Month: August 2014

Submitted by Dmitry Orlov via ClubOrlov blog,

With regard to the goings-on in Ukraine, I have heard quite a few European and American voices piping in, saying that, yes, Washington and Kiev are fabricating an entirely fictional version of events for propaganda purposes, but then so are the Russians. They appear to assume that if their corporate media is infested with mendacious, incompetent buffoons who are only too happy to repeat the party line, then the Russians must be same or worse.

The reality is quite different. While there is a virtual news blackout with regard to Ukraine in the West, with little being shown beyond pictures of talking heads in Washington and Kiev, the media coverage in Russia is relentless, with daily bulletins describing troop movements, up-to-date maps of the conflict zones, and lots of eye-witness testimony, commentary and analysis. There is also a lively rumor mill on Russian and international social networks, which I tend to disregard because it’s mostly just that: rumor. In this environment, those who would attempt to fabricate a fictional narrative, as the officials in Washington and Kiev attempt to do, do not survive very long.

There is a great deal to say on the subject, but here I want to limit myself to rectifying some really, really basic misconceptions that Washington has attempted to impose on you via its various corporate media mouthpieces.

1. They would like you to think that there is a Russian invasion in the East of Ukraine. What’s actually happening is a civil war between the government of Western Ukraine (which no longer rules the east in any definable way) and the Russian population of Eastern Ukraine. Ukraine has been falling apart for decades—ever since independence. The eventual break-up was inevitable, but the catalyst for it was the military overthrow of Ukraine’s legitimate government and its replacement with cadres hand-picked in Washington.

 

2. They would like you to think that the Russian government stands behind Lugansk People’s Republic and Donetsk People’s Republic—the two regions which, based on referendum results, have chosen to break away from Kiev. In fact, the Russian government has refused to recognize these republics. They have received no official political support from Moscow, which asked for the referendums to be postponed, and repeatedly asked for a cease-fire and an international, negotiated settlement to the crisis. The leadership of LPR and DPR has refused, and now aims for an outright military victory.

 

3. They would like you to believe that the Russian government is arming the “rebels” in Eastern Ukraine. To the contrary, the Russian government has withheld all military support, limiting itself to providing humanitarian supplies to the hundreds of thousands of people whose lives have been destroyed by artillery and rocket fire coming from the Ukrainian forces. The weapons in the “rebels’” arsenal are trophies, which they seized from the retreating Ukrainian forces. That said, the “rebels” are indeed being supported—but by the Russian people, not the Russian government. Remember, these are all Russians, on both sides of the border, and the Ukrainian government no longer controls any of it.

 

4. They want to convince you that Russia poses a threat to peace in Europe, and that the crisis in Ukraine is part of an imperialist Russian strategy to resurrect the USSR. Nothing could be further from the truth. The overarching Russian ambition is for Russia to be a normal country, subject of international law, at peace with the whole world, and integrated into the global economy. The Russian government is doing next to nothing to prevent Russians in areas that were once part of Russia from being slaughtered right in their homes using artillery and rocket fire. This makes for a distressing spectacle, but the Russian people understand that enlarging the military conflict beyond the by now purely notional borders of Ukraine is not the answer.

 

5. They want to assure you that Kiev will eventually prevail in the conflict. In fact, the Ukrainian military is being systematically destroyed. Shelling civilians is the only activity which they have been able to carry out successfully. The government in Kiev has instituted three mobilizations, one after the other, sending into battle boys and old men (maximum draft age is now 60). Their soldiers are badly armed, badly trained, completely demoralized, and they mostly refuse to fight. The casualties run into the tens of thousands. Ukraine is quickly running out of tanks and APCs, which are all old Soviet-era and have been rusting for decades. It appears that Ukraine no longer has an air force at all. The war is far from over, but now, for the first time, LPR and DPR actually have something resembling an army, and that army is going on attack. Once the Ukrainian military collapses altogether, it seems likely that other parts of Ukraine will declare independence from Kiev.

 

6. They want you to think that the government in Kiev is legitimate, popular and stable. In fact, there are huge protests going on in Kiev at this very moment. The entire country is beyond bankrupt and is falling apart in real time, not just in the east, but everywhere. The people are beyond angry. The military units retreating from the east are in a foul mood, and may soon decide to turn their weapons against those who ordered them into battle. The people are beyond angry, and it seems probable that another revolution, only half a year since the last one, is in the works.

I hope that you can absorb this basic information and use it to filter out the propaganda that you read in Western newspapers and hear on the nightly news (if they mention Ukraine at all). Don’t automatically assume that if your side is full of it, then the other side is too. You don’t have to settle for lies.

via Zero Hedge http://ift.tt/1wKkM9F Tyler Durden

From Guy Haselmann of ScotiaBank

Undermining the Integrity of Financial Markets

Introduction

Financial markets are broken. Fundamental analysis and Modern Portfolio Theory are relics of the past. Investors used to care about maximizing a portfolio’s expected return for a given amount of targeted risk. The goal used to be that prudent diversification through the analysis of security correlations could move the Efficient Frontier Line ‘up and to the left’. In other words, improve returns per unit of risk.

Today, Fed policies have commandeered investor thinking and altered investor behavior. The powerful driver of moral hazard has fueled greed, and imbued  more fear of underperforming peers and benchmarks, than fear of downside risks. Some investors are buying the riskiest assets simply because prices have been rising. Some investors say they are buying equities instead of Treasuries because ‘equities have upside, while bonds yields are puny and their prices are capped at par’.

Fed policies have led to (investor) herd behavior that has plunged market volatilities and manipulated asset prices and correlations to lofty levels. The rallying cry has simply become “don’t fight the Fed”. Relative return – without regard for risk – is all that matters. As a result, future return expectations have fallen with ever-rising prices; correspondingly, risk levels have risen in parallel. The allure of the Fed’s magic spell has lapsed investors into a soporific state of cognitive dissonance, with them focusing more on trying to justify valuations, rather than on the Upside Downside Capture Ratio.

Markets have thus mutated into one of two possible combustible states. Either financial assets have all transcended into prodigious bubbles, or stocks and bonds are signifying two completely separate outcomes. Either possibility will have dangerous repercussions for the economy, and for portfolios and investors. At the moment, I believe that the Treasury market has it right, signifying concerns about disinflation and future growth.

Using Financial Asset Prices as a Policy Tool

Uber-accommodation and aggressive promises by the Fed have been successful at chasing money into equities and the lowest part of the capital structure – as was its intent – but the stellar performance of equities have been divorced from the underlying economy for the last few years. (Note: better earnings from improved margins are unsustainable without revenue growth.)

Fed policies have also laid the foundation for debt issuance to fund private sector share buybacks and mergers, creating the self-reinforcing illusion that all is well. Super-subsidizing the cost of debt destabilizes the basic tenets of investment. By creating an environment, whereby investor decisions are enticed into the junkiest credits and equities (the junkier the better), and whereby financial market manipulation is being used as a policy tool, the Fed is undermining the integrity and foundation of financial markets.

Investors have also been led to believe, that should pressures build on those risky securities, more subsidies will be offered. This dangerous feedback loop is unsustainable. At some point – probably in the very near future – investors will lose faith in the central banks’ ability to support the economy through higher financial asset prices.

It is far too early for history to judge the success (or lack thereof) of QE policy. The smug references of claiming victory by some FOMC members likely derives not from comprehensive faith in their success, but rather from attempts at maintaining confidence in the institution. After all, Fed policies are experimental, have had questionable success, and the unintended consequences of the actions have yet to be felt.

On balance, markets have too much faith in the FOMC, which is over-promising on what can reasonably be delivered with such limited powers. Bigger than the bubble in financial asset prices is probably the bubble in Fed-confidence.

Big Objectives, Limited Tools

As far as economic management is concerned, the Fed really only has one basic instrument: managing liquidity through managing the supply of money. How does it make sense that the Fed can achieve its dual mandate objectives of price stability and full employment with this one blunt tool? When all you have is a hammer, than everything looks like a nail. With this one tool in mind, it seems silly to think that heated debates arise after each new piece of economic data, on how much to tweak money supply. A $17 trillion economy cannot be micro-managed.

Debate even shifts between the focus on the price mandate and the employment mandate and whether there is a trade-off between them. It does not require much thought to realize that the ‘dual mandates’ of the Fed are bewildering and illusory and in need of a face-lift.

Even more problematic is the prospect that FOMC analysis could be faulty. In 2012, I wrote that “the Fed should not confuse good deflation with bad deflation in that good deflation is a drop in prices caused by technology-enhanced declines in the costs of production. Trying to fight such imagined deflation would lead to asset bubbles and problems elsewhere”. Bad deflation is when the consumers stop spending because they believe prices will be lower in the future. Globalization and technological advancements result in the ‘good type’ of deflation. Zero interest rate policy expedites the process, rather than reversing or easing price pressures.

Dubious Economic Ideology

The group-think FOMC has perpetuated this state of being, because Fed leadership believes in the same outdated economic theories popularized over a half-century ago. Bernanke and Yellen, among others, were influenced by a few Noble Laureates during their studies in the 1970’s; those such as, James Tobin, Paul Samuelson, and Bob Solow. Samuelson was credited with creating ‘Neoclassical Synthesis’, which all policymakers use as their basic approach (they also use faulty neoclassical fullemployment optimization models).

The Samuelson ‘synthesis’ basically says that with skillful monetary and fiscal policy, the economy can be kept close to full employment and will behave as  the models of long-run growth suggest it will. However, every now and then (like the present), the emphasis will have to be on the short run. Few would argue that the Fed has taken this path, and in doing so, has created a ‘time-inconsistency’ problem whereby it is trying to bring demand forward at the expense of the future.

In past speeches, Yellen has blamed the Fed’s extraordinary measures on the underutilization of labor resources (slack). It was interesting, however, that when Yellen presented at Jackson Hole in front of the foremost academic experts on labor markets, she did not reveal any biases regarding the amount of labor slack. Had she regurgitate any of her earlier assumptions (that were used to justify current policy), she would have likely opened herself up to criticism; especially given the complex relationship between employment, wages, inflation, and growth.

By showing more ambivalence and lacking the confidence to share those assumptions with this group of academic ‘experts’, she exposed the dubious and experimental nature of FOMC policies. It can therefore be argued that the FOMC is basing the greatest experiment in Fed history on low-confidence assumptions about labor market slack and Phillips Curve trade-offs.

Solow, Samuelson and Tobin explicitly acknowledged the non-static nature of the Phillips Curve due to shifts in expectations and to hysteresis. Yellen seemingly ignored this aspect of their work, because it did not jive with the Fed’s policy actions.

(For review and emphasis) ‘Hysteresis’, according to Investopedia, is: “the delayed effects of unemployment. As unemployment increases, more people adjust to a lower standard of living. As they become accustomed to the lower standard of living, people may not be as determined to achieve the previously desired higher living standard. In addition, as more people become unemployed, it becomes more socially acceptable to be or remain unemployed. After the labor market returns to normal, some unemployed people may be disinterested in returning to the work force.”

Counter-productive Policy

The Fed cannot do anything about hysteresis and has had little, if any, help from the fiscal tools that could help. Using monetary tools where a fiscal solution is required has consequences, and further enables fiscal stalemate. Furthermore, it could be argued that holding interest rates at zero for a prolonged period of time is actually counter-productive.

As mentioned earlier, corporations have been incentivized to issue cheap debt, but those who are not buying back shares or increasing dividends are using the proceeds to modernize plant and equipment. Improved productivity has resulted, but those gains have not spilled into wage improvement; hence, feeding the Fed’s argument of ‘slack’.

As a matter of fact, gains in productivity through modernization have exposed production redundancies, allowing firms to lay-off workers and cut prices. Certainly capitalist societies always strive for advancement in this manner, but Fed policy has turbo-charged the process. Without new and modernized job training, old jobs become outdated, unemployment swells, and hysteresis results.

Conclusion

The FOMC has backed itself into a predicament where there is no easy escape. Its policies might be counter-productive for the economy and harmful to financial markets, which will likely to lead to tarnished credibility in the near future.

If the economy muddles along or stalls, the effectiveness of QE will be questioned. In the unlikely possibility that the economy grows satisfactorily, the Fed will be accused of being behind the curve.

Investors betting on Fed promises, and its hopes of navigating economic ‘lift-off’, will likely have a difficult path going forward. Investors smart enough to have believed in the implicit information embedded in (unloved) long dated Treasuries (+25% YTD) should continue to reap the best reward per unit of risk.

Since February, I have predicted that 30-year Treasury yields would drop below 3% before the end of year. The yield reached 3.05% today; earlier than anticipated. I expect 30-year yields to outperform for a while longer, and continue the march to lower yields. Those expecting much higher (back end) yields will likely be waiting quite a long time; possibly even a year or more. Waiting for inflation in recent years has been like waiting for Godot (he never shows up).

via Zero Hedge http://ift.tt/1C7A1K1 Tyler Durden

Submitted by David Stockman via Contra Corner blog,

That was quick! Last November Snapchat was valued at $2 billion in the private VC market; by Q1 that had risen to $7 billion; and yesterday it soared to $10 billion. Gaining $8 billion in market value in just nine months is quite a feat under any circumstance – but that’s especially notable if you’re are a company with no profits, no revenues and no business model.

And, yes, that’s not to mention the “product”, either.  Apparently, Snapchat’s 100 million teenage and college users mostly swap pics of their private parts which vanish after 15 seconds – or so they think. In that respect, Snapchat’s business challenge may not be lack of “demand”, but whether its exhibitionist “customers” will be copasetic with sharing their 15 seconds of fame with advertisers.

Time will tell, unfortunately. In the meantime, however, its evident that Snapchat’s spectacular valuation rise is not about how to discount the potential value stream from monetizing dirty pictures. Instead, it reflects the crazy dynamics of late stage financial bubbles. And on that score, Wolf Richter has hit the nail squarely on the head, as usual.

As he explains in today’s post, Snapchat’s spectacular valuation run-up is just a new and more sophisticated form of “pump and dump”. In this instance, the venture capital firms involved have apparently invested trivial amounts of chump change in the two recent funding rounds in order to peg dramatically higher paper valuations in preparation for an imminent IPO. In numeric terms they have invested less than $30 million since last November, meaning that they have been able to leverage an $8 billion valuation gain at a ratio of 266:1.

By strategically deploying less than $30 million, KPCB, and DST Global before it, have ratcheted up Snapchat’s valuation from $2 billion to $10 billion. With the stroke of a pen, in a deal negotiated behind closed doors, they have created an additional $8 billion in “wealth” that is now percolating through the minds of employees with stock options and through the books of the early investment funds.

To be sure, Wall Street has sponsored such market-rigging ploys since time immemorial. However, the true evil of rampant central bank money printing is that it vastly enables and amplifies such speculative ventures, while at the same time eviscerating the natural checks and balances against speculative manias which are embedded in honest financial markets.

Specifically, zero money market rates (ZIRP) for 68 months running have unleashed carry trade gambling in the financial markets like never before. That’s because professional Wall Street speculators can acquire risk assets and “fund” them on high leverage— through margin accounts, options trades or specifically crafted “structured finance” deals from their prime brokers—- at tiny interest rates. The resulting “spread” is bubblicious—especially when the Fed’s implicit “put” under the stock averages fuels a rambunctious “buy the dips” psychology among traders.

Under those circumstances—which are rampant at the moment—a gambler’s wildest dream comes true. The carry cost side of a leveraged gamble is pinned at close to zero by the solemn commitment of the central bank, while the asset value side of the trade ratchets ever higher owing to the endless bid of the dip buyers.

And its actually even better. The obvious effect of the Fed’s incessant market coddling since at least the days of the LTCM bailout in September 1998, but especially since Bernanke went all-in September 2008, is that the natural short interest in the stock market has been punished, bloodied, and destroyed. Consequently, downside insurance on speculative portfolios (i.e. puts on the S&P 500) is dirt cheap, meaning aggressive traders can protect themselves against an unexpected (and unlikely) plunge in the broad market while barely denting their gains from high flying momo stocks in favored sectors like social media or whatever happens to be the flavor of the week.

Needless to say, cheap downside insurance only enlarges and strengthens the bid for high flyers—-a dynamic that works wonders in the IPO market, especially. Accordingly, lunatic valuations have once again flourished in the new issues market as if its 1999-2000 all over again.

And like then, the resulting devil’s workshop environment incentivizes the smart money to concoct schemes to exploit the bubble—like yesterday’s 266:1 leveraging of Snapchat’s valuation. That this will end in tears for the “slow money” IPO sheep who show up for the shearing, goes without saying.

What needs remark, however, is the enormous damage that these kinds of financial deformations and distortions do to the real economy and the capitalist machinery of invention and enterprise. By all the historic evidence, Kleiner Perkins has been one of the greatest incubators of technological progress and business innovation in modern times.  Surely it has better things to do, therefore, than run a  crude 1920s style pump and dump scheme that will contribute nothing to society except painful losses for the retail investors who take the bait.

So here’s the thing. Free central bank money corrupts free markets absolutely—-that should be more than evident by now. But owing to the dense economic fog on her Keynesian windshield, Janet Yellen and her band on money printers in the Eccles Building remain clueless as to the  monumental corruption that is being injected into financial markets by Fed policy.

Would that Yellen should at least read Wolf Richter’s excellent post on the present moment’s most spectacular example of that. Better still, perhaps a trip back to San Francisco  where bubble opulence ricochets thru the entire economy would be in order. She might discover that the median housing price has soared to more than $1 million; and that none of the inhabitants of the “labor market” that she is so vainly attempting to revive even qualifies for a standard mortgage.

By Wolf Richter At Wolf Street

How much does it cost to manipulate an entire market? Not much. And it’s getting cheaper!

It was leaked on Tuesday by “people with knowledge of that matter,” according to the Wall Street Journal, that VC firm Kleiner Perkins Caufield & Byers had decided in May to plow up to $20 million into message-app maker Snapchat, for a tiny portion of ownership. An undisclosed investor also committed some funds. The deal, which apparently hasn’t closed yet, would give Snapchat a valuation of $10 billion.

That’s a big step up from November last year, when the valuation was $2 billion. At the time, the company had raised $130 million in three rounds of funding. By now that would be closer to $160 million, after it was also leaked that Russian investment firm DST Global had put some money into it earlier this year, boosting its valuation to $7 billion at the time, once again, “according to two people familiar with the matter.”

At a valuation of $10 billion, it joins the top of the heap: app makers Uber ($18.2 billion) and Airbnb ($10 billion), cloud storage outfit Dropbox ($10 billion), and Palantir, the Intelligence Community’s darling ($9.3 billion).

Unlike the others in that group, Snapchat is marked by the absence of a business model and no discernable revenues. But there is hope that it could eventually pick up some revenues by advertising to its 100 million or so users, mostly teenagers and college students, without turning them off.

But in this climate, no revenues, no problem. Into the foreseeable future, the company will produce a thick stream of undisclosed red ink.

But the investment was an ingenious move.

For KPCB, a huge VC firm, the investment would amount to petty cash. Why did it do this deal? If it could exit at an enormous valuation of $20 billion, it would only double its money – a paltry multiple, given the risks. It would only make $20 million, still petty cash. But there was a reason….

By strategically deploying less than $30 million, KPCB, and DST Global before it, have ratcheted up Snapchat’s valuation from $2 billion to $10 billion. With the stroke of a pen, in a deal negotiated behind closed doors, they have created an additional $8 billion in “wealth” that is now percolating through the minds of employees with stock options and through the books of the early investment funds.

Snapchat’s new valuation isn’t an isolated event. It’s a product of all recent valuations, and it is itself now ricocheting around and is used to set the valuations at other startups. That’s the multiplier effect. What seemed like an absurd valuation yesterday becomes the norm tomorrow, on the time-honored principle that once a valuation is already absurd, it no longer faces resistance from any rational limit. And nothing stands in the way for the multiplier effect to ratchet valuations ever higher.

Nothing, except the potentially troublesome exit for these investors. Because, without exit, these paper gains will remain paper gains, and eventually will disintegrate into dust.

To exit gracefully, investors can sell the company via an IPO mostly to mutual funds and ETFs that are stashed in retirement funds and investment portfolios. Or they can sell it to giants like Facebook or Google that can pay cash (borrowed or not) or print their own currency by issuing shares, both of which come out of the pocket of current stockholders. At the far end of both transactions are mostly unwitting retail investors.

Inflating Snapchat’s valuation by $8 billion with a few millions dollars rigs the entire IPO market that depends on buzz and hype and folly to rationalize these blue-sky valuations. Unnamed people “knowledgeable in the matter” who leak these valuations to the Wall Street Journal are an integral part of the hype machine: It balloons the valuations of other startups. And it creates that “healthy” IPO market where money doesn’t matter, where revenues and profits are replaced by custom-fabricated metrics.

The hope is that the IPO market remains “healthy” long enough for investors to be able to unload hundreds of these companies at crazy valuations. The hype surrounding these valuations is creating more enthusiasm about IPOs in a self-reinforcing loop. The hope is also that the broader stock market continues to soar so that potential acquirers can print more overvalued shares to acquire more overvalued startups so that the exists can come about. Under the motto: after us the deluge.

The deluge will wash over retail investors.

While it’s possible that one or the other startup might become the next Facebook or Google, there are only a few Facebooks and Googles, but there are many startups whose business model and permanent lack of profits will eventually bring them down to reality, either in the portfolios of retail investors, or as a write-off by the acquirers, whose shares are also stuffed into the nest eggs of retail investors. Along the way, Wall Street extracts fees from all directions. That’s the Wall Street money transfer machine. It smells like a rose when all stocks go up, but when the tide turns…. OK, that won’t ever happen.

With fundamentals and economic realities having become totally irrelevant these days, economists are reassigned to tout stocks. Read…. Economist: Stocks No Longer Risky, Will Go Up ‘Steadily’

via Zero Hedge http://ift.tt/1mZiOc4 Tyler Durden

President Obama ‘knows’ how to handle Putin’s ‘continuation’ (not ‘invasion’) – more sanctions (and costs for Europe) – but when it comes to beating the most “barbaric” terrorists known as ISIS, ISIL, or The Islamic State; he had this to offer… “I don’t want to put the cart before the horse. We don’t have a strategy yet.” Rest assured Americans – who have been told that ISIS could be crossing the borders every day and a constant threat, President Obama is ‘working on it’. Perhaps most crucially, while we ‘joke’ that the administration has no strategy, it is noteworthy that Obama stated it was “not US policy to defeat ISIS, only reverse gains.”

 

QUESTION: Do you need Congress’s approval to go into Syria?

OBAMA: You know, I have consulted with Congress throughout this process. I am confident that as commander in chief I have the authorities to engage in the acts that we are conducting currently. As our strategy develops, we will continue to consult with Congress, and I do think that it’ll be important for Congress to weigh in and we’re — that our consultations with Congress continue to develop so that the American people are part of the debate.

 

But I don’t want to put the cart before the horse. We don’t have a strategy yet.

 

I think what I’ve seen in some of the news reports suggests that folks are getting a little further ahead of where we’re at than we currently are. And I think that’s not just my assessment, but the assessment of our military, as well. We need to make sure that we’ve got clear plans, that we’re developing them. At that point, I will consult with Congress and make sure that their voices are heard.

 

But there’s no point in me asking for action on the part of Congress before I know exactly what it is that is going to be required for us to get the job done.

Maybe instead of golfing around Martha’s Vineyard, he could have been working on “strategy”?

*  *  *

But perhaps more crucially…

…my priority at this point is to make sure that the gains that ISIL made in Iraq are rolled back and that Iraq has the opportunity to govern itself effectively and secure itself.

 

All headlines from Obama’s presser will be “no strategy”. But real significance, he says not US policy to defeat #ISIS, only reverse gains.

— Jon Williams (@WilliamsJon) August 28, 2014

*  *  *

“Do nothing stupid” like admit you don’t have a strategy?

*  *  *

And this wins the internet today…

The Audacity of Taupe http://ift.tt/1zMKfLZ

— Jared Keller (@jaredbkeller) August 28, 2014

* * *

Of course – to be serious for a moment – as long as Qatar has a strategy on how to progress on its Gazprom-bypassing pipeline to Europe, whether Obama had a strategy is completely irrelevant.

via Zero Hedge http://ift.tt/XWxliU Tyler Durden

Submitted by Chris Martenson via Peak Prosperity,

The current bubbles in financial assets — in equities and bonds of all grades and quality — raging in every major market across the globe are no accident.

They are a deliberate creation. The intentional results of policy.

Therefore, when they burst, we shouldn’t regard the resulting damage as some freak act of nature or other such outcome outside of our control. To reiterate, the carnage will be the very predictable result of some terribly shortsighted decision-making and defective logic.

The Root of Evil

Blame can and should be laid where it belongs: with the central banks.

They were the “experts” who decided to confront the excesses of decades past (which saw borrowing running at roughly 2x the rate of real economic growth) with even easier monetary policies designed to spur even more borrowing.

Rather than take stock of the simple fact that nobody can forever borrow at a faster rate than their income is growing (no matter how large that entity may be), the Fed, the ECB, the BoJ and the BoE have conveniently overlooked that simple fact and then boldly claimed that the cure is identical to the disease.  If the problem is debt then the solution is even more debt.

If the Fed, et al. were doctors, they would prescribe alcohol to the alcoholic. They would administer more lead to the lead-poisoned patient. They would call for more water to put in the pool where a drowning individual is floundering.

The bottom line is that the Fed and its ilk made the disastrous decisions that gave us the first two burst bubbles of the new millennium. And the wonder of it all is that, instead of being met at the gates with torches and pitchforks and held to account for their errors, they have instead been granted even greater powers, less oversight, and practically zero blame.

And now they’ve given us a third and, I suspect, final bubble. By which I mean I think the effects of this bursting bubble will be so horrendous that a hundred years might pass before people will again be in the mood to speculate on fantasy wealth.

My hope is that, when this third bubble pops, the figurative (and, perhaps, literal?) torches and pitchforks come out. Finally forcing the central banks to answer to the public for their grievously poor decisions.

And yes, the investing public also bears a portion of the responsibility for playing along with the central banks. For years, some have consoled themselves with stories about how This Time Is Different, and many have ignored many obvious warning signs as they’ve enjoyed stock market and bond gains fueled by seemingly limitless liquidity.  

But in the end, it’s the central banks that  set the tempo and the melody at the dance hall.  When they flood the world with liquidity and set interest rates to 0%, they enforce a Hobbesian choice: either play along in the risk markets, or sit in cash earning less than nothing as inflation eats away at your purchasing power.

The central banks are entirely to blame for mis-pricing money and that is the fundamental error that drives every bubble and betrays capital into hopeless investments.

So let’s all remember to place blame where it is due when the bubble bursts. We shouldn’t act surprised because there’s really no honor in being caught unawares by something so obvious.

The Biggest Bubble(s) Of All Time

We’ve covered the equity bubble in the past, but today we’re going to cover the bond bubbles (yes, plural) because the current excess in the bond market is the granddaddy of them all, and is far larger than anything ever recorded in history by a very wide margin.

But for the sake of completeness, regarding equities, if you ever wanted to get the willies about the stock market in a single chart, I think this one from Doug Short of Advisor Perspectives which plots the relationship between equity prices and margin debt is about as good as it gets:

(Source)

Margin debt is simply money borrowed to buy equities.  Typically speaking, an average investor with $100,000 in an account can buy up to $150,000 worth of stock. Margin debt is fuel to a rising market and a lead anchor for a falling market. 

Yes, perhaps this time is different, or perhaps it’s exactly the same with speculators borrowing more and more as stock prices rise, sure in the knowledge that they will be smart enough to get out of the way of a falling market (this time).

But, enough of material we’ve covered here recently. Back to bonds.

When the bond bubble bursts, so much that people believe to be true will be revealed to be obvious and distressingly ordinary illusions.

When there’s simply too much debt, in the period leading up to a debt bubble’s bursting, everyone is counting on getting paid his or her money back, both the interest and the principal. After the bubble bursts, it’s plainly obvious that no such thing will be happening.

As is always the case with bubbles (of any sort), the only important question that needs to be answered is: Who will take the losses?

One simple answer to that question is: Whoever is holding the bonds when the bubble bursts.

Bubbles are structured like a game of hot potato. When the timer finally dings, the person holding the potato loses. It doesn’t matter one whit whether the ‘hot potato’ was a tulip bulb, swamp land, a house in Las Vegas, or a paper financial security.

The really striking part about the global bond markets today is that the potatoes have never been more numerous, or hotter.

I suppose this would be a good time to revisit how Einstein defined insanity: trying the same thing over and over again and expecting different results.

Unfortunately for those hoping for a different outcome, history is 100% consistent on the matter: Bubbles always burst. And when they do, what people thought was fabulous wealth is proven illusory, and it simply vanishes.

Not that this clear historical record is keeping humans from trying to cheat the odds.

Given that the Fed has engineered three increasingly larger bubbles within an unprecedentedly-short fifteen-year time span, perhaps we shouldn’t persecute them. After all, they may easily be able to plead ‘not guilty’ by reason of insanity.

$100 trillion – is that a lot?

We frequently throw around big numbers in our analysis. We even try to explain them in terms that help us mentally grasp an appreciation of their enormity (watch the video How Much Is A Trillion?, as an example). But the size of the bond market across the developed world defies even our best efforts.

After all, if $1 trillion dollars is a stack of $1,000 bills 68 miles high, then I guess $100 trillion would be a stack 6,800 miles high:

Global Debt Exceeds $100 Trillion as Governments Binge, BIS Says

Mar 9, 2014

 

The amount of debt globally has soared more than 40 percent to $100 trillion since the first signs of the financial crisis as governments borrowed to pull their economies out of recession and companies took advantage of record lowinterest rates, according to theBank for International Settlements.

 

The $30 trillion increase from $70 trillion between mid-2007 and mid-2013 compares with a $3.86 trillion decline in the value ofequitiesto $53.8 trillion in the same period, according to data compiled by Bloomberg.

 

The jump in debt as measured by the Basel,Switzerland-based BISin its quarterly review is almost twice the U.S.’sgross domestic product.

Note that global debt climbed by $30 trillion between 2007 and 2013, a 42% increase while global equities actually declined a few trillion (to $54 trillion), yielding a global debt-to-equity ratio of almost 2. [Note: Global equities are now valued at $66 trillion and are pouring on almost $1 trillion/week lately. Of course, they have a habit of going down, from time to time, even more quickly than they rise.  Something that is easy to forget in today’s environment]

So, a 42% increase in just 6 years. Did global GDP advance by 42% during this same period? No. Not even close.

Did private companies borrow all that money planning to plow back into productive enterprises? Nope. Companies borrowed relatively little of $30 trillion, and even then, they mainly used that newly-borrowed money to buy back shares and/or stash it on their balance sheets.

Who did borrow all that money then?

Why, nations did. Sovereign entities that were desperate to keep things afloat and borrow heavily (because private concerns weren’t able to take on new debt fast enough). 

Why? Because the world’s debt pile must keep expanding. That’s the world we live in today. If the pile should start to contract, the game of Who Will Take The Losses? begins. And governments know (sometimes consciously, sometimes subconsciously) that the debt bubble has become so monstrous, and so interconnected globally, that even a moderate correction will wipe out so many players that the world financial system will be brought to its knees. Or worse.

In Part 2: Something Very Wicked This Way Comes, we provide great detail into why sovereign and corporate (both high-grade and junk) debt markets simply and mathematically must contract. Current prices are so historically divorced from fundamentals at this stage that this ‘prediction’ is about as elementary as counting on gravity to bring a tossed stone back to earth.

Given the excesses of the stock and bond markets I am increasingly concerned that this next bubble burst will be far worse than any that has yet come since I’ve been alive. Countries will fail financially and economically, political upheaval will follow, fortunes and dreams will be shattered, and lots of people will lose their jobs.

In short, lots of things will break and cease to function as the greatest wealth transfer in all of history plays out.

Click here to read Part 2 of this report (free executive summary, enrollment required for full access)

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Good news was bad news for stocks (and gresat news for bonds) today as GDP's best sent stocks reeling early on, only to ramp back magically into the European close. For the next 4 hours, the S&P 500 traded in a 1.5 point range. While stocks dumped and pumped, Treasury yields went only on direction, lower (30Y -3bps today and -8bps on the week). FX markets were less chaotic than yesterday with early EUR weakness leaking back as the US day rolled on (USD -0.15% on the week). Silver, gold, and oil rose on the day (though well off spike highs during the EU session as Russia 'invasion' headlines hit). Copper tumbled the most in over 4 months. While equity markets closed modestly lower (Trannies red on the week), VIX and Credit markets weakened somewhat further.

UPDATE: Once cash markets closed, futures surged with S&P pushing up to unchanged to yesterday's cash close…

 

Cash equity indices on the day – once again dump and pump into EU close.. then tread water in a very narrow range for the rest of the day…

 

Trannies remain red on the week but Russell back off its exuberance…

 

As Futures managed to get back to pre-"Invasion" headline levels… before losing theminto the close…

 

But "most shorted" stocks did not get squeezed…yet…

 

Bonds and stocks are both bid still…

 

Treasuries were not buying the low volume lift off in stocks…

 

FX markets were less crazy than yesterday… but USD remains lower on the week…

 

Gold, silver, and oil recoupled at around a 1% gain on the week…

 

As Copper tumbled the most in 4 months…

 

And Silver ripped and dipped but held some 'invasion' gains…

 

 

Charts: Bloomberg

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