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COMING UNGLUED: Market Fragility and Credit Market risk indicators are now at post-Lehman levels.

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MORAL METASTASIS : Malfeasance, Manipulation & Malpractice - Metastasis is the spread of a disease from one organ or part to another non-adjacent organ or part. Cancer occurs after a single cell in a tissue is progressively genetically damaged to produce a cancer stem cell possessing a malignant phenotype. These cancer stem cells are able to undergo uncontrolled abnormal mitosis, which serves to increase the total number of cancer cells at that location. The moral fiber of our society is going through this same process as it breaks down, spreads and metastasis. We are presently in the process of Moral Metastasis that will prove fatal if not immediately operated on and surgically removed. Sadly, however it has gone undetected too long and the damage it has caused is now irreparable. MORE>>

MARKET ANALYTICS & TECHNO-FUNDAMENTAL ANALYSIS

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	PART I - Understanding FINANCIAL REPRESSION
	PART II - FINANCIAL REPRESSION in Europe
	PART III - FINANCIAL REPRESSION in the US & ASIA
	PART IV - Preparations for FINANCIAL REPRESSION

Password: macro

EU DEBT CRISIS: Current Scenarios for Further Stop Gap Fixes

The European Debt Mutualization Options Matrix 07-20-12 Zero Hedge

As Barclays points out, the Summit produced an agreement in principle to achieve banking and fiscal union in the medium to long term. However, this commitment was lacking detail and as we pointed out earlier, is now critically exposing once again the fundamental flaw of disunited and self-interested European union of idiosyncratic nations.

While the decision to give the ESM the 'capability' to recapitalize banks directly solidified the medium-term commitment to a financial markets/banking union, there were no specific announcements/agreements from the EU Summit on various debt mutualization possibilities for the near term. If the eurozone debt crisis worsens, such that Spain loses market access and needs to be put into a full program (which a 7% yield and recent auctions suggests), policy makers will be required to give some serious thought to alternative plans, and in particular an accelerated move towards some form of debt mutualization - those options are laid out simply here (in all their unlikely transfer-of-sovereignty scenarios).

Barclays: Eurozone Debt Mutualization options, A Comparison

Market developments might relatively quickly push policy makers to consider various debt mutualization proposals, which will likely require significant transfers of sovereignty. In addition, most of these proposals come with varying degrees of challenges in terms of time to implementation, effectiveness of firepower, costliness to core countries and moral hazard. Of all the proposals, we find the ESM gaining a banking licence and leveraging itself at the ECB to be the most practical solution, especially in reaction to an acute funding crisis. However, legal considerations could prevent this from happening in the near term. Among the remaining potential choices, we believe Euro T-bill and Debt Redemption Fund proposals also look promising.

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Our approach here is to attempt to analyze the proposals separately by taking into account all of the criteria. The ultimate goal for the eurozone in the long term (ie, around 10 years) would be a fully fledged Eurobond solution once the economic and fiscal integration of Europe is in place. And this would require strong implementation of existing frameworks/plans such as the fiscal compact and European Semester stability plans by all eurozone members, but also an ultimate development of a fiscal body at the eurozone level (such as a central treasury/budget office), which would imply completion of transfer of sovereignty. As such, proposals such as ESM gaining a banking license and Euro T-bills can be seen as initial milestones on a roadmap for Europe, which will ultimately lead to a Debt Redemption Fund or fully fledged Eurobonds.

EU: GDP versus Deleveraging Credit Growth

He Who Deleverages Best: Presenting The 'Credit Intensity' Of Europe's GDP Growth 07-21-12 Zero Hedge

There exist those pathological Economics 101 acolytes who say that no matter what happens in the global economy, since it is all supposedly a closed system, whether one incurs leverage at the sovereign or private-sector level is largely irrelevant, and that is all translates into economic growth as long as the system is experincing a net leverage increase. Usually these same acolytes come up with economic theories which attempt to validate and justify infinite sovereign debt incurrence, usually to explain why socialism can be funded (if only in various formerly capitalist societies). At the heart of their thinking is the Kalecki profits equation which says that:

Profits = Investment – Household Savings – Government Savings – Foreign Savings + Dividends

Or in other words, as long as the non-government sector is expanding its savings (reducing leverage), aggregate economic output remains the same as long as the government is doing the opposite. Of course, as we explained before this equality breaks immediately in a real world in which one evaluates the impact of asset age, amortization, depreciation and otherwise the impact of reality on profitability. But does that mean that every economics theory that says corporate deleveraging is offset by sovereign leverage is wrong? Not necessarily. it just says that there is far more to the final outcome than what an Neo-Keynesian Econ 101 textbook alleges.

To evaluate the impact of private sector deleveraging on economic growth/GDP in the context of a rapidly releveraging sovereign, we present the following analysis from Citi which observes various European countries and analyzes the "credit intensity" of GDP growth, or in other words which country has preserved, or even grown its GDP even as its private sector has seen substantial deleveraging. The results are interesting and may present a framework for evaluation the winners and losers in Europe in the era of "great sovereign leveraging", permitting a reverse engineering of the success stories, and applying their lessons to the losers.

Citi has compiled data analyzing private sector leverage and cross referenced it to countries who have seen massive sovereign debt expansion in the past 5 years, however offset with various degrees of private sector deleveraging. The results are as follows :

Given the persistent tensions from the financial sphere and the precarious situation of some banking systems, it is interesting to compare how much leverage has been accumulated in the last ten years in various euro area member states and how much economic activity was generated during the same period (see Figure 4). This allows us to measure the ‘credit-intensity’ of GDP growth. In particular, we concentrate on the last five years to see whether the relationships have evolved.

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In peripheral countries such as Spain, the last two years (Q4 2009 to Q4 2011) saw a 16-point drop in the real credit outstanding without triggering a contraction in the level of economic activity. Over the same period, Ireland was perhaps the most successful peripheral country, with real credit outstanding shrinking by 57 points while the real GDP level rose by 4 points. In Portugal, while the reduction in real credit outstanding was more limited, worth 12 points in the last two year, the level of real GDP still declined, albeit by a modest 2 points. Italy is the only country within the peripheral group that experienced an increase in the amount of private sector real credit outstanding, with a gain of 5 points. Yet, the corresponding increase in real GDP was limited to just 2 points.

Core and soft core countries recorded GDP gains, with Finland (7pt) and Germany (6pt) clearly in the lead, compared to Austria (5pt), Belgium (4pt) and France (3pt). Interestingly, Belgium managed to grow its GDP despite experiencing a clear deleveraging phase. Note that Germany is the only euro area member state to have recorded an increase in its GDP level since 2002 while its level of private sector credit outstanding has declined during the last decade .

So while the occasional success story may exist, the danger is as always one of extrapolating into the future too far, especially a future in which private sector growth will very likely be even more constrained in the coming years. The danger is that expanding sovereign leverage will no longer be private sector offset, which it obviously is not in the general case, and will simply become a headwind to growth, at both the macro as well as micro levels.

Looking ahead to the next few quarters, there is a clear risk that banks operating in peripheral countries will either maintain tight lending standards or restrict lending even more in the event of further increases in the proportion of non-performing loans. Unless those countries implement sufficiently comprehensive structural reforms to lift potential growth, economic activity is at risk of contracting further in the coming quarters, increasing investors concerns about debt sustainability.

QE III: China Needs to be Support this, and it isn't QUITE YET.

Why Is The Fed Not Printing Like Crazy? 07-21-12 John Aziz Azizonomics

The answer to why Bernanke isn’t increasing inflation when his former self and former colleagues say he should be is actually nothing to do with domestic politics, and everything to do with international politics. Most of the pro-Fed blogosphere seems to live in denial of the fact that America is massively in debt to external creditors — all of whom are frustrated at getting near-zero yields (they can’t just flip bonds to the Fed balance sheet like the hedge funds) — and their views matter, very simply because the reality of China and other creditors ceasing to buy debt would be untenable.

Why else would the Treasury have thrown a carrot by upgrading the Chinese government to primary dealer status (the first such deal in history), cutting Wall Street’s bond flippers out of the deal? As John Huntsman (in his days as ambassador to China) reported in a cable back to Washington, China is keen to stop buying low-yield treasuries and start buying other assets, but the US is desperately pushing China back toward treasuries. Only a brutal 2008-style collapse can bring on the kind of printing — QE3, NGDP targeting and beyond — that the pro-Fed blogosphere wishes to see, because it is only under those circumstances that China and other creditors will happily support it.

To a heavily-indebted nation, creditors have big leverage on monetary policy.

RISK: Systemic Problems Becoming both Obvious & Critical

Market-Top Economics 07-19-12 Zero Hedge

• As human-beings we have developed an uncanny ability to rationalize what we know to be bad news and convince ourselves, "This time is different," despite the fact that it usually never is.
• In a previous article I provided analysis on economic/equity decoupling (cognitive dissonance) and showed that the economy as we know it cannot persist--we are either due for a literal gap-up in leading economic conditions, or we are due for a serious correction in US equities. With today's 5.4% slip in existing home-sales, let's go with the latter.
• Velocity of M2 Money Stock (blue) and the S&P500 (red): Inversion in the velocity & SPX correlation led to a market crash in 2000 and 2007. No evidence suggests that we should break that trend this time.

Market tops are classically defined by:

1. The revelation of fraud within the financial sector
2. The collapse of financial institutions under their own weight
3. Sweeping revenue loss within the financial sector
4. The erection of massive buildings.

Where there is smoke, there is fire; where there is coordinated financial fraud, there are systemic issues. In this case, it seems that the banks involved in LIBOR rigging were attempting to manipulate short-term interest rates in order to literally engineer the price of derivatives contracts. This is a scary notion, and I believe that it is apt to infer that these banks have trillions in losses on shadow derivative contracts that they have been attempting to cover up with interest rate manipulation.

CAPITAL DESTRUCTION: The "Sudden Capital Death Syndrome"

Falling Interest Rates Destroy Capital 07-20-12 Keith Weiner

I have written other pieces on the topic of fractional reserve banking (http://keithweiner.posterous.com/61391483 and http://keithweiner.posterous.com/fractional-reserve-is-not-the-problem) duration mismatch, which is when someone borrows short-term money to lend long-term and how falling interest rates actually encourages duration mismatch (http://keithweiner.posterous.com/falling-interest-rates-and-duration-mis...).

Falling interest rates are a feature of our current monetary regime, so central that any look at a graph of 10-year Treasury yields shows that it is a ratchet (and a racket, but that is a topic for another day!). There are corrections, but over 31 years the rate of interest has been falling too steadily and for too long to be the product of random chance. It is a salient, if not the central fact, of life in the irredeemable US dollar system, as I have written (http://keithweiner.posterous.com/irredeemable-paper-money-feature-451).

A bond issuer is short a bond. Unlike a homeowner who takes out a mortgage on his house, a bond issuer cannot simply “refinance”. If it wants to pay off the debt, it must buy the bonds back in the market, at the current market price. Let’s repeat that. Anyone who issues a bond is short a security and that security can go up in price as well as go down in price. It is the bond issuer’s capital that flows to the bondholder.

(1) Hold Until Maturity;

(2) Mark to Market;

(3) Two Borrowers, Same Amount;

(4) Two Borrowers, Different Amounts;

(5) Net Present Value;

(6) Capitalizing an Income;

(7) Amortization of Plant; and

(8) Real Meaning of an Interest Rate.

Debtors slowly pay down their debts and reduce the principle owed. This would reduce the NPV of their debts in a normal environment. But in a falling-interest-rate environment, the NPV of outstanding debt is rising due to the falling interest rate at a pace much faster than it is falling due to debtors’ payments. The debtors are on a treadmill and they are going backwards at an accelerating rate.

Irving Fisher, writing about falling prices proposed a paradox: “The more the debtors pay, the more they owe.” How apropos is Fisher’s eloquent sentence summarizing the problem!

NIXON'S REMOVAL OF US FROM GOLD STANDARD: Fallout Now Evident

Explaining Wage Stagnation 07-19-12 John Aziz Azizonomics

The end of the Bretton Woods system correlates beautifully to a rise in income inequality, a downward shift in total factor productivity, a huge upward swing in credit creation, the beginning of financialisation, the beginning of a new stage in globalisation, and a myriad of other things.

The long-term issue was the fundamental change in the nature of the global trade system and the nature of money that took place in 1971 when Richard Nixon ended Bretton Woods.

US GROWTH Key Paradyns Suggest a New Normal Ahead

Three Converging Factors May Slash Economic Growth By 71% 072-12 Daniel Amerman

Everything from the ability to pay for Social Security, to projected federal deficits, to retirement planning and stock market valuations is based upon assumptions that the United States and other nations will emerge from crisis and return to "normal" long-term growth rates. What happens if we don't return to those growth rates?

There are strong historical reasons to believe that the United States growth rate could drop from a long-term historical rate of 3.5%, to an annual rate of 1.3% - and a per capita rate of 0.2% - in the coming decades. If so, then over a period of a little more than 20 years this would compound to a 71% reduction in economic growth.

This lack of future growth would result in a 40% smaller overall economy, compared to what it would be with normal growth. Because current government deficit projections, stock market valuations, and retirement planning models are all based upon "normal growth", the results would be catastrophic. There would be a much smaller economy available to support retirement and government promises, almost no growth in the stock market, and a long-term collapse in the value of retirement portfolios and pension plans

This may sound extreme. Yet, the three factors reducing long-term growth rates are not wild "gloom and doom" projections, but rather are quite fundamental factors that form the bedrock of the economic and financial present and future, albeit little noticed in the exciting daily hubris of the financial news.

1. Debt Overhangs
2. An Aging Population
3. Adjusting For Population Growth

US RECESSION: Signs Becoming Overwhelming

The Evidence Of A Coming Recession Is Overwhelming 07-20-12 Comstock Partners

We first noticed the first signs that the economy was beginning to soften about three months ago. Now the evidence of a slowdown has become so overwhelming that it is difficult to avoid the conclusion that we are headed for a recession. We cite the following as evidence.

• RETAIL sales (both total and non-auto) have dropped for three consecutive months. This has happened only five times since 1967----four times in 2008, and one now. Vehicle sales have tapered off with May and June being the two weakest months of the year.
• CONFIDENCE: Consumer confidence for both the Conference Board index and the University of Michigan Survey are at their lowest levels of 2012. The small business confidence index declined in June to its lowest level since October and has now dropped in three of the last four months. Plans for capital spending and new hiring have dropped sharply.
• JOBS: On the labor front, June payroll numbers were weak once again and averaged only 75,000 in the second quarter. The latest weekly new claims for unemployment insurance jumped back up to 386,000 and the last two months have been well above the numbers seen earlier in the year.
• MANUFACTURING: The ISM manufacturing index for June fell 3.8 points to 49.7, its first sub-50 reading in the economic recovery. Most recently the Philadelphia Fed Survey for July was negative (below zero) for the third consecutive month.
• Core factory orders, while volatile on a month-to-month basis, have declined 2.6% since year-end, and the ISM numbers indicate the weakness is likely to continue.
• SERVICES: The ISM non-manufacturing index for June dropped to its lowest level since January 2010.
• HOUSING: Despite all of the talk about a housing bottom, June existing home sales fell 5.4% to its lowest level since the fall of last year. In addition mortgage applications for home purchases have been range-bound since October.
• LEI The Conference Board Index of leading indicators has declined for two of the last three months and is now up only 1.4% over a year earlier, the lowest since November of 2009, when it was climbing from recessionary numbers. The ECRI Weekly Leading Index is indicating a recession is either here now or will begin in the next few months.

REGIONAL

• GLOBAL: The breadth and depth of the slowdown are greater than the growth pauses experienced in mid-2010 and mid-2011, and indicate a strong likelihood of recession ahead.
• EU: In addition the foreign economies will be a drag as well. A number of European nations are already in recession and others are on the cusp. The debt, deficit and balance sheet problems of the EU's southern tier are a long way from any solution, and will not remain out of the news for long.
• CHINA is coming down from a major real estate and credit boom, and is not likely to avoid a hard landing. The Shanghai Composite is in a major downtrend, declining 28% since April 2011. The view that China is immune because of their unique economic system reminds us of what people were saying about Japan in 1989.

The stock market is ignoring these fundamentals as it did in early 2000 and late 2007 in the belief that the Fed can pull another rabbit out its hat. It couldn't do it in 2000 or 2007 when it had plenty of weapons at its disposal. Now there is little that the Fed can do, although it will try since it will not get any help, as Senator Schumer so aptly pointed out at Bernanke's Senate testimony. In sum, we believe that the stock market is in store for a huge disappointment.

EARNINGS: Unit Revenues Must Fall Based Falling GDP & Inflation

Are Analysts' Revenue Estimates Signaling A Recession? 07-20-12 Zero Hedge

If inflation is running around 2%, a 1% increase in revenues means a negative 1% growth rate for units sold, assuming constant mix.

1. On average, the Street expects the 30 companies of the Dow to post only 1.0-1.5% year-over-year top line growth for Q3 2012, down from the 3.0-3.7% expectations it had baked into its financial models just 60 days ago.
2. Also, these analysts now peg Q4 2012 at 3.9% growth, but those numbers are falling quickly
3. Analysts are reducing their revenue expectations across the board – only 3 of the Dow 30 companies saw increased expectations for Q3 2012 revenues in the past 30 days, with a similarly dismal count for Q4 2012 expectations.

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Analysts started off 2012 thinking that Q3 and Q4 would average about 4-6% revenue growth for the Dow companies. By April, they began to grow a bit concerned, nibbling away at Q3 revenue estimates but leaving Q4 numbers largely unchanged. In May and June they started to ratchet back expectations more aggressively, to something more like 2-3% for Q3 and 4-5% for the final quarter of the year.

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1. For the third quarter of 2012, the analysts that cover the Dow stocks expect to see only 1.0 – 1.5% year-on-year top line growth for the overall index and the non-financial names, respectively. That will be the worst comparison since the Financial Crisis, and show sequential deceleration/stagnancy from Q2 2012’s expected 3.2% comp overall and 1.5% comparison for the non-financial names.
2. Analysts are still holding out some hope for Q4, but I can tell you from years of experience doing such models that this is probably because they do not want to reduce their full-year earnings estimates just yet.
3. What is also notable is that the cuts in expectations over the past 30 days have been widespread. Analysts are only marginally more bullish on 3 names of the Dow 30 for the back half of the year, and the increases in revenue growth here is miniscule.

CONVULUTED THINKING: When corporations feel the pinch from a slower economy, they lay off workers. When they lay off workers, the Fed executes on its dual mandate and increases liquidity. And when the Fed increases liquidity, stocks go up.

EARNINGS: Abysmal Earnings Season

The Abysmal Earnings Season Explained In Two Charts 07-21-12 Zero Hedge

The following two charts show just why any hopes that corporate earnings can mask the US economic deterioration this year, as they did in 2011 (probably the first and only way in which 2012 is not a carbon copy of 2011 so far), should be promptly dashed.

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Basically revenue growth is abysmal. But no surprise there - after all we have been warning for nearly a year that with the Fed intervening directly in corporation cash allocation decisions (via ZIRP), management teams are much more eager to hand out retained earnings in the form of dividends than reinvest via CapEx - an extremely short-sighted strategy and one that backfires immediately with cash-generating assets around the world already at record old age. (for more read: "How The Fed's Visible Hand Is Forcing Corporate Cash Mismanagement").

And with revenue growth absent, EPS can only grow if corporations cut even deeper into the muscle and let even more workers off, since employee pay is already abnormally low and can not realistically be cut any more. Sure enough, ex-financials, Year over Year EPS growth is now at 0% for the first time since the Lehman collapse!

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In other words, corporations have already extracted all the growth they could courtesy of ZIRP.

It is all downhill from here, as only the negative consequences of the Fed's disastrous policies now predominate in finance and the economy.

As an appendix, here is a full summary of the earnings season to date:

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