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Chinese Growth Slows Most Since Lehman; Capex Worst Since 2001; Electric Output Tumbles To Negative

While China may have mastered the art of goalseeking GDP, always coming within 0.1% of the consensus estimate, usually to the upside, even if the bogey has seen dramatic declines in the past few years, dropping from double digit annualized growth to just 7.5% currently and the projections hockey stick long gone...

... it may need to expand its goalseek template to include the other far more important measure of Chinese economic activity, such as Industrial production, retail sales, fixed investment, and even more importantly - such key output indicators as Cement, Steel and Electricity, because based on numbers released overnight, the Q2 Chinese recovery is now history (as the credit impulse of the most recent PBOC generosity has faded, something we have discussed in the past), and the economy has ground to the biggest crawl it has experienced since the Lehman crash.

What's worse, and what we predicted would happen when we observed the collapse in Chinese commodity prices ten days ago, capex, i.e. fixed investment, grew at the slowest pace  in the 21st century: the number of 16.5% was the lowest since 2001, and suggests that the commodity deflation problem is only going to get worse from here.

As JPM summarized earlier today, pretty much every economic data release was a disaster, missing consensus significantly, and suggesting GDP is now trending at an unprecedented sub-7%.

"Today China released major indicators of economic activity for August. Industrial production growth slowed to 6.9%oya (consensus: 8.8%), slowest pace since the global financial crisis period of late 2008/early 2009, suggesting that the economy has lost  momentum again following the 2Q recovery. On the domestic front, both fixed investment and retail sales came in weaker than expected. Fixed investment growth decelerated notably to 16.5%oya ytd in August (J.P. Morgan: 16.8%, consensus: 16.9%), the slowest pace of growth since 2001, while retail sales increased 11.9%oya (J.P. Morgan: 12.4%; consensus: 12.1%). Recall that August merchandise exports (released on Monday) still showed solid growth pace at 9.4%oya, while imports disappointed, falling 2.4% y/y".

It wasn't just the economic indicators: there was pronounced weakness in the biggest Chinese asset, far more important to the local economy than stocks: the housing market:  Home sale area fell 13.4% Y/Y in August, compared to the fall at 17.9% Y/Y in July. In value term, home sale fell 13.7% Y/Y in August, compared to the fall at 17.9% Y/Y in July. In other words, those predicting the bursting of the Chinese housing bubble better be paying attention as it is currently taking place.

Which also means that with organic cash flow plunging, real estate developers had to resort to the capital markets increasingly more, and raised 7.9 trillion yuan year-to-date by August (up 2.7% ytd), compared to 6.9 trillion yuan year-to-date by July (up 3.2% ytd). Basically, this means that in order to delay the hard landing, China is now pushing its banks into the all-in moment as everyone is mobilized to stop the one event that could result in a global depression: recall - Chinese banks have over $25 trillion in assets, the bulk of which is backed by housing.

Finally, and perhaps most disturbing, was that alongside a slowdown in cement and steel production, Chinese electrical output saw its first Y/Y decline since Lehman, dropping by a "shocking bad" 2.2% (in Bloomberg's words) by far the best economic indicator of what is going on in the middle kingdom.


Putting it all together, here is JPM: "Overall, the August activity points at some downside risks going ahead. Note that trade surplus is strong in recent months, but this is mainly because weaker-than-expected import growth, which is related to the story of weak domestic demand. The weakness in domestic demand is not only reflected in real estate activity, but also in manufacturing and other sectors. To some degree this is good news, as slowdown in manufacturing and real estate investment is a critical part of economic re-balancing. Nonetheless, it remains unclear what other sectors could arise and provide alternative source of growth in the near term."

Or, as Bloomberg's Tom Orlik shows, based on these real-time economic indicators, China's GDP has tumbled to a shocking 6.3% from 7.4%, and far below the 7.5% GDP target set by the premier.


And since it is unclear what can drive growth, JPM is happy to provide one solution: more easing of course. Then again, even JPM confirms that this will be an hard uphill climb: "Despite the weak data in August, there is no sign that the Chinese government will ease macro policies in the near term. In a speech earlier this week, Premier Li reiterated that China’s growth is within a reasonable range, and the government will rely more on structural reform, rather than stimulus, to support economic growth."

But recall that China has used big words before, such as last summer when it swore it would engage in a 1 trillion deleveraging, only to quickly forget all about it when its banking system nearly collapsed after overnight repo rates soared to 25%.

So what are the options? Here, again, is JPM:

What measures could be introduced to stabilize the growth momentum?


First, the central bank has adopted unconventional measures to ease the monetary policy since 2Q. These include a target for relatively low market interest rates (e.g. repo rates and SHIBOR); targeted credit easing, such as the PSL, re-lending, targeted RRR and target rate cut; tighter rules on shadow banking activity and improve the credit support to the real sector (via compositional shift from shadow banking to bank loans in total social financing). It is likely that the PBOC will expand the PSL operation in the coming months to support targeted sectors (e.g. environment, water conservation, small business).


Second, given the limitations in fiscal policy to support investment in 2H14, the government may introduce measures to encourage the participation of private investment. Such measures include removing government control, opening market access, or the public-private-partnership (PPP) model.


In addition, we expect housing policies will be further eased to slow down the adjustment process in the housing market. Many local governments have removed or eased the home restriction policies in recent months, and since July mortgage support for first-home buyers has improved (e.g. lower mortgage rates and improved mortgage availability). In recent weeks some real estate developers were allowed to raise funds from the bond and equity market. A next possible policy option could be the easing in loan-to-value restrictions for second-home buyers, which now is subject to a maximum LTV of 40%.


More importantly, this administration has announced some supply-side policy measures. It remains to be seen whether these measures will be implemented in practice. The areas that are worthy of special attention include: (1) administrative reform, i.e. removal of government control and private access to sectors used to be controlled by the state sector; (2) reduction of the tax and fee burden for the corporate sector; (3) reduction of funding cost for business borrowers especially for small business.

In other words, we are now in a world in which the biggest economy, Europe, is about to enter a triple-dip recession, and the third largest standalone economy, China, is undergoing an economic standstill, and all hopes and prayers are that China will join the ECB in activating monetary easing once again. But yes, the Fed will not only conclude QE but will supposedly begin rising rates in just over two quarters.

Good luck with that.

Technical Overview Ahead of Next Week's Key Events

Next week may very well be one of the most important weeks of the year.  There are a number of events that individually and collectively have the potential to spur significant moves across the capital markets.  These events include the Scottish referendum, FOMC meeting, and the launch of the ECB's TLTRO facility.


In addition, the Swiss National Bank meets, and it has indicated that negative rates have not been ruled out to help defend the currency cap. Catalonia's parliament will decide whether to push forward with a non-binding survey/referendum that has been rejected by the national government.  Some observers have attributed the under-performance of Spanish assets (after a period of out performance) to the idea that the strong showing of the Scottish nationalists has some bearing on Catalonia's independence.


Given the potential for these events to drive the capital markets, and that the volatility of volatility, if you will, has risen, an overview of the technical condition of the capital markets may be particularly helpful now.  At the risk of oversimplifying, the US dollar is in a strong uptrend against the major currencies and most of the emerging market currencies.  Speculative positioning in the future market has been concentrated in amassing significant short euro and yen positions.   The market was net long Australian and Canadian dollars, but the recent price action suggests a substantial position adjustment took place, and more than what is captured in the position report for the week ending September 9.


There has also been a sharp reversal in US yields.  The 10-year Treasury yield was near the lows for the year in late August below 2.35%.  It briefly traded poked through 2.60% before the weekend. It has now satisfied a Fibonocci retracement (38.2%) of the yield decline from January through August. The next retracement target is near 2.68%.  Barring a shock, the yield can climb into the 2.75%-2.80% in the coming weeks.


Yields around the world have risen with US Treasuries (which is why political scientists rather than investment advisers formalized the hypothesis of a G-zero world). European bond yields have risen less, and several emerging markets and Australia experienced larger increases in yields.   Generally speaking, in rising interest rate environment, one would expect the credit spreads to widen, with lower credit yields rising more.


The S&P 500 set record highs on September 4, but the technical tone has deteriorated in recent session.  The development is somewhat reminiscent of the topping pattern carved out in the second half of July, when the S&P 500 also registered record highs.  It is as if investors are happy to take profits on rallies.  Perhaps this reflects a mistrust for the equity gains or belief that the environment that facilitated them will change soon  We note that the five and twenty day moving average are set to cross, and this cross-over has done a good job in recent months of signaling the trends. The poor close before the weekend warns of follow through losses next week.  Initial targets are in 1970 and then 1958,  It takes a break of the 1940 area to signal a test on the August low in front of 1900.


Most equity markets also fell last week, but lets looks at the exceptions first.  The weakening of yen may have helped encourage the 1.8% rally in the Nikkei.  Soft Chinese CPI underscores the scope for potential easing of policy, and this may have helped the national markets rise 1-2%.  The MSCI emerging market equity index recorded its 3-year high on September 4, while the S&P was making its record high.  It fell each session last week, and the five and twenty day moving averages have crossed.   All of the Fibonocci retracement objectives have been surpassed, highlighting the risk that the index 1045-50 area (~1.5%-2.0% decline).  


Commodity prices have fallen sharply.  The CRB Index is off more than 10% since late June, and 4% this month alone.  The momentum is too much and some signs of consolidation were seen toward the end of the week in which twice the index gapped lower.  Of note, for American drivers gasoline prices at the pump are at six-month lows (average price in US, according to AAA). Oil prices themselves staged a potentially important technical reversal last week.  The move through $96 would indicate a low of some significance was likely in place.   The price of gold is at an eight-month low. Raising interest rates increase the opportunity cost of holding gold, and the rally in the dollar may deter other buyers.  


Taking a closer look at the foreign exchange market, we share four points.  First, the euro's record long losing streak of eight weeks ended with a firm close before the weekend.   The $1.3000 level has psychological significance, while the retracement of the ECB-induced slide is $1.3010.  It may take a move through the $1.3045 area to encourage short covering.  


Second, the dollar has made new highs against the yen for eleven consecutive sessions.  The rise in US yields, and the official jawboning, took place after the move was well under way.    The advance in the dollar has met no resistance.  The diversification of Japan's public funds, the increased portfolio outflow, and speculators are among the featured yen sellers.  With ECB officials talking the euro lower, Japanese officials may sense a greater sense of flux, and have welcomed the yen's decline, and recognizing the fundamental economic considerations behind it. The dollar finished last week near its highs, and further near-term gains are likely.  The JPY108 level beckons but real target seems to be closer to JPY110.  


Third, the gap that was created a the start of last week's trading, in response to the YouGov poll that showed the Scottish independents with a lead, has not been fully filled.   A small gap still exists between $1.6277-$1.6283.  We think that nearly every one really expects the "no" vote to carry the day and the speculative positioning in the futures market bears this out.    There is a sense that sterling has been oversold, but the risks are great, and the cost of hedging (implied volatility) is high.   It takes a break of $1.60 to signal something important.  It is likely to remain intact until the referendum.  A "yes" victory would wreak havoc.  Sterling would sell-off sharply, and likely drag down short-term rates.  The market would price in a political and economic crisis.  At the same time, a "no" victory would allow the market to focus on favorable UK fundamentals and a pound that has lost 12 cents over he past two months.  On a as-expected "no" vote, our target for sterling is $1.65-$1.66.  


Fourth, a negative attitude to the European currencies and yen are not new.  The new thing that has taken place is that the dollar-bloc currencies have also now fallen out of favor.  The Australian and New Zealand dollars were the weakest of the majors last week.  The yen barely eclipsed the Canadian dollar to take third place.   The technical indicators warn of further losses ahead.  In addition, the take-away from the recent price action in the other major currencies, is that this is does not the kind of dollar market that one has been rewarded for fading breakouts.  Both the Australian and Canadian dollar have broken out of their previous ranges.  Technically, there may be scope for another 2% decline in the coming weeks.  


Observations based on speculative positioning in the futures market:  


1.  There were two significant (10k+ contract change in gross positions) position adjustment in the CFTC reporting period ending September 9.  First, short-covering reduced the gross short yen position by 14.8k contracts to 118.0k.  The yen has continued to sell-off and new shorts were likely established since the reporting period ended.  Second, the bulls went shopping in sterling.  They extended the gross long position by 13.8k contracts to 81.3k.  It was the most buying in five months. It is also larger than the euro, yen and Swiss franc gross positions combined.   


2.   The other twelve gross currency positions we track were adjusted by less than 5k contracts.  Generally speaking, this reflected the position squaring in the sense that most of the currency futures (but the Swiss franc and the Australian dollar) saw a small reduction in gross short positions.  Outside of sterling that we discussed above, there was virtually now buying of the currency futures during the reporting period.  Combined the euro, yen, and Swiss franc saw an increase of 2.5k gross long contracts.  Gross longs were reduced in Canadian and Australian dollars and the Mexican peso.   The out-sized losses in these currencies in recent says suggests were longs have been liquidated.  


3.  Speculators in the US 10-year Treasury futures bought into the decline through September 9. During the week they added almost 58k long contracts for a gross position of 440.2k contracts.  The gross shorts edged a little higher.  The 8.4k contract increase brings the gross short position to 473.5k contracts.  The net short position fell to 33.3k contracts from 82.7k.   An important question is when will the longs capitulate?   We think that the yields are a little more than  half way to what may be a new equilibrium (~2.75%).

Russia Sends Second Humanitarian Convoy Into Ukraine, And Nobody Says A Word

About a month ago, when Russia sent a humanitarian convoy to aid ethnic Russians in east Ukraine, the Western world, and of course media, screamed bloody murder, with everyone from NATO to the Kiev government declaring it, without a shadow of a doubt, an invasion, a Trojan Horse, and a convoy of arms deliveries for the rebels caught in the Ukraine civil war, not necessarily in that order. Nobody thought it could possibly be just that: a convoy of humanitarian aid delivering provisions to hundreds of thousands of civilians caught in the middle of a war. Then finally, after weeks of delays, the convoy was allowed in and after unloading its cargo, promptly returned to Russia without a single incident.

Fast forward to today, when hours ago Russia sent a second humanitarian convoy into east Ukraine, which entered without enter the approval of Kiev or the oversight of the Red Cross and nobody said a word.

As if all the posturing and warmongering rhetoric have long since departed the Ukraine, now that the US is fully engaged in yet another war, this time not a proxy civil war but one involving doing Qatar's natural gas pipeline bidding once more, meaning it is time to conclude what was started in early 2013 and once again try to dethrone Syria's assad so that the all important Gazprom-displacing pipeline from the middle east can finally make its way to Europe, aided by a soon to be new, pro-American government in Syria.

But back to Ukraine where the second convoy barely made news and the details about it were only revealed several paragraphs deep inside this AP article about ongoing fighting near the Donetsk airport:

On Saturday Russia also sent a convoy across the border of Ukraine, loaded with what Russian reports said was humanitarian aid, without the approval of Kiev or oversight of the international Red Cross. A similar convoy in August was loudly condemned by Ukrainian officials as an invasion, but this time around Lysenko simply called the move "illegal." The country's top leaders have remained silent, underscoring how dramatically the mood has shifted in the Kiev government since a cease-fire deal was struck.


The last truck crossed onto Ukrainian soil early Saturday from the Russian border town Donetsk, some 200 kilometers (120 miles) miles east of the Ukrainian city with the same name, Rayan Farukshin, a spokesman for Russia's customs agency, told the Associated Press by phone.


The Organization for Security and Cooperation in Europe's observer mission to the Russian-Ukrainian border said 220 trucks had crossed into Ukraine. Only 40 trucks were checked by the Russian border guard, while the other 180 were waved straight through, it said. None of the vehicles were inspected by the Ukrainian side or by the ICRC.


"Ukraine border guards and customs were not allowed to examine the cargo and vehicles," Lysenko said. "Representatives of the Red Cross don't accompany the cargo, nobody knows what's inside."


The Russian emergency ministry, which coordinated previous humanitarian aid deliveries to Ukraine, could not be reached for comment about the convoy.

Even the AP is confused by the change in rhetoric:

In August, Ukrainian officials said that a first convoy of humanitarian aid from Russia would be seen as an invasion of the country, and loudly protested any attempts by Russia to unilaterally bring in the aid. Eventually Russia sent its trucks across the border and into rebel-held territory without the oversight of the International Red Cross, contrary to an agreement signed between Ukraine and Russia.


A representative of the ICRC's Moscow office said they had not been informed about the current convoy, either.


"We were not officially notified of an agreement between Moscow and Kiev to ship the cargo," Galina Balzamova said Saturday.

Others were also quick to point out the inconsistencies in a narrative that changes day to day:

Last time Russia sent a humanitarian aid convoy to Ukraine, the SBU chief said it was an "invasion."

— Nataliya Vasilyeva (@NatVasilyevaAP) September 13, 2014

The vast difference in reaction to this Russian convoy and the previous one shows how much things have changed in #Ukraine in a few weeks.

— Paul Sonne (@PaulSonne) September 13, 2014

Back in Kiev, the confused Western-puppet government, while reiterating the generic talking points, had no idea how to frame the second Russian humanitarian "invasion" so it just kept silent.

At a conference with politicians and business leaders in Kiev, Ukrainian Prime Minister Arseniy Yatsenyuk said that Ukraine was "still in a state of war" with neighboring Russia and struck out against President Vladimir Putin, whose goal he said was to "take the entire Ukraine." "He cannot cope with the idea that Ukraine would be a part of a big EU family. He wants to restore the Soviet Union," Yatsenyuk said.


Despite the tough talk, often heard among Ukrainian politicians as they gear up for parliamentary election, Yatsenyuk made no mention of the Russian convoy.

RIA reports that the distribution of Russian humanitarian aid will start as early as Monday, according to the First Deputy Premier Minister of the self-proclaimed Luhansk People's Republic Valery Potapov: "We will start giving out [humanitarian aid to the population] on Monday," the official said. He also noted that the Luhansk authorities have designed a system of humanitarian aid distribution following the previous Russian humanitarian aid convoy, delivered to the Eastern Ukrainian city in late August. Which suggest that the convoy will remain around Donetsk for at least 48 hours, something with the Kiev regime of a month ago would loudly label as a undisputed invasion, and yet this time, nobody says a word.

Which goes back to what we wondered about last week: why the push by both sides, Ukraine and Russia, to mask the ongoing events in eaat Ukraine under a blanket "ceasefire" regime, when clearly nothing has changed and when the fighting between the Ukraine army and separatists is waged daily: who is it that benefits the most from a facade of fake clam and what happens next?

Round 2 for the Japanese Yen

By: Chris Tell at

Today's article is compliments of our friend Mark Schumacher at ThinkGrowth. Mark has been a reader and subsequently become a regular bouncing board for us with respect to publicly traded equities, market sentiment and the like. I always value his thoughts and it is a rare occasion that we disagree. Enjoy!


As our portfolio clients are well aware, we have been long the US dollar vs. the Japanese yen (USD/JPY) via a sizable position in YCS - purchased in the mid $40s - for almost two years beginning around the time Shinzo Abe was elected Prime Minister after running on his three arrows platform:

  1. Monetary stimulus
  2. Fiscal stimulus
  3. Structural change

He promised large doses of each to invigorate the Japanese economy and I took him at his word knowing it meant a much weaker yen.

Arrow #3 WILL work but it is politically very difficult to implement as it requires near term pain during the adjustment phase to produce the positive long-term benefits of improved productivity and more efficient allocation of resources; labor and capital. Progress on arrow #3 has been dismal, and to my knowledge nothing significant is in the pipeline. I would not hold my breath on this one.

He has delivered on the first two arrows by inflating the money supply, lowering interest rates and expanding government budget deficits. The longer arrows #1 and #2 are implemented the weaker the yen and later JGBs (Japanese government bonds) will ultimately become. The hope is that the weaker yen will stimulate exports and somehow provide a net boost to the country even though Japan is a large importer especially of energy, commodities and labor-intensive manufactured components.

The theories and policies underlying arrows #1 and #2 are founded on fairy dust. It is an academic pipe dream to believe currency debasement and government debt are shortcuts to prosperity. Yet the dream lives on... not just in Japan either.

Post Abe's election the USD/JPY exchange rate rapidly appreciated from the low 80s to the high 90s and we benefited nicely with YCS appreciating about $20 into the mid $60s. Since then the exchange rate has been in a narrow range with the yen losing some value and YCS being flat through the first eight months of this year.

However, post this consolidation period, it looks like a second round of yen weakness is now occurring and there appears to be an identifiable catalyst. Notice how YCS (a long USD short JPY fund) is moving sharply higher again in the two year chart below.

2-Year Chart of YCS

The Yen's Second Wave of Weakness Begins

The catalyst for the next wave of yen weakness is the most recent release of Japanese economic data which was worse than expected. In Q2 the Japanese economy as measured by GDP shrank 7.1% due to a fall in both consumer spending and capital investments.

After 18 months of Abe's massive monetary and fiscal stimulus the economy is not gaining meaningful traction to say the very least. I see this as another demonstration of how these policies cannot expand the size of the economic pie because they do not create wealth or economic prosperity, in fact, they destroy it by unnaturally skewing incentives and therefore behavior.

In a world run by rational minds, the weak Q2 data along with a string of other weak Japanese economic data would be an impetus to ditch arrows #1 and #2 and focus on #3 in which case there would be no compelling reason for us to be short the yen.

Rather than question the cause-and-effect assumptions underlying their monetary and fiscal policies in the face of a failure of results, policy makers almost always conclude that the problem was either the size or timing of their programs. This may be counter intuitive to your logical mind, but the longer Abe's policies fail to deliver the hoped-for economic results, the more intensely they will be implemented... bad for Japan, good for our investment in YCS.

Expect more yen weakness over the coming year as the exchange rate heads back towards where it was pre-2008's financial crisis.

15-Year Chart of USD vs. JPY


As you can see, Mark is a sharp thinker. We have previously published some of his musings on portfolio diversification, buying out of favor stocks and market volatility, and I encourage you to read them.

- Chris


"Now, there is something called "Abenomics." I didn't coin the word. Markets did. It is the name given to my three-arrowed economic booster plan. Japan has been battling deflation for more than a decade. My plan, or "Abenomics," is to put an end to that, first and foremost." - Shinzo Abe

Obama’s ISIS War Is Not Only Illegal, It Makes George W. Bush Look Like A Constitutional Scholar

Submitted by Mike Krieger of Liberty Blitzkrieg blog,

Rudderless and without a compass, the American ship of state continues to drift, guns blazing.


- Andrew J. Bacevich, the Boston University political science professor and former Army colonel who lost his son in the Iraq war in 2007, in a recent Reuters article.

I have spent the past several days outlining my deep concerns about the “ISIS crisis” and Obama’s willingness to employ extreme propaganda in order to once again embark on another poorly thought out military campaign here and here. What I have also come to realize is that his latest war plan is brazenly illegal and unconstitutional.


While critics have been questioning the legality of U.S. military campaigns consistently since the end of World War II, one trend has become increasingly clear. With each new President and each new war, we have witnessed those who hold the office act more and more like dictators, and less and less like constitutional executives.

One very important, and up until recently, overlooked point about Obama’s latest “war on ISIS” is that this is not at all just more of the same. This crosses yet another very important line of shadiness, and if we as as American public allow him to do so, we will suffer grave long-term consequences to our economic future as well as our liberties. This is very serious stuff.

No one has outlined this point better than Bruce Ackerman, a professor of law and political science at Yale, in yesterday’s New York Times op-ed: Obama’s Betrayal of the Constitution. He writes:

BERLIN — PRESIDENT OBAMA’s declaration of war against the terrorist group known as the Islamic State in Iraq and Syria marks a decisive break in the American constitutional tradition. Nothing attempted by his predecessor, George W. Bush, remotely compares in imperial hubris.


Mr. Bush gained explicit congressional consent for his invasions of Afghanistan and Iraq. In contrast, the Obama administration has not even published a legal opinion attempting to justify the president’s assertion of unilateral war-making authority. This is because no serious opinion can be written.


This became clear when White House officials briefed reporters before Mr. Obama’s speech to the nation on Wednesday evening. They said a war against ISIS was justified by Congress’s authorization of force against Al Qaeda after the Sept. 11, 2001, attacks, and that no new approval was needed.


But the 2001 authorization for the use of military force does not apply here. That resolution — scaled back from what Mr. Bush initially wanted — extended only to nations and organizations that “planned, authorized, committed or aided” the 9/11 attacks.


Not only was ISIS created long after 2001, but Al Qaeda publicly disavowed it earlier this year. It is Al Qaeda’s competitor, not its affiliate.


Mr. Obama may rightly be frustrated by gridlock in Washington, but his assault on the rule of law is a devastating setback for our constitutional order. His refusal even to ask the Justice Department to provide a formal legal pretext for the war on ISIS is astonishing.


Senators and representatives aren’t eager to step up to the plate in October when, however they decide, their votes will alienate some constituents in November’s midterm elections. They would prefer to let the president plunge ahead and blame him later if things go wrong. But this is precisely why the War Powers Resolution sets up its 60-day deadline: It rightly insists that unless Congress is willing to stand up and be counted, the war is not worth fighting in the name of the American people.


But for now the president seems grimly determined to practice what Mr. Bush’s lawyers only preached. He is acting on the proposition that the president, in his capacity as commander in chief, has unilateral authority to declare war.


In taking this step, Mr. Obama is not only betraying the electoral majorities who twice voted him into office on his promise to end Bush-era abuses of executive authority. He is also betraying the Constitution he swore to uphold.

Think about this for a second. Barack Obama is using the 2001 Authorization for Use of Military Force (AUMF), which allowed for military action against “nations and organizations that planned, authorized, committed or aided the 9/11 attacks.” ISIS wasn’t even a twinkle in Abu Bakr al-Baghdadi’s eye back in September 2001. Even more stunning, ISIS and al-Qaeda more closely resemble enemies than allies. Yet this doesn’t seem to affect Nobel Peace Prize winning Barry Obama’s war planning. You can’t get much more insane and Orwellian than that.

Who cares right? This won’t ever affect you. So what if some bombs fall on innocent Arab civilians? Wrong.

One of the most terrifying aspects of this whole war push if Obama is able to pull it off, is that the reasoning (or lack thereof) could ultimately be applied to the detention of U.S. citizens indefinitely without a trial.

Yes, what I am referring to is the National Defense Authorization Act, or NDAA, which allows for the indefinite detention of American citizens without a trial. I covered this frequently several years ago when Chris Hedges and others were suing the Obama Administration regarding the constitutionality of this law. In fact, one of my most popular posts ever was, NDAA: The Most Important Lawsuit in American History that No One is Talking About.

One of the ways in which the U.S. government has defended the NDAA is by saying it can only be used against “a person who was a part of or substantially supported al-Qaeda, the Taliban, or associated forces that are engaged in hostilities against the United States or its coalition partners.” Glenn Greenwald noted in Salon in his, Three Myths About the Detention Bill, that:

Section 1021 of the NDAA governs, as its title says, “Authority of the Armed Forces to Detain Covered Persons Pursuant to the AUMF.”  The first provision — section (a) — explicitly “affirms that the authority of the President” under the AUMF  ”includes the authority for the Armed Forces of the United States to detain covered persons.” The next section, (b), defines “covered persons” — i.e., those who can be detained by the U.S. military — as “a person who was a part of or substantially supported al-Qaeda, the Taliban, or associated forces that are engaged in hostilities against the United States or its coalition partners.” 

Notice that the above says “pursuant to the AUMF,” which is the exact law the Obama Administration is using to justify his latest war. If he is able to start a war with ISIS based on the AUMF, despite the fact that ISIS and al-Qaeda are not allies at all, he or a future President could similarly use the AUMF and the NDAA to imprison anyone, anywhere for an indefinite amount of time based on the same absurd non-claim.

Let this all sink in for a second. Do you still support these ISIS strikes?

Oil Price Plunge? It's The Global Economy, Stupid!

The decline in the price of oil - in the face of surging geopolitical pandemonium - has been lauded as indicative of both US' awesomeness in energy independence and a tax cut for Americans... but, as the following chart suggests, there may be another - much more realistic - explanation for why oil is plunging... demand!


World GDP expectations for 2014 just tumbled to their lowest since estimates started...


Maybe - just maybe - that explains the price of oil...


Charts: Bloomberg

Credit Suisse Warns Of "Self-Fueling Negative Feedback" In Scotland; Here's Who Is Exposed

While we noted earlier the dramatic outflows and record selling in stocks in UK, Credit Suisse warns, it could get much worse...

The flow diagram below explains how the uncertainty over Scotland's currency and ability to backstop its financial sector can set in train a self-fuelling feedback loop of rising risks and costs to the Scottish financial and sovereign sectors, and a steady migration of capital, activity, jobs and taxes.


And these are the companies most exposed to Scottish economy(via Bloomberg) including sales, manufacturing  or employment:

Aerospace, Defense, Industrial:

Amec (majority of 28% of UK rev.: BofAML), Aggreko (Glasgow HQ), Babcock (owns Air Power and sites near Rosyth, Clyde dockyards; 4,750 staff), BAE (Glasgow dockyards, significant interests/staff, govt contracts), Hunting (majoring of 14% UK rev.: BofAML), James Fisher (Defense unit based in Ichinnan), Petrofac (majority of 26% U.K. rev: BofAML), Rolls-Royce (2,400 employees, six facilities), Weir (HQ Glasgow, 13,750 employees), Wood Group (majority of 30% U.K. rev.: BofAML)

Asset Management:

Aberdeen Asset Management (HQ in Aberdeen, 2,062 employees), Jupiter Fund Management, Hargreaves Lansdown
If “yes” vote, single-tier pension from 2016


Lloyds (3.7% of total assets, 6.3% of total customer loans), RBS (1.4%, 3.6%), Barclays (0.3%, 0.8%), HSBC (0.1%, 0.4%).

TSB, RBS, Lloyds, NAB Top Banks Exposed to Scottish Independence Risk

Business Services:

Aggreko (HQ in Glasgow, manufacturing & product development facility in Dumbarton), Rentokil Initial, Capita (has contract for provision of IT to Scottish public sector), Teleperformance (call centers, ~4,000 employees)


Elementis (site in Livingston), BASF (Paisley, Lewis), Dow Chemical (Grangemouth), ExxonMobil (Fife Ethylene) Johnson Matthey (sites in Aberdeen, Edinburgh), Syngenta (Grangemouth)


GlaxoSmithKline (manufactures pharma ingredients at Montrose, respiratory medicine at Irvine)

Food & Beverages:

AG Barr (40% of sales), Diageo (29 whiskey distilleries, 4,000 staff, GBP3b in sales), Pernod Ricard (owns Glenlivet, Chivas Regal; 15 Scotch distilleries, 2 bottling sites); Heineken (Edinburgh brewery)

General/Food Retail:

Sainsbury (8,000 staff, 60 stores), Tesco (Scottish workforce is ~4x Sainsbury’s, according to Barclays), Wm Morrison, Next, Kingfisher, Asda


Standard Life (HQ Edinburgh, 8,000 employees)

Oil & Gas:

BG (16% of output in U.K.), Total (5%), BP (3%), Shell (3%), OMV (1%)

Westhouse: EnQuest (all P&D UNKS assets, except Alma/Galia in Scottish part of North Sea), Ithaca all (P&D UKNS assets, except Anglia, Topaz, Wytch Farm field); Parkmead (all UKNS assets, except for 7 blocks in Southern Gas Basin, 2 licenses in Central North Sea); Faroe (Blane, Curlew South assets)

Property/House Builders:

Via FX, businesses moving: Derwent London (Glasgow holdings), British Land, Berkeley, Bovis, Redrow
Weaker GBP would increase attractiveness of U.K. commercial real estate, good news for London house prices: Barclays


IAG, Ryanair, EasyJet, Royal Mail (may be renationalized, ~7% employees), FirstGroup (Aberdeen HQ, ScotRail franchise), Stagecoach (Perth HQ, runs Scottish buses), John Menzies (Edinburgh HQ), National Express (~1% of rev.) Air Passenger Duty to fall 50%


Centrica (risk to assets, operations in North Sea; policy risk)
SSE (Perth HQ; Distribution/Transmission assets, policy risk; has 47% of EV in Scotland, Credit Suisse says)
National Grid (policy risk) and Pennon (through Viridor), mid-single digit % exposure for both, UBS says
Iberdrola (owns Scottish Power, has nearly 15% of EV in Scotland, Goldman says)

Scottish economy makeup as of 2011:

Govt, health, education ~22% of GVA; Financial, insurance, real estate ~17%; Distribution, hotels, catering ~13%; Manufacturing ~12%; Professional, support services ~10%; Transport, storage, communication ~8%; Construction ~7%; Mining ~3%

*  *  *

Longer term, Credit Suisse warns, the "cat is out of the bag".

Companies and governments have been forced to reveal contingency plans and unshakeable premises have been seen as vulnerable to attack (What is a pound? What is the UK?) A decisive (or, in the near term, a narrow) "No" puts these issues back on the back burner behind monetary policy and the like. But any "Yes" (and over time, in our view, a narrow "No") reopens similar questions elsewhere.

And as Citi warned previously,

More broadly, "Referendum Risk" is one of the more powerful manifestations of what we have termed Vox Populi risk, the Crimea being a particularly powerful, if extreme, example. In particular, what happens in Scotland will be particularly closely watched in Spain, which is facing a referendum on Catalan independence. Latent independence movements elsewhere, such as Belgium, could also be influenced by the outcome in Scotland. We regard the revival of local/national concerns, from Scotland to Spain and beyond, as part of continuing anti-establishment sentiment and a backlash against globalisation. And the UK experience (with growing support for UKIP alongside faster economic growth) raises the issue that economic recovery alone may not be enough to reverse the rise in anti-elite, anti-establishment sentiment.

End Of Empire - The 'De-Dollarization' Chart That China And Russia Are Banking On

History did not end with the Cold War and, as Mark Twain put it, whilst history doesn’t repeat it often rhymes. As Alexander, Rome and Britain fell from their positions of absolute global dominance, so too has the US begun to slip. America’s global economic dominance has been declining since 1998, well before the Global Financial Crisis. A large part of this decline has actually had little to do with the actions of the US but rather with the unraveling of a century’s long economic anomaly. China has begun to return to the position in the global economy it occupied for millenia before the industrial revolution. Just as the dollar emerged to global reserve currency status as its economic might grew, so the chart below suggests the increasing push for de-dollarization across the 'rest of the isolated world' may be a smart bet...



As Deutsche Bank's Jim Reid explains,

In 1950 China’s share of the world’s population was 29%, its share of world economic output (on a PPP basis) was about 5% (Figure 98). By contrast the US was almost the reverse, with 8% of the world’s population the US commanded 28% of its economic output.


By 2008, China’s huge, centuries-long economic underperformance was well down the path of being overcome (Figure 97).


Based on current trends China’s economy will overtake America’s in purchasing power terms within the next few years. The US is now no longer the world’s sole economic superpower and indeed its share of world output (on a PPP basis) has slipped below the 20% level which we have seen was a useful sign historically of a single dominant economic superpower. In economic terms we already live in a bipolar world. Between them the US and China today control over a third of world output (on a PPP basis).

However as we have already highlighted, the relative size of a nation’s economy is not the only determinant of superpower status. There is a “geopolitical” multiplier that must be accounted for which can allow nations to outperform or underperform their economic power on the global geopolitical stage. We have discussed already how first the unwillingness of the US to engage with the rest of the world before WWII meant that on the world stage the US was not a superpower inspite of its huge economic advantage, and second how the ability and willingness of the USSR to sacrifice other goals in an effort to secure its superpower status allowed it to compete with the US for geopolitical power despite its much smaller economy. Looking at the world today it could be argued that the US continues to enjoy an outsized influence compared to the relative size of its economy, whilst geopolitically China underperforms its economy. To use the term we have developed through this piece, the US has a geopolitical multiplier greater then 1, whilst China’s is less than 1. Why?

On the US side, almost a century of economic dominance and half a century of superpower status has left its impression on the world. Power leaves a legacy. First the USA’s “soft power” remains largely unrivalled - US culture is ubiquitous (think McDonald’s, Hollywood and Ivy League universities), the biggest US businesses are global giants and America’s list of allies is unparalleled. Second the US President continues to carry the title of “leader of the free world” and America has remained committed to defending this world. Although more recently questions have begun to be asked (more later), the US has remained the only nation willing to lead intervention in an effort to support this “free world” order and its levels of military spending continues to dwarf that of the rest of the world. US military spending accounts for over 35% of the world total and her Allies make up another 25%.

In terms of Chinese geopolitical underperformance there are a number of plausible reasons why China continues to underperform its economy on the global stage. First and foremost is its list of priorities. China remains committed to domestic growth above all other concerns as, despite its recent progress, millions of China’s citizens continue to live in poverty. Thus so far it has been unwilling to sacrifice economic growth on the altar of global power. This is probably best reflected in the relative size of its military budget which in dollar terms is less than a third the size of Americas. Second China has not got the same level of soft power that the US wields. Chinese-style communism has not had the seductive draw that Soviet communism had and to date the rise of China has generally scared its neighbors rather then made allies of them. These factors probably help explain why in a geopolitical sense the US has by and large appeared to remain the world’s sole superpower and so, using the model of superpower dominance we have discussed, helps explain why global geopolitical tensions had remained relatively low, at least before the global financial crisis.

However there is a case to be made that this situation has changed in the past five or so years. Not only has China’s economy continued to grow far faster than America’s, perhaps more importantly it can be argued that the USA’s geopolitical multiplier has begun to fall, reducing the dominance of the US on the world stage and moving the world towards the type of balanced division of geopolitical power it has not seen since the end of the Cold War. If this is the case then it could be that the world is in the midst of a structural, not temporary, increase in geopolitical tensions.

Why do we suggest that the USA’s geopolitical multiplier, its ability to turn relative economic strength into geopolitical power, might be falling? Whilst there are many reasons why this might be the case, three stand out. First, since the GFC the US (and the West in general) has lost confidence. The apparent failure of laissez faire economics that the GFC represented combined with the USA’s weak economic recovery has left America less sure then it has been in at least a generation of its free market, democratic national model. As this uncertainty has grown, so America’s willingness to argue that the rest of the world should follow America’s model has waned. Second the Afghanistan and in particular the Iraq War have left the US far less willing to intervene across the world. One of the major lessons that the US seems to have taken away from the Iraq war is that it cannot solve all of the world’s problems and in fact will often make them worse. Third, the rise of intractable partisan politics in the US has left the American people with ever less faith in their government.

The net result of these changes in sentiment of the US people and its government has been the diminishment of its global geopolitical dominance. The events of the past 5+ years have underlined this. Looking at the four major geopolitical issues of this period we raised earlier – the outcome of the Arab Spring (most notably in Syria), the rise of the Islamic State, Russia’s actions in Ukraine and China’s regional maritime muscle flexing – the US has to a large extent been shown to be ineffective. President Obama walked away from his “red line” over the Syrian government’s use of chemical weapons. The US has ruled out significant intervention in Northern Iraq against the Islamic State.

America has been unable to restrain Pro-Russian action in Ukraine and took a long time (and the impetus of a tragic civilian airplane disaster) to persuade her allies to bring in what would generally be considered a “first response” to such a situation - economic sanctions. And so far the US has had no strategic response to China’s actions in the East and South China seas. Importantly these policy choices don’t necessarily just reflect the choice of the current Administration but rather they reflect the mood of the US people. In Pew’s 2013 poll on America’s Place in the World, a majority (52%) agreed that “the US should mind its own business internationally and let other countries get along the best they can on their own”. This percentage compares to a read of 20% in 1964, 41% in 1995 and 30% in 2002.

The geopolitical consequences of the diminishment of US global dominance

Each of these events has shown America’s unwillingness to take strong foreign policy action and certainly underlined its unwillingness to use force. America’s allies and enemies have looked on and taken note. America’s geopolitical multiplier has declined even as its relative economic strength has waned and the US has slipped backwards towards the rest of the pack of major world powers in terms of relative geopolitical power.

Throughout this piece we have looked to see what we can learn from history in trying to understand changes in the level of structural geopolitical tension in the world. We have in general argued that the broad sweep of world history suggests that the major driver of significant structural change in global levels of geopolitical tension has been the relative rise and fall of the world’s leading power. We have also suggested a number of important caveats to this view – chiefly that a dominant superpower only provides for structurally lower geopolitical tensions when it is itself internally stable. We have also sought to distinguish between a nation being an “economic” superpower (which we can broadly measure directly) and being a genuine “geopolitical” superpower (which we can’t). On this subject we have hypothesised that the level of a nations geopolitical power can roughly be estimated multiplying its relative economic power by a “geopolitical multiplier” which reflects that nations ability to amass and project force, its willingness to intervene in the affairs of the world and the extent of its “soft power”.

Given this analysis it strikes us that today we are in the midst of an extremely rare historical event – the relative decline of a world superpower. US global geopolitical dominance is on the wane – driven on the one hand by the historic rise of China from its disproportionate lows and on the other to a host of internal US issues, from a crisis of American confidence in the core of the US economic model to general war weariness. This is not to say that America’s position in the global system is on the brink of collapse. Far from it. The US will remain the greater of just two great powers for the foreseeable future as its “geopolitical multiplier”, boosted by its deeply embedded soft power and continuing commitment to the “free world” order, allows it to outperform its relative economic power. As America’s current Defence Secretary, Chuck Hagel, said earlier this year, “We (the USA) do not engage in the world because we are a great nation. Rather, we are a great nation because we engage in the world.” Nevertheless the US is losing its place as the sole dominant geopolitical superpower and history suggests that during such shifts geopolitical tensions structurally increase. If this analysis is correct then the rise in the past five years, and most notably in the past year, of global geopolitical tensions may well prove not temporary but structural to the current world system and the world may continue to experience more frequent, longer lasting and more far reaching geopolitical stresses than it has in at least two decades. If this is indeed the case then markets might have to price in a higher degree of geopolitical risk in the years ahead.




McStain is in charge of our vetting

And moderate rebels we're getting

It's all just a game

These guys are the same

And fighting for ISIL

I'm betting

The Limerick King











Why PIMCO Thinks "The Bursting Bubble" Is Not The Biggest Risk

Authored by PIMCO's Paul McCulley,

When I entered the Fed-watching business over three decades ago, a clichéd phrase of advice from graybeards was: “Watch what they do, not what they say.” Thinking back, there was not actually much Fed rhetoric to either watch or hear.

Paul Volcker was new in the job of Fed Chairman, Ronald Reagan had just been elected President, and Ted Turner had not yet launched CNN Headline News. All three men are now recognized as giants of transformative change in America’s life, altering not just how we conduct our affairs, but also how we think about ourselves.

It really was a good time to be a newly minted graduate in short pants on Wall Street. The fiscal authority was pursuing something called supply side economics and the monetary authority was putatively pursuing monetarism. Keynes was in rehab for inflationary intoxication, and Friedman was the straw stirring the free-to-choose drink. The visible fist of government was cursed and the invisible hand of markets celebrated.

Ah, yes, a most interesting time to start a career on Wall Street: a time of existential ferment in our nation’s economic policy, best characterized by tight monetary policy, loose fiscal policy and blind belief in the ability and willingness of capitalists to regulate and discipline their own affairs. At such a juncture in history, the advice of the graybeards to me to watch what “they” do rather than what they say was sage counsel.

This was particularly the case in watching the Volcker-led Fed, which pegged short-term interest rates, but said it didn’t, maintaining that it simply controlled growth in the money stock via changes in “the degree of pressure on bank reserve positions.” Volcker also thundered that the Fed had virtually no influence over long-term interest rates, which were putatively sky high because of outsized budget deficits and inflationary expectations.

Accordingly, the Fed-watching community of that era was, in practice, a community of plumbers: We spent a huge amount of effort and time anticipating and reverse engineering the day-to-day flows (called “operating factors”) that drove the activities of the New York Fed’s Open Market Desk, which were necessary to maintain the existing “degree of pressure on reserve positions.”

Yes, we were obsessed with what the Fed actually did, which they ordinarily did at 11:40 Eastern time: customer repo versus system repo, term versus overnight, bill passes versus coupon passes and the dreaded matched sale. Were the operations strictly “technical,” orchestrated to sterilize the net of churning operating factors, or was the Desk implementing a FOMC-directed change in the degree of pressure on reserves – to wit, changing the FOMC’s implicit fed funds rate target?

To be sure, we Fed nerds were also expected to forecast such changes, with especial focus on changes in the FOMC’s “inter-meeting bias,” also known as the “tilt,” which granted the Chair authority to implement changes without further FOMC deliberations. But our day job was as plumbers, to literally figure out when policy changes were actually unfolding by chasing the Fed’s open market transactions through the banking system’s pipes.


Dot mavens
Now a graybeard, I preach to youngsters the opposite of the sermon I was given: Watch what they say, not what they do. The Secrets of the Temple that Bill Greider wrote so poignantly about in 19831 are no longer secret. The FOMC not only very publicly pegs the fed funds rate (albeit in a 25 basis point range, so as to maintain some degree of no-hands-Mom myth), but also provides “forward guidance” as to its fed funds rate peg: The FOMC forecasts itself!

In 2012, Ben Bernanke institutionalized this glasnost in what have become known as the blue dots: an array of all FOMC participants’ individual forecasts of where they think the Fed should/will peg the fed funds rate – over the next 2–3 years, as well as in the proverbial “longer run.” The blue dots are shown in this Dot-ology Box.    

Thus, the game of Fed forecasting is no longer an absolute sport, as in my youth, but a relative game: The FOMC’s dots are the benchmark, and forecasting is an over-under game versus those dots. To be sure, today’s game is similar to yesterday’s game, in that betting money on Fed forecasts involves wagering relative to market prices, notably the forward curve for future short rates.

What is new is that the forward curve is now an explicit instrument of monetary policy. More bluntly: The Fed explicitly seeks to influence and manage long-term asset prices, all of which, by the (Gordon) laws of financial arithmetic, embed expectations of future Fed policy.

The Fed doesn’t put it exactly that way, of course, preferring to speak of influencing “financial conditions.” Political correctness and all that. But “financial conditions” don’t have ticker symbols with prices: Long-term financial assets do – bonds, stocks and currencies.

Thus, central bank watching in today’s world is all about reverse engineering where central banks “want” those big-three asset prices, which are now Fed “targets,” in a fashion similar to the money stock “targets” of my youth. That is not to suggest, I hasten to add, that central bankers always get what they want!

There are many slips between cup and lip, between instruments and targets. Reality has a nasty habit of intruding on wants and best intentions. And needs.


Doing what we were trained to do!
We Fed-watching plumbers of long ago now finally get to do what, for me, is most rewarding: reverse engineering the internal consistency, or lack thereof, in the FOMC’s theoretical musings. And, in turn, opining on the logic of the explicit FOMC forecasts of its own future behavior, in the context of those theoretical footings.

Yes, for me, it is the most satisfying time of my Fed-watching career. And not just because I’ve got a cool new job, though I do. What I pinch myself most about is actually one blue dot: the FOMC’s “longer-run” forecast of the steady-state “neutral” fed funds rate, which has a current “central tendency” of 3¾%, recently shaved from 4%; see the Dot-ology Box!

Recall: It was only in 2012 that the Fed began explicitly hanging its collective hat on a numerical longer-run forecast for its short-term peg! But the 4% “neutral” number has long existed in the ether of Fedspeak, notably since 1993, when John Taylor devised and divined his famous Rule, which postulates that a perfectly tamed business cycle should/will beget a 4% fed funds rate: a 2% real rate plus an at-target 2% inflation rate, in the context of at-potential, or full-employment, GDP growth.

Taylor’s Rule was and is a cyclical operating guide for the FOMC to modulate the fed funds rate on both sides of secular “neutral,” founded on the cyclical Phillips Curve trade-off between unemployment and inflation. Rational-expectations perfection would be no modulations at all: Markets would so understand the FOMC’s reaction function, efficiently discounting prescribed modulations in the Fed’s policy rate, as to obviate the FOMC from having to make them!

Indeed, Taylor argues – to this very day! – that if only the Fed had religiously followed his Rule over the last two decades, the U.S. economy at present would be in a much finer place than it is. Not a perfect place, to be sure, not even Taylor would argue, but a much better place.

I have no present desire to pick a fight with Taylor about his counterfactual assertion: Serenity starts with accepting that which cannot be changed, and that includes history. Forward!

But I do applaud John for the ubiquity that his Rule has achieved, because it conveniently frames conventional wisdom, which can also be called active intellectual laziness – which has plagued my profession pervasively ever since the Minsky Moment of 2007–2008.

The Taylor Rule was not designed for dealing with Liquidity Trap pathologies, because it was modeled on a time frame that didn’t include any Liquidity Traps! At least in the United States, and when Taylor published his Rule in 1993, Japan was in the infant years of its then-denied Liquidity Trap.

As a pragmatic matter, the Taylor Rule over the last half decade has been useful primarily in confirming the wisdom of Keynes’ parting observation in the closing chapter of The General Theory:

“The ideas of economists and political philosophers, both when they are right and when they are wrong, are more powerful than is commonly understood. Indeed, the world is ruled by little else. Practical men, who believe themselves to be quite exempt from any intellectual influences, are usually slaves of some defunct economist.”

The tenacity of some FOMC participants in defending the rounds-to-4% longer-run blue dot confirms too, perhaps, the robustness of yet another Keynes dictum:

“Worldly wisdom teaches that it is better for reputation to fail conventionally than to succeed unconventionally.”


Channeling Rudi
Long-time – and patient! – readers probably are now bracing for an ode to Minsky, a most unconventional theorist, an outcast and renegade in academic circles, whose Financial Instability Hypothesis has greatly informed and influenced my own work.

Gotcha: Ain’t going to do it!

Rather, I want to riff on the work of another (sadly passed) man, who was held in highest esteem at the highest rungs of the academy: Rudi Dornbusch. In 1976,2 Professor Dornbusch took on conventional wisdom that floating exchange rates – adopted after the breakup of the Bretton Woods fixed rate regime a half decade earlier – were inexplicably volatile, relative to the doctrine of monetarism, as espoused by none other than Milton Friedman.

Conventional monetarist religion had held that a regime of floating exchange rates would unleash market forces to adjust exchange rates in real time, guided by the lodestar of Purchasing Power Parity (PPP), thus truncating buildup of imbalances in trade, which had, in the earlier fixed exchange rate regime, begot violent volatility when governments were “forced” to break the fixes.

Reality did not conform to those monetarist promises, with wild over- and under-shooting of PPPs, and Dornbusch sought to theoretically explain why, developing his exquisitely simple, yet elegant model of rational overshooting. Its theoretical foundation is very simple: Prices on Wall Street move much more quickly than prices on Main Street.

Duh, you say, don’t we all know that? Yes, we do. But that reality is often assumed away in economic theory, most especially in high academic churches steeped in the efficient markets hypothesis, presuming that the invisible hands of markets all wear the same behavioral gloves.

They don’t. What Dornbusch demonstrated was that:

1) If a country has an “overvalued” currency on a PPP basis (its burgers are way overpriced relative to the rest of the world on the Big Mac Index) and is experiencing a growth-debilitating erosion in trade, and

2) If the country responds with a “shock” of monetary easing, slashing interest rates (as it is free to do under a floating exchange rate regime!), then

3) Its currency will rationally plummet not just to “fair,” but to “undervalued” on a PPP basis.

The reason:

1) A country’s Main Street prices (inflation) are very slow to adjust to the “shock” of monetary easing (reducing imports and increasing exports, improving growth), and

2) Until that adjustment has unfolded, global investors will be stuck with the country’s shocked-lower interest rates, and accordingly,

3) Will rationally be willing to hold the country’s bonds only if its currency plummets below PPP, fostering expectations of room for future appreciation.

Simply put: Rudi explained to us that global investors will buy a country’s rich bonds only if the country’s currency falls so far as to make its burgers dirt cheap.

Really, his model is that simple, yet profound (as all great breakouts in economic theory tend to be!). In turn, Rudi’s theoretical nugget provides huge insight into the why and how of escape from a Liquidity Trap: Wall Street prices move much more quickly and further than Main Street prices.


Wall Street’s unjust moment
Traditionally, the political catechism of monetary policy is that the Fed doesn’t really give a damn about Wall Street, that the capital markets are only the conduit between the Fed and Main Street. Main Street outcomes for employment and inflation are what really matter, we are taught, and thus the only “targets” of monetary policy. And so long as a Liquidity Trap can be avoided, this theological tenet has a loud ring of truth.

This was particularly the case before financial deregulation, when monetary policy “worked” primarily through the conventional banking system, with Main Street’s savers on the liability side of banks’ balance sheets, and Main Street’s borrowers on the asset side. Wall Street was a place walled off from the banking system (by Glass-Steagall, among other things), where people of money traded securities amongst themselves, while also channeling capital – notably equity – to the frontiers of economic growth.

In that catechism and that world, the notion of the Fed “targeting” stock and other long-term financial asset prices was blasphemy. And politically, it still is. But that world no longer exists: Wall Street and the deregulated banking system – conventional and shadow – have morphed into one.

In turn, when a Liquidity Trap hits, the Fed is in a pickle. The Fed can take its policy rate to the Zero Lower Bound (ZLB), but it will not generate a revival of either increased demand for or supply of bank credit and, in lagged train, upside action for prices and wages on Main Street. Such is the nature of monetary policy in a Liquidity Trap, which is akin to the position of a cheesecake vendor at a convention of recovering overeaters: The customers ain’t buying, even though they are known to like the product, and the price is zero.

In which case, the Fed isn’t impotent. But with the banking system and its Main Street customers locked in the Nurse Ratched Center for Deleveraging of Balance Sheets, where exuberance, rational and otherwise, is strongly discouraged, the monetary authority, by default, must turn to Wall Street for able-and-willing partiers.

Yes, it is a Hobson’s choice. Theoretically, the choice should never be on the table, if the fiscal authority is willing and able to party hardy, backed by the sovereign’s borrowing prowess. But if the fiscal authority demurs, for whatever reasons of defunct orthodoxy, the monetary authority must – unless it wants to nursemaid an enduring Liquidity Trap – dance with Wall Street.

It is not a tasteful choice for the Fed at all. It reeks with social injustice. But it also happens to be the only viable choice: Use all available powers, with whatever-it-takes abandon, to reflate prices that are amenable to going up: long-term bonds and stocks.


How does it work?
Printing money to reflate Wall Street prices is normally thought to “work” through a trickle-down channel: Make the wealthy wealthier and they will spend more ebulliently, stimulating aggregate demand more generally. There is indeed an element of this dynamic involved. But it is not, in my analysis, the straw that stirs the Liquidity Trap-escape drink.

For, you see, Liquidity Traps are born of preceding (Minsky-type) excesses of debt-to-equity ratios. That is, there is too much private sector debt relative to equity, not too much debt per se. It’s a private sector balance sheet problem that begets an income statement problem, not the other way around.

To be sure, a recession in the wake of a Minsky Moment does create an aggregate demand, and thus aggregate income problem, as recessions poleaxe employment and labor’s bargaining power for wage gains. This dynamic turbo-charges Main Street’s woes in managing any given debt-to-equity ratio.

But the existential macro problem in a Liquidity Trap is a balance sheet problem: too little equity relative to debt. This problem can be mightily relieved by driving up the price of assets that are the collateral for debt, thereby restoring and creating equity.

Yes, “creating” equity: Capital gains – realized or not – are the only newly created asset without an associated, offsetting liability. “Paper wealth!” some of you are no doubt retorting under the breath. And arithmetically, I won’t quarrel with you. I will simply remind that a Minsky Moment itself is a “paper” problem: too much dodgy paper debt relative to the paper value of levered assets.

Accordingly, getting out of a Liquidity Trap with monetary policy playing the lead role necessarily involves a Dornbuschian sequence of rational overshooting: The Fed must drive up Wall Street prices, which move quickly, so as to get to Main Street prices that move up slowly, most importantly, wages.

This sequencing implies that Wall Street’s prices axiomatically will, in the short run, “overshoot” their long-term fair value, as the Fed appropriately and credibly commits to staying at the ZLB, until paper wealth creation endogenously deleverages private sector balance sheets sufficiently to restore animal-spirited risk taking on Main Street.

This sequencing implies that Wall Street prices must become very rich relative to Main Street prices in order to achieve so-called escape velocity from the Liquidity Trap. At the transition point, Wall Street prices will be rationally “overvalued” relative to their long-term “fair value.”

Rational? Ain’t it just a bubble? No, because unless and until Main Street prices go up, Wall Street prices will be rationally priced on the assumption – sometimes called a “Fed Put” – that the central bank will stay pinned against the ZLB.

As and when the Rudi Lag plays itself out, however, Wall Street’s prices must rationally re-price to two-sided Fed policy risks.

*  *  *

Bottom line
This process has been unfolding for well over a year now, ever since Ben Bernanke signaled a plan for ending QE3, a necessary condition for the FOMC to even consider lifting off the ZLB. The early stages of Wall Street’s re-pricing, now known as the “taper tantrum,” were rational, even if violent. Ever since, Wall Street has been in a “price discovery” process for what the post-Liquidity Trap “neutral” Fed policy rate should/will be, once the Fed begins liftoff from the ZLB.

Long-term bond prices have rationally not recovered all the ground lost in the taper tantrum: Removal of the Fed Put axiomatically should lift the term premium for duration risk. But yields have fallen, also rationally, as the market has rejected the FOMC’s rounds-to-4% blue dot: PIMCO’s New Neutral before your eyes!

Stock prices are, of course, higher than before the taper tantrum, and rationally so: If bonds reject the FOMC’s 4% blue dot, then stocks should, via a Gordon Model, rationally follow suit. And they have.

Thus, Wall Street has, so far, gotten lucky twice: the Unjust Moment followed by The New Neutral. Somehow, it just doesn’t seem right. And it isn’t; it just is.

But as Martin Luther King intoned long ago, the arc of the universe does bend toward justice. And as I wrote in July,3 I think it will do so with the Fed letting the recovery/expansion rip for a long time, fostering real wage gains for Main Street.

This implies that the dominant risk for Wall Street is not bursting bubbles, but rather a long slow grind down in profit’s share of GDP/national income. And you can stick that into a Gordon Model, too!

Bonds and stocks may at present be rationally valued, but borrowing from the lyrics of Procol Harum’s Keith Reid: Expected long-term returns are turning a more ghostly whiter shade of pale.

The One Company Most At Risk From Russian Sanctions Is Actually American

When Exxon Mobil CEO Rex Tillerson detailed a $3.2 billion deal to drill for oil in Russia's Arctic Sea two years ago, he predicted that the project would strengthen the ties between the U.S. and Russia. However, as WSJ reports, Exxon has instead wound up in the cross hairs of U.S. foreign policy, which could threaten one of the company's best chances to find and tap significant — and much needed — amounts of crude oil. If the venture is significantly delayed or hampered, it would deal a blow to Exxon's efforts to replenish its store of fuels it pumps from the ground. The company's production has been essentially flat for years, and last quarter fell to the lowest level since 2009. More costs?



As WSJ reports,

The U.S. on Thursday announced new sanctions targeting Russia's financial, defense and energy sectors in a bid to punish the Kremlin for stoking the military conflict in Ukraine. Details of the sanctions, designed to match new measures imposed by the European Union, are set to be released Friday.


A U.S. official said the new penalties would affect Exxon's current drilling in the icy Kara Sea with its Kremlin-controlled partner, OAO Rosneft, though the extent of the impact was unclear Thursday.


No other Western energy company has as much direct exposure to Russia as Exxon, thanks to a $3.2 billion deal giving the company access to a swath of the Arctic larger than Texas that could hold the equivalent of billions of barrels of oil and gas.




Exxon is "assessing the sanctions," said Alan Jeffers, a company spokesman. "It's our policy to comply with all laws."




If the venture is significantly delayed or hampered, it would deal a blow to Exxon's efforts to replenish its store of fuels it pumps from the ground. The company's production has been essentially flat for years, and last quarter fell to the lowest level since 2009.


Russia's Arctic is one of the few regions in the world that could hold enough oil and gas to boost Exxon's output.

We leave it Exxon Mobil's CEO to conclude...

"We always encourage the people who are making those decisions to consider the very broad collateral damage of who are they really harming with sanctions."

The Fed Has A Big Surprise Waiting For You

Submitted by Raul Ilargi Meijer via The Automatic Earth blog,

Risdon Tillery Greenwich House day care, New York May 1944

The topic of potential interest rate hikes by central banks is no longer ever far from any serious mind interested in finance. Still, the consensus remains that it will take a while longer, it will take place in a very gradual fashion, and it will all be telegraphed through forward guidance to anyone who feels they have a need or a right to know. Sounds like complacency, doesn’t it?

Now, it seems obvious that the Bank of Japan and the ECB are not about to hike rates tomorrow morning. In Europe, dozens of national politicians wouldn’t accept it, and in Japan, it would mean an early end to many things including Shinzo Abe.

But the Bank of England and the Fed are another story. Though if the Yes side wins in Scotland next week, the narrative may change a lot of Mark Carney and the City. That leaves the Fed. And it’s important to realize and remember that, certainly after Greenspan entered the scene, speaking in tongues, the Fed has become a piece of theater. The Fed is about perception. About trying to make people believe something, and make them act a certain way that they choose for them.

That’s why after the Oracle left they pushed first a bearded gnome and then a grandma forward as the public face. The kind of people nobody would perceive as a threat. Putting a guy who looks like second hand car salesman in charge of the Fed wouldn’t work.

Not when a big financial crisis looms, and then continues on for a decade and counting. That makes keeping up appearances the no. 1 priority. That’s when you want a grandma, or you’d lose your credibility real fast. You need grandma for your theater, for the next play you’re going to stage.

That market volatility today is at record lows is part of a big play, or a big scene in a play if you will. And the goal is not to make markets look good, as many people think. Making markets look good, making the economy look good, is just an intermediate step designed to lure everyone in.

You make people believe you got their back. All the big investors. Because they make tons of money, while they thought maybe the crisis could have really hurt them. Even the public at large feels you got their back. Because they don’t understand what the sleight of hand is.

The big investors understand, but you got them believing you will play that hand forever, or let them know well ahead of time when you intend to fold. The big investors think you will skim the public, but not them. They think you’re all on the same side. And the public thinks you’re healing the economy, and saving their jobs and homes and pensions.

When rate hikes are discussed, like I did two weeks ago in This Is Why The Fed Will Raise Interest Rates, most people have similar initial reactions. ‘They can’t do that, it would kill the economy, or at least the recovery’.

But the truth is, there is no recovery. It’s just a scene in a play. And the economy is completely shot, it only appears to be left standing because the Fed poured oodles of money into it. Or rather, into a part of the economy that it can control, that it can get the money out of again easily: Wall Street banks. And Wall Street equals the Fed.

Charles Hugh Smith, in What If the Easy Money Is Now on the Bear Side?, notices that there are hardly any bears left in the market, and that shorts are disappearing as a source of revenue for bulls. Interesting, but he doesn’t yet connect all the dots. CHS thinks big money managers can make ‘the play’, that they can fool the rest of the market and unleash a tsunami that will bury the bulls.

I don’t think so. I think what goes on is that the Wall Street banks, many times bigger than the biggest money managers, see their revenues plunge. As they knew they would, because free money and ultra low rates are not some infinite source of income, since other market participants adapt their tactics to those things as well.

Which is what Charles Hugh Smith points to, but doesn’t fully exploit. And it’s not as Wolf Richter presumes either:

After years of using its scorched-earth monetary policies to engineer the greatest wealth transfer of all times, the Fed seems to be fretting about getting blamed for yet another implosion of the very asset bubbles these policies have purposefully created.

The Fed doesn’t fret. The Fed has known for years that the US economy is dead on arrival. They’ve spent trillions of dollars backed, in the end, by American taxpayers, knowing full well that it would have no effect other than to fool people into believing something else than what reality says loud and clear.

Philip Van Doorn, who I quoted two weeks ago, got quite a bit closer in Big US Banks Prepare To Make Even More Money

For most banks, the extended period of low interest rates has become quite a drag on earnings. Net interest margins – the spread between the average yield on loans and investments and the average cost for deposits and borrowings – are still being squeezed, since banks realized the bulk of the benefit of very low interest rates years ago

That is the essence, and that is why grandma will announce higher rates, against a backdrop of 4% GDP growth numbers and a plethora of other ‘great’ economic data and military chest thumping abroad.

The US economy is dead. The Fed has known this for a long time, but pumped it up to where it is now to draw in all the greater fools, the so-called big investors who have made money like honey from QE and ZIRP. They are the greater fools. The American real economy ceased being a consideration long ago.

We’re in for big surprises, and they won’t be pretty, they’ll be pretty nasty. There are far too many people who think of themselves as smart who don’t see the difference between a theater play and a reality show. And I don’t mean CHS or Wolf, they’re much more clever than your average investment advisor.

The Fed will raise rates because that will make the biggest banks the most money. There’s nothing else that matters. The Fed can’t revive the US economy, that’s just a foolish notion. But it can suck a lot of wealth out of it.

What Would You Pay An NFL Cheerleader?

When the Buffalo Bills play their home opening game, the team will be without its cheerleading squad -- the Buffalo Jills, for the first time since 1967. The squad has been suspended because some former cheerleaders are suing the team claiming wage theft. What does an NFL cheerleader cost? Bloomberg Businessweek's Ira Boudway looks at the math.


Remember, $15 per hour for fast-food workers is considered a 'fair' livable wage by the President.

Is Scotland Big Enough To Go It Alone?

Submitted by Peter St. Onge via the Ludwig von Mises Institute,

Back when Quebec was weighing secession from Canada, I was a lowly American undergrad living in Montreal. It was an exciting time, since in America we have our railroads torn up and population starved when we secede. Now that Scotland is going through the motions, I figured I’d stir the pot, economically.

The question in 1995 was whether Quebec should secede from the Canadian Confederation. Passions were high; one secessionist leader unwisely argued that a "Yes" win would lock voters into secession like "lobsters thrown into boiling water." Fueling the drum-beat were federalist of impending economic, political, and currency chaos. At the end, the vote was incredibly close: 49.4 percent voting for secession, 50.6 percent voting no.

As Scotland goes to the polls to decide on its own separation from the United Kingdom, the tone of the campaign is, again, high on passion and, again, secessionists are inching toward the magical 50 percent line. But don’t uncork the single malt quite yet: as of today (September 2, 2014), bookies in London still put the odds at 4-to-1 against the non-binding referendum. But it remains a real possibility. [Check the latest odds here.]

One core debate is whether Scotland is too small and too insignificant to go it alone. During the Quebec referendum there was a nearly-identical debate, with secessionists arguing that Quebec has more people than Switzerland and more land than France, while federalists preferred to compare Quebec to the US or the “rest-of-Canada” (ROC, in a term from the day).

In a curious coincidence, 2014 Scotland and 1994 Quebec have nearly the same population: about 5–6 million. About the same as Denmark or Norway, and half-a-million more than Ireland. Even on physical area Scotland’s no slouch: about the size of Holland or Ireland, and three times the size of Jamaica. The fact that Ireland, Norway, and Jamaica are all considered sustainably-sized countries argues for the separatists here.

So small is possible. But is it a good idea?

The answer, perhaps surprisingly, is resoundingly “Yes!” Statistically speaking, at least. Why? Because according to numbers from the World Bank Development Indicators, among the 45 sovereign countries in Europe, small countries are nearly twice as wealthy as large countries. The gap between biggest-10 and smallest-10 ranges between 84 percent (for all of Europe) to 79 percent (for only Western Europe).

This is a huge difference: To put it in perspective, even a 79 percent change in wealth is about the gap between Russia and Denmark. That’s massive considering the historical and cultural similarities especially within Western Europe.

Even among linguistic siblings the differences are stark: Germany is poorer than the small German-speaking states (Switzerland, Austria, Luxembourg, and Liechtenstein), France is poorer than the small French-speaking states (Belgium, Andorra, Luxembourg, and Switzerland again and, of course, Monaco). Even Ireland, for centuries ravaged by the warmongering English, is today richer than their former masters in the United Kingdom, a country 15 times larger.

Why would this be? There are two reasons.

First, smaller countries are often more responsive to their people. The smaller the country the stronger the policy feedback loop. Meaning truly awful ideas tend to get corrected earlier. Had Mao Tse Tung been working with an apartment complex instead of a country of nearly a billion-people, his wacky ideas wouldn’t have killed millions.


Second, small countries just don’t have the money to engage in truly crazy ideas. Like Wars on Terror or world-wide daisy-chains of military bases. An independent Scotland, or Vermont, is unlikely to invade Iraq. It takes a big country to do truly insane things.

Of course there are many short-term issues for the Scots to consider, from tax and subsidy splits, to defense contractors relocating to England. And, of course, the deep historico-cultural issues that an America of Franco-British descent should best sit out.

Still, as an economist, what we can say is that Scotland’s big enough to “survive” on its own, and indeed is very likely to become richer out of the secession. Nearer to the small-is-rich Ireland than the big-but-poor Britain left behind.

The ISW's Strategy To Defeat The Islamic State

While a misnomer, if President Obama is to be believed, The Islamic State, according to The Institute for the Study of War, poses a grave danger to the United States and its allies in the Middle East and around the world. As they exclaim, reports that it is not currently planning an attack against the American homeland are little comfort. Its location, the resources it controls, the skill and determination of its leaders and fighters, and its demonstrated lethality distinguish it from other al-Qaeda-like groups..."It must be defeated," they conclude... and here's how.

Via The Institute for the Study of War,

The Islamic State is a clear and present danger to the security of the United States. It must be defeated.


Developing a strategy to accomplish that goal is daunting. The situation today is so bad and the momentum is so much in the wrong direction that it is impossible to articulate a direct path to an acceptable endstate in Iraq and Syria. American neglect of the deteriorating situations in both countries has deprived us of the understanding and even basic ground intelligence needed to build a strategy. We must therefore pursue an iterative approach that tests basic assumptions, develops our understanding, builds partnerships with willing parties on the ground, especially the Sunni Arabs in Iraq who will be essential to set conditions for more decisive operations to follow.


The core challenge facing the U.S. in Iraq and Syria is the problem of enabling the Sunni Arab community stretching from Baghdad to Damascus and Turkey to Jordan to defeat al-Qaeda affiliates and splinters, while these extreme groups deliberately concentrate in Sunni majority areas. Persuading those communities to rejoin reformed states in Iraq and Syria after long seasons of internal strife will be daunting. But their participation in state security solutions will be essential to keep al-Qaeda from returning. Many of these populations, especially Syrians, may be losing confidence in such a post-war vision.


The problem in Syria is relatively easy to state, but extremely difficult to solve. The Assad regime has lost control of the majority of the territory of the Syrian state. It has violated international law on many occasions and lost its legitimacy as a member of the international community. Assad himself is the icon of atrocities, regime brutality, and sectarianism to Sunni populations in Syria and throughout the region.  His actions have fueled the rise of violent Islamists, particularly ISIS and JN. U.S. strategy must ensure that none of these three actors control all or part of Syria while supporting the development of an alternative, inclusive Syrian state over time.

Full ISW ISIS Defeat Strategy document below:


Defeating ISIS



*  *  *

So that's it - off we go to war again... as the conclude...

The strategy to defeat and destroy ISIS must instead be determined, deliberate, and phased, allowing for iterative decisions that adjust the plan in response to the actual realities on the ground. The U.S. is not positioned to estimate these ground conditions accurately without more direct engagement of the Sunni populations in Iraq and Syria. Developing this accurate intelligence picture, which should be accomplished in conjunction with military action to disrupt ISIS and end its current offensive, means that the first phase of the U.S. strategy should be a movement to contact. The operational risks of this phase outweigh the strategic risks of decided to destroy ISIS and then engaging insufficiently.

Europe Folds To Russian Demands, Delays Ukraine Free Trade Deal By Over A Year

While the world was poring through the details of the latest round of preannounced western sanctions against Russia - a round which Russia commented would have virtually no actual impact - and just as excitedly awaiting the Kremlin's retaliation which Putin warned is coming shortly, far from the glare of the center stage Europe quietly folded to a bigger Russian demand namely to delay the implementation of a Ukraine free trade deal by more than one year until the end of 2015 and likely beyond.

As AFP reported, EU Trade Commissioner Karel de Gucht said, after talks with Russian and Ukrainian ministers, that the free trade agreement which Ukraine and its imploding economy had hoped would be implemented in the immediate future, will instead be delayed. Perhaps the date of the provisional launch has something to do with it: EU sources said the trade deal was to have taken effect on November 14, i.e. in the middle of Europe's cold, snowy, GDP-sapping winter. The European Council of 28 members states must now sign off on the delay.

De Gucht said that once Kiev ratifies the EU Association Accord, expected next week and which was negotiated at the same time as the Deep and Comprehensive Free Trade Agreement, then Brussels would offer "additional flexibility" in the hope of meeting Russian concerns that its economy would suffer if the DCFTA deal went ahead.

This would be done as part of efforts to "fully support the stabilisation of Ukraine," he said after talks with Ukraine Foreign Minister Pavlo Klimkin and Russian Economy Minister Alexi Ulyukayev. "Such flexibilty will consist in the delay until 31 December 2015 of the provisional application of the DCFTA," he said.

Additional flexibility? That sounds very close to what Obama promised Putin's right hand guy, Dmitry Medvedev, nearly three years ago.

Sometimes glitches in the matrix such as this one make one wonder just how much of what is going on right now between the "west" and Russia has been long pre-agreed and pre-approved by the "feuding" sides, and what is really going on behind the scenes.

But back to what the data available for popular consumption: in effect while Russia and the West are engaging in populism-happy trade and capital flow wars what is taking place at a higher level is far more nuanced, and it is here that a far more pragmatic EU is certainly concerned about pushing Russia too far.

The reason why Moscow is against the Ukraine free trade agreement is because Russia sees it as bolstering Kiev and potentially harming its own economy by allowing an influx of cheaper/better EU goods into the country, an important Russian market. Equally damaging, Moscow said these goods could then be sold on into Russia itself, damaging domestic industry.

Of course, with Europe launch sanction after meaningless sanction, in a world that is all about leverage and optics, the last thing the EU could afford is to be perceived as folding to the Kremlin in a matter which could really hurt the Russian economy. So instead DeGucht presented the delay as win-win for all sides, saying the preferential tariffs addressed "the very difficult economic situation in Ukraine" while the delay in implementing the deal leaves "15 months for either party to make remarks, proposals."

One can just imagine the remarks and proposals that Putin would have uttered had Europe not delayed the agreement.

What's more interesting, Russia may just win another major round in the political war that is taking place just behind the surface: the preferential tariffs announced in March and due to expire in October offered Ukraine significant reductions in customs duties worth about 500 million euros per year, the commission said.

Still, had the free trade deal passed today, it would have allowed the economically devastated Ukraine, whose economy is rapidly imploding, to boost its exports to Europe by one billion euros per year, according to the commission.

In June, the EU and Ukraine signed the long-delayed Association Agreement, the very deal whose 11th-hour refusal last year by then president Viktor Yanukovich plunged the former Soviet country into chaos. It sparked a wave of pro-European protests that eventually toppled the Kremlin-backed Yanukovich in February and ushered in a pro-Western government that deeply angered Moscow.

What goes unsaid is that the signed agreement was merely yet another optical pseudo intervention: in reality is provided nothing to Ukraine but simply sent signals to the global community that the "west" had the upper hand when it comes down to Kiev realpolitik.

If only for now. 

But once the Ukraine people have been forced to go through a full winter with no benefit from the Russian bear, it remains to be seen just how enthusiastic they will be about the ongoing western-backed (and funded, and orchestrated) revolution.

As for Europe's true "leverage" vis-a-vis Russia, the following quote from AFP encapsulates it best:

"If you want to solve a conflict, you have to be flexible," a European source said when asked about the delay in the trade deal.

And speaking of memorable quotes, one my want to timestamp these:

In Kiev, Poroshenko thanked the EU for the new sanctions. "A friend in need is a friend indeed," Poroshenko said.


"I feel a full part of the European Union family," he added.

Let's all check back on how Ukraine, and whoever is its president then, feels about being part of the European Union "family" in a year. Or less.

5 Things To Ponder: "Bear-ly" Extant

Submitted by Lance Roberts of STA Wealth Management,

"It is a bad sign for the market when all the bears give up. If no-one is left to be converted, it usually means no-one is left to buy.” - Pater Tenebrarum

That quote got me thinking about the dearth of bearish views that are currently prevalent in the market. The chart below shows the monthly level of bearish outlooks according to the Investors Intelligence survey.

The extraordinarily low level of "bearish" outlooks combined with extreme levels of complacency within the financial markets has historically been a "poor cocktail" for future investment success. 

As Michael Sincere recently stated rather sarcastically:

"If you study history, you know that no one thought the price of tulips, houses, or stocks would ever go down. Even most bulls believe that 'one day' there will be a correction, but that day is far away. After all, the Fed has an unlimited supply of magical tools, and they are determined to keep the market from falling.


Unfortunately for soul-searching bears, the Fed trumps all. As long as new money flows into stocks, interest rates are low, and the market keeps going up, why worry?"

That is the focus of this weekend's list of "Things To Ponder."

1) The Death Of Bears by Pater Tenebrarum via Acting Man Blog

“What prompts this missive is news that yet another prominent bear has apparently given up. The thing is, this bear – Wells Fargo analyst Gina Martin Adams – wasn’t even a bear, but merely a somewhat reluctant bull, whose targets got taken out a few times. It is interesting from a psychological perspective that a not overly foaming-at-the-mouth bull is considered a “bear” by the financial media, a “famous bear” even. She has now recanted, and has apparently been preceded by several others. An SPX target of 1850 points apparently made her the “most bearish strategist” on Wall Street!


‘Gina Martin Adams of Wells Fargo has long been known as the most bearish strategist on Wall Street. After all, at 1,850, she had the lowest year-end S&P target among major strategists. But on Tuesday, she got rid of that year-end target and initiated at 12-month target of 2,100, reflecting a mildly bullish outlook.’



Given that no prominent bearish Wall Street strategists seem to be left now – not even those forecasting 5% dips or flat markets – we won’t be able to report on any additional conversions."

2) The Two Pillars Of Full-Cycle Investing by John Hussman via Hussman Funds

"As value investor Howard Marks observed last week:


'Today I feel it’s important to pay more attention to loss prevention than to the pursuit of gain. Although I have no idea what could make the day of reckoning come sooner rather than later, I don’t think it’s too early to take today’s carefree market conditions into consideration. What I do know is that those conditions are creating a degree of risk for which there is no commensurate risk premium.'


So while many observers pronounce victory at halftime, in the middle of a market cycle, at record highs and more extreme market valuations than at any point except the 2000 peak, remember the two pillars. First, the combination of high confidence, lopsided bullishness, overvaluation, and overbought multi-year advances has predictably been resolved by steep market losses, time and time again across history. Second, strong market return/risk profiles warranting constructive or leveraged investment positions emerge in every market cycle, generally following a material retreat in valuations, coupled with an early improvement in market action. We believe that one of these is descriptive of present market conditions, and the other is well worth our patience.

History teaches clear lessons about how this episode will end – namely with a decline that wipes out years and years of prior market returns. The fact that few investors – in aggregate – will get out is simply a matter of arithmetic and equilibrium. The best that investors can hope for is that someone else will be found to hold the bag, but that requires success at what I’ll call the Exit Rule for Bubbles: you only get out if you panic before everyone else does. Look at it as a game of musical chairs with a progressively contracting number of greater fools.”

3) Eerie Parallels To 1937 by Dr. Robert Shiller via Project Syndicate

“The current world situation is not nearly so dire, but there are parallels, particularly to 1937. Now, as then, people have been disappointed for a long time, and many are despairing. They are becoming more fearful for their long-term economic future. And such fears can have severe consequences.”

Read Also: For 90% Of Americans There Has Been No Recovery


4) The Tailwind To Stocks Is Gone by GaveKal Capital Blog

“Generally as equity prices rise, commercial hedgers take on a greater short position, and when price fall they take on a greater long position.  When the position of commercial traders is significantly short, it suggests a large short position has been built up.  If commercial traders are short and get their directional bets wrong, it provides fuel for the market to propel higher as commercial traders have to cover their shorts by buying stock.  In turn, if commercial traders have closed out their short positions, this suggests there may be little fuel left for the upside in stocks.”

“This short covering induced buying has helped the equity markets attain all-time highs.  But, now the short covering has largely been completed and will no longer provide much of a tailwind for stocks.”


5) Tracking The Decline Of Risk Aversion by Scott Grannis via Calafia Beach Pundit

“For most of the past five years I've argued that one of the dominant features of this recovery was risk aversion. The Great Recession so scared and shocked the world that risk aversion became exceptionally high. I've also argued that the main purpose of the Fed's QE program was to supply a very risk averse world with safe securities, by essentially converting ("transmogrifying") notes and bonds into T-bill equivalents (aka bank reserves). The point of QE was not to stimulate the economy, as many have argued, but to accommodate the world's intense demand for safe assets.”

Bonus Read: Profits Without Prosperity by William Lazonick via Harvard Business Review

Profits Without Prosperity

Have a great weekend.

Little-known fact: When the stock exchange closes, the guy who comes out on the balcony with that big hammer slams it on the head of the person who lost the most money that day… – George Carlin


WTF VIX Moment Of The Day

Because it's Friday... "unrigged?"

Nothing says "aggressively sell VIX" into the weekend like the start of another war in Iraq...

Chart: Bloomberg

It seems even the VIX momentum-ignition tool can't trump Fed hawkishness concerns... better luck next time Kevin.

Bonds Worst Run Since "Taper Tantrum" Sends Stocks To 4-Week Lows

The entire US Treasury complex surged higher in yield this week, rising 12-16bps (2Y +5bps) as the last 2 weeks are the worst for 10Y since last June's Taper Tantrum. Despite all the 'bonds-go-down-so-stocks-will-see-inflows' rotation buffoonery, stocks slipped to their worst week in the last six, as hawkish Fed concerns spread through markets. High-yield credit notably underperformed and VIX pushed back above 14 (its highest in a month). The USDollar rose 0.5% - 9th week in a row (despite EUR unch on the week) led by a 3% collapse in AUD and 2% in JPY & CAD. Gold and Silver dropped 3% on the week (worst in over 3 months, lowest in 8 months to $1230). WTI prices whipped around but ended -1% at $92. Of course, because it's Friday, the last hour saw manic VIX-selling, S&P futures buying (in 1 lots) to lift it magically off the lows to VWAP, but the S&P ended being the worst of the major US equity indices on the week (S&P <2,000; Dow <17,000).

Year-to-date, gold slipped to +2%, bonds are still leading but as the USD surged since August 'something' changed...


Not a pretty week for stocks - worst in six weeks with S&P the laggard!


As The S&P 500 loses 2,000...


And Dow loses 17,000...


VIX tried its best to get stocks higher into the Friday close...


ALL S&P sectors ended the week red led by Energy and Utes...


An ugly week for bonds...


Treasuries have worst 2-week run since the Taper Tantrum last year...


Where do they meet? (if at all?)


High-yield credit led the weakness on the week...


FX markets saw the US rise for the 9th week in a row (best run since Jan 2012) to fresh 14-month highs... but EUR ended unchanged - it was AUD, CAD, and JPY weakness that drove it


Ugly week for commodities. Gold tumbles most in over 2 months to 8 month lows...


Charts: Bloomberg

Bonus Chart: The exuberance in US financial stocks is not at all reflected in US financial credit markets...

Now where have we seen that before?