slowing down and the U.S. is grinding into much slower rates of growth.  Even Japan, despite their best efforts through a massive QE program, cannot seem to break the back of the deflationary pressures on their economy.  This is a problem that has yet to be recognized by the financial markets.

The recent inflation reports (both the Producer and Consumer Price Indexes) show deflationary forces at work.  Wages continue to wane, economic production is stalling and price pressures are falling.  More importantly, there are downward pressures on the most economically sensitive commodities such as oil, copper and lumber all indicating weaker levels of economic output.  The battle against deflationary economic pressures has been what the Federal Reserve has been forced to fight since the financial crisis.  The problem has been that, much like "Humpty-Dumpty", the broken financial transmission system, as represented by the velocity of money, can't be put back together again.

The weak level of economic growth, global deflationary pressures, demographic trends and excess indebtedness which derails productive investment are keeping inflationary pressures suppressed.  The chart below shows the Composite Inflation Index (CII), an average of the consumer and producer price indexes, versus interest rates.  With inflationary pressures turning lower it is highly unlikely that we will see interest rates rising anytime soon

Our long term view on the 10-year Treasury remains at 1%.  Despite the Federal Reserve's ongoing efforts to inflate asset prices; such inflation is not translating to "Main Street" in the form of higher wages, increased consumption or higher standards of living. The Federal Reserve has often discussed that there are limits to monetary policy and they may have found those limits in its most recent endeavors.

The same goes with the U.S. dollar.  With Japan engaged, on a relative basis, in a Quantitative Easing program twice as large as the U.S. on an economy just one-third the size, the suppression of the Yen has boosted the Dollar higher in recent months.  However, the deflationary pressures globally are likely to create a feedback loop on Japan's effort to create inflation leading to a economic decoupling that creates a potential disaster in Japan.   This is the bet that Kyle Bass has made and anticipates happening in the next 24 months.

The chart above shows the U.S. Dollar versus the CII.  Historically, downturns in the composite inflation gauge lead to, not surprisingly, declines in the dollar.  Currently, the economic data is confirming that we are likely to see dollar weakness sooner rather than later.

The bottom line is that the "bond bull market" likely still has a bit of life left in it. The deflationary pressures that weigh on the consumer and the economy are likely going to keep downward pressure on rates for some time to come as the Fed comes to realize that they have been caught in the same "liquidity trap" that has plagued Japan for a generation.  Those same pressures will also temper any "dollar bull market" for the foreseeable future as well. 

The real concern for investors, and individuals, is the actual economy.  We are likely experiencing more than just a "soft patch" currently despite the mainstream analysts rhetoric to the contrary.  There is clearly something amiss within the economic landscape and the recent decline in rates, the dollar and inflation are telling us that.

    

Wolf Richter   www.testosteronepit.com   www.amazon.com/author/wolfrichter

It was announced Friday afternoon, when no one was supposed to pay attention: after years of controversy, heated rhetoric, intense lobbying, and stiff opposition from some unlikely bedfellows, with multinational industrial and chemical companies weighing down one side of the bed, and environmentalists tossing and turning on the other, the Obama Administration decided in favor of the US oil and gas industry. With geopolitical ramifications.

The Department of Energy “conditionally authorized” Freeport LNG Expansion LP and FLNG Liquefaction LCC (Freeport) to export domestically produced liquefied natural gas to countries with which the US does not have Free Trade Agreements (PDF, 132 pages). Already allowed are exports to the 20 countries with FTAs – most of them in the Americas, but also Australia, Korea, Singapore, Israel, Jordan, Bahrain, Oman, and Morocco. But exports to the remaining 180 or so countries have to jump through some hoops.

So Freeport’s LNG Terminal on Quintana Island, Texas, is now authorized to export 1.4 billion cubic feet per day (Bcf/d) of LNG for 20 years to those non-FTA countries. Freeport joins Cheniere Energy Inc.’s Sabine Pass terminal in Cameron Parish, Louisiana, with an export capacity of 2.2 Bcf/d. Freeport’s and Cheniere’s combined capacity would amount to 5.2% of US production (estimated at 69.3 Bcf/d in 2013). Other companies are cooling their heels in line at the DOE, which would, as it said, “process the applications currently pending on a case-by-case basis.” At snail’s pace. The administrations sole concession to environmentalists.

“DOE has had the remaining applications on its desk for months and should ensure that these applications are approved without any further delay,” groused Erik Milito, of the American Petroleum Institute, a trade association representing over 500 oil and gas companies.

Hurdles remain. DOE approval is just another step. The plants will have to get a permit from the Federal Energy Regulatory Commission (FERC) and must pass an environmental review, which could be a nail-biter. And none of the plants are up and running yet.

Then there is an unknown: how will world markets react to this additional supply that competes with at least 63 LNG export terminals currently planned or under construction worldwide? US production can rise to meet that new demand, as the gas glut in recent years has demonstrated in its bloody manner. But for production to rise significantly, the price – which is still below the cost of production for most “dry” gas wells – must rise as well.

Industrial and chemical companies that use natural gas for energy or as feedstock are deeply worried. Would they end up having to pay European prices? Or catastrophically, Japanese prices? The gas industry and its pundits have feverishly assured them that LNG exports would have “only minimal impacts” on gas prices in the US. Yet, the moment DOE announced its decision Friday afternoon, natural gas spiked about 3%, before retracing some of it.

The largest potential customers for LNG are Europe and Japan – staunch allies of the US. Europe is furiously trying to break the stranglehold that Russia’s Gazprom has on its gas supplies. Norway has morphed into a large producer, but it isn’t nearly enough. With prices two to three times higher than in the US, cheaper US gas hitting these markets would wreak havoc in Russia and its political clout in Europe. It would be a game changer in the EU economy, which is bogged down in high energy prices. And it would bring the European allies closer to the US.

But it might not happen, at least not initially: because there is Japan, the world’s largest most desperate importer of LNG since the shutdown of its 50 surviving nuclear reactors following the Fukushima meltdowns. The country is doing some serious soul-searching about nuclear power, and whether or not to bring reactors back on line. Meanwhile, its utilities are getting ripped off by distant natural gas suppliers that charge over four times the current price in the US.

Freeport already inked contracts with BP for half of its capacity and with the Japanese utilities Osaka Gas and Chubu Electric for the other half. So at least half, but probably much more of its shipments would be destined for Japan, still the most lucrative market in the world. Those contracts are already being leveraged by the Japanese government in its negotiations with Gazprom on a number of deals, including Japanese participation in an undersea pipeline from Russia’s Far East – which is far only from Moscow – to its neighbor, Hokkaido, the largest island of Japan.

But environmental groups in the US, already fuming at their erstwhile messiah, are getting madder with every fossil-fuel deal the Administration approves. The controversial Keystone Pipeline, which Native American opponents have equated to “environmental genocide,” is waiting in the wings. The Administration simply doesn’t want to get run over by the momentum of the oil and gas industry, and the thousands of high-wage jobs it has created. And it wants to lick its geopolitical chops.

The status of the US dollar as the world reserve currency gives the US tremendous advantages. Among them: it allows the Fed to export inflation, while the Federal Government can run a huge deficit with impunity. But now an angry Russia has had enough! Read.... Russia’s Plan For The BRICS To Dismantle The Dollar System

    

70% of graduates had at least some debt according to the latest poll from Fidelity Investments but as the Wall Street Journal reports the average student-loan debt for a borrower who received a bachelor's degree in 2013 is $30,000 - an all-time record. With $986 billion of outstanding student loan debt (up 50% from Q1 2009) and unemployment rates running at or near all-time highs for the 16-24 year old cohort in this nation, it is little surprise that delinquencies are surging. The unemployment rate among graduates is 7.1% (which is considerably worse than it looks given that many are stuck in low-paid jobs) but it is those who don't complete college that face the greatest burden - the median annual income of a non-completer was $25,000 (compared to $33,900 for a degree holder), less than the average student loan debt. As the WSJ notes though, the 2013 class is unlikely to hold the 'most indebted class ever' title for long as 2014 enrollments and tuition costs look set to continue the 20 year trend...

 

 

Chart: Wall Street Journal

    

Submitted by Daniel Cloud

Boldly They Rode And Well

I believe that Shinzo Abe has made a very serious strategic miscalculation. I used to be confused in much the same way he now seems to be, but I was cured of my confusion by thinking about Chinese inflation.

For a long time, I was puzzled by the fact that America’s endless multi-stage QE program seemed to have no effect on measured inflation, on the CPI and the PPI. But then I realized that by only looking at the United States and their three hundred million-plus people, I was missing the big picture, missing the most important part of its aggregate impact on the Earth’s seven billion inhabitants.

QE may never have much of an effect on the inflation rate in the fifty states of the United States of America, because it is workers in the developing world, and in particular, in China, who are the marginal hires in our still-globalizing, still-offshoring world economy. There is no distinct American economy, now, there is no Chinese economy, there is only the world economy, and the Fed makes policy for large parts of it. China has the kinds of structural rigidities in its labor, goods, information, and asset markets that make inflationary psychology very probable. It already had an ongoing and stubborn problem with inflation before QE started, so the required psychology already existed. And, perhaps most importantly, much of the money the Fed is printing doesn’t actually end up in the United States. It ends up being added to the reserves, and therefore the domestic money supply, of countries like China, who want to keep their currencies pegged, or quasi-pegged, to the dollar.

Why? Simply letting their currency appreciate would do to the Chinese what it did to Japan in the late ‘80’s. But to keep the yuan from appreciating against the dollar as a result of the increased supply of dollars from QE, the government of China must buy all the dollars anyone shows up with, at the pegged exchange rate. To pay for them, China must issue yuan, and pay them out to the holders of those dollars. That makes the supply of yuan in circulation increase by the same amount – as the dollars are added to the country’s reserves, the domestic money supply has a matching increase. The authorities can try to “sterilize” this hot money, by selling treasury bills, but experience has shown that the flows are simply too large and long term for this to be very effective. 

Since this means the money supply in China is constantly increasing at what would otherwise be an undesirably rapid rate, the result, as readers of Zero Hedge already know, is a persistent problem with inflation. Inflation is a form of taxation; by printing money, the State funds itself by taking a little bit of wealth away from each holder of the currency. (Or in the case of the dollar, of all the various currencies pegged to it…)

In 2012, according to a recent post on ZH, citing the WSJ, nominal private sector wages in China were up 17.1 percent. This means wages are compounding at a rate much, much higher than GDP growth, and the process shows no signs of stopping. That endless increase feeds through into product prices – not the prices of exported products, since it’s necessary to stay competitive in dollar terms, but the prices of ones sold into the domestic market. The same effect is echoed all through the developing world, in any country that wants to participate in dollar-based world trade, and feels it has to keep its currency in a stable relationship with the dollar to do so without undue disruption. That increase in the cost of the goods and services available to them makes the middle class, and the many people who are still poor in those countries, worse off than they otherwise would have been. (It was rising food prices, tied to Chinese demand, that were the straw that finally broke the camels’ back in Egypt and Syria.) On the other hand, the American policy that ultimately causes it helps the Fed’s main constituency, developed-country banks, and helps developed-country governments keep spending, and allows developed-country political actors to maintain their patronage networks.

QE works, politically, because it is mostly a tax on consumers in the developing world. It keeps the banking system in Europe, and therefore the rest of the world, from collapsing, for the time being, it maintains the existing set of political arrangements, and the costs fall mainly on people who will never have a chance to vote in an OECD election. Ben Bernanke’s great triumph, as an ideologue, is to have come up with a Rawlsian, distributive justice argument in favor of what really amounts to taxing the poor to protect the assets of the rich. (To add insult to injury, in a country like China, where nobody ever gets to vote on anything, it’s taxation without any hint or whisper of representation. Egypt showed us what that can lead to, though as Americans we shouldn’t need reminding.) Given the actual goal, which is to maintain the status quo in world affairs as long as possible, it isn’t clear what other policy could have been chosen, but the justification offered in public is, of necessity, somewhat ironic.

The risk to world markets, at the moment, comes from the fact that the people who run the Fed and Treasury may actually be sincere in offering that justification, that the irony may be unintended. Their somewhat myopic focus on the developed world – which is, after all, where all the relevant political constituencies live – means that they may not actually understand that robbing the poor to pay the rich is what they’ve been doing. All they know, perhaps, is that the policy didn’t cause anyone who mattered to them any pain – so it seems possible that they have perceived it as actually costless, as a free lunch. It’s easy to be incurious about how migrant workers in Wuhan are doing, when the Chinese press can’t really cover their situation, and you never meet or talk to such people yourself. (Somehow they don’t get invited to G7 meetings…)

Certainly, the Japanese don’t seem to have been let in on the joke. We’ve been doing QE for years. It hasn’t had any of the predicted catastrophic effects. We kept obnoxiously pointing this out to everyone, and voicing our exasperation at their failure to emulate us. Eventually the political pressure for adopting such an apparently costless, and riskless, and kind-hearted policy became irresistible, and there was a coup at the Bank of Japan.

The mistake Abe is making, though, is to think the same trick that worked for the US will work for them. The problem, as Shirakawa no doubt realizes, is that the two country’s situations are not at all analogous, because the yen isn’t really a reserve currency in the same way the dollar is. There is no population of natural sovereign buyers who will be forced to print their own currency to mop up excess yen, as there is for the dollar. No sovereign is going to want to dramatically increase the allocations of their country’s reserves to the yen, not when it’s in the middle of being deliberately devalued, or really ever. Russia and China and Saudi Arabia don’t need any more yen, they have plenty. Oil isn’t priced in yen. Japan isn’t the world’s largest economy, or even its second largest. World trade isn’t conducted in yen. The emerging economies will just let it collapse. There is no natural sovereign sink for yen to drain into, as there is for the dollar, no group of buyers of last resort with bottomless pockets and no choice but to buy.

But that means nobody else is going to want to hold yen either. Why own a currency when the issuer publicly plans to make it worth less, and to raise the inflation rate well above the current long-bond yield at the same time? That isn’t a store of value; it’s a live grenade. People in the private sector, wishing to survive, will fling the grenade away. There is nothing to stop them, no natural buyer the other side, because the only player who could possibly defend the yen – the BoJ – is publicly committed, in a politically irrevocable way, to the opposite path. Because of the relative success of QE in the United States, policy-makers will be complacent about the risks. 

The mistake Abe is making is to generalize from the experience of the central bank of the world’s primary reserve currency to his own very different situation. Japan can’t tax its allies to support its insolvent State by printing money, because (aside from the US, which is also broke) it has no allies. Any liquidity it squirts at them will simply splash off. What will really happen is, therefore, exactly what you would expect to happen to a country with a convertible currency and a very large national debt which credibly announces that it plans to abruptly double its money supply – there will be a scramble to get out, and the yen will decline, or Japanese bond yields will rise, until one or the other reaches a level that offers some prospect of a positive return. Though of course, there will be overshooting.

That means a much, much lower yen, and/or much higher JGB yields, which would of course be instantly fatal. So, as George Soros has already warned, what we may actually get (unless Abe flinches, and reverses course, which is hard for him to do now he’s actually pulled his sword out, yelled “Banzai!”, and started the cavalry charge) is an uncontrolled devaluation of the yen, to some level that would seem wildly unrealistic to us now, with incalculable risks for the stability of world markets. And it’s all based on a mistake, an incorrect analogy with America’s situation. “Boldly they rode and well, into the jaws of Death, into the mouth of Hell…” The nobility of failure may, I suppose, be some consolation, for Abe, personally, at least.

The only really unusual thing about this particular case is the fact that the uncontrolled devaluation has been publicly announced, in advance, in a way that’s extremely credible. That makes it an unprecedented experiment – which could easily turn out to be the recipe for an unprecedented disaster.

    

Now that the Federal Reserve has hired every single pennystock trader and momentum-chasing algo in the world (or at least is enjoying Citadel's helping hand in regards to the latter) it is time for the Fed's human resources department to branch out and fill those really important gaping holes.

Great job opportunity! Penetration Tester: rfer.us/FRS5ERsd.

— Federal Reserve Jobs (@FedReserveJobs) May 18, 2013

h/t @shark_wahlberg

    

It was less than a month ago that the new Italian government of the pseudo-technocrat Letta, of Bilderberg 2012 and Aspen Institute fame, was voted in by a majority of the PD and the PDL parties (the latter agreeing so Berlusconi would get an extension of his much needed political immunity from assorted prison sentences). It may not last too long. As Reuters reports, it took just 20 days for Letta's approval rating to plunge by 25%, dropping from 43% at the start of the month to 34%, according to an SWG institute poll. It would appear the Italian people (unlike their Japanese peers who at least according to government-controlled media data could not be happier with PM Abe, supposedly because of the bubblelicious 50% rise in the Nikkei225 year to date, even though under 20% are actually invested in the stock market making one wonder just how credible polling, and all other data in Japan actually is) don't have Mrs. Watanabe's childish fascination wth soaring stock bubbles, sexy bonds, mini skirts and 2% inflation bras, and instead demand real economic results. Which also means the protests are once again back.

Thousands of people protested in Rome on Saturday against austerity policies and high unemployment, urging new Prime Minister Enrico Letta to focus on creating jobs to help pull the country out of recession.

 

"We hope that this government will finally start listening to us because we are losing our patience," said Enzo Bernardis, who joined the sea of protesters waving red flags and calling for more workers' rights and better contracts.

 

Less than a month in power, Letta is trying to hold together an uneasy coalition between his center-left Democratic party and the center-right People of Freedom, led by former prime minister Silvio Berlusconi.

 

Confidence in the government, cobbled together after inconclusive elections, is already falling, with one poll on Friday by the SWG institute showing its approval rating had dropped to 34 percent from 43 percent at the start of the month.

 

"We can't wait anymore" and "We need money to live" were among slogans on banners held up by the crowds.

 

Letta promised to make jobs his top priority when he came to power in April after two months of political deadlock. But several protesters complained he was not sticking to his vow, focusing instead on a property tax reform outlined this week.

The people's chief demand: end that perpetual scapegoat for everything that is wrong in Europe, "austerity" (the same austerity that was never actually implemented but since it distracted from politicians' gross incompetence, it was a handy propaganda tool). The problem, as all those who are even remotely familiar with finance know is that in a Keynesian world, it is all about credit creation - the same credit creation which can no longer take place in Europe for the various reason explained before.

Union leaders said he needed to shift away from the austerity agenda pursued by former Prime Minister Mario Monti, who introduced a range of spending cuts, tax hikes and pension reform to shore up strained public finances.

 

"We need to start over with more investment. If we don't restart with public and private investments, there will no new jobs," said Maurizio Landini, secretary-general of the left-wing metalworkers union Fiom.

 

Italy is stuck in its longest recession since quarterly records began in 1970, and jobless rates are close to record highs, with youth unemployment at around 38 percent.

 

Other protesters were pessimistic that Letta's fragile government would be able to take effective action.

Of course to get "investments", one needs funding, and the problem is that virtually all sovereign bond issuance - for now driven by the BOJ's monetization-facilitated carry trade impulse - is going to indirectly prop up the local insolvent banking system, not to fund public spending. That too will become clear in due course, but for now there is hope.

However, even the hope is running out, leading to the people's, accurate, conclusion:

"This government will last a very short time," said demonstrator Marco Silvani. What we need is a new leftist party that fights for the rights of the people," he said.

Or, in other words, the same left party "solution" that France got and that has managed to crush the local economy to a double-dip recession in just one year.

    

While it does have all the impromptu genuineness of a made for C-Span soap opera, the following exchange between Rep. Mile Kelly (PA) and the IRS' commissioner Miller was the highlight of yesterday's grilling of the IRS by the House Ways and Means committee, because rehearsed or not, it does capture the prevalent sentiment the US public harbors not only toward its tax collectors, but the government in general.

"The IRS can do almost anything they want to anybody they want any time they want. This is very chilling for the American people.... This is a Pandora's box that has been opened. The American people should be outraged and they are. This has nothing to do with political parties - this has to do with highly targeted groups. This reconfirms everything that the American public believes. This is a huge blow to the faith and trust the American people have in their government. Is there any limit to the scope of where you folks can go? Is there there any question that you should have asked: how much money do you have in your wallet, who do you get emails from, whose sign do you put up in your front yard: this ia tax question? The fact that you all can do just about anything you want to anybody: you can put anybody out of business any time you want.... I think the American people have seen what's going on right now in the their government. This is absolutely an overreach and this is an outrage for all Americans."

And while contemplating these questions, let's make government even bigger, and also why has that pesky Second amendment not been overturned yet?

    

There is a reason why in Europe, no matter how much some want to deny it, the Cyprus deposit confiscation "resolution" has become the norm. Quite simply "Europe's economy struggles with too many banks, too much debt and too little growth. A long history of empire, trade, war and commerce means a long history of banking. The world’s first state-guaranteed bank was the Bank of Venice, founded in 1157, and the world’s oldest bank today is also Italian, Monte Paschi di Siena (founded 1472). In many European countries, bank assets dwarf the size of the local economy and are far in excess of other regions in the world. This is similarly reflected in the local stock exchanges: even now financials account for 42% of the Spanish stock market and 31% of the Italian stock market versus  ust 16% in the US."

Visually, this translates as the following dramatic chart, which shows why Europe no longer has a choice in kicking the can, and what we have said from the very beginning, a Mellonesque asset liquidation of bad "assets" is the only option:

It is in Europe that the biggest debt burden lies, and it is Europe that is desperate for the biggest inflation impulse to purge away the debt in the absence of liquidation, or a spike in asset quality. However, as we showed yesterday with Europe's €500 billion NPL timebomb, the asset quality of Europe's banking sector is imploding at an unprecedented pace, and is correlated most tightly to the surging unemployment in the periphery, which intuitively makes much sense: without jobs, consumers can't pay off their debt.

NPLs:

... compared to unemployment:

This means that the only resolution to a massively overlevered banking sector, where inflation just refuses to arrive and assist in the bad-asset "cleansing", is the start of liability impairment, which will allow the long overdue process of balance sheet restructuring, instead of merely can kicking, to commence. Whether this implies deposit confiscation, well that matters in which country one is, and how many NPLs have been accumulated.

And another problem: the reason why core inflation is gone from Europe is that not only is the hot central bank money not targeting European assets (except for new Japanese Yen chasing after peripheral bonds for as long as there is a carry trade arb, which at this rate won't last long), but because credit creation in the private sector is dead: as the chart below shows, even credit growth in Germany is now negative:

So what is the only option for a continent in which there are simply too many encumbered assets (recall that unlike the US the bulk of credit in Europe is secured - perhaps the starkest difference between the two credit systems) and in which the private sector credit creation pipeline is clogged: simple - the ECB has to join the Fed and the BOJ in monetizing assets, and creating "credit growth" de novo. Alas, as the past three years have shown, when it comes to outright monetization in Europe, not only does it have to be sterilized to appease the (correctly) inflation-weary Germans, but most likely has to come in the form of a structured debt vehicle or an extended loan, like the ESM or the LTRO.

In fact, none other than former ECB member Lorenzo Bini Smaghi told Goldman's Allison Nathan in a recent interview that QE by the ECB - an outcome most expect once the impact of BOJ QE fizzles - is unlikely. The reason why:

Lorenzo Bini Smaghi: QE in Europe would likely entail the ECB purchasing a representative basket of Euro area government bonds. And so they would probably have to buy large quantities of German and French bonds, rather than the bonds of countries that could use more support; the impact on spreads would not necessarily be in the right direction. So from a technical point of view, the case for QE in Europe is less clear cut.

Needless to say, his outlook on Europe is less than optimistic:

Lorenzo Bini Smaghi: In 15 years I'm a bit more confident because I think the adjustments will have been made. Europe will become more competitive and stronger. So I am a long-term optimist. But I am also a short-term pessimist; the near-term adjustment is maybe a bit too tough and too front-loaded so the next five years are going to be very difficult.

And to think all of this could have been avoided if the Mellon advice of liquidating bad assets, which have accumulated in massive proportions in Europe (and in the shadow banking system in the US, but that is the topic of a different post), had been heeded, as we suggested, from the very beginning. To quote Andrew Mellon:

The government must keep its hands off and let the slump liquidate itself. Liquidate labor, liquidate stocks, liquidate the farmers, liquidate real estate. When the people get an inflation brainstorm, the only way to get it out of their blood is to let it collapse. A panic is not altogether a bad thing. It will purge the rottenness out of the system. High costs of living and high living will come down. People will work harder, live a more moral life. Values will be adjusted, and enterprising people will pick up the wrecks from less competent people.

Of course, the time for liquidation will come sooner or later, only this time the pain and suffering that will accompany it will be order of magnitude greater than had the system been purged in the dark days following the Lehman collapse.

    

Japan continues to be the world's biggest financial story. The consensus seems to be that the country's extraordinary economic measures are good for both itself and the world. I've detailed previously how Japan's efforts are likely to have terrible domestic economic consequences, whether they succeed or not. Today, I'm going to explore the latter idea: that Yen depreciation will benefit other countries as they'll depreciate their own currencies, which will make their economies more competitive too. This idea, put forward by some serious financial commentators, is laughable as it ignores both history and any sense of simple logic. The implications are worth exploring though as competitive currency devaluations have already begun and are likely accelerate from here.

Better figures, but...

First, let's provide some context by looking at recent events in Japan. Over the past week, Japan released GDP figures for the first quarter of 2013 which showed growth of 0.9% from the previous quarter, versus expectations of a 0.7% rise. Annualised, GDP grew 3.5%, the fastest in a year, and topped a 1% rise in the fourth quarter of last year.

Ironically, Japan 3.5% annualised growth in the first quarter crushed most other developed countries, including the U.S., where there's supposed to be meaningful recovery going on (it recorded 2.5% growth).

Looking under the hood at Japan's figure though, the result wasn't that impressive. That's because the GDP figure is a real figure, rather than a nominal one. Adjusted for a larger than expected GDP deflator (a measure of domestic prices) of -1.2%, nominal GDP grew 0.4% from the previous quarter, less than analyst expectations of 0.5%.

On the positive side though, private consumption and exports did trend up. Consumption rose 0.9%, as expected, and was up for a second consecutive quarter. This suggests that consumers may be buying into Abenomics (the nickname for the Japanese Prime Minister's new policies) and willing to spend more. Exports also contributed 0.4% to GDP as they benefited from a 30% decline in the Yen since November last year.

Separate figures gave contradictory signals as to whether Japanese businesses are buying into Abenomics. Machinery orders in March increased 14% from the prior month, or 2.5% from the previous year. This beat expectations for growth of 3.5% and -4.9% respectively. The machinery orders figures ran counter to earlier numbers which showed capital spending for the first quarter declined 0.7%.

All in all, the economic data show mild improvement. Whether there's a sustained future bounce is the big question. There are two things that will indicate whether Japan's policies are starting to have a real impact: rising inflation and wages. Both haven't happened yet and the latter especially is critical to policy success.

Bond yields spike 

The other interesting action of the past week has been in Japan's bond markets. Japanese government bonds (JGBs) have had a spectacular sell-off over the past week. Yields on 10-year JGBs rose by half of its value at one stage. This was despite buying from the Bank of Japan (BoJ) of government bonds ranging from 1 to 10 years to the tune of 1.2 trillion yen (US$12 billion).

The economic bulls argue that rising bond yields mean the economy is starting to normalise and that the Bank of Japan (BoJ) is succeeding in its aim to spur inflation (which will drive yields higher).

The bears suggest that increasing yields are a terrible sign as they mean liquidity in bonds is drying up as the market becomes increasingly controlled by a single buyer, the BoJ.

Either way, the BoJ is now buying 70% of new government debt issuance and that is likely to increase going forward. The government can't allow bond yields to rise as this will mean interest on government debt rises too. Japan is in an unenviable position on this front as interest on government debt already consumes more than 25% of government revenue. A further sharp rise in bond yields will be a disaster.

While it's clear that the BoJ can partially control the bond and equity markets (it's buying stocks too), it has less direct control over the currency market. The yen has had an extraordinary tumble since the new government came to office in December. With more money printing to come, the yen is almost certainly heading much lower though. That's despite being clearly oversold in the very short-term.

Yen decline is good for Europe?

A conscious decision to devalue the yen may or may not work in Japan (I've argued the latter for some time). But a related question is whether that decision is good for countries outside Japan.

I have addressed this question briefly before. But I thought it was worth going into some more detail given the issue has garnered more debate over the past month.

In particular, there's been an argument gaining traction in serious economic circles that the yen's decline will be good for other countries as it will force them to print money in order to lower their own currencies and remain economically competitive. This is particularly the case for European exporters, such as Germany, which are being hurt by the rising competitiveness of Japanese exporters due to the lower yen.

U.S. economics professor, Tim Duy, makes the case:

"... this [yen depreciation] is exactly what the global economy needs right now. If Germany and by extension Europe experiences weaker growth, European policymakers will need to respond. And they are not likely to respond by buying Yen to hold its value up. They are likely to respond by stimulating their domestic economy directly via easier monetary policy and, hopefully, easier fiscal policy.

In other words, successful domestically-orientated policy in Japan will have second-round effects that will induce further policy easing [in] Europe. And a good kick in the pants in Europe is exactly what we need right now. Rather than thinking about Japan's policy as triggering "competitive devaluations", think of it as triggering "coordinating global easing."

And an assistant U.S economics professor, David Beckworth, similarly argues:

"The ECB [European Central Bank] may ease to keep the Euro from getting too expensive and in the process shore up European domestic demand. How ironic it would be if Abenomics were to accomplish in the Eurozone that intense human suffering could not: moving the ECB to forcefully act."

I cannot think of a more preposterous and dangerous idea than that being put forward by these seemingly eminent individuals. Let's put aside the idea that countries are made stronger by weakening their currencies, which history has refuted time and time again.

No, let's focus instead on drawing out their argument to its logical conclusion. If Europe abandons austerity (which it has never really pursued) and prints money to significantly weaken its currency, this would start to equalise the competitiveness of the likes of German exporters against Japanese exporters.

In other words, Japan's exporters are gaining global share at the moment vis-à-vis the Europeans due to its lower currency. These gains would reverse if Europe depreciates its own currency.

Naturally, the Japanese wouldn't be happy with this at all. They would print more money to accelerate the depreciation of the yen. The Europeans would again retaliate upon losing export share. And so it would go on. Overall, any gains through currency devaluation would be short-lived.

But that's not the end of it. If you assume that other countries follow Europe in devaluing their own currencies, then the whole world would be after lower currencies. This would be of little benefit to Japan. Put simply, Japan's policies depend on other countries not following their lead.

It's not hard to see a currency fight turning more nasty. If Japan can't gain an advantage from deliberate yen depreciation, it's likely to try other means. Those other means include increased tariffs and/or trade sanctions. Once this happens, global trade would be hit and everyone would lose.

The above discussion has left aside the real reason for Japan's currency deprecation: to import inflation. A declining yen makes imports more expensive, thereby potentially inducing higher inflation. That's what Japan is targeting. I'll leave this issue for another day though.

When does retaliation begin in earnest?

This brings us to the issue of when the rest of the world will begin to react to Japan's policies in earnest. Of course, some countries have already reacted. Recently, South Korea and Australia surprised with interest rate cuts. Switzerland and New Zealand have moved directly to cap their currencies. And Thailand and the Philippines are looking to move soon. It's clear that Japan's weak yen policies are already having a large impact on other countries.

Other major exporting countries such as Germany and China are clearly worried. Both have expressed concerns about Japan's policies as their own respective currencies have strengthened considerably, particularly in yen terms.

If you're like me and expect the yen to continue to decline over the next 12 months, it won't be long before so-called currency wars start to intensify. And unlike the economic ideologues who think that everyone will win when this happens, I think the reality is likely to prove very different.

This post was originally published at Asia Confidential: http://asiaconf.com/2013/05/17/why-japan-is-bad-for-the-world/

    

Five days ago, when describing the launch of the joint-US, South Korean naval military exercise in the East Sea, we said that "for all his endless posturing, North Korea's Un has done absolutely nothing. And if his inability and unwillingness to translate threats into actions continue, that will pretty much be it for North Korea's hope to even get a few loose pennies as a nuisance factor" be it from the US, Japan, South Korea, or anyone else who is listening. It seems the South Korean leader has taken the hint, and overnight escalated from merely constant jawboning into at least some variant of activity, when he fired three short-range missiles into the sea off the eastern coast of the Korean peninsula on Saturday, "once again stirring tensions that had appeared to ease in the wake of a recent series of bellicose statements directed at South Korea and the U.S."

WSJ reports that in a short briefing, South Korea's defense ministry said Saturday that North Korea had fired two guided missiles into waters off the Korean peninsula in the morning, followed by a third missile in the afternoon.

"In our judgement, the missiles are short-range guided missiles, not mid-range missiles such as the Musudan," defense ministry spokesman Kim Min-seok said. "South Korea's military is on high alert to prepare for any hostile acts from the North following the guided-missile launch today."

This means the launched missile is most likely the appropriately named Nodong:

Is there a reason to be concerned? Hardly, especially for those who have been following the seemingly endlessly escalating rhetoric out of NK, whose only purpose is to extract a nuisance value premium from anyone, just so it shuts up.

Shin Jong-dae, professor at the University of North Korean Studies, said the launches were more likely a means of drawing attention from the international community than a test launch.

 

"North Korea is an expert at crisis diplomacy or crisis marketing," Mr. Shin said.

 

Kim Yong-hyun, professor at Dongkuk University's North Korean Studies department, said the North appears to hope that launching missiles will prompt an offer of dialogue from the U.S.

Which is why ignoring the country so far has worked, however like any irrational actor whose only mode of behavior is attempting the same failed action until there is a response (like the Federal Reserve, for example), at some point North Korea, for whom the opportunity cost of actual military escalation is declining with every day it gets no appeasement from the West, may just lash out. Especially if such overt provocations as a US nuclear carrier swimming in its back yard for "naval exercises" continue.

    

    

 

The Congressional Budget Office put conservative economic thinkers on their ass this week. In this Report (pdf), the CBO concluded that the US budget deficit is about to collapse to insignificance. The improvement in the deficit outlook is so large that it has lead liberal thinkers to start calling for more stimulus spending. If it were not for the three scandals brewing for Obama (Benghazigate, IRSgate and APgate) I think there would be calls to spend some more government money.

The CBO assessment of the deficit profile relies on every trick in the book. The assumption is that all of the variables that weigh on the deficit will be improving over the next few years. Tax collections will remain at historically high levels. Government spending will decline as the economy improves. Fannie Mae and Freddie Mac will be kicking $95Bn into the coffers. Social Security will cost less than previously thought, the same favorable result is assumed for both Medicare and Medicaid. And of course, there will be no wars or military incursions that have to be paid for. But, by far, the biggest driver of the reduced deficits will come from a robust economic recovery that is set to occur. This is the CBO forecast for top line GDP growth:

 

 

Wow! 6.5% growth is coming our way! Don't worry at all about the endless recession in Europe. Don't consider the rapid slowdown in China either. And please don't worry about the fact that the Fed is going to be taking its foot off the gas over the next 24 months - all that won't make any difference. The USA is set for a spurt of growth not seen for years.

What could the CBO be hanging its hat on when making this bold predictions of rapid economic expansion? I wonder if the CBO is relying on Obamacare to provide the big boost. This is the only significant economic development on the horizon. It will change everything when it's finally implemented. It will result in 32 odd million more people having access to healthcare. And when those people do have health insurance, they will be going to Doctors, getting treatments and medicines. And with those visits and related spending, the economy will get a lift - at least that is the thinking.

 

There is some evidence that Obamacare is going to ratchet up health spending. The New England Journal of Medicine has done a study on the results of an experiment in Oregon. Some 6,000 people were given access to Medicaid for two years. There was a control group of another 5,000 people who did not get access to health insurance. What did those who won the lottery for the free health benefits do? They went to Doctors of course. The study showed that those with insurance were 2Xs more likely to visit a doctor, and would take twice as many prescription drugs. Obamacare will result in an increase in medical diagnostics; the number of MRI's, X-rays, blood test etc. will increase markedly when free health insurance is available. The cost of all these new medical services will add to GDP, and increase employment in healthcare.

The Oregon study showed that healthcare spending rose by $2,750 for those who had access to Medicaid versus the control group. If these results are applied to all of the 32m people who have no insurance today, it would result in an increase in spending of $90Bn - that comes to 5.5% of GDP. While not all of that spending is going to happen, its pretty clear that Obamacare is going to ramp up the economy by a meaningful amount - a 2% net increase in economic activity is possible.

 

To the extent that Obamacare is measured as a jobs program it may be considered a "success". More medical spending will be the result. The larger question of what it will do for the health profile of Americans is not at all a sure thing. I was surprised by the conclusions drawn by the Oregon study:

 

This randomized, controlled study showed that Medicaid coverage generated no significant improvements in measured physical health outcomes in the first two years

 

The reason why overall health results were not improved for those with insurance was interesting. People who have healthcare available to them often adopt risky behavior. For example, those who had health insurance in the Oregon study were much much more likely to smoke. (10% increase over those that did not have health insurance) This conclusion confirms what has been observed in other situations. When people have seat belts, they think they are safe, so they drive faster. It appears that the same holds true on health related matters.

The pessimist in me says that the roll-out of Obamacare is going to be anything but a success. The state insurance exchanges will not be up and running on time. Getting those 32m people to sign up for Medicaid will not happen at the pace that is currently anticipated. Obamacare will not be the economic stimulus that is hoped for, it won't improve the nations health levels by much, and it's going to cost an absolute bundle in the form of increased taxes. My guess is that in 2-3 years most folks in the country are going to hate Obamacare, but it it will be impossible to get rid of by then.

 

    

The US dollar posted strong across the board gains. It is being driven by the anticipation of favorable developments in the US, in the form of a possible slowing of the Fed's asset purchases, and less favorable developments abroad.

While it is technically poised for additional gains, the biggest risk to the dollar comes from Fed Chairman Bernanke's midweek testimony.  His commitment to QE and readiness to taper purchases, as others have suggested, will be closely scrutinized.  The failure to confirm these growing market ideas, spurred in part by comments from two (non-voting) regional Fed presidents, could prompt some profit-taking on long dollar positions.

While speculation that the Fed may take one of its feet off the accelerator in the next week month helped lift the dollar, other countries are easing policy.  There has been even more talk about the ECB adopting a negative deposit rate.  Continued sub-50 readings in the flash PMI,  due midweek, will heighten the sense that the euro zone continues to contract for the seventh consecutive quarter.

The ongoing decline in the yen is meeting little official resistance. Chinese officials, for example, seem more upset by comments by the mayor of Osaka (which the US also criticized for being "outrageous") then they about the depreciation of the yen. The US Dollar Index has risen 3.7% from the low on May 1 to its best level since 2010, and it recording its best two week run since in a year.

Euro:   A large head and shoulders pattern is being carved out.  The neckline is seen near the late March and early April lows around $1.2740.  Below there is the low from last November near $1.2660, which is just below the $1.2680 retracement objective ($1.2680) of Draghi's OMT induced rally.  The measuring objective of the head and shoulders pattern would carry the single currency below $1.20, our year-end target.  The euro's 50-day moving average crossed below the 200-day (golden cross) for the first time since last October.

Yen:   The pullbacks in the US dollar continue to be shallow.  This is not giving the longs any pain and it gives many momentum and trend followers a sense that it is a one way bet, a mindset that often proves dangerous.  Support now is seen in the JPY102.35-60 area.  Although there are reports of option structures before, many have their sights set on JPY105.

Sterling:  The upside correction from the mid-March low near $1.4830 has ended decisively.  That correction had held a up trend line, which sterling closed below at the start of the week near $1.5350.  A convincing break now of $1.5120 area suggests a return to, and likely a break of, this year's low.  Sterling has also broken below a trend line connecting the lows of the past three years.  This sours the longer-term outlook and warns of a move toward $1.42.

Canadian dollar:  The US dollar is flirting with trend line resistance against the Canadian dollar going back to 2011.  The year's high was set on March 1 near CAD1.0340.  A break of it opens the door for a move toward CAD1.05-CAD1.06.

Australian dollar: The Aussie has fallen out of favor in a big way.  It has been aggressively sold-off; the largest decline over a 10-day period in more than a year and a half.  It has convincingly broken a trend line drawn off the 2011-2012 lows that came in just above $0.9800.   An investment bank called for a move to $0.8000.  This corresponds to the 2010 lows and a 61.8% retracment of the post-Lehman rally.  It may be a reasonable longer-term objective, and by the OECD's purchasing power parity model,  the Australian dollar is almost 30% over-valued.  However, given the difficulty in forecasting exchange rates and the substantial risks that are involved, as well as mitigating factors like Australia's triple-A credit rating and a currency that is gaining recognition as a reserve asset, we suggest medium term investors should anticipate half of that move, or $0.8900-$0.9000 and place stops accordingly.  

Mexican peso:  Over the past year, the Mexican peso has appreciated by 11.5% against the US dollar; making it the strongest among the G7 and liquid emerging market currencies.   While we recognize attractive underlying fundamentals, technical factors have made us more cautious.  A dollar bottom has been carved out over the past month.  The long peso position remains large and a move above MXN12.40 could spur a further dollar short squeeze.  A correction could carry the greenback into a MXN12.60-MXN12.80 range.

Observations from the latest CFTC report of the CME currency futures:

1.  Participation rose as new gross positions were established across the board, with two minor exceptions, short Canadian dollar and short Mexican peso positions were trimmed.  

2.  There were 4 substantial (more than 10k contracts) position adjustment and they were all adding to the gross short positions:  euro, yen, Swiss franc, and Australian dollar.  

3.  The 36% rise in gross short Australian dollar positions to a record 75.1k contracts was sufficient to switch the net position to the short side for the first time since last June.  Nevertheless, the gross long position remains the second largest among the currency futures, behind the Mexican peso.

4. The gross short euro position is just below 100k contracts.  Last June, as the tensions were mounting that led to the Draghi's OMT offer, the gross short position was 250k contracts.  The gross short sterling position is approaching the record from March of 105k contract.  The price action and the increase in open interest since the CFTC period ended suggests new shorts have been established.  

    

Submitted by Michael Krieger of Liberty Blitzkrieg blog,

I’d like to say that the following is unbelievable, but it’s not.  Unfortunately, it is all too believable.

From ABC:

The Internal Revenue Service official in charge of the tax-exempt organizations at the time when the unit targeted tea party groups now runs the IRS office responsible for the health care legislation.

USA! USA!

Sarah Hall Ingram served as commissioner of the office responsible for tax-exempt organizations between 2009 and 2012. But Ingram has since left that part of the IRS and is now the director of the IRS’ Affordable Care Act office, the IRS confirmed to ABC News today.

 

Her successor, Joseph Grant, is taking the fall for misdeeds at the scandal-plagued unit between 2010 and 2012. During at least part of that time, Grant served as deputy commissioner of the tax-exempt unit.

 

Grant announced today that he would retire June 3, despite being appointed as commissioner of the tax-exempt office May 8, a week ago.

 

“Obamacare empowers the agency that just violated the public’s trust by secretly targeting conservative groups,” Rep. Marlin Stutzman, R-Ind., added. “Even by Washington’s standards, that’s unacceptable.”

 

Sen. John Cornyn even introduced a bill, the “Keep the IRS Off Your Health Care Act of 2013,” which would prohibit the Secretary of the Treasury, or any delegate, including the IRS, from enforcing the Affordable Care Act.

 

“Now more than ever, we need to prevent the IRS from having any role in Americans’ health care,” Cornyn, R-Texas, stated. “I do not support Obamacare, and after the events of last week, I cannot support giving the IRS any more responsibility or taxpayer dollars to implement a broken law.”

Pure 100% unadulterated Banana Republic.

Full article here.

    

The following map (via AON) measures the risk of political violence to international business in 200 countries and territories, based on three icons indicating the forms of political violence which are likely to be encountered: Terrorism and sabotage; Strikes, riots, civil commotion and malicious damage; and Political insurrection, revolution, rebellion, mutiny, coup d'etat, war and civil war.

 

click image for huge legible version

 

Notable Risk Trends:

    

Submitted by Adam Taggart via Peak Prosperity blog,

Everyone knows the odds of winning in a casino are worse than 50% (often much worse depending on the game played). So who wouldn't rush to a casino where, instead, the odds were overwhelmingly in the gambler's favor?

That's the promise of today's stock market, which has been experiencing an aberrantly high percentage of up days all year. Toss your money into the market and on any given day, you're much likelier to make money than not.

So far, May 2013 has been a gambler's paradise, in which a whopping 76.9% of the trading days for the S&P 500 have been up:

The chart below shows just how far 2013's up day percentage exceeds previous years:

Of course, none of this boondoggle is merited by the underlying fundamentals, which clearly are not good.

But if you're one of the top 10% of Americans that owns 81.2% of all stock market wealth, send a bottle of Bollinger to Ben and his buddies at the Federal Reserve as thanks for keeping the punch bowl so nicely spiked:

(Source)

However, if you're one of the 9% of Americans who actually understands the concepts of "reversion to the mean" and "overshoot", you may want to run -- not walk -- to cash in any chips you may still have on the table. But if you have to keep money in the stock market, be sure to work with a prudent financial adviser that prioritizes risk management and is skeptical of today's easy winnings.

Like all good benders, this is going to end with one heck of a hangover...