ZeroHedge RSS Feed

A Culture Of Fear And Intimidation...

Submitted by Simon Black of Sovereign Man blog,

Last week when I arrived to Bangladesh, the immigration officials there were positively ecstatic to see a foreign tourist entering the country.

I’ve also been to places in Africa and the South Pacific where you’re greeted upon arrival by dancing tribespeople singing songs of welcome.

It’s not quite the same in the Land of the Free. In fact, before they even let people in the country, they program us to be afraid and intimidated.

For one thing, all the immigration officers are armed. There’s absolutely no reason for a government agent to carry a loaded pistol when all he does is stamp a passport. This is EXTREMELY uncommon in the rest of the world. Only in the Land of the Free.

Just like the airport security farce, which has millions of travelers assume the “I surrender” pose inside a radiation machine, US immigration checkpoints are there to train people to be afraid and submit to the state’s authority.

When you step back and look at the whole government apparatus, it’s apparent that this culture of fear and intimidation applies across the entire spectrum.

We’re programmed, for example, to be terrified of the IRS. It’s to the point that getting audited consistently ranks among people’s top fears in the Land of the Free, right up there with snakes and unexpected death. It’s quite sad, actually.

And whether this Soviet-style idea to target opposition political groups came from the top or from the lower ranks, it smacks of an entire organizational culture gone awry… one that thinks it has unlimited power and authority to squash anyone it wants.

We’re also programmed to fear the police… who are more commonly donning combat boots, assault rifles, and these hideous Urban Assault Vehicles as a show of force, as if they’re on patrol in Kandahar.

And we’re programmed to subordinate ourselves to the interests of the state… whether it’s “shared sacrifice”, i.e. everyone must universally suffer because politicians are incompetent, or ratting out our neighbors to Homeland Security (if you see something, say something) or the IRS.

There’s so much more. We’re told that we can be attacked by drones, held in military detention, or have our children taken away by the government. These are powerful tools in stoking a culture of fear to keep an entire civilization under control.

Yet these constant abuses of power are diametrically opposed to how a free society is supposed to conduct itself.

You’re probably aware of a particularly fitting quote, most frequently credited to Thomas Jefferson– “Where the people fear the government, you have tyranny. Where the government fears the people you have liberty.” It’s absolutely true.

(There is no evidence that Jefferson ever said this, nor is the phrase contained in his works. It was first seen in print in John Basil Barnhill’s article, ‘Indictment of Socialism No. 3? in 1914.)

Jefferson did write in a 1789 letter to Welsh philosopher Richard Price that “wherever the people are well informed they can be trusted with their own government; that whenever things get so far wrong as to attract their notice, they may be relied on to set them to rights.”

Unfortunately this isn’t happening; ‘the people’ aren’t rising up to set things right.

And this is an important reminder: we cannot rely on a government or society to provide us with freedom or the economic opportunity which stems from it. We can’t wait for tens of millions of people to ‘wake up’ and ‘vote the bums out’. Or take to the streets.

If history is any indicator, the fear and intimidation will likely get worse. This problem doesn’t just go away, and it doesn’t resolve itself.

The only viable strategy is to abandon the herd and focus on what we can all do as individuals to safeguard our wealth, preserve our liberties, and ensure the continued safety of our families.

    

Quote Of The Day

The only sane central banker in the world, the Bundesbank's Jens Weidmann, take the prize for today's quote of the day with the following:

  • ECB'S WEIDMANN WISHES JAPAN `GOOD LUCK IN THEIR EXPERIMENTS'

So do we. They will need it.

And some other pearls from his speech:

  • WEIDMANN: JAPAN SHOWS MONETARY POLICY CAN BE PUSHED INTO DIFFICULT SPOT
  • WEIDMANN: COUNTRIES MUST RESPECT THE RULES OF MONETARY UNION
  • WEIDMANN SAYS ASKING ECB TO CALM MARKETS CREATES A WEAK EUROPE
  • WEIDMANN SAYS STATE INSOLVENCIES MUST BE POSSIBLE IN EURO AREA

And now cue the Princetonians.

    

Full Text And Wordcloud Of Obama's "Don't Drone Me, Bro" Speech

One can read "The Lethal Presidency of Barack Obama" to get a true sense of Obama's "the best defense is a relentless drone everyone offense, ignore collateral damage and take out a few Americans in the process" policy. Or one can stare at rising stawks and enjoy their Obamaphones. Obe can't have both.

Word cloud:

And full speech (via WaPo):

President Obama’s May 23 speech on national security

President Obama delivered remarks on national security on May 23, 2013, at National Defense University in Washington, D.C. Here are his full remarks as prepared for delivery.

It’s an honor to return to the National Defense University. Here, at Fort McNair, Americans have served in uniform since 1791– standing guard in the early days of the Republic, and contemplating the future of warfare here in the 21st century.

For over two centuries, the United States has been bound together by founding documents that defined who we are as Americans, and served as our compass through every type of change. Matters of war and peace are no different. Americans are deeply ambivalent about war, but having fought for our independence, we know that a price must be paid for freedom. From the Civil War, to our struggle against fascism, and through the long, twilight struggle of the Cold War, battlefields have changed, and technology has evolved. But our commitment to Constitutional principles has weathered every war, and every war has come to an end.

With the collapse of the Berlin Wall, a new dawn of democracy took hold abroad, and a decade of peace and prosperity arrived at home. For a moment, it seemed the 21st century would be a tranquil time. Then, on September 11th 2001, we were shaken out of complacency. Thousands were taken from us, as clouds of fire, metal and ash descended upon a sun-filled morning. This was a different kind of war. No armies came to our shores, and our military was not the principal target. Instead, a group of terrorists came to kill as many civilians as they could.

And so our nation went to war. We have now been at war for well over a decade. I won’t review the full history. What’s clear is that we quickly drove al Qaeda out of Afghanistan, but then shifted our focus and began a new war in Iraq. This carried grave consequences for our fight against al Qaeda, our standing in the world, and – to this day – our interests in a vital region.

Meanwhile, we strengthened our defenses – hardening targets, tightening transportation security, and giving law enforcement new tools to prevent terror. Most of these changes were sound. Some caused inconvenience. But some, like expanded surveillance, raised difficult questions about the balance we strike between our interests in security and our values of privacy. And in some cases, I believe we compromised our basic values – by using torture to interrogate our enemies, and detaining individuals in a way that ran counter to the rule of law.

After I took office, we stepped up the war against al Qaeda, but also sought to change its course. We relentlessly targeted al Qaeda’s leadership. We ended the war in Iraq, and brought nearly 150,000 troops home. We pursued a new strategy in Afghanistan, and increased our training of Afghan forces. We unequivocally banned torture, affirmed our commitment to civilian courts, worked to align our policies with the rule of law, and expanded our consultations with Congress.

Today, Osama bin Laden is dead, and so are most of his top lieutenants. There have been no large-scale attacks on the United States, and our homeland is more secure. Fewer of our troops are in harm’s way, and over the next 19 months they will continue to come home. Our alliances are strong, and so is our standing in the world. In sum, we are safer because of our efforts.

Now make no mistake: our nation is still threatened by terrorists. From Benghazi to Boston, we have been tragically reminded of that truth. We must recognize, however, that the threat has shifted and evolved from the one that came to our shores on 9/11. With a decade of experience to draw from, now is the time to ask ourselves hard questions – about the nature of today’s threats, and how we should confront them.

These questions matter to every American. For over the last decade, our nation has spent well over a trillion dollars on war, exploding our deficits and constraining our ability to nation build here at home. Our service-members and their families have sacrificed far more on our behalf. Nearly 7,000 Americans have made the ultimate sacrifice. Many more have left a part of themselves on the battlefield, or brought the shadows of battle back home. From our use of drones to the detention of terrorist suspects, the decisions we are making will define the type of nation – and world – that we leave to our children.

So America is at a crossroads. We must define the nature and scope of this struggle, or else it will define us, mindful of James Madison’s warning that “No nation could preserve its freedom in the midst of continual warfare.” Neither I, nor any President, can promise the total defeat of terror. We will never erase the evil that lies in the hearts of some human beings, nor stamp out every danger to our open society. What we can do – what we must do – is dismantle networks that pose a direct danger, and make it less likely for new groups to gain a foothold, all while maintaining the freedoms and ideals that we defend. To define that strategy, we must make decisions based not on fear, but hard-earned wisdom. And that begins with understanding the threat we face.

Today, the core of al Qaeda in Afghanistan and Pakistan is on a path to defeat. Their remaining operatives spend more time thinking about their own safety than plotting against us. They did not direct the attacks in Benghazi or Boston. They have not carried out a successful attack on our homeland since 9/11. Instead, what we’ve seen is the emergence of various al Qaeda affiliates. From Yemen to Iraq, from Somalia to North Africa, the threat today is more diffuse, with Al Qaeda’s affiliate in the Arabian Peninsula – AQAP –the most active in plotting against our homeland. While none of AQAP’s efforts approach the scale of 9/11 they have continued to plot acts of terror, like the attempt to blow up an airplane on Christmas Day in 2009.

Unrest in the Arab World has also allowed extremists to gain a foothold in countries like Libya and Syria. Here, too, there are differences from 9/11. In some cases, we confront state-sponsored networks like Hizbollah that engage in acts of terror to achieve political goals. Others are simply collections of local militias or extremists interested in seizing territory. While we are vigilant for signs that these groups may pose a transnational threat, most are focused on operating in the countries and regions where they are based. That means we will face more localized threats like those we saw in Benghazi, or at the BP oil facility in Algeria, in which local operatives – in loose affiliation with regional networks – launch periodic attacks against Western diplomats, companies, and other soft targets, or resort to kidnapping and other criminal enterprises to fund their operations.

Finally, we face a real threat from radicalized individuals here in the United States. Whether it’s a shooter at a Sikh Temple in Wisconsin; a plane flying into a building in Texas; or the extremists who killed 168 people at the Federal Building in Oklahoma City – America has confronted many forms of violent extremism in our time. Deranged or alienated individuals – often U.S. citizens or legal residents – can do enormous damage, particularly when inspired by larger notions of violent jihad. That pull towards extremism appears to have led to the shooting at Fort Hood, and the bombing of the Boston Marathon.

Lethal yet less capable al Qaeda affiliates. Threats to diplomatic facilities and businesses abroad. Homegrown extremists. This is the future of terrorism. We must take these threats seriously, and do all that we can to confront them. But as we shape our response, we have to recognize that the scale of this threat closely resembles the types of attacks we faced before 9/11. In the 1980s, we lost Americans to terrorism at our Embassy in Beirut; at our Marine Barracks in Lebanon; on a cruise ship at sea; at a disco in Berlin; and on Pan Am Flight 103 over Lockerbie. In the 1990s, we lost Americans to terrorism at the World Trade Center; at our military facilities in Saudi Arabia; and at our Embassy in Kenya. These attacks were all deadly, and we learned that left unchecked, these threats can grow. But if dealt with smartly and proportionally, these threats need not rise to the level that we saw on the eve of 9/11.

Moreover, we must recognize that these threats don’t arise in a vacuum. Most, though not all, of the terrorism we face is fueled by a common ideology – a belief by some extremists that Islam is in conflict with the United States and the West, and that violence against Western targets, including civilians, is justified in pursuit of a larger cause. Of course, this ideology is based on a lie, for the United States is not at war with Islam; and this ideology is rejected by the vast majority of Muslims, who are the most frequent victims of terrorist acts.

Nevertheless, this ideology persists, and in an age in which ideas and images can travel the globe in an instant, our response to terrorism cannot depend on military or law enforcement alone. We need all elements of national power to win a battle of wills and ideas. So let me discuss the components of such a comprehensive counter-terrorism strategy.

First, we must finish the work of defeating al Qaeda and its associated forces.

In Afghanistan, we will complete our transition to Afghan responsibility for security. Our troops will come home. Our combat mission will come to an end. And we will work with the Afghan government to train security forces, and sustain a counter-terrorism force which ensures that al Qaeda can never again establish a safe-haven to launch attacks against us or our allies.

Beyond Afghanistan, we must define our effort not as a boundless ‘global war on terror’ – but rather as a series of persistent, targeted efforts to dismantle specific networks of violent extremists that threaten America. In many cases, this will involve partnerships with other countries. Thousands of Pakistani soldiers have lost their lives fighting extremists. In Yemen, we are supporting security forces that have reclaimed territory from AQAP. In Somalia, we helped a coalition of African nations push al Shabaab out of its strongholds. In Mali, we are providing military aid to a French-led intervention to push back al Qaeda in the Maghreb, and help the people of Mali reclaim their future.

Much of our best counter-terrorism cooperation results in the gathering and sharing of intelligence; the arrest and prosecution of terrorists. That’s how a Somali terrorist apprehended off the coast of Yemen is now in prison in New York. That’s how we worked with European allies to disrupt plots from Denmark to Germany to the United Kingdom. That’s how intelligence collected with Saudi Arabia helped us stop a cargo plane from being blown up over the Atlantic.

But despite our strong preference for the detention and prosecution of terrorists, sometimes this approach is foreclosed. Al Qaeda and its affiliates try to gain a foothold in some of the most distant and unforgiving places on Earth. They take refuge in remote tribal regions. They hide in caves and walled compounds. They train in empty deserts and rugged mountains.

In some of these places – such as parts of Somalia and Yemen – the state has only the most tenuous reach into the territory. In other cases, the state lacks the capacity or will to take action. It is also not possible for America to simply deploy a team of Special Forces to capture every terrorist. And even when such an approach may be possible, there are places where it would pose profound risks to our troops and local civilians– where a terrorist compound cannot be breached without triggering a firefight with surrounding tribal communities that pose no threat to us, or when putting U.S. boots on the ground may trigger a major international crisis.

To put it another way, our operation in Pakistan against Osama bin Laden cannot be the norm. The risks in that case were immense; the likelihood of capture, although our preference, was remote given the certainty of resistance; the fact that we did not find ourselves confronted with civilian casualties, or embroiled in an extended firefight, was a testament to the meticulous planning and professionalism of our Special Forces – but also depended on some luck. And even then, the cost to our relationship with Pakistan – and the backlash among the Pakistani public over encroachment on their territory – was so severe that we are just now beginning to rebuild this important partnership.

It is in this context that the United States has taken lethal, targeted action against al Qaeda and its associated forces, including with remotely piloted aircraft commonly referred to as drones. As was true in previous armed conflicts, this new technology raises profound questions – about who is targeted, and why; about civilian casualties, and the risk of creating new enemies; about the legality of such strikes under U.S. and international law; about accountability and morality.

Let me address these questions. To begin with, our actions are effective. Don’t take my word for it. In the intelligence gathered at bin Laden’s compound, we found that he wrote, “we could lose the reserves to the enemy’s air strikes. We cannot fight air strikes with explosives.” Other communications from al Qaeda operatives confirm this as well. Dozens of highly skilled al Qaeda commanders, trainers, bomb makers, and operatives have been taken off the battlefield. Plots have been disrupted that would have targeted international aviation, U.S. transit systems, European cities and our troops in Afghanistan. Simply put, these strikes have saved lives.

Moreover, America’s actions are legal. We were attacked on 9/11. Within a week, Congress overwhelmingly authorized the use of force. Under domestic law, and international law, the United States is at war with al Qaeda, the Taliban, and their associated forces. We are at war with an organization that right now would kill as many Americans as they could if we did not stop them first. So this is a just war – a war waged proportionally, in last resort, and in self-defense.

And yet as our fight enters a new phase, America’s legitimate claim of self-defense cannot be the end of the discussion. To say a military tactic is legal, or even effective, is not to say it is wise or moral in every instance. For the same human progress that gives us the technology to strike half a world away also demands the discipline to constrain that power – or risk abusing it. That’s why, over the last four years, my Administration has worked vigorously to establish a framework that governs our use of force against terrorists – insisting upon clear guidelines, oversight and accountability that is now codified in Presidential Policy Guidance that I signed yesterday.

In the Afghan war theater, we must support our troops until the transition is complete at the end of 2014. That means we will continue to take strikes against high value al Qaeda targets, but also against forces that are massing to support attacks on coalition forces. However, by the end of 2014, we will no longer have the same need for force protection, and the progress we have made against core al Qaeda will reduce the need for unmanned strikes.

Beyond the Afghan theater, we only target al Qaeda and its associated forces. Even then, the use of drones is heavily constrained. America does not take strikes when we have the ability to capture individual terrorists - our preference is always to detain, interrogate, and prosecute them. America cannot take strikes wherever we choose – our actions are bound by consultations with partners, and respect for state sovereignty. America does not take strikes to punish individuals – we act against terrorists who pose a continuing and imminent threat to the American people, and when there are no other governments capable of effectively addressing the threat. And before any strike is taken, there must be near-certainty that no civilians will be killed or injured – the highest standard we can set.

This last point is critical, because much of the criticism about drone strikes – at home and abroad – understandably centers on reports of civilian casualties. There is a wide gap between U.S. assessments of such casualties, and non-governmental reports. Nevertheless, it is a hard fact that U.S. strikes have resulted in civilian casualties, a risk that exists in all wars. For the families of those civilians, no words or legal construct can justify their loss. For me, and those in my chain of command, these deaths will haunt us as long as we live, just as we are haunted by the civilian casualties that have occurred through conventional fighting in Afghanistan and Iraq.

But as Commander-in-Chief, I must weigh these heartbreaking tragedies against the alternatives. To do nothing in the face of terrorist networks would invite far more civilian casualties – not just in our cities at home and facilities abroad, but also in the very places –like Sana’a and Kabul and Mogadishu – where terrorists seek a foothold. Let us remember that the terrorists we are after target civilians, and the death toll from their acts of terrorism against Muslims dwarfs any estimate of civilian casualties from drone strikes.

Where foreign governments cannot or will not effectively stop terrorism in their territory, the primary alternative to targeted, lethal action is the use of conventional military options. As I’ve said, even small Special Operations carry enormous risks. Conventional airpower or missiles are far less precise than drones, and likely to cause more civilian casualties and local outrage. And invasions of these territories lead us to be viewed as occupying armies; unleash a torrent of unintended consequences; are difficult to contain; and ultimately empower those who thrive on violent conflict. So it is false to assert that putting boots on the ground is less likely to result in civilian deaths, or to create enemies in the Muslim world. The result would be more U.S. deaths, more Blackhawks down, more confrontations with local populations, and an inevitable mission creep in support of such raids that could easily escalate into new wars.

So yes, the conflict with al Qaeda, like all armed conflict, invites tragedy. But by narrowly targeting our action against those who want to kill us, and not the people they hide among, we are choosing the course of action least likely to result in the loss of innocent life. Indeed, our efforts must also be measured against the history of putting American troops in distant lands among hostile populations. In Vietnam, hundreds of thousands of civilians died in a war where the boundaries of battle were blurred. In Iraq and Afghanistan, despite the courage and discipline of our troops, thousands of civilians have been killed. So neither conventional military action, nor waiting for attacks to occur, offers moral safe-harbor. Neither does a sole reliance on law enforcement in territories that have no functioning police or security services – and indeed, have no functioning law.

This is not to say that the risks are not real. Any U.S. military action in foreign lands risks creating more enemies, and impacts public opinion overseas. Our laws constrain the power of the President, even during wartime, and I have taken an oath to defend the Constitution of the United States. The very precision of drones strikes, and the necessary secrecy involved in such actions can end up shielding our government from the public scrutiny that a troop deployment invites. It can also lead a President and his team to view drone strikes as a cure-all for terrorism.

For this reason, I’ve insisted on strong oversight of all lethal action. After I took office, my Administration began briefing all strikes outside of Iraq and Afghanistan to the appropriate committees of Congress. Let me repeat that – not only did Congress authorize the use of force, it is briefed on every strike that America takes. That includes the one instance when we targeted an American citizen: Anwar Awlaki, the chief of external operations for AQAP.

This week, I authorized the declassification of this action, and the deaths of three other Americans in drone strikes, to facilitate transparency and debate on this issue, and to dismiss some of the more outlandish claims. For the record, I do not believe it would be constitutional for the government to target and kill any U.S. citizen – with a drone, or a shotgun – without due process. Nor should any President deploy armed drones over U.S. soil.

But when a U.S. citizen goes abroad to wage war against America – and is actively plotting to kill U.S. citizens; and when neither the United States, nor our partners are in a position to capture him before he carries out a plot – his citizenship should no more serve as a shield than a sniper shooting down on an innocent crowd should be protected from a swat team

That’s who Anwar Awlaki was – he was continuously trying to kill people. He helped oversee the 2010 plot to detonate explosive devices on two U.S. bound cargo planes. He was involved in planning to blow up an airliner in 2009. When Farouk Abdulmutallab – the Christmas Day bomber – went to Yemen in 2009, Awlaki hosted him, approved his suicide operation, and helped him tape a martyrdom video to be shown after the attack. His last instructions were to blow up the airplane when it was over American soil. I would have detained and prosecuted Awlaki if we captured him before he carried out a plot. But we couldn’t. And as President, I would have been derelict in my duty had I not authorized the strike that took out Awlaki.

Of course, the targeting of any Americans raises constitutional issues that are not present in other strikes – which is why my Administration submitted information about Awlaki to the Department of Justice months before Awlaki was killed, and briefed the Congress before this strike as well. But the high threshold that we have set for taking lethal action applies to all potential terrorist targets, regardless of whether or not they are American citizens. This threshold respects the inherent dignity of every human life. Alongside the decision to put our men and women in uniform in harm’s way, the decision to use force against individuals or groups – even against a sworn enemy of the United States – is the hardest thing I do as President. But these decisions must be made, given my responsibility to protect the American people.

Going forward, I have asked my Administration to review proposals to extend oversight of lethal actions outside of warzones that go beyond our reporting to Congress. Each option has virtues in theory, but poses difficulties in practice. For example, the establishment of a special court to evaluate and authorize lethal action has the benefit of bringing a third branch of government into the process, but raises serious constitutional issues about presidential and judicial authority. Another idea that’s been suggested – the establishment of an independent oversight board in the executive branch – avoids those problems, but may introduce a layer of bureaucracy into national-security decision-making, without inspiring additional public confidence in the process. Despite these challenges, I look forward to actively engaging Congress to explore these – and other – options for increased oversight.

I believe, however, that the use of force must be seen as part of a larger discussion about a comprehensive counter-terrorism strategy. Because for all the focus on the use of force, force alone cannot make us safe. We cannot use force everywhere that a radical ideology takes root; and in the absence of a strategy that reduces the well-spring of extremism, a perpetual war – through drones or Special Forces or troop deployments – will prove self-defeating, and alter our country in troubling ways.

So the next element of our strategy involves addressing the underlying grievances and conflicts that feed extremism, from North Africa to South Asia. As we’ve learned this past decade, this is a vast and complex undertaking. We must be humble in our expectation that we can quickly resolve deep rooted problems like poverty and sectarian hatred. Moreover, no two countries are alike, and some will undergo chaotic change before things get better. But our security and values demand that we make the effort.

This means patiently supporting transitions to democracy in places like Egypt, Tunisia and Libya – because the peaceful realization of individual aspirations will serve as a rebuke to violent extremists. We must strengthen the opposition in Syria, while isolating extremist elements – because the end of a tyrant must not give way to the tyranny of terrorism. We are working to promote peace between Israelis and Palestinians – because it is right, and because such a peace could help reshape attitudes in the region. And we must help countries modernize economies, upgrade education, and encourage entrepreneurship – because American leadership has always been elevated by our ability to connect with peoples’ hopes, and not simply their fears.

Success on these fronts requires sustained engagement, but it will also require resources. I know that foreign aid is one of the least popular expenditures – even though it amounts to less than one percent of the federal budget. But foreign assistance cannot be viewed as charity. It is fundamental to our national security, and any sensible long-term strategy to battle extremism. Moreover, foreign assistance is a tiny fraction of what we spend fighting wars that our assistance might ultimately prevent. For what we spent in a month in Iraq at the height of the war, we could be training security forces in Libya, maintaining peace agreements between Israel and its neighbors, feeding the hungry in Yemen, building schools in Pakistan, and creating reservoirs of goodwill that marginalize extremists.

America cannot carry out this work if we do not have diplomats serving in dangerous places. Over the past decade, we have strengthened security at our Embassies, and I am implementing every recommendation of the Accountability Review Board which found unacceptable failures in Benghazi. I have called on Congress to fully fund these efforts to bolster security, harden facilities, improve intelligence, and facilitate a quicker response time from our military if a crisis emerges.

But even after we take these steps, some irreducible risks to our diplomats will remain. This is the price of being the world’s most powerful nation, particularly as a wave of change washes over the Arab World. And in balancing the trade-offs between security and active diplomacy, I firmly believe that any retreat from challenging regions will only increase the dangers we face in the long run.

Targeted action against terrorists. Effective partnerships. Diplomatic engagement and assistance. Through such a comprehensive strategy we can significantly reduce the chances of large scale attacks on the homeland and mitigate threats to Americans overseas. As we guard against dangers from abroad, however, we cannot neglect the daunting challenge of terrorism from within our borders.

As I said earlier, this threat is not new. But technology and the Internet increase its frequency and lethality. Today, a person can consume hateful propaganda, commit themselves to a violent agenda, and learn how to kill without leaving their home. To address this threat, two years ago my Administration did a comprehensive review, and engaged with law enforcement. The best way to prevent violent extremism is to work with the Muslim American community – which has consistently rejected terrorism – to identify signs of radicalization, and partner with law enforcement when an individual is drifting towards violence. And these partnerships can only work when we recognize that Muslims are a fundamental part of the American family. Indeed, the success of American Muslims, and our determination to guard against any encroachments on their civil liberties, is the ultimate rebuke to those who say we are at war with Islam.

Indeed, thwarting homegrown plots presents particular challenges in part because of our proud commitment to civil liberties for all who call America home. That’s why, in the years to come, we will have to keep working hard to strike the appropriate balance between our need for security and preserving those freedoms that make us who we are. That means reviewing the authorities of law enforcement, so we can intercept new types of communication, and build in privacy protections to prevent abuse. That means that – even after Boston – we do not deport someone or throw someone in prison in the absence of evidence. That means putting careful constraints on the tools the government uses to protect sensitive information, such as the State Secrets doctrine. And that means finally having a strong Privacy and Civil Liberties Board to review those issues where our counter-terrorism efforts and our values may come into tension.

The Justice Department’s investigation of national security leaks offers a recent example of the challenges involved in striking the right balance between our security and our open society. As Commander-in Chief, I believe we must keep information secret that protects our operations and our people in the field. To do so, we must enforce consequences for those who break the law and breach their commitment to protect classified information. But a free press is also essential for our democracy. I am troubled by the possibility that leak investigations may chill the investigative journalism that holds government accountable.

Journalists should not be at legal risk for doing their jobs. Our focus must be on those who break the law. That is why I have called on Congress to pass a media shield law to guard against government over-reach. I have raised these issues with the Attorney General, who shares my concern. So he has agreed to review existing Department of Justice guidelines governing investigations that involve reporters, and will convene a group of media organizations to hear their concerns as part of that review. And I have directed the Attorney General to report back to me by July 12th.

All these issues remind us that the choices we make about war can impact – in sometimes unintended ways – the openness and freedom on which our way of life depends. And that is why I intend to engage Congress about the existing Authorization to Use Military Force, or AUMF, to determine how we can continue to fight terrorists without keeping America on a perpetual war-time footing.

The AUMF is now nearly twelve years old. The Afghan War is coming to an end. Core al Qaeda is a shell of its former self. Groups like AQAP must be dealt with, but in the years to come, not every collection of thugs that labels themselves al Qaeda will pose a credible threat to the United States. Unless we discipline our thinking and our actions, we may be drawn into more wars we don’t need to fight, or continue to grant Presidents unbound powers more suited for traditional armed conflicts between nation states. So I look forward to engaging Congress and the American people in efforts to refine, and ultimately repeal, the AUMF’s mandate. And I will not sign laws designed to expand this mandate further. Our systematic effort to dismantle terrorist organizations must continue. But this war, like all wars, must end. That’s what history advises. That’s what our democracy demands.

And that brings me to my final topic: the detention of terrorist suspects.

To repeat, as a matter of policy, the preference of the United States is to capture terrorist suspects. When we do detain a suspect, we interrogate them. And if the suspect can be prosecuted, we decide whether to try him in a civilian court or a Military Commission. During the past decade, the vast majority of those detained by our military were captured on the battlefield. In Iraq, we turned over thousands of prisoners as we ended the war. In Afghanistan, we have transitioned detention facilities to the Afghans, as part of the process of restoring Afghan sovereignty. So we bring law of war detention to an end, and we are committed to prosecuting terrorists whenever we can.

The glaring exception to this time-tested approach is the detention center at Guantanamo Bay. The original premise for opening GTMO – that detainees would not be able to challenge their detention – was found unconstitutional five years ago. In the meantime, GTMO has become a symbol around the world for an America that flouts the rule of law. Our allies won’t cooperate with us if they think a terrorist will end up at GTMO. During a time of budget cuts, we spend $150 million each year to imprison 166 people –almost $1 million per prisoner. And the Department of Defense estimates that we must spend another $200 million to keep GTMO open at a time when we are cutting investments in education and research here at home.

As President, I have tried to close GTMO. I transferred 67 detainees to other countries before Congress imposed restrictions to effectively prevent us from either transferring detainees to other countries, or imprisoning them in the United States. These restrictions make no sense. After all, under President Bush, some 530 detainees were transferred from GTMO with Congress’s support. When I ran for President the first time, John McCain supported closing GTMO. No person has ever escaped from one of our super-max or military prisons in the United States. Our courts have convicted hundreds of people for terrorism-related offenses, including some who are more dangerous than most GTMO detainees. Given my Administration’s relentless pursuit of al Qaeda’s leadership, there is no justification beyond politics for Congress to prevent us from closing a facility that should never have been opened.

Today, I once again call on Congress to lift the restrictions on detainee transfers from GTMO. I have asked the Department of Defense to designate a site in the United States where we can hold military commissions. I am appointing a new, senior envoy at the State Department and Defense Department whose sole responsibility will be to achieve the transfer of detainees to third countries. I am lifting the moratorium on detainee transfers to Yemen, so we can review them on a case by case basis. To the greatest extent possible, we will transfer detainees who have been cleared to go to other countries. Where appropriate, we will bring terrorists to justice in our courts and military justice system. And we will insist that judicial review be available for every detainee.

Even after we take these steps, one issue will remain: how to deal with those GTMO detainees who we know have participated in dangerous plots or attacks, but who cannot be prosecuted – for example because the evidence against them has been compromised or is inadmissible in a court of law. But once we commit to a process of closing GTMO, I am confident that this legacy problem can be resolved, consistent with our commitment to the rule of law.

I know the politics are hard. But history will cast a harsh judgment on this aspect of our fight against terrorism, and those of us who fail to end it. Imagine a future – ten years from now, or twenty years from now – when the United States of America is still holding people who have been charged with no crime on a piece of land that is not a part of our country. Look at the current situation, where we are force-feeding detainees who are holding a hunger strike. Is that who we are? Is that something that our Founders foresaw? Is that the America we want to leave to our children?

Our sense of justice is stronger than that. We have prosecuted scores of terrorists in our courts. That includes Umar Farouk Abdulmutallab, who tried to blow up an airplane over Detroit; and Faisal Shahzad, who put a car bomb in Times Square. It is in a court of law that we will try Dzhokhar Tsarnaev, who is accused of bombing the Boston Marathon. Richard Reid, the shoe bomber, is as we speak serving a life sentence in a maximum security prison here, in the United States. In sentencing Reid, Judge William Young told him, “the way we treat you…is the measure of our own liberties.” He went on to point to the American flag that flew in the courtroom – “That flag,” he said, “will fly there long after this is all forgotten. That flag still stands for freedom.”

America, we have faced down dangers far greater than al Qaeda. By staying true to the values of our founding, and by using our constitutional compass, we have overcome slavery and Civil War; fascism and communism. In just these last few years as President, I have watched the American people bounce back from painful recession, mass shootings, and natural disasters like the recent tornados that devastated Oklahoma. These events were heartbreaking; they shook our communities to the core. But because of the resilience of the American people, these events could not come close to breaking us.

I think of Lauren Manning, the 9/11 survivor who had severe burns over 80 percent of her body, who said, “That’s my reality. I put a Band-Aid on it, literally, and I move on.”

I think of the New Yorkers who filled Times Square the day after an attempted car bomb as if nothing had happened.

I think of the proud Pakistani parents who, after their daughter was invited to the White House, wrote to us, “we have raised an American Muslim daughter to dream big and never give up because it does pay off.”

I think of the wounded warriors rebuilding their lives, and helping other vets to find jobs.

I think of the runner planning to do the 2014 Boston Marathon, who said, “Next year, you are going to have more people than ever. Determination is not something to be messed with.”

That’s who the American people are. Determined, and not to be messed with.

Now, we need a strategy – and a politics –that reflects this resilient spirit. Our victory against terrorism won’t be measured in a surrender ceremony on a battleship, or a statue being pulled to the ground. Victory will be measured in parents taking their kids to school; immigrants coming to our shores; fans taking in a ballgame; a veteran starting a business; a bustling city street. The quiet determination; that strength of character and bond of fellowship; that refutation of fear – that is both our sword and our shield. And long after the current messengers of hate have faded from the world’s memory, alongside the brutal despots, deranged madmen, and ruthless demagogues who litter history – the flag of the United States will still wave from small-town cemeteries, to national monuments, to distant outposts abroad. And that flag will still stand for freedom.

Thank you. God Bless you. And may God bless the United States of America.

    

Richard Koo Warns Of "Beginning Of The End" For Japanese Economy

The surge in Japanese long-term interest rates is likely causing some lost sleep among bond market participants and policymakers (despite their ignorance of the moves in the BoJ minutes) as Nomura's Richard Koo notes, if this trend continues (now added to by the collapse in stock prices) it could well mark the “beginning of the end” for the Japanese economy.

Although the stock market has (until now) welcomed the yen’s continued slide against the dollar, Koo warns that this trend needs to be carefully monitored, as simultaneous declines in JGBs and the yen can be interpreted as a loss of faith in the Japanese government and the Bank of Japan. The biggest concerns are that the extreme volatility in Japanese stocks and bonds is occurring at a time when the BOJ was buying large quantities of government bonds.

Until the recent events there was an expectation in the JGB market that bond prices would not fall substantially even if the Bank’s aggressive easing program depressed the yen and lifted inflation expectations as long as the BOJ remained a major buyer. It is now clear that even large-scale BOJ purchases of JGBs cannot stop yields from rising.

 

Via Richard Koo, Nomura,

The lies are working (too well)...

Mr. Kuroda’s psychological tactic of repeating a lie often enough that it becomes the truth has succeeded brilliantly.

 

The problem is that it works on lenders as well as on borrowers. Moreover, borrowers are agents in the real economy and need time to react, whereas lenders are financial sector entities that can respond instantaneously, creating the possibility that lenders will react sooner than borrowers.

 

The fact that the BOJ has also reversed the traditional order of things and is trying to spark an economic recovery by generating inflation has increased the possibility that higher long-term rates driven by inflation concerns will emerge sooner than higher long term rates rooted in a recovery in the real economy.

But that is leading to a 'bad' (uncontrollable) rise in rates...

If we refer to higher interest rates driven by an economic recovery as a “good” increase and higher rates sparked by inflation concerns as a “bad” increase, I think there is a significant possibility that the latter will emerge first in this case.

 

That would not only weigh heavily on the first shoots of private loan demand to arise in a long time but could also focus attention on the banks’ and the government’s financial health, damping the positive momentum in the economy and markets seen over the last four months.

 

This kind of contradiction in timing is called the “time inconsistency problem,” and it will continue to hang over the policies of the Kuroda BOJ.

Simply out, Koo's perspective is that the BoJ needs to rein itself in...

BOJ needs to declare it will not tolerate overshooting of inflation

 

What can the BOJ do? To begin with, the Bank and the government could make it clear that they are targeting a 2% rate of inflation but at the same time, they will not under any condition tolerate a significant overshooting of that rate.

 

By stating that they will not accept an overshooting of the target, the Bank of Japan and the government could reassure the markets that there will be no plunge in the yen and no bouts of uncontrollable inflation.

    

The Winners And Losers In Today's NEE And AEP Flash Crashes

(Milli)seconds after today's market open, utilities NextEra Energy (NEE) and American Electric Power (AEP) did what most stocks in the New Normal do when there is an unexpected event (like a 4 sigma plunge in the Nikkei): they flash crashed.

What is different about AEP and NEE is that unlike most other daily stocks that implode in a matter of milliseconds, the collective market cap of the two companies was nearly $60 billion, which in turn sent the broader utilities index down over 10%. Of course, for a few milliseconds it was more like $30 billion: because that is how much in capitalization was lost in under one second, when today's flash crash du jour struck.

But fear not: anyone who got stopped out under $76.19 in NEE and under $46.03 in AEP are the "lucky" ones, and the trades were marked as "Aberrant." Alas since that simply means the trades are excluded from daily high and low charts, that is hardly comforting for anyone. 

In other words, the "unlucky ones" are, well, everyone, because no trades were actually DKed. So to all those who lost electronic money due to what was an electronic trading algo gone wrong, can submit an electronic complaint to the NYSE, which will be promptly ignored by an electronic email filter. In other news, investor confidence in electronic markets has never been higher.

NEE

AES

Courtesy of Nanex

    

UBS On Japan - Are You 'Abe'liever?

Authored by Duncan Wooldridge via UBS,

We totally get why many are excited by the recent cyclical improvement in the Japanese economy. However, just because industrial production is turning up on the back of exports and 1Q GDP grew more than expected doesn’t mean Abeconomics is working. Our colleague, Paul Donovan, correctly pointed out these improvements occurred before the Bank of Japan aggressively started to ramp up base money and there’s been no structural reform to date. Hence, most of the improvement in Japan is probably best described as a standard cyclical improvement in the aftermath of very depressed growth that was also heavily influenced by last year’s downturn in global trade. Recent positive momentum in the economy will likely be sustained for a few more quarters and then of course later this year and early next year consumption should accelerate ahead of a consumption tax hike scheduled for April 2014. So for Abe-believers there will be fuel to support their optimism. However, once you move beyond that and think about what comes afterwards things look more challenging.

Can Japan sustainably lift aggregate demand above supply? If that cannot be done then it’s hard to see deflation resolved in a fundamentally positive way. Aggregate demand is heavily influenced by demographics and exports. We published chart 1 recently and it shows that historically the growth rate in Japan’s labour force is an excellent indicator for inflation. That’s because the growth in the labour force affects the level and growth of aggregate wages since total wages equal the number of workers multiplied by wages per worker. That has an affect on consumption and aggregate demand. We did some back of the envelope calculations that suggest even with wages per worker growing by 1% the aggregate wage level might not rise.

 

Meanwhile the consensus is busy writing report after report on what Japan means for Asia. In our view, the more interesting question is what does Asia mean for Japan? Exports will play a vital role in Japan’s efforts to raise aggregate demand above supply. So here’s the problem. We’ve argued consistently that Asia is 5 years into building a credit bubble in an effort to substitute credit-led domestic demand to offset trend weakness in external demand.

Our central thesis back in 2009 was that Asia’s willingness to increase leverage would be helpful to growth, asset prices and profits in the region, and by extension intra-Asian trade. But we also argued that with time and higher leverage Asia’s credit-led growth would suffer from diminishing marginal benefits of taking on more debt. That is arguably where much of the region is today and partly explains why Chinese growth is beginning to disappoint expectations.

It’s highly likely that Asian economic growth a few years from now will slow significantly as the region’s credit-led growth policies become progressively less effective and produce untoward headwinds for growth. After all, there is always a significant slowdown in growth waiting for you on the other side of any aggressive credit expansion. The problem for Japan is that over 50% of her exports go to Asia. Hence, improving exports are currently helping cyclically but a slowdown in exports – led by weakening Asian demand -- a year or so out is likely. A slowdown in exports to Asia along with a shrinking Japanese consumer base will make it more difficult for Japan to sustainably inflate aggregate demand relative to capacity or supply.

This is especially true since capacity is sticky and Japan arguably has too much capacity. A country’s capital stock, along with labour, allows it to provide goods and services to the population; i.e., to meet aggregate demand. Japan has the highest per capita capital stock in the world despite having a shrinking population that is expected to accelerate over the next few decades. The only country in our sample that presently looks similar to Japan is Germany.

However, that’s not an apple to apple comparison. First, it’s true that Germany’s capital stock is high, far higher than the US, and its population is shrinking. But in Germany’s case its internal demographics are far less important because it is part of the European Union and importantly labour can move freely between Germany and other EU members. Hence, even though Germany’s population is shrinking its labour force continues to grow unlike Japan, and as we mentioned earlier that affects aggregate demand. Secondly, Germany shares the same currency with its major trade partners, which gives it a competitive advantage in many respects.

So we sum it all up like this. There are definitely signs that Japan’s economy are improving cyclically. However, structurally demographics remain a major headwind to raising aggregate demand. We feel many investors have not yet considered what slower growth for Asia will mean for Japan in the medium term. This will make it more difficult to raise aggregate demand above supply since capacity is sticky and Japan already has excess capacity.

    

Oklahoma Tornado Devastation: Before And After Picture

The biggest story of the early part of the week was the massive 1+ mile-wide Tornado ploughing through a suburb of Oklahoma City leading to dozens of deaths and billions in damage. And while the story has already faded from the 15 minutes of collective random access memory, the following aerial picture showing just how devastating nature can be when it so chooses, is one to behold.

h/t @911buff

    

Revealed: Apple’s “Offshore” Cash Isn’t Even Offshore

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

No one accused Apple of having violated US tax laws. The Senate subcommittee investigation and hearings merely exposed how Apple is dodging income taxes by doing what multinationals do: taking advantage of the handouts and loopholes that the US Congress and governments around the world are handing them. Tim Cook emerged smelling like a rose, the triumphant CEO of America’s most iconic welfare queen. Alas, much of the discussion was based on a fairytale.

Apple got into this pickle because it had decided to fund a juicy stock buy-back and dividend program by taking on a record $17 billion in debt rather than paying income taxes on “repatriating” part of its $102 billion in “offshore” cash.

The Senate investigation showed that Apple sheltered at least $74 billion from US income taxes between 2009 and 2012 by using a “complex web” of offshore mailbox companies. One such Irish subsidiary with no employees made $30 billion and didn’t pay a dime to a single government anywhere, not even Ireland. Another Irish mailbox company paid 0.05% in taxes on $22 billion in profit. Over the years, these untaxed “offshore” profits accumulated to $102 billion held by Irish subsidiaries – the moolah Apple refused to “repatriate.”

Turns out, Apple wouldn’t have to repatriate it. The money is already safely ensconced in TBTF banks in New York. The Irish mailbox subsidiaries, on whose books this money is for accounting purposes, transferred it to bank accounts in New York; it is managed by an Apple subsidiary in Reno, Nevada; and Apple’s accountants in Austin, Texas, keep the books, according to the Senate report that vivisected Apple’s tax dodge strategies.

“Apple does not use tax gimmicks,” Apple wrote lamely in response. It’s just that money doesn’t stop at borders or oceans; accounting does. So, in these crazy times of ours, where fairytales are reality, “offshore” actually means “onshore.” The difference between taxed income and untaxed income.

In this manner, US corporations have stashed away a $1.6 trillion of untaxed profits in “offshore” subsidiaries. And yet, as in Apple’s case, much of that is actually in the US. Just because the cash is nominally held by an offshore mailbox company doesn’t mean that it can’t be transferred to the US, where it can do the job money is supposed to do – beget more money.

That explains another corporate mystery. When Congress, after heavy lobbying by the largest US corporations, declared a “repatriation holiday” in 2004 to encourage the “return” of $300 billion to be invested in the US, nothing happened. The “repatriated” profits were taxed at the minuscule rate of 5.25% – less than the payroll taxes withheld from their US working stiffs. The companies made some adjustments on their books. But there were no investments and no hiring because the money had already been deployed in the US. The New York Times reported:

On the contrary, some of the companies that brought back the most money laid off thousands of workers, and a study by the National Bureau of Economic Research later concluded that 92 cents on every dollar was used for dividends, stock buybacks or executive bonuses. A study by the Congressional Joint Committee on Taxation estimated that a similar program would result in $79 billion in forgone tax revenue over a decade.

Apple is among the two dozen multinationals that are flailing their arms at Congress to obtain a new “repatriation holiday” that would allow them to “repatriate” hundreds of billions at a super-low tax rate. In return, they dangle in front of us the promise of investment and jobs. Yet much of that money is already in the US. It would not cause any additional hiring or investment. It would simply be a handout benefitting the largest behemoths, but not the hundreds of thousands of smaller companies that don’t have the resources to lobby Congress or make special deals with governments around the world. They don’t have the time and money to create that “complex web” of offshore mailbox companies but are instead struggling on a daily basis to stay alive in their dog-eat-dog world.

Beyond the unfair advantages that these loopholes bestow on a few large companies, but not on smaller ones that get raked over the coals by the tax code, there is a broader fairness problem, as Senator John McCain pointed out in his opening statement: “As the shadow of sequestration encroaches on hard-working American families, it is unacceptable that corporations like Apple are able to exploit tax loopholes to avoid paying billions in taxes.”

To identify the root cause of the problem, the Senator doesn’t have to look far. The only entity to blame is Congress. It’s addicted to the corporate money flow that keeps campaigns greased. It threatens or promises changes to the tax code to milk these companies. And it loves to succumb to lobbying. That’s how these loopholes ended up in the tax code. They didn’t get there on their own.

Last month, Senators Sherrod Brown, an Ohio Democrat, and David Vitter, a Louisiana Republican, introduced a resolution calling for the end of the implicit subsidies that TBTF banks enjoy and that put taxpayers at risk. The Senate voted 99-0 in support. Now they’re turning their ideas into actual legislation. Read.... Can Two Senators End “Too Big to Fail?” 

    

The Biggest Market Sell-Offs in History

 

Originally posted http://www.tothetick.com/the-biggest-market-sell-offs-in-history

As stock markets are poised to open or close around the world and we see exactly what damage has been done to the major indexes due to the Chinese fake-data scandals that have come to light coupled with the Federal Reserve’s monetary policy meeting, we are waiting with baited breath: Buy! Buy! Buy! Or: Sell! Sell! Sell! Whichever way we turn, someone is bound to make money somewhere in the world out of all of this. Isn’t that why we are in this business?

The Nikkei dropped by 7.3% at the end of the day and Hong Kong’s Hang Seng dipped by 2.5%. Shanghai maintained a moderate fall at just 1.2% (if you believe that data now!). The Asian markets are down. How will the Europeans fare? They are already declining this morning. The CAC 40 is down already 2.32%. The FTSE 100 is down 1.94% so far this morning. The DAX is posting a 2.64%-decrease.

Plus, when the Bureau of Labor Statistics in the US will announce its unemployment figures this morning and tell us what the damage is. The Federal Reserve didn’t manage to allay fears as Ben Bernanke publicly stated that he wouldn’t be pulling the plugs on the stimulus program, but which was later contradicted by the minutes telling the full story that if the recovery shows through, then we will be pulling money out by June. That’s too soon for some. Are we in for another rocky ride?  Maybe. You can never tell, really.  But, if we look back in history, then we can see the worst stock market crashes that have taken place and why.

Here’s the ranking. Chronological order!

1. Black Tuesday October 29th 1929

The Dow Jones industrial average plummeted by 11% and 16 million shares were traded on one day. That was a record in itself. It took until 1954 for the average to get back to the pre-crash figure. There was a knock-on effect even back then and Canada lost 50% of its value in shares.

2. Black Monday October 19th 1987

Bad news issued on October 14th in the US triggered the stock crash in 1987. The Dow lost 100 points on October 16th and then a further 500 on the 19th. By the time October came to a close, there was a drop in the US of 22.68%. The UK fared even worse with a drop of 26.45%. Hong Kong did worst of all with a loss of 45.5%

3. Mini Crash October 27 1997

This time it was in Asia and international-currency speculation trouble. The Dow declined and triggered a drop in Argentina, Mexico and Brazil (13-15%). European suffered from the knock-on effect and plunged too.

4. September11th 2001

No need to say why and what happened on this fateful day. People bought into traditional safe buys like gold and bonds and fled everything else as global markets took a battering. Oil prices shot through the roof. Tokyo dropped to a 17-year all-time low. European indexes dropped to pre-1998 levels, with the FTSE 100 losing 5.7% with a loss of $98 billion.

5. China February 27th 2007

The Dow Jones lost 416 points in one day and fell 3.3%. Chinese stocks fell like a tonne of bricks and US manufacturing statistics aided and abetted that even more.  The FTSE fell 1.85%. Chinese stock lost $140 billion in value.

6. September 29th 2008

The House of Representatives’ failure to bail-out the toxic-mortgage assets of banks ($700 billion) sent markets into turmoil. The Dow lost 429 points (in just 5 minutes flat!).

7. Flash Crash May 6th 2010

The Dow Jones plummeted by 1, 000 points in half an hour. The Nasdaq had to cancel all trade that day s the drop was too big to deal with.

Looking back, it seems like most crashes have taken place in September or October. But, the worst day of the year is officially called ‘Blue Monday’. It is calculated every year and the next one is on January 20th 2014…so maybe! It was calculated by Dr. Cliff Arnall at Cardiff University, based upon weather conditions, lack of sunshine, debt level (after Christmas) and time elapsed because of failed New Year resolutions, amongst other things.

We can see that since 1929, there have been far worse stock market crashes and down-days in history. Some of them are closer than we would like for our own comfort. The world has become a smaller place and we are all living in each other’s pockets. The unemployment figures get published at 8.30 am ET. Then, they will be closely followed by the new home sales. Let’s see what that does to the markets. But, given the present world situation, I doubt if we can hold out for some good news. Just prove me wrong…for once!

 

    

"Terminal State Of Broken"

Originally posted at Monty Pelerin's World blog,

As markets continue to confound, it is useful to reflect on this quote from Jim Sinclair, particularly the last sentence:

The world has taken on a “virtual reality” with no reference to what really is. This is the biggest market power play of smoke and mirrors in history. It is happening because the financial system is in a terminal state of broken.

I could not agree more. This same view has been expressed since the inception of this website (over three and a half years ago). Mr. Sinclair’s wonderfully clever and colorful phrase,”terminal state of broken,” captures matters well. He used it with respect to financial markets, but it applies to much more.

The terminal state of broken also applies to government and the institutions contained therein. Furthermore, these areas have infected non-governmental institutions, especially those which derive their existence and/or success from a close association with government. These include the educational system, defense industry, highly regulated industries like medicine and finance and a host of others.

The common denominator in all of this is government. It is the modern day equivalent of typhoid Mary, infecting all that it comes in contact with duplicity, dishonesty and corruption. This “brokeness” now infects the very morality and civility of society. Institutional behavior provides the moral guidelines (or lack thereof) for society. Corruption, deceit and theft are not virtues, yet if they are practiced openly they cease to become vices.

Immorality in higher institutions weakens the social and moral fabric of a society. Incivility and coarseness is the least of the problems. Justice Brandeis commented on the “trickle down” effect of institutional behavior, focusing on that of government itself:

In a government of laws, the existence of the government will be imperiled if it fails to observe the law scrupulously. Our government is the potent, the omnipotent teacher. For good or ill, it teaches the whole people by its example. If government becomes a lawbreaker it breeds contempt for law: it invites every man to become a law unto himself. It invites anarchy.

Brandeis’ warning was early enough to head off our current condition, but it went unheeded. Instead, our “omnipotent teacher” chose to ignore ethics and morality as they stood in the way of the desire for power and wealth.


Albert J. Nock

Government increasingly took on the Nockian (Albert J. Nock) description:

Taking the State wherever found, striking into its history at any point, one sees no way to differentiate the activities of its founders, administrators and beneficiaries from those of a professional-criminal class.

Years of misbehavior, favoritism and outright criminal acts produced a view of government officials that ranks below that of used-car salesmen. No other group or institution is held in lower esteem. Government’s survival is no longer based on a functional, moral need. Its continued survival depends upon its ability to distribute largess.

The wealthy and the poor now consider themselves allies with government. The wealthy are provided favors and leeway that free markets would not allow. The poor are bribed with “goodies” that government takes from the productive in exchange for votes.

“Terminally broken” is the exact description for our current situation. Terminally, I interpret, as hopelessly, as in unfixable. Terminally also implies a temporary condition, one that cannot last very long. The unstable equilibrium that now exists is not too different from the eye of a hurricane. Any movement out of this rather small protective area will produce havoc.

    

Political Polling Popularity?

Originally Posted http://www.tothetick.com/political-polling-popularity

Popularity is something that can be determined by two things. Firstly, it doesn’t last! When too many people start liking you anyway, there is always someone that is there ready to knife you in the back. ‘Heil Caesar!’ soon turns into ‘Et tu, Brute’! Secondly, it depends on not what you tend to do but on what the other people (normally those that are voting for you) tend to think you are actually doing in the current circumstances. Popularity is nothing more then, in short, than an inherent social phenomenon that can rarely be explained and can rarely be understood. That doesn’t mean we can’t try, though!

Time and time again, we can look back in history, even our own recent history and say ‘why the heck did I vote for so-and-so’ or ‘he hasn’t done anything since he got into power’. Time goes on, and we forget, we reminisce and we end up seeing that person as being not quite as bad as they were at the time they were in power. French President François Hollande is banking on that right now, anyhow. He is grinning and baring it right now in the hope that the lowest popularity of the French Republic for a President will soon be a thing of the past. Or is he going to go down in history as the most unpopular President that France has ever had? Somebody said that his popularity wouldn’t increase as much as unemployment. 74% of the French are unhappy with him. But, that could have been predicted way before. The French nicknamed him ‘Mr. Flabby’. They thought they had it worse with former President Nicolas Sarkozy, but his ratings only hit rock bottom at 70% being unhappy in April 2011.

Have politicians got it wrong today. Is there too much spin, and not enough action. We’re talking about real action of course. Not just rhetoric. Not just the words we hear over and over again. The words that crop up in combinations these days are ‘resilience’, ‘getting back on track’, ‘going back to core values’, ‘unity’, ‘redefining economics’. Words, words, words. Where’s the action?

We have lists of the most ridiculous world leaders and influential people in our societies that are created. But, how can we rank their popularity against each other? If social networks are anything to go by, we could say that networks like Twitter can make or break people around the world. A US news agency once tweeted that there had been not one but two explosion at the White House in April this year. It was fake, but it brought about economic nose-dive and sent the markets into a tailspin. The Dow Jones dropped 140 points immediately. It might have picked up its losses after just a momentary blip that lasted nothing more than a few minutes, but the temporary loss was calculated at something like $135 billion by specialists. That’s a lot of dangerous money on the line when you get it wrong.

So, maybe Twitter is the answer to who is the most popular? Or, at least who makes us think they are the most active. Remember, it’s all about making people think you’re doing something, isn’t it? President Obama hits the top of the list in the world with the greatest number of tweets and followers. He has 24 million following him on average and that’s an improvement of 15 million since a year ago. Did all those people really follow him? Followers? Even the mere word makes us project them into a position of ‘leadership’, doesn’t it? They lead, we follow. We’re ‘followers’, not doers. But, they seem to forget that we can also ‘undo’ (them). Before Hugo Chavez died on March 5th this year, he was the second most active leader on Twitter. He used it as a media tool to fight against his opponents in the run up to the elections in Venezuela from his sick bed. He still had 20 million fewer followers than Obama though.

But, right now, who is popular in politics? Most European leaders have been retired to country estates or foreign countries in the wake of the political instability that has been our daily bread since the financial crisis took over our lives! Oh! That’s another word I should have added to the lips of the leaders of our countries. There were 11 EU leaders that have been ousted since 2008. Just to name but a meager few:

  •       June 5th 2011

Portugal waved goodbye to Prime Minister Jose Socrates.

  •       September 20th 2011

Slovenia had had enough of Prime Minister Borut Pahor.

  •       October 11th 2011

Slovakia got rid of Iveta Radi?ová.

  •       November 6th 2011

Greece saw George Papandreou resign.

  •       November 12th 2011

Italy kicked out Silvio Berlusconi.

  •       November 20th 2011

Spain voted heavily against Jose Zapatero.

  •       May 6th 2012

France wiped the floor with President Nicolas.

2011/2012 was definitely not the year that was. One that will be forgotten…or remain etched in the minds of those that had to step down or that were forced to.

Popularity ratings of most world leaders is on the wane. Is it the economic times and the financial troubles? The access to information? The rumors that spread like wildfire? The coming clean on this scandal and that scandal that gets revealed in our whistle-blowing age? Tittle-tattling is nothing new anyhow. Obama currently stands at below the average rating of all US Presidents (54% between 1938 and 2013), at 49%. His lowest rating was just 38% in 2011. He has a popularity rating of 49% today in May 2013, but he was at 69% in 2009. But, can we believe what we see in the polls? Mahmoud Ahmadinejad, President of Iran came in just after Queen Elizabeth II of England in a popularity poll for world leaders not so long ago.

When it comes to dishing the dirt, the politicians are always the ones in the firing line. They are the ones that take daily decisions (or don’t for that matter!) that affect our lives for better and for worse. But, hey we never got married. I didn’t say ‘I do’. So, it’s better to oust them as soon as they get too covered in the muck that’s being raked. A good mud-fight is always fun…what did a philosopher say one day ‘lupus est homo homini’, roughly translated as ‘Man is man’s wolf’? Woof! My bark is worse than my bite!

    

The Nikkei's Collapse: A 1987 Refresher

Last night's awe-full plunge in the Nikkei 225 may have come as a shock to many but it was right on cue if one believes in the past as a guide to the future. As ForexLive notes, the striking correlation between the current rampage in the Japanese stock market and that of 1987 is stunning. In 1987, the index had a remarkably smooth 89% rally that began in early November, lasted 186 days, and was followed by a 9.1% correction. Currently, the Nikkei 225 has had a remarkably smooth 85% rally that began in late October and has lasted 191 days culminating with last night's 9% correction. If past continues to be prologue, last night's wipe out should be entirely forgiven within three days and promptly forgotten (as a transitory blip). If, however, this time really is different, well...

 

One thing seems clear, for better or worse, a new volatility regime may have just begun in Japanese stocks - just as it did 6 weeks ago in Japanese bonds...

 

(h/t @ForexLive)

    

European Stocks Dive Most In 10 Months

There was quite a bit of dispersion among European equity indices today (with Italy worst and Spain actually holding up - albeit down 1.4%) but the European equivalent of the S&P 500 (the BE500) dropped 2% - its biggest single-day plunge in 10 months. Credit markets - just as in the US - have been warning of a disconnect for two weeks and today's equity dive has more than halved that divergence. European sovereigns are wider by 10-15bps. Europe's VIX is over 2 vols higher at 18.4% (its highest in a month). European financial stocks dropped by their most in 3 months and European high-yield credit worsened by its most in 3 months. A late-day ramp made things alook a little better than they had earlier with a 100 pip rally in EURUSD off earlier lows seemingly providing some help.

European stocks dropped their most in 10 months...

 

as stocks caught down to credit...

 

Charts: Bloomberg

    

Delinquent Student Loans Hit Record, 30% Of 20-24 Year Olds Are Unemployed And Not In School

Almost a year ago we shared a calculation according to which "Over $120 Billion In Federal Student Loans In Default", suggesting that the next credit crisis has already arrived. Since then the topic of the student loan bubble has become a household topic. Sadly, that does not mean it has gotten any better. In fact, according to the latest Education Department data it has gotten as bad as it has ever been. As Bloomberg reports, not only have overdue student loans reached an all-time high but the number of young people aged 20-24 out of school and unemployed is at a record high: not quite astronomic by European standards, but hardly a ringing endorsement of an economy set to transition labor tasks to the next generation, especially with the employment of those 55 and older at all time highs.

From Bloomberg:

Eleven percent of student loans were seriously delinquent -- at least 90 days past due -- in the third quarter of 2012, compared with 6 percent in the first quarter of 2003, according to the report by the U.S. Education Department. Almost 30 percent of 20- to 24-year-olds aren’t employed or in school, the study found.

 

The research is being released amid concern in Congress and President Barack Obama’s administration about rising college costs and $1 trillion in outstanding student loans, the largest category of consumer debt besides mortgages. Borrowers say the burden is affecting their choice of jobs and their ability to buy homes and get married.

 

“Today’s economy puts young graduates in a difficult position,” Jack Buckley, commissioner of the National Center for Education Statistics, which published the report, said in a statement. “A college diploma no longer guarantees a direct pathway to the middle class, making it harder to justify the expense of a degree.”

It's not all bad news: those saddled with tens of thousands of student debt at least have a leg up on those with no college education, supposedly:

College graduates have an edge in the job market, showing the need for higher education, Buckley said. The employment rate for young adults who are college graduates is 87 percent, compared with 64 percent for those with only a high-school diploma, the report found.

Which is great news for college grads looking for temp jobs and other openings for which they never even went to college. Oh well: new normal and all that. And if all else fails, they can just open an E*Trade account, take some trading lessons from the E*trade baby, and just BTFD.

    

Guest Post: Generation X: An Inconvenient Era

Submitted by Charles Hugh-Smith of OfTwoMinds blog,

A data-based look at the financial context of the past 30 years from the perspective of Gen X.

  I am honored to publish an insightful essay by longtime contributor Eric A. on the inconvenient financial era Generation X finds itself in. What sets this essay apart from most other generational analyses is its focus on data and charts.   (Eric's most recent essays here were A Brief History of Cycles and Time, Part 1 and Part 2.)   In The Brewing Generational Conflict (May 15, 2013), I mentioned the Cultural Monster Id (CMI) that arises whenever inter-generational emotions are freely expressed. Every generation-- the Baby Boomers, Gen X and Gen Y/Millennials--is slammed for its supposed character flaws.   Personally, I don't find much value in these outpourings of Cultural Monster Id, for several reasons. One is that generations do not naturally divide into crisp cohorts; people are shaped by the events and shifting myths/worldviews of their culture. As a result there is an inescapable arbitrariness to bright lines between generations.    There's also a bit of intrinsic falsity in defining generational characteristics. Were the draftees of the Vietnam Era any less heroic than the draftees of World War II? Were the volunteers of World War II and Vietnam any more heroic than the volunteers of Desert Storm?   We can while away many a night around the campfire lambasting or lauding various supposedly generational traits, but I don't think that gets us anywhere useful. Ultimately, there is an element of luck in history, and it doesn't neatly favor generations evenly.   For example, the Silent Generation (born 1925-42) got stuck with a thankless war in Korea (1950-53), but was handed a golden opportunity to buy housing in the late 1960s before Boomer demand and geographical constraints sent it skyrocketing. Homes in high-demand areas purchased in the late 60s (before most Boomers could afford to buy a house) doubled in value in a few years and went on to rise 10 or even 15-fold in the ensuing 35 years.   Luck matters, timing matters, but so does context.   There are four Grand Narratives at work: demographics, resource extraction/pillaging, geopolitical conflict and the nature of the economy. The last two are heavily influenced by the first two; some studies suggest that large cohorts of unmarried, under-employed males are precursors to war, as political leaders channel that restless and potentially disruptive force against external enemies.   Economies based on endless resource extraction founder when the resources are found to be less than endless.   The Grand Narrative of the U.S. economy is a global empire that has substituted financialization for authentic, sustainable economic expansion. In shorthand, those people with capital and access to credit can take advantage of the many asset bubbles financialization inflates. They have a chance to do very well for themselves, if they have the presence of mind to exit the asset bubble before it deflates.   Those people who do not have capital or access to credit become poorer. That is the harsh reality of neofeudal, neocolonial financialization. Neofeudalism and the Neocolonial-Financialization Model (May 24, 2012)   Large cohorts generate their own self-referential feedback loops. A large cohort of home buyers drives up real estate as demand exceeds supply, and those who get in early are handsomely rewarded. Those seeking similar returns provide the fuel for further advances. This is the basic story of housing from 1970 to 2006 and the stock market from 1981-2013, as the Baby Boom cohort bought houses and saved for retirement via stock and bond mutual funds.   As the Boomer cohort sells its homes and stocks, supply will exceed demand and prices will decline, especially if household capital and access to credit are also declining. This selling cycle will also be self-reinforcing.   In my view, the reality Eric describes is part of the larger destructive narrative of financialization. Those people who are prepared for the inevitable collapse of the financialization era of debt, centralized manipulation and fantasy will do well for themselves and their families.   My position on the entitlements promised to the Baby Boomers has been clear since 2005 (Boomers, Prepare to Fall on Your Swords June 2005): demographics, the changing job market and the destructive consequence of financializing the U.S. economy render the entitlements promised (Social Security and Medicare) unpayable.   Here is Eric's essay:  

Lately there has been some talk about Generation X and retirement.

“The typical Gen X couple, born between 1966 and 1975, only has enough savings to replace half of its pre-retirement earnings. Married Americans born during the first part of the baby boom, from 1946 to 1955, can expect to retire with about 82 percent of their income.” (Gen X Has New Reason to Resent Boomers as Retirement Looks Bleak).

The response from some circles has been that the net worth of GenX is half that of their parents because they’re slackers who blew the money. Really?

Setting aside how the Boomers have been the most spendthrift generation in American history, quadrupling personal household debt and doubling US Federal debt in a single lifetime, I’d like to focus on something much simpler: 6th grade math.

Financial people should easily recognize this chart:

This is your standard net worth chart, starting with an income of $20,000 at age 20 and increasing income by 3% a year to a pleasant $40,000/year at age 43. This person saved a standard 10% of their income, and invested at the standard 6%/year compounded.

Standard lifetime incomes have a tendency to rise from your 20s to your 50s and level off, so your real income-generating years are strongly back-loaded. This earnings chart from Canada is pretty standard:

As for 6% compounding markets, this is what portfolios from 1980-2000 looked like:

Wow, this investing stuff is easy! But we know what happened after that. The Dow has since gone sideways for a brutal 13 year Bear market:

Oh well, those are the breaks. Markets tend to have a periodicity that rise for >20 years, but then reverse or at least stall in a bear market for <20 p="" years.="">
So what does this have to do with GenX?

Everything. Investing is an exponential function. One of the interesting aspects of the exponential function is that interest compounds very slowly at first, then increasing the amount contributed by interest ever-faster as time goes on. This is why Brokers are adamant about people beginning to invest when they are young: no realistic level of interest can make up for the compounding effect of time. Here is the same assumption as above—3% income rise, 10% savings with 6% compounding -- taken from age 20 to 65, halting peak income at a reasonable $55,000/year:

Note it takes 21 years to reach the first $100k, but only 8 to reach the $200k and 4 to reach $300k. This compounding-made-real actually happened from 1980-2000.
Here is a matrix of the 4 Generations:

Note anything on this chart? The Boomer generation had a rough start in the bear market of the 70’s, but were only about 25 when it ended, so the Bull run coinciding with 20 of their core income years. Very nice.

Quick look to the right and you’ll see GenX. When did they come into their equivalent earning years? Year 2000, just as the market was cut in half:

Why should that matter? The Dow has now recovered and gone to new highs of 14,000.
Well, let’s run the charts and see. Again assuming $20k starting income, 3% income growth, 10% savings, and full investment in the Dow as a proxy, let’s compare GenX income theory to reality:

Wow! Right at the 10-year compounding point in 2000, the X-er’s market clock was re-set to zero. Then in 2008, the next 10-year compounding point, they were re-set to zero again!

Remember what we said about compounding being strongly back-loaded? The difference in 6% compounding vs the market stalling at the critical 10 year mark has cut GenX net worth in half! And if this chart was inflation-adjusted their net worth would be another 30-50% lower!

This is even assuming the massively optimistic assumption that GenX incomes are neatly rising from $20k to $55k. They’re not:

What did the Bloomberg article say again, that GenX has half the retirement savings of their parents? That reality is exactly what we predicted given the math. Anybody want to argue about how Boomers worked hard to succeed but GenX and Y are slacking wastrels? Or does math trump all?

But okay, maybe despite advertising to the contrary GenX should have known better than to trust a 19 year-old bull market. Maybe they should have gone short. If so, when? Going short in 2001, they would have to have reversed and gone long in ’03, then short in ‘08, then long in ’09, and possibly short again sometime soon? Is asking a whole generation to pick 5 exact tops and bottoms reasonable? Perhaps not. If not, where should they have put their money?

Bonds? Interest has averaged under 3% since 2000:

The chart of 3% vs 6% interest: a 25% difference over 10 years:

Maybe they should have invested in houses. Here’s your table of average buying ages:

Severely burned by stocks, GenX statistically became first-time homebuyers at the age of 32, not much older than when their parents did. However, they bought their first home in 2005, not 1985. How did that work out?

Whoops! Sorry, suckers, stole your money again: your peak home-buying years coincided with another bubble! Housing was no safe-haven. Not only that, but again, the catastrophe is not the up-front losses but the 10 years of lost compounding that can never be re-made. The math says that if GenX worked until they were 80, they will NEVER recover.

But there is only one national economy, all the same houses, same stocks, same companies: to some extent it’s not a matter of national wealth, but the DISTRIBUTION of wealth in the nation. So if GenX was systematically disenfranchised by engineered stock and housing bubbles plus low interest rates, who was their expected slice of GDP transferred to?

Again:

That’s right, the Boomers, in allegiance with the financial elite, engineered a transfer of all other generations’ income to themselves. This, plus being born in an expanding demographic, was the totality of their investing genius.

Why should anyone protest this observation? What do you think the decades-old phrase “the national debt has enslaved our children” means? It means that the Boomers, who were in power at that time, took all the wealth of the nation for themselves and left their children with the bill.

That’s not a surprise, it’s well-known fact that has been approved of by everyone in power for 20 years. I’ve been hearing it openly stated since before the National Commission on Social Security in 1983. When I was 13, my national parents said that I would pay their debts so they could get wealthy at my expense, and they have fully kept their promise. Now I am 43 and not only had the $80,000 of my net worth systematically stolen, but being unable to outvote them, have been saddled against my will with the $50,000/person of the national debt. An estimate of $130,000 per person has been transferred. From us, GenX and Y, to them. And with 10,000 Boomers a day retiring and a 1:1 worker to recipient ratio, they expect much, much more.

So think again before you so easily dismiss the 25% unemployment rate and 3rd-world incomes of Generations X and Y and start with a short lesson on the problems of exponential functions.

Yet this terrible math leaves the question of what's next? Can this unequal state of affairs remain a permanent feature of American life? Can the work of one group-- the very hours of their life--be morally claimed and transferred to another by dictate? That is to say, does one generation have the right to enslave another, whether physically with chains they never earned, or financially with debts they never accrued? And if this transfer was voted into power by a generation and enforced by government dictate, why can’t Generation X and Y vote to transfer all the Boomers’ wealth back to themselves?

We don’t know at this time, but with the Dow at all-time highs it would seem that, one way or another, incomes and prices can only revert to the mean. And brother, speaking from the bottom, it’s a long way down to here.

 

    

Spot The Bubble: Average New Home Price Soars By Most Ever In One Month To All Time High

Curious why in yesterday's FOMC minutes the following line "a few participants expressed concern that conditions in certain U.S. financial markets were becoming too buoyant" received special attention? Here is the reason: as the chart below shows, according to the census bureau, the average new home sale price just hit a new all time high, rising by a record 15.4% to a record $330,800. In a country in which real disposable consumer income is flat at best and in reality declining, it only makes sense that the average new home price just hit a level not seen since the prior credit-bubble fueled housing peak.

Average new home sale price:

And the sequential change in the average new home sale price:

Obviously both of the above charts are justified by the average real disposable income per capita in the US:

Or maybe not...

    

Replace Your Home Office With A Cellphone: Deadbeat Carrier Creative Destruction In The Ongoing Mobile Computing Wars

I have personally tested the T-Mobile LTE service in a NYC subway (the 42nd street station) using what is currently the best (big brand) mobile handset available, the LG Optimus G Pro.

 20130522 140401 3799

The speeds I attained are phenomenal for a cell phone. This combo is more than capable of replacing a small business or home network Internet connection through FiOS or AT&T.

This is a similar LTE speed test performed in the AT&T store in Union Square, NYC.

 20130522 143033 26462

The majority of my work is now done off of smart phones, so I know this stuff fairly well. AT&T charges roughly 3x what T-Mobile would charge for about 31GB of bandwidth use, while T-Mobile delivered 2.5x the speed. Now, T-Mobile's network is not under load yet, and results can vary by location, weather, yada, yada... Long story short, if T-Mobile continues to focus on being a pure play pipe provider, AT&T and Verizon will need to get their shit together!!!

T-Mobile, if they play their cards right, can truly shake up the industry. If you did not already know, T-Mobile has eliminated carrier subsidies of handsets and has instead given a 0% APR (allegedly, although an implied rate could be built into the price of the hardware) loan to have the user pay for the device directly, and has reduced the price of its plans commensurately. T-Mobile has also dropped contract requirements totally and has made a big push into its pre-paid plans with an offer of unlimited data. It is this option that makes a lot of sense for power users and techies. Today's Android phones (ex. the LG Optimus G Pro) have more than enough oomph to power an office - and I mean it. I actually do it.

With a 14 - 32mbs always on connection, you can fully replace Microsoft Office, your overpriced DSL, FiOS, AT&T, etc. connection, and your overpriced cell phone carrier with a single phone, some inexpensive peripherals and a single $70 per month ($76 with all taxes and fees included) T-Mobile plan.

This is a very big deal, for if consumers start using their heads and pull out a calculator or two, AT&T and Verizon have an awful lot of price slashing to do, and the likes of the pretty but considerably less functional OEMs such as Apple have a lot of R&D and production ramping to do as well.

You have heard me predict this in the past.

April and May 2012 I opined on the carriers

US Cellular Carriers Are At Risk Of Being Marginalized Into Nothingness Unless They Learn To Think Outside The Box... Yesterday

The Death Of The Deadbeat Carriers, Part 2 

This week I opined on Apple, et. al.

Is It Time To Buy Apple As A Valuation Play

What Sell Side Wall Street Doesn't Understand About Apple - It's Not The Leader Of The Post PC World!!!

 

Of course, this doesn't look to good for Microsoft or Intel, for the Android camp is encroaching on the Wintel camp much faster than the Wintel camp is returning the favor. 

I have a lot of thoughts and ideas circling these developments. Institutional and professional subscribers (click here to subscribe) are welcomed to email or call me to discuss this further.

 

    

The Bronze Swan Arrives: Is The End Of Copper Financing China's "Lehman Event"?

In all the hoopla over Japan's stock market crash and China's PMI miss last night, the biggest news of the day was largely ignored: copper, and the fact that copper's ubiquitous arbitrage and rehypothecation role in China's economy through the use of Chinese Copper Financing Deals (CCFD) is coming to an end.

Copper, as China pundits may know, is the key shadow interest rate arbitrage tool, through the use of financing deals that use commodities with high value-to-density ratios such as gold, copper, nickel, which in turn are used as collateral against which USD-denominated China-domestic Letters of Credit are pleged, in what can often result in a seemingly infinite rehypothecation loop (see explanation below) between related onshore and offshore entities, allowing loop participants to pick up virtually risk-free arbitrage (i.e., profits), which however boosts China's FX lending and leads to upward pressure on the CNY.

Since the end result of this arbitrage hits China's current account directly, and is the reason for the recent aberrations in Chinese export data that have made a mockery of China's economic data reporting, China's State Administration on Foreign Exchange (SAFE) on May 5 finally passed new regulations which will effectively end such financing deals.

The impact of this development can not be overstated: according to independent observers, as well as firms like Goldman, this will not only impact the copper market (very adversely) as copper will suddenly go from a positive return/carry asset to a negative carry asset leading to wholesale dumping from bonded warehouses, but will likely take out a substantial chunk of synthetic shadow leverage out of the Chinese market and economy.

Naturally, for an economy in which credit creation is of utmost importance, the loss of one such key financing channel will have very unintended consequences at best, and could potentially lead to a significant "credit event" in the world's fastest growing large economy at worst.

But before we get into the nuts and bolts of how such CCF deals operate, and what this means for systemic leverage, we bring you this friendly note released by Goldman's Roger Yuan overnight, in which Goldman not only quietly cut their long Copper trading recommendation established on March 1 (at a substantial loss), but implicitly went short the metal with a 12 month horizon: a huge shift for a bank that has been, on the surface, calling for a global renaissance in the global economy, and in which Dr. Copper is a very leading indicator of overall economic health and end demand.

From Goldman:

Closing: Long LME copper September 2013 contract at $7,482/t, a $236/t (3.1%) loss

 

Following the initial sell-off in copper prices in the second half of February 2013, we established a long copper position at $7,718/t in the September contract (on March 1, 2013). We believed that the fall in copper prices, reflecting in part concerns about Chinese activity, was overdone. We reiterated this view on April 22, post further substantial price declines. Since then, prices have rebounded strongly, with the September contract closing at $7,482/t on May 22, up by 10% from the May 1 low of $6,808/t.

 

The emergence of the risk that CCFDs unwind over the next 3 months – we had assumed that deals would continue indefinitely – has complicated our near-term bullish copper view (from current prices). On the one hand, our fundamental short-term thesis is playing out – copper inventories are drawing, copper’s main end-use markets in China are growing solidly (property sales +39% yoy, completions +7% yoy, auto’s output +14% yoy Jan-April 2013), seasonal factors are currently supportive, Chinese scrap availability is tight, positioning also remains short, and policy risks are, arguably, mildly skewed to the upside.

 

Set against this is the likely near-term unwind in CCFDs and, critically, our view that copper is headed into surplus in 2014 (the window for higher copper prices is shortening). On net, we now see the risks to our 6-mo forecast of $8,000/t as skewed to the downside, and, in this context, we unwind our September long copper position at $7,482/t, a $236/t (3.1%) loss, given the recent strong rally in LME prices to near our 3-mo target of $7,500/t. Additionally, we believe that a further rally in copper prices in the near term would be a good selling opportunity taking a 12-month view [ZH: translated: short it].

 

Consumers: We believe that consumers will have a better opportunity to enter the copper market to buy taking a 12-month view. Following the recent sharp sell-off in zinc we are increasingly bullish on the outlook from current prices and as such believe consumers should take advantage of current low levels.

 

Producers: Our base case of a sharp slowdown in growth of Chinese construction completions in 2014, in the context of above-trend supply growth, presents significant longer-term downside risks to global copper demand growth and prices. Therefore we continue to believe that any further rallies in the copper price in 2013 represent a good opportunity to hedge, and in our view other non-producer market participants should continue to monitor any copper positions in light of the 2014 downside risks.

 

So just what is the significance of CCFDs? As it turns out, it is huge. Goldman explains (get a cup of coffee first: this is now a simple walk-thru):

The combination of Chinese capital controls and a significant positive domestic (CNY) to foreign (USD) interest rate differential has, in recent years, resulted in the development and implementation of large scale ‘financing deals’ which legally arbitrage the interest rate differential via China’s current account. These Chinese ‘financing deals’ typically use commodities with high value-to-density ratios such as gold, copper, nickel and ‘high-tech’ goods, as a tool to enable interest rate arbitrage. With the notional value of the deals far exceeding the export/import value of the commodities used, and likely significantly contributing to the recent run-up in China’s short-term FX lending (and related upward pressure on the CNY), China’s State Administration of Foreign Exchange (SAFE) announced new regulations to address these issues (May 5), to be implemented in June.

SAFE’s new policies are, in our view, likely to bring these Chinese ‘financing deals’ to an end over the next 1-3 months. Having said this, some uncertainty remains around the implementation of the new policies by SAFE and Chinese banks, the speed at which the policies impact the market, and the possibility that new financing deals are “invented”. Owing to these uncertainties, a complete unwind of CCFDs is still at this point considered a risk.

In this note we provide a full example of a typical deal and discuss our understanding of the impact of an unwind in Chinese Copper Financing Deals (CCFDs) 1 on the copper market.

 

Our view is that the bulk of copper stored in bonded warehouses in China – at least 510,000t at present, as well as some inbound copper shipments into China – is being used to unlock the CNY-USD interest rate differential. This material has not been entirely unavailable to the market (deals can be broken if costs rise, such as a tightening of LME spreads), but the inventory has been effectively financed by factors exogenous to the copper market for some time.

 

We find that a complete unwind of CCFDs would be bearish for copper prices as the copper used to unlock the differential would shift from being a positive return/carry asset to a negative carry asset for those who currently hold it. As such this inventory will likely become more ‘available’ to the global market. Initially stocks would likely move into the Chinese domestic market to ease the current tightness, until the current SHFE price premium to LME closes.

 

After the SHFE-LME price arbitrage closes sufficiently, the remaining bonded stock (over and above day-to-day working flows) would likely shift from bonded warehouses to the LME. We expect that the ex-China (LME) market would likely see inventory increases as a result, as China draws on bonded stocks instead of importing and as excess bonded stocks are shifted back on to the LME. We estimate that the ex-China market will need to ‘carry’ a minimum of 200-250kt of additional physical copper over the coming months, equivalent to 4%-5% of quarterly global supply. The latter would most likely result in a widening contango, including downward pressure on cash prices.

 

Specifically, the current LME 3-15 month contango is 1.1%, compared to full carry of c.3%-3.5%.

 

The emergence of this bearish risk – we had assumed that deals would continue indefinitely – complicates our near-term bullish copper view. Indeed, our fundamental short-term thesis is unfolding – copper inventories are drawing, copper’s main end-use markets in China are growing solidly (property sales +39% yoy, completions +7% yoy, auto’s output +14% yoy over the Jan-April 2013 period), seasonal factors are currently supportive, and scrap availability in China is reportedly tight. Positioning also remains short, and policy risks may be mildly skewed to the upside (ECB meeting June 6 and FOMC meeting June 18-19).

 

The other factors that have recently supported a rebound in copper prices have been mine supply disruptions at Grasberg in Indonesia (c.480kt for 2013E), and the threat of further strikes in Chile ahead of the Chilean elections and at Grasberg ahead of contract negotiations (the current labour contract ends in September). Our forecast 2013 disruption allowance of 5.8%, or c.900kt is designed to account for these kinds of developments, and so far this year our allowance looks reasonable, meaning that these disruptions are not set to impact our overall balance forecast.

 

Set against this is the likely near-term unwind in CCFDs and, critically, our view that copper is headed into significant surplus in 2014 (the window for higher prices is shortening). On net, we now see the risks to our 6-mo forecast of $8,000/t as skewed to the downside. In this context, we unwind our September long copper recommendation at $7,482/t, a 3% loss.

If you haven't shorted copper after reading the above.... we suggest you re-read it.

Ploughing on: below is the reason for SAFE's new dramatic regulations, and why China decided to go ahead and kill CCFD, unintended consequences be damned:

China’s foreign currency reserves have risen significantly since the start of the year, placing upward pressure on the CNY (Exhibit 1). This development prompted SAFE, China’s regulator of cross-border transactions, to announce a new set of regulations on May 5, to be implemented in June.

 

 

The new regulations can be split into two parts, and broadly summarised as follows:

 

a) The first measure targets Chinese bank balance sheets. This measure aims to:

 

i) Directly reduce the scale of China’s FX loans, thus reducing the scale of letter of credit (LC) financing (bank loans), thereby reducing the volume of funding available for CCFDs (though not specifically targeting CCFDs); and/or

 

ii) Raise banks’ FX net open positions (banks are required to hold a minimum net long FX position at the expense of CNY liabilities), thus raising LC financing costs, thereby increasing the cost of funding CCFDs.

 

Specifically, Exhibit 2 shows that SAFE aims to implement a bank loan to bank deposit ratio of 75%-100% going forward, compared to an existing ratio of  >150%.

 

 

b) The second measure targets exporters and/or importers (‘trade firms’) by identifying any activities that mainly result in FX inflows above normal export/import backed activities (i.e. trades for the purpose of interest rate arbitrage, amongst others). This measure would force entities to curb their balance sheets if they are found to be involved in such activities.

 

Since May10 SAFE has been requesting ‘trade firms’ provide detailed information of their balance sheets and trading records, in order to categorize them as either A-list or B-list firms by June 1, 2013. B-list firms will be required to reduce their balance sheet significantly by cutting any capital inflow related trade activities.

 

To avoid being categorized as a B-list firm by SAFE, ‘trade firms’ may reduce their USD LC liabilities in the near term, with CCFDs likely impacted. It is not yet clear what happens to the B-list firms once they are categorized as such. However, if B-list firms were prohibited from rolling their LC liabilities this could increase the pace of the CCFD unwind, since these trade firms would likely need to sell their liquid assets (copper included) to fund their LC liabilities accumulated through previous CCFDs.

 

These new regulations are likely to impact a number of markets and market participants. In this note we focus on the impact on CCFDs and the copper market. Should a) and b) be enforced, copper financing deals are highly likely to be impacted.

* * *

That explains China's macro thinking. But what does it mean for the actual Copper Financing Deal? The below should explain it:

An example of a typical, simplified, CCFD

 

In this section we present an example of how a typical Chinese Copper Financing Deal (CCFD) works, and then discuss how the various parties involved are affected if the deals are forced to unwind. Exhibit 3 is a ‘simplified’ example of a CCFD, including specific reference to how the process places upward pressure on the RMB/USD. We believe this is the predominant structure of CCFDs, with other forms of Chinese copper financing deals much less profitable and likely only a small proportion of total deal volumes.

 

A typical CCFD involves 4 parties and 4 steps:

  • Party A – Typically an offshore trading house
  • Party B – Typically an onshore trading house, consumers
  • Party C – Typically offshore subsidiary of B
  • Party D – Onshore or offshore banks registered onshore serving B as a client

Step 1) offshore trader A sells warrant of bonded copper (copper in China’s bonded warehouse that is exempted from VAT payment before customs declaration) or inbound copper (i.e. copper on ship in transit to bonded) to onshore party B at price X (i.e. B imports copper from A), and A is paid USD LC, issued by onshore bank D. The LC issuance is a key step that SAFE’s new policies target.


 

Step 2) onshore entity B sells and re-exports the copper by sending the warrant documentation (not the physical copper which stays in bonded warehouse ‘offshore’) to the offshore subsidiary C (N.B. B owns C), and C pays B USD or CNH cash (CNH = offshore CNY). Using the cash from C, B gets bank D to convert the USD or CNH into onshore CNY, and trader B can then use CNY as it sees fit. 

 

The conversion of the USD or CNH into onshore CNY is another key step that SAFE’s new policies target. This conversion was previously allowed by SAFE because it was expected that the re-export process was a trade-related activity through China’s current account. Now that it has become apparent that CCFDs and other similar deals do not involve actual shipments of physical material, SAFE appears to be moving to halt them. 

 

Step 3) Offshore subsidiary C sells the warrant back to A (again, no move in physical copper which stays in bonded warehouse ‘offshore’), and A pays C USD or CNH cash with a price of X minus $10-20/t, i.e. a discount to the price sold by A to B in Step 1. 

 

Step 4) Repeat Step 1-Step 3 as many times as possible, during the period of LC (usually 6 months, with range of 3-12 months). This could be 10-30 times over the course of the 6 month LC, with the limitation being the amount of time it takes to clear the paperwork. In this way, the total notional LCs issued over a particular tonne of bonded or inbound copper over the course of a year would be 10-30 times the value of the physical copper involved, depending on the LC duration. 

 

Copper ownership and hedging: Through the whole process each tonne of copper involved in CCFDs is hedged by selling futures on LME futures curve (deals typically involve a long physical position and short futures position over the life of the CCFDs, unless the owner of the copper wants to speculate on the price).

 

Though typically owned and hedged by Party A, the hedger can be Party A, B, C and D, depending on the ownership of the copper warrant.

As Goldman further explains, the importance of CCFD is "not trivial" - that is an understatement: with the implicit near-infinite rehypothecation in which the number of "circuits" in the deal is only a factor of "the amount of time it takes to clear the paperwork", there may be hundreds of billions, if not more, in leverage resulting from this shadow transaction that has been used in China for years. Now, that loop is about to end. The reality is nobody can predict what the impact will be, but whatever it is - i) it will extract tremendous leverage from the system and ii) it will have adverse impacts on both China's ability to absorb inflation and grow its economy.

How important are CCFDs? They are not trivial!

 

Chinese ‘financing deals’, including CCFDs, are likely to contribute to China’s FX inflows since they involve direct FX inflows through China’s current account. Specifically, for CCFDs, the immediate cross-border conversion of FX to onshore CNY after Party C pays Party B for the copper warrant (Step 2) directly contributes to China’s FX inflows. In terms of outflows, the issuance of LC (FX short-term lending) by Party D to Party A (Step 1) is not associated FX outflow by definition, and when the LCs expire they tend to be rolled forward. Step 3 occurs offshore, so there is no inflow/outflow related to this transaction.

 

In this way, the net Chinese FX inflows/outflows associated with CCFDs are equivalent to the change in the value of the notional LCs. We make some broad estimates of how much of China’s short-term FX lending could be accounted for by CCFDs.

 

Specifically, our best estimate suggests that roughly 10% of China’s short-term FX lending could have been associated with CCFDs since the beginning of 2012 (Exhibit 4). In April 2013, we estimate that CCFDs accounted for $35-40 bn (stock) of China’s total short-term FX lending of $384 bn (stock), making various assumptions. More broadly, Chinese bonded inventories and short-term FX lending has been positively correlated in recent years (Exhibit 5).

 

Two key questions remain: how the upcoming unwind will impact each CCFD participant entity...

How an unwind may impact each CCFD participant

 

As we discussed on pages 4 and 5, SAFE’s new regulations target both banks’ LC issuance (first measure) and ‘trade firms’ trade activities (second measure). Here we discuss how the different entities (A, B, C, D) would likely adjust their portfolios to meet the new regulations (i.e. what happens in a complete unwind scenario).

 

Party A: Party A, without the prospect of $10-20/t profit per Step 1-3 iteration, is likely to find it hard to justify having bonded copper sitting on its balance sheet (the current LME contango is not sufficient to offset the rent and interest costs). As a result, Party A’s physical bonded copper would likely become ‘available’, and Party A would likely unwind its LME short futures hedge.

 

Party B, C: To avoid being categorized as a B-list firm by SAFE, Party B and C may reduce their USD LC liabilities by: 1) selling liquid assets to fund the USD LC liabilities, and/or 2) borrowing USD offshore and rolling LC liabilities to offshore USD liabilities. The broad impact of this is to reduce outstanding LCs, and CCFDs will likely be affected by this. It is not yet clear what happens to the B-list firms in detail once they are categorized as such. However, if B-list firms were prohibited from rolling their LC liabilities this would increase the pace of the CCFDs unwind. In this scenario, these trade firms would have to sell their liquid assets (copper included) to fund their LC liabilities accumulated through previous CCFDs.

 

Party D: To meet SAFE’s regulations, Party D will likely adjust their portfolios by reducing LC issuance and/or increasing FX (mainly USD) net long positions, which would directly reduce the total scale of CCFDs and/or raise the LC financing cost, respectively.

... And what happens to copper prices (hint: GTFO)

Implications for copper - bonded copper moves from a positive carry asset to negative carry asset

Implications for copper - bonded copper moves from a positive carry asset to negative carry asset

 

We expect that a complete unwind of CCFDs, everything else equal, is likely to be bearish for copper prices, LME spreads, and bonded premiums.

 

CCFDs involve a long copper physical positions and a short futures position on the LME. The physical position would be sold if CCFDs unwound and the short futures positions bought back. The newly available physical copper would not be financed by the China and ex-China interest rate differential anymore (not a positive carry asset anymore), and would instead need to be financed by a natural contango (in the interim copper becomes a negative carry asset), everything else equal.

 

Theoretically then, the physical market, over a short period (say, one quarter), may need to absorb as much as c.400kt of copper, equivalent to 8% of quarterly global copper supply.

 

By contrast, the LME futures market would need to absorb buying of c.0.2%-0.3% of quarterly traded LME volumes and c.6% of daily average 2012 open interest. The impact on the physical market is therefore likely to be relatively large, in spite the fact that an unwind of CCFDs does not result in the creation of new copper (i.e. aggregate global copper inventory impact is 0/our inventory chart does not change).

 

What about in practice?

 

Since there are no comparable historical examples to make reference to, what happens when CCFDs unwind in practice is open for debate. We believe that since the downward pressure on the physical market is large, both in absolute terms and relative to the upward pressure on the futures market, near-term prices are likely to come under relatively significant pressure. Further, if the market fears the unwind of CCFDs, physical buyers may hold off on purchases, and futures sellers may bet on lower prices (offsetting either in part or more than offsetting the financing deal related unwind buying). In this way it is likely that in practice the whole copper price curve would be under pressure in the case of a complete CCFD unwind, at least until the contango widens sufficiently to compensate for the cost of carry.

 

We see the following as a likely chain of events in a complete unwind scenario:

  • China would draw on bonded until it is ‘full’. In the current market bonded copper stocks will likely initially flow into the domestic Chinese market, since SHFE prices are above LME prices, with the SHFE curve in backwardation and LME in contango.
  • Chinese imports fall/remain low, placing upward pressure on LME stocks. Since China is drawing bonded inventories to meet its demand, Chinese copper imports are likely to be under downward pressure beyond May, resulting in any excess material ex-China turning up on the LME as well (Exhibit 7). Remaining bonded stocks (ex-stocks in transit), would shift to LME. Once China is ‘full’ (i.e. the import arbitrage closes, bonded physical premia decline, SHFE price and curve softens), the remaining excess bonded inventory will likely make its way on to the LME. Since China is in deficit at present (drawing bonded and SHFE inventories, SHFE in backwardation), due in part to seasonal factors, the inventory numbers noted above, in practice, will likely be smaller but still very large. Our best estimate would be a minimum of 200,000-250,000t of stock could shift/build on the LME over the next 2-3 months, or 4%-5% of quarterly global consumption.
  • LME contango to widen. Higher LME stocks suggest higher LME copper spreads, including downward pressure on the front end. Exhibit 8 illustrates that over the last 6 years, the buildup of LME inventory has been consistently associated with widening LME spreads into contango, and the scale of contango is mostly driven by financing cost and inventory levels. With excess copper flowing into LME warehouses, the spread needs to widen further to finance the carry trade effectively. For reference, LME annual rents are c.$150/t or 2% of copper prices. Assuming an annualized financing cost of 1%-1.5%, full carry is c.3%-3.5%, compared to current LME 3-15 month contango of 1.1%.

 

The main caveat to the above is that a complete unwind in CCFDs is still subject to the implementation of the policy by SAFE, Chinese banks and ‘trade firms’, and the possibility that new financing deals are “invented”. As a result, we will continue to closely monitor implementation of the policy by banks via monitoring bonded physical premiums, SHFE spreads and bonded stock flows.

Finally, what does all this mean for explicit rehypothecation chain leverage (initially just at the CCFD level although a comparable analysis must be done for systemic as well) and CCFD risk exposure:

Leverage in CCFDs

 

Below is a demonstration of the LC issuance process in a typical CCFD. Assuming an LC with a duration of 6 months, and 10 circuit completions (of Step 1-3) during that time (i.e. one CCFD takes 18 days to complete), Party D is able to issue 10 times the copper value equivalent in the form of LCs during the first 6 month LC (as shown from period t1 to t10 in Exhibit 10). In the proceeding 6 months (and beyond), the total notional value of the LCs remains the same, everything else equal, since each new LC issued is offset by the expiration of an old one (as shown from period t11 to t20).

 

In this example, total notional amount of LC during the life of the LC = LC duration / days of one CCFD completion* copper value = 10. In this example, the total notional amount of LC issued by Party D, total FX inflow through Party D from party A, and total CNY assets accumulated by party B (and C) are all 10 times the copper value (per tonne).

 

To raise the total notional value of LCs, participants could:

  • Extend the LC duration (for example, if LC duration in our model is 12 months, the notional LC could be 20 times copper value)
  • Raise the no. of circuits by reducing the amount of time it takes to clear the paperwork
  • Lock in more copper

 

Risk exposures of parties to CCFDs

 

Theoretically, Party B risk exposure > Party D risk exposure > Party A risk exposure

 

  • Party B’s risks are duration mismatch (LC against CNY assets) and credit default of their CNY assets;
  • Party D’s risks are the possibility that party B has severe financial difficulties. (they manage this risk by controlling the total CNY and FX credit quota to individual party B based on party B’s historical revenue, hard assets, margin and government guarantee) (Party D has the right to claim against party B (onshore entity), because party B owes party D short term FX debt (LC)). If party B were to have financial difficulties, party D can liquidate Party B’s assets.
  • Party A’s risk is mainly that party D (China’s banks) have severe financial difficulties (Party A has the right to claim against party D (onshore banks), because Party A (or Party A’s offshore banks) holds an LC issued by party D). In the case of financial difficulties for Party B, and even in case Party D has difficulties, Party A can still get theoretically get paid by party D (assuming Party D can borrow money from China’s PBoC).

In brief (pun intended): a complete, unpredictable clusterfuck accompanied by wholesale liquidations of "liquid assets", deleveraging and potentially a waterfall effect that finally bursts China's bubble, all due to a simple black swan. Although, in reality, nobody knows. Just like nobody knew what would happen when the government decided to let Lehman fail.

So... is this China's Lehman?

    

The Dire State of the Platinum-Palladium Miners

During the third week of May each year, representatives of the platinum industry gather in London, for an event that has become known as ‘Platinum Week’. Platinum Week centers on an industry dinner sponsored by the London Platinum and Palladium Market (LPPM) which marks the anniversary of the inauguration of the London Platinum Quotation (the forerunner of the present London Fixings) in 1973.

This event is attended by platinum group metals (PGM) producers, refiners, fabricators and traders. The first major event of the week is the publication of Johnson Matthey’s annual review of supply and demand for the PGM markets.

According to Johnson Matthey, the platinum market was in deficit by 375,000 ounces in 2012, close to their forecast made last November. The palladium market was also undersupplied but by a much larger margin of more than 1 million ounces.

For platinum and palladium, this was a reversal of the position a year earlier when both were in surplus. Gross demand for these metals continues to recover from the slump in 2008. Overall, gross demand for platinum fell by only 50,000 ounces year-over-year to 8.045 million ounces, a stronger performance than might have been expected.

The automotive market has been a major focus of attention and we believe that many observers will be surprised that demand from this sector grew from 3.185 million ounces in 2011 to 3.24 million ounces last year.

In Europe, auto catalyst demand fell from 1.505 million ounces to 1.33 million ounces as the car industry continued to slow. The surprise growth in demand comes from the Chinese jewelry market, where demand grew strongly to 1.95 million ounces. According to Mitsui, in net terms Chinese jewelry demand was larger than gross automotive demand for platinum in Europe for only the second year ever. The launch of a platinum ETF in South Africa is also positive for demand this year. The ABSA fund has already purchased 283,000 ounces of platinum as of the 17th of May. Overall we view the demand statistics from 2012 as very bullish for platinum and palladium in 2013.

While demand is expected to remain solid for 2013, the bull case for the PGM story is on the supply side. As we analyze the state of the miners, their situation is getting progressively worse, even more so than we expected.

Investors in platinum stocks have dumped their shares in a panic over the last six weeks, fearing that the platinum sector is in terminal decline. Since April the sector has fallen by 20%, bringing the cumulative decline for the year to 30%. What has caused this exodus? The results coming in from the PGM miners have been awful. Take Impala Platinum, the world’s second-biggest producer of the metal, which said that more of its shafts are producing at a loss as prices decline and costs rise. “These units are being monitored on a continuous basis to determine their ongoing viability.”

According to ‘Implats’, average extraction costs increased 23% to 15,957 rand ($1,766) an ounce for the nine months through March from a year earlier.1 This implies that at today’s platinum price, Implats is losing close to $300 per ounce produced.

For a longer-term view of the industry, we were intrigued by an article by David Holland and Brian Kantor entitled: “Thinking in the same old way will not rescue the platinum industry”. The analysis highlights why we have had such a negative view on the miners. For this study the authors aggregated the historical financial statements of the five largest South African platinum miners (Anglo American Platinum, Impala, Lonmin, Northam and Royal Bafokeng) and calculated the inflation-adjusted cash flow return on operating assets (“CFROI”), which is the real measure of return on capital for the industry.

The glory days for platinum mining were between the years 1999 to 2002 and provided the first wave of extraordinary fortune for platinum miners. The real return on capital exceeded 20%, making it one of the most profitable industries in the world at that time (the average CFROI for global industrial and service companies is 6%).

The second wave of fortune occurred during the global commodities "super cycle" from 2006 to 2008. Again, platinum mining became one of the most profitable businesses in the world. The good times ended abruptly at the end of 2008, when platinum miners saw their real return on capital drop to 1% — much less than their cost of capital.

In 2012, the CFROI in the platinum sector of South Africa’s economy was a miserable -0.6%, the lowest return on capital since 1992. Suffice to say, platinum miners are not producing sufficient returns to satisfy shareholders, or to support their operations. This has resulted in unavoidable cost-cutting, lay-offs and scaling back of capital expenditure plans.

And what does the future hold? The authors took analysts’ expectations for this year and next and estimated the real return on capital at a value destructive level of 0% for this year and a depressed 3.4% until 2017. There is no hint of a return to superior profitability in the share prices of platinum miners. In a nutshell, South Africa’s platinum miners are destroying value and are expected to continue to do so. They are in a dire state.2

Adding to this ‘perfect storm’ for platinum miners are the wage negotiations with the largest union of mineworkers. The South Africa National Union of Mineworkers in two weeks' time will present a demand for a wage increase of "no less than 10%" and up to 60% for its industry members to take effect from July, union spokesman Lesiba Seshoka said Monday.3 Given the financial state of the largest platinum miners these new demands will be difficult, if not impossible to meet. This aggressive stance has rattled mining investors after wildcat strikes last year at platinum and gold mines killed 50 people and cost billions in lost output.

Investors are not sticking around to find out what happens next with the miners and are taking positions in the metal itself, which we believe will be rewarding in the long term. As reported by Bloomberg, holdings of all platinum ETFs have increased by 30% since the beginning of this year and palladium holdings have increased by 16%. Both are healthy increases over a short period of time, highlighting investors’ preference for the metal over the miners. Given the data and opinions provided at Platinum Week, we continue to believe in a bright future for these two precious metals.

www.sprottgroup.com/thoughts 

1 Implats Assessing Shafts’ Viability as More Become Unprofitable. Retrieved on May 22, 2013 from: #0066cc;">http://www.bloomberg.com/news/2013-05-02/implats-assessing-shafts-viability-as-more-become-unprofitable.html

2 Thinking in the same old way will not rescue the platinum industry. Retrieved on May 22, 2013 from: #0066cc;">http://www.bdlive.co.za/opinion/2013/05/14/thinking-in-the-same-old-way-will-not-rescue-the-platinum-industry

3 South Africa Union to Seek 'Double-Digit' Wage Rise. Retrieved on May 22, 2013 from: #0066cc;">http://online.wsj.com/article/SB10001424127887324482504578454603754058118.html

This report contains forward-looking statements which reflect the current expectations of management regarding future growth, results of operations, performance and business prospects and opportunities. Wherever possible, words such as “may”, “would”, “could”, “will”, “anticipate”, “believe”, “plan”, “expect”, “intend”, “estimate”, and similar expressions have been used to identify these forward-looking statements. These statements reflect management’s current beliefs with respect to future events and are based on information currently available to management. Forward-looking statements involve significant known and unknown risks, uncertainties and assumptions. Many factors could cause actual results, performance or achievements to be materially different from any future results, performance or achievements that may be expressed or implied by such forward-looking statements. Should one or more of these risks or uncertainties materialize, or should assumptions underlying the forward-looking statements prove incorrect, actual results, performance or achievements could vary materially from those expressed or implied by the forward-looking statements contained in this document. These factors should be considered carefully and undue reliance should not be placed on these forward-looking statements. Although the forward-looking statements contained in this document are based upon what management currently believes to be reasonable assumptions, there is no assurance that actual results, performance or achievements will be consistent with these forward-looking statements. These forward-looking statements are made as of the date of this presentation and Sprott does not assume any obligation to update or revise.

Views expressed regarding a particular company, security, industry or market sector should not be considered an indication of trading intent of any fund or account managed by Sprott. Any reference to a particular company is for illustrative purposes only and should not to be considered as investment advice or a recommendation to buy or sell nor should it be considered as an indication of how the portfolio of any fund or account managed by Sprott will be invested.

 

    

Pages