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Superpower Blunders: Czechoslovakia In 1938

Submitted by Erico Matias Tavares of Sinclair & Co.

Superpower Blunders: Czechoslovakia In 1938

The Czechoslovakia crisis of 1938 marked a pivotal shift in the balance of power in Central Europe, putting the major world superpowers in a collision course. The policies of one superpower in particular made inevitable what was to come less than a year later - World War II.

This episode provides important historical insights on geopolitics, appeasement strategies, buffer zones, ethnic tensions – and unintended consequences.


Czechoslovakia was formed as a sovereign state in October 1918, and eventually became one of the most democratic, prosperous and best administered of all the nations that emerged out of the collapse of the Habsburg Empire after World War I.

In 1930, the country had a population of 15 million, consisting of 6 million Czechs (40% of total), 4 million Slovaks (27%), 3.2 million Germans (21%), and the balance (12%) split between Hungarians, Polish, Ruthenians and foreigners. The large number of minorities arose from the need to give Czechoslovakia defensible and viable frontiers. This was a sensitive issue for the sizeable German speaking population, which had previously attempted to unite with German Austria.

There were four main regions in the country (listed from west to east): Bohemia, Moravia, Slovakia and Ruthenia. The western regions were wealthier. The border districts of Bohemia and Moravia and the domestic portion of Silesia were inhabited primarily by German speakers, a region known as the Sudetenland (a name derived from the Sudetes Mountains, which run along the northern border).

The Sudetens were unhappy with the state of the Czechoslovak union, and not just because of their longing to reunite with whom they perceived to be their cultural brethren. Their region had been the most industrialized of the Habsburg Empire, and suffered disproportionately from the curtailment of markets pursuant to the new territorial division; they were largely at the “giving end” of the country’s agrarian reforms; and the government was primarily controlled by the Czechs.

Their discontentment became even more pronounced after the onset of the world depression in 1929. Hitler’s subsequent rise to power and the perception that his policies were restoring Germany to its former glory only added more fuel to the fire. And before long, tempers were boiling over.

The Sudeten Issue

Only a part of the Sudetens were Nazis, but these were noisy, organized and funded from Berlin. Accordingly, their numbers grew steadily. The Czechoslovak government became alarmed with this development, banning the Nazi Party in 1934. Under Konrad Henlein, however, it merely changed its name to the Sudeten German Party (“SdP”) and promptly became the agent for Hitler’s campaign in the country.

As a result of Henlein’s insistent demands, the government progressively granted more autonomy to the Sudetens, including a proposal for full local administration by 1937. While he evidently could not state this publicly, Henlein’s real intent was to tear apart the Czechoslovak state. Therefore, he kept increasing his demands to the point where he and Hitler knew would became unacceptable, particularly as they undermined the country’s fortified security in the north against Nazi Germany.

On 24 April 1938, the SdP issued the Karlsbader Programm, demanding full autonomy for the Sudetenland and the freedom to profess Nazi ideology. If Henlein’s demands were granted, the region would be able to finally align itself with Nazi Germany.

Czechoslovakia's political crisis was now in full bloom. And the government found little help from its Western counterparts.

Choosing a Lesser Evil

Despite its internal struggles, Czechoslovakia featured impressive military capabilities. Its army consisted of 34 divisions, ranking amongst the better equipped in Europe; it had an excellent fortification system (provided the configuration of its borders remained intact); and it had alliances with France, the Soviet Union, as well as Romania and Yugoslavia under the Little Entente.

After the Anschluss, Nazi Germany’s invasion of Austria, Bohemia was surrounded on three sides. However, Hitler could not safely invade this region as the Czechoslovaks could counter from their fortified base into Bavaria.

As it turned out, Hitler relied on more than just political subversion to break any military stalemate, and from an unlikely source: his major Western European adversaries.

Seemingly fearful that Czechoslovakia could never stand up to Nazi Germany after its invasion of Austria, not even if the Soviets came to its aid, the British government of Neville Chamberlain started putting pressure on key counterparts to reach a political compromise – and particularly on the Czechoslovaks to make concessions to Hitler in exchange for assurances of non-aggression. The idea was to turn the country into a neutral territory like Switzerland, with no significant military alliances and whose peace would be guaranteed by France and Nazi Germany.

In addition to avoiding a direct military confrontation, there was an undertone to Chamberlain’s appeasement overtures towards the Nazis: creating a strong buffer zone against the Soviet Union. In Britain’s assessment of the balance of power in Central Europe, Hitler was perceived as a lesser evil than Stalin. And should Nazi Germany’s influence ever start to get out of bounds, even at the expense of the French, the Brits could counter it by closely aligning themselves with the English-speaking world – including the United States.

The French, Germany’s fiercest adversaries over the previous hundred years, had similar concerns when looking out to the East. The fear of Bolshevism was pervasive in political circles, particularly amongst influential conservatives, who viewed the fall of Czechoslovakia as a way to undermine Stalin’s aspirations in Central Europe. Moreover, sitting behind the fortified Maginot line, the French government did not want to face Nazi Germany alone and increasingly took its lead from the British government.

The Soviets were thus the only significant European power seeing Hitler’s pretensions with great consternation. Right after the Anschluss, they called for consultations to stop Nazi aggression and eliminate the prospect of a major confrontation. They were dismissed outright by the British, who in turn publicly stated that they would not come to the rescue of Czechoslovakia in case of an invasion.

As we shall see, Britain’s role in this whole crisis proved decisive in many more ways than one.

The Munich Agreement

The Czechoslovaks resisted British and French pressure, and on 20 May 1938 a partial mobilization was under way in response to a possible Nazi German invasion. They were right to be cautious. Ten days later, Hitler signed a secret directive for war against Czechoslovakia to begin no later than 1 October of that year.

A new mediator appointed by the British eventually persuaded the Czechoslovak government to agree on a plan acceptable to the Sudetens, in large part because it never wished to sever its ties with Western Europe. Accordingly, on 2 September, nearly all the demands of the Karlsbader Programm were granted.

Intent on obstructing conciliation, however, the SdP held demonstrations that provoked police action on 7 September. The Sudetens broke off negotiations on 13 September, after which violence and disruption ensued. As Czechoslovak troops attempted to restore order, Henlein flew to Germany, and on 15 September issued a proclamation demanding the takeover of the Sudetenland by Germany.

On the same day, Hitler met with Chamberlain and demanded the takeover of the Sudetenland under the threat of war, as he claimed that the Sudetens were being slaughtered. Despite an official British investigation confirming that Sudeten leaders had been behind the unrest, Chamberlain nevertheless referred the demand to the British and French governments, which was promptly accepted.

The Czechoslovaks protested, arguing that Hitler's proposal would eventually leave them at his mercy. In response, Britain and France issued an ultimatum. Chamberlain contended that the Sudetens’ grievances were justified and believed that Hitler's intentions were limited. On 21 September, Czechoslovakia finally capitulated. The next day, however, Hitler added new demands, insisting that the claims of Poland and Hungary also be satisfied.

The capitulation precipitated an outburst of national indignation. In demonstrations and rallies, both Czechs and Slovaks called for a strong military government to defend the integrity of the state. A new cabinet was installed, and on 23 September a decree of general mobilization was issued. The Soviet Union announced its willingness to come to Czechoslovakia’s assistance. The Czechoslovak President, however, refused to go to war without the support of the Western powers.

As all of this was unfolding, the British and French governments took steps to align public opinion with their ultimatum on Czechoslovakia. Accordingly, a war scare with Nazi Germany was built up by grossly exaggerating its military capabilities, reaching full panic mode by 28 September.

On that day, Chamberlain reached out to Hitler for a conference. Hitler met the following day in Munich with the government heads of France, Italy and Britain; all signed what would be known as the Munich Agreement. The Czechoslovak government, which was neither invited nor consulted, capitulated on 30 September and agreed to abide by the agreement.

Czechoslovakia’s Borders After the Munich Agreement

The Munich Agreement stipulated that Czechoslovakia must cede the Sudeten territory to Germany, with its occupation completed by 10 October. An international commission would supervise a general vote to determine the final frontier. Hungary and Poland would also get lands and people. Britain and France promised to join in an international guarantee of the new frontiers against unprovoked aggression. Ominously, Germany and Italy decided not to join this guarantee until the Polish and Hungarian minority problems were settled.

A Plot to Assassinate Hitler

When Hitler signed the secret directive to invade Czechoslovakia, he set in motion a chain of events in his own country which might have changed the course of history. Unfortunately for his compatriots and the rest of the world, Hitler’s diabolic lucky charm was still with him during that time.

In that directive, Hitler clearly stated his “unalterable decision to smash Czechoslovakia by military action in the near future”. In the case of war with Czechoslovakia, whether France intervened or not, all forces should be concentrated on the Czechoslovaks in order to achieve an “impressive success” in the first three days of the invasion. Only then could forces be transferred to the French frontier. All regular forces were to be withdrawn from East Prussia in order to speed up the defeat of the Czechoslovaks. No major provision was made for a war against the Soviets. The deployment of troops would begin on 28 September 1938.

Several Nazi military leaders were in shock, alarmed by the prospect of a quick defeat by exposing so many flanks to foreign aggression. This was also shared by the entire Foreign Ministry, except for Ribbentrop, the Foreign Minister and a Nazi to the core. Hitler was isolated in his mountain retreat, cut off from any outside contacts by his inner circle. This group insisted that the Soviet Union, France and Britain would not fight and that the Czechoslovaks were bluffing.

By August the dissenters were becoming desperate. They reached out to senior foreign allies in order to make Hitler realize the folly of his plan, to no avail. Finally, a conspiracy of major generals and important civil leaders was formed to pursue the three strategies: (i) make Hitler see the truth; (ii) to inform the British of their efforts and ask them to stand firm on the Czechoslovak issue and to tell the German government that Britain would fight if Hitler made war on Czechoslovakia; and (iii) to assassinate Hitler if he nevertheless issued the order to invade.

Although many messages were sent to Britain in the first two weeks of September by senior German officials, the British refused to cooperate. Accordingly, a plan was made to assassinate Hitler as soon as the attack was ordered.

This project was canceled at noon on 28 September when news reached Berlin that Chamberlain was going to Munich to yield to Hitler’s demands. The attack order was to have been given by Hitler at 2:00 P.M. that day.

An Alternative Reality…

Even if Hitler had survived that assassination attempt, a war against Czechoslovakia might not have been as quick as he had planned for.

Germany had 22 partly trained divisions on the Czechoslovak frontier, while the Czechoslovaks had 17 first-line and several other divisions which were superior from every point of view except air support. In addition, they had excellent fortifications and higher morale. By the third week of September, Czechoslovakia had 1 million men and all its divisions under arms. The Germans increased their mobilization to 31 and ultimately to 36 divisions, but this likely still represented a smaller force.

The Soviets had about 100 divisions. While these could not be used directly against Germany, because Poland and Romania would not allow them to pass over their territory, they would have been a threat to ensure the neutrality of Poland and Hungary, effectively isolating Germany. In any case, the Soviet Air Force could help Czechoslovakia directly; the Soviets could have likely overrun East Prussia across the Baltic States and from the Baltic Sea, since it had been almost completely denuded of regular German Army forces.

France, which did not completely mobilize, had the Maginot Line fully manned on a war basis, plus more than 20 infantry divisions and 10 motorized divisions. They might have overrun Germany from the western side.

In air power the Germans had a slight edge in average quality, but in numbers of planes it was far inferior: Germany had 1,500 planes; Czechoslovakia had less than 1,000; France and England together had over 1,000; the Soviet Union may have had around 5,000.

These facts were known to the British government via their foreign diplomats and intelligence operators, and further reinforced by the messages sent by the plotting German generals in their attempts to avoid a military disaster.

… And What Actually Happened

On 5 October, five days after capitulating to the Munich Agreement, the President resigned, realizing that the fall of his country was inevitable. He was correct in his assessment.

The Munich Agreement was violated on every point in favor of Nazi Germany, so that ultimately the German Army merely occupied all the places it wanted. Hungarians and Polish followed suit, and took over large parts of the territory. As a result, Czechoslovakia was shred to pieces. The only democracy in the region collapsed. The Soviet alliance was ended and the Communist Party outlawed. The anti-Nazi refugees from the Sudetenland were rounded up by the Prague government and handed over to the Nazis to be destroyed.

The terms of trade were substantially skewed in favor of Nazi Germany, which absorbed all the resources it could to maintain its rapid militarization. The economy in what was left of the country promptly collapsed, and had to rely on British and French aid to remain minimally viable.

Czechoslovakia had been a major manufacturer of machine guns, tanks and artillery to supply its once impressive army of 34 divisions. Many of these factories would continue producing Czechoslovak weapon designs, adding to the Nazis’ arsenal during World War II. Entire steel and chemical factories were moved out and reassembled in Austria.


In the aftermath of the Czechoslovakia crisis, Nazi Germany reigned supreme in Central Europe. Chamberlain must have been pleased because this was exactly what he intended.

And it would not be long before he realized that this had been a blunder of historical proportions.

Is the Dollar's Momentum Easing? Is Deeper Pullback in the Stock Market Likely?

The US dollar turned in a mixed performance in the last week of January.  It slipped against the euro, yen, sterling and the Swedish krona, while rising against the other G10 currencies. The Swiss franc was the weakest of the majors, losing about 4.5% of its value against the dollar, encouraged by signs the Swiss National Bank may have intervened.  


The dollar also rose against most of emerging market currencies, except for a handful of eastern and central European currencies.  The Russia ruble depreciated by nearly 10% following the S&P's removal of its investment grade status, and a compromise struck with Greece to discuss further sanctions given the increase in hostilities in east Ukraine.  


In addition to technical factors, which we pointed out last week, an important consideration that has stalled the dollar's upside momentum are the doubts about a mid-year rate hike.  The FOMC statement had upgraded its economic assessment, but did recognize the important of international developments.  Whereas we regarded that as a prudent addition, many others viewed it as an escape clause of sorts.  


The implied yield of the December Fed funds futures contract fell 3.5 bp on the week to 41 bp. It finished 2014 at 71 bp.  The same general pattern was evident in the December 2015 Eurodollar futures.  The implied yields fell 5 bp on the week to 66.5 bp.  It finished last year at 91.5 bp.  


Our fundamental views have not changed.  We continue to think that a Fed hike in June is the most likely scenario.  We would not place much emphasis on the sub-3% Q4 14 preliminary print on Fed policy for the middle of 2015.  The preliminary estimate for GDP is subject to statistically significant revisions, especially as a third of the trade (December trade balance will be released next week) and inventory data is not yet available.  Moreover, the 2.6% pace of expansion is probably closer to what the Fed views as trend growth in the US than the 4.8% growth in April-September period.  


In addition, the FOMC statement drew attention to the divergence between market-based measures of inflation expectations and surveys.  The survey have shown much greater stability than the market-based measures, like the break-evens (comparing the TIPS yield to conventional bond yields).  This was underscored ahead of the weekend as the University of Michigan's survey found the long-term (5-10 year) inflation expectation unchanged at 2.8%.  


Our dollar bullish outlook also remains intact, though the consolidation phase against the euro, yen and sterling may continue for a few more days.  The euro has spent that last three sessions within the roughly $1.1225-$1.1435 trading range established on January 27.  Last week we suggested potential toward $1.1460.  


The dollar has traded in a JPY117.20-JPY118.80 trading range for nearly two weeks.  It has not closed above its 20-day moving average (~JPY118.20), which has capped upticks over this period. The decline in US Treasury yields and the heavier tone in equities (S&P 500 -2.0% on the week) can see the dollar move lower against the yen.  The key support of the broader range is JPY115.50.  


Sterling is interesting from a technical perspective.  It has slipped below $1.50 four times over the past seven sessions.   The RSI is neutral, but the MACDs are gentle trending higher since bottoming in the early January.    The top end of the range comes is in the $1.5225-50 area.  No inspiration is likely to come from the BOE meeting, which is most unlikely to change policy at this juncture.  More incentives will come from the three PMI reports.  The service and manufacturing PMIs are expected show modest improvement. 


The dollar-bloc currencies remain under pressure.  After the Swiss franc, the New Zealand dollar (-2.4%), the Canadian dollar (-2.1%) and the Australian dollar (-1.7%) were the weakest of the major currencies.   They have been crushed January.  Encouraged by soft data and the surprise Bank of Canada rate cut, the Canadian dollar fell 8.4% against the US dollar in January.  


The New Zealand dollar, weighed down by the end of the RBNZ mini-tightening cycle, stepped up rhetoric about the over-valued currency, and falling commodity (including milk prices), lost 6.8% against the greenback.  The Australian dollar fell almost 5% in January.  Expectations have increased that the RBA will cut rates as early as next week.  


That said, the US dollar's advance to almost CAD1.28 before the weekend may have exhausted the near-term move.  A consolidative phase would not be surprising.  If such a phase does unfold, we see initial support for the US dollar in the CAD1.2540-80 area.  


The Australian dollar shed nearly three cents in the second half of last week.   If the RBA does cut interest rates and suggest room for additional easing, the Australian dollar could spike lower, toward around $0.7640.  However, the failure to cut and provide dovish guidance could see the Aussie back toward $0.7900.  


Before the weekend NYMEX's March crude oil futures contract briefly traded above its 20-day moving average (~$47.60) for the first time since the end of last September.  It did not manage to close above it, though the June contract did.  The day before prices set a new contract low.  While the downside momentum has stalled, we would not want exaggerate the pre-weekend price action.   Given the price action, it is surprising to see how much the RSI and MACD has have corrected. There is not compelling technical evidence that an important low is in place.


The US 10-year US Treasury yield finished at new lows for the move near 1.66%.  The next technical support is seen in the 1.57%-1.61% area from 2013.  However, given the likely decline in CPI and some disappointing data (durable goods, GDP), the political storm in Europe, and the low international yields, investors should be prepared for the 10-year Treasury yield to fall to new record low.  That means below the 2012 low near 1.38% recorded the same month that the euro zone's existential crisis had appeared to peak.  


The S&P 500 lost about 2.7% in the last week of January, which is nearly the year-to-date loss. Support in the 1988 area has been tested.  A break convincing break signal a move toward 1972 on the way to 1957. A break of that lower level would open the door to a move to  1924 and the old gap from mid-October 2014 found roughly between 1905-1909.  The technical tone is poor and the pre-weekend close on its lows warns of the risk of a gap lower opening on Monday.  


Observations from the speculative positioning in the futures market:


1.  The increased volatility in the foreign exchange market has not encouraged increased position taking in the currency futures.  In the Commitment of Traders report for the week ending January 7, there was only one gross position adjustment more than 10k contracts, and it was to reduce risk.  The gross short yen position was pared by 13.2k contracts to stand at 91.2k, the smallest in since the summer.  Since early December when the dollar peaked against the yen in the spot market, the gross short yen position has been cut by 62k contracts. 


2.  Of the remaining 13 gross currency positions we track, nine were adjusted by less than 5k contracts.  The four that were adjusted by more than 5k contracts were accounted for by two currencies the Australian dollar and Mexican peso.  The speculative gross long and short Australian dollar positions increased by 6.3k (to 16.1k contracts) and 8.6k (to 65k contracts) respectively.  The speculative gross long peso position increased by 7.7k contracts to 26.7k.  The gross short position rose by 6k contracts to 71.3k. 


3.  Overall, bottom picking in the currency futures was evident.   Only the euro saw a cut in the gross long position.  It fell by 1.6k to 50.5k contracts.  It remains the largest speculative gross long position.  The increase in gross long positions, given the downtrend and net short position reflects anticipation of a pullback in the US dollar.  


4.  US Treasury bears have been punished by the continued rally.  The net short position fell to 108k contracts from 146k.  It is the smallest net short position since early December.  The gross short position was chopped by 67.3k contracts to 454.6k.  The bulls took profits, trimming their longs by 29.6k contracts to 346.7k.  

ECB Threatens Athens With Bank Funding Cutoff If No Deal In One Month: February 28 Is Now D-Day For Greece

As Deutsche Bank's George Saravelos politely puts it, "Developments since the Greek election on Sunday have moved very fast." And indeed, so far the new Tsipras cabinet, and here we focus on the words and deeds of the new finance minister Yanis Varoufakis, has shown that the market's greatest hope - that the status quo in Greece will continue - has been crushed into a pulp (and so have Greek stock and bond prices) especially following yesterday's most recent comments by the finmin in which he said that Greece "does not want the $7 billion" from the Troika agreement and that it wants to "rethink the whole program", culminating with an epic exchange with Eurogroup chief Jeroen Dijsselbloem in which Greece made it clear that the "constructive talks" are over.

And suddenly the Eurozone is stunned, because what had until now been its greatest carrot when it comes to dealing with Greece, has become completely useless when the impoverished, insolvent nation itself says it no longer needs a bailout, seemingly blissfully unaware of the consequences.

So earlier today the ECB's Erikki Liikanen, tired of pleasantries and dealing with what to Europe is a completely incomprehensible and illogical stance, one which is essentially a massive defection by Greece in the European "prisoner's dilemma", and which while leading to a Greek financial collapse and Grexit - both prerequisites to a subsequent Greek economic recovery unburdened by the shackles of the Euro - would also unleash a European depression, came out and directly threatened Greece that it now has 1 month until the end of February to reach a deal with the Troika, or else the ECB would cut off lending to Greek banks, in the process destroying the otherwise insolvent Greek banking sector.

And since only the ECB backstop has prevented a banking sector panic, the ECB is essentially betting the house, and the sanctity of the Eurozone (because after a Grexit all bets are off which peripheral leaves next) that the threat, and soon reality, of a bank run (at last check Greece had about €145 billion in deposits still left in its bank after JPM's latest estimate of €15 billion in outflows in January) will finally force Varoufakis and Tsipras to sit at the negotiating table with the understanding that not they but the Troika has all the leverage.

Reuters explains:

A deal on extending Greece's bailout deal must be found by the end of February or the European Central Bank will not be able to continue lending to its banks, ECB council member Erkki Liikanen said on Saturday. Europe's bailout programme for Greece, part of a 240-billion-euro ($270 billion) rescue package along with the International Monetary Fund, expires on Feb. 28 and a failure to renew it could leave Athens unable to meet its financing needs and cut its banks off from ECB liquidity support.


Greece's new leftist government, which aims to ease the strict terms of the bailout that have imposed harsh austerity, opened talks with European partners on Friday by flatly refusing to extend the current programme or to cooperate with the international inspectors overseeing it.


"We (ECB) have our own legislation and we will act according to that... Now, Greece's programme extension will expire in the end of February so some kind of solution must be found, otherwise we can't continue lending," Liikanen, also the governor of Finland's central bank, told public broadcaster YLE.


"I don't believe that one can hide from the realities in the economy," he said in an interview.

The question arose why when Greece already has undergone a Private Sector Involvement restructuring, i.e. a bankruptcy that however only impacted private entities and not official ones, such as the ECB, can't Greece have another debt haircut to which Liikanen responded that: "A significant debt restructuring has been carried out with private investors. The ECB cannot fund a state directly, which is what it would mean in this case."

Odd: because that is precisely what the ECB is doing with QE, when it monetizes any of a number of Eurozone deficits. To this Liikanen also had a quick response:


Well, it is, but we'll let that slide for the time being. The bigger issue is that since the ECB directly holds tens of billions of Greek debt, any impairment on this debt would crush what the ECB has been saying from day one: that it can not suffer losses on the debt it has monetized or otherwise transferred over to its balance sheet. Such an impairment would immediately destroy Draghi's credibility, and promptly lead to furious screams from around the Eurozone as taxpayers suddenly realize all too well they are on the hook for funding the Eurozone's most insolvent members, first Greece and then everyone else who has already entered a toxic deflationary spiral. And since the ECB would finally be exposed for being Europe's "bad bank", the scramble to dump as much toxic exposure on Draghi would begin in earnest in the process launching the beginning of the end of the Eurozone.

One can almost see why Greece does think it has all the leverage.

That said, Greece now also has a countdown in which it can and will have to make a decision what to do with its leverage, and precisely 28 days until its very own D-Day which is now February 28, 2015 as per today's ECB threat.

So with February now shaping up to be an even more volatile month for Europe, and thus the world, than January and December (both of which closed red) here is the full schedule of events and what the "known unknowns are" in the next 4 weeks, courtesy of Deutsche Bank.

From George Saravelos' Update on Greece

It is worth bearing in mind that the timing, scope and commitment to the policy changes announced by Greek ministers is highly uncertain, not least because the legislative agenda is likely to be directed by the leadership team of the new government rather than individual line ministries. This still leaves plenty of uncertainty on the new government’s intentions. On the more negative side, the breadth of statements was so wide and the speed with which they were made so quick, that we now consider an extension of the February 28th program expiry date as a key date within the negotiation process: Europe and the Troika are very likely to request an explicit commitment from the Greek government to close the current mission review and not reverse previous policy. The precise form such a commitment would take is unclear at this stage, but our underlying assumption is that uncertainty around the new government’s policy intentions is so high, that Europeans will request assurances before proceeding with more in-depth negotiations over the program in Q2.

In turn, the above developments will likely have important implications for Greek bank financing at the ECB. Termination of the program on February 28th renders GGB-based collateral ineligible at Eurosystem refinancing operations, but still allows Greek banks to shift funding to Emerency Liquidity Assistance. However, ELA usage is under bi-weekly ECB review and is very likely to be on a rising trend over the next few weeks: to accommodate potential deposit flight; to absorb foreigners’ refusal to roll-over t-bills that are maturing; and to absorb fresh government t-bill issuance to finance upcoming debt repayments to the IMF and other obligations. These large needs make it likely that the availability of ELA usage is itself linked to program extension above.

All of the above then leaves three things that need to be clarified over the next few weeks.

First, under what conditions would the Troika be willing to extend the program and what form would this extension take? Our initial expectation was that a technical extension would have been offered to July followed by a successor ECCL program. Recent market developments and poor budget execution leave Greece’s ECCL eligibility an open question however, and it is possible that the Troika now only accepts program extension by a full year to coincide with the conclusion of the IMF program in March 2016. Such a large extension would be more difficult for the Greek government to manage domestically.

Second, does the ECB link Greek bank ELA provision to program extension as well? Given rising usage over the next few months, we would consider this an increasing possibility.

Third, what will the Greek government’s response to these conditions be? Public statements over the last 48-hours make it particularly difficult to envisage the government’s reaction function. On the one hand an offer of a one year extension and a written commitment to close the review would be particularly difficult for the government to manage domestically. On the other hand, the suspension of ECB financing of Greek banks would be exceptionally damaging to the economy.

Here is an indicative timeline of key events that will likely provide answers to these questions:

  • Friday January 30th – Eurogroup President Dijsselbloem meets with the Greek finance minister Varoufakis and Deputy PM Dragasakis in Athens. A press conference will follow, with the meeting likely setting the tone of negotiations to follow.
  • Sunday February 1st - Greek finance minister Varoufakis meets UK finance minister Osborne in London
  • Monday February 2nd – Greek finance minister Varoufakis meets French finance minister Sapin in Paris Tuesday
  • February 2nd - Greek finance minister Varoufakis meets Italian finance minister Padoan in Rome
  • Wednesday February 4th-5th – Bi-weekly ECB review of ELA
  • Wednesday February 4th – Likely t-bill auction to cover 1bn redemption on 6th
  • Thursday February 5th - Greek parliament opens, elects new speaker of the House
  • Saturday February 7-9th Government presents legislative agenda to parliament, vote of confidence midnight Monday 9th
  • Wednesday February 11th – Likely tbill auction to cover 1.4bn maturity on 13th
  • Thursday February 12th – European Council of EU Leaders, Tsipras likely to meet Merkel on sidelines
  • Friday February 13th – Voting for new Greek President begins, EC Commissioner Avramopoulos most likely candidate as per various media reports, originating from New Democracy. Likely completed by second round on the following day requiring 151 MP majority
  • Monday February 16th – Eurogroup where Greece likely to be top of agenda, conditions for extension of program to be made explicit by now
  • Wednesday February 18th-19th- - Bi-weekly ELA review
  • Saturday February 28th – Current EFSF program expires

In sum, developments and pressure on Greece have accelerated over the last few days, with a very large degree of uncertainty around both the Greek government’s and Troika’s position on how negotiations will proceed. We expect this to be ultimately resolved by a Troika request from the Greek side to commit to program completion and the broad contours of previously committed policy, particularly with regard to structural reform. In turn, program extension may itself be linked to ongoing ECB/ELA financing of Greek banks. The precise form this request takes and the Greek government’s reaction will ultimately determine the path Greece takes in coming weeks and months.

Greeks Turn to Gold on Bank Bail-in and Drachma Risks

The Greek stock market is down over 36% year to date; the risk of global contagion in the event of a Greek exit is very real. Ordinarily such a crisis would require a massive coordinated effort from global stakeholders, perhaps directed by the IMF or some other pan-national financial body. But not in this case; the rhetoric is nationally-based and biased without unity of purpose across finance ministries. Recent official soundings from the UK and German governments saying that exposure to Greece is limited only underscores the depth of denial, ignorance and lack of consensus that exists within the euro area. A Greek exit from the euro would profoundly weaken the euro experiment and create a dangerous precedent for all future crises in the region.

The European economy is the largest middle class economy in the world. With over 400 million relatively affluent consumers it represents a massive portion of the net global economy and as such a breakup of part of it would be felt across the world in credit spreads and capital decisions for years to come. This would not have been because of Greek exit, but rather because of the inability of the authorities to manage the crisis as risks initially built up, then as bail outs were designed and implemented and then as these efforts surely failed.

We are witnesses to an epic failure of planning, statecraft and social justice. Regardless of where your politics lie, these elements are critical for a modern globally connected economy to function.

Sadly, the geopolitical backdrop is one of suspicion and hostility in the form of a festering proxy war between western and Russian interests in Ukraine and regional crisis and humanitarian catastrophe in the middle east as Syria and Iraq descend into stateless anarchy. These factors reduce the odds of a successful solution in Greece being found in time.

The share value of Greek banks cratered up to 30% Wednesday alone, before pulling back on Thursday as fears grew that the new government may not intend to soften their stance now that they are in office.

In what is probably the worst performance for the sector on record, the four major banks – Bank of Piraeus, Alpha Bank, National Bank of Greece and Eurobank – all closed more than 25% lower. Athens stock exchange closed 6.4% lower.

It marks an acceleration of the losses incurred over Monday and Tuesday in the immediate aftermath of the Syriza victory. From London’s Telegraph.

Greece’s banks have lost almost 40pc of their value in the three days since Syriza ascended to power in Sunday’s election as the dual threats of a bank run and the loss of support from the European Central Bank threaten a liquidity squeeze.

Forbes list five main causes for the collapse:

  1. Deposit flight has accelerated.
  2. ECB liquidity could be cut off.
  3. Potential public and private debt restructuring.
  4. Low profitability.
  5. Reliance on deferred tax assets – Forbes explains it as an over-reliance by Greek banks on liquidity from the state.

Greek banks are hemorrhaging deposits. The telegraph reports, “Banks also risk a repeat of the deposit flight seen in 2012. Up to €8bn of private sector deposits has been pulled out of Greek banks since November, according to Moody’s”, adding that bank deposits have fallen 5% in the last two months.

The Financial Times paints an even more dramatic picture of bank runs and capital flight.

The real danger is that the Greeks themselves lose confidence. There are tentative signs that money is again being sent abroad, as it was in mid-2012. Nikolaos Panigirtzoglou at JPMorgan points out that €350m was sent from Greece to Luxembourg money funds since the start of last week. Extrapolating to all cash flight, he estimates as much as a 10th of Greek deposits may have left already this year. If a Greek bank panic develops it will strengthen the German hand, and make negotiations that much harder.

In the event of any or all of these possibilities, gold and silver bullion will perform well as a currency of last resort.

Greek coin and bullion dealers with whom GoldCore spoke, confirmed an increase in demand for gold coins and bars in recent weeks and since the election.

GoldCore have Greek clients both in Greece and living in the UK and throughout the world. We have seen a definite upsurge in interest, inquiries and demand since the election last Sunday.

Concerns about bank holidays and also a return to the drachma have returned and Greeks are looking for ways to prevent further destruction of their wealth.

For Greeks, Storage in Switzerland remains a favoured way of owning gold.

The comprehensive guide to bail-ins: Protecting Your Savings in the Coming Bail-in Era


Today’s AM fix was USD 1,263.50, EUR 1,114.98 and GBP 837.42 per ounce.
Yesterday’s AM fix was USD 1.275.50, EUR 1,129.36 and GBP 842.25 per ounce.

Gold and silver both fell yesterday. Gold dropped 2.13% or $27.30, closing at $1,257.60/oz. Silver fell 5.78% or $1.04 and closed at $16.95/oz.

Meet Loretta Lynch – Obama’s Attorney General Nominee Who Might Be Even Worse than Eric Holder

Submitted by Mike Krieger via Liberty Blitzkrieg blog,

On matters of policy, Ms. Lynch called capital punishment “an effective penalty” and said she disagreed with Mr. Obama’s statements that marijuana was no more harmful than alcohol. She called the National Security Agency’s collection of American phone records “certainly constitutional, and effective.”


– From the New York Times article: Criticism of Holder Dominates Hearing on Loretta Lynch, Attorney General’s Possible Successor

Eric Holder made a career out of protecting and coddling financial oligarchs (his 1999 memo essentially invented “Too Big to Jail”). This was such a lucrative decision for Mr. Holder, that it allowed him to climb all the way to the top of his profession. The dividends that supporting this man ultimately paid to Wall Street criminals were priceless. Not only were they bailed out despite wrecking the U.S. economy, they have since funneled all of the wealth gains since 2008 to themselves, while remaining above the law. This truly remarkable heist is what both Barack Obama and Eric Holder will be remembered for by history. Congratulations guys.

When Eric Holder announced his resignation, many of us breathed a sigh of relief thinking it can’t get much worse, but not so fast. The authoritarian streak and rampant cronyism of the Obama administration is a well oiled machine. You didn’t think you’d get off that easily did you? Enter Loretta Lynch.

I’ve touched upon Mrs. Lynch’s record previously, in the post, Wall Street Journal Reports Obama’s Attorney General Nominee Has Been Involved in $904 Million in Asset Forfeitures. Here’s an excerpt:

As a prosecutor Ms. Lynch has also been aggressive in pursuing civil asset forfeiture, which has become a form of policing for profit. She recently announced that her office had collected more than $904 million in criminal and civil actions in fiscal 2013, according to the Brooklyn Daily Eagle. Liberals and conservatives have begun to question forfeiture as an abuse of due process that can punish the innocent.

Naturally, that was just the tip of the iceberg. What we have learned from her ongoing confirmation hearing is that she’s a lover of NSA spying and the death penalty, while disagreeing with the statement that “marijuana is no more harmful than alcohol.”

I wonder if she has much personal experience to base this opinion on, or if it’s just more of the same we “know what’s best for you plebs, despite the fact that we have no idea what we are talking about.”

Meet the new Attorney General, same as the old. From the New York Times:

Ms. Lynch had steeled herself for tough questioning from a new Republican-controlled Judiciary Committee, particularly on her views of President Obama’s immigration policy. But the questioning was mostly cordial, and, most important, the Republicans on the committee who hold the key to Ms. Lynch’s confirmation — she needs three of their votes to proceed to a vote by the full Senate — showed little opposition.

Of course it was cordial. Other than perhaps immigration, she basically espouses complete and total neo-con principals.

On the issue of immigration, Ms. Lynch said she found it “reasonable” that the Justice Department had concluded it was lawful for Mr. Obama to unilaterally ease the threat of deportation for millions of unauthorized immigrants. Mr. Holder similarly endorsed that view.


Democrats see some Republicans, such as Senators Lindsey Graham of South Carolina, Orrin G. Hatch of Utah and Jeff Flake of Arizona, as possible confirmation votes. Mr. Flake said he had made no decision on Ms. Lynch but had come away with a favorable impression and expected that she would be confirmed.


On matters of policy, Ms. Lynch called capital punishment “an effective penalty” and said she disagreed with Mr. Obama’s statements that marijuana was no more harmful than alcohol. She called the National Security Agency’s collection of American phone records “certainly constitutional, and effective.”


Senator Sheldon Whitehouse, a Rhode Island Democrat on the panel, said she had given “a flawless performance.” Senator Richard Blumenthal, Democrat of Connecticut, called her testimony “among the most accomplished and impressive that I’ve seen as a member of this committee.”

Oh, but there’s more. As if you needed proof that Ms. Lynch shares Eric Holder’s financial oligarch coddling tendencies, the International Business Times reports that:

WASHINGTON — In advance of her nomination hearing, Loretta Lynch did what every cabinet nominee is required to do: fill out a questionnaire listing all her media interviews so lawmakers can evaluate her candor. But the questionnaire U.S. attorney general nominee Lynch submitted to the Senate Judiciary Committee has a notable omission. Lynch failed to include an interview in which she defended the controversial settlement she orchestrated with the bank HSBC.


The bank was accused of knowingly allowing Mexican drug cartels to launder money and of allowing violations of economic sanctions against countries including Iran, Libya, Sudan and Cuba. Lynch, then the U.S. Attorney for the Eastern District of New York, allowed the bank to avoid prosecution in 2012 by paying a $1.9 billion fine and submitting to a monitor for five years to oversee compliance. Critics slammed the deal as an example of the Obama administration’s pattern of going easy on the financial industry. In the Dec. 11, 2012, interview she did with CBS News, Lynch endorsed the settlement and dismissed criticism of the deal as “shortsighted.”


Lynch’s boss at the time of the HSBC deal, Assistant Attorney General Lanny Breuer, who was then head of the Department of Justice’s criminal prosecution division, resigned after a scathing Frontline piece that highlighted Justice’s failure to try any of the banks tied to the recession and the risky trades that led to it. It was during a discussion of HSBC before the Senate Judiciary Committee that Attorney General Holder famously said some banks — although not HSBC specifically — were too big to prosecute

Well there you have it. This woman, like Eric Holder, will be an unmitigated disaster for freedom in America.

That’s what “liberal” looks like in today’s America.

"We Can't Do This Forever," Fed Admits "Market Will Overwhelm Us"

In a somewhat stunning admission of the truth in central planning (that the Swiss just experienced first hand - and perhaps Venezuela has been experiencing for years), The Philly Fed's Charles Plosser explains the following...

"It may work out just fine, but there’s a risk to that strategy, and the risk is that we wait until the point where markets force us to raise rates and then we have to react quickly and aggressively. I believe that if we wait too long, then we run the risk of falling very far behind the curve or disrupting the economy by rapid rate increases.




The history is that monetary policy is not ultimately a very effective tool at solving real economic structural problems. It can try for a while but the problem then is that it’s only temporarily effective, and when you can’t do it anymore you get the explosion yesterday in the Swiss market.


One of the things I’ve tried to argue is look, if we believe that monetary policy is doing what we say it’s doing and depressing real interest rates and goosing the economy and we’re in some sense distorting what might be the normal market outcomes at some point, we’re going to have to stop doing it. At some point the pressure is going to be too great. The market forces are going to overwhelm us. We’re not going to be able to hold the line anymore. And then you get that rapid snapback in premiums as the market realizes that central banks can’t do this forever. And that’s going to cause volatility and disruption.


...I think the jury is still out on the costs. Because the cost I was worried about was the longer-term cost of unraveling all of this. So maybe I was right, maybe I was wrong. That remains to be seen.


I do worry about the longer-term implications for the institution. Part of my criticism has been that we have pushed the boundaries into fiscal rather than monetary policy. That has brought us praise and opprobrium. Perhaps justifiably on both counts. I do wonder as I look down the road five or 10 years, how will that shape the institution? What happens to our independence? What happens to our ability to do things effectively? Given all that we’ve done — maybe it was all for the best, but even if it was — are there going to be longer-term ramifications that we may end up regretting later?"

*  *  *

So - what happens when the markets realize this?


Source: The Washington Post

The Bond Market Has Reached Tulip Bubble Proportions

By EconMatters



Fed Officials Trying to Send Signals to the Bond Market


James Bullard on Friday noted that the Bond Market was far too dovish in relation to where the Fed is in regard to raising rates in June, and this might be the understatement of the year so far. For example the U.S. 2-Year Bond Yield is 0.45 or 45 basis points, think about this for a moment. Even if the Fed fund`s rate finishes the year at 50 basis points which is well below the Fed`s most conservative forecasts, and we use a conservative annual inflation rate of 1% (I know oil has dropped but there are more inflation categories than just the energy component). Moreover, the overall annual inflation rate is well above 1% right now, and you factor in that this bond is paying a 2-year risk premium for tying up one`s capital with all kinds of inflation risks over that 2-year time frame, this has to be the stupidest investment of all time.  

2-Year U.S. Bond Yield is 45 Basis Points


To buy the 2-Year Bond when the Fed has practically stated that after two FOMC meeting`s they are liable to raise rates at least 25 basis points at the earliest (think April) and June at the latest so that is 25 basis points right there added to the Fed Fund`s rate, and needs to be added to the 2-Year Bond calculation so the current Fed target rate is 0.00 - 0.25 with the daily rate on 1/29 of 0.11 or 11 basis points, so add the June 25 basis rate hike to the current daily rate of 11 basis points and you get a 36 basis point starting point for borrowing money, add an annual inflation rate of 1%, and we are at 136 basis points for evaluating the 2-Year Bond given this rather charitable and conservative analysis.


Read More: European Bond Market: Bubble of all Bubbles!


June Rate Hike Telegraphed to Markets


Remember this June rate hike by the Fed has been pretty well telegraphed to market participants, and nothing changed in the latest Fed Statement in fact it became even more hawkish with language changes in the statement released this week. Therefore whether one completely takes out the inflation component leaving a 36 basis point starting point, a 45 basis point yield on the 2-Year is beyond absurd. It is an example of just how much risk taking and froth there is currently in the bond markets due to so much cheap money sloshing around the financial system right now. The only way an investor can make money with a negative real rate of return if you factor in the inflation rate is by using an insane amount of leverage on these very low borrowing costs. Low borrowing costs aren`t enough to make this trade work, it takes huge scale to make this a ‘worthwhile trade’ in a negative real rate scenario that this trade offers up to the risk taker. 


Read More: Low Rates and QE are Deflationary at the Zero Bound

Leverage & Bond Market Instability in Overcrowded Trade


Therein lies the problem for the Federal Reserve and Central Banks around the world, they have enticed investors to chase yield at negative real rate scenarios with huge leverage to make such a low yield vehicle trade profitable and worth doing. This is going to cause massive instability to the financial system when this trade ends like we all know it will because the numbers involved are nonsensical to say the least. 


Unemployment Rate 5% in 2015


Just on Friday one of the most dovish members of the Federal Reserve,  San Francisco Federal Reserve Bank President John Williams said the U.S. will see real GDP growth around 3 percent in 2015, and that the unemployment rate will touch 5 percent by the end of the year. Where do traders think that leaves the Fed Funds Rate? The U.S. 2-Year Bond is currently pricing in no rate hike for all of 2015 and 2016, and no inflation whatsoever, in fact a negative rate of inflation over the next two years. 


Read More: Even Mainstream Academia Worried about Massive Bubbles in Markets


The Tulip Lunacy in the Bond market is just off the charts stupidity at its finest, go ahead and buy the 2-Year Bond this upcoming week, I am sure this Bond will be good in four months when the Fed hikes rates 25 basis points, maybe if you are lucky there is a greater fool than you, but from the stampede that is sure to follow on the exit of this trade at these prices in the bond markets, you better be first!


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Another Step Down The Long, Slow Road To IRA Nationalization

Submitted by Simon Black via Sovereign Man blog,

Let’s take a brief walk into financial reality for a moment.

At the time of this writing, the United States government’s official debt is nearly $18.1 trillion.

Now, let’s look at who the biggest owners of that debt are:

1) Taxpayers of the United States.


If you’ve held a job in the Land of the Free, 15.3% of your salary has gone to fund Social Security and Medicare.


Each of these programs holds massive trust funds that are supposed to pay out beneficiaries, both present and future.


Conveniently, the trust funds are required by law to buy US government debt.


And given that every single US taxpayer is an ultimate beneficiary of these trust funds, that ranks the people of the United States as among the biggest holders of US debt.


How sustainable is this? Not very.


The 2014 trustee reports for both Medicare and Social Security indicate that nearly ALL of the trust funds are sliding towards insolvency.


This isn’t some wild conjecture. The people in government who manage these trust funds are flat out telling us that they’re about to go bankrupt.


Let that sink in for a bit… then ask yourself: how long can two insolvent programs continue to be among the largest owners of US government debt?


2) The Federal Reserve


Now that we know Social Security and Medicare cannot continue to buy Treasuries indefinitely, we turn our attention to the Fed, which as of today, holds over $2.4 trillion in US government debt.


The Fed is essentially the lender of first resort to the US government and has singlehandedly managed to mop up the vast majority of government debt over the last several years.


Problem is, the Fed has to print money to do this. And the Fed has created so much money over the last few years that it’s now borderline insolvent.


The Fed’s capital now stands at just 1.27% of its total assets. To be clear, this is a razor thin margin of safety.


No other central bank in the world (except Canada, curiously) would be able to post such a pitiful number and still pretend to be credible.


But make no mistake, there is a level of monetary expansion that’s too far. And the Fed is already getting close to this danger zone.

Bottom line, the Fed is not going to be in a position to write blank checks to the US government indefinitely without becoming insolvent and causing an epic currency crisis.

And when that happens, where else can Uncle Sam go? Who else will buy his debt?

Simple. You.

More specifically, your retirement account.

According to Internal Revenue Service estimates, there’s close to $5 trillion in individual retirement accounts in the Land of the Free.

This is money that taxpayers prudently set aside for retirement, hopefully cognizant that Social Security isn’t going to be there for them.

Devoid of any other easy lender, $5 trillion is far too irresistible for such a heavily indebted government to ignore.

I’ve long warned that the government could easily nationalize a portion of all IRAs.

It would be so simple for them to do– just a single executive order and a couple of phone calls.

They’ll probably wait for some market crash, and then sell it to Americans like this:

"For your own protection, we will henceforth require banks to invest your retirement savings in the safety and the security of US government bonds.”

These bonds, of course, are so safe that they fail to pay an interest rate that even keeps up with inflation, effectively guaranteeing that you’re going to lose money.

It started happening last year.

In his 2014 State of the Union address, President Obama announced his MyRA program.

MyRA is basically an IRA that invests directly in… you guessed it… government bonds.

He pitched it as an easy for Americans to save for retirement “with no risk of losing what you put in”.

Step two came when both the President and Treasury Secretary embarked on a blitzkrieg-style marketing campaign to pump the program, pledging that they would aggressively push businesses to sign up their employees.

Now comes step three.

Find out more in today’s podcast where we talk about the obvious, looming threats to your retirement security, and the structures you can build to do something about it.

(click image for link to pdetailed podcast)


If you have an IRA, you need to know this.

I’ve also put together a free report about safeguarding your IRA; it’s a scaled down version of a premium report that I sent to our Sovereign Man: Confidential members recently, but it contains a lot of valuable information.

You can download it here:


IRA Report


*  *  *

Our goal is simple: To help you achieve personal liberty and financial prosperity no matter what happens.

Visualizing The Cost Of Living Around The World

Imagine that users submitted hundreds of thousands of prices for everyday items, and that they all got compiled into a massive database. Then, suppose a worldwide index of prices was created that compared the cost of living across different places by using these many data points.

Well, that’s already happened at Numbeo which is the world’s largest database of user contributed data about cities and countries.

This infographic uses this information to show the most expensive and cheapest places to live by country. While it is missing some of the granularity of looking closer at individual regions and cities, it does do a good job of showing a broad perspective on living costs.

Switzerland and Norway may not surprise you as two of the most expensive countries. However, Venezuela might not have been a place that was on your radar. Of course, in retrospect, when you have inflation spiraling out of control at a rate of 64% per year, that will make things a bit pricey.

Want cheap goods and services? Head over to India, Nepal, and Pakistan. With about 1.5 billion people spread between those three countries, labour is cheap and the cost of living is very low.


Click image for massive legible version


h/t Visual Capitalist

As China's Offshore Yuan Crashes To A 2 Year Low, Beijing Warns Its Citizens: "Don't Buy Dollars"

We won't go into the specific details of China's burst housing bubble, the shady underworld of its pyramid scheme wealth-management products, the fact that any hard asset in China is rehypothecated literally a countless number of times, the nuances of its deflating shadow banking system, or even the complexities of its alleged capital controls (alleged, because as a reminder, they only exist for the common folks - the really wealthy Chinese are naturally exempt from any capital flow constraints). We will point out something even more disturbing.

Recall that China, a mercantilist, export-driven country, has a currency that is pegged to the dollar in all but name (yes, the technical peg was dropped in 2005 but since then the PBOC controls the daily moves in the strictest and tiniest of increments), a dollar which has soared in the past 6 months to levels which have prompted countless other central banks to ease in recent weeks, and even forced the Swiss National Bank out of the currency wars, waving a flag of surrender. As a result, China's exports have been crushed regardless of what fabricated and goalseeked Chinese data will have gullible observes believing.

And while the value of the local Yuan, the CNY, is set by bureaucrats and policy makers on a daily basis, and trades in a tight band around a specific, political number and thus never truly reflects the fair value of the Chinese currency, its offshore cousin, the CNH, floats and is impacted by the private demand of the Yuan. As such, the latter is far more indicative of the pressures that face the Chinese economy and what financial interests dictate should be the fair value of the domestic currency.

It is also the former, the Offshore Yuan, that overnight hit a two-year low, reaching a level not seen since September 2012.


Why do we bring this up?

Because in a notice posted on Chinese media yesterday, China is now openly scrambling and on the defensive, when it comes to an ever stronger rush by the locals to get out of their own currency and into the US dollar.  As Want China Times reports, "prompted by the robust performance of the US dollar, growing numbers of Chinese are considering converting renminbi to dollar-denominated assets." It is for those "growing numbers" that China has a polite warning: "experts are advising them to think carefully before making the move."

And this is how China is hoping to keep locals more interested in the Renminbi than in the greenback:

Chinese-language China Business News reports that yield rates for US-denominated wealth-management products range only 1.2-2.5% per annum at major domestic banks, such as China Merchants Bank, Bank of Shanghai, and Farmers Bank of China, a far cry from renminbi-denominated products, such as deposits at Yu'e bao, the monetary fund under internet giant Alibaba, which hit 4.4%.


Interest rates for one-year timed deposits at major domestic banks now stand at 3.3%, much higher than the mere 0.95% for corresponding US-dollar deposits.


Investors in US dollar-denominated assets have the option of subscribing to the existing 10-odd QDII (qualified domestic institutional investor) funds, such as the Guangfa Fund, launched by the Bank of Communications, focusing on investments in US realty, which often generates higher returns but also entails higher risks.

In other words, China is pitching an investment in Ponzi schemes as a higher-yielding alternative than putting one's money in an appreciating dollar. Which, in retrospect is backed by another Ponzi scheme, so at least superficially it does makes sense. The bigger problem is that it would appear that the local citizens have figured out that in a time when the US Dollar is ascendent, the knock on effects on the Chinese economy are quite dangerous, and from the collapse in exports, to the imploding banks, to the halt in commerce and urbanization, the dollar suddenly looks like a far better option especially when the local currency is unbacked by anything: not gold, not crude, nothing.

The punchline from the Chinese media:

A forex trader said that despite the recent plunge in the value of renminbi against the greenback, the exchange rate of the former will fluctuate moderately at most, as the renminbi is essentially pegged to the greenback in value, according to China Business News.

Yes... unless China does indeed proceed to become merely the latest in a long chain of countries - main export competitors Japan, the Eurozone and Korea included - who have already devalued against the USD: something numerous experts have quietly voiced in recent weekly is not only possible by just a matter of time.

And why not: after all with China's economy dramatically slowing, it is virtually inevitable that China will have to devalue to spur its export-driven economy.

Of course, the flipside is that the resultant surge of capital flows in the USD assure that the US economy, with its currency at never before seen heights, grinds to a halt, the stock market crashes, and the US export industry falls like dominoes. In many ways, this would be reminiscent of the short-term pain Greece would suffer if its exits the Eurozone, the financial collapse that would follow and wipe out the legacy wealth but set the country on strong footing with its own currency going forward and a way to fix imbalances not only by cutting wages and welfare, but through its own currency as well.

And finally, even if China does devalue now, it knows very well that it has a currency put later: after all those thousands of tons of undisclosed gold that the PBOC has accumulated "secretly" since 2009 can very easily be used to backstop a new-regime currency, once which would redefine the global world order, and serve as the world's reserve.

When will all this happen? Nobody knows, however it is clear that with every passing day that the stronger dollar forces China's exporters into an ever more untenable position, the D(evaluation)- day comes closer.

Unless, of course, the Fed capitulates in the meantime, and crushes all hope of a rate hike or even proceeds with more quantitative easing or even NIRP. In that case all bets are off, and so is the Fed's credibility, leading to an even more... exciting world.

The Fed Is Now Frontrunning Value Investors

Submitted by Nick Nanda And Kai Wu of Kaleidoscope Capital (pdf)

The Fed Is The New Value Investor


Something strange seems to be developing beneath the surface in markets since the financial crisis. Stocks, especially U.S. stocks, have delivered abnormally high returns. The S&P 500 has produced an astounding 15% per year for the last five years. But when you strip away market exposure, active managers have had a surprisingly hard time beating the market. Outperforming the market is always difficult, but even well-known professionals with stellar track records spanning decades have stumbled since the crisis.

Since 1997, hedge funds have delivered approximately the same returns as the market but with about half the risk [Exhibit 1]. Risk can be defined as volatility or perhaps better as peak-to-trough loss in stress events such as 2008. Doubling the risk-adjusted return of the market is a tall order. It’s no wonder institutions have been showing up in droves pouring cash into hedge funds.

However, this high-level analysis misses an important wrinkle. Some of these returns have been earned by simply running net long the stock market. While actual market exposure is not available, we can proxy using beta [Exhibit 2]. Over the past 18 years, hedge fund net long exposure (beta) seems to have been remarkably stable, around 34%.

To calculate the true value added by hedge funds, we need to adjust for their consistent net long exposure. Deducting the returns resulting from positive market exposure produces an interesting picture [Exhibit 3].

This chart tells a tale of two distinct periods [Exhibit 4]. In the first period (1997-2009), hedge funds delivered spectacular performance. The second period (2010-2014), however, has been dismal. The last five years have been a terrible time to be invested in the average hedge fund.


While one of the reasons for this recent underperformance is hedge funds’ fee structures, which we believe to be unfavorable to investors (See upcoming Kaleidoscope paper on hedge fund fees), there may be other factors at play.


As value investors, we were also interested in how our competitors had fared. We examined the performance of ten prominent value investors, each running multi-billion dollar U.S.-focused equity mutual funds. These managers have track records spanning several decades and well-deserved reputations as best-in-class. We created a “Top Value Investor Index” comprised of these ten funds. Over the past 18 years, these investors have beaten value stocks by 1.1% per year net of fees while taking less risk [Exhibit 5].

The Top Value Investor Index is comprised solely of long-only mutual funds, but many of our managers hold cash when markets get expensive. As a result, their long-run average beta is only 0.75. As we did with hedge funds, we can strip out this beta. Since 1997, our hand-picked value investors beat the market by 2.1% per year adjusted for trailing beta [Exhibit 6]. They underperformed entering the 2000 Tech Bubble but regained all their performance (and then some) when the bubble burst. They again underperformed into the 2008 financial crisis but rebounded strongly in 2009.

As with hedge funds, we noticed an interesting decay in performance since the financial crisis. From 1997-2009, our value investors won by 2.9% annually. However, since 2010, they have added almost no value [Exhibit 7].

In fact, the current five-year period is the worst for our value investors with the exception of the tech bubble peak and credit crisis trough [Exhibit 8].

We’re seeing a similar story play out in both hedge funds and value managers. Both groups delivered risk-adjusted returns far in excess of the market for an extended period. But over the past five years, they have struggled.


Why have value managers failed to outperform? In order to answer this question, let’s first attempt to precisely define their investment strategy. (We will start with value managers, but will return to other investment styles in a later paper).

Let’s go back to the late 1990s, when the Tech Bubble was in full swing. Coming into 2000, technology stocks had performed extremely well [Exhibit 9]. On the other hand, “old-economy” value stocks like U.S. Air had greatly lagged.

Technology stocks were extremely expensive and value stocks were very cheap. Given these valuations, many investors sold the flaky dotcoms and invested in the boring old-economy companies. As the bubble continued to inflate, it turned out to be an extremely painful bet. Several well-regarded value managers went out of business. In 2000, the bubble finally collapsed and those who managed to hang in significantly outperformed.

The world is often too quick to declare the beginning of a new era as a means to justify extraordinary valuations. In the early 1990s, the land under the imperial palace in Tokyo was famously said to be worth more than all of the land in California. Japanese companies traded at similarly ridiculous valuations [Exhibit 10]. Several books were written in the United States declaring the inherent superiority of the Japanese way of doing business.

Once again, value investors bet too early against Japanese equities and suffered for several years. Eventually, Japanese stocks and property prices retreated to more normal levels and value investors reaped handsome rewards.


esides the risk of short-term underperformance, what is the risk of being a value investor? In the case of technology stocks, the risk was that the advocates of the new economy were correct and the Warren Buffett-style of valuing companies based on their profitability would be rendered meaningless. Similarly, it was plausible that the Japanese, with their legendary work ethic and efficiency, would permanently leave everyone else in the dust. We believe that value investors get paid to underwrite the risk associated with paradigm shifts.

Since markets rarely have paradigm shifts, value investors generally profit from betting on mean reversion. That is until that rare bird - a genuine “this time is different” event - comes down the pike. The most recent example of this was U.S. financial stocks in 2007. After underperforming the market by 23% in 2007, financials appeared extremely cheap. The price-to-book ratio of financials approached half that of the market. Since 1990, there had been only three situations (1991, 1994 and 2000) when valuations of financial stocks had fallen this low [Exhibit 11]. In every case, buying them had resulted in large subsequent gains.

Armed with this data, several value investors saw the 2007 selloff as an obvious buying opportunity. In 2008, when Bear Stearns went bust, these investors, believing the bet to be even more attractive, loaded the proverbial boat. And why wouldn’t they? For most of their lifetimes, they had been rewarded for doubling down each time their stocks went against them.

A typical conversation between two value managers would go something like this: “Bill, if you liked the stock at $50 you must love it at $25. Surely you’re going to buy more, right?” Clients lauded portfolio managers for having conviction in their thesis and nerves of steel when they responded to underperformance by increasing their bet. Those investors who acted less bravely often ended up losing the account. So the incentives were clearly in place for investment professionals to respond in this manner.

Unfortunately, what followed was very costly for many value managers. In October 2008, Lehman Brothers collapsed and billions of dollars of write-offs ensued [Exhibit 12]. Several value managers who bought or over-weighted financial stocks went out of business. It has been over six years since the bet on financials was first placed. Even today, the fundamentals of U.S. financials have still not recovered relative to the broad market.

Fortunately, years like 2008 don’t come around too often. However, when they do, value investors are more or less guaranteed to run straight into the teeth of it. As a result, the return profile of value investors tends to resemble a series of modest gains followed by the occasional large loss.

Consider the prominent value manager who famously outperformed the S&P 500 for fifteen years in a row. His performance [Exhibit 13] was often compared to Babe Ruth’s famous hitting streak. Billions of dollars poured into his mutual fund. Then, in a mere three years he managed to wipe out almost all of his accumulated gains.

This profile of small gains followed by the occasional large loss looks awfully similar to that of writing insurance. The insurance underwriter safely collects a monthly premium until the hurricane blows through, resulting in large losses. Similarly, selling stock market insurance through put options earns consistent returns until a 1987- or 2008-style market crash strikes. While value investors rarely traffic in actual options, one has to wonder if there is something about their strategy that intrinsically results in this short option profile.

The next section assumes some familiarity with options. For those of you who have never dealt with options, feel free to skip it and go directly to “Don’t Fight the Fed.”


hat exactly is the trading strategy of a value investor? Let’s look to Hewlett-Packard, a stock that was recently in favor with many value investors. In the summer of 2011, the price of HP almost halved [Exhibit 14].

When a well-known stock like HP collapses, it is bound to spark the interest of value investors. Every manager will have his or her own unique estimate of fair value, but let’s assume that the consensus fair price for HP was $40.

With the stock at $50, the investor would have no position. Let’s assume that the typical value manager would start buying only when the stock fell to $35. She would increase her position as the price continued to drop, until reaching her maximum position with the stock at $20. Based on this behavior, we can draw the value investor’s reaction function [Exhibit 15].

Instead of following this strategy, what if the manager had decided to sell a 6-month put option struck at $27.5? (We picked $27.5 because it is the level at which the manager would be halfway invested). Selling put options is scary because, as a stock drops, effective exposure (delta) tends to quickly increase. Conversely, as a stock rallies, exposure to price moves decreases. Similar to our value investor, the put option seller’s exposure increases in response to adverse price moves. In fact, the reaction functions of the two investors are almost identical [Exhibit 16].

For the sake of simplicity, let’s assume that our value investor would exit her position in the same manner as she entered. Let’s further assume that her estimation of fair value does not change over time. If we do this, we can track her HP exposure through time. We can also monitor her exposure assuming she had opted instead to sell a put option [Exhibit 17]. Once again, the value investor’s and option seller’s positions line up almost perfectly.

This is a startling conclusion. While value investors almost never explicitly sell options, their trading strategy gives them exposure very similar to that of option sellers. We don’t think it’s too much of a stretch to say that value investors are selling options! We can only speculate, but perhaps Warren Buffett was aware of this fact when he chose to sell long-dated puts on the stock market in the mid-2000s.

Geek note: Value investors don’t simply start buying when a stock drops below fair value. They wait for stocks to fall materially below fair value before buying. In the prior example, value investors might estimate fair value to be $40 but only start buying at $35. This gap between fair value and their buy trigger defines their “margin of safety”. To be more precise, value investors replicate the profile of an out-of-the-money -- rather than an at-the-money -- put option seller.

By stepping in when prices are falling, value investors provide a form of insurance to the market. Like all insurance, this activity should produce positive returns on average for the underwriter. Careful value investors have certainly prospered over the long run. The puzzle is why providing insurance through value investing has not been rewarded over the past five years.


Perhaps the most important new factor in the markets over the last five years has been the massive intervention by global central banks. The goal of the intervention has been to stimulate economic activity by pushing up asset prices. They have achieved this by lowering cash rates, forcing investors to seek yield in risky assets such as credit and high dividend-paying stocks. But the impact of Fed intervention has also caused the broader stock market to appreciate as earnings yields seem relatively more attractive with cash now yielding zero.

While many have discussed the effect of Federal Reserve intervention on the level of asset prices, few have focused on the impact of the timing of intervention. The crucial aspect of Fed activity is that it occurs reliably in response to market declines. In fact, every major decline since 2008 has been met with a swift response by the Fed [Exhibit 18].

Value investors sell options by increasing exposure to stocks as they fall in price. Similarly, the Fed effectively sells options by stepping in every time the market begins to decline. Both value investors and the Fed provide insurance to the market by supporting it when it begins to sell off. In other words, the Fed is the new value investor.

To be fair, the Fed has been supporting the market since the late 1980s. But there is an important difference between the actions of the Fed under Yellen versus Greenspan and Bernanke. In 2008, the Fed allowed Bear Stearns and Lehman Brothers to fail. Given the massive wipeout that followed, this decision is now viewed as a dangerous mistake. Having learned their lesson, the Fed is now rushing in to support the market in response to even routine 20% drops. In this way, the Fed is acting like a value investor who demands a small margin of safety before investing.

In the past, the Fed has actually helped value managers. By waiting to respond in 2008, Bernanke allowed asset prices to get to distressed levels, giving value investors just enough time to do their analyses and snap up attractively priced securities. In fact, several value investors got heavily invested in early 2009, right in time for Fed intervention to kick in, giving them a very high return over a short period. As shown by our Top Value Investor Index, 2009 was a fabulous time to be bottom-fishing for deep value stocks.

Since 2010, however, the Fed has changed tactics. The Fed is now reacting far more quickly. Small market selloffs are followed by immediate responses. By quickly riding to the rescue, the Fed is effectively front-running value investors. Consider the massive funds raised by distressed debt investors to buy credit in Europe in anticipation of great buying opportunities. Due to Fed-style jawboning by the European Central Bank, prices for European credit instruments never got to extreme levels [Exhibit 19], As a result, many of these funds have either remained un-invested or generated mediocre returns.

Central banks are the new multi-trillion dollar value investors. Since value investing is effectively option selling, we should be able to see the impact of the Fed in options markets. Entering 2010, the implied volatility of short- dated options had returned to normal levels from the distressed peaks of the crisis. On the surface, it appeared that the Fed had prevailed and markets were now functioning normally. While the prices of short-dated options had returned to average levels, however, long-dated option prices remained elevated [Exhibit 20]. In fact, in mid-2011, the implied volatility of long-dated options reached levels similar to that of 2008. The market had bought into the Fed guarantee over the short-run, but was expecting trouble over the long-run.

The Fed sensed this unease. Fed officials responded in September 2011 by declaring that rates were going to stay “lower for longer”. Not surprisingly, this commitment caused long-term rates to rally. Interestingly, the market also viewed this promise of low rates as a commitment that the Fed was not ready to take off the training wheels anytime soon. This caused long-dated implied volatility to collapse. The market’s increased confidence spurred a strong rally. Since the announcement, the S&P 500 has nearly doubled in value.



Besides demanding a smaller margin of safety, the obvious response to central bank intervention is to become a “Fed Watcher” and attempt to anticipate Yellen’s and Draghi’s actions. Some investors who have traditionally avoided macro investing are now going down this path. This is a fun game to play but a hard one to win. For those value investors who would rather stick to their knitting, we believe there are a couple of promising avenues.

First, the Fed is focused on developments in the equity and fixed income markets. However, it does not respond to movements in many other asset classes. For instance, crude oil has tumbled -50% since the summer without evoking a response from the Fed. Value investors have historically focused their efforts on equity and credit markets, as these assets have a series of discountable cash flows. However, as discussed, Fed intervention has made these markets more difficult to navigate. Currency and commodity markets are harder to value, but their fair price can be estimated using other means. Commodity markets and currencies with less active central banks should provide fertile opportunities for open-minded value investors.

Our second suggestion is slightly technical, but is potentially quite important. The Fed watches the absolute level of markets but cares little about the relative dispersion across markets. So while QE has managed to crush the day-to-day volatility of the stock market, the spread between the best and worst performing sectors is still very wide. For example, Biotech stocks have been one of the best performing groups over the last five years, delivering a 32% average return. On the other hand, gold stocks have returned -15% per year. Like the Fed, most value investors focus on absolute than on relative value. Since the Fed is likely to intervene before stocks can reach absolute levels of cheapness, this puts value investors directly in the crosshairs of the Fed. By focusing on relative value, investors can continue to demand large margins of safety.

The irony of this whole situation is that the most careful value investors who demand the greatest margin of safety have been hurt most by the Fed’s intervention. On the other hand, investors who are willing to take the Fed’s backstop at face value have prospered. If we have learned anything from 2008, it is that the buildup of moral hazard in the financial system can be extremely destabilizing. Rather than dance to the Fed’s music, Kaleidoscope is focusing its research efforts on applying value investing to more fertile areas minimally impacted by the actions of the Federal Reserve. We would warmly recommend you do the same.

* * *


1 Active managers should be evaluated net of their equity market exposure
2 On this basis, hedge fund managers and value investors have both struggled since 2010
3 Value investors tend to have high hit rates but suffer large losses in paradigm shifts
4 Value investors’ trading strategies replicate short out-of-the-money put options
5 Similarly, the Fed effectively sells put options by intervening when markets fall
6 The Fed has become more quick to respond to market declines, front-running value investors with large margins of safety
7 Given Fed intervention, value investors should extend their opportunity set to currencies, commodities, and relative value

"Obama Is Clueless On Inequality," David Stockman Rages "The Problem Is [The Fed]"

Echoing Elliott's Paul Singer's "greatest irony of politicians railing against inequality," former Reagan OMB Director David Stockman raged that when it comes to inequality, everyone can see the symptom, but "President Obama is clueless as to the cause," blasting that the problem is not capitalism, "the problem is in the Eccles Building and the 12 people sitting there thinking that zero interest rates are some magic elixir that will cause this very toubled economy to revive.! It won't, "these people are dangerous and destructive," Stockman exclaims, and sooner or later the inequality they have created is going to cause a huge political reaction.



As Singer previously opined...


Inequality in the U.S. today is near its historical highs, largely because the Federal Reserve’s policies have succeeded in achieving their aim: namely, higher asset prices (especially the prices of stocks, bonds and high-end real estate), which are generally owned by taxpayers in the upper-income brackets. The Fed is doing all the work, because the President’s policies are growth-suppressive. In the absence of the Fed’s moneyprinting and ZIRP, the economy would either be softer or actually in a new recession. 


The greatest irony is that the President is railing against inequality as one of the most important problems of the day, despite the fact that his policies are squeezing the middle class and causing the Fed – with the President’s encouragement – to engage in the radical monetary policy, which is exacerbating inequality. This simple truth cannot be repeated often enough.

The Death Of The American Dream In 22 Numbers

Submitted by Michael Snyder via The End of The American Dream blog,

We are the generation that gets to witness the end of the American Dream.  The numbers that you are about to see tell a story.  They tell a story of a once mighty economy that is dying.  For decades, the rest of the planet has regarded the United States as “the land of opportunity” where almost anyone can be successful if they are willing to work hard.  And when I was growing up, it seemed like almost everyone was living the American Dream.  I lived on a “middle class” street and I went to a school where it seemed like almost everyone was middle class.  When I was in high school, it was very rare to ever hear of a parent that was unemployed, and virtually every family that I knew had a comfortable home and more than one nice vehicle.

But now that has all changed.  The “American Dream” has been transformed into a very twisted game of musical chairs.  With each passing year, more people are falling out of the middle class, and most of the rest of us are scrambling really hard to keep our own places. 

Something has gone horribly wrong, and yet Americans are very deeply divided when it comes to finding answers to our problems.  We love to point fingers and argue with one another, and meanwhile things just continue to get even worse.  The following are 22 numbers that are very strong evidence of the death of the American Dream…

#1 The Obama administration tells us that 8.69 million Americans are “officially unemployed” and that 92.90 million Americans are considered to be “not in the labor force”.  That means that more than 101 million U.S. adults do not have a job right now.

#2 One recent survey discovered that 55 percent of Americans believe that the American Dream either never existed or that it no longer exists.

#3 Considering the fact that Obama is in the White House, it is somewhat surprising that 55 percent of all Republicans still believe in the American Dream, but only 33 percent of all Democrats do.

#4 After adjusting for inflation, median household income has fallen by nearly $5,000 since 2007.

#5 After adjusting for inflation, “the median wealth figure for middle-income families” fell from $78,000 in 1983 to $63,800 in 2013.

#6 At this point, 59 percent of Americans believe that “the American dream has become impossible for most people to achieve”.

#7 In 1967, 53 percent of Americans were considered to be “middle income”.  But today, only 43 percent of Americans are.

#8 For each of the past six years, more businesses have closed in the United States than have opened.  Prior to 2008, this had never happened before in all of U.S. history.

#9 According to the New York Times, the “typical American household” is now worth 36 percent less than it was worth a decade ago.

#10 According to one recent report, 43 million Americans currently have unpaid medical debt on their credit reports.

#11 Traditionally, owning a home has been one of the key indicators that you belong to the middle class.  Unfortunately, the rate of homeownership in the U.S. has now been falling for seven years in a row.

#12 According to a survey that was conducted last year, 52 percent of all Americans cannot even afford the house that they are living in right now.

#13 While Barack Obama has been in the White House, the number of Americans on food stamps has gone from 32 million to 46 million.

#14 The number of Americans on food stamps has now exceeded the 46 million mark for 38 months in a row.

#15 Right now, more than one out of every five children in the United States is on food stamps.

#16 According to a Washington Post article published just recently, more than 50 percent of the children in U.S. public schools now come from low income homes.  This is the first time that this has happened in at least 50 years.

#17 According to the Census Bureau, 65 percent of all children in the United States are living in a home that receives some form of aid from the federal government.

#18 In 2008, 53 percent of all Americans considered themselves to be “middle class”.  But by 2014, only 44 percent of all Americans still considered themselves to be “middle class”.

#19 In 2008, 25 percent of all Americans in the 18 to 29-year-old age bracket considered themselves to be “lower class”.  But in 2014, an astounding 49 percent of all Americans in that age range considered themselves to be “lower class”.

#20 It is hard to believe, but an astounding 53 percent of all American workers make less than $30,000 a year.

#21 According to one recent survey, 62 percent of all Americans are currently living paycheck to paycheck.

#22 According to CNN, the typical American family can only “replace 21 days of income with readily accessible funds”.

The key to the recovery of the middle class is jobs.

The truth is that without middle class jobs, it is impossible to have a middle class.

Unfortunately, more middle class jobs are being offshored, are being replaced by technology, or are being lost to a slowing economy every single day.  The competition for the jobs that remain is incredibly intense.  Just consider the following example

In 2012, Eric Auld, an unemployed 26-year-old with a master’s degree in English, decided to find out what was on the other side of the black hole. He created a fake job ad as an experiment:


Administrative Assistant needed for busy Midtown office. Hours are Monday through Friday, nine to five. Job duties include: filing, copying, answering phones, sending e-mails, greeting clients, scheduling appointments. Previous experience in an office setting preferred, but will train the right candidate. This is a full-time position with health benefits. Please e-mail résumé if interested. Compensation: $12-$13 per hour.


If you have ever applied for a job like that, I offer my condolences. You have better odds at the casino. Auld received 653 responses in 24 hours. 10% of the applicants had more than 10 years of experience, and 3% of them had master’s degrees. Presumably, one of them would get the job. But what does that mean? It means that all the other experienced applicants and master’s degree holders would remain unemployed. That is about 64 experienced workers and about 19 workers with master’s degrees.

So how can we get this turned around?

How can we start to increase the number of middle class jobs in America once again?

"It's Different This Time" GDP Hockey-Sticks Edition

Year after year, hope-strewn economists mark up GDP expectations for the year-ahead (in order to defend top-down their S&P 500 earnings forecasts and why investors should always BTFD)... and year after year, those GDP expectations are slashed drastically. Welcome to 2015...


Consensus GDP forecasts have had one path year after year - top left to bottom right...


It's different this time


h/t @M_McDonough

5 Things To Ponder: Ascending Contingencies

Submitted by Lance Roberts via STA Wealth Management,

I spill a lot of digital ink pointing out potential investment risk to investors. As I have stated in the past, the reason I do this is because the media expends a great amount of effort to avoid such a discussion because it does not attract viewership/readership. (Also, since their advertisers are primarily Wall Street related firms - suggesting an individual carry more cash is not financially beneficial.)

However, there are two problems with my approach. Because I share my view of risk with you, I am considered a "bear." Fair enough.  However, that moniker assumes that I am sitting in cash, hoarding gold and "beanie-weenies" and expecting an immediate demise of the known universe. However, that is hardly the case as a read of my weekly e-newsletter will show a long history of successfully navigating the ebbs and flows of the market. 

For this reason, as I wrote recently, if I am a bear then I am an "almost fully invested bear." However, that is the point of this weekend's reading list. Recent market actions, the rapid decline in interest rates, earnings deterioration and plunging energy prices have all made me much less comfortable being long the market.

While the "buy and hold" crowd suggests this is all rubbish, it should be worth remembering that every single one of that group never saw the corrections in 2000 or 2008 until it was far too late.  Their only excuse was "no one could have seen it coming." The truth is that many did see what was coming.

Paying attention to what is happening at the margin leads to an understanding of when the "tides" begin to shift. With the general complacency in the markets beginning to deteriorate and risk appetites receding, these have historically been predictors of corrections or worse.

This weekend I am heading to Vancouver to speak at a financial investment conference, so here is what I will be reading on the plane.

1) Vanguard Warns Advisors On Risk by Trevor Hunnicutt via Investment News

Investors are taking a level of risk not seen since 1999 and 2007, and financial advisers should restrain the impulse of clients to boost sagging returns.


Martha G. King, who oversees Vanguard Group Inc.'s adviser-sales division, said investors have taken on the highest stock exposure in their portfolios since the years preceding two recent market routs.


“I do see some advisers adding risk to their portfolios to provide yield substitutes for those old reliables that aren't delivering what they wanted, and that's worrisome."

Read Also:  The Markets Will Riot by Albert Edwards via Advisor Perspectives


2) Ignore The Bears by Alan Hartley via Advisor Perspectives

"Despite six consecutive years of positive returns in the current bull market, we likely have further to go. Historically, the U.S. stock market has provided positive calendar-year returns about 75% of the time.


Said another way, the U.S. stock market has fallen in about a quarter of the years since 1926. Most declines—about 80%—were accompanied by recessions. Those that weren’t can be counted on one hand.

  • The U.S. economy should continue to expand and that bodes well for stocks
  • The next bear market will likely start due to a recession or geopolitical conflict and not from the start of Fed interest rate increases or time elapsed
  • The current economic landscape is favorable to growth
  • Stock markets are priced for low returns
  • We do not own the stock market, but 17 well-researched, individual companies
  • We still expect double-digit returns from our portfolios"

Read Also:  Yesterday's Dip Was A Warning  by David Stockman via ContraCorner


3) Caught In  A Debt Trap by Ralph Atkins and Michael Mackenzie via FT

"'The economic fabric of our society has been built on the premise of positive nominal interest rates. Negative interest rates are an unprecedented experiment,' says Claudio Borio, head of the monetary and economic department at the Bank for International Settlements in Basel, which acts as a think-tank for central bankers. 'If it’s not temporary, there are going to be significant implications.'


Tumbling yields are partly the result of central bankers becoming big bond buyers: QE by the Bank of Japan is in full swing; the ECB’s programme starts in March.


But low and negative bond yields also tell a story of persistently slow economic growth and low inflation, even after adjusting for recent sharp falls in oil prices. They imply bond markets think central banks will fail to boost inflation any time soon — exactly the opposite of what the BoJ and ECB plans are supposed to achieve."

Video: Dollar Creating Systemic Risk by Larry McDonald via CNBC


4)  Important Signs To Watch by Cris Sheridan via Financial Sense

"Here is a chart of the S&P 500 (shown in blue) with four different measures of financial stress provided by various Federal Reserve regional banks. As you can see, financial market stress started to bottom over the course of last year and has now started to move higher. This typically happens prior to market selloffs and, if all four measures make a sustained move into positive territory (above the x-axis), also raises the possibility of a much deeper bear market.



Bottom line: financial risks have risen from their lows and may put pressure on U.S. stocks ahead; keep a close eye on corporate profits and U.S. leading economic data for broader deterioration."



5) The Bears Are Back by CNN Money

"The bears build their case that a crisis is near on four factors: falling oil prices, stagnant wages, the "two-edged sword" of a strong US dollar and big trouble abroad.


Weaving their four factors together, the bears' quilt for 2015 is quickly looking gloomy and gray. The U.S. markets are already overdue for a correction -- a drop of 10% or more -- and this global backdrop could exacerbate the fall when it comes."

Bonus Read: Games People Play by Bill Gross via Janus Funds

Must Read: A Dozen Things I've Learned About Value Investing via 25iq

"The only reason a great many American families don't own an elephant is that they have never been offered an elephant for a dollar down and easy weekly payments." - Mad Magazine

Have A Great Weekend

January Jitters Jolt Stocks - S&P Loses Key 2,000 Level; Bonds' Best Month Since June 2010

Given the following - Silver and Bonds win in January followed by Gold, Stocks and Oil Lose...

  • Treasury Bonds - Best month since June 2010
  • Crude Oil - 7th month lower in a row (same as 2008/9) and manic ramp to green on the week (best week since Dec 2013)
  • S&P 500 - Worst month since last January, first two-month drop since May 2012 (worst week in last 8)
  • Dow Transports - Worst month since Sept 2011
  • Gold - Best month since Jan 2012 (worst week in 6)
  • Silver - Best month since June 2014 (worst week since Sept 2013)
  • Swissy - Best month since Dec 2008 (worst week sicne Sept 2011)
  • US Dollar Index - Best month since May 2012 (up 7 months in a row)

We suspect this will help...


Bu, for human oil shorts this afternoon, we suspect this sums up their message to the manipulators and their machines...


We have to start with WTI because that was a fucking joke!!!! This 8.3% ramp into the NYMEX close was the biggest single-day ramp since June 2010... (in case you wonder what happened... read this complaint)


Which magicaly levitated stocks... to the NYMEX close...


Now where have we seen that before?


Crude down for the 8th month in a row... for only the 2nd time in history


*  *  *

Anyway... take a breath because it was quite a month/week/day...

Today's market was domianted by fading yesterday's Yellen pump bounce and the momo ignition from crude which was faded...NOT OFF THE LOWS


On the week, Trannies are the laggard... NOT OFF THE LOWS


On the month, stocks are ugly...


With financials monkey-hammered...


Who could have seen that coming?


Since QE3, only NASDAQ is green (thanks to AAPL)


The S&P 500 dropped back below its 100DMA after Yellen's intervention - that is a problem... And The S&P 500 Lost 2000 at the close


Obviously oil stands out on the week (thanks to today's idiocy) but gold recovered to unch while silver was slammed...


Energy stocks spiked (again) - credit didn't!! Trade Accordingly!


The US Dollar dropped modestly this week (down 0.5%) despite a huge drop in Swissy)


Treasury yields plunged on the week (new 30Y record lows)


Of  course stocks just kept on buying and disbelieving bonds...


And on the month, 3Y is -20bps and the entire rest of the curve is down around 50bps!!


Bonds best month since June 2010...


Credit continues to flash red - just like it did in 2008...


Charts: Bloomberg

Bonus Chart: Unless you got in at the IPO price, you are a loser in SHAK!!

In Denmark You Are Now Paid To Take Out A Mortgage

With NIRP raging in the Eurozone and over €1.5 trillion in European government bonds trading with negative yields, many were wondering when any of this perverted bond generosity will spill over to other debtors, not just Europe's insolvent governments (who can only print negative interest debt because of the ECB's backstop that it will buy any piece of garbage for sale in the doomed monetary union). In fact just earlier today we, rhetorically, asked a logical - in as much as nothing is logical in the new normal - question: 

Who will offer the first negative rate mortgage

— zerohedge (@zerohedge) January 30, 2015

Little did we know that just minutes after our tweet, we would learn that at least one place is already paying homeowners to take out a mortgage. That's right - the negative rate mortgage is now a reality.

Thanks of Mario Draghi's generosity with "other generations' slavery", and following 3 consecutive rate cuts by the Danish Central Bank, a local bank - Nordea Credit - is now offering a mortgage with a negative interest rate! This means, according to, that Nordea have had to pay instead of charging interest to to a handful of customers, says housing economist at Nordea Kredit, Lise Nytoft Bergmann for Finance.

From DR, google-translated:

The interest rate has balanced around 0 in a level between minus 0.03 percent plus 0.03 percent. Most have paid a modest positive interest rate, but there are so few who have had a negative rate. It is quite an unusual situation, says Lise Nytoft Bergmann.


It is residential customers who have chosen to stick with F1-loan that now benefit from the negative interest rate. F1 loan form has otherwise been strong returns in recent years in favor of fixed interest loan.


Although interest rates are negative, it is not something that can be felt by customers as contributions and other costs continue to be paid. In turn, interest will be deducted from the contribution.


Precisely because it is an unusual situation, Nordea Kredit's IT systems are not geared to the situation when the computers are only used to collect interest.


Lise Nytoft Bergmann says that there is no cause for concern, and that the new situation can be handled, "but sometimes we have to use duct tape and paste."

This is just the beginning: according the Danish media outlet, as a result of variable-refinancing, as recently as a week from now "a greater share of customers could have a negative rate."

Mortgage Denmark is one of the mortgage banks, where F1 rate also is close to zero, and here you are very excited about the upcoming negotiations, says Christian Hilligsøe Heinig, chief economist of the Mortgage Denmark.


We have an auction just around the corner and it is very exciting to see how interest rates are going. We can go and get negative interest rates, says Christian Hilligsøe Heinig to JP Financial.

And just like that, first in Denmark, and soon everywhere else in Europe, a situation has now emerged where savers who pay the bank to hold their cash courtesy of negative deposit rates, are directly funding the negative interest rate paid to those who wish to take out debt. In fact, the more debt the greater the saver-subsidized windfall.

That all this will end in blood and a lot of tears is clear to anyone but the most tenured economists, however in the meantime, we can't wait to take advantage of the humorous opportunities that Europe (and soon Japan and the US) will provide in the coming months, as spending profligacy will be directly subsidized and funded by the insolvent monetary system, while responsible behavior and well-paid labor will be punished, first with negative rates and soon thereafter: with threats, both theoretical and practical, of bodily harm.

h/t @AndreasBay

How Do You Solve A Problem Like Syriza?

Submitted by Raul Ilargi Meijer via The Automatic Earth blog,

First off, no, I don’t think Syriza is a problem, I just couldn’t resist the Sound of Music link once it popped into my head, as in ‘headlines you can sing’. I think Syriza may well be a solution, if it plays its cards right. But that still leaves politicians and investors denominating Tsipras et al as a problem, if not a menace. Now, investors may not need to possess any moral values – though things would probably have been much better if that were a requirement -, but you can’t say the same for politicians. Politics is supposed to BE about moral values.

And supporting Samaras and his technocrat oligarchy, as has been the EU/Troika policy, doesn’t exactly show a high moral standard. Not just because trying to influence an election is an no-go aberration (though it’s so common in the EU you’d almost forget that), but certainly also because of what Samaras and the EU have done to the Greek people over the past few years. And neither does it show in what happens now, where the Greeks, steeped in Troika-induced misery as they are, are labeled greedy bastard cheats.

Since the EU lies as much about Greece as it does about Russia, it’s only fitting that the former should speak out for the latter. And it’s deliciously easy: the EU wants to step up sanctions against Russia (because the Ukraine shelled Mariupol?!), but EU sanctions decisions require unanimity. Since Greek-Russian relations have historically been close, Syriza resisting ever tighter sanctions should be no surprise.

At the end of the day, European taxpayers shouldn’t be angry at Greece, no matter how much their media try to stoke that anger, but at their own banks, governments and central banks. Things pertaining to Greece and its debt are not at all what they seem. Most of it is just another narrative originating in Brussels, Frankfurt and the financial media cabal. Not much is left of this narrative if we dig a little deeper. This from Mehreen Khan for the Telegraph today may be a little ambivalent in what it points to, but it certainly puts the Greek debt in a different light from the ‘official’ one:

Three Myths About Greece’s Enormous Debt Mountain

€317bn. Over 175% of national output. That’s the enormous debt mountain that faces the new Greek government. It is the issue over which the country is set to clash with other countries in the eurozone. As it stands, Greece’s debt-to-GDP ratio is the highest in the currency bloc. It has been steadily rising as the country has undergone painful austerity and experienced a severe contraction in economic output. The new far-left/right-wing coalition is now demanding a write-off of up to 50% of its liabilities. The government argues that this is the only way Greece can remain in the single currency and prosper.


According to the newly appointed finance minister, who first coined the term “fiscal waterboarding” to describe Greece’s plight, the EU has loaded “the largest loan in human history on the weakest of shoulders – the Greek taxpayer”. So far, the rest of the eurozone is adamant that it will not meet demands for debt forgiveness. And yet, the value of Greece’s debt mountain has been called a meaningless “accounting fiction” by Nobel laureate Paul Krugman. So what does Greece’s €317bn debt really mean for the country and its creditors? And can it ever be paid back?


Myth 1: They can never pay it back. Ever. Never say never. On the issue of repaying back its liabilities, it’s more a question of time, rather than money. Greece has already been the beneficiary of a number of debt extensions, and in 2012, underwent the biggest private sector debt restructuring in history. The average maturity on Greek government debt currently stands at 16.5 years. The sustainability, or otherwise, of the country’s burden relies more on the timetable for repayment rather than the overall stock of the debt, argue many economists. The chart below shows the repayment schedule on the country’s €245bn rescue package and extends all the way out to 2054.

Source: Hellenic Republic Public Debt Bulletin

Although the question of cancelling any portion of the principal owed to Greece’s creditors seems to be a firm no-go area, the idea of further debt extensions could be an option. But as noted by Ben Wright, allowing Greece more time to payback its loans is still a fiscal transfer in all but name.


Myth 2: Greece is paying punitive interest rates. Not really. Greece has managed to negotiate favourable terms on which it can service the cost of its loans and the interest paid by the country is far below that of Spain, Ireland, and Portugal (see chart below). Think-tank Bruegel calculates that Greece paid a sum equal to around 2.6% of its GDP (rather than the widely quoted figure of around 4%) to service its loans last year. This is because Greece will actually receive back the interest it pays to the ECB should it continue to meet its bail-out conditions.

Even without a further renegotiation on interest payments, the costs could be even lower this year. In the words of economist Zolst Darvas from Bruegel:

Given that interest rates have fallen significantly from 2014, actual interest expenditures of Greece will be likely below 2% of GDP in 2015, if Greece will meet the conditions of the bail-out programme.

It is this combination of such long maturities and rock-bottom interest rates, that has led at least one former ECB governing board member to argue that Greece’s debt burden is far more sustainable than many of its southern neighbours.

Who owns Greek debt? (Source: Open Europe)

Myth 3: Greece won’t recover without debt forgiveness. Wrong again. For all the fixation on the outstanding stock of Greek debt, kickstarting growth in the country is more likely to happen through a relaxation of budget rules rather than a debt cancellation. With the coffers looking sparse, the Syriza-led government is also asking for a renegotiation of the surplus rules imposed on the country. Greece is currently required to run a primary surplus of 4.5% of its GDP. Before taking account of its debt interest payments, it is likely to achieve a primary budget surplus of around 3% of its national output this year. This severely limits the new government’s room for fiscal manoeuvre. It also makes it almost impossible for Syriza to fulfil its pre-election promises to raise the minimum wage and create public sector jobs.

According to calculations from Paul Krugman:

Dropping the requirement that Greece run a primary surplus of 4.5% of GDP would allow spending to rise by 9% of GDP, and that this would raise GDP by 12% relative to what it would have been otherwise. Unemployment would fall by around 10% relative to no relief.

None of this is to deny that Greece would hugely benefit from a significant debt cancellation. But the politics of the eurozone means that this is virtually impossible. However, there do seem to be other ways that Greece could start tackling its enormous debt mountain.

And if that is not enough to change your mind about what the reality is in the Greek debt situation, David Weidner at MarketWatch has more, from an entirely different angle, that nevertheless hammers the official narrative just as much, if not more. Weidner refers to work by French economist Eric Dor, as cited by Mish Shedlock last week. What Dor contends is that a very substantial part of Greece’s debt to EU taxpayers was nothing but Wall Street wagers gone awry.

Not exactly something one can blame the Greeks in the street for, just perhaps the elite and oligarchy. Instead of restructuring their banks, the richer nations of Europe, like the US, decided to transfer their gambling losses to the people’s coffers. And though there are all kinds of reasons provided, which even Weidner suggests may be ‘genuine’, not to restructure a banking system, in the end it is a political choice made by those who owe their power to those same banks.

The result has been that Greece was saddled with so much debt, they had to borrow even more, and the Troika could come in and unleash a modern day chapter of the Shock Doctrine. How convenient.

How Wall Street Squeezed Greece – And Germany

Europe’s political leaders and bankers would have you believe that the conflict between Greece and the European Union is a tug of war between a deadbeat nation and its richer ones who have come to the debtor’s aid time and time again. Instead, what most of these leaders miss is that it’s a bank bailout in plain view.


What’s really happened is that since Greece ran into serious trouble repaying its debts four years ago, Germany, France and the EU have instituted what can only be described as a massive bailout of its own financial system – shifting the burden from banks to taxpayers. Last week, Mike Shedlock republished research by Eric Dor, a French business school director, and it shows the magnitude of the shift. To put it simply, German taxpayers are on the hook for roughly $40 billion in Greek debt. German banks? Just $181 million, though they do hold $5.9 billion in exposure to Greek banks. Those numbers are a flip-flop from where things stood less than five years ago.

German banks were heavily exposed to Greek debt when the crisis began, but they’ve been bailed out and now German taxpayers are on the hook. French banks were similarly bailed out by the European Union.

This massive shift from private gains to public losses was done through the European Financial Stability Facility. Created in 2010, this was the European Union’s answer to the U.S. Troubled Asset Relief Program, the Treasury Department’s 2008 bailout program. There are some differences. The EFSF issues bonds, for instance, but the principle is the same. Governments buy bad bank debt and hold it on the public’s books.


The terms set by the EFSF are basically what’s at issue when we hear about Greece’s new government being opposed to austerity in their nation. The Syriza victory, which was a sharp rebuke to the massive cost-cutting in government spending, including pensions and social welfare costs, drew warnings from leaders across Europe. “Mr. Tsipras must pay, those are the rules of the game, there is no room for unilateral behavior in Europe, that doesn’t rule out a rescheduling of the debt,” ECB’s Benoît Coeuré said.


“If he doesn’t pay, it’s a default and it’s a violation of the European rules.” British Prime Minister David Cameron’s Twitter account said, the Greek election results “will increase economic uncertainty across Europe.” And Jens Weidmann, president of the German central bank, warned the new ruling party that it “should not make promises that the country cannot afford.” Those sound like very threatening words. And one wonders if these same officials made the same tough statements to Deutsche Bank, Commerzbank, Credit Agricole or SocGen when they were faced with potentially billions in losses when the banks were holding Greek debt.


European leaders such as Angela Merkel in Germany, Francois Hollande in France and Finnish Prime Minister Alexander Stubb have been eager to beat down Greece and stir broader support at home by making it an us-against-them game. Not to deny that Greece’s financial troubles do threaten the European Union, but today’s crisis pitting nation against nation was created by these leaders in an effort to minimize losses at their biggest lending institutions. Perhaps the move to shift Greek liabilities to state-owned banks (Germany’s export/import bank holds $17 billion in Greek debt) was necessary, but that doesn’t make it fair, or the right thing to do. Europe, like the United States, seems to be at the beck and call of its financial industry.


Michael Hudson recognized this early on. In 2011 he wrote that in Europe there is a belief “governments should run their economies on behalf of banks and bondholders. “They should bail out at least the senior creditors of banks that fail (that is, the big institutional investors and gamblers) and pay these debts and public debts by selling off enterprises, shifting the tax burden onto labor. To balance their budgets they are to cut back spending programs, lower public employment and wages, and charge more for public services, from medical care to education.”


Yes, Greece overspent. But to do so, someone had to overlend. German and French banks did so because of an implicit guarantee by the EU that all nations would stick together. Well, the bankers and politicians have stuck together. Everyone else seems to be on their own. Merkel and the austerity hawks of Europe who won’t share the responsibility for a system’s failure are doing the bidding of banks. At least in Greece, the lawmakers are put into power by the people.

And that still leaves unaddressed that Greece as a whole may have overspent and -borrowed, but it was the elite that was responsible for this, egged on by the likes of Goldman Sachs, whose involvement in the creative accounting that got Greece accepted into the EU, as well as the derivatives that are weighing down the nation as we speak, is notorious.

The world’s major banks got rich off the back of the Greek population at large, and when their wagers got so absurd they collapsed, the banks saw to it that their losses were transferred to European -and American – taxpayers. And those taxpayers are now told to vent their anger at those cheating, lazy Greeks, who are actually notoriously hard workers, who have doctors prostituting themselves, and many of whom have no access to the health care those same doctors should be providing, and whose young people have no future to speak of in their own magnificently beautiful nation.

The Troika, the EU, the IMF, and the banks whose sock puppets they have chosen to be, are a predatory force that has come a long way towards wiping Greece off the map. And we, whether we’re European or American, are complicit in that. It’s Merkel and Cameron etc., who have allowed for their banks to transfer their casino losses to the – empty – pockets of the Greeks, and of all of us. That is the problem here.

And that’s what Syriza has set out to remediate. And for that, they deserve, and probably will need, our unmitigated support. It’s not the Greek grandmas (they’re dying because they have no access to a doctor) who made out like bandits here. It’s the usual suspects, bankers and politicians. And you and I, too, are eerily close to being the usual suspects. We should do better. Or else we are dead certain of being next in line.