JAPANESE RECESSION - Third Streight Quarter

Japan Contracts Third Straight Quarter; No Escape 02-13-13 Mish

RISK - Canary Signs - Covenant Lite Loans Are Back Again

Cov-Lite Loans Hit Record In 2012 As January High Yield Covenant Protection Drops To New Lows 02-12-13 Zero Hedge

Those who traded credit in the frothy days of 2007 will recall that virtually every piece of new paper, including LBO debt, would come to market with the skimpiest of creditor protections, i.e., "covenant lite" which to many was an indication that money was literally being thrown without any discrimination in the last epic chase for yield, just as many were preparing for the imminent market backlash. Which they got shortly thereafter. Judging by the amount of covenant lite loans issued in 2012 as a percentage of total and compiled by Brandywine Management, which just surpassed the credit bubble frenzy of 2007 at more than 30% of total issuance, the bubble in credit is now well and truly back - a job well done Federal Reserve, just 5 years after the last credit bubble.

And that's just for loans.

A quick look at high yield bond space shows exactly the same, with Moody's reporting that the covenant quality of North American high-yield bonds continued to slide in January, and has hit a new low in the month of January.

From Moody's:

Moody's Investors Service says in its second monthly report on its recently launched Covenant Quality Index (CQI). The index shows that covenant quality began to erode last July, at the same time that high-yield bond issuance started to climb.

"Our three-month rolling average CQI deteriorated to 3.89 in January from 3.79 in December," says Alexander Dill, Head of Covenant Research at Moody's and author of "Bond Covenant Quality Resumes Slide." "The single-month score for January was 4.08, a marked deterioration from 3.55 in December and the previous low of 4.06 in November."

The CQI uses a five-point scale, with 1.0 representing the strongest covenant protections and 5.0, the weakest. It peaked at 3.40 last July.

But investors are not being compensated for accepting weaker covenants, Dill says. "While investors are taking on more covenant risk, average spreads to benchmark yields have tightened, fueled by strong demand and a record volume of issuance." Indeed, the average benchmark spread of bonds in Moody's High-Yield Covenant issued since October is close to the level seen in the first half of 2011, though the CQI shows much weaker covenants.

Last month's decline can be explained largely by an increase in high-yield-lite issuance. High-yield lite covenant packages, which lack a restricted payments and/or a debt-incurrence covenant, accounted for 34.6% of issuance in January, compared with 3.2% in December. Continuing a recent trend to convert to high-yield lite from full high-yield covenant packages, Netflix, Lear and Crown Americas all issued bonds with high-yield lite packages last month.

January also saw a higher percentage of bonds rated Ba, which generally have high-yield-lite covenant packages or full covenant packages with low covenant quality. These accounted for 58% of issuance in January, compared with the average of 27% since Moody's began tracking the CQI in January 2011.

Luckily, just like in 2007, there is no risk at all of overheating: after all the Fed has a tremendous track record of intercepting bubbles in the credit, housing, and "stocks with an N/M PE multiple" asset classes. Surely they will deal with this one promptly and resolutely.

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...

REGULATORY ARBITRAGE - Looks Like Land Bansk Are the Next Transfer to the Public

Euro-Land Banks In Trouble 02-15-13 Pater Tenebrarum of Acting-Man blog, via ZH

A recent study by Ernst & Young has revealed that euro-land banks in the aggregate now hold € 918 billion ($1.23 trn.) in non-performing loans (7.6% of all loans outstanding). E&Y sees about 15.5% of all loans in Spain and 10.2% of all loans in Italy as likely to be in NPL status (this exceeds the most recent official numbers somewhat).

In light of such staggering numbers, the idea to use the ESM for direct bank recapitalization seems somewhat ambitious. This is especially so as the idea to employ the ESM to take over the costs of already bailed out banks is being pushed by a number of euro area members. No doubt Ireland and Spain would be happy to see that (in fact, Spain is already the 'exception' as the ESM is potentially on the hook for € 100 billion for its banks – but this is structured as a loan to Spain's government, not a direct bank bailout).

The problem is that if the ESM wants to retain its AAA rating, it will have to back any financing it obtains from the markets with far higher guarantees if it rescues banks rather than governments. Given that what has been pumped into ailing euro-zone banks to date already amounts to €300 billion,  its official capacity could be quickly exceeded if these existing bailout commitments were taken over by it.

Taxpayer-funded bank rescues in the euro area so far – the total already amounts to €300 billion, and that is not counting what might be used to bail out Cypriot banks and what may still be required in Italy and Spain (chart via Die Welt).

CURRENCY WARS -UK Kings Response - Applying ever more monetary stimulus is like 'Running up a Hill'.

Countries are using devaluation to gain an advantage - and Britain is one of the worst offenders 02-13-13 Jeremy Warner The Telegraph

EUROPEAN RECESSION - Eurozone Contracts 0.6%

Eurozone Economy Contracts .6% in 4th Quarter; France Down .3%, Germany Down .6%, Italy Down .9%; Expect ECB Jawboning on the "Strong Euro"02-14-13 Mish

As expected in this quarter (but not by economists) eurozone economies contracted at the sharpest rates in four years with Germany, France, and Italy falling short of consensus estimates.

The eurozone consensus was .4%. The 17-nation bloc shrank at .6% quarter-on-quarter while the broader 27-nation bloc shrank .5% quarter-on-quarter.

From the above Financial Times link:

Germany and France, the eurozone’s two biggest economies, both saw output shrink. German GDP shrank 0.6 per cent in the period while France contracted 0.3 per cent compared with the previous three months. Both were marginally worse than the consensus forecasts of 0.5 per cent and 0.2 per cent respectively.

Italy’s economy shrank 0.9 per cent, also more than expected, and its sixth consecutive fall. Both Dutch and Austrian GDP also contracted. The figure for the wider EU – all 27 member states – was a fall of 0.5 per cent.

The steep German decline reflected a sharp drop in net exports and investment in plants and machinery. Although business surveys have been much more upbeat, the weakness underscores how the recent appreciation of the euro could threaten an export-led recovery.

Insee, France’s national statistics agency, said manufacturing output fell 2.3 per cent in the fourth quarter after a 0.9 per cent rise in the third quarter.

1. Germany gives (not lends) more bailout money to the rest of Europe
2. The eurozone breaks up

GLOBAL RECESSION - String Signs of a Potential Global Recession (Defined by <3%)

Global Q4 GDPs Dump 02-14-13 Zero Hedge

It started overnight in Japan, where Q4 GDP posted a surprising and disappointing 3rd quarter of declines, then quickly spread to France, whose Q4 GDP declined -0.3% Q/Q missing expectations of a -0.2% drop, down from a +0.1% increase, then Germany, whose GDP also missed expectations of a -0.5% drop, declining from a +0.2% increase to a -0.6% drop, then on to Italy (-0.9% vs Exp. -0.6%, last -0.2%), Portugal (-1.8%, Exp. -1.0%, last -0.9%), Greece (down -6.0%, previously -6.7%), Hungary (-0.9%, Exp. -0.3%), Austria (-0.2%, down from 0.1%), Cyprus (-3.1%, last -2.0%), and so on.

To summarize: Eurozone GDP dropped far more than expected, or posting a -0.6% decline in Q4, worse than the -0.4% expected, which was the largest drop since Q1 2009, and down from the -0.1% posted in Q3. And since this was a second consecutive negative quarter of GDP decline for the Eurozone, the technical recession (double dip? triple dip? is anyone even counting anymore?) in Europe too is now official.

Who could have possibly foreseen this disappointing development for Europe? Maybe all those who were warning that for the frail and weak continent the last thing it needed was a surge in the currency, which is precisely what it got in Q4. Sure enough, the EURUSD has tumbled over 100 pips overnight, with more fuel added to the flames courtesy of the ECB's Constancio who added out of the blue that negative interest rates are always possible, and the ECB is technically read if needed - hardly the statement one makes if one wants to push their currency higher.

Sure enough, the EURUSD was trading at just about 1.330 at last check, and likely to test recent support levels.

And since the US futures trade in lockstep with the EURUSD, please don't adjust your monitors: that odd non-green color of the futures is not a malfunction.

Some more from Goldman on the European economic collapse in Q4:

Broad-based negative surprise in largest EMU economies. The country breakdown showed that outturns in Germany, France and Italy were all weaker than expected.

• Germany: -0.6%qoq in Q4 after +0.2%qoq in Q3. The statistical office does not provide a breakdown by expenditure components (which will be released on February 22), but suggested that domestic demand was mixed: both private and public consumption increased slightly, while investment probably declined strongly. The contribution from net trade to GDP was negative, with the decline of exports outpacing the decline in imports.

• France: -0.3%qoq in Q4 after +0.1%qoq in Q3. The breakdown by expenditure components was somewhat more positive than the headline GDP reading. Private consumption remained resilient, growing by 0.2%qoq, and public consumption continued to support activity (+0.4%qoq). However, investment declined at a faster pace than in Q3 (-1.0%qoq in Q4 after -0.5%qoq). Overall, the contribution of total domestic demand (excluding inventory changes) was flat in Q4, down from +0.1ppt in Q4. Net trade contributed positively to growth for the second consecutive quarter (+0.1ppt after +0.3ppt in Q3), with the contraction of imports (-0.8%qoq) outpacing the contraction of exports (-0.6%qoq). Changes to inventories shaved 0.4ppt off French GDP in Q4, dragging the aggregate figure into negative territory.

• Italy: -0.9%qoq in Q4 after -0.2%% in Q3. The pace of contraction of 0.9%qoq (after -0.2%qoq in Q3) in Italy was significantly more acute than expected (Cons:-0.6%qoq, GS: -0.3%qoq). A detailed breakdown of the data will not be available until March 11. The surprisingly weak GDP data come at a sensitive time in the election campaign and could potentially damage support for the existing austerity/reform programme. The parliamentary elections will be held on February 24 and 25.

• Spain: -0.7%qoq in Q4 after -0.4%qoq in Q3 (already published on January 29). The outturn was also slightly weaker than Consensus and our expectations for -0.6%qoq. The preliminary data release provides no breakdown in terms of output by sector or by expenditure component (to be published on February 28). A weak quarter was, however, expected on the basis of the consumer spending response to September's VAT rise.

Smaller economies - including core countries - in negative territory. Q4 GDP in Portugal was particularly weak: it contracted sharply by 1.8%qoq after -0.9%qoq. Finnish GDP contracted 0.5% in Q4, after -0.3% in Q3, while both Dutch and Austrian outputs were down 0.2%qoq.

Some comments on the EURUSD response, and other currency pairs, after the ugly economic data via Bloomberg:

ING:

• EUR/USD correcting, with outside risk to 1.3260 area, ING’s Chris Turner and Tom Levinson say after GDP data; 1.3430/60 should be the sell area
• Widening European sovereign CDS spreads may also prove mild EUR negative; watch for interest in short EUR cross trades again with short EUR/NZD increasingly popular
• Signs of independent weakness in EUR may weigh on EUR/JPY, USD/JPY; break of 93.00 in USD/JPY risks losses to 92.00/92.20 area

Danske Bank:

• Fundamental case for weaker JPY remains, though pace of weakening may “slow substantially” vs recent months
• Cites likely candidate for new BOJ governor comments that inflation targets wouldn’t be attainable without JPY correction; USD/JPY in the 90-100 range would mark return to equilibrium
• May see additional easing linked to April 3-4 BOJ meeting with possible new dovish majority on board
• Looks for G-20 to affirm that countries’ current policies don’t represent exchange-rate manipulation

Deutsche Bank:

• Market underestimating negative impact of BoE monetary policy on medium-term GBP outlook, note to clients says
• EUR/GBP PPP adjusted for CPI 0.81 vs 0.75 a few years ago, wedge between unit labor costs in U.K. and euro zone increasing at even faster  pace; with costs in euro zone collapsing on debt crisis, EUR/GBP PPP likely to rise “even faster” in coming years
• Gilt market/GBP correlations recently have been turning
• Targets another 5% move in trade-weighted index, looks for EUR/GBP to reach low 0.90s, GBP/USD to eventually drop to low 1.40s by year end

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."

ASIAN DOMINANCE - China-US Cold War

Welcome To The New Cold War 02-15-13 Asia Confidential via ZH

Make no mistake: America and China are on a collision course and the battleground is Asia.

The China-Japan dispute has little to do with a small group of islands in the South China Sea. It's about a new world power, China, wanting to assert its authority in Asia. And it's about the U.S being threatened by China's increasing power and wanting to contain it. That's what makes the current dispute so dangerous. Even if the fight dies down, the battle for dominance in Asia between the U.S. and China will continue.

 For investors, the implications from this are not only the potential for

1. Increased trade disputes between the U.S and China. But also, the
2. Likelihood of rising friction between Asian countries themselves.

In fact, we're already seeing it as these countries are being forced to side with either America or China. Intra-Asian trade will be impacted too. Welcome to the new Cold War.

Asia is the new battleground

.... Which brings me to the present day. I can't help but thinking that we're entering a new period of rising tensions between countries. As well as a Cold War in Asia. The 2008 financial crisis and subsequent economic downturn, as well as rising food inflation, have led to the fall of several, once-considered impregnable governments in the Middle East. The installation of new governments in their place is proving problematic.

By contrast, increasing tensions in Asia have nothing to do with the economic downturn or food inflation. Instead, they've come about from the rise of China as a new world power. China is staking its claims as a world power both economically and politically, focusing particularly on its own neighbourhood, Asia. And other nations are increasingly concerned about it.

China-Japan dispute: appearances deceive 

The current conflict between China and Japan is supposedly over five tiny, uninhabited islands, Senkaku or Diaoyu islands, in the South China Sea. And the abundant natural gas in the area. China has been challenging Japan's claims over the Senkaku islands and its control of them. The situation has become increasingly tense and in late January there was almost a shoot-out. Japan claims that China beamed fire control radar at a destroyer owned by the Japanese Navy - a first step to potentially firing a missile at it.

The dangers of the conflict lay with politicians on all sides wanting to prove their military credentials by appearing tougher than the one another, with little regard for the consequences. This kind of behaviour is similar to that which almost led to catastrophic consequences during the Cuban missile crisis in 1962.

Stepping back from the minutiae of the dispute though,

it's ultimately about the changing balance of power in Asia.

China has already become an economic power, now being the world's second largest economy. It's Asia's largest trading partner in both exports and imports. It's seeking the political power to match its economic might. And it's aggressively building military capabilities to achieve this goal.

Japan, on the other hand, is angry over China's economic prowess and wary of its political ambitions in the region. Japan has watched its share of imports in all markets shrink while China's share has rapidly expanded. Japanese companies have been forced to shift the production of manufactured goods to China and other low-cost countries, which has contributed to the country's depressed economic activity. The current dispute is effectively Japan's way of saying: "enough is enough".

Of course, Japan's principle ally in Asia is America. The U.S. has publicly remained neutral over the disputed islands, but privately there's little doubt that it's siding with Japan.

The backdrop is that the U.S. has historically been Asia's most influential political power but the dynamics are changing with the rise of China. That's why official American foreign policy has been to "pivot" towards Asia and away from area such as the Middle East. China believes that this pivot is about the U.S. containing its power and it's right. Of course, America denies this but logic dictates otherwise.

In a previous note, I suggested that it was no coincidence that The New York Times ran arguably anti-China stories U.S. election. I love the Times and some of the stories, such as Premier Wen's family secret fortune, were fantastic pieces of journalism. But I've got no doubt that the sources feeding these anti-China articles were mostly from the Obama administration. It's part of a toughened stance towards China.

Asia is splintering 

Thus far, the U.S. has played its hand well in Asia. It's strengthened relationships with Vietnam and the Philippines by subtly backing their own claims against China to territories in the South China Seas. It's also strengthened military alliances with South Korea, Singapore, Indonesia and Australia. And it's managed to become a key ally to Myanmar, a country with immense potential that is starting to open up to the world, and where China arguably has blundered.

Asia itself has splintered. Countries are being forced to ally with the U.S. or China. "You're either with us or against us" in military speak. This trend is most apparent at the 10-member, Association of South-East Asian Nations (Asean). Asean has practically stopped functioning because of the bickering over China's territorial claims in the South China Sea.

Last year, Cambodia chaired the association and as an ally to China, pressed its friend's territorial claims. Vietnam and the Philippines strongly objected, and the various arguments became public at Asean meetings. With Brunei now chairing the association, it's hoped these arguments will die down.

But I wouldn't count on it. Asean is pushing for a collective agreement over China's claims while China itself only wants discussions and/or agreements with the countries directly impacted by the claims. In short, expect more diplomatic posturing and possibly open hostility.

Why it matters for investors 

There are several implications from this new Cold War.

In any war, cold or otherwise, trade usually suffers. You're likely to see the U.S. and China introduce new trade tariffs and sanctions between the two countries.

The U.S. will also start pressuring Asian allies to align their investment policies with it. From China's side, you're already seeing work to move away from the dollar as the world's reserve currency.

Of course, the elephant in the room is China being the second-largest holder of U.S. government debt. For economic reasons, China's already started to reduce its holdings due to reduced foreign currency reserve growth (which we've talked about recently).

The implications of this new war spread much further than just the U.S.-China relationship though. Intra-Asian trade will be impacted too. Consider that

exports within Asia account for around 56% of total Asian exports.

In other words, Asia matters more than the rest of the world. Consider also that intra-Asia trade grew 3.5x over the past decade, or a 15% Cagr. Tidy.

Hat tip: Joshua Saldanha.

China's export trade share in Asia though has fallen from 51% in 2002 to 44% now. It's become more export dependent on the rest of the world and less on Asia.

On the other hand, Asean has benefited greatly from intra-Asian trade. As a percentage of total exports, Asia accounts for 69% of Asean exports, up from 60% a decade ago. It's not hard to see that Asean could be a big loser from increased trade frictions.

Source: http://asiaconf.com

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

STATE OF THE UNION - How The Administration Wants to Grow the US Economy

STATE OF THE UNION

Text of Speech

These Are The 17 Things We Can Do To Grow The Economy 02-12-13 White House

White House Economic Plan by

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.

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."

BANK DEPOSITS - Will Soon See Competition Against Prop Desks for Excess Bank Deposits

Investors' Attitudes Toward Corporate Cash Hoards Have Made A Major Bullish Shift 02-12-13 BI

As the credit markets froze during the height of the financial crisis, companies who relied on the short-term debt markets to finance their day-to-day operations quickly learned the importance of having liquidity on their books in the form of cash.  Even the healthiest companies found themselves struggling to pay their employees due to the credit crunch.

However, the financial markets have improved significantly since the crisis.

Bank of America Merrill Lynch's Michael Hartnett just published this chart showing investors' evolving attitudes toward corporate cash.

And it tells us everything.

As you can see from the dotted line, during the financial crisis, investors wanted companies to use their cash flows to slash debt and build up their cash positions.

After the crisis, we were left with a global economy in critical condition with limited growth prospects. As you can see from black line trending up, investors wanted their shareholder value returned in the form of dividends and buybacks.

But in more recent months, you can see a burst of optimism manifesting in the blue line, which represents the desire for more capital expenditures.  In other words, investors want companies to take some risk and invest in growth.

This is a very clear shift in investors attitudes toward cash deployment.

REAL WEALTH - Unencumbered DCF -- Free Cash Flow is KING!

It Sure Feels Like A Recession 02-12-13 Morgan Stanley via ZH

While stocks suggest all is well, and anecdotal macro data (seasonally slandered by fiscal cliff drag-forwards and 'weather') might offer hope that green shoots are back; one glance at the following chart of US, Europe, and Asia (ex-Japan) EBITDA tells a very different story. With cashflow clearly barely budging, is it any wonder that companies are creating conservative balance sheets? It sure feels like a recessionary environment...

Morgan Stanley

GORDONTLONG.COM MARKUP

SECURITY-SURVEILLANCE COMPLEX - Stealth and Unconstitutional

Meet Stingray Surveillance: The "Unconstitutional, All-You-Can-Eat Data Buffet" 02-13-13 Michael Krieger of Liberty Blitzkrieg blog,via ZH

It’s getting impossible to keep track of all the new spy tools being rolled out by the police state in the name of “fighting terrorism”, aka spying on innocent American citizens unconstitutionally.  I thought that I had my hands full the other day with ARGUS: The World’s Highest Resolution Video Surveillance Platform, but this “Stingray” system is already being deployed illegally in cities throughout the United States.  As the EFF states: “The Stingray is the digital equivalent of the pre-revolutionary British soldier.”  From the EFF:

The device, which acts as a fake cell phone tower, essentially allows the government to electronically search large areas for a particular cell phone’s signal—sucking down data on potentially thousands of innocent people along the way. At the same time, law enforcement has attempted use them while avoiding many of the traditional limitations set forth in the Constitution, like individualized warrants. This is why we called the tool “an unconstitutional, all-you-can-eat data buffet.”

Recently, LA Weekly reported the Los Angeles Police Department (LAPD) got a Department of Homeland Security (DHS) grant in 2006 to buy a stingray. The original grant request said it would be used for “regional terrorism investigations.” Instead LAPD has been using it for just about any investigation imaginable.

Of course, we’ve seen this pattern over and over and over. The government uses “terrorism” as a catalyst to gain some powerful new surveillance tool or ability, and then turns around and uses it on ordinary citizens, severely infringing on their civil liberties in the process.

Stingrays are particularly odious given they give police dangerous “general warrant” powers, which the founding fathers specifically drafted the Fourth Amendment to prevent. In pre-revolutionary America, British soldiers used “general warrants” as authority to go house-to-house in a particular neighborhood, looking for whatever they please, without specifying an individual or place to be searched.

The Stingray is the digital equivalent of the pre-revolutionary British soldier.

On March 28th, the judge overseeing the Rigmaiden case, which we wrote about previously, will hold a hearing on whether evidence obtained using a stringray should be suppressed.  It will be one of the first times a judge will rules on the constitutionality of these devices in federal court.

It will be interesting to see what happens in late March.  I will be watching.

Full article here.

As Secretive "Stingray" Surveillance Tool Becomes More Pervasive, Questions Over Its Illegality Increase 02-12-13

THE ROADMAP - Argentina Shows the Way

This Is What Textbook Capital Controls Look Like 02-12-13 Simon Black of Sovereign Man blog, via ZH

Selling snake oil and issuing unbacked paper currency are not so different. They're both wildly successful ploys for the guys pulling the strings. And they're both complete scams that depend solely on the confidence of a willing, ignorant public.

But once the confidence begins to erode, the fraud unravels very, very quickly, and the perpetrators resort to desperate measures in order to keep the party going.

In the case of fiat currency, governments in terminal decline resort to a very limited, highly predictable playbook in which they try to control... everything...

1. imposing capital controls,
2. exchange controls,
3. wage controls,
4. price controls,
5. trade controls,
6. border controls, and
7. sometimes even people controls.

These tactics have been used since the ancient Sumerians. This time is not different.

Today, Argentina presents the most clear-cut example. Here the 'mafiocracy' unites organized crime, big business, and politicians to plunder wealth from Argentine citizens. Just since 2010, President Cristina Fernandez has--

* Nationalized private pensions, plundering the retirement savings of her people.

* Increased tax rates across the board-- income, VAT, import duties, etc. as well as imposed a new wealth tax.

* Inflated Argentina's money supply, printing currency with wanton abandon; M2 money supply has increased 215% in the past three years.

* Driven the value and purchasing power of the currency down by 50%. Street-level inflation is now 30%+ per year.

* Made a mockery of official statistics, comically understating the level of Argentine inflation and unemployment. She even began punishing economists for publishing private estimates of inflation that didn't jive with the government figures.

* Taken over control of one industry after another, most notably the nationalization of Spanish oil firm YPF's Argentine assets.

* Imposed export controls of agriculture products from beef to grains, forcing growers to sell at artificially lower domestic prices.

* Imposed capital controls, reducing her citizens' capability to dump their poorly performing currency and hold gold, dollars, euros, or anything else.

* Imposed a two month 'price freeze' on items in the supermarket, and encouraged retail consumers to rat out any grocer that doesn't abide by the government order.

* Imposed controls over the media, most recently ordered an advertising ban in Argentine newspapers (weakening their financial position).

Cristina's policies here are leading to shortages in everything from food to fuel to electricity. Hardly a month goes by without major strikes and disruptions to public services. The purchasing power of their currency is diminishing rapidly. And most people are completely trapped.

Of course, there were a handful of people who saw the writing on the wall. They learned the important lesson never to trust their government. They moved their savings to stable foreign banks. They purchased property abroad. They bought gold and silver, and stored it overseas. They were prepared when the plundering began.

The developed West is rapidly heading down this path. Europe is beginning to impose capital controls, and the IMF has sanctioned them. The US is rapidly printing its currency into oblivion, and confidence is eroding quickly. Russia just purchased an historic amount of gold, choosing real assets over more US dollar reserves.

It would be foolish to think the same things can't happen in the West. And even if it never happens, would you be any worse off for taking some of these basic steps?

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.

A DEFLATIONARY CYCLE - Brings About Currency Wars

Currency Wars Will Only Get Worse 02-14-13 Comstock Partners

CURRENCY WARS - G-7, G-20 Communiques Meaningless Politcal Posturing

No End in Sight for Global “Currency Wars” Gary Dorsch, Editor, Global Money Trends

With frigid temperatures expected to hover between 15-degree and 23-degree Fahrenheit this weekend in Moscow, it’s a wonder why the world’s most powerful finance chiefs and central bankers would schedule their Feb 15-16th meeting in Vladimir Putin’s backyard. Instead, a better venue for the Group-of-20 would’ve been the Cayman Islands. The Islands are warm year-round, with average highs holding steady in the 80’s. January and February are the coolest months with lows averaging in the lower 70’s. However, Russia holds the presidency of the G-20 this year, - so finance chiefs will have to endure the frozen tundra.

A January 16th warning issued by Russia’s central banker Alexei Ulyukayev has also set the narrative for the G-20 meeting.

“The world is on the brink of a fresh “currency war.” Japan is weakening the yen and other countries may follow. If Japan continues to pursue a softer currency, reciprocal devaluations would hurt the global economy. We’re on a threshold of very serious and confrontational actions. The new government of Japan is a course towards a very protectionist monetary policy through a sharp depreciation of the yen. Other colleagues from respected central banks and governments already pursue this policy. This is not a path towards global coordination but rather a separation.”

Alexei Ulyukayev
Russia’s Central Bank Governor
01/16/13 G-20 Narrative

"The Federal Reserve’s “protectionist” gambit to roll out more quantitative easing (QE) would reignite “currency wars” with drastic consequences for the rest of the world. It has to be understood that there are consequences. The Fed’s QE-program ($85-billion per month of money printing) will only have a marginal benefit in the US as there is already no lack of liquidity. And that liquidityis not going into production. Furthermore, Japan’s decision to expand its own QE, coming on the heels of the Fed’s decision (to expand QE to $85-billion per month), is evidence of growing global tensions. That’s a currency war.”

Guido Mantega,
Brazil’s Finance Minister

Yi Gang, a deputy governor of the People’s Bank of China (PBoC), and chief of the State Administration of Foreign Exchange, said he’s worried about the fallout from QE and the Zero Interest Rate Policy (ZIRP), in the G-7 economies.

“QE for developed economies is generating volatility in financial markets in terms of capital flows. Competitive currency devaluation is one aspect of it. If everyone is doing super QE, which currency will depreciate?”

Yi Gang,
A Deputy Governor of the People’s Bank of China (PBoC),
and Chief of the State Administration of Foreign Exchange

As the European, Japanese, and US-governments sink deeper into a morass of debt, the ruling politicians are pressuring their central bankers to print more money, in order to finance their budget deficits.

So far, five central banks:

In turn, the tsunami of ultra-cheap cash is inflating bubbles in the world’s bond and stock markets. On Feb 13th, hedge fund trader Jim Rogers commented, “The US-stock market is near its all-time highs because the Federal Reserve is printing staggering amounts of money. This is very artificial,’’ Rogers warns. And the willingness of the political puppets at the Fed and other central banks to keep buying hundreds of billions of dollars' worth of government bonds makes it easier for the ruling political elite to sustain the massive deficit spending that’s running up a record-breaking national debt. Rogers adds, “It’s a vicious cycle and it’s all insanity. No sound person in his sound mind would say, this is the way to run things. Of course, it’s going to lead to more inflation. But the government says we don’t have inflation. If you shop, you know that there’s inflation.’’

Global investors appear to be convinced that several more trillions worth of printed currencies will be flowing through the global pipeline in the years ahead. “It’s outrageous what they’re doing,” Jim Rogers, chairman of Rogers Holdings told CNBC television on Feb 8th. “The Federal Reserve is printing money as fast as they can, and the Bank of Japan says they’re going to print unlimited money. You know what the Federal Reserve said? ‘We’ll match you and we’ll print more money, too! “This is insane!”Regarding Fed chief Ben Bernanke, Rogers said, “He doesn’t understand economics, he doesn’t understand finance, he doesn’t understand currencies. All he understands is printing money,’” Rogers said.

As the chart above shows, - the Bank of Japan (BoJ) and the Fed have been flying under the radar, - engaged in a “competitive currency devaluation,” since the middle of 2009. Both central banks have increased their local money supply, and used the freshly printed monies to purchase vast quantities of mortgage or government debt. For its part, the BoJ has increased the size of the monetary base in circulation to a record ¥132-trillion, - that’s up nearly +44% from ¥92-trillion three years earlier. Likewise, the Fed’s money printing spree has increased the size of the high octane MZM money supply by $2.15-trillion, or +23% since May of 2010, in a race to the Foggy Bottom with a “beggar thy neighbor” – “currency war.”

Until recently, Japan was losing the tug-of-war over the yen’s exchange rate versus the US-dollar. The sheer size of the Fed’s massive QE onslaught overpowered the BoJ’s counterattack. The US-greenback tumbled to a 15-year low of ¥76 in the second half of 2011. The BoJ was forced to step-up its intervention efforts on two occasions, when it injected ¥13.5-trillion of liquidity ($175-billion) in July and October of 2011 into the Tokyo currency market, its biggest intervention effort since 2004. Still, the BoJ’s herculean efforts couldn’t lift US-dollar above ¥82 for most of 2012. Largely as a result of the chronically weak US$ /yen exchange rate, Japan’s exports fell -5.8% last year, and the country logged a record annual trade deficit of ¥7-trillion  ($78-billion) in 2012. It was second consecutive annual trade deficit recorded by Japan that for decades racked up hefty surpluses, helping to finance its ballooning debt.

Little more than 20-years ago, Japan’s economy was being held out as an exemplary model destined to become the wave of the future for global capitalism. Yet on Feb 14th, Tokyo announced that

• its economy, the third largest in the world after China and the US, had contracted for a third straight quarter.
• Japan has endured its fifth recession over the past 15-years, hobbled by the unrelenting strength of the Japanese yen, which undercuts its export opportunities and corporate earnings that are repatriated from overseas.
• Companies listed on the Nikkei-225 index said their net income had plunged -31% on average, in the July-to-September quarter compared with a year earlier.

Former Prime Minister Noda acknowledged that the situation was “severe” and said the government would meet it with a “sense of crisis.” But his words only served to underscore the failure of successive governments to revive the Japanese economy since the collapse of the real estate and financial bubble at the beginning of the 1990’s. Noda announced he would dissolve the lower house of parliament on Nov 16th, triggering an election on December 16th that in turn, swept his Democratic Party of Japan from power.

Japan’s Liberal Democratic Party, (LDP) under the leadership of Shinzo Abe, reclaimed control of the government, and immediately began to exert maximum pressure on the BoJ to buy an “unlimited amount” of long-term government bonds (JGB’s), in order to weaken the yen, and thereby raise the cost of imported goods. The unlimited printing of yen would continue until Japan’s inflation rate rose to +2%.

“We need to overcome the crisis that Japan is undergoing. We have promised to pull Japan out of deflation and correct a strong yen. The situation is severe. We need to do this. Quantitative easing by the BoJ will help to correct a too strong yen and it will push-up stock prices. That will help boost investment and lead to rises in wages, jobs and household revenues. We’d like to shorten the time needed for this to happen,”

Japanese Prime Minister Shinzo Abe - Dec 16th.

The Kyodo news agency said the LDP would draft an extra budget for 2012/13 worth up to 10-trillion yen and issue debt to pay for it.

A few days later, on Dec 20th, the BoJ agreed to expand its JGB-buying and lending program, by ¥10-trillion to ¥101-trillion ($1.1-trillion) by a unanimous vote, increasing its QE pipeline for the third time in the past four months. And even before the BoJ officially begins its Big-Bang QE counterattack sometime in April, Japan’s LDP chief has already managed to engineer a significant strengthening of the US$ to as high as 94-yen this week, simply through a bit of “Jawboning.” Koichi Hamada, a chief advisor to PM Shinzo Abe, helped to give the US$ a lift above the psychological barrier of ¥90 by saying on Jan 20th, “If the dollar goes above ¥110 there may be reason for worry, but at ¥100 or ¥95 yen, it’s OK,” he said.

As a result of a weaker yen across the board, - against the US-dollar, China’s yuan, the Korean won, and the Euro, Japan’s Nikkei-225 index turned in its strongest performance in seven years, surging more than +30% higher since Mr Noda’s government fell on Nov 16th. Likewise, Wisdom-Tree’s Japan Hedged Equity Fund (NYSEArca: DXJ) with its tilt towards Japanese exporters soared by $10 per share to as high as $41 this week.“The proof is in the pudding. Evidence is stronger than any talk,” LDP advisor Hamada remarked, citing the significant rally in the Nikkei-225 index as a result of a weaker yen.

Wisdom Tree’s fund, - DXJ is useful for US-investors, - it hedges its currency exposure to the Japanese yen by shorting yen futures and forward-contracts. It doesn’t necessarily carry a net short-yen exposure; rather,“the Index and the Fund seek to track the performance of equity securities in Japan that is attributable solely to stock prices without the effect of currency fluctuations.” On Nov 30th, DXJ started a new “revenue filter,” and removedcompanies that derive more than 80% of their revenues from Japan from the portfolio. For the top 10-holdings, 41% of their revenue is generated in Japan, down from 73% under the previous mix. Currently, the top-8 holdings in DXJ are (1) Mitsubishi UFJ Financial Group 5.8%, (2) Takeda Pharmaceutical 5%, (3) Canon 4.45%, (4) Honda Motor 4%, (5) Mitsui 3.4%, (6) Japan Tobacco 3.1%, (7) Nissan Motor 3%, and (8) Toyota Motor 3%.

In New York, Toyota Motor (NYSE ticker: TM) has seen its stock price soar from roughly $77 in mid-November to around $105 in mid- February, its highest close in more than four years. The yen’s slide helps Japanese makers of cars and ships compete against their Korean rivals in markets such as Europe and the US. Also,Toyota’s annual operating profit increases by ¥35-billion for every 1-yen drop in the value against the US-dollar, according to the carmaker. At Toyota, the world’s biggest carmaker, net income for the quarter ended Dec 31st was ¥31.55 per share, up +22% from a year earlier. Even without the help of a weaker yen, Toyota recaptured its #1 sales crown from General Motors by selling 9.75-million vehicles globally in 2012, with impressive product lineups and marketing initiatives.

However, on January 30th, the French government began to complain loudly about Tokyo’s underhanded techniques to weaken the value of the yen. Not only did the Euro surge +26% higher to 127-yen, a 33-month high, but through the effects of cross currency trading, the Euro’s exchange rate versus the US$ also rose above $1.3500. That’s far above what some economists estimate to be the threshold of pain for French exporters at $1.2200. “The Euro is too high compared with what the European economy deserves,” said France’s Industry Minister Arnaud Montebourg. In response, the Group-of-7 clique of finance officials hastily crafted a communiqué, pledging to refrain from engaging in a currency war, responding to France’s allegations of the deliberate manipulation of the yen exchange rate.

G-7’s Phony Communiqué,

“We, the G-7 finance ministers and central bank governors, reaffirm our longstanding commitment to market determined exchange rates and to consult close in regard to actions in foreign exchange markets. We reaffirm that our fiscal and monetary policies have been and will remain oriented towards meeting our respective domestic objectives using domestic instruments, and that we will not target exchange rates. We are agreed that excessive volatility and disorderly movements in exchange rates can have adverse implications for economic and financial stability”

G-7 communiqué

If ten people read the same communiqué, each one may understand it differently. Perhaps, only one of them will interpret it correctly. As such, in the opinion of the Global Money Trends newsletter, the G-7 is skirting a fine line, - saying that outright buys and sells of currencies in the open market, and the use of “Jawboning” to influence foreign exchange rates is off limits. However, it’s permissible for central banks to print unlimited amounts of their respective currencies, if it’s used to monetize debt. Buying bonds is allowed, even though the scheme has the indirect effect of influencing foreign exchange rates.

Not surprisingly, Japanese Finance chief Taro Aso welcomed the communiqué, saying on Feb 12th that it recognized Tokyo’s threat to unleash Big-Bang QE, which could flood the world with as much as ¥100-trillion, - is not aimed at the foreign exchange markets. “It was meaningful for us that the G-7 properly recognizes that steps we are taking to beat deflation are not aimed at influencing currency markets,” Aso told reporters. The problem with this logic of course, is that the traders in the FX-markets view QE as the most lethal weapon in the central banks’ arsenal for influencing bond yields and currency exchange rates.

Russia Weighs in on Global Currency War, As tension over the Japanese yen’s exchange rates grows and G-7 central bankers try to head-off the outbreak of a full scale “currency war,” that could spread beyond the Tokyo and US-currency markets, - Alexei Moiseev, Russia’s Deputy Finance chief told the CNBC television network on Feb 14th, that the G-7, of which Russia is not a member, should not be making unilateral policy decisions or announcements on foreign exchange policies. “This kind of decision should have been discussed on the G-20 platform. This is G-20 week and the very reason that the focus in developing economic policy has shifted to the G-20 is that the G-7 no longer represents a sufficient proportion of the world’s financial markets and economies,” he said.

In regards to Moscow’s handling of the Russian rouble, Moiseev replied, “We are actively moving away from any manipulation of the currency. Last fall, the central bank officially declared that Russia is moving towards a flexible exchange rate so we have a target of 2015 to commit to make no interventions in the exchange market,” said Moiseev. On Feb 13th, Russia’s central bank (Bank Rossi) decided to hold its refinancing rate unchanged at 8.25% for the fifth month in a row, rebuffing a call by President Vladimir Putin to join the currency war bandwagon, by easing its monetary policy. The Russian economy is grappling with a +7.1% inflation rate, and Bank Rossi says its not in an enviable position to lower interest rates, until inflation cools off first. A stronger ruble has help contain the cost of imports.

However, the Kremlin shouldn’t be too upset if the BoJ and the Fed continue to print an extra $2-trillion of paper currency in the year ahead. Other central banks could join the currency war, including the People’s Bank of China, (PBoC), which on Feb 5th, injected450-billion yuan ($72-billion) into the Shanghai money markets, its largest single-day injection ever conducted in the interbank market, in order to prevent the value of the Chinese yuan from rising against the US-dollar, and to artificially inflate Shanghai red-chips. As more central banks join the race to devalue their currencies, it could act to lift the price of Russia’s most important commodity.

Moscow has high oil prices to thank for bolstering its stash of foreign currency reserves, reaching $533-billion this week, and in turn, high oil prices is supporting capital inflows into the Ruble and the local stock market. Two-thirds of the Russian Trading System (RTS) Index is made up of stocks in the energy sector, which are benefitting from high crude oil and natural gas prices around the globe (outside of the US). Exports of fuels and metals typically account for three-quarters of total Russian exports, and the natural gas and oil sector is responsible for as much as 60% of federal budget receipts. In order to fulfill its budget obligations in 2013, Moscow’s break-even point for Urals blend is around $117 per barrel.

Perhaps, Mr Putin’s most striking achievement is having fixed Russia’s fiscal mess. In contrast to persistent budget deficits in the 1990’s, and a sovereign debt default in 1998, Putin has taken advantage of bigger streams of revenues from crude oil and natural gas, to repay Russia’s external debt and built-up assets in a stabilization fund, which was recently used to inject fiscal stimulus into the local economy. As a result of budget surpluses and debt repayments, Russia’s public-debt-to-GDP ratio has declined to 6% of GDP, down sharply from 61% in the year 2000. But Russia’s budget balance is still heavily dependent on the oil price. Strip oil out and its public finances have been deteriorating since 2005.

Russia’s dependence on energy is greater today than in the mid-1990’s, when it represented less than half of exports. Russia’s output of crude oil climbed to 10.5-million barrels per day in November, a post-Soviet high. However, at current rates of production, Russia’s known oil reserves, including fields in the Arctic, could be depleted in just 20-years. Kazakhstan, by comparison, can sustain its current output for 60-years, Saudi Arabia for more than 70-years and the United Arab Emirates for more than 90-years.

For now, the fate of the Russian ruble is closely linked to the price of the Urals blend crude oil. Last year, the price of Urals blend suddenly plunged from $124 per barrel to as low as $90 per barrel. Likewise, Russia's ruble tumbled -15% to 2.9-US-cents, its lowest level since April 2009 as it tracked the falling price of crude oil. Russia’s stock markets also suffer when traders pull their money out of riskier, Emerging markets like Russia’s. Over a 3-month period, the RTS Index plunged by -30%, briefly wiping out $260-billion of market value. However, with the subsequent recovery of Ural crude oil to $117 per barrel, much of the ruble’s and the RTS index have been restored. The Fed’s QE-scheme and the effects of Tokyo’s “yen carry” trade are helping to fuel the recovery in the Russian financial markets.

The Hong Kong Monetary Authority (HKMA) has intervened repeatedly in the currency market since October 20th, injecting a total of HK$107-billion, in order to defend an archaic and fixed currency peg with the US-dollar. Under the currency peg, the HKMA is obliged to intervene when the US- dollar hits HK$7.75 or HK$7.85 to keep the band intact. In reality, the HKMA can supply an unlimited amount of local notes for foreign currencies, albeit at the cost of higher consumer price inflation. Over the course of the past four years, the HKMA has more than doubled the size of the local M1 money supply, in a determined effort to counter the Fed’s QE onslaught. In turn, the increase in the M! money supply has helped to lift the price of Gold +125% higher to around HK$12,700 today.

Thanks to the peg, Hong Kong is forced to adopt the monetary policy of the US. The Fed’s policy of targeting the fed funds rate between zero-percent and 0.25% is matched by the HKMA targeting its overnight repo rate at an absurdly low 0.50%. As a result, the HKMA’s repo rate is pegged about -3% below the city’s inflation rate. Negative interest rates have encouraged traders to buy riskier assets, such as Gold or stocks listed in the Hang Seng Index. If the US$ peg were to disappear tomorrow, the HKMA could hike interest rates to combat inflation. Many analysts forecast that the Hong Kong dollar would appreciate by a minimum of +15%. In turn, the price of Gold and the Hang Seng could tumble sharply.This scenario is still several years away, but once the Chinese yuan becomes fully convertible, the ultimate endgame would be a Hong Kong dollar/yuan peg.  

Looking forward, -

the G-7’s call for a cease fire in the global currency war won’t take hold, if the BoJ and the Fed won’t agree to turn-off their printing presses.

That’s not likely to happen anytime soon. The betting is that Tokyo’s Big-bang QE would contain sufficient firepower to push the US-dollar towards 100-yen and lift the Euro to 135-yen. Central banks in China and Hong Kong could respond by printing money, and other central banks, in Brazil and Korea might resort to various methods of capital controls, such as placing a stiff tax on foreign investment in their local bond and stock markets. There is simply no end in sight to the “Currency Wars,” as long as the BoJ and the Fed won’t stop monetizing debt.

When will the G-20 central banks finally agree to tighten the money spigots? Most likely, the End Game for the global “Currency War” will only arrive when the G-7 Bond Vigilantes are resurrected from the dead. It would take a significant decline in Treasury bond prices, and sharply higher bond yields, caused by

1. the outbreak of hyper-inflation or
2. record high crude oil prices,

before central bankers are forced to recognize the folly of their dangerous game. In turn, sharply higher bond yields could be a catalyst for a synchronized global economic downturn, and the onset of a Bear market for equities. The Day of Reckoning is unknown, but it’s helpful to be on the lookout for the early warning signs. 

PRICE CONTROLS - Currency Wars Lead to Price Controls Which Leads to CONTROLS

Are Price Controls Coming To Venezuela, Where "Nymphomania" For Dollars Is The Next Big Thing 02-14-13 Financial Times via ZH

In typical 'crazy-talk' ways, Venezuela is 'pledging' that its currency devaluation will not increase inflation in the country and, as The FT reports, has warned it will crack down on businesses that raise prices. Hot on the heels of Argentina's ignoration of inflation and recent price controls (and advertising bans), it would appear Venezuela is next as grey market dollars are changing hands for 22 Bolivars - massively lower than the official (just devalued) 6.3 Bolivars per USD rate. An 'equilibrium' rate is believed to be around 9 Bolivars but with Chavez still MIA and Maduro running the show, the 'nymphomania' for dollars - as Venezuela's finance minister called it - continues as businesses are simply unable to find tenable USD to use for imports. Contagion is also spreading as Colombia's FinMin Cardenas fears goods being smuggled across the border - creating inflation there too.

Via The FT,

Venezuela’s government warned that it would crack down on businesses that raise prices as it pledged that a devaluation of its currency would not increase inflation.

The black market price for dollars in the country has risen to a record high, at more than 22 bolivars. That compares to the new official exchange rate of 6.3 bolivars per dollar, with the old 4.3 rate eliminated last Friday. Economists said that at 6.3 bolivars to the dollar, Venezuela’s currency remains overvalued, with the “equilibrium” price believed to be about 9 bolivars.

...

Finance minister Jorge Giordani spoke of “nymphomania” for dollars in Venezuela this week. But businesses criticised his failure to announce alternative sources of foreign currency for importers after a central bank-run system known as the Sitme was scrapped last Friday. Businesses had been able to obtain dollars for 5.3 bolivars through the Sitme.

Fears are growing that businesses will find it increasingly hard to obtain dollars to import goods, possibly forcing them to resort to the more expensive black market for foreign currency, with about a third of consumption in Venezuela supplied by imports.

Mauricio Cárdenas, the finance minister in neighbouring Colombia, expressed concern that the devaluation could lead to an increase in goods being smuggled across the border. A rise in inflation in Venezuela and other distortions caused by price controls could create an incentive for some goods to be sold illegally in Colombia.

Mr Chávez cracked down on businesses after the government’s previous devaluation in January 2010, expropriating supermarkets deemed to be raising prices excessively. There are signs that Mr Maduro will be no less severe