DEBT SATURATION - Rogoff's Sovereign Debt Default Levels

Sovereign Defaults Past And Present In One Chart 02-11-13 Zero Hedge

When a sovereign nation accumulates too much debt, far more than its economic growth can sustain, there are only two ways out: inflating the debt away, or defaulting. The global central banks have bet not only the house but the entire $700 trillion derivative house of cards that they can generate the former in order to preserve the equity tranche (controlled by the same entities that also control the central banks) above the insurmountable global debt load, and certainly there are more than enough historic examples of instances where a nation literally destroyed its currency by hyperinflation in order to eliminate the debt overhang. Because when it comes to getting the Goldilocks outcome of just enough inflation to slowly grind the debt away, the track record of the world's central planners is simply woeful.

The flipside to the great reflation operation is that while Bernanke and company try year after year to bring enough base money into the system to generate the "virtuous" inflationary cycle, they are increasingly hitting against the statutory limit, which in this case is the amount of debt in the system that keeps on rising year after year, until one day the central banks will have run out of time. This is the moment when global debt - both at the individual sovereign level and consolidated - is so vast, default is the only option. In other words, one can only attempt to reflate so many times before the time runs out.

As the chart below shows, in some 200 years of history, when expressed as a ratio of total sovereign debt to tax revenues, the empirical data as compiled by Reinhart and Rogoff ranges from 2x to 16x. This is shown by the blue bars in the chart below.

So where are we in this cycle as the debt clock counts down?

As the red bars show, we are in a very uncomfortable place, with Japan now at the highest such ratio in history, well above the highest recorded which always ended up in default, while the US, whose such ratio is over 600%, is above the long-term average of circa 520% in default triggering public debt/revenue. The problem is that every current and subsequent attempt to reflate merely pushes both of these higher, until one day the marginal growth creation of every dollar in new debt becomes negative.

How much higher can consolidated global debt go before global GDP is not only no longer growing, but every incremental dollar in debt has a negative impact on GDP, as was the case for the US in the fourth quarter? Keep an eye on global economic growth: if and when the world enters outright recession: the most feared outcome by all central bankers who realize they are out of weapons and their only recourse is much more of the same, that may be cue to quietly leave town.

And some further thoughts on this issue, courtesy of none other than Dylan Grice, circa precisely three years ago:

As is the case for today’s central bankers, Von Havenstein was faced with horrible fiscal problems; as is the case with today’s central bankers, the distinction between fiscal and monetary policy had blurred; as is the case for today’s central bankers, the political difficulty of deflating was daunting; and, as is the case for today’s QE-enthralled central bankers, apparently respectable economic theory reassured him that he was doing the right thing.

One might think that the big difference is that today we have a greater expertise. Surely we understand what happens when deficits are financed with printed money, and that it is only backward and corrupt states that don’t know any better, like Bolivia and Zimbabwe? But just a few years ago didn’t we think that it was only backward and corrupt states that suffered banking crises too?

And anyway, how could Von Havenstein not have known that the continued and escalating printing of money to fund government deficits would cause inflation? The United States experience of unrestrained money printing during the Civil War has been well documented, as had the hyperinflation of revolutionary France in the late 18th century. Isn’t it possible that, like today, he was overconfident in his ability to control his creation and in the economic theory which told him such control was possible? Certainly, in an article in the New York Times on the eve of the First World War, again from Liaquat Ahamed’s book, there seems to have been evidence of the general optimism that there would be no “unlimited issue of paper money and its steady depreciation … since monetary science is better understood at the present time than in those days.”

The fact is we do understand the economics of inflation. Despite what economists everywhere say about being in ‘uncharted territory’ with QE, we know that if you keep monetizing deficits eventually you get inflation, and we know that once you’re on that path it can be extremely difficult to get off it. But we knew that then. Despite what economists everywhere say about being in "uncharted territory" with QE, we know that if you keep monetizing deficits eventually you get inflation, and we know that once you're on that path it can be extremely difficult to get off it. But we knew that then. The real problem is that inflation is an inherently political variable and that concern over debt sustainability and unfunded welfare obligations leaves us more dependent on politicians than we have been in many decades. Frank Graham concluded his 1930 study of the Weimar hyperinflation with the following observation, which I think is as ominous as it is apt today:

"The mills of international finance grind slowly but their capacity is great. It is also flexible. The one condition is that the hoppers be not unduly loaded in the effort to get the whole grist from a single grinding. So much for the economics of the question. What politics has in store is, however, an inscrutable mystery. It can only be said that such financial difficulties as may occur will almost certainly arise from political rather than from economic sources."

STEALTH INFLATION - More than Just the Government Hiding Reality - A Grand Illusion

More Stealth Inflation As Maker’s Mark Slashes Alcohol Content 02-11-13 Michael Krieger of Liberty Blitzkrieg blog, via ZH

They just ain’t making Maker’s like they used to.  According to the company, an apparent bourbon shortage has besieged the company leaving it no choice but to cut the alcohol content of their booze from 45% to 42%.

I’m sorry, but this excuse reeks of marketing spin.  What manufacturer decides to dilute their product when they face high demand, rather than just raise the price by 3% and keep the quality intact?  In a world

1. where horse meat is increasingly finding its way into “all beef” product,
2. where biotech salmon is soon to hit the streets and
3. where Subway’s foot long sandwiches are less than 12 inches,

I’d be willing to bet this is simply just another case of good old fashioned stealth inflation.

From the UK’s Daily Mail:

Distillers of a world famous bourbon has cut its alcohol content so it can meet increasing demand for the drink.

The owners of Maker’s Mark, which is distilled Loretto, Kentucky, said they are unable to produce the bourbon fast enough.

It announced that the bourbon – which used the slogan ‘It tastes expensive… and is’ – will drop its alcohol content by three per cent.

It will now be reduced to 42 per cent ABV from 45 per cent.

Shame they couldn’t just dilute it with horse meat.

Full article here.

FUNDAMENTALS - Inflation Expectations and DCF

It's Not The Economy, It's Inflation & The Fed Stupid 02-11-13 Credit Suisse and Bloomberg via ZH

It will not be a great shock to ZH readers, but the sad truth (no matter what one is told by the plethora of talking heads and commission takers) is that neither EPS upgrades or EPS outlooks are in any way correlated to equity market performance. Instead, the central bank balance sheet size and forward inflation expectations are the key factors. As Credit Suisse notes, in fact over the past few years, EPS upgrades and outlooks are negatively correlated with stocks!

Even as current inflation (CPI) is supposedly fading, forward inflation expectations have risen and supported equity P/E valuations.

and until recently, central bank balance sheets remain supportive of stocks...

However, in the last few weeks, as stocks have surged ahead, a few things have changed with the world's central banks seeing the lowest growth in their balance sheets since the crisis began...

and in the last few weeks, forward inflation expectations have dropped notably - after peaking at post-crisis peaks once again...

So, it's not at all about the fundamentals; it's about the central banks and inflation - and in the short-term, they are losing some willpower - as the ECB is loathed to expand its balance sheet (which is the current drag) and implicitly weaken its currency (as we discussed earlier).

Source: Credit Suisse and Bloomberg

FLAWED FINANCIAL SYSTEM - Collapsed Marginal Utility

Occam's Gold vs Rube Goldberg's Fiat 02-11-13 Santiago Capital via ZH

From the 'simplicity' of a Gold Standard to the 'complexity' of our current fiat system, Santiago Capital draws a handy analogy between the over-complicated machines of 'Rube Goldberg' that represents the interactions between the various actors affecting the size and velocity of our monetary base and the 'simplest possible, but no simpler' world of 'Occam's Razor'-prone gold. In two brief presentations, Brent Johnson introduces the two systems and explains that in order to keep the shark of our economy alive, one of two things must happen:

1. monetary velocity must be maintained or the
2. monetary base must rise.

Obviously both are inflationary. From how the system is designed to its drastic implications, simple, brief, concise, and what to do about it.

Presentation 1: How The System Is Designed... Introducing Occam's Gold Standard and Goldberg's Fiat system, and the enormity of our credit-based fiat system's liabilities... and how new money enters the system.

Presentation 2: The Reality And Its Implications... What happened after the dot-com bust til now... the Fed plugging the hole... the monetary base has only contracted 8 times YoY in the last 93 years with the last significant contraction occurring 60 years ago... the Fed will not let it fall (or the shark is dead)... from the ramifications of false CPI to the ignorance of facts in the CBO projections, from "it just doesn't happen" to the marginal utility of new debt, there is only one way out for the Fed (and they need to keep it quiet from the masses)...

Simply put (by Stein) "If something cannot go on forever, it will stop"... whether we decide to do it ourselves or the market does it for us, our over complicated system of money is going to stop...

and as such - buy protection against this absolutely certain eventuality.

CANARIES - HYG Bonds and Euro Stoxx 50

Canaries in the Coal Mine Suggest Near Term Caution 02-08-13 Chris Puplava FSN

HYG BONDS - Shift Occurring in High Yield Credit

This Week's Data On Fund Flows Contain A New Disturbing Signal 02-08-13 BI

This week's record outflows from high-yield bond ETFs could be a warning sign for investors in risk assets

ETF - Hold 20 Percent of HG - HY Corporates

Rising Rates Could Create A Disorderly Bond Market Sell-Off Unlike Anything We've Ever Seen 02-05-13 BI

The Wall Street consensus is that Treasury yields are headed higher in 2013. That's big news because it could mark the end of a three-decade bull market in bonds.

Strategists expect those higher yields – driven by an upturn in economic growth – to cause bond investors, who after three decades aren't used to seeing negative returns, to reallocate toward equities. Hence, a "Great Rotation."

The prospect of higher yields has the government bond market on edge, but it's also sparked some intense analysis of what could happen to corporate debt markets if rates rise. The rumblings from a few firms in notes to clients are that not everyone is going to come out a winner.

To put it another way, rising rates could wreak serious havoc on corporate debt markets.

BofA credit strategist Hans Mikkelsen describes how it could unfold in what he describes as the "biggest risk" to the market in a note to clients:

In our view, a disorderly rotation out of bonds – characterized by higher interest rates and wider credit spreads – is the biggest risk for investment grade corporate bond investors this year. The key problem is that, with the rise of bond funds and ETFs, individual investors now have a means to trade illiquid corporate bonds in a much more liquid manner.

When interest rates rise and NAVs decline, we are concerned that redemptions will lead to a situation where too many illiquid underlying corporate bonds come out of funds – especially as dealers have little capacity to act as buffer in the new regulatory environment.

Forced selling – and no one to take the other side of the trade.

 "But we have never seen a disorderly rotation," writes Mikkelsen. So, how that sort of scenario would pan out is uncertain.

We have seen two big moves out of bonds spurred by rising interest rates, in 1994 and in 1999, but the picture is radically different now, thanks to the rise of mutual funds in the corporate bond market.

Federal Reserve Flow of Funds, BofA Merrill Lynch Global Research

Mutual funds and ETFs, whose investors are typically going to head for the exits if they observe negative returns, have accounted for a big portion of the buying in recent years as investors across the spectrum have searched for yield. Thus, a decent share of the market is exposed to forced selling by these funds.

In comparing today's set-up to 1994 and 1999, Mikkelsen writes:

However, what is different this time is that, following continued declining interest rates and quantitative easing, bond fund assets under management have expanded significantly.

Moreover, the share of corporate bonds in mutual fund fixed income assets has increased to 42% from 24% in 1994 and 31% in 1999. Hence, mutual funds and ETFs now own 19% of the corporate bond market (high grade and high yield), up sharply from 9% and 10% in 1994 and 1999, respectively.

Thus, if we were to experience outflows from bond funds of the magnitude seen in 1994 and 1999, the impact on corporate bonds this time would be much more severe.

On top of the illiquid nature of the instruments being used to trade corporate bonds and the growing share of the market held by those instruments, there may be another massive, secular headwind for credit markets to contend with if things really pan out for the American economy.

The "Great Rotation" itself.

Huge January flows into equity funds weren't a sign of the Rotation, but it still exists as a prediction for the latter half of 2013 or 2014 if U.S. economic growth picks up as market economists expect.

So, here is what the "Great Rotation" looks like from the credit perspective, according to Mikkelsen:

Moreover, following the extended declines in interest rates, and associated outsized fixed income total returns, households now hold more than 13% of their financial assets in fixed income – at the upper end of the historical range and sharply above the low of 8% we saw more than 30-years ago in the early 1980s before interest rates began their secular decline.

This higher fixed income allocation to us is a direct result of the extended environment of declining interest rates – when interest rates start increasing, we look for households to reduce allocations to fixed income. This, despite the underlying bond friendly demographics.

Of course households’ percentage allocation to fixed income automatically declines when stock prices increase – but there is reason to suspect that households will play a more active role in rebalancing out of bonds, into stocks as interest rates increase.

Combine the "Great Rotation" with a corporate bond market uniquely vulnerable to rising interest rates and credit markets may have a tough go of it this year or next.

Mikkelsen thinks 10-year Treasury yields would have to keep rising past 2.5 percent and on toward 3 percent in 2013 in order for a sell-off in credit like the one described above to occur.

"Timing is obviously also important," he writes, "as the disorderly scenario requires a fairly rapid, as opposed to slow and drawn out, increase in rates."

Citi strategist Stephen Antczak, on the other hand, writes that if 10-year yields rise "anywhere near what our economists expect (again, 2.5% by year end)," that total returns in bond funds could be negative, which would create a forced selling situation

HY - No Returns

From Risk-Return To "No Risk, No Return" Courtesy Of Central Planning 02-08-13 Diapason Commodities via ZH

Central Banks have repressed the sovereign bond markets of the world's currency printers to extreme. This relative pricing makes stocks look extremely cheap on an equity risk premium basis (thank you Ben); however, everyone knows this and, as we have discussed many times, margin balances and net long positions are as high as they have ever been. A zealous belief in the power of the central bank has compressed the market's risk perception to near-zero - but at the same time, returns have been crushed as even junk bond yields are at record lows. In other words - there is no risk any more, and no conventional return. Or rather, the only "return" is in the wholesale herding of cattle into the "safety" of the equity beta butcher house.

Equity risk premium (relative to repressed bonds) make stocks look 'attractive'...

But everyone knows that...

leaving No Risk...

and no conventional return either...

This won't end well...

200 Years Of Escalating Policy Mistakes 02-08-13 Zero Hedge

"Central Bankers and policymakers can’t stop themselves from interfering." To be fair on them (unusual in his case), SocGen's Albert Edwards admits the pressure to do something in the face of “bad” economic news is overwhelming. The general public or more inconveniently, the electorate, clamor for action from policymakers to counter any economic pain. Any ‘Austrian School’-type suggestion that it is best to let the cycle play out is derided as heartless and defeatist. Something can and must always be done. Whether intervention makes things worse in the medium to long run is an inconvenience that can be ignored until later. We feel Edwards pain as he "sheds tears of despair as [he] was reminded of the blundering incompetence of our overconfident policymakers, whose interventions, despite their best intentions, seem to bring about financial crises with increasing rather than decreasing regularity."

STATISM - It Takes A Compliant Society

Seldom do moral questions come into the discussions of eliminating enemies of the state.

Drone Wrath for a Compliant Society 02-10-13 Sartre BATR.org

The military has transformed warfare into a deadly computer game with drone weapons. Media programs like Weaponology or Future Weapons on the Military Channel provide detailed examples of the lethalness of autonomous technology. The use of drones as the preferred method of carnage is well established. Seldom do moral questions come into the discussions of eliminating enemies of the state. The rules of engagement vested in international law and the Geneva Convention, either ignored or rewritten for high-tech 21st Century combat, becomes the foundational tactic to maintain the killing force of the grand empire.  

The video, Remote Control War, is an informative summary of the capabilities and uses of a drone air force. After viewing the range of aftermaths from GPS targeting, ponder the role of perpetual DARPA conflict. The distress from invented terrorism is used against the American public as a tool to incrementally relinquish basic rights and individual liberties. Matt K. Lewis offers up this assessment in an item published by This Week, Obama, drones, and the blissful ignorance of Americans.

"And here's the ugly truth: Obama is giving us what we want . . .

Americans, it turns out, don't really have the stomach for the unseemly business of taking prisoners, extracting information from prisoners, and then (maybe) going through the emotional, time consuming, and costly business of a trial.

American citizens want someone who will make the big, bad world disappear. Problems only exist if we have to confront them. Obama has made warfare more convenient for us — and less emotionally taxing."

Beware of the unseen predators over foreign lands for the blowback is the real source of the instability and a root cause of hatred for American hegemony. What you are witnessing is the imbalance between Legislature and the Presidency. The war powers responsibility of Congress, long surrendered to the imperial commander and chief of killing incorporated is a national tragedy.

In another TW article, Peter Weber raises an essential question, Will Congress curb Obama's drone strikes?, provides a mainstream assessment that seems lacking within the federal government.

"Since at least the 9/11 attacks, Congress has been less than confrontational with the White House over presidential powers to conduct war and anti-terrorism operations, to the dismay of civil libertarians. So we had President George W. Bush's warrantless domestic wiretaps retroactively green-lighted by Congress, torture only officially nixed by a change in presidents, and a big ramping-up of lethal drones being used to kill terrorism suspects under President Obama. But Obama's decision to kill at least two Americans working for al Qaeda in Yemen in 2011, and the legal justification that emerged in a leaked white paper (read below) this week, has caused a big, unusual outcry from both the Left and Right."

The esteemed New York Times, part of the Obama fawning media, continues to carry water for the administration in Congress to See Memo Backing Drone Attacks on Americans.

"This week, NBC News obtained an unclassified, shorter "white paper" that detailed some of the legal analysis about killing a citizen and was apparently derived from the classified Awlaki memorandum. The paper said the United States could target a citizen if he was a senior operational leader of Al Qaeda involved in plots against the country and if his capture was not feasible."

One might be accused of NYT bashing if you dare point out that their reporting resembles a briefing session from White House press secretary, Jay Carney. The use of warbots on home soil is a short step from spreading terminal sanctions of homeland security.

Reason.com warns of the threat from a robotic police state and the common ground to oppose this misuse of surveillance in the essay, The Bipartisan Opposition to Domestic Drones.

"Both the progressive American Civil Liberties Union and the libertarian Rutherford Institute cheer legislative efforts to place strict limits on unmanned aerial vehicles, or UAVs. And, prodded by privacy groups, state lawmakers nationwide-Republicans and Democrats alike-have launched an all-out offensive against the unmanned aerial vehicles.

The prospect of cheap, small, portable flying video surveillance machines threatens to eradicate existing practical limits on aerial monitoring and allow for pervasive surveillance, police fishing expeditions and abusive use of these tools in way that could eliminate the privacy Americans have traditionally enjoyed in their movements and activities," the bill's author, Sen. Robyn Driscoll, a Democrat from Billings, testified."

The ACLU presents a list of provisions that the Civil Liberties organization advocates. AlsoRead the ACLU's full report on domestic drones. "Congress has ordered the Federal Aviation Administration to change airspace rules to make it much easier for police nationwide to use domestic drones, but the law does not include badly needed privacy protections. The ACLU recommends the following safeguards:

USAGE LIMITS: Drones should be deployed by law enforcement only with a warrant, in an emergency, or when there are specific and articulable grounds to believe that the drone will collect evidence relating to a specific criminal act.

DATA RETENTION: Images should be retained only when there is reasonable suspicion that they contain evidence of a crime or are relevant to an ongoing investigation or trial.

POLICY: Usage policy on domestic drones should be decided by the public's representatives, not by police departments, and the policies should be clear, written, and open to the public.

ABUSE PREVENTION & ACCOUNTABILITY: Use of domestic drones should be subject to open audits and proper oversight to prevent misuse.

WEAPONS: Domestic drones should not be equipped with lethal or non-lethal weapons."

Relying on Rutherford Institute Model Resolution, Charlottesville Becomes First U.S. City to Limit Police Drones; TRI Calls on Rest of Country to Follow Suit.

"In a 3-2 vote, members of the Charlottesville City Council adopted a resolution drafted by The Rutherford Institute which urges the Virginia General Assembly to prevent police agencies from utilizing drones outfitted with anti-personnel devices such as tasers and tear gas and prohibit the government from using data recorded via police spy drones in criminal prosecutions. In so doing, Charlottesville has become the first city in the country to limit the use of police spy drones, providing momentum and inspiration for other cities across the country to follow suit.

The passage of the resolution, which also places a two-year moratorium on the use of drones within city limits, coincides with a Department of Justice memo leaked to the media which outlines the Obama administration's rationale for assassinating U.S. citizens via drone strike. With at least 30,000 drones expected to occupy U.S. airspace by 2020, John W. Whitehead, president of The Rutherford Institute, has called on government officials at the local, state, and federal level to do their part to safeguard Americans against the use of drones by police. Rutherford Institute attorneys have drafted and made available to the public language that can be adopted at all levels of government in order to address concerns being raised about the threats posed by drones to citizens' privacy."

When was the last time that a civil liberty issue developed an alliance of purpose to oppose the despotism of the totalitarian murder regime?

The Judge Napolitano YouTube: Killing Americans with Drones is Nowhere Justifiable Under The Constitution, goes unheeded as the country sinks into a zombie trance of public acquiescence. The compliant society is rooted in denial and disbelief.

Even so, some of the more perceptive state legislatures are waking up to the danger of domestic drone operations. Texas "Anti Drone" Laws Would be Toughest in USA, and "prohibit federal law enforcement or federal officials from flying drones over Texas to spy on random citizens. Only individuals who are suspected with reasonable cause could be the target of drone surveillance, and only with a warrant issued by a judge of an open and public court."

Politico details, "Virginia Gov. Bob McDonnell has not decided whether he will sign a bill barring state and local agencies from using drones for two years — the first legislation of its kind in the country that passed through the state’s General Assembly Tuesday with bipartisan support."

The National Defense Authorization Act is the latest unconstitutional measure that targets domestic citizens for punitive punishment. Due process, now reduced to "Due or Die" is the harbinger of the use of domestic drone capitulation. What will it take to awaken submissive citizens that the capability of foreign deployed drones easily can be weaponized for local operations?

The Obama administration has demonstrated an eagerness to trump up a bogus domestic terrorist threat that requires a surrender of our Bill of Rights. Reaper drones are a much greater peril than just a violation of privacy. A technology that is rapidly expanding and designed to militarize the police state into a killing field of reputed rebellious Americans - violates true national security.

"Making warfare more convenient and less emotionally taxing" is the direct opposite of the horror of battle. When a false flag surgical strike targets your location and your person, it will not be an episode in a computer simulation.