Bruce Krasting

Deutche Bank's Ackermann on the LTRO

2012-01-27T08:13:00.000-08:00

Note: I'm experimenting with video. Bear with me.

Bernanke Goes All In

2012-01-25T17:55:00.000-08:00

Well, we got an inflation target from the Fed. Basically, thinking at the Fed has been eliminated. The process has been automated. Bernanke has convinced the Fed board to adopt Core PCE as a determinate of monetary policy. So long as CPCE stays below 2%, Ben is going to have his foot planted on the monetary metal. It’s “full speed ahead” according to the Chairman. He's pushed things off until 2014 - a very long time from now.

My question: “Why is the Fed using CPCE versus another measure of inflation?” The very good news is that there is answer, and it comes from a very "reliable' source – The Federal Reserve. A detailed analysis on this topic was conveniently made public just a month ago.

Alan Detmeister produced a doosey of a report. Ya gotta love the title page:

This beast runs 25 pages, it includes tons of charts and references. It compares the utility of using Core PCE to a dozen other inflation yardsticks. There are easy-to-understand formulas to support the conclusion:

Guess what? Good old Alan makes a compelling argument. Anyone who tries to question the use of CPCE is going to get hit over the head with this report. This is just one of the many charts that prove (according to Detmeister) that CPCE is the only way to go when considering monetary policy:

There’s just one teeny problem with Alan’s work. He did all of that comparing and studying using data from pre-2010. Using that information, CPCE lines up very well as a consistent barometer of inflation. But the analysis falls to shit when you look beyond 2009. CPCE took a nose-dive after 2009 (versus CPI and Core CPI):

Information on CPCE and the other measures of inflation is available monthly. There’s no reason (that I can think of) why the Fed chose to deliberately omit two years of data that would conflict with the “desired’ conclusion. To me, it looks like the authors manipulated the report.

I think the Fed made a mistake targeting inflation. It's now stuck with the choice. It can’t go back on this without looking awfully stupid. The policy of allowing CPCE to determine the direction of monetary policy will last the until the end of Bernanke’s term at the Fed. Then it will be abandoned in favor of more pragmatic approaches to decision making.

I think there is enough monetary juice in the global system for there to be a risk of inflation north of 2%. We shall see. I think Bernanke is going to get his balls squeezed. He deserves that fate, he put them in a vise. As of today, he no longer has choices. He’s made himself a slave to a single dopey statistic.

The markets are the best measures of how people perceived today's announcements from the Fed. The dollar pissed on the Fed in general, the gold market hit Bernanke square in the face with an ingot.

Want a Raise? Vote on it! The Swiss do.

2012-01-23T16:45:00.000-08:00

Switzerland is vote crazy. It has a referendum on most issues. There is a vote coming up that I’m sure will pass. This time around, the Swiss are going to vote themselves a big salary increase. As a result, Switzerland will have the highest minimum wage on the globe. That’s nice for the Swiss.

The annual minimum wages of Switzerland’s neighbors: (Link)

Being on the top of the list of minimum guaranteed income is a positive reflection on the Swiss economy. But it will also bring envy. It is an embarrassment of riches. I don’t think it will go unnoticed. The country is surrounded by economic problems, yet it's flourishing.

Switzerland has insured that its domestic companies are insulated from the economic chaos of its neighbors. It has achieved this with a currency peg. This appears to be a simple solution. So far, the peg is working. But there are consequences to this policy. In order to maintain an artificially low value for the Franc, the Swiss Central Bank (SNB) has had to absorb a huge chunk of official reserves, the bulk of which has been in Euros.

An argument has been put forward by the SNB, economists and bloggers, that there is no reason why the Swiss can’t continue to absorb foreign reserves. They argue that it doesn’t matter if it is E260b today, it would not matter if it were E500b in six months. I disagree. The SNB has investment restrictions. It only invests its Euro reserves in the debt obligations of France and Germany.

At some point we will see headlines like these:

Month #1

Finance Ministers of France, Germany, Netherlands Call on Switzerland to Invest excess reserves in Bonds of ECB.

Month # 2

Swiss Finance Minister Rejects Calls for Reserve Diversification
“The investment policies of the SNB are not for discussion”

Month #3

Merkel travels to Bern to discuss direct investment in EU Central Bank

Month #4

Swiss Parliament Rejects Pressure from Neighbors
Swiss President: “The Swiss people have no ability to influence the SNB”

Month #5

EU leaders threaten economic sanctions against Switzerland
French President, “We can have Beggar my Neighbor policies too!”

Month #6

EU Considers Tariffs on Swiss Agricultural Products
Farmers Protest

Month #7

Swiss Tourist Industry in Slump
Hotelier: “We have a bad image, so people don’t come”

Month #8

Belgium’s rail road Cancels Purchase of Swiss Locomotives

Pressure from government responsible

Month #9

Swiss Politicians Raise Possibility of Referendum on Independence of the SNB

SPP Leader, “Let the people decide”

Two Days Later

SNB Reverses Stance On Investments. Will Invest 10% of Euro Reserves in ECB Debt.
Major concession. Threat of vote forced change in policy.

Month #10

Swiss Reserves Rise to New Record
Up E100B in Six Months

One Week Later

Italian Finance Minister Calls on Swiss for Direct Investment in
Italian Bonds – Swiss say, “No”.

One Week Later

Italian Parliament Considers New Laws on Swiss Bank Accounts.
Severe restrictions, penalties to equal 50% of account balances

Two Days Later

SNB to Hold 10% of reserves in direct obligations of Italian government bonds
Italian Press: We put a gun to their head; they said “Si”.

Two Days Later

Spanish Finance Minister Travels to Bern to Discuss Bond Sales
The question for the SNB: “Is Portugal next to visit?”

This is a bit whimsical, but I hope you get the point. I doubt the Swiss can hold unlimited amounts of reserves without pressure on them to diversify those huge holdings to some of the governments (and the Supra-nationals). I’m surprised that this has not happened already. Possibly Switzerland’s neighbors will look at the results of the upcoming vote on the minimum wage, and start asking those questions.

This very rich country may end up being the banker for some of its neighbors. What comes around, often goes around.
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Will the Fed Bring Clarity or Confusion?

2012-01-21T17:41:00.000-08:00

Next Wednesday, between 12:30 and 2PM, we will get a ton of new information to digest and analyze. The Federal Reserve will make a series of statements while unveiling its new communication effort. A portion of the new information will be contained in the revised Summary of Economic Projections (SEP).

The Fed has worked long and hard on its new communication policy. The question is, “What will people think and how will the markets react?” I believe that there is a very good possibility that the Fed's plan will add to uncertainties regarding monetary policy. Contrary to its objectives, the new "openness and clarity" may end up causing the confusion.

The Fed will provide information regarding member's thinking on the future size of the Fed’s balance sheet (BS). This is critical. We might see a consensus view that the Fed’s balance sheet will grow another 25% over the next 18 months. That would bring this headline:

Fed Signals Another $1T Of QE
Stocks rise sharply. Oil, copper, gold see largest one-day rise in two years

TIPs spreads widen to 2.5%

We could just as easily get a consensus opinion that the Fed’s BS will remain unchanged for the foreseeable future. That would also be a shocker:

Fed Forecasts End of QE
Global stocks in broad retreat.
Next move is to tighten?

The Fed will provide information regarding its thinking on GDP, inflation and the timing of an increase in the Federal Funds rate (new info). This is all potentially explosive data. The Fed's most recent read (November) on the economy painted a somewhat upbeat picture. Almost all of the data since then has been on the positive side. While I doubt the Fed will signal that happy days are here again, it would appear likely that a +2.0% growth forecast for GDP is in the cards. How is the Fed going to square this (relatively) upbeat economic assessment with a loose monetary policy that is currently at ~~biblical~~ historic levels? The answer is, "It can’t".

Fed Predicts Improvement. To Keep Monetary “Pedal on the Metal”

Global Central Bankers Critical, OECD head says, “Reckless”
Dollar in rout, Gold rises $65

For the Fed to continue ZIRPing, Twisting and QEing, it has to support the policy with a bleak assessment on the economy. A negative outlook is the only scenario that justifies maintaining, let alone expanding, the existing "emergency" monetary measures.

I think the Fed will hint that monetary contraction is in our future (about a year away, if not sooner). To me, the only circumstance that would avoid this conclusion is if the Fed were to come out with some decidedly disappointing expectations for growth and unemployment for the next 36 months. This too would make for headlines:

Fed Downgrades Expectations
Three More Years of Sub-par Growth

A downbeat assessment would influence the Congressional Budget Office (CBO). On January 30, the CBO will release its ten-year economic outlook. This is what they said a year ago:

The CBO forecasts for 2011 were off the mark. I think they will have to significantly downgrade their expectations for 2012 and 2013. The CBO numbers are the basis upon which long-term estimates for future deficits and the financial status of Social Security (and other big entitlement programs) are made. The Office of Management and Budget (OMB) uses these numbers to craft legislation for the White House.

I find it interesting that the forecast that would best serve Ben Bernanke’s desire to maintain and expand monetary policy is exactly the opposite forecast that the CBO “wants” to use in evaluating America’s macro economic outlook.

On Friday, Morgan Stanley’s David Greenlaw commented on prospects for the Fed’s announcements this week:

In sum, there seems to be some risk of significant market confusion next week.

At the end of the day, we’re concerned that market confusion next week could lead to an unintended tightening of financial conditions.

Mr. Greenlaw is assuming that the Fed will produce an economic forecast that will force a conclusion that further easing is off the table. We may get that. The alternative is that the Fed downgrades its collective assessment for growth, inflation and interest rates. Should it do that, the folks at the CBO will have to either scramble to adjust their own expectations, or face severe criticism for presenting a rosy view of the future while the Fed is singing a different tune.

What will we get next week? Will it be clarity?

Or confusion?

Either way, I can’t wait.

Note: This is a Banksy. What original oil painting is this from?

Three of a Kind

2012-01-20T04:55:00.000-08:00

On the Debt Ceiling

The Treasury Department emailed its fans a blog entry setting out its position on extending the debt limit. The very fact that the Treasury Department feels the need to post blogs on this topic worries me. They wouldn’t be doing this if they actually thought that passing the ceiling was a slam-dunk.

Dr. Jan Eberly made numerous arguments as to why the debt ceiling should not be an issue at all. Some were valid. As part of the last go around on the debt ceiling there was an agreement to cut spending. The terms of that deal led to $2T of budget cuts. That being done, there's no valid reason to dispute the matter. At least that is the position of Treasury.

Possibly, the Treasury's own mind-set will trip it up. It acts like it hasn't gotten the memo on what the debt ceiling issue means to most folks. Read what Eberly had to say about the consequences of failing to raise the ceiling:

Really Jan? I don’t think this is correct. Changes in the trajectory of the debt ceiling would most certainly have a significant effect on revenues, spending, the size of the deficit and the amount of outstanding debt.

I think the debt ceiling will be increased. It’s politically the wrong time for this fight. But in a year from now the gloves will come off. They have to. At some point the Administration will have a tough fight on their hands, and it won't win any arguments pretending that the size of the debt does not directly impact spending. That’s exactly what this debate is all about.

The Shitty 30

Citizens for Tax Justice has a report out on one of my hot-button topics. Corporate taxes. They produced a list called the Dirty Thirty. The time span covered 2008 – 2010. The results compare 30 companies' actual tax rates and how much they paid to lobbyists. The list:

I don’t think these companies are actually cheating on their taxes. But they are cheating the American public. They are allowed to avoid paying taxes (and getting monstrous refunds to boot) because of the tax code. The problem is that the same folks who run these companies are also creating the tax laws that they greatly benefit from.

The best proof of that is #2 on the list. GE has a negative tax rate of 45% on over $10b of domestic income. Shameful. Yet the boss at GE, Jeff Immelt, is best buds and a senior adviser to the President. Shameful.

Not that long ago Bank of America got hit with a shovel from its customers after it tried to jack up fees. BAC was on the nightly news and the blogs. It folded under the pressure. The CEO of BAC (what’s his name) acknowledged today that it was the backlash from consumers that forced the change in policy.

It worked perfectly with BAC. Public outrage and customers closing their accounts forced good old what’s-his-name to change direction. I wish it was as easy with the likes of GE. BAC was stealing nickels and dimes. GE is in it for the billions.

Dead End in Health Care?

An interesting report from the CBO today examines various efforts to contain the costs of delivering healthcare. The report reviews 34 separate programs over a twenty-year period.

The conclusion after this multi-decade, multi-billion dollar effort?

The evaluations show that most programs have not reduced Medicare spending

In nearly every program involving disease management and care coordination, spending was either unchanged or increased relative to the spending that would have occurred in the absence of the program

It wouldn’t be fair to blame the caregivers or the administrators for the failures. The patients were suffering from chronic heart/lung diseases and diabetes. There are no “cheap” alternatives in treating these conditions.

The cost of healthcare in general, and Medicare in particular, will eventually sink the country. I don’t see any disagreement on that conclusion.

We will hear plenty on this topic over the next 10 months. Both Reds and Blues will claim that waste and inefficiency are the problem. That “They” have a plan to contain the costs and make the problems go away. Don’t listen to them. The CBO says so.

We need a Plan B. It will not be a very pleasant discussion at all.

Winter

2012-01-18T18:32:00.000-08:00

You may have heard that Seattle got socked by a big snowstorm. There were winds as high as 110mph. It was unusual for this to happen. It set some records. I took a look at the storm that bumped into the Pacific North West.

What happened in Seattle is a sideshow. The storm in the Pacific is enormous. Only a fraction of this beast has hit land so far. The following image shows that bad weather stretches all the way to Hawaii.

The experts haven’t figured out where this storm is headed. It might head north, it might stay south. If it’s the later, then it is going to beat up Central California and then head east bringing a ton of snow with it.

As “events” go, this one is worth watching after for the next couple of days. A good discussion Here.

h/t: dp

Greece, China and the USA

2012-01-17T17:32:00.000-08:00

On Greece

I spoke with someone from Athens today. It's not a pretty picture.

Issues related to subsistence have replaced the fervor for demonstrations. This may not last according to this resident.

The closing of stores and shops is escalating. Apparently, 20% of all retail establishments are shuttered. Nearly every block has one reminder of the ongoing depression in the economy.

The Greek Diaspora is in full swing. People are leaving the country, old and young alike. They are going to Europe, where the prospects of jobs stink, but not as badly at Greece. They are also fleeing to America (family members in the US have been helping out), Australia (where some are welcome) and South America.

The talk is that the Greeks are becoming the new Palestinians. They leave their homes, as there is no future there, but all the time they wish they never left.

As the shops close and the people leave, the economy shrinks. My Greek friend is convinced that government revenues are collapsing as a result. Whatever estimates the Troika were looking at six-months ago are pure fantasy today. The country is imploding.

People are feeling hopeless, and the situation is getting worse. In this fellow’s opinion, there is not a chance in hell that Greece will avoid a default. Two years ago there was a general belief that Greece could manage through a crisis, and avoid defaulting and sustain the link to the Euro. That is no longer the case.

This friend understands that a transition from the Euro to the Drachma would cause huge additional pain. It would devalue the pensions of every citizen by at least 50%. He understands that a default would mean that Greece would be a debt pariah. In spite of this, he prefers that it would come sooner rather than later. He thinks this is the prevailing sentiment in the country. There is nothing desirable about this choice. It’s now just inevitable.
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On Cement

The big Swiss cement company Holcim announced a charge to assets as a result of a write down of fixed assets. Here's the headline and a look at Holcim’s stock performance. Note that the stock got clipped for a 1/3 of it value about 8 months ago.

The large cement producers from France and Germany also had their stocks whacked at about the same time.

Actually there is not much good news for the cement boys anywhere:

A question for readers: How big is China when it comes to cement? Keep in mind that the EU and the USA have GDPs of about $15T apiece. China is much smaller and has a GDP closer to $6T. Knowing that, what’s your guess on how China stacks up in the world of cement? I would have thought that China was as big as the US or EU. The economy is smaller, but they are building so much, my guess was about equal.

Wrong. wrong. wrong. I must admit, I was blown away by this:

China is 25 Xs larger than either the US or EU! When it comes to cement, forget the rest of the world and focus on what is happening in the country with a 54% market share.

China’s cement production has been on a tear for years. But it's slowing down. The production for 2011 will come in at 1.88mm metric tones, an increase of only 6% over 2010 (the slowest in 15 years). The Cement Association of China is forecasting that 2012 total production will be “about the same as 2011”. We shall see. I saw this article on cement pricing in Sichuan province.

Since 2004 China' GDP has doubled. So has its cement production. That's not a coincidence. The forecast for unchanged production in 2012 is inconsistent with high growth in GDP. What does zero growth in cement production translate into Chinese economic growth? My guess is that 4% GDP would be a good result. That would be well below stall speed for China.

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On Continuing Resolutions

The CBO sent a memo to the House and the Senate. It was reminder of all of the stopgap measures that are in place. The government is running on a series of continuing resolutions. How big a deal is this? Potentially, it’s a very big deal. The amount involved is $969B!

There are two lists. This first one looks at the spending for which the necessary enabling legislation has already expired:

This one is for those expenditures whose authorizations expire on or before September 30 of this year:

You might rightly ask, “What’s that big chunk of money being spent on?” The biggest chunk is the military (68%). Even with partisan politics and an election year, the military will likely get its money without much of a fight. The CBO report spells out where the rest of the dough is being spent. (It runs 100 pages.) Some snippets:

General Admininstration
Unauthorized FY 2012 Appropriations: 11,519,966,000

United States Marshals service
Unauthorized FY 2012 Appropriations: 11,806,793,000

National Institutes of Health
Unauthorized FY 2012 Appropriations: 30,689,990,000

Western Hemisphere Drug Elimination
Unauthorized FY 2012 Appropriations: 1,061,000,000

Operations of the Peace Corps
Unauthorized FY 2012 Appropriations: 375,000,000

Migration and refugee assistance
Unauthorized FY 2012 Appropriations: 1,639,000,000

Department of State diplomatic and consular programs
Unauthorized FY 2012 Appropriations: 8,275,386,000

Section 8 tenant-based housing assistance
Unauthorized FY 2012 Appropriations: 18,914,369,000

Low-income home energy assistance
Unauthorized FY 2012 Appropriations: 3,478,246,000

Noxious Weed Control and Eradication
Unauthorized FY 2012 Appropriations: Not Available

Brown Tree Snake Control and Eradication
Unauthorized FY 2012 Appropriations: Not Available

Assistance to trafficking victims in the United States
Unauthorized FY 2012 Appropriations: 9,794,000

Administration on Aging programs
Unauthorized FY 2012 Appropriations: 1,473,703,000

Bureau of Labor Statistics
Unauthorized FY 2012 Appropriations: 610,224,000

National Endowment for the Arts
Unauthorized FY 2012 Appropriations: 292,510,000

Pandemic and All-Hazards Preparedness Act
Unauthorized FY 2012 Appropriations: 62,700,000

Project Bioshield
FY 2012 Appropriations: Not Available

Strategic Petroleum Reserve
FY 2012 Appropriations: 192,704,000

National Highway Traffic Safety Administration
FY 2012 Appropriations Authorized 24,693,000,000

Federal Trade Commission operations:
Unauthorized FY 2012 Appropriations: 311,563,000

Centers for Disease Control programs regarding infertility and sexually transmitted diseases
Unauthorized FY 2012 Appropriations: 964,855,000

Corporation for Public Broadcasting
Unauthorized FY 2012 Appropriations: 445,000,000

Administrative expenses for Government National Mortgage Association guarantees of mortgage-backed securities
Unauthorized FY 2012 Appropriations: 19,500,000

Funds appropriated to the President for international assistance.
Unauthorized FY 2012 Appropriations: 16,462,253,000

Secretary of Health and Human Services refugee and entrant assistance programs
Unauthorized FY 2012 Appropriations: 769,789,000

Pacific Salmon Treaty
Unauthorized FY 2012 Appropriations: 123,566,000

Nutria Eradication and Control Act
Unauthorized FY 2012 Appropriations: Not Available

Bureau of Land Management
Unauthorized FY 2012 Appropriations: 973,552,000

Paperwork Reduction Act of 1995
Unauthorized FY 2012 Appropriations: Not Available

Renewable energy research and development
Unauthorized FY 2012 Appropriations: 963,000,000

Appropriations for the Coast Guard
(1) Operation and maintenance
Unauthorized FY 2012 Appropriations: 7,051,054,000
(2) Acquisition, construction, rebuilding, and improvement Unauthorized FY 2012 Appropriations: 1,403,924,000
(3) Retired Pay
Unauthorized FY 2012 Appropriations: 1,400,700,000

Specialty crop research initiative
FY 2012 Appropriations Authorized 100,000,000

Food animal residue avoidance database program
FY 2012 Appropriations Authorized 2,500,000

National Sheep Industry Improvement Center
FY 2012 Appropriations Authorized 10,000,000

Block grants for energy efficiency
FY 2012 Appropriations Authorized 2,000,000,000

Central Intelligence Agency Retirement and Disability Fund
FY 2012 Appropriations Authorized 514,000,000

Have a look at the report. There are hundreds of line items for expenses. Something for everyone to hate.

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New CBO report – Lower (not increase) the early retirement age!

2012-01-15T06:19:00.000-08:00

At one point or another, all the big name politicians have indicated they would support changing the minimum Early Eligibility Age (EEA) rules for Social Security. Obama has said it, so has Boehner. Even guys who love Social Security, like Sen. Harry Reid, thought it might be okay. Many economists have publicly opined that raising the EEA for benefits is good economics, as the average life expectancy is higher than it was forty years ago. To me, the most significant evidence that a consensus is forming on this important issue is the fact that the ultimate supporter of the Grey Panthers, the AARP, came out with its support last year.

I think that all of these deep thinkers are wrong. In fact, a good case can be made for lowering the minimum retirement age from 62 to 60. From the Congressional Budget Office report on the consequences of increasing the Early Eligibility Age (EEA):

If that doesn’t convince you, consider these words:

Budgetary Effects

The budgetary effects of a rise in the EEA in the short term would be different from those over a longer period. Federal outlays would decline in the short term because people would have to wait until they were older to apply for Social Security benefits. Over time, higher subsequent monthly benefits would offset an increasing share of the savings from delayed eligibility.

How is it possible that all of the folks pushing for an increase in the EEA could be wrong on this issue? Intuitively it makes sense. Delaying the age for benefits should reduce expenses for SS and therefore save it money, thus keeping it solvent for longer. It sounds so simple. Why doesn’t it work?

The answer is that increasing the EEA won't improve the finances of Social Security (or the country as a whole). SS discounts the amount payable if early retirement is opted for. It is calculated so that SS is “expense neutral” if benefits are taken at today’s EEA of 62 years versus the higher benefits available by waiting until 64 years.

The following formulas are a simplified look at how this works:

Case #1
Benefits payable at age 62 = $1,000 per month
Average Life / (years of benefits)= 78 / (16 years)
Total life time benefits = $192,000

Case #2
Benefits payable at age 64 = $1,142
Average Life / (years of benefits) = 78 / (14 years)
Total life time benefits = $191,856

The formula that SS uses to discount benefits for those seeking payments prior to their Full Retirement Age (FRA) is quite simple:

The reductions are based on the month of claiming: A benefit is reduced by 5/9 of 1 percent for each of the first 36 months before the FRA.

For example, if a man was expecting a monthly check of $1,000 at FRA, he would receive $810 monthly if they took benefits three years earlier. This simple formula immunizes SS from the cost of those seeking benefits early.

I hope that this discussion proves the point. There is no economic consequence to SS (or to the overall fiscal position of the US) from raising the EEA. Now consider what would happen if the EEA were to be lowered from age 62 to 60 years.

Using the same 5/9th% monthly discount rate, the individual who seeks benefits at age 60 would get a check 13% less than what he would have received by waiting until he was 62 to quit working. Using the formula from above:

Case #3
Benefits payable at age 62 = $1,000 per month
Benefits payable at age 60 = $870 per month
Average life (years of benefits) = 78 / (18)
Life time benefits = $188,000

Note: The $188,000 number above does not take into consideration the time value of money and changes in payments of Disability Benefits. When these factors are built into the equation, the numbers between the various ages of retirement all equal out.

Today, approximately 60% of eligible beneficiaries elect to get their SS checks at age 62 (EEA). I can't’ accurately project how many people would elect to retire at age 60 or 61, if it were possible to get discounted benefits at earlier ages. I think it's a large number.

Of the 3.6mm individuals who will get new SS benefits this year, 2.2mm (60% of total) are getting their checks upon reaching the EEA. If the EEA were lowered to age 60, how many people would take advantage of the change? Given that there are two years worth of individuals who would be eligible for reduced benefits, an estimate for the number of people who might opt-in to early retirement, if given the chance, is between zero and 4.4mm. For the sake of discussion, call it 2mm. That would be very helpful.

What would this do for the economy? It would shrink the supply of available workers. It would happen fairly quickly over the course of the first two years that the EEA adjustments became effective. As older workers leave the workforce earlier, the demand for younger workers would increase. People at all ages (including older workers not seeking to retire) would “move up the ladder” faster. There would be more new job openings for younger workers coming into the labor force.

High unemployment is corrosive to society. It’s particularly problematic when the shortage of jobs creates very high rates of unemployment for young workers. High youth unemployment is the scourge of Europe today. Total unemployment in some of these countries is around 10%, but youth unemployment is over 20%. The situation is similar in the USA. The numbers have not yet reached the levels in Europe, but the trend in the USA is firmly in place. If nothing is done, the likely outcome is for youth unemployment north of 20% in the USA.

Based on the information provided by the CBO, I think it should have analyzed changing the EEA down (as well as up). Lowering the EEA would be neutral to the long-term finances of both SS and the country. It would also open up a few million jobs. Many of those jobs would be entry level positions. Just what we need. This chart illustrates the problem we face. Employment for younger workers is currently at a post WWII low.

I can’t figure out why the CBO didn’t consider the implications of a reduction of the EEA. A team of analysts must have worked on the report for weeks. But they only looked “inside of the box”; the CBO needs to look “outside of the box” to find options for the issues we face.

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Note: The CBO also looked at raising the Full Retirement Age (FRA) from 67 to 70. This is a different kettle of fish than increasing (or decreasing) the EEA. This approach would benefit SS. But it would have a range of negative consequences as well. I’ll discuss increasing the FRA in a separate post. Enough on SS/CBO for one day.

Tyler Durden and Paul Krugman agree! – The EU is toast!

2012-01-14T12:12:00.000-08:00

A rare occurrence in journalism happened today. Tyler Durden of Zero Hedge is in agreement with – hold on – Paul Krugman of the NY Times.

Both writers point readers to the FAQ from S&P on the downgrades in Europe on Friday. Both hone in on one particular section. I’ll repeat it:

We believe that a reform process based on a pillar of fiscal austerity alone risks becoming self-defeating, as domestic demand falls in line with consumers’ rising concerns about job security and disposable incomes, eroding national tax revenues.

There is absolutely no way to achieve economic growth while pursuing fiscal austerity. It just doesn’t work like that. The only other possibility is for Italy and Spain to re-establish their legacy currencies. That is S&P's unwritten, but clear message.

Boom!

The point on legacy currencies made by S&P is actually an old one. Many have insisted that monetary union between north and south was a mistake. But for S&P to have put it on the table is very confrontational to existing EU thinking regarding the need for a breakup. European leaders have all along ignored the blogs and various MSM commentators. Their line has always been, “A breakup is unthinkable”. Not any longer.

I don’t expect “Merkozy” to change their stance on the single currency issue anytime soon. But others will. The message in the S&P FAQ will not be ignored. We’re going to see it in the MSM, and we’re going to hear about it from both the political and the financial sides of governments (and of course, the blogs).

The thought process of a resumption of legacy currencies won't start on Monday. Before this can be accepted as a viable option, things have to first get worse. Much worse. Liquidity has to dry up further. Bond spreads for Italy and Spain have to widen. Funding conditions for the banks have to get worse. Equities (especially bank stocks) have to be broadly declining. The economies of the region need to be in recession coupled with very high rates of unemployment. Declines would be most severe in Spain and Italy. Social disturbance would be on the rise.

Reading the S&P FAQ, you have to conclude that the conditions that would force a return of the legacy currencies will happen, and they will happen in the next twelve months.

There are some very substantial currency implications built into this line of reasoning. If you believe, as I do, that things have to get (much) worse before we see Pesetas and Liras again, then you might logically conclude that the Euro is first headed south against the crosses. EURUSD at 1.100 would not be out of the cards in this scenario.

But consider the end game for this. What's the value of a Euro if Spain, Italy, Ireland and Portugal were no longer part of the monetary union? That price starts at EURUSD 1.6000.

I look at this and wonder if the currency trade of the new millennium is taking shape.

Good news from Treasury! Tax-Payer’s Bank Ramps Up Assets

2012-01-12T15:31:00.000-08:00

The Federal Financing Bank (FFB) released its most recent monthly data today. The Treasury owns this bank, meaning the citizens own it. The folks at the FFB are doing a heck of job. Assets rose in the month by a very respectable $866,000,000 (18% annualized growth!). The bank ended November with assets totaling $58.4B; it’s levered 15-1.

A look at where that “growth” came from.

The Post Office got (another) $84.9 mil, bringing the total IOU up to a hefty $13.6B. I looked at the monthly advance and thought, “Gee, that’s an odd number.” Actually it makes perfect sense. Multiply the November draw ($84.9) by 12 and you get 1,018.8B. Of that number, an even Billion is the legal annual borrowing limit of the PO. The balance of $18.8mm is the interest on the whole IOU at an average interest rate of ...hold on... 0.14%.

This result speaks for itself. The deep thinkers at the FFB have this figured down to the penny! An “elegant” solution, at that. Near zero cost of debt and the willingness to lend more principal to receive interest (keep the loan “current”) avoids a stinky problem in an election year. An artful kick of the can that almost no one sees.

The FFB made great strides in expanding the book of loans to large private sector companies. Ford got (another) $145 large:

Private sector loans now total $2.2B. In addition to Ford, the list of borrowers includes Nissan, Fisker, Tesla and Vehicle Production Group.

A big “Way to go!” is due for the record-breaking increase in the FFB’s exposure to solar farms during the month. An additional $181mm came on the books. Some mid-night oil was consumed to achieve all that! The loans (secured by a first lien on mirrors and plastic in the desert) now total just shy of $2.2B.

The only negative to this good news is that any aspiring presidential candidate wanting to cast stones at this Administration's solar investments need look no further then this list to find the necessary stones to toss. Still, a very impressive effort. On the flip side, the Administration needs some help in the sand states, and this delivers on a promise to the Greens.

Another area where the FFB deserves an A+ for its efforts is the big refinancing and new loans for America’s rural utilities. No less than 73 individual loans were refinanced during November. At the same time, a whopping $465,000,000 of new loans were booked. This outstanding performance brought the total utility loans to a record $29.8B. (I hear the boss, Tim Geithner, has a bottle of champagne ready for the day the FFB hits $30B. – Get it cold Tim!)

So who are these titans of industry that the FFB is loaning our money to? And at what terms? It’s a very long list. It can be found here. The following are just a few of the well-know companies that are getting some “extra attention” from Uncle Sam.

It’s hard to find any new business effort where the FFB is not getting the job done. But, to be balanced, there is one area that needs some attention. Two years ago, the FFB’s portfolio of loans secured by Foreign Military Sales stood at a healthy $545M. Here we are two years later, and the loan balances have fallen to a miserly $294M. That’s a 47% drop in just two years! These Department of Defense sponsored loans are “money good” investments - good business for America. There are plenty of opportunities out there. More effort is warranted. Another $200M of foreign military sales will pay big dividends! Rumor has it, some big deals are in the works. The folks at the FFB are up to the challenge.

What’s Next for the SNB? Something Important?

2012-01-11T19:55:00.000-08:00

A curious development took place today. Rather a subtle one. But when it comes to watching central banks, the subtleties are often worth noting. I’m assuming all readers know that the head of the Swiss National Bank (SNB) is out. The question is, “What’s next?” Strangely enough the answer is, “Nothing”.

I wrote the other day that Thomas Jordan would be appointed as the next head of the SNB. Wrong. Jordan was made “Acting” head of the SNB. At first I thought this was just a formality and that Jordan would soon get the final approval. After all, he was the logical candidate, and someone has to run the place, right? He has the credentials. He appears to have been a significant factor in setting policy. He knows where the bathroom is, and knows who does what at the SNB (he’s been there 15 years).

However, I learned today that Mr. J is not the shoe-in I thought he was. The new Swiss Federal President, Eveline Widmer-Schlumpf, said this:

"It could take several weeks and potentially months before the cabinet appoints a successor for Philipp Hildebrand."

Months? Did she really say months? Does she not understand that the markets hate uncertainty? That there is a fair bit at stake here?

She does not offer a reason for the long delay, but continued:

“The Federal Council had no legal duty of supervision. The National Bank is independent.”

By this she means that the political side of the equation has nothing to say about the activities of the SNB. That’s true, but then why should it take a period of months before the leadership at the SNB is re-established?

In odd twist, Ms. Widmer-Schlumpf also happens to be the Swiss Finance Minister (go figure). One can safely assume that she understands the risks associated with a delay. By itself, it causes uncertainty. This elevates the risk of a market test of the 1.2 peg. That risk could be avoided with a rapid appointment of Jordan and a reaffirmation of the independence of the SNB.

So why is she taking the risk? The answer is that there is opposition to the continuation of the independent status of the SNB. Widmer-Schlumpf can’t do what she wants to because of that opposition.

What the hell does that mean? A few thoughts:

What appears to be coming up for discussion in Switzerland is the independence of the central bank. Who does it report to? Who controls it? What are its powers? What checks are there in the system?

These are very weighty questions. It’s understandable that this could take months. While Mr. Jordan may ultimately get the nod and become the true boss at the SNB, it's likely that the SNB will be be subject to new rules and oversight when he finally does gets that title.

There was no reaction to this news in the markets. It’s early days. I suspect we’ll be hearing more on this in coming months . There are two very critical issues at stake. One is the future status of the peg and the sovereignty of the Swiss currency. That’s a big one.

Much more significant, and long overdue, is the broader discussion regarding the central bank’s independence. I find it interesting that this is happening in Switzerland. As far as independent central bankers go, the SNB is on top of the list. At least it was.

Post Mortem on Hildebrand – Got Verdeckel!

A significant amount of information had been provided to the public prior to Hildebrand’s resignation, none of which proved he had prior knowledge of his wife’s intentions to trade currencies. We now know he was lying.

After the resignation, the SNB released an email that appears to have been withheld to the press and the external auditors who reviewed the Hildebrand affair. The note was from Sarasin bank to Hildebrand. In it, the author reminded Hildebrand that he had agreed, in a phone call on August 14th, to a currency "diversification" strategy by Kachya.

This was the smoking gun that brought Hildebrand down.

There is an odd twist to this story. Just prior to being on national TV to discuss the issues with Hildebrand and the SNB, the National President of Switzerland, Widmer-Schlumpf, (yes, the same as above) received a copy of the damning email. She understood immediately the significance of the document and what it would mean. What did she do?

She went on TV and defended Hildebrand and what had happened with his currency transactions. She said the government was supporting the existing leadership at the SNB. She did this to a big audience knowing full well that Hildebrand had misstated the facts and that it was now certain he would have to resign or be fired.

Later she was asked about this. She responded:

“I thought about canceling the appearance.”

The President thought about it? After thinking about it, she went on TV and perpetuated the story that there was insufficient evidence to force Hildebrand out. Is this a fib? Is this how things get done by world leaders? They go on TV and say stuff that is not true?

I can’t think of a screwier end to this screwy story.

Social Security - January 2012 and Beyond

2012-01-11T05:39:00.000-08:00

The January 2012 numbers for Social Security (SS) show a mixed picture. The results mirror what is going on in the economy. There is clear evidence that revenues at SS are recovering; there is equally clear evidence that America’s social expenditures are rising at a rate that exceeds the rate of recovery.

The following numbers are adjusted for any consequences of the 2% payroll tax deduction for 2011 and 2012. As a reminder, the Treasury pays into to SS every month an amount equal to the 2% shortfall. The country ends up more indebted, but there is no net consequence to SS. Some YoY comparative data on the key numbers:

Clearly, the problem is that benefit payments are increasing more rapidly than revenues. There are two contributing forces pushing up costs, (1) 10,000 additional people sign up for benefits every day of the week and (2) inflation (COLA) is rising. The January 2012 YoY increase in benefit payments was $4.1B. Of that amount, approximately $2.1B is attributable to inflation; the balance of $2B is due to more folks getting checks.

We crossed a big corner at SS in 2010 when the first annual cash flow deficit was reported. SS will never again see a cash surplus. The only question is how rapidly the deficits will rise. It’s a bit early in the year for me to provide a credible 2012 forecast for SS. My read of the January numbers confirms my suspicions. The improvement in the economy will be trumped by increasing benefit costs. Net-net, a modest deterioration in the cash position is my base case. I think SS will produce a $56B cash shortfall in 2012 (2010 = -49B, 2011 – 47B). The changes in the net cash position at SS over the past seven years show the extent of the deterioration:

The expense side of the SS equation can’t be altered. The only variables that make a difference are interest rates and the economy (jobs).

The interest rate side of the equation is easy to contemplate. SS’s income from interest is going to decline in 2012 and beyond. Ben Bernanke’s ZIRP, QE and Twist have seen to that. Ben has made it clear that interest rates will remain at historical lows for well into the future. SS is America’s biggest saver ($2.6 Trillion), it will therefore pay a price as the low interest rate environment is endlessly extended.

In June of this year, SS will re-invest its maturing bonds (and any cash it has) in a new strip of securities that have maturities from 1 to 15 years. The interest rate for these Special Issue Treasury Securities is set by a (stupid) 60-year old formula. This year, the formula will produce a yield for the new investments that is the lowest in history. Take a look at the historical interest rates that SS has received on its surplus:

The following shows the maturities and the interest rates on SS's holdings of Treasury securities. Note that in the next few years, all of the high coupon bonds will be rolling off. The old bonds will be replaced with much lower yielding assets.

This is the expectation for interest income at SS based on its 2011 report to Congress:

Here is the forecast on interest rates on which the above interest income forecasts were made.

This simply does not add up. SS will have to significantly revise downward its projections for interest incomes (there is no way the Fed is going to back off ZIRP anytime soon).

The economy is much harder to ponder. As of today, there is a case than can be made for continued job growth. But for how long? America has a bad habit of slipping into a recession every four years or so. The last one was in 2008, so we’re due. I think that the US will muddle through the first part of 2012 with continued modest job growth. However, a slowdown looks to be in the cards by the end of the year. As of today, there are a dozen economic headwinds that will kick in as of 1/1/13 - all of the Bush tax cuts, the SS payroll reduction and a substantial cutback in government spending (the sequestered amounts).

If we experience a recession in 2013, and the Fed maintains its low interest rate policies, it will be a very bad year for SS. The cash deficit would explode under these conditions. It could easily exceed $100b. The wheels will come off of SS’s cart. As we are seeing now, it is extremely difficult for SS to bounce back in good times. it will be impossible if we hit another economic slow patch.

This is precisely the scenario I’m anticipating for 2013. It will be a decisive year. If we end up going down an economic road as I have described, then SS will fall into full deficit (operating cash deficit + interest income). That would happen circa 2015. The Social Security Trust Fund is forecasting this event but it believes it will happen in 2021. When people realize that the Trust Fund has topped out, and the implications are understood, significant changes at SS will follow.

I point readers to a raging debate going on in Japan. To cover the growing deficits at Japan’s equivalent of SS, consumption taxes are being increased from 5% to 10% on everything purchased in the country. This massive tax increase is far too low to cover the problem. To bring balance to the system, VAT taxes have to rise to 17%.

Japan is in a different situation than the US. Its population is even older (and aging more rapidly) than ours. As in many other examples, the US is about ten-years behind Japan. But we are catching up quickly. In just a few years, America will have a similar raging debate on SS. We too will be faced with a dilemma. Either taxes have to raised, or benefits have to come down. The alternative is that the US follows Japan into the land of 200% debt-to-GDP. Unlike Japan, The US can’t survive at that rate. We will blow up before we get to 200%.

We won't see any reforms in America’s entitlement programs in 2012. The election will see to that. The immediate priorities of 2013 will not include SS. The other problems facing the economy will be more pressing. But by 2014, the jig will be up. By then, there will have been so much damage to SS that a very significant set of changes will be required to minimize what will then be seen as a systemic risk.

Note: I get the occasional beef about using graffiti in my articles. "Phooey" is what I say to that. This one by Banksy is perfect for this piece. No?
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The Next Head of the SNB – Thomas J. Jordan

2012-01-09T07:46:00.000-08:00

Mr. Jordan is my guess as the next head of the Swiss National Bank. He’s been at the SNB since 1997. He moved up from the economics department and is now the Vice Chairman.

Mr. J is well qualified. This link to his CV shows that he is an academic at heart. He has never worked in the private sector. “Euro Technocrat” comes to mind.

A quick review of some of J’s writings convinces me that he has been a strong advocate of an active and interventionist role in financial markets by the SNB.

He was actively involved with the bailout of UBS in 2008. The SNB created a SPIV where UBS dumped its toxic assets. This came to a $60B transaction. 90% of the funding came from the SNB, the balance came from UBS, but the SNB back doored the money to UBS to get the deal done.

In the 4th quarter of 2008 the financial world was coming apart. There were big funding problems with Swiss Banks as global liquidity dried up. Jordan was actively involved with formulating the SNB response. He flooded the domestic market with liquidity. He wrote of the period in this article. His words:

The turmoil in the money market prompted the SNB to conduct money market operations to an extent that had never before been witnessed. There were days when up to five auctions were held. The volume of the operations varied considerably. On record days, we carried out operations worth over CHF 100 billion.

Note: CHF 100B is equal to 20% of Swiss GDP. This is equivalent to $3 trillion in the US markets

The extent of the money market operations also has a major impact on the size of the SNB’s balance sheet. Before the crisis, approximately CHF 20 billion of the balance sheet went towards monetary policy; today, we are looking at around CHF 80 billion.

This was the first step of many for what has become a massive increase in Swiss reserves (now CHF260B, a 7 fold increase). Clearly, Jordan was pushing the reserve increases as a solution in 2008. No doubt but that he has continued to be a strong advocate for continued reserve accumulation as a “simple” solution to the problems Switzerland faces.

I found this article at Bloomberg dated 8/11. On this day Jordan made a very important public statement. He confirmed, that after legal review, it was possible for the SNB to establish a currency peg. (There was a question if a peg violated the currency laws of the country) Two important points:

-Jordan had to have been the one at the SNB who was pushing for the peg. He took it on his own to resolve the legal questions. When he had done that, he went public. This was a warning/threat to the FX market that the SNB would soon act (they did, two weeks later).

-This happened on August 11. Four days before Kashya Hildebrand did her fateful FX trade. I maintain that Kashya had key insights into what would soon unfold with the devaluation of the Franc. She never discussed with her husband on 8/11 the important information provided by Jordan? While it no longer matters, I find this aspect of the affair very hard to believe. This story has more holes than the cheese of Switzerland.

Should Thomas Jordan be appointed as the next head of the SNB I would strongly suspect that one of his first acts will be a confirmation that “Existing Policy Measures of the SNB” (AKA – the Peg) will be maintained. The "peg" is Jordan’s baby. He will not back off. If pushed by the market, I believe he would step up to the plate and aggressively defend the peg.

That said, the Hildebrand Affair has significantly weakened the SNB. I have said this before, I will say it again. There are powerful political forces in Switzerland who are philosophically apposed to the unending reserve accumulation by the SNB. These opposition forces have had a major victory. They have forced Hildebrand out; something they have been attempting to do for years.

The opposition to the strategies and tactics of the SNB will not end. Should we see another significant increase in Swiss reserves this issue is going to come right back on the table. I think that additional reserve accumulation is now inevitable. So the stage is getting set for a showdown.

On Trading Central Tendency

2012-01-08T19:19:00.000-08:00

It’s been about a week since the Federal Reserve announced its new policy of providing information to the public regarding the direction of US interest rates. The new policy is not, generally, a surprise. The Wall Street Journal’s Jon Hilsenrath told us something was coming weeks ago. I've been pondering whether this is a positive or a negative development. I’ve concluded that this step by the Fed will backfire and will prove to be a mistake.

It’s tough to argue against a policy of more disclosure by the Fed. The members are a secretive bunch to begin with. Most people have a level of distrust of the Fed. More information about what they are doing and why, would be helpful. However, I believe the decision to provide more info has nothing to do with the Fed wanting to be more open and lovable. The Fed has taken this step in an effort to make its current policy decisions more effective.

I think any policy of the Federal Reserve should be designed to stand the test of time. It must be effective in all anticipated future conditions. The move by the Fed may well achieve the desired short-term objectives. Businesses, investors and individuals will have a greater degree of certainty regarding the future direction and timing of changes in interest rates. On balance, the additional information should have mildly positive consequences on new capital investments by companies, the process of capital formation in the markets, and it might allow individuals to make better long-term investment choices. What’s not to like?

The Fed currently publishes information regarding the thinking of the Fed members on both GDP and inflation (the SEP report). I was surprised to see that the revised report will now include a projection for the likely timing of the first rate hike. (This aspect of the Fed's release was not in the WSJ article.)

The 12 Fed governors will provide their estimates of when the first rate hike will occur. The top and bottom three will be excluded. The full range of estimates could, for example be from 2013 to 2016. But the narrow estimate would be more precise. It could be from June 2013 to June of 2014.

In the above example, the “Central Tendency” of the expectation for a change in Fed policy towards a tightening stance is a very specific date - it would be December of 2013. This date is far enough away from today that any concerns about rising rates should be eliminated. As this information is transmitted through the markets, it should have a beneficial effect. Where’s the beef?

Consider what happens with the passage of time and changing scenarios.

-With each additional quarterly report, there will be time decay. From the first report, the Central Tendency will be (in my example) 20 months away. Unless the Fed governor' consensus changes, the timeline for a rate hike will get closer with each report. Not a big deal for the second report. But by the third report, the Central Tendency will fall to only 11 months (assuming the Fed's estimates don't change). While still months away, I think that markets and businesses will begin reacting to what is a big warning sign (and a specific timeframe) for a contraction. By establishing a date certain in the mind of the market, the Fed will have drawn a distinct line in the sand. As we get closer to the line, there will be, inevitably, indigestion.

-Most likely there will be changes in the Central Tendency as individual Fed Governors throw in their two cents each quarter. What might happen if it is announced that the CT has been pushed farther out by four additional months? I think we would get headlines that look like these:

-A change bringing the CT for a rate hike forward by three months would be even more dramatic. The headlines might look like this:

We will inevitably go through short-term changes in economic measures. In one quarter, inflation may be on the hot side. In another, the economy could be showing signs of weakness. (We had exactly these conditions in 2011, when oil spiked up and we had a tsunami that had global short-term consequences.) Fed policy should look through these events. In fact, the Fed correctly anticipated that the shock in Japan and the spike in oil would be short-lived. But the Fed potential flip-flopping (either way), and changes that are made to the CT, creates the possibility of confusion by all concerned. We might see these sorts of things as a result:

There are several other headlines we might see as a result of the increased information the Fed will provide:

Sometime after that headline we might get this one (I would love it).

Or we might see something like this:

My bottom line is that the Fed may have helped its cause in its battle with (perceived) deflation. But it will backfire as time passes and the necessity to normalize monetary policy nears. I think the Fed will come to ~~hate~~ regret this step. So will the markets.

On FX

2012-01-07T09:13:00.000-08:00

On October 25 I wrote about what, at the time, looked like an overvalued EURUSD (it was 1.3950). Zero Hedge had an article attributing the strength to ongoing capital repatriation by EU (primarily French) banks. My words:

As long as there is Euro repatriation, the EURUSD will remain overvalued. It’s about day-to-day demand, not the backdrop of the news.

I can’t predict how long this will take to wash out. My guess is under a month. I think the Euro is a big short. I can see EURUSD = 1.3000

I covered that up Friday morning. (Note: This was a nice win, but, alas, there is “ugliness” on other parts of my sheet). I went for a long walk feeling pretty good about being disciplined.

About a mile into the woods I started having second thoughts. I turned around, came home, made a call and spent a good chunk of the realized FX gains buying expensive puts on the Euro. Fuck discipline.

Let me try to explain my schizophrenia. On one hand I don’t think the EU is going down without a fight. I think there is a decent chance that some additional steps are announced in the next few weeks that will give the appearance of an all out effort to save the Euro Zone. Something significant could come from the IMF. We could get news from the US Treasury in the form of a draw down of the Exchange Stabilization Fund. There could also be additional measures by the US Federal Reserve. The ECB could announce un-sterilized bond purchases (Euro QE#1). There are a number of other possibilities.

The market is short Euros (in big amounts) against everything from Yen, USD, Sterling, and Kroners. This is a very crowded trade at the moment. I hate crowds. That was the reason for the AM bailout of a long held position.

But there’s another possibility. We could see the whole Euro experiment unwind by March. The Fed can’t really do a thing. Their hands are tied. Bernanke has already said he would not bailout the EU. If he reverses himself he will lose his credibility, and his job (He knows that). Tim Geithner can’t do much with what is available to him. The ESF has no size behind it ($105 billion). The IMF will probably do something, but the most it could bring is a few hundred billion Euros. If the ECB goes into the QE business the rating agencies and the market will retaliate. My bottom line is that no one has a bazooka.

Consider the news of the past week in Europe. Hungary is falling apart in an ugly way. In Berlin and Bern there are significant political scandals (Wulff and Hildebrand). Important elections are coming in France. The whole area is rapidly moving into recession. The rating agencies will be downgrading core countries over the next month. The refinancing requirements of the Sovereigns and their banks can’t be accomplished in the current environment. We may have a failed auction that tips the scale to chaos.

What is one option that is not now being considered and would have a beneficial affect on the EU? Simple. Devalue the currency by 20%.

Far fetched? Impossible? Maybe. But that is exactly what happened on 9/22/85 when then Treasury Secretary James Baker engineered a significant devaluation of the dollar with the Plaza Accord. To achieve the desired devaluation the global central banks sold dollars. I know, I was strapped to a seat for a week.

There are no central banks that want to do this. It would hurt the US, Japan, UK, Brazil, Korea and China. But they don’t want an implosion of the EU either. A significant devaluation would be a big boost to short-term economic prospects for the EU. It would do little for the solvency/funding problems. But it would stimulate growth and create some jobs. Without that, the EU is dead anyway, so devaluation is not out of the cards.

A compelling argument for a coordinated devaluation is the Swiss Franc. The Swiss National Bank engineered a 20% devaluation last year. With a “little help from its friends” the ECB and the French/German central banks could pull the same maneuver. Desperate times require desperate measures.

What are the odds of a coordinated devaluation of the Euro? Not high, is the answer. But it’s not zero either. It doesn’t mean much if a low rent blogger brings up stuff like this. It would, however, be significant if one of the EU papers ran an editorial along these lines. Better yet, one of the ‘deciders’ could say something about how “desirable” a cheaper Euro would be. The odds of something like that are pretty high in my book. It wouldn’t take much talk to get the markets riled up.

So I bought those puts. Like most puts, they’ll likely expire out of the money. But there is a 1 in 5 chance they will come into the money big time. If they do, I’ll have an another FX win, but the rest of the sheet will go deep into the red…..

Red Alert on the CHF?

I’m not satisfied with the responses by Philipp Hildebrand. But the Swiss newspapers are all giving him a break. The Swiss love their head of the SNB. He was a swimming champ. He’s good looking, and so is his wife. It seems, for the moment, that his conduct will be swept under the rug.

But, behind the scenes, Hildebrand will remain under attack. There is a dark political angle to this story; powerful people in Switzerland want Hildebrand out. They blame Phillipp for the mishandling of the currency intervention that led to a $21b loss for the SNB. I think these same powerful people are afraid that the current SNB policies could deliver a very damaging blow to the country.

Swiss foreign reserves rose to nearly CHF 260b (50% of GDP) at the end of December. That’s up significantly from November. In addition to these published reserves, the SNB has stated that it has used options to maintain the EURCHF above 1.200. So we really don’t know how big an exposure the SNB has.

If one more shoe drops on Mr. Hildebrand (or his wife), he will be out. That would immediately give rise to the question of whether the peg will be maintained. The real reason that Hildebrand is in such trouble today is that he was responsible for the intervention policy that led to the dangerous reserve accumulation. Given that, it’s likely that his successor would not be so willing to follow the same path. A new SNB chief would, at a minimum, have to reconsider the intervention/peg policy.

If Hildebrand is forced out I think the SNB would have to step up and absorb a few hundred billion addition Euros. I don’t think they can do that. Something like that could bust the SNB.

Please don’t read this as a suggestion to speculate on the CHF. The scenario I describe is not the likely outcome. I am suggesting that one pay closer attention to the CHF crosses. If the EURCHF backtracks close to the 1.2 level there is going to be fallout across all markets.

The EURCHF closed at 1.2147 on Friday. That’s a two-month low. I (and a bunch of others) made note of this close. I’m sure the folks at the SNB did too.

Three Long Waves

2012-01-05T18:38:00.000-08:00

Our economic slump is pushing four years now. The evidence is easy to find: huge deficits, slow growth, mortgage defaults, declining real estate prices, high unemployment and an economy that can’t produce enough jobs. There are less obvious consequences too. Here's a look at three changes that are taking place. None of them good.

A Bubble in Lawyers

An interesting article from the American Bar Association on the current status quo of lawyers coming out of law school, things stink for the new crop of lawyers. In 2008, when the skids were coming off the economy, what did many college graduates do? They thought, “The hell with getting a job in the middle of a recession.” They went to law school instead.

How did so many people get the money to get a law degree? They borrowed it from Uncle Sam of course. The (virtually) unlimited amount of federal dollars for graduate level education was part of the HERA stimulus bill. Now all those new lawyers are looking for a job in a crowded field, and they’re up to their eyeballs in debt. From the ABA article:

-In 2010, 85 percent of law graduates from ABA-accredited schools boasted an average debt load of $98,500.

-Assuming a total debt of $150,000 (the amount currently carried by several thousand law graduates), the total monthly payment is $1,743.46 a month for 10 years. The median starting salary for a lawyer who graduated from law school in 2010 is $63,000 (Debt=40% of take home pay).

-Heavy loans now threaten to consume the future earnings and livelihood of the nation’s young lawyers.

-The influx of so many law school graduates—44,258 in 2010 alone, according to the ABA—into a declining job market creates serious repercussions that will reverberate for decades to come.

-Direct federal loans have become the lifeblood of graduate education, and they shelter law schools financially from the structural changes affecting the profession.

-Given the likelihood of some form of curb in federal student lending, there are gut-wrenching times ahead for law schools.

-Bad things happen when lawyers and law professors stick their heads in the sand.

Rents on the Rise

It’s not surprising that rents are rising. Last year the increase was, on average, only 2.5%. This year it could be double that. People do need shelter, and are forced to rent because:

-Rents are still cheaper than buying

-There is no upside to ownership

-Few have the 20+% down payment required to buy

-Few can qualify for a mortgage given tighter lending standards (FICO scores)

Some data points from Bloomberg (Link).

-U.S. apartment vacancies dropped to a 10-year low in the fourth quarter, allowing for rent increases that are likely to continue this year.

-The vacancy rate was 5.6 percent in the previous three months and 6.6 percent a year earlier. The vacancy rate has fallen for seven straight quarters.

-For all of 2011, 37,678 rental units were completed, the lowest annual total in 31 years.

Rising rents could have a significant consequence on Fed policy this year. Ben Bernanke has sworn not to ignore his obligations regarding inflation. Ben looks at Core CPI and has said repeatedly that Core CPI above 2% would not be tolerated.

Bernanke faces the problem that core CPI has a 21% weight based on “Owners Equivalent Rent”. A 5% increase in this category would, by itself, cause a 1% increase in Core CPI.

Oddly, the lingering recession is the reason for the higher rents. One would expect that rents would be muted while the economy is weak. That was not the case in 2011. Additional upward pressure on rents will put a floor of 1%+ on CPI in 2012. As a result, there is very little wiggle room for all the other components that make up the index if it is to remain around 2%.

This must drive Bernanke crazy. In the end, it will force him to abandon his prior pledge on inflation.

Declining Labor Force Participation

Tomorrow, the Non-Farms Payroll numbers will be released. I think this data series is mostly noise. Monthly changes in employment can’t be accurately measured when the (non cell phone) sampling is done with only 0.01% of the workforce.

I will be looking at the Labor Force Participation Rate (LFP). This important number may have hit a new 30-year low in December. In November it stood at 64.0%.

It’s not surprising that the LFP is in decline. After three tough years, people are leaving the workforce. Some are retiring early and getting Disability Insurance/early Social Security benefits. Some just fall off the grid and work for cash in the black economy. Either way, they don’t show up in the survey data so the LFP falls. This is a terrible development for local, state and federal government tax receipts.

The following chart is from 2007, before the SHTF. This was forecast data for future LFP based on the thinking at the time. Needless to say, we missed the estimates. It’s interesting to note that the current LFP of 64% is about where we were expected to be in 2025. That four-year-old estimate got crushed by a four-year recession.

Kashya Hildebrand Speaks – Sinks Hubby?

2012-01-04T11:31:00.000-08:00

I wrote about Kashya Hildebrand’s inappropriate FX trades the other day. The story has some new legs today (Bloomberg). The wife of the president of the Swiss National Bank (SNB) has done the one thing she never should have. She talked. Any chance this affair had of falling off the radar screen was lost when she went on Swiss TV.

A recap:

-8/15/11 Kashya sells CHF 400,000 short against the dollar at USDCHF .7936.

-9/9/11 the SNB devalues the CHF.

-10/4/11 Kashya covers the short and earns an FX profit of CHF 75,000 ($83,000). The return is 16.5% of the amount traded. She did this in just 50 days (120% annualized).

-November 2011 an employee of Sarasin Bank, Basel steals the information about Kashya’s trades and leaks it to a Swiss politician, Christoph Blocher.

-There is a formal investigation. On Friday night, 12/23/11, the SNB makes a public announcement that the FX transactions have been reviewed and there is nothing improper about them. The timing of the release of information was clearly an effort to bury the story.

-1/3/2012 Kashya goes on TV in what appears to me like a snotty and inappropriate defense of her actions.

Kashya’s words:

“My interest in the dollar purchase was motivated by the fact that it was at a record low and almost ridiculously cheap.”

I think this is bullshit. Yes the dollar was cheap at the time. There was a global panic occurring. To counter-trade the market at precisely the time the CHF was hitting all-time highs takes balls and an extraordinary sense of timing.

Kashya may have committed a fatal error with those words. She teed this up. Now there has to be a follow up. I’ve been trading FX for years. There is no way in hell that Kashya just happened to luck out. There is only one possible exception. If she was a regular trader of the USDCHF, she might be able to justify the impeccable results of the 8/15 trades. But if she can’t demonstrate that she was a repeat "banger" in the FX markets, then the idea that she just happened to think the CHF was “cheap” and was worthy of a spec, falls very, very flat.

It is a fact that 70 to 80 percent of the financial transactions of the Gallery are in dollars. The reason is that the artists come from many different ethnic groups, and that we participate in many art fairs around the world.

Kashya is attempting to argue that her FX trading is directly related to her art gallery business. Oh really? If that were the case, this story would never have made the headlines. If she had purchased a specific painting that was priced in dollars it could be argued that the transaction was in the normal course of her business. Importers hedge their FX exposures all the time. That’s not what happened here.

There was no painting that was being hedged. If there were, Kashya would have shown an invoice long ago. This was an outright speculation on her part. The proof is that she never took delivery of the dollars she bought. When she had a big unrealized gain, she did what any smart spec would do, take the profit.

Some personal color on this. Kashya worked for Moore Capital fifteen years ago. Guess what? During that same period, I was playing hard in the FX markets. Check my Bio. I knew Moore from back then. Louis Bacon was running the show. Moore was then (and still is) on the very top of the list of big hitters in the FX markets. They had deep pockets, great traders and they were wired.

There are no laws on the books (that I know of) regarding insider information and FX trading. Information is the key to success. Information comes in the form of expensive data systems. It also comes the old-fashioned way, word of mouth. That was true in 1995. It’s no different today. Kashya worked in a shop that understood how money was made in FX. You don't forget these lessons. FX has always been about the money, and how to get more of it.

Here's my suggestion to Kashya and Philipp Hildebrand, the Swiss media (who are reading this, thanks!) and Christoph Blocher:

Publish the FX trading activity for Kashya Hildebrand for the past 12 months. There are only two possible outcomes:

A) Kashya was a regular FX trader. She bought and sold CHF against other currencies on more than one occasion over the course of a year.

B) The 8/15 speculative transaction was a one-of-a-kind event.

Which one is it? If it is A, then Kashya repeatedly abused her position. She put her husband at risk for conflict of interest considerations. Philipp would have been an ass to let her do any regular trading. If scenario A is proven, then Philipp looks very bad indeed. It would have been extraordinary poor judgment on his part if this were the case.

If it is B, then Kashya is damned. She had to have a very specific reason to do an FX spec. If it’s shown that this was a unique event, then it’s compelling evidence that she acted with specific foreknowledge. She was wired, just like the firm she used to work at was famous for being.

A or B, I think that Kashya’s attempt to defuse this issue has backfired. She has put herself (and her husband) in a difficult corner. She has offered up an excuse for her actions. Now it’s time to reveal some facts. Either way, it will look bad.

The outcome of this is far from certain. If Kashya is either caught in a lie, or shown to be a regular FX trader, it could easily mean the end for Mr. Hildebrand. This affair just makes the SNB look silly. That won’t be tolerated for long.

I do wonder if there are any FX implications attached to all of this. My guess is that if we were to get a surprise new head of the SNB there would be no change to the 1.20 EURCHF peg. At least not right away. But if there is a change at the top at the SNB, I suspect the life span of the peg will be shortened.

We may well have a situation where the market is forced to ask the question:

“Now that the brainchild of the peg is gone, how much is the SNB willing to intervene at 1.20?”

If the market forces this issue, it will have broad consequences. A speculative attack on the CHF would upset all markets. Thanks in advance Kashya!
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I love a stink

2012-01-01T06:53:00.000-08:00

My kind of story in the Swiss papers today. I love it when big shot central bankers get their dirty laundry made public.

Kashya, the wife of Phillip Hilldebrand (head of the Swiss National Bank) sold Swiss Francs just a few days before the Swiss National Bank initiated exchange controls and devalued the Franc. The timing of the transactions was nearly perfect. The suggestion is that “pillow talk” between husband and wife lead to the trades.

Don’t expect heads to roll over this transgression. There has been a complete review by Swiss authorities and the conclusion is that there were no insider trading violations by the wife. That’s not to say that trades did not happen.

Apparently, Kashya Hildebrand bought ~$500,000 when she shorted the CHF. This relatively small transaction netted the Hildebrand family only ~$50,000 in less than one month. Being that the amount is so small, the conclusion is that nothing nefarious has taken place. From NZZ.

Therefore no central banker in the world would risk his job.

Really? Only $50k extra for the wife’s account? That’s not enough incentive? I guess so. Hubby earns CHF 862,000 ($950,00) at the SNB. (A sweet deal, Ben Bernanke takes in less than $200k)

What's fascinating about this story is how it came about. Who blew the whistle on wifey? The answer is that Kashya Hildebrand maintained an account with a (very) private bank called Sarasin. When she did the trades back in August someone at the bank alerted an opposition politician, Christoph Blocher. Blocher brought the evidence to the Swiss President, Micheline Calymy-Rey and insisted on an investigation.

The information was leaked by a bank employee? To a politician? Folks, this stuff is not supposed to happen in Switzerland. This is the land of banking secrecy. This leak is highly illegal. This affair proves one point. There is no secrecy left in Swiss banking (for residents and non-residents alike). Anyone who thinks there is, is just wrong.

It’s not possible to know the facts in this story. It’s been whitewashed. There are a number of possible scenarios. I wish I knew which one was right:

-Philipp Hildebrand never told his wife about the pending exchange controls and devaluation of the CHF.

-Kashya Hildebrand acted independently; she never informed her husband of the transactions she made with the family’s money (she also bought dollars and sold CHF for her daughter).

-Kashya Hildebrand routinely bought and sold dollars. The timing of the transactions (August 15th) was pure coincidence.

-No other employees of the SNB (or their family members) sold Swiss Francs in advance of the devaluation.

-ALL OTHERS.....

This story stinks. It’s about political intrigue, stolen information from secret banks, leaked information from Central Banks and possible insider currency trading. A nice way to kick off the New Year!

Congress Sics IRS on “Enemies”

2011-12-29T05:16:00.000-08:00

I was thinking of writing a book. “The Coming Age Warfare”. If I did get around to it, the following story might be the first chapter. Like most wars, the one I see coming between young and old will simmer for years. Along the way there will be skirmishes that result in injury and bad feelings. I find this example comical. But there is nothing funny about it.

Three members of Congress have shot a cannon at the American Association of Retired Persons (AARP). Republicans Herger (CA), Boustany (LA) and Reichert (WA) sent a letter to the head of the IRS asking that the tax status of AARP be reviewed.

AARP is a 501(c)(4). That means they pay no taxes at all. Sort of like a church. At first look this might make sense. After all, the AARP is a non-profit that is just trying to help out the oldsters. Right?

Wrong! AARP took in $600,000,000 during 2010 from endorsement deals. Not a penny of taxes was paid.

Anyway, the AARP fired back with a (mealy mouthed) letter the next day:

AARP Response to Recent Letter from Reps. Herger, Boustany and Reichert

We are disappointed that the letter seeks to decry the exact kind of pro-consumer, market-changing efforts that AARP has led since our founding in 1958.

You can bet the folks over at the AARP are “disappointed” that some congressmen have sic’ed the IRS on them It’s worth $150mm a year to them.

I wouldn’t worry about the AARP just yet. They have an army of political friends and some big shot lawyers. It’s a safe bet that the IRS sits on this until 2013 when a (potentially) new IRS Commissioner has the corner office. In the meantime, one can expect that the AARP will direct their campaign ~~investments~~ contributions wisely. They will support those candidates who will push to preserve the cushy tax status of the AARP.

Note:
This business with tax breaks for the AARP (and other big 501(c)(4)s) is another good example of how screwed up our tax laws are. The current system just creates carve-outs and preferences for powerful groups. Why? The answer is that those same powerful groups have control over the outcome.
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2012 - Things that will happen

2011-12-27T03:21:00.000-08:00

Significant economic and political changes will make 2012 a historical year. The globe has experienced relative calm for the past 24 months. That stability won't last much longer. Events that are not on anyone's radar screen will matter the most. The following are the things that I think might happen, but it's the surprises that worry me.

-Silas Kiplagat will win the 1500-meter race at the Summer Olympics in London. The time will be 3:33:22.

-Obama will drop Joe Biden from the ticket. Obama will want a Veep that has a chance to be a viable presidential candidate. He will chose Hillary Clinton.

-Green Bay will beat Denver in the Super Bowl. (Millions of Christians will be disappointed).

-Mitt (the suit) Romney will be the Republican presidential candidate. The nomination will be a fight to the very end. Newt (the fool) Gingrich will come close, but will not get the nod. Romney will announce that his running mate will be South Carolina Governor, Nikki Haley. Her presence on the ticket will give Mitt a chance.

-Ron Paul will run as a third party candidate (Green) He will get 10% of the popular vote. He will upend any chance the Republicans have.

-The presidential election will go to Obama. Ending up with only 44% of the vote, he will not have a mandate. The battleground states will be Pennsylvania and Ohio. Billions will be spent on getting the votes in those states. Pennsylvania will go to Obama. Ohio will go with Romney. The electoral vote margin will be very narrow as a result.

-The Kepler spacecraft (link) will identify a planet that has the capacity to sustain life (the ultimate safe haven). The scientists at CERN will confirm the observation of particles exceeding the speed of light. These developments will result in significant rethinking by the scientific community.

-The Senate will be split evenly between Democrats and Republicans. The new VP will have deciding votes on several key issues.

-Republicans will retain their majority in the House. Gridlock will be the outcome. There will be no new legislation of significance in 2012. A lost year.

-Iran will attempt to disrupt sea traffic in the Straits of Hormuz. Naval exercises by NATO, USA and China will be required to escort tankers through troubled waters. There will be an incident culminating in shots being fired. It will scare the hell out of everyone, but full military action will be avoided.

-Iraq will fall into sectarian violence. Car bombings will beset the country. The Kurds, in the north, will attempt to separate themselves from Baghdad. Turkey will get involved as a result of border problems. In the south (Basra/oil ports), the local Shia government will ask neighboring Iran, to help bring stability. The Iranians will establish a police presence.

-Brent crude prices will swing between a low of $80 and a high of $155. The highest level will be reached in September.

-Australia will suffer from a significant economic slowdown. The A$ will fall to 90 versus the buck.

-Cyprus will make a significant new gas find. This will result in territorial claims by Turkey. The UN, lead by Russia, will get involved in the dispute.

-Europe’s economic problems will not be solved. Every effort will be made to kick the can down the road. Neither the can nor the road will collapse; that will happen in 2013. EU GDP will struggle to hold zero.

-It will be confirmed that Iran has nukes and the capacity to deliver them. Iran will successfully test fire a Shahab 3c missile. Israel will not attack Iran.

-The US housing market will stabilize. Rental costs will rise by 7%. This, coupled with extremely low debt costs, will increase the demand for homes. In addition, the costs of constructing new homes will soar due to rising costs of materials. Virtually everything used to build a home (from cement to shingles) will rise in price by 10%. Construction of new homes will remain muted as a result.

-During the year, the ECB will be forced to actively intervene in the EU bond market on multiple occasions. Ten-year yields for Italy will range from 5 to 8%. Spanish yields will rise to 10% at one point. French bonds will reach 7%. The enormous refinancing requirements of EU countries and banks will be a constant problem. The market will become obsessed with the weekly bond auctions. There will be many disappointing results.

-The EU banks will struggle, kept alive by LTROs and E150B of new equity injections into the banks (a la Tarp). Public assistance to the banks will exceed E1 Trillion. The EU banks will not adopt the Basel Core Tier 1 capital ratio of 9% in June; the planned recapitalization will be shelved for a year. There will be much discussion about the scale of the government's involvement, which will be recognized as unsustainable. By year's end, the noose will be tighter and the financial options greatly diminished. By December 2012, the Euro Zone won't be expected to survive another year.

-The Swiss National Bank will maintain the 1.20 peg to the Euro. By the end of the year, the talk will be about how much longer the peg will continue. The SNB will acknowledge that the peg was a temporary measure. The speculation will be about how long “temporary” actually is.

-The Euro will range from a high of 1.4 to a low of 1.15. The low for the year will occur in November.

-The Yen will (finally) weaken. The low for the USDYEN will be 76.5 the high will be 90. (It's a great short). The problem for Japan will be its 200% debt to GDP. Global investors will shun the Japanese bond markets. Ten-year yields will rise to over 2% as a result. While Japan has gotten away with its excessive debt for years and global investors always had reasons to park cash in Japanese Government Bonds (JGBs), there will be no reasons left in 2012.

-As the US's presence in Afghanistan winds down, the Taliban will retake the country. The chaotic US exit will be compared with the end of the Viet Nam war.

-The Syrian government will fall. The country will face an uncertain future. There will be sectarian violence in Libya. Sophisticated weapons, including SAM missiles will be used. In Egypt, Field Marshal Tantawi, will consolidate power. Protests will continue throughout the region. The MENA economies will broadly suffer.

-The S&P will range from a low of 900 to a high of 1400. The high for the year will occur before June.

-The US GDP will languish. Growth will range from 1.5 to 2%. There will be clear evidence of a slowdown by mid-year. Unemployment will fall to as low as 8.5%, but will end the year back above 9%. The BLS will report 1.6mm of new jobs created during the year but the "birth/death" model will reduce that by 600,000. Labor force participation will continue to decline.

-Modest economic activity and core inflation above 2% will tie the Federal Reserve’s hands for the first part of the year. Politics will prevent it from acting prior to the election. In December of 2012, the Fed will be free to initiate another round of QE - an $800 billion Large Scale Asset Purchase (LSAP) will follow. The Fed’s new POMO operations will be divided equally between Treasury bonds and Agency Mortgage paper.

-The Vix will be volatile. The average for the year will be 30. It will exceed 45 twice.

-Greece will continue pretending it wants to be in the EU and tied to the Euro, until July. Its deteriorating economy and inability to service its restructured debt will force Greece to leave the EU and re-establish the Drachma. The New Drachma will trade as high as 1,000 to the dollar (800/Euro). When the Drachma is brought back (over a weekend), the Greeks will formally default on their external debt. This won't be the crisis that everyone fears, but it will add to the instability in the other peripherals. Populations in Ireland and Portugal will protest that their countries should follow Greece’s steps.

- The Academy Award winners:

Best Movie War Horse

Best Director Steven Spielberg

Best Actor George Cloony

Best Actress Michelle Williams

Best Support. Actor Christopher Plummer

Best Support. Actress Jessica Chastain

Best Orig. Screenplay The Tree of Life

Best Adapted " War Horse

-North Korea will be a problematic. Counter to expectations, Kim Jung-Un will not be the actual ruler. The generals will conspire with Kim’s uncle, Jan Song Taek, to take over leadership. There will be an occasional pop shot from north to south. The real trouble will come when NK boards and then sinks a S. Korean fishing vessel. This will bring US aircraft carriers off the shores of NK. China will hate this development. A nasty incident is the most likely outcome.

-The Miami Heat will fail to make the playoffs. LA will beat Boston.

-Keynesian economic thinking will be further discredited in 2012. The pump-priming Keynesians had their day in the sun, and now people will want a different approach. Paul Krugman will write a total of 100 blogs decrying this development. Larry Summers will write an OpEd for the WSJ warning that the US faces a strategic crisis if it does not contain the trajectory of the national debt.

-Gold will be very volatile. It will fall to below $1400 at one point. It will end the year above $2000.

-There is a significant risk of a big economic hiccup at the end of the year. The election has deferred dozens of tax/spending issues to 1/1/13. There is enough deflationary firepower built into the system to trigger a big slowdown. Post election, there will be just weeks to sort it out, or face the music. The drama and the pain of the just completed election will make it impossible to avoid a conflict.

-Japan will confront two divergent issues. Debates regarding the future development of nuclear energy for civilian use will arise as the true costs of the disaster at Fukushima are realized. Significant portions of the country will have to be abandoned. Costs of encapsulating and cleaning up will exceed $50 billion. At the same time, a growing force within the country will push to develop tactical nuclear weapons. The US's mandatory budget cuts for its military will elicit an extraordinary change which will take years to play out. Japan will lose confidence that its "protector" will be able to protect it.

-India will surprise everyone. GDP growth will fall from 9% to 3% (well under stall speed). Inflation will exceed 10%. The trade and current account deficit will rise. The Rupee will hit 60 per dollar.

-China’s GDP will fall to 4%. China has already overspent in infrastructure development. The buildout of empty cities will slow and unemployment will rise rapidly. This will stress the country and lead to political protests in many cities.

-Tiger Woods will win a major.

-China will continue to fund the west. It will allocate more capital to the core countries of Europe. China will get trade deals in exchange for its willingness to buy bonds. The holdings of US treasury debt will decline modestly for the year. The Chinese will react to the ongoing pressure from the US to force the Yuan to appreciate by doing precisely the opposite. The CHY will be worth the same next year as it is today.

-Bank of America will be forced to pare down its asset base. The stock will spend most of the year under $5. The subordinated debt will trade cheap.

-Goldman Sachs will go private. There will be many layoffs. The Squid will end up stronger than ever.

-The San Francisco Giants will win the World Series. The Yanks will be the loser.

-In March, it will finally be determined that MF Global used re-hypothecation to fund its operations. The customer losses will be attributed to this activity. Realized customer losses will exceed $1B. JPM will be identified as one of the banks that grabbed MFG assets in the final days. Customers will file civil claims against JPM, but those will be dismissed. Criminal charges will not be filed against MFG, Corzine nor JPM. The flaws in the system will be attributed to Reg. T. The Fed will promise a thorough review of the country’s margin rules. Nothing will be completed until 2013.

-AAPL will trade as high as $450. It will end the year under $350. The company will come out with a TV that won't be much of a success. Apple will lose out to Amazon (and others) in the "Cloud". This will prove to be a strategic error.

-The cost of solar panels will fall to a level where large scale, privately funded solar farms become viable. The debt for these farms will be functionally secured by a public utility and will be repackaged with shorter maturities that have a AAA rating. The lowest tranches of debt will have returns as high as 20%. Wall Street will love it and so will investors. Some utility stocks will do well as they have secured a source of renewable energy that meets the recently legislated requirements (RECs).

-Boeing’s shares will fall to $55. There will be problems with the Dream Liner.

-Dividend stocks will underperform the broad averages. The observation will (finally) be made that this is a very crowded trade and 2% does not compensate investors for their risks.

-Creative Cause (son of Giant's Causeway) will win the Kentucky Derby.

-The Chevy volt will suffer from numerous battery problems. There will be fires that result in serious injuries. The future of GM’s electric car will come into question. The stock will fall to the teens. Tesla’s outlook will become uncertain. Obama’s investment in Tesla will be a campaign issue.

-La Nina conditions will persist for the first six months of the year, bringing a series of big storms to Asia. Substantial new flooding will occur in the Philippines and Thailand. West Texas will have another dry year, the central states will have above average rain, and the North East will have a very bad winter.

-Silver will follow gold up and down. It will underperform gold. It won't hit $50.

-Narco violence in Mexico will escalate. There will be gun play on the border. Mexico will reiterate its position that the problem is the demand from the gringos, not the supply from Mexico. This thinking will lead to renewed discussion on legalization of Marijuana. Phillip Morris’s stock will rise above $90 in anticipation.

-BRIC investments will continue to underperform. Several big hitters will repudiate this investment strategy. That will mark the bottom of these markets on a comparative basis.

-Global food inflation will continue to be a problem. Global growth will advance by 2%, the cost of feeding ourselves will increase by 5%. Asia/India will bear the biggest brunt of the increasing cost of food. Wheat prices will rise 12%.

-US inflation will remain on the high side. Core will average 2.5% (1/2% above the Fed’s target). CPI will come in at 3.8%. Real inflation will be much higher. Treasury Tips will underperform. The Ten-Year Tips/Coupon spread will widen to 2.75%.

-Few countries will avoid social protests and demonstrations. Many will turn violent. America will not be spared. The angst of the people will be directed at their leaders, their lenders and the IMF. A redo of 2011.

-The election will spur debate on the future of America’s entitlement programs. There will be broad based agreement that the time has come to address the problems with Social Security, Medicare and Medicaid. Politicians will try to divert the focus away from Social Security by pointing fingers at the Disability Insurance side of SSA. While it’s correct that this program is a complete disaster, the DI Fund is not the problem. The Retirement Fund is the real problem. The attention that DI will get is just a diversion from what is actually wrong with America’s favorite entitlement program. This will be a “young” versus “old” fight. Both sides will come to understand this.

-The summer of 2012 will bring the largest polar ice melt in history. The Mayan calendar will end with no consequence.

Edna

2011-12-25T05:00:00.000-08:00

At around this time over the past few years I’ve written about the posh holiday parties I went to. No luck this year. I went from the A-list to the Shit-list (I blame the blogging). So instead of eating fancy canapés and talking with very important people, I went and saw Edna.

Edna was born in 1918. She’ll be 94 years old in January. Her mother died young, she went to a home for children when she was eight. In 1936 the home went bust due to the depression and a shortage of donors. She has interesting stories of what it was like to live in Jersey City during the second depression of 1937. She remembers where she was when she learned that Pearl Harbor had been bombed. Her husband went to fight in Italy during WWII. She lived an average life, and enjoyed every minute of it.

Two years ago I got a call from an Emergency Room. Edna had arrived in an ambulance. She could not breathe and they were going to vent her. I thought it was over. Not the case. Five days in the hospital (steroids, oxygen, antibiotics and 24 hr. care) followed by twenty-one days in a rehab and she was back on her feet.

Edna’s medical problems were caused by old age. There is a valve that allows food and water to flow to the stomach, but blocks it from getting into the lungs. Edna’s did not work well. The result was "aspiration pneumonia". She had two failed operations operations to repair the valve.

There is a treatment for this. They poke a hole in the patients stomach, put in a tube and tie it to a bag that the patient wears on her on hip. Ensure gets fed to the patient via the bag. Nothing goes down the throat. Problem solved. Edna wanted no part of that.

Edna’s been to the emergency room/hospital a total of six times since that first episode. She averaged four days each time. She has had two operations and spent seven weeks in rehab.

The medical profession can truly work miracles these days. This woman should have been dead (at 92 years old) when she had her first episode. If this were 1981, she would died.

With each brush with pneumonia she was advised that she should opt for the bag. If she didn’t, then she would get sick again. I spoke with her about this on several occasions. She told me the same thing she told her Doctors:

No bag! I’d rather be dead then not eat or drink again!

I can’t blame her. But there is an ugly side to this. Given the cost of the treatment (100drs of thousands?) over the past 24 months there are questions that society has to ask Edna. (1) Does she have the right to say "no" to the medical alternative? (2) If she says "no", does society (Medicare pays for all of Edna’s bills) still have to pay for the repeated hospitalizations?

In 2011 the answers to those questions are "yes" and "yes". No treatment is without patient consent and every hospital would put out a maximum effort if she were wheeled in the ER door again. America can pay for Edna today. She is a very small percentage of the population. We are still a wealthy enough nation that we can afford to give Edna the treatments and the choices. That will not be the case in ten years.

America’s population is aging very rapidly. There will be a bulge over the next twenty years. I’ve looked at these numbers. They are out of control. I don’t think it’s possible that the country can provide the level of care that Edna has gotten to all of those other Edna’s out there.

The Edna story is a death panel story. It’s a horrible discussion to have. Does Edna, at 94, have the same medical rights to make choices as does a thirty year old? If you say no, how do you respond to new knees at 74 and new hips at 84? When you start drawing lines, it’s very hard to stop.

The easiest thing to do about this is nothing. No one wants to touch this hot potato. I can’t blame them. That said, in less than ten-years the question of what to do about Edna will be asked and answered. In the end “she” must lose some of her rights. For the life of me, I can’t figure out how that can be accomplished.
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Bad Governance, Bad weather

2011-12-23T03:43:00.000-08:00

Bad Governance

The House finally passed the lousy two-month extension of payroll tax breaks. The CBO scored the Bill that is now law. The costs for 59 days (and annualized if extended for all of 2012):

Social Security....................$19.8B........Annualized $119.B
Extended Unemployment.....$8.4B........Annualized $50.4B
Medicare...............................$3.4B........Annualized $20.4B
Totals........(two months).....$31.2B........Annualized $181.8B

The total cost of $31B is paid for with an increase in mortgage fees to be charged by Fannie and Freddie. Given that these two are providing 90% of new mortgages, most folks who buy a home or refi an old mortgage will get hit with these fees. CBO estimates when these fees will come into the Treasury.

This information raises some questions. I posed them to CBO and did not hear back.

1) The bill sucks money out those who have a mortgage. But if this method of financing the stimulus were used to cover the other ten-months of 2012 it would but a monster bite in those homeowners. It is dumb economic policy to stick it to those who borrow money for the next ten years to pay for a two-month stimulus. It is insane to think that this could be expanded to cover a full years worth of stimulus.

My point is that there is a funding hole for expanding the stimulus beyond February. We can look forward to another ~~stupid~~ big fight. It will be interesting to see whose pockets get fleeced next. Maybe a levy on farmers, pro athletes or even the Boy Scouts will come up for considerations. Those options are no dumber than taxing mortgages.

2) Note that the revenue from the tax on mortgages is $1.3B in fiscal 2012. Fiscal 12 ends on 9/30, therefore the tax kicks in prior to 9/30. The 1.3b is at least three months worth of revenue (as compared to full year 2013 @4.6B). Based on this information I conclude that the start date for the mortgage tax is June 1, 2012.

We have seen in the past what happens when a subsidy for housing ends. The housing market reacts pre and post the ending of the stimulus in a predictable fashion. Buyers do what they can to get a deal done before the subsidy goes away. Demand is “borrowed” from the future.

The tax on mortgages will work in a similar manner. Post 5/30, a buyer who takes out a $600,000 mortgage will pay an extra $50 a month ($6,000 over ten years). Will this influence demand on a short-term basis? I would expect so. The RE hucksters will be pushing this all spring:

“Buy Now! Close Quick! Avoid the Tax!

After 6/1 there will be a drop off in demand for housing. This seems particularly dumb to me as this will happen right in front of the election. Possibly the Republicans (the tax on mortgages was their idea) think that a weak housing market coming into November plays to their hand. I think they will end up with egg on their faces.

3) The Republican leaders hate Fannie and Freddie. The reason they insisted that the 2012 stimulus be paid for on the backs of mortgagors is that they want to force F/F out of business. I hate F/F too. But 2012 is not the time to make mortgages more expensive

The Republican Party has been digging their heels in fighting against every form of tax increase. But what do they do to achieve their objectives? They raise taxes, just like the Democrats do.

I would give the Democrats a C- grade on how this worked out. The Republicans deserve a D-. America is suffering from bad governance.

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Bad Weather

Today there are reports of 1000+ deaths from flooding in the Philippines. Last week another 750 were killed from massive floods in southern Thailand. A month ago the Thai capitol, Bangkok was inundated for a month. Deaths by drowning and water borne illnesses are in the thousands. These hundred-year floods are the result of the same weather pattern that brought the floods to Australia a year ago. La Nina conditions have persisted in the Pacific Ocean.

The following chart looks at the long-term ENSO cycles. Below zero is La Nina, above brings El Nino conditions. The data shows that neutrality in ocean temperatures was achieved in September. But today we are rapidly turning back to strong La Nina conditions. The chart shows several occasions in the past where the ENSO cycle was negative then neutral and finally negative again. It’s more normal to see a cycle shift from a La Nina to a El Nino.

Both El and La conditions bring the potential for severe weather. When the cycle persists the damage that it brings is concentrated in the same parts of the globe. This slide looks at Asia today. There are severe storms all over the region. The rest of the globe has relatively tranquil conditions.

For the US, the return of a strong La Nina means that West Texas will stay dry, above average rain in the central part of the country is probable and the NE looks like it is going to get a miserable winter; Cold and snow.

The farmers say, "A drought will scare you to death, but too much rain will kill you." As usual, the farmers are right.
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Too Close to Home?

2011-12-20T11:34:00.000-08:00

Two headlines. Similar stories. The first from Switzerland:

The United States authorities have offered to lift the threat of legal action against 11 Swiss banks in exchange for information, a Swiss paper reported on Sunday.

This is part of a very long story. The US Justice Department has been doing everything it can to get the names of US citizens who have Swiss bank accounts. The DOJ damn near busted UBS over this a few years back. Now they are going after the other Swiss banks. The lawyers at the DOJ don’t kid around:

“Give us the names or we’ll sue the shit out of you”.

Given what happened to UBS ($780mm in fines), the other banks have no choice but to fold and hand over the info.

This second story ratchets things up a bit and brings it home:(Link)

A federal district court judge has given the Internal Revenue Service permission to serve a “John Doe” summons on the California State Board of Equalization demanding the names of residents who transferred property to their children or grandchildren for little or no money, from 2005 to 2010.

The IRS has used John Doe summons to seek lists of American taxpayers unreported offshore accounts at Swiss Bank UBS and at HSBC’s bank in India.

These pushy techniques have worked well in Switzerland. The hard working folks at the DOJ/IRS are now bringing them to California. This means that the IRS can look at anyone’s real estate transactions. With John Doe warrants, they can go fishing/snooping wherever they like.

Think what you will of this. The country is starved for revenue. The outfit that is charged with collecting that revenue has an army of tough-minded lawyers behind it. It will have the power to turn over stones as it pleases. In the end this effort will raise some additional revenue. It will scare the crap out of a few folks as well. Some will cheer this. I see the John Doe warrants as a big and dangerous step on a very slippery slope. It sure won’t do much for Uncle Sam’s image.

Unrelated Note:

In my forecasts for 2011 I said:

-Kim Jong-Il will die. His son will take over. The heir is a nut, there will be more military exercises that results in shells landing on S. Korea soil. China will make public statements that it is trying to bring order; behind the scenes they will be applauding the chaos.

I got the first part right. I believe I will be right on the second part too. This could get very messy. Fast.

Throw the bums out!

2011-12-18T05:08:00.000-08:00

The bumbling fools in D.C. have done it again. They’ve screwed us all one more time. The low rent morons who are running the show have kicked the can down the road for (get this) two months.

On Saturday the Senate agreed to a bill that would A) extend unemployment benefits B) extend the 2% payroll tax deduction and C) delay a cut in Medicare reimbursement rates. The deciders agreed to do all the extending, delaying and pretending for two lousy months. In other words, Congress will be back at it over these critical issues in less than six weeks.

There have been dozens of articles from smart people connecting the dots between the uncertain tax policies business’s face and their reluctance to hire more workers. I’ve heard Pols from both sides say the same. It’s true. But the best that Washington can do is move the ball forward by 59 days; disgraceful.

The two-month extension amounts to $33b that will be retained in the economy. I would not be surprised if the benefit of the stimulus will be lost by the continued uncertainty that is being caused by D.C. What has been “accomplished” is just a loss.

The bright guys who came up with the plan have a mechanism to pay for it. They’re going to charge homeowners a new fee for the next ten years. If you get a mortgage from one of the federal agencies (90% of mtg. market) you’ll pay an extra price. It only comes to $15 a month if your mortgage is less than $220k. But if you live on either coast or in any big city, the cost of housing will force you to pay a bigger price. $45-50 a month is a more realistic way to consider the implications. What’s an extra $600 a year? It’s just another nail in the coffin for housing.

By far and away the weakest link in the economy is housing. There is not much that can be done about it. It takes time and there will be pain. But there is no excuse for congress to force homeowners to absorb the full cost of the stimulus. The legislation results in mortgagors directly subsidizing doctor's Medicare reimbursement rates! How stupid is that? What are these people thinking of? This is terrible economic policy, and every legislator who signs the Bill, knows that fact.

The problem with the legislative process in this case was the side deals that got included in the horse-trading. This time the issue was the Keystone XL pipeline. The Republicans wanted it; the Democrats opposed it. Why does the fate of the pipeline have to be tied to the fate of important economic legislation? Why can’t we have an up and down vote on issues? The Deciders lumped these two divergent considerations together and in the process shot us in the foot. We end up with another stopgap measure and few weeks before we have to do it all over. My Senator, Chucky Boy Schumer (D-N.Y.) had this to say about the conflict that is sure to come in February:

“It’s a fight we welcome”

These clowns love this stuff. It has nothing to do with the right choices; it’s about the next election. They don’t give a damn about the country or it’s citizens. It’s about keeping their powerful jobs.

I know whom I’m voting for in the next election. I’m voting against anyone that is currently “in”. I don’t care what stripe they wear. I want the other guy/gal. I’m going to vote against Chuck Schumer and all the other "ins". I want to send a message to every damn one of them. The ones who have their hands on any levers today; are no longer wanted.

Some will argue that I’m being irrational. That if enough voters thought as I do all the folks who now run governments would be out, and a crop of new ones, who didn’t know where the bathroom was, would take over. I don’t care. We can’t do worse than the current lot.
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Social Security in violent transition?

2011-12-16T04:15:00.000-08:00

Jackie Calmes at the NYT has a good summary regarding the last minute effort to get an extension of the 2% payroll tax reduction for 2012. (There is consideration this morning for a two month extension) There are some subtleties of the debate that are worth noting. Both sides agree that an extension should happen, but within both parties there is surprising opposition. The lovers of Social Security see the handwriting on the wall. They fear that a second year of a payroll tax break may be the last step leading to significant changes in America’s biggest social program.

However, that the payroll reduction hurts SS is a common misperception. That's not correct. Every month, the Treasury transfers cash to SS in order to make up for the shortfall. I follow this stuff; if these transfers had not been made, I (and a bunch of others) would have blown the whistle months ago.

As a result of these transfers, SS ends up unharmed by the tax break. Other taxpayers foot the bill. But since we have a deficit to begin with, this just adds to the countries red ink. Uncle Sam is digging into one pocket and transferring wealth to SS. This is the socialization of Social Security. What does it mean if SS becomes a ward of the state? Charles Blahous, an ex Bush advisor had this to say:

“The payroll-tax cut would take a major step toward transforming Social Security from what it has long been — an earned benefit, funded by separate worker payroll taxes — into an income-tax based system more akin to welfare.”

For years the SS defenders have pointed out that SS is self-funding and does not contribute to the deficit. That was not true in 2011 (to the tune of $115b). The on-budget expense/increase to public debt will be $120b in 2012. That’s real money.

It's an unfortunate fact that the US economy will flounder if workers pay only 2/3rd of the statutory rate in 2012. That’s how fragile the economy is. It’s not likely that things will be much different a year from now. Another “one time only’ extension of the FICA tax breaks will be on the table twelve months from today. From the Times:

Robert Reischauer, Ex CBO and SSA.
“Imagine that next December the unemployment rate is 8 percent and a year later it’s 7.4 percent. We’ll still be trying to stimulate employment and terminating the payroll tax holiday will be a big hit on most families, one that will hurt job growth.”

Reischauer is right, we will not revert to the statutory rates, much less the 1% increase that is require to stabilize SSA. I think he's also correct with his projection of a huge fight:

“The nightmare that I have is that when it comes time to raise the tax back up to 6.2 percent, conservatives are going to propose that these two percentage points of payroll tax be devoted to individual accounts. That will precipitate a huge fight and could change Social Security in a fundamental way.”

There is a huge brawl in front of the country on this issue. Folks on both sides are deeply entrenched. The following is an exchange I saw on Angry Bear blog. It's an example of the rhetoric we will get, The fellow who wrote this, Dale Coberly, is a fairly well-know contributor to the SS debate. Dale loves SS and hates anyone who thinks that changes are required. If you have any doubts how visceral a fight we're in for, consider this bit of fluff:

rjs
just a heads up...

Bruce Krasting says Social Security 2011 - Another Bad Year...he concludes: The current thinking is that SS is a problem that can be worried about in another ten years or so. That's simply not true.
12/08/2011, 13:00:51
– Reply

coberly
rjs

there are bigger liars than Krasting writing about SS. I can't keep up with them all, and with Obama killing SS outright with the permanent payroll tax holiday, and the Democrats and Progressives rallying behind him, there is nothing more I can do.

Maybe Krasting will be out of a job soon.

The stalwarts of SS recognize that the program is now vulnerable. They want bad things to happen to those who believe changes are essential. We're going to have a fight. A big one. Think, “Age Warfare”.
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