US Economy Expected to Grow Only 1.5% Per Year For The Next Decade

   It seems that Ben Bernanke and fellow central bankers had a sobering moment during their annual Jackson Hole retreat. One of the papers presented at the meeting was titled "After the Fall," by Carmen and Vincent Reinhart. The paper studied previous financial crises and country specific shocks including the 1929 stock market crash, the 1973 oil shock, the 2007 U.S. sub prime collapse and fifteen severe post-World War II financial crises to determine how economies recovered over a 10 year period following the event. The results were not encouraging and portend a similarly grim fate for the US and European economies: low GDP growth, high unemployment, and declining home prices. It will feel pretty much like a perpetual recession for the real economy.  Here are the main conclusions from the paper:
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Delusional MIT Economist Wants The Fed To Helicopter Drop Money

  The Keynesians must be really desperate. In an article titled "A helicopter drop for the Treasury," MIT economics professor Ricardo Caballero wants the US government to cut taxes for everyone. So far so good, but there is a catch: the Federal Reserve will have to print enough money to make up the expected loss to government revenues. The key for Mr. Caballero is to cut taxes while not increasing the public debt (since when did Keynesian's care about the national debt?). According to this classically trained economist, printing money is the solution to all of America's problems. It will magically put the US on a road to recovery and prevent the US from falling into the liquidity trap. It really takes a Keynesian economist to come up with this incredibly insane idea. Unfortunately, this is the best idea the Keynesians have and what's scary is that the Fed might like this plan. Here is the article:
Quantitative easing, when directed to Treasuries, adds a little bit of good to the mix by lowering the cost of funding public debt, and it also helps a little bit with the long-run cost of capital for the private sector. But these are second-order effects; the Treasury still increases public debt at a fast pace, and a slightly lower cost of capital doesn’t much help the private sector if aggregate demand is not there to buy the goods in the first place.


Instead, what we need is a fiscal expansion (e.g. a temporary and large cut of sales taxes) that does not raise public debt in equal amount. This can be done with a “helicopter drop” targeted at the Treasury. That is, a monetary gift from the Fed to the Treasury.

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JP Morgan Says Not To Worry About Surging Bond Prices

   JP Morgan is out with a report telling investors not to worry about surging bond prices and that they do not necessarily mean we are entering a deflationary spiral as some have postulated. Looking back at prior economic cycles, JP Morgan notes that bond yields often bottom out approximately 2.5 years after the end of a recession. So the current rise in price of the 10-year Treasury is not completely unexpected and is simply following the pattern from previous recoveries. The firm also says that the two primary catalysts for the recent rise in bond prices are a decrease in inflation expectations and record buying of US bonds by US households. The current 5-year break-even rate on bonds is 1.3%, down from around 2% reached backed in June. Furthermore, US household purchases of treasuries has surged 46% year over year in Q1 2010. In fact, households are the second largest holder of US treasuries, ahead of Japan and only $100 billion behind China. If that was not enough to arrest deflationary concerns, JP Morgan goes on to mention that the strong resiliency of commodity prices indicates that deflation is a remote possibility at this point. I agree, oil at 75, copper at 3.30, and gold at 1238 hardly make sense if we are entering a deflationary period. The deflation scare mongering is just a ploy by central bankers to print more money. Below is a chart which shows the 10-year Treasury over the last 35 years.













Here is the full report from JP Morgan:
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Weekend Humor





















I have too much free time. Enjoy

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Eurozone GDP Growth Lags in August---Recession Lurks

   The EuroCoin indicator released today reported that Eurozone GDP growth came in at a bleak 0.37% in August. This indicator is a real-time indicator of Eurozone GDP and is released on a monthly basis, making it an important leading indicator. From the press release:

In August €-coin fell slightly, from 0.40% in July to 0.37%. The value of the indicator in this quarter indicates a slackening of the recovery compared with the previous three months.


The yield curve and the course of industrial production in the main euro-area countries held back the indicator, which was nevertheless sustained by the favourable results of business and consumer surveys.












   While we in the US are debating the chances of a double-dip, the EU already seems to already have arrived there with the debt crisis taking a heavy toll on the EU economy (especially the PIIGS). The only positive factor is that a weaker euro led to an increase in exports. However, this does not help the weaker countries like Greece, Spain, and Portugal because they lack a strong export industry. About the only hope for these debt plagued countries is for them to somehow increase exports, which will help restructure their balance of payments. There are only a few ways of rapidly increasing exports: currency devaluation or internal devaluation. A lower currency is not likely because the ECB controls monetary policy for the euro. This means that the only alternative for the PIIGS is an internal devaluation to help reduce costs and make goods and services more competitive in the export market. This option has already been implemented by some Eastern European countries like Latvia and Estonia. They reduced wages 20-35% across the board to regain competitiveness. It came at a great cost to the general population as poverty increased greatly, but, of course, these folks are used to suffering. Early indicators seem to suggest that this internal devaluation has worked despite the high social costs. The problem for the PIIGS is that their populations are less receptive to severe wage cuts, reduced benefits, and higher taxes.  

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In Gold Emerging Countries Trust

   Deutsche Bank has a great piece about forex reserves and the EU debt crisis. It noted that while the Euro has held up surprisingly well, gold has been the major beneficiary, especially among emerging economies.  Industrialized countries, however,  have reduced their gold reserves. This reveals the differing philosophies of industrialized nations as compared to those of the emerging counties. Industrialized countries trust fiat paper money, and emerging nations trust gold as the ultimate reserve currency.



















Black Swan Insights

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AAII Investor Sentiment Plummets--Contrary Buy Signal?

       The American Association of Individual Investors released its weekly sentiment survey which showed a large decline in investor bullishness as wild market fluctuations whipsawed investors. Bullish sentiment fell to 20.74% from 30.11%, but bearish sentiment rose 49.47% from 42.47% during the previous week. The percentage of investors who described themselves as neutral on the stock market rose to 29.79% from 27.42%, according to the poll. The historical average of investor bullishness is 39%. With invesor bullishness at 20%, this would be a contrary buy signal because retail investors are usually wrong.

The chart below shows how sentiment has changed over the last 3 months:


 
 
 
 
 
 
 
 
 
 
 
 


Below is a 2 year chart of the AAII Sentiment Survey. You will notice that major bottoms usually coincide with a AAII bearishness number north of 50%.

 
















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Anthony Ward's Sweet Tooth Has Cost Him $230 Million

   Anthony Ward is probably ruing his $1 billion cocoa purchase back in July. Since news leaked of Ward's activity, the price of cocoa has fallen by 23% as the market digests a stronger crop out of the Ivory Coast. This decline in cocoa prices means Ward has lost about $230 million. Ward's investment thesis was that weather conditions would negatively impact supply from the Ivory Coast, which produces approximately 50% of world cocoa production. So far this has not occurred. The only major news in the cocoa market today was the announcement by the International Cocoa Organization, which upped expected cocoa demand by 3,000 tons. Overall the ICCO estimates the cocoa market will be in deficit of 72,000 tons during 2010-2011. As we speculated earlier, these kinds of market corners rarely work as the market starts to trade against your position leading to large losses. The real question is how much pain can Ward take before he liquidates his cocoa position?

From Dow Jones:
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The "Goldman Sachs Conspiracy"---A Chinese Bestseller

  The giant vampire squid seems to have made enemies in China. A new book detailing Goldman's role during the 2008 financial crisis has become a Chinese bestseller. The New York Times reports: 

The nearly 300-page, highly dramatized account covers much of the same ground as a widely cited piece by Matt Taibbi last year in the Rolling Stone magazine that portrayed the Wall Street institution as a ''a great vampire squid wrapped around the face of humanity, relentlessly jamming its blood funnel into anything that smells like money.''
Li's book takes ample license in its attacks on Goldman Sachs. The company's ultimate goal, he says in the first chapter, is to ''kill China.''
''Like a fox chewing a bone, Goldman Sachs knows the rules of the game and when to go for your neck,'' it says.
With the ''cruel character of a Manchurian tiger, the group creeps around the world, like a veteran hunter stalking its prey, when it smells blood it pounces!'' the chapter says.
Li, in an online chat, said the book was no exaggeration.
''The real financial battle is even more dramatic than my book, according to my knowledge of the markets,'' he said. ''Goldman Sachs is the hand behind the financial crisis, maybe even its cause.'' He soon plans to publish a third book about the company.

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Bernanke Explains How To Escape The "Liquidity Trap"

   Bernanke likes to remind everyone that he is an expert on the great depression and knows how to prevent it from happening again in the US. Apparently, he is also an expert on Japan and its struggle with chronic deflation following its housing bubble in the 1980's. In fact Bernanke wrote an article in 2000 titled "Japanese Monetary Policy: A Case of Self-Induced Paralysis," where he  lectured BOJ officials about what they could and should have done differently to to avoid a deflationary outcome. He went on to postulate that the BOJ was not trying hard enough to stimulate the economy and that 0% interest rates are just one tool to beat deflation. The Fed Chairmen even went so far as to assert that he knew how to escape a liquidity trap caused by 0% interest rates. The reason I bring this up is because it gives people a good idea of what Bernanke's next move may be. The US is dangerously close to falling into the dreaded "liquidity trap" as deflation takes hold and monetary policy loses its effectiveness.

Here are some of his suggestions to the BOJ:
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Insider Trading Alive and Well

   Hats off to the SEC. They always see to catch the little guy trying to trade on a little inside information while completely ignoring multi-billion dollar ponzi schemes. It should serve as a reminder to anyone who is considering committing insider trading with capital reserves of less than $100 million---you will be caught within days. Only the big boys are allowed to trade on inside information like the person who purchased 40,000 out of the money put options on Bear Stearns 8 days before it collapsed (have not heard from the SEC on that trade).  Reuters is reporting that the SEC has just caught 2 Spanish traders who bought out of the money call options on Potash Corp. days before the BHP bid:
The Securities and Exchange Commission has charged two residents of Madrid, Spain with insider trading and obtained an emergency court order to freeze their assets after they made nearly $1.1 million in illegal profits by trading in advance of last week's public announcement of a multi-billion dollar cash tender offer by BHP Billiton Plc to acquire Potash Corp. of Saskatchewan Inc.

The SEC alleges that Juan Jose Fernandez Garcia and Luis Martin Caro Sanchez purchased - on the basis of material, non-public information about the impending tender offer - hundreds of "out-of-the-money" call option contracts for stock in Potash in the days leading up to the public announcement of BHP's bid on August 17. Garcia is the head of a research arm at Banco Santander, S.A. - a Spanish banking group advising BHP on its bid. Garcia and Sanchez jointly spent a little more than $61,000 to purchase the contracts in U.S. brokerage accounts. Immediately after BHP's offer was announced publicly on August 17, Garcia and Sanchez sold all of their options for illicit profits of nearly $1.1 million.
   I wish the SEC would go after bigger prizes like high-frequency trading. This is the most important issue considering it was rogue bots who caused the May 6th crash. But I guess the SEC has more important things to do such as watching porn

Black Swan Insights
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LMAO-- China's Ten Day Traffic Jam Could Last Until Mid-Septemeber

   After living in Los Angeles and communting on the 405 freeway, I thought I had seen it all. Apparently not. From the WSJ:
A 100-kilometer traffic jam near the Chinese capital that officials say could last until mid-September has become a symbol of the dark side of China's love affair with the automobile. Officials say traffic has been snarled along the outskirts of Beijing and is stretching toward the border of Inner Mongolia ever since roadwork on the Beijing-Tibet Highway started Aug. 13. The following week, parts of a major road circling Beijing were closed, further tightening overburdened roadways.

As the jam on the highway, also known as National Highway 110, passed the 10-day mark Tuesday, local authorities dispatched hundreds of police to keep order and to reroute cars and trucks carrying essential supplies, such as food or flammables, around the main bottleneck. There, vehicles were inching along little more than a third of a mile a day. Zhang Minghai, director of Zhangjiakou city's Traffic Management Bureau general office, said in a telephone interview he didn't expect the situation to return to normal until around Sept. 17 when road construction is scheduled to be finished and traffic lanes will open up.

Villagers along Highway 110 took advantage of the jam, selling drivers packets of instant noodles from roadside stands and, when traffic was at a standstill, moving between trucks and cars to hawk their wares.  
So much for Chinese efficiency.
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Yen Surges As BOJ Desperately Tries To Debase Currency

     If aliens came down to observe global financial markets they would conclude that we must be insane: case in point the price action of the Yen. It bewilders the intellect that the Yen remains the strongest the currency in the world despite continuous money printing, ultra low interest rates, and an egregiously high debt to GDP of around 220%. If that was not enough to ensure a weak currency, the BOJ and Ministry of Finance openly state they want a lower Yen. Yet in our current bizarro world, the Yen is the ultimate safe haven go to currency during economic turmoil. Reuters is now reporting that the Japanese government and BOJ are again considering ways to weaken the Yen, including direct currency intervention to sell the Yen. This is not a new strategy---from 2000-2004 the BOJ constantly intervened to sell the Yen. Did it work? No but that did not stop them from wasting hundreds of billions trying. Intervention almost always fails as the SNB (Swiss Central Bank) will tell you as they lost around $8 billion trying to weaken the Swiss franc. Central bank intervention only works when it is coordinated by the G-7 like the successful attempt to prop up the Euro in  2000. That was one of the few currency interventions that worked. The BOJ is destined to fail. Who knew it was so hard to debase a currency? 













Three month chart of Yen Futures

Black Swan Insights
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Greek Austerity Measures Not Working--Tax Hikes Fail

Interesting piece from Kathimerini (Greece Newspaper) regarding the problems Greece faces implementing tax hikes as part of their austerity plan:
As the government and opposition argued about whether or not new measures are on the cards, Finance Ministry figures indicated that an original austerity program of tax hikes and salary cuts had failed to bring in the projected revenue. An increase in the tax on tobacco, for example, brought in an additional 250 million euros in the first six months of the year, far below the target of 1.13 billion euros. Overall increases in the tax on tobacco, fuel and alcohol are believed to have failed to hit the target due to the parallel wage cuts, which have led to a plunge in consumer spending. Experts estimate that losses to state revenue because of the slump in consumer spending will amount to 2 billion euros by the end of the year.
   This is an unwelcome development for the EU bureaucrats who recently announced that Greece was making excellent progress implementing financial reforms. No wonder Greece 5-Year CDS is trading at 870 bps. Greece is doomed, and everyone knows it. The only question is when it will all come crashing down. According to Intrade there is approx. 50% chance of a European country leaving the Euro by Dec 31, 2014.  

Black Swan Insights
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Federal Reserve Loses Bid To Keep Bank Bailout Secret

Per Bloomberg Article :  In another defeat for the illegal Federal Reserve, the New York Court of Appeals refused to consider the central bank's appeal to withhold records relating to the 2008 bank bailouts (amounting to over $2 trillion). The ruling by the Court of Appeals affirmed a decision by a lower court, which ruled that the Federal Reserve must disclose the documents. While this is a temporary victory for transparency and democracy, it could to be short lived as the Fed and its owners (JPMorgan Chase & Co., Bank of America Corp., Citigroup Inc., Bank of New York Mellon Corp., Deutsche Bank AG, HSBC Holdings Plc, PNC Financial Services Group Inc., UBS AG, U.S. Bancorp and Wells Fargo & Co. ) will likely appeal the decision to the Supreme Court. The Fed claims that disclosure of the documents will cause institutions "severe and irreparable competitive injury.” This is nothing but bullshit from the privately owned Fed. The truth is that the bankers (shareholders of the Fed) want their illegal bailouts hidden from the public to avoid congressional scrutiny. Perhaps the tide is turning against the once untouchable Federal Reserve. Or will the Supreme Court sell out America to the bankers again?

Hats off to Bloomberg for taking legal action against the Fed.


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No Bond Bubble--- Just Another Fed Machination

   Bloomberg has an article about record money flowing into bonds over the last 2 years. A total of $480 billion has rushed into bonds compared to $497 billion that went into dot com stocks between 1999-2000. So does this constitute a bubble? Many economic commentators and bloggers have suggested as much. They regurgitate the usual reasons why bonds will do poorly in the future and should be avoided: low yields, purchasing power to be eroded by inflation, the dangers of following the herd into an investment. I do not think we are in a bond bubble--yet. In fact, investors are simply responding to the Federal Reserve's interventions and market distortion. Since the Fed took rates down to zero, it does not make sense to hold funds in money market accounts, but investors are still fearful of equity markets.What are they to do? Invest in bonds.
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Weekend Reads and Audio

1. We are running out of helium--only 25 year supply left--maybe helium is the next great investment

2.  The Death of Quant Funds

3. Stock Market is Still for Suckers

4. King World News Interview-- John Williams of ShadowStats

5. Goldseek Radio--Ron Paul and Harry Dent

6. Peak Oil Theory Has Peaked

7. The Stealth Debt Restructuring: Inflation

8. Emerging Markets are Still Looking Good--Deutsche Bank



Posting will be lite over the weekend. I am recovering from food poisoning courtesy of the Getty Villa Restaurant. Don't get the triple cheese pizza and cheese platter!!!

Black Swan Insights
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Fed President Bullard Really Wants To Steal Your Money Through Inflation

    Fed President James Bullard said in an interview with the WSJ that he wants more money printing if the US experiences anymore disinflation. Note that he did not use the Keynesian scare word deflation; instead disinflation is perceived as the the new bogeyman. Bullard went on to say that the Fed needs to resume money printing to increase inflation. What surprises me is how open Bullard is about his desire to steal America's purchasing power. There is no hiding the fact that the goal of the Federal Reserve is to create inflation. Its funny: if I put a gun to your head and steal your money, you would be angry, but if a supercilious economist at the Fed reduces the purchasing power of your currency, that is okay. Bullard argues that the US needs to achieve the 2% target for inflation and that money printing is the way to accomplish it:
  Part of the goal here is you are trying to defend the inflation target from the low side. Monetizing debt is widely recognized to be inflationary. It will be both perceived as inflationary and it actually will be. You would push core inflation higher, toward target. Of course you don’t want to overdo this and create a lot of inflation down the line. But we are on the low side of the inflation target at this point so the idea is to move up toward the target.

   If I remember right, the Fed's mandate is full employment and price stability. Having 2% inflation means that prices double every 36 years. Is this price stability? I don't think so. What I don't understand is why no one seems to object to the Fed's intention to destroy the dollar. No economist I have ever talked to has ever been against inflation. They all like the idea of 2-3% inflation because they incorrectly believe that it stimulates spending as people buy stuff before the price goes up. They fear that 0% inflation or (gasp) deflation would cause a depression as people and businesses forgo spending, waiting for lower prices. Of course, this is an absurd notion. The real reason the Fed and the government want inflation is because it reduces the real value of the government's national debt. It it just a coincidence that inflation is usually 3%, and the yearly budget deficit is around 3%, too. Bernanke in his deflation speech, confirmed that the government has a strong incentive to create inflation. It is unfortunate that the American people do not understand this concept. Even Lenin understood this and noted that the:
best way to destroy the capitalist system was to debauch the currency. By a continuing process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens. By this method they not only confiscate, but they confiscate arbitrarily; and, while the process impoverishes many, it actually enriches some. The sight of this arbitrary rearrangement of riches strikes not only at security but [also] at confidence in the equity of the existing distribution of wealth.
   It is sad that a nefarious character like Lenin had a better understanding of economics than most capitalist economists. Whatever your views about the Fed, you have to admit that they have done a terrific job of reducing the dollar's value by 96% since 1913.  

Black Swan Insights
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Is The Fed Really Out of Bullets?

   A common slogan by economic pundits is that the Federal Reserve is "out of bullets" when it comes to monetary policy. They note that the Fed funds rate is already at 0% and QE 1 has failed to stimulate the economy. With banks not lending the Fed has fallen into the dreaded liquidity trap as de-leveraging mitigates expansionary monetary policy. The pundits say that we are destined to end up like Japan and stagnate for 20+ years in a deflationary environment.  What people forget is how devilishly creative Ben Bernanke is when it comes to monetary policy. But what choices are left for Zimbabwe Ben?

I have outlined a few possible tools still available to the Fed:

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Charting The Supposed Economic Recovery

   If you want a clear visualization of how weak the current recovery is compared to the post-world war II average here are 8 charts to prove it. Make sure to look at the last chart which compares the current decline in home prices to what happened during the great depression--hint the current decline is much worse.



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How Merrill Lynch Hid $31 billion In Toxic Assets Off Balance Sheet

   The New York Times has a fascinating article detailing how Merrill Lynch was able to hide $31 billion in toxic CDO assets off balance sheet beginning in early 2006. During the housing bubble of 2002-2007 Merrill made big money packaging mortgages and selling CDO's to investors. If the firm was unable to sell certain tranches of a CDO they would normally go to AIG to buy some credit protection, but in early 2006 AIG stopped selling credit protection on risky assets backed by mortgages. This left Merrill with a serious problem and left them exposed to billions in possible losses. To solve the problem, Merrill created a special purpose vehicle called Pyxis, which issued short term debt backed by the cash flow from the CDO's. But as the New York Times points out there was a catch:
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Irish 5 Yr CDS On The Rise

Is there something brewing in Euro CDS land? While equity markets remained quite during another summer day, there were some interesting movements in European sovereign CDS with notable widening in Italian and Irish 5 Yr CDS. There has been no news that would account for the unusual movements so they are worth keeping an eye on. Of course if you are country like Italy with a debt to GDP ratio of 115%, it is just a matter of time before it all comes crashing down. Ireland too is in trouble and is one failed bond auction away from ending up like Greece.

Entity Name       5 Yr       Mid Change (%)        Change (bps)       CPD (%)


Italy                 197.67         +9.66                          +17.41               15.75

Ireland             303.23         +6.80                          +19.30               22.80

Germany           47.34         +5.36                             +2.41                 4.04

Greece           847.95          +3.51                          +28.79                51.00

Source: CMA Datavision

Black Swan Insights
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Financial Globalization Has Rendered The System Increasingly Susceptible To Collapse

   A published report by the Hong Kong Monetary Authority titled "Analyzing Interconnectivity Among Economies" found that the trend of financial globalization has weakened the world economy by making it vulnerable to systemic collapse resulting from external shocks. The report goes on to state that individual countries have lost control over their own economic security as a result of this financial interconnectivity, creating policy problems for government leaders and central bankers. One of the major findings of the report was that "economies register a significantly higher sovereign risk once the condition that another economy is in distress is imposed." The problem is that traditional CDS pricing does not correctly price this risk, leaving market participants exposed to billions in potential losses. The threat becomes more severe if systemically important institutions like money center banks are affected by this mispricing of risk because of the domino effect during financial crises.
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Krugman Gets It Wrong On Social Security--Again

   Keynesian ideologue Paul Krugman is out with a piece in the New York Times praising Social Security as proof that the government is the solution to poverty in America. He wants us all to celebrate Social Security's 75th anniversary. He goes on to lament the fact that some Democrats and most Republicans are considering cutting benefits and/or raising the retirement age to 70. According to Krugman, Social Security is in a strong financial position and should not be changed because it would hurt the poor. Ever the elitist, Krugman takes it upon himself to set the record straight on Social Security stating:
 About that math: Legally, Social Security has its own, dedicated funding, via the payroll tax (“FICA” on your pay statement). But it’s also part of the broader federal budget. This dual accounting means that there are two ways Social Security could face financial problems. First, that dedicated funding could prove inadequate, forcing the program either to cut benefits or to turn to Congress for aid. Second, Social Security costs could prove unsupportable for the federal budget as a whole.

But neither of these potential problems is a clear and present danger. Social Security has been running surpluses for the last quarter-century, banking those surpluses in a special account, the so-called trust fund. The program won’t have to turn to Congress for help or cut benefits until or unless the trust fund is exhausted, which the program’s actuaries don’t expect to happen until 2037 — and there’s a significant chance, according to their estimates, that that day will never come.
   I am impressed with the arrogance of this economist who has been wrong time after time. Just for readers to remember, this simpleton called for the Fed to create a housing bubble in 2002 to "stimulate" the economy. What is particularly scary is that the ruling class in Washington and at the Fed listens to this bedlamite. Anyway, Krugman again makes numerous mistakes when he discusses the alleged solvency of Social Security. He asserts that because Social Security ran surpluses for 25 years, it has credit in a special account called the trust fund. This is not correct. While it is true that Social Security did run surpluses, the problem is that the government already has spent them. In return,  Social Security was given nothing more than an accounting entry confirming the fact. The truth of the matter is that all Social Security has is paper IOUs from a bankrupt and heavily indebted federal government, which has been forced to print money to pay its bills. If the government was to make good on these IOUs they would have to either borrow more money, raise taxes, cut spending, or print money. Krugman would be correct if the government had not stolen the Social Security's surplus for the past 25 years and used it to fund normal government spending. But they have spent the surplus, and  so the idea of a trust fund with hundreds of billions stashed a away for a rainy day is a lie. If Social Security is to be funded after it slips into perpetual deficit, it will come from directly from the government and not from people paying into Social Security.
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There Is No Deflation

   With the recent weakness in the economy many economists have warned that the US faces a deflationary future. Their solution is to print money to counter any deflationary forces. As readers will know, I strongly disagree with this idea because there is no deflation. I am not going to get into the inflation/deflation debate because it is not productive and both sides remain obstinate. However I will note that Fed President Hoenig made a speech yesterday which noted:
One final note about deflation: The consumer price index was a mere 18 in 1945 but was 172 at the start of this century. Today, despite our most recent crisis, the CPI is over 219. Not once during more than half a century has the index systematically declined. I find no evidence that deflation is the most serious threat to the recovery today.
   People commonly mistake asset price deflation with general price deflation. Asset price deflation is part of the credit cycle. When a credit bubble bursts (e.g. housing market), prices have to fall back to a proper clearing level set by the market. However, there is a certain group of economists, who believe that the Federal Reserve should never let this process occur. Instead they postulate that the Fed should debase the dollar through inflation, which increases the nominal price of assets. They argue that the "deflationary risk" of falling prices is to great and that the Fed should do everything in their power to prevent it. This is why the Fed will not allow home prices to fall to their natural level.  One other aspect of Hoenig's speech I found noteworthy was his discussion on negative real interest rates and why it it destructive to the economy. He mentioned that the Fed made the mistake in 2003-2004 of keeping interest rates artificially low for too long, which led to a speculative housing bubble. What I find unbelievable is that the Federal Reserve refuses to learn from their own mistakes. They admit that low interest rates create dangerous price bubbles, but at the same time have lowered interest rates to 0%. They have kept rates at all time lows for over a year even though they know this is going to cause unintended problems in the future. What the hell are they thinking at the Fed?
  
    The way I see it the goal of 0% interest rates is to create another asset bubble to bail out the economy. The Fed may claim that this is not their intention, but actions speak louder than words. They understand that the real economy has been permanently disabled thanks to the financial crisis and housing bubble. Under their line of reasoning the only thing that can cause a temporary recovery in the economy would be another credit bubble,which is bigger than the housing bubble. It remains to be seen whether they can accomplish this because the demand for credit throughout society (businesses, consumers, etc) is declining at a rapid rate. Another problem is that the banking system is insolvent which means banks are not going to be extending credit and loans like they did before. We know that 0% interests rates encourage speculation as people look for alternatives to 0%. However, most Americans have already given up on stocks and are piling into bonds despite the threat of inflation and low returns on 10 year Treasuries. According to traditional economic thinking this is the exact opposite of what you would expect rational people to do. They should be moving their assets into riskier investments rather than safer ones. If these trends continue expect more economic stagflation as the economy limps along and high commodity prices ensure inflation. It remains to be seen whether the Fed will get their wish of another credit bubble.

Black Swan Insights  
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A Little Humor To End The Day

Bernanke on monetary policy and the economy.
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IMF Calls for A New Global Currency

   In a report titled "Reserve Accumulation and International Monetary Stability" the IMF makes the argument that the only way for the world economy to achieve financial stability is for the adoption of a new global currency. The IMF claims that with a global currency, the world economy will no longer have to suffer exchange rate volatility or be dependent on the monetary policies of a single nation (the US). This is no longer a conspiracy theory, it is currently being considered by the elite of the world.  Here is the IMF's line of reasoning:

A more ambitious reform option would be to build on the previous ideas and develop, over time, a global currency. Called, for example, bancor in honor of Keynes, such a currency could be used as a medium of exchange—an “outside money” in contrast to the SDR which remains an “inside money”.
One option is for bancor to be adopted by fiat as a common currency (like the euro was), an approach that would result immediately in widespread use and eliminate exchange rate volatility among adopters (comparable, for instance, to Cooper 1984, 2006 and the Economist, 1988). A somewhat less ambitious (and more realistic) option would be for bancor to circulate alongside national currencies, though it would need to be adopted by fiat by at least some (not necessarily systemic) countries in order for an exchange market to develop.
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US Economic Outlook--3 Possible Scenarios

   Market participants and economists have noted that the macro outlook for the US economy is particularly uncertain. There seems to be so many contradicting variables that lead to differing conclusions. On one hand you have strong corporate profits, easy monetary policy, and growth from emerging markets. On the other hand the US has high structural unemployment, egregious levels of government debt, and a housing depression. I believe the US economy faces 3 possible economic scenarios:  Economic Stagnation (1-2% GDP growth), Economic Depression (severe economic contraction), and Hyperinflation. You will notice that there is no V-Shape economic recovery with strong growth (4-5%) option. Anyone who has studied economic history will tell you that economic and financial conditions simply do not support this outcome as a realistic possibility. The main reasons for this include de-leveraging, an insolvent banking system, collapse of housing market, record levels of government and private sector debt, and high unemployment. Under these conditions it is impossible to have a strong and healthy economy. Lets review 3 possible economic scenarios:
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Anthony Ward's Cocoa Speculation May Be In Trouble

   As we speculated earlier, trying to publicly corner a market is a sure way to financial ruin (just ask the Hunt brothers). So far Anthony Ward's seems to be learning this the hard way. Since news of Ward's large purchase leaked out, the price of cocoa has plummeted by approx 10.5%, as an improved crop outlook from the Ivory coast has eased supply concerns. This is contrary to Ward's bet that a poor crop from the Ivory Coast would lead to a supply shortage and higher cocoa prices. It is surprising that Ward could be so wrong when it comes to the supply/demand situation. He has an extensive information gathering operation ,which gives him an inside track to the worldwide cocoa market. In particular, he has people on the ground in the Ivory Coast monitoring the weather, cocoa volume at major ports, and general crop conditions. His firm also acts as a distributor of cocoa and coffee in the region, which gives him an information advantage when it comes to where cocoa is being shipped. But so far, all of this has not helped him with his cocoa operations.    

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Small Business Optimism Declines--Great Recession Continues For The Real Economy

   Contrary to what you hear from the large multinationals, the real economy in the US (e.g. small businesses) never recovered and is trapped in a never ending recession/depression. The National Federation of Independent Business announced the results of their July survey. The results were not positive:
The Index of Small Business Optimism lost 0.9 points in July and reached 88.1 following a sharp decline in June. The Index has been below 93 every month since January 2008 (31 months), and below 90 for 24 of those months, all readings typical of a weak or recession-mired economy. Ninety percent of the decline this month resulted from deterioration in the outlook for business conditions in the next six months. 
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Federal Reserve Announces QE "Lite"

  Hat tip Nomura Securities who predicted this development 2 weeks ago. The Federal Reserve announced today that:
To help support the economic recovery in a context of price stability, the Committee will keep constant the Federal Reserve's holdings of securities at their current level by reinvesting principal payments from agency debt and agency mortgage-backed securities in longer-term Treasury securities. The Committee will continue to roll over the Federal Reserve's holdings of Treasury securities as they mature.
   This is an important turn of events because it means that QE (money printing) is likely permanent and the Fed is intent on monetizing debt contrary to what they say. I don't care what anyone says this action will eventually lead to high inflation. It also shows how duplicitous and deceitful the Federal Reserve really is. For the last 14 months or so they have argued that their actions were only to stimulate the economy by injecting money temporarily. When the economy showed sings of stabilization they would reduce the balance sheet accordingly. But today's actions show otherwise. Its interesting because QE 1 has largely failed as the real economy shows little signs of progress and is currently at risk of a double dip without more government stimulus.
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European Banks Faced Funding Problems ECB Bank Lending Survey Says

   The ECB released their July Bank Lending Survey which asked banks about lending conditions in Europe and whether the banks are facing any troubles funding their operations. This is a quarterly survey by the ECB and was conducted between June 14th and July 12th, so it was taken before the completion of the European bank stress tests. But it gives you an indication of the problems European banks were having securing funding. The real problem was in the wholesale funding market and short term money markets. The banks seemed to have learned nothing from the Northern Rock and Lehman Brother's failures. Both institutions relied heavily on wholesale funding and watched it dry up in a matter of days. But who needs financial prudence when you have the ECB. Here is an excerpt from the survey:

 For the second quarter of 2010, possibly reflecting the renewed financial market tensions following concerns about sovereign risk, banks generally reported a deterioration in their access to wholesale funding across all segments, but more intensely as regards access to short-term money markets and the markets for debt securities issuance. On balance, in the second quarter of 2010 around 30-40% of the banks surveyed (excluding those banks that replied “not applicable”) reported deteriorated access to money markets and around 40-50% of the banks reported deteriorated access to debt securities markets. In addition, true-sale securitisation of corporate loans and loans for house purchase also became somewhat more difficult in the second quarter of 2010. On balance, between 20% and 30% of the banks for which this business is relevant (around 60% of the sample group) reported deteriorated access to securitisation of respectively corporate loans and mortgage loans. Moreover, according to 37% of the banks for which this business is relevant (which is the case for 40% of the sample group), synthetic securitisation, i.e. the ability to transfer credit risk off balance sheet, deteriorated.
It is unclear whether credit conditions have improved very much since the bank stress tests. While bank CDS spreads have tightened, Eurlibor has steadily risen which gives you a mixed message. The real problem for the European banks is their dependence on wholesale funding as opposed to more stable funding sources such as bank deposits.

Black Swan Insights
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Weekend Reads

If you have time this weekend you may want to check out these articles.

1. Yuan As A Reserve Currency--Deutsche Bank

2. Latin America-Not just a commodity play---JP Morgan

3. Telling Swiss secrets: A banker's betrayal--Global Post

4. No Wheat Shortage--Global Stocks Adequate---Tell that to the speculators bidding up wheat

5. Goldman Sachs Estimates Derivatives May Provide 35% of Revenue--BusinessWeek



Have a good weekend.

Black Swan Insights
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How Can There Be A Recovery Without Jobs?

I know I know employment is a lagging economic indicator but this is ridiculous. In my opinion there can be no recovery without jobs. The US has to create 250,000 jobs just to keep pace with the growing population. We were told by the experts that jobs would come gradually, but according to his chart it has not happened. Of course the markets could care less because they are expecting more money printing by the Federal Reserve.

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"Nothing Down" Makes a Comeback: So Much For Increased Lending Standards

  While I never trust statistics from the National Association of Realtors, I do enjoy reading their realtor surveys. One important question from the June survey was "If the buyer obtained a loan, what percent was the down payment?" Here are the results:

Buyer did not make a down payment                  14%

Buyer made a down payment of 1% to 2%           3%

Buyer made a down payment of 3% to 6%          38%

Buyer made a down payment of 7% to 10%          9%

Buyer made a down payment of 11% to 20%       21%

Buyer made a down payment of 21% to 99%       16%


   That's right :14% of home buyers purchased a home without a down payment (and you thought banks had raised their lending standards). More importantly, 55% of home buyers put less than 7% down. The reason there is a large number in the 3-6% area is because FHA usually requires a 3% down payment. You would have thought that banks and mortgage lenders would have learned by now that it is important for home buyers to put up at least 10% down. This way they have some skin in the game and are less likely to default on a loan. Evidently, financial institutions have learned nothing from the whole real estate market collapse and subsequent financial crisis. I tried to confirm these results from a realtor I know in the Chatsworth, California area, and was told that it is possible to  purchase a home without a down payment, but you have to have good credit. In my opinion, these kind of stats how  vulnerable the US housing market is to any further decline in home prices. How many home buyers in the no down payment category are willing to endure negative equity? My guess is not many, and the same can be said for people in the 3-6% category. Talk about weak hands! These people will simply walk away and contribute to the bloated housing inventory.

Black Swan Insights    
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Oil Prospects In Somalia

   Here is an interesting collection of reports from Somalia Watch, which describe why Somalia could be the next major oil producer in the world. Based upon UN reports and early oil exploration activities Somalia could be the next Uganda which recently found oil. Somalia is a largely unexplored area due to ongoing civil wars and political chaos. But times have changed, especially in the Northern Region called Puntland which is a self-governing area independent of the central government. This is where Somalia's two major basins are located and where previous exploration activities were carried out by major oil companies before the beginning of the civil war. When it comes to current investment opportunities there is a company called Africa Oil Corp, which owns the largest land package in Somalia and is scheduled to drill its first exploratory well in the 4th quarter of 2010. I have an article about Africa Oil Corp Here. When it comes to oil exploration Somalia is currently under the radar to investors, but that may soon change in the next 9 months.

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How A Mistake By The Supreme Court Allowed Fiat Money In the US

   Here is a very interesting research paper from the Bank of Japan which discusses how the US got off the bi-metallic system and evolved into a purely fiat-money system. The real culprit according to the author is not FDR or Nixon, but the US Supreme Court which failed to properly distinguish between fiscal and monetary policy when deciding the constitutionality of Greenbacks (notes issued by the government to finance the Civil war) and Legal Tender Laws in the 1860's. The Court affirmed the legality based on an incorrect interpretation of the Constitution which allows Congress to borrow money. The Court argued that issuing fiat currency was within the government's power to borrow. These important decisions were vital to destroying America's metallic based monetary system and the purchasing power of the dollar.  The author concludes that "that monetary arrangements in the U.S. have departed sharply from those specified by the Constitution, and that the change has been based in crucial ways on invalid reasoning."

 Here is an excerpt from the article:
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So You Wanna Predict A Banking Crisis?

   According to a recently released working paper from the Hong Kong Monetary Authority (Central Bank), the key to predicting an impending banking crisis before it occurs is to watch the spread between LIBOR and OIS (Overnight Index Swap) rates. During normal times, the spread between the two rates is low, representing a healthy and liquid market. But during times of severe market dislocations, the spread starts to widen, which indicates liquidity problems in the interbank funding markets. The report goes on to say that if you had followed this indicator during the Fall of 2008, you would have been alerted to the market collapse and credit freeze a few days before they actually occurred. To be precise, the indicator flashed a warning signal on September 18th 2008, just days after Lehman's bankruptcy. At the time the market had not fully realized the dire consequenes. While the report mainly discusses how this is a useful tool for policy makers to anticipate and prepare for a banking crisis, I am more interested in this indicator as a trading tool. From the chart below you will see that the trigger for a banking crisis is when the spread is over 125 bps.
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Quantitative Easing Propaganda From the Bank Of England

   I happened to come across the Bank of England's (BOE) website yesterday and saw an interesting article titled "Quantitative Easing: Putting more money into the economy to boost spending." I am always fascinated by how much contempt central banks have for the general public. They talk to us like children in an Orwellian police state. The purpose of the BOE's article is to convince the British public that inflation is a good thing. If the public wants a strong economy they should also want inflation. Of course to the rational person, inflation is a great evil and represents an illegal confiscation of purchasing power. It has ruined the middles class in western economies because wages never keep up with inflation, which results in a decrease in the standard of living. But lets see the Bank of England's propaganda in action:
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Thoughts From Marc Faber--- Aug 1

Legendary investor Marc Faber is out with his monthly report which discusses the US economy, QE 2, equity markets, China's property sector, and the EU debt crisis. Here are a few highlights:

1. Stock market outlook is uncertain. Faber is less confident that markets will fall to 850-900 because of the inevitable money printing (aka QE 2), which will boost asset prices. Possible trading range developing with 1040 as the bottom and 1170 as the top for the S&P 500. Even so he would be reducing equity exposure on any stock market strength.

2. Euro is likely to bounce around erratically between 1.25 and 1.35. Faber hates the dollar and euro but likes undervalued Asian currencies.

3. If you have to buy stocks make it Asian equities and REIT's in Thailand, Singapore, and Malaysia. They have high yields and are attractive compared to 3% 10 year treasuries. Asian economies will continue to grow at a healthy clip even with weakness in the US and Europe, which makes them good investments.

4. China's economy will continue to do grow even if the property market declines sharply. The growing Chinese middle class will support increased domestic consumption. Wages in China have gone up giving hundreds of millions of people increased purchasing power.

5. US municipal debt will likely become a major problem in the future. As of the 1st quarter of 2010 there is an estimated $2.8 trillion in outstanding municipal debt, which can never be repaid and will require a federal bailout. Another issue is state and local government pension plans, which are severely underfunded.

6. Gold is a buy after its seasonal bottom usually in September. Long term trend is up and as long as Bernanke is Fed Chairman, gold will do well.

7. Likes agricultural commodities and related stocks (but says avoid commodity ETF's because of the roll). In particular Faber likes wheat, rice, and soybeans. He also likes the fertilizer and seed stocks.

8. Faber expects rising agricultural prices will lead to civil unrest and violence in some countries.


Black Swan Insights
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Key Events For The Week

It is hard to believe that we are already in August, but here we go.

Monday  Aug 2

1. ISM Manufacturing (July)

2. Construction Spending

3. Reserve Bank of Australia Rate Decision * (always important to the carry traders)

Tuesday  Aug 3
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