Barclays Fined For Manipulating Price Of Gold For A Decade; Sending “Bursts” Of Sell Orders

It was almost inevitable: a week after we wrote “From Rothschild To Koch Industries: Meet The People Who “Fix” The Price Of Gold” and days after “Barclays’ Head Of Gold Trading, And Gold “Fixer”, Is Leaving The Bank“, earlier today the UK Financial Conduct Authority finally formalized what most in the “tin-foil” hat community had known for years, when it announced that it fined Barclays £26 million for manipulating “the setting of the price of gold in order to avoid paying out on a client order.” Furthermore, the FCA confirmed that those inexplicable gold raids which come as if out of nowhere, and slam gold with a vicious force so strong sometime they halt the entire market, had a very specific source: Barclays whose trader “Daniel James Plunkett, sent out a burst of orders aimed at moving the price of the yellow metal.”

This took place for a decade. As the FT reports:

The FCA said Barclays had failed to “adequately manage conflicts of interest between itself and its customers as well as systems and controls failings, in relation to the gold fixing” between 2004 and 2013.

Some further details on Plunkett’s preferred means of manipulating the gold price.

The FCA said Mr Plunkett had manipulated the market by placing, withdrawing and re-placing a large sell order for between 40,000 oz and 60,000 oz of gold bars.

 

He did this in an attempt to pull off a “mini puke”, which the FCA took to mean a sharp fall in the price of gold. As a result, the bank was not obliged to make a $3.9m payment to the customer under an option contract.

Which is precisely what we have shown many times here for example in “Vicious Gold Slamdown Breaks Gold Market For 20 Seconds“, when a sell order so aggressive comes in it not only takes out the entire bid stack with an intent not for “best execution” but solely to reprice the market lower. Recall from September:

There was a time when, if selling a sizable amount of a security, one tried to get the best execution price and not alert the buyers comprising the bid stack that there is (substantial) volume for sale. Of course, there was and always has been a time when one tried to manipulate prices by slamming the bid until it was fully taken out, usually just before close of trading, an illegal practice known as “banging the close.” It appears that when it comes to gold, the former is long gone history, and the latter is perfectly legal. As the two charts below from Nanex demonstrate, overnight just before 3 am Eastern, a block of just 2000 GC gold futures contracts slammed the price of gold, on no news as usual, sending it lower by $10/oz. However, that is not new: such slamdowns happen every day in the gold market, and the CFTC constantly turns a blind eye. What was different about last night’s slam however, is that this time whoever was doing the forced, manipulation selling, just happened to also break the market. Indeed: following the hit, the entire gold market was NASDARKed for 20 seconds after a circuit breaker halted trading!

 

To summarize: a humble block of 2000 gold futs (GC) taking out the bid stack, and slamming the price of gold, managed to halt the gold market: one of the largest “asset” markets in the world in terms of total notional, for 20 seconds.

And Mr. Plunkett in action:

To be sure Barclays was truly sorry, and pinky swears that having been caught manipulating the gold market for ten years it will never do it again:

The news is also a fresh blow to Barclays’ chief executive Antony Jenkins as he tries to overhaul the culture of the London-based lender. Mr Jenkins took over 18 months ago after his predecessor, Bob Diamond, stepped down amid the Libor scandal.

 

Analysts said the fine reflected badly on the industry – as well as the hard-charging, revenue-focused business model that Barclays had previously been operating.

 

Mr Jenkins said in a statement on Friday: “We very much regret the situation that led to this settlement . . . These situations strengthen our resolve to improve.” The bank discovered the misconduct after the client complained. It then reported the incident to the regulator, for which it received a 30 per cent discount on its fine for co-operation.

 

Ian Gordon, analyst at Investec, said that in pure financial terms, the fine was “utterly inconsequential, both in a group context, and in relation to the quantum of other conduct costs”. He was referring specifically to the bank’s provisions for the mis-selling of payment protection insurance and interest rate hedging products

So a wrist slap, we get that. One wouldn’t expect more – after all the banks run the show.  And yet, one wonders: is this just a case of “Fab Tourre-ing” the scandal, and redirecting all attention to just one (preferably junior) person? To be sure, this one trader made handsome profits from gold manipulation…

Mr Plunkett boosted his trading book by $1.8m at the expense of a customer, who was later compensated. He has now been banned from “performing any function in relation to any regulated activity” and fined £95,600. At the time, Barclays was one of five banks that set the price of the precious metal twice a day. Tracey McDermott, the FCA’s director of enforcement and financial crime, said: “A firm’s lack of controls and a trader’s disregard for a customer’s interests have allowed the financial services industry’s reputation to be sullied again.”

… but is this just an attempt by the FCA to pass this off as the proverbial “only cockroach”, especially when as we reported earlier this week, none other than Barclays head of trading Marc Booker quietly left dodge?

The speculation is further heightened when one considers that Plunkett had left Barclays nearly two years ago in October 2012! According to his FCA record:

Prior to Barclays Plunkett worked as a lowly junior trader at Dresdner and RBC – and this is the a manipulation mastermind?

In other words this is indeed nothing more than another instance of “Kerviel” or “Tourre” thrown at the wolves of public consumption just so the attention can be redirected from the real manipulation elsewhere.

This is hardly surprising, as we noted three days ago when we wrote about the Barclays head gold trader termination:

“Bottom line: just like the Silver Fixing which last week announced its winddown, the days of the 117-year-old Gold fix are numbered. But to preserve continuity of riggedness and manipulation, perhaps they can just outsource their job duties to the biggest manipulators of all: Bank of England, the Fed and, of course, the BIS.”

So yes: it is now a fact that gold is manipulated by various commercial banks, and that those gold “raids” one sees every morning usually around the time of the London fix aren’t accidental at all but are entirely designed to reprice the market, but how deeper does the rabbit hole go?

[FCA Director Tracy] McDermott added: “Firms should be in no doubt that the spotlight will remain on wholesale conduct and we will hold them to account if they fail to meet our standards.”

Alas, this is a lie – by handing Plunkett to the public on a silver platter, it simply means that the real big players in the gold manipulation market will simply be allowed to continue business “as usual.”

So for those who want the real people behind the real manipulation before they all scatter into the dust, we urge you to reread “From Rothschild To Koch Industries: Meet The People Who “Fix” The Price Of Gold.” Because the gold manipulation rabbit hole goes far, far deeper than just one single, solitary trader…




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Brickbat: You Can Do Whatever You Feel

Officials  at
Bennett Elementary School in Fargo, North Dakota, have canceled a
first-grade class’s participation in the school talent show after
one parent complained their act is racist.
The students were to perform the song “YMCA” dressed as the Village
People. But one mom said having children dress as an Indian would
be offensive.

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Guest Post: What Are The Boundaries Of ‘Legitimate’ Espionage?

Submitted by Robert Farley via The Diplomat,

Are the norms of appropriate espionage changing? Glenn Greenwald’s new book, based on revelations from Edward Snowden, critically highlights an episode from the 2010 UN Security Council vote on sanctions against Iran.  At the behest of U.N. ambassador Susan Rice, the NSA targeted the delegations of at least four countries for surveillance and analysis in order to provide the U.S. with better intelligence on how those states might vote.  Although the overall impact remains unclear, this collection could have given the U.S. the ability to make targeted “side payments” to the countries in question, to frame its rhetoric differently, or to have a better sense of the progress of the campaign.

Greenwald’s use of this example has evoked some debate among diplomatic and intelligence analysts, as it strays far from the central themes of the Snowden Project, which involve mass data collection and global public surveillance. Along with the recent indictment of five PLA officers on charges of cyber espionage, it drags the focus onto the question of how nations spy on one another, and where the appropriate boundaries for “legitimate” espionage lie.

The UNSC incident was reminiscent of one of the most famous cryptography successes of the 20th century, the U.S. intercept of Japanese information at the Washington Naval Conference in 1921. Japan, the United States, and the United Kingdom disagreed about where the ratios limiting naval construction should fall, with the Anglosphere powers arguing that the great distances of the Pacific meant that Japan could manage its defense with fewer ships. While the United States argued for a 10:6 ratio in capital ship construction, Japan held out for a 10:7 ratio.

Led by the remarkably colorful Herbert Yardley, U.S. cryptographers broke Japanese codes and provided U.S. negotiators with crucial information about how far, precisely, the Japanese were willing to push their opposition to the proposed warship ratios. In the end, the Japanese accepted the U.S. proposal, allowing the Treaty (and eventually, its successors) to move forward and substantially reduce the number of warships in global navies. Not incidentally, it helped relieve the enormous pressure that the naval race was putting on the British and Japanese economies. Indeed, the biggest issue for Japan may not have been the codebreaking itself, but rather the later public announcement of the intercept, which humiliated the military and the diplomatic corps. Embittered by the lack of government support and impoverished by the stock market crash of 1929, Yardley detailed these achievements in 1931’s The American Black Chamber. This resulted in worldwide attention to the codebreaking success, and a lifetime blacklist for Yardley.

But isn’t the UNSC different? In some ways, yes; the UNSC is a long-term, established institution that’s key to international governance. But then the point of the Washington Naval Treaty was to conclude a viable, sustainable global peace. Every participant wanted, and in some cases desperately needed, to achieve an agreement on the limitation of naval weaponry. The only question that cryptography helped resolve was “who shall this viable, sustainable global peace favor the most?” Of course, the peace did not remain viable or sustainable, but it’s hard to argue that U.S. cryptography was decisive in pushing Japan to renounce the system of naval arms limitation.

The indictment of the five accused Chinese hackers raises similar questions. The United States and other countries have engaged in cryptography for quite some time to gain advantages in trade negotiations. The theft of intellectual property doesn’t seem such a large departure from this practice, especially given that the theft of foreign military and economic secrets was celebrated, rather than frowned upon, a century ago. This doesn’t mean that the Department of Justice was wrong to indict the hackers, but rather that we should perhaps all approach questions of economic and diplomatic espionage with a trifle less indignation.

 




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Chinese Premier Li Keqiang Punctures The Keynesian “Excess Savings” Myth

Submitted by David Stockman via Contra Corner blog,

For two decades now mainstream Keynesian economists have been gumming about China’s remarkable economic boom and its accumulation of unprecedented foreign exchange reserves. The latter hoard has now actually crossed the $4 trillion mark.

But this whole narrative is PhD jabberwocky with a Wall Street accent. What the People’s Printing Press of China has been doing is simply passing the hot potato by converting the vast inflow of dollars, euros and yen emitted by DM central banks into a fantastic flood of RMB. This massive expansion of the domestic monetary system, in turn, enabled the greatest credit bubble in world history.

Stated differently, China’s total credit market debt outstanding did not explode from $1 trillion to $25 trillion in just the last 14 years because the sons and daughters of rice farmers working in export factories went on a savings binge, thereby enabling a healthy expansion of debt-financed investment.

To the contrary, the central banks of the world went on a money printing binge and the comrades in Beijing took the bait. Namely, they chronically and massively scooped up excess foreign exchange from trade and capital inflows and stuffed it into the vaults at the central bank. This was supposed to keep the exchange rate battened down and the growth and export miracle ramping.

In age old fashion this mercantilist gambit seemed to work for a while—indeed, a long while of nearly two decades. But all the time the aging autocrats who ran the system, and who had learned their economics from Mao’s Little Red Book, were  actually swapping the labor of their young people and resources of their land for debt emissions of the profligate West. And in the process they were steadily inflating a fantastic credit bubble that financed the construction of anything that could be imagined by local party cadres and “businessmen” alike—-airports, bridges, highways, high-rises, office towers, train stations, fast rail, shopping malls, new cities, endless factories.

But the massive construction site within China’s borders defied the laws of economics and plain old rationality.  It is literally impossible for an economy to record double-digit GDP growth year-upon-year in which 50% of the gain is due to “fixed asset” investment in public infrastructure and private real estate and industrial capacity. The reason is that no society could sustain the level of consumption forbearance and mass austerity that would be required to fund such massive investment out of honest savings.

Instead, the party overlords got lured into a dangerous economic Ponzi. They sent more and more freshly minted credit—-20-35% more in some years—down the state controlled banking system where it was parceled out to state controlled enterprises, local party rulers and independent entrepreneurs.

These recipients turned it into cement, rebar, fabrications, office towers, coal mines, power plants and port facilities—-without regard for sustainable rates of return. And when returns disappointed or failed to materialize at all—such as in the empty new cities, malls and luxury apartment buildings— more credit was advanced to keep these “investments” solvent. That is, new debt was issued to pay interest on the old.

So parallel to the downward cascade of credit was an equal and opposite upward back haul of fixed asset GDP.  In short, Beijing could hit its national GDP target nearly to the decimal point year after year because its was printing GDP through the machinery of a credit driven command-and-control economy, not presiding over anything that resembles a sustainable capitalist economy.

In a sense, after the disastrous failure of Maoism, the party dictatorship has maintained its lease on life only be synching-up with the global central banking swindle that has been underway for four decades now—but especially since 1994 when Greenspan panicked after that year’s bond market route.

The giant issue facing China, however, is that it is at the end of the money-printing chorus line. It has now absorbed so much excess debt from the West and thereby inflated its credit Ponzi to such an insensible extent, that even its current rulers can see the hand-writing  on the wall.

In a recent speech, in fact, Premier Li let the cat out of the bag, calling China’s massive hoard of foreign exchange for what it is—-a vendor loan to foreign customers who buy but do not sell; who consume but do not produce. Suddenly, what has been ballyhooed for two decades as evidence of the Chinese miracle is officially labeled a “big burden”.

Actually, it has been a burden all along. The comrades have presided over the erection of a Ponzi of such immense and convoluted magnitude that they have no hope of unwinding it without a thunderous “hard landing”

 May 11 – Reuters: “China’s war chest of foreign currency reserves has become a headache as its continued rise could stoke inflation in the long term, Premier Li Keqiang said… pledging to reduce the country’s trade surplus. China’s foreign exchange reserves, the world’s largest, grew by $130 billion in the first quarter, to a record $3.95 trillion… ‘Frankly speaking, foreign exchange reserves have become a big burden for us, because such reserves translate into the base money, which could affect inflation,’ Phoenix New Media Ltd quoted Li as saying… ‘From China’s perspective, macroeconomic controls could face tremendous pressures if the overall trade is imbalanced.’ China will take steps to reduce its trade surpluses with the rest of the world…”




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Carmaker Hype Sends Palladium To Highest Against Gold In 10 Years

Gold is trading at the lowest level relative to palladium since 2004 as Bloomberg notes that prospects for a record shortage has lured investors to the metal used in pollution-control devices for cars amid concern that supply will be disrupted. As the chart below shows an oz of gold buys only 1.54 oz of palladium (less than a 3rd of the 5oz gold could buy in 2009) as supply problems (mining strikes and Russian sanctions) collide with demand expectations (the ‘recovery’ of the global car market). Despite GM’s problems, record levels of channel-stuffed inventories, and a still stagnant consumer (showing no interest in big purchases), IHS expects a record level of auto sales this year at 85 million. Seems like this ratio is an interesting derivative play on the excessive exuberance in the world’s car market expectations.

 

 

As Bloomberg notes,

Russia and South Africa are the world’s biggest producers of palladium.

A 17-week strike over pay at the South African mines of Anglo American Platinum Ltd., Impala Platinum Holdings Ltd. and Lonmin Plc, the largest producers, has squeezed supplies while western nations threaten Russia with sanctions for its actions in Ukraine. Johnson Matthey Plc predicts palladium’s shortage will expand to 1.61 million ounces in 2014 from 371,000 ounces last year. That would be the biggest shortfall since at least 1980, based on data on the company’s website.

“Beside the currently most important triggers for the price of palladium, namely the tense strike situation in South Africa as well as possible sanctions towards Russia in the Crimea crisis, global demand from the automobile industry should not be neglected,” Sonia Hellwig, senior manager for sales and marketing at Heraeus Metals Germany GmbH & Co. in Hanau, Germany, said by e-mail. “Furthermore the palladium ETFs continuously create positive impulses for the palladium price.”

IHS Automotive predicts that global auto sales will climb to a record 85 million this year. Usage by automakers increased 3.6 percent to a record 6.91 million ounces in 2013, according to Johnson Matthey, which makes about one in three of the world’s catalytic converters.

 

Just ignore this…

 

And this…




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The Connection Between Oil Prices, Debt Levels, And Interest Rates

Submitted by Gail Tverberg of Our Finite World blog,

If oil is “just another commodity,” then there shouldn’t be any connection between oil prices, debt levels, interest rates, and total rates of return. But there clearly is a connection.

On one hand, spikes in oil prices are connected with recessions. According to economist James Hamilton, ten out of eleven post-World War II recessions have been associated with spikes in oil prices. There also is a logical reason for oil prices spikes to be associated with recession: oil is used in making and transporting food, and in commuting to work. These are necessities for most people. If these costs rise, there is a need to cut back on non-essential goods, leading to layoffs in discretionary sectors, and thus recession.

On the other hand, the manipulation of interest rates and the addition of governmental debt (by spending more than is collected in tax dollars) are the primary ways of “fixing” recession. According to Keynesian economics, output is strongly influenced by aggregate demand–in other words, total spending in the economy. Any approach that can increase total spending–either more debt, or more affordable debt will increase economic output.

What is the Direct Connection Between Increased Debt and Oil Prices?

The economy doesn’t just grow by itself (contrary to the belief of many economists). It grows because affordable energy products allow raw materials to be transformed into finished products. Increased debt helps energy products become more affordable.

Figure 1.

Figure 1.

Without debt, not a very large share of the total population could afford a car or a new home. In fact, most businesses could not afford new factories, without debt. The price of commodities of all sorts would drop off dramatically without the availability of debt, because there would be less demand for the commodities that are used go make goods.

With commodities, such as oil or copper, there is a two way pull:

  1. The amount it costs to extract the oil or copper (including taxes, shipping costs, and other indirect costs), and
  2. The selling price for the commodity. The selling price reflects the customers’ ability to pay for the product, based on wages and debt availability. It also reflects other issues, such as the availability of cheaper substitutes.

The availability of increased cheap debt tends to pull oil (and copper and other commodity) prices high enough that businesses find it profitable to extract these commodities. This is why Keynesian economics tends to work–at least historically. When oil prices dropped to the low $30s barrel in 2008, the issue was very much a “decrease in debt outstanding” problem–taking place even before the Lehman bankruptcy–as I will show in later charts.

Figure 2. Oil price based on EIA data with oval pointing out the drop in oil prices, with a drop in credit outstanding.

Figure 2. Oil price based on EIA data with oval pointing out the drop in oil prices, with a drop in credit outstanding.

The peak in oil prices took place in July 2008. When we look at US mortgage amounts outstanding, we find that home mortgage debt hit a peak on March 31, 2008, and very slightly declined by June 30, 2008. The bankruptcy of Lehman Brothers did not take place until September 15, 2008. A further decline in the amount of home mortgages outstanding occurred from that point on, partly because of declining sales prices and partly because commercial organizations bought homes to rent them out.

Figure 3. US home mortgage debt, based on Federal Reserve Z.1 data

Figure 3. US home mortgage debt, based on Federal Reserve Z.1 data

When we look at consumer credit outstanding, we find that consumer credit outstanding hit a maximum on July 31, 2008, and began declining by August 31, 2008. (Consumer credit is available monthly, while mortgage debt is available only quarterly. Some definitional change regarding consumer credit must have taken place as of December 31, 2010, to cause the jump in amounts in the graph.)

FIgure 4. Consumer Credit Outstanding based on Federal Reserve Data. Student Loan data was available only for 12/31/2008 and subsequent. Prior amounts were estimated.

FIgure 4. Consumer Credit Outstanding based on Federal Reserve Data. Student Loan data was available only for 12/31/2008 and subsequent. Prior amounts were estimated.

When student loans are excluded, consumer credit outstanding (including such items as credit card debt and auto loans) is still not back up to the July 31, 2008 level today (Figure 4).

I have not shown commercial and financial debt, but they decreased as well, with somewhat later peak dates, coinciding more with the Leyman collapse. In my view, the spending of individual citizens is primary. When their spending falls, it quickly ripples through to business and government accounts. We see this affect slightly later.

The Federal Government quickly stepped in with more spending (funded by debt), as shown in Figure 5, below.

Figure 5. U S publicly held federal government debt, based on Federal Reserve data.

Figure 5. U S publicly held federal government debt, based on Federal Reserve data.

If we combine all United States debt (Figure 6, below), including both government and non-government, it becomes clear that the rate of increase in debt slowed markedly in 2008 and subsequent years.

Figure 6. US debt, excluding debt which is owed to governmental agencies such as the Social Security Administration. Amounts based on Federal Reserve Z.1 data.

Figure 6. US debt, excluding debt which is owed to governmental agencies such as the Social Security Administration. Amounts based on Federal Reserve Z.1 data.

Without this increasing debt, oil prices dropped to less than one-fourth of their maximum values (Figure 2). Prices of other energy products–even uranium–dropped as well. Somehow the high prices of oil that occurred in early 2008 had turned off the “pump” of ever-increasing debt that had previously held up commodity prices.

Oil Prices and Interest Rates–the Two Big Factors Affecting Discretionary Income

If oil prices spike, clearly discretionary income falls, for reasons described above. If interest rates spike, suddenly goods that are bought with credit (such as automobiles, homes, and new factories) become more expensive. Thus, a spike in interest rates will tend to adversely affect discretionary income as well. If the Federal Reserve wants to counter high oil prices (which continue to affect discretionary income adversely for the long term), it needs to keep interest rates low. Hence, the attempts to keep interest rates low for the long term.

The primary approach to keeping interest rates low has been Quantitative Easing (QE).US QE was begun in late 2008 and has been kept in place since. Other major countries are also using QE to keep interest rates down. The hope is that with very low interest rates the economies can somehow recover.

QE Doesn’t Really Work, Because it Doesn’t Fix Wages, Which are the Underlying Problem

When oil prices are high, wages tend to stagnate (Figure 7, below).

Figure 7. Average US wages compared to oil price, both in 2012$. US Wages are from Bureau of Labor Statistics Table 2.1, adjusted to 2012 using CPI-Urban inflation. Oil prices are Brent equivalent in 2012$, from BP’s 2013 Statistical Review of World Energy.

Figure 7. Average US wages compared to oil price, both in 2012$. US Wages are from Bureau of Labor Statistics Table 2.1, adjusted to 2012 using CPI-Urban inflation. Oil prices are Brent equivalent in 2012$, from BP’s 2013 Statistical Review of World Energy.

The reason why wages tend to stagnate when oil prices are high has to do with the adverse impact high oil prices have on the economy. Consumers cut back on discretionary spending. This leads to a loss of jobs in discretionary sectors. Also, labor is one of the biggest costs most businesses have. If profits are squeezed by high oil prices, the logical response if to try to reduce wages in response. One way is to outsource production to a lower-wage country. Another is to mechanize the process more, thereby slightly increasing fuel usage but significantly decreasing wage costs.

Instead of going to individuals as wages, the money from QE seems to go to speculators, who use it to bid up stock prices and land prices. The money from QE also tends to hold home prices up, because some homes are purchase by speculators. The money from QE also helps encourage investment in marginal enterprises, such as in shale gas drilling. As a recent Bloomberg, described the situation, Shale Drillers Feast on Junk Debt to Stay on Treadmill.

What Really Pumps Up the Economy is a Rising Supply of Cheap Oil

One piece of evidence supporting the view that a rising supply of cheap oil pumps up the economy is the rising average wages seen in Figure 7 (above) during periods when oil prices are low. Another piece of evidence that this is the case is the close correlation between oil consumption (and energy consumption in general) and inflation-adjusted GDP (Figure 8, below).

Figure 8. Growth in world GDP, compared to growth in world of oil consumption and energy consumption, based on 3 year averages. Data from BP 2013 Statistical Review of World Energy and USDA compilation of World Real GDP.

Figure 8. Growth in world GDP, compared to growth in world of oil consumption and energy consumption, based on 3 year averages. Data from BP 2013 Statistical Review of World Energy and USDA compilation of World Real GDP.

When there is an inadequate supply of oil, it affects GDP growth. This happens because there is no inexpensive, quick way of switching away from oil. We need oil for very many uses, including transport, agriculture, and construction. In the late 70s and early 80s, we tried to switch away from oil as much as possible. Now the low-hanging fruit for making such a switch are mostly gone.

The spike in oil prices signaled that something had changed dramatically. We could no longer count on a rising supply of cheap oil to pump up the economy. People’s job opportunities were dropping. They found it necessary to cut back on debt. Either that, or creditors cut off credit availability. One way or another, citizens started using less debt.

World Oil Supply

World oil supply is growing only very slowly, as illustrated in Figure 9. While we hear much about the growth in oil from shale formations in the US, this is mostly acting to offset falling production elsewhere.

7. Growth in world oil supply, with fitted trend lines, based on BP 2013 Statistical Review of World Energy.

Figure 9. Growth in world oil supply, with fitted trend lines, based on BP 2013 Statistical Review of World Energy.

It is this lack of growth in oil supply together with the high price of oil that is holding back world economic growth. As stated previously, very low interest rates are needed to even maintain the level of economic growth we have now.

The Difference Between and Growing and Shrinking World Economy for Repaying Debt

In a growing economy, it is possible to repay debt with interest. But once an economy flattens, it is much harder to repay debt.

Figure 10. Repaying loans is easy in a growing economy, but much more difficult in a shrinking economy.

Figure 10. Repaying loans is easy in a growing economy, but much more difficult in a shrinking economy.

It is likely that it is this problem that underlies the difficulty economies have in increasing their indebtedness. Very low interest rates can help, but ultimately, if the economy is not expanding, debt doesn’t work well. Wages are not growing in inflation-adjusted terms, and because of this, it is not possible for citizens to take on much more debt. Increased student debt gets in the way of buying homes using mortgages later.

The Unfortunate Oil Price Problem We Have Now

The problem we have now is that a rising supply of cheap oil is no longer possible. Most of the cheap-to-extract oil is already gone.

Instead, the cost of extraction keeps rising, but wages are not going up enough for people to afford the high cost of extracting oil (even with super-low interest rates). The unfortunate outcome is that oil prices are now too low for many producers. I described this in my post, Beginning of the End? Oil Companies Cut Back on Spending.

Because oil prices are too low for companies doing the extraction, we really need higher oil prices. But if oil prices are higher, they will put the country (and the world) back into recession. Interest rates are already very low–it is not possible to lower them further to offset higher oil costs. We are reaching the edge of how much central banks can do to hold economies together.

The Effect of Rising Interest Rates on the Economy

If it takes very low interest rates to offset the impact of high oil prices, it should be clear that rising interest rates, if they ever should occur, will have a disastrous effect on the economy. If interest rates should rise, they could be expected to have a number of adverse effects, pretty much simultaneously.

  • They make the monthly payments for a new home or new car higher, reducing the sales of both
  • They reduce the sales price of existing bonds (carried on the books of banks, pension funds, and insurance companies)
  • They likely will reduce stock market prices, because bonds will look like they will yield better in comparison.
  • Also, the country will be shifted into recession, and lower stock prices will result based on the apparently worse prospects of most companies.
  • The resale value of homes will likely drop, because fewer people will be in the market for  a move-up home.
  • The US government will need to pay higher interest on its debt, necessitating a rise in taxes, further pushing the country toward recession.
  • With higher taxes and more layoffs, there will be more defaults on debts of all kinds. Banks, insurance companies, and pension plans will be especially affected. Many will need to be bailed out, but it will be increasingly difficult to do so.

The Federal Reserve has said that it is in the process of scaling back the amount of debt it buys under QE. The expected effect of scaling back QE is that interest rates will rise, especially at with respect to longer-term debt. For a while, US interest rates did rise, and home sales dropped off.  But more recently in 2014 year to date, interest rates seem to be falling rather than rising. This is strange, since this is the period when the scaling back of QE is supposedly actually taking place, rather than just planned. It is possible that overseas transactions are distorting what is really happening.

Getting Out of this Mess

The substitution of debt for additional salary isn’t necessarily a very good one, even with very low interest rates. For example, the maximum length of new car loans has increased from five years to six years to seven years, allowing people to afford more expensive cars. The catch is that loans are “underwater” longer, and it becomes harder to buy a replacement car. So ultimately, buyers tend to keep their cars longer, reducing the demand for new cars. The problem isn’t entirely solved; to some extent it is just delayed.

It is hard to see a way out of our current predicament. The ability of consumers to pay higher prices for goods and services under normal circumstances requires higher wages. But if higher wages are not available, higher debt plus very low interest rates can “sort of” substitute. This cannot be a permanent solution, because there are too many things that will disturb this equilibrium.

As we have seen, rising interest rates will bring an end to our current equilibrium, by raising costs in many ways, without raising salaries. It will also reduce equity values and bond prices. A rise in the cost of extraction of oil, if it isn’t accompanied by high oil prices, will also put an end to our equilibrium, because oil producers will stop drilling the number of wells needed to keep production up.  If oil prices rise (regardless of reason), this will tend to put the economy into recession, leading to job loss and debt defaults.

The only way to keep things going a bit longer might be negative interest rates. But even this seems “iffy.” We truly live in interesting times.




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China’s Rising ‘Working Class Insurrection’ Problem

Last week we highlighted the stunning images of China’s “fists and daggers” police force training for a “working class insurrection.” It appears to be good timing, given last night’s terrible blasts in Urumqi. The chart below shows the worrying escalation in social unrest in China – at a time when the leadership is pushing a “strike first” anti-terrorist policy that appears to be failing badly. The “serious violent terrorist incident” that occurred last night in Urumqi, killing 31 and injuring 94, was the worst in years and prompted domestic security chief Meng Jianzhu to vow to strengthen a crackdown on the “arrogance of terrorists,” but, as one analyst warns tightening controls on the Uighur region may be “smacking them in the face.”

 

 

As Reuters reports,

he Xinjiang government could not be immediately reached for comment, but China’s Foreign Ministry spokesman Hong Lei said the attack “should be condemned jointly by the Chinese people and the international community”.

“The Chinese government has the confidence and the ability to combat the terrorists,” Hong said at a daily news briefing. “These terrorists are swollen with arrogance. Their schemes will not succeed.”

In a posting on its Chinese-language microblog account, the U.S. Embassy said it offered condolences to victims of the “violent attack”, but stopped short of labeling it terrorism.

In contrast, Russian President Vladimir Putin expressed condolences over what he called the “terrorist act” in Urumqi in a telegram to Chinese President Xi Jinping on Thursday, the Kremlin said, a day after a visit to Shanghai that produced a landmark agreement on supplies of Russian natural gas to China.

President Xi said police would tighten security at possible targets and vowed to “severely punish terrorists”, Xinhua reported.

However, in recent weeks, China has intensified a crackdown on Uighurs in the region, jailing dozens for spreading extremist propaganda and manufacturing arms, among other charges.

Christopher Johnson, a former China analyst at the CIA, said China’s leadership may eventually realize that a policy of constantly tightening controls on Xinjiang may not be effective in preventing attacks.

“I’m kind of doubtful that they are going to announce some sort of more liberal policy,” said Johnson, who now works at the Center for Strategic and International Studies in Washington.

“But sooner or later I think they are going to have to come to that reality because the evidence is just smacking them in the face.”

But hey – buy stocks because PMI printed in contraction but better than expected… even if employment was dismal.




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Happy (Temporary) News for Hungry Homeless in Daytona Beach: Fines Dropped Against Couple Feeding Them

I blogged last week about Daytona Beach hitting the generous
couple Debbie and Chico Jimenez and some of their associates with

over two thousand bucks in fines
for the crime of feeding the
homeless in a public park.

Happier news out of Florida today,
via NBC News
: the fines have been dropped!

However, this is just the calm before a likely storm, as the
couple, obdurate in their sin, still have the wickedness in their
hearts compelling them to feed the homeless in a place easy to get
to them, the public park.

And they swear they are going to continue to do it. Which could
mean more troublee:

The couple was warned, they said, that if they re-launch their
Wednesday food-sharing sessions at Manatee Island Park in Daytona
Beach, they will again face criminal charges – and more.

“It’s jail time if we get caught,” said Chico Jimenez, 60, a
retired construction manager who, with his wife, a retired auto
parts store manager, operates a New Smyrna
Beach-based ministry called
“Spreading the Word Without Saying a Word.” Since receiving the
citations, the couple has been lugging boxes of food to
impoverished families who have homes, and to people living in camps
in wooded areas within the community, they said.

The Jimenezes told NBC that they will apply for a permit,
which they expect will be denied, and that they then will sue the
city for violating their civil rights.

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