another site
If
there’s a day of the year to notice the paradox of organized labor,
writes Ira Stoll, Labor Day is it. The paradox is this: even as
private sector unionism has declined, public sector unionism is in
some ways more influential than ever. Indeed, public sector unions
are so important that it’s impossible to tell the story of the big
city and state governments without accounting for their
influence.
from Hit & Run http://ift.tt/1Ck9jhg
via IFTTT
Based on the unprecedented collapse in trading volumes of cash products over the past 6 years, one thing has become clear: retail, and increasingly, institutional investors and traders are gone, probably for ever and certainly until the Fed’s market-distorting central planning ends. However, one entity appears to have taken the place of conventional equity traders: central banks.
Courtesy of an observation by Nanex’s Eric Hunsader, we now know, with certainty and beyond merely speculation by tinfoil fringe blogs, that central banks around the world trade (and by “trade” we mean buy) S&P 500 futures such as the E-mini, in both futures and option form, as well as full size, and micro versions, in addition to the well-known central bank trading in Interest Rates, TSY and FX products.
In fact, central banks are such active traders, that the CME Globex has its own “Central Bank Incentive Program”, designed to “incentivize” central banks to provide market liquidity, i.e., limit orders, by paying them (!) tiny rebates on every trade. Because central banks can’t just print whatever money they need, apparently they need the CME to pay them to trade.
So the next time you sell some E-minis, ask yourself: is the ECB on the other side? Or the BOE? Or, perhaps, you are selling S&P 500 futures to Kuroda. Who knows: there is no paper trail anywhere, although a FOIA request and/or the discovery from a lawsuit, class action or otherwise, of the CME’s central bank incentive program would likely yield some stunning results.
But the only place where “discovery” would be by far the most interesting, is for the CME to disclose just which central banks provide, or take such as at 8am every morning when one market sell order takes out the entire bid staack, the most liquidity when it comes to central bank trades in “Metals Futures Contracts (Physicals).”
Because imagine the shock and awe if and when it is uncovered that the biggest active manipulators of gold are not some junior-level traders out of Britain’s criminal bank cartel, but the central banks themselves.
Finally, while the list above deals with international central banks “providing” ES liquidity, those wondering why the NY Fed is not on the list and just how the Fed’s active trading team participates in the market without breaking the law, we have just one word: Citadel.
Source: Modifications to Central Bank Incentive Program. CME/CBOT/NYMEX/COMEX #14-038
via Zero Hedge http://ift.tt/1wTnEkL Tyler Durden
The palladium price made a new 13 year high today and reached $909/oz, its highest since February 2001. Markets fear that the global supply of palladium could be impacted by the threat of further sanctions against Russia.
Palladium in U.S. Dollars – 20 Years (Thomson Reuters)
The Russian mining industry has not been the target of sanctions so far, but with the oil sector already affected and the gas sector possibly the target of upcoming sanctions by the EU, markets remain fearful.
Russia is the world’s largest palladium producer accounting for over 40% of global production. This is mainly through Norilsk Nickel, the world’s largest mining company which mines nickel, copper and palladium in the area of Norilsk in Siberia, the world’s most northerly city. Palladium is mined as a by-product of nickel and copper mining.
The majority of palladium produced is used in automobile catalytic converters and demand has been buoyant recently due to higher sales in the auto industry. Recent miner strikes in South Africa have also disrupted supply for the big South African palladium producers, Amplats, Impala and Lonmin.
Investment demand for palladium has also been strong recently and as acted as a competing demand to industrial users.
EU Draws Up Further Sanctions Against Russia
Diplomatic fallout from the conflict in Ukraine continues to intensify. Amid claims and counter-claims by the Russian and Ukrainian sides concerning the fighting and incursions in Eastern Ukraine, the war of words has stepped up.
Russian President Vladimir Putin was quoted as saying last Friday that “I want to remind you that Russia is one of the most powerful nuclear nations. This is a reality, not just words.” While visiting EU leaders in Brussels at the weekend, Ukrainian President Petro Poroshenko said “we are very close to the point of no return, which is full scale war.”
As fighting continues, European Union leaders met in Brussels yesterday and recommend that the European Commission draw up further economic sanctions against Russia that would be imposed unless Russia demonstrates a de-escalation of its involvement in the conflict in Eastern Ukraine.
The recommended proposal includes “a provision on the basis of which every person and institution dealing with the separatist groups in the Donbass will be listed.” Donbass is the region in eastern Ukraine that encompasses the Donetsk and Luhansk areas that are currently the scene of the heaviest fighting in the conflict.
Up until now, the EU’s sanctions against Russia have targeted specific individuals, and a number of companies in strategic industries such as the Russian financial sector and high tech oil sector equipment sector.
The next set of potential sanctions is believed to still focus on the energy and finance industries, but would extend to sectors such as Russia’s gas sector., and step up the financial sanctions.
In the financial area, there appear to be plans by the EU to continue to limit access for Russian companies to the western financial markets. Further financial sanctions have also been discussed such as attempting to limit Russian access the sovereign bond markets and access to syndicated lending deals but, for now, these broader financial sanctions appear to be in reserve.
Russia has already imposed a ban on EU food imports and the EU is still fearful of retaliatory economic sanctions from Russia, which could extend to the EU aerospace, shipbuilding and car manufacturing sectors. This could ignite a harmful trade war which is why some EU member states are hesitant on sanctions at this time.
UK Moots Nuclear Financial Option Of Banning Russia From SWIFT
Last week, the UK was said to be proposing that Russia be blocked from the international SWIFT bank transfer network. If this occurred it would essentially shut Russian banks and other companies out of the international banking network. SWIFT is a Brussels based organisation and so it is obliged to follow any sanctions that are imposed by the European Commission.
However, the very fact that a proposal even exists to shut out Russia from the SWIFT network shows that the Ukrainian crisis is now taking on a more ominous tone, and that geopolitical risk is set to rise from here unless diplomatic intervention can somehow retrieve the situation.
With a heightened terror threat level being imposed in the UK, a potential ratcheting up of sanctions on Russia, and the threat of a larger trade and currency war on the horizon, September should be an interesting month for the precious metals markets.
The UK has raised the country’s terror threat level from substantial to severe, its second highest level. MI5 and MI6 said there was no information to suggest an attack was imminent.
The 13 year anniversary of September 11 looms next week and given developments in recent days and weeks, one must be wary of new attacks in the UK , U.S. and other western nations.
MARKET UPDATE
Today’s AM fix was USD 1,287.25, EUR 979.34 and GBP 774.47 per ounce.
Friday’s AM fix was USD 1,285.75, EUR 975.83 and GBP 774.55 per ounce.
Gold fell $2.00 or 0.16% to $1,287.30 and silver slipped $0.05 or 0.26% to $19.48 per ounce Friday. For the week, gold was up 0.54% while silver remained unchanged.
Today, the U.S. markets are observing a national holiday for Labor Day.
Platinum is trading at $1,424, unchanged from Friday. Palladium is again up strongly at multi-year highs at $909, up 1.5% from Friday’s $895.
With the Labor Day holiday today in the US, markets are expected to be quieter than usual, but given that it’s now September, the remainder of the week is set to see higher volumes and more market activity as traders return and refocus following what is traditionally considered the holiday month of August.
by Ronan Manly, GoldCore Consultant. Editor Mark O’Byrne of GoldCore
Receive our award winning research here
via Zero Hedge http://ift.tt/1qVjL67 GoldCore
The violent protests that raged yesterday have turned deadly as clashes between riot police and anti-government protesters left 3 dead and at least 470 injured according to The WSJ. The military, who are acting as mediators between PM Sharif and opposition leader Imran Khan have warned both sides that they neither support the others view or sanction further use of violence to suppress crowds. Mr. Khan exclaimed to the people, "if you want to be free, if you want to have a real democracy, the time has come;" as another protester noted "the police were brutal, but that is good because whenever blood is shed in a movement, it turns into a revolution." Meanwhile, the so-called "soft-coup" as WaPo refers to it continues to harden (threatening $3bn of US aid) as Prime Minister Sharif is left with fewer and fewer options.
Policemen run away from anti-government protesters #Islamabad September 1, 2014 #Pakistan http://ift.tt/1qjCImN
— 1924 (@1924_AEK) September 1, 2014
#Crisis en #Pakistán: Manifestantes irrumpen en la estación de #TVestatal ? http://t.co/Z9r5CQ28n4 http://ift.tt/1qjCImT
— Mundo El Comercio (@Mundo_ECpe) September 1, 2014
Islamabad has been paralysed since an estimated 70,000 protesters arrived from Lahore on August 15 and marched on Constitutional Avenue – which houses the National Assembly and the Prime Minister’s residence. Since then schools and offices have remained closed.
Anti-government protesters beat a riot policeman #Islamabad September 1, 2014 #Pakistan http://ift.tt/1qjCImV
— 1924 (@1924_AEK) September 1, 2014
Protesters sezied State TV (then lost control again)
Early on Monday, a group of between 400 and 600 protesters invaded Pakistan Television’s English-language service in the heart of the capital and forced it off air. Shortly before ending transmission, its announcer said: "They have stormed the PTV office. PTV staff performing their duties are being beaten up."
The brief occupation was ended by Pakistan Rangers paramilitary troops.
PM Sharif's room for manoeuvre was severely restricted by Pakistan’s army chief General Raheel Sharif on Sunday, when a conference of his corps commanders issued a statement voicing “serious concern” over the violence and “large scale injuries and loss of lives”. He warned that “further use of force will only aggravate the problem”.
The army chief had publicly clashed with the prime minister on Friday after Mr Sharif denied he had asked him to mediate in talks with Imran Khan and Tahir-ul-Qadri earlier in the day. He told the National Assembly that the army "did not ask to play the role of mediator, neither have we requested them to play such a role."
The "soft-coup" continues…
For much of Pakistan's independent existence, the country's politics have been dominated by its powerful military. The generals have a long history of interrupting and meddling with civilian rule. The election last year of Prime Minister Nawaz Sharif marked the first time in almost seven decades that Pakistan was able to carry out a peaceful transfer of power between civilian governments.
But the specter of the army now looms large once more. In order to placate heated protests against his rule, Sharif agreed this week to mediation by the army, an institution that is respected by a vast cross-section of society.
…
"If Nawaz Sharif survives, for the rest of his term, he will be a ceremonial prime minister—the world will not take him seriously," said Ayesha Siddiqa, an Islamabad-based analyst told the Wall Street Journal. "A soft coup has already taken place. The question is whether it will harden."
* * *
Additionally,
A group of hackers in Pakistan hacked several government portals, including that of the Army, and leaked 23,000 bank records in a bid to support the ongoing anti-government protests in the country, the Dawn reported.
'Islamabad Administration has reported that police used 10,000 gas shells, 1000 chemical gas, 5000 rubber bullets on protesters demanding resignation of Nawaz Sharif' said Imran Khan.
Parliament "tent" house. Via @faizanlakhani The real owners of Parliament House #Islamabad #Pakistan http://ift.tt/1qVhN5J
— Ahmed (@Shaforama) September 1, 2014
Bunlar da Pakistan Gezi'cileri. http://ift.tt/1qVhN5L
— Nehir Nur (@NJakaranda) September 1, 2014
* * *
The FT provides a quick primer Q&A on The Pakistan Protests (and more background can be found here)
Why the trouble now after last year’s successful election?
The real origins of the two big demonstrations that began in mid-August in Lahore, moved to the capital Islamabad and then erupted in violence – causing three deaths in an attempt to storm the official residence of Prime Minister Nawaz Sharif – are a little obscure. But the street supporters of Imran Khan, the former cricket star turned politician, complain about corruption and say the general election of May last year won by Mr Sharif was rigged. Those loyal to Tahirul Qadri, an Islamic scholar with a fiery turn of phrase, talk of the need for “revolution” and are angered by the police killings of up to 14 of their number in previous demonstrations in Lahore in June. The two protests have coalesced in an encampment in the so-called secure “red zone” in the heart of the capital, in front of Parliament and other official buildings.
What’s in it for Imran Khan and Tahirul Qadri?
This is perhaps the most puzzling aspect of the crisis. Although the 2013 election was marred by violence and doubtless by incidents of cheating, most observers say Mr Sharif – supported by the majority of voters in the populous Punjab – was the clear overall winner. The election was also hailed as an important step towards a sustainable democracy, because it marked the first time that one democratically elected government had taken over from another in Pakistan’s history. Mr Khan’s Pakistan Tehreek-e-Insaf (Pakistan Justice Movement) came third, but won control of the restive Khyber-Pakhtunkhwa province. His enemies accuse him of ambition and vanity because he failed to win the post of prime minister for himself, and some members of his party have rebelled against what they see as his undemocratic tactics. Mr Qadri, meanwhile, is normally based in Canada. He is a religious moderate by the standards of Islamic Pakistan, but politically radical – inveighing against corruption and nepotism among politicians.
Is the army behind all this?
Yes, at least that is what many Pakistanis believe, including those with a military background. The army overthrew Mr Sharif once before, when General Pervez Musharraf staged a military coup d’état in 1999. This time around, Mr Sharif is seen to have offended the generals in three ways. First, he is determined to pursue the case for treason against Mr Musharraf, instead of letting him fly back quietly into exile in the Gulf or in London. Second, Mr Sharif is eager to make peace with India, and the armed forces need India to remain the bogeyman so that they can justify their large numbers and hefty slice of the annual budget. Third, Mr Sharif has been trying to negotiate peace with Islamic extremists of the Pakistan Taliban, but the army has come round to the view that the militants must be crushed. The generals struggled for months before winning Mr Sharif’s authorisation of their current offensive in North Waziristan along the Afghan border.
Why is Nawaz Sharif unable to cope?
He has always been rather unfocused, but at the time of last year’s election he seemed to have learnt from past mistakes (this is his third go as prime minister). Since taking office, he has launched various projects – including power stations – that should eventually help alleviate the country’s electricity shortage and other problems. Yet political commentators say he now appears to have lost interest in governing. As the crisis brewed, he baffled his supporters by spending 10 days on a spiritual journey in Saudi Arabia.
Is there an economic impact on Pakistan?
Yes, but it is hard to calculate. Transport and the functioning of the central government have been badly disrupted by more than two weeks of troubles, and the US might be forced to withhold some of its aid for Pakistan if the armed forces overtly took power. The real problem is the loss of what little international confidence there was in Pakistan’s investment climate.
What next?
Among the possible outcomes is the resignation of Mr Sharif and the installation of a technocratic government tacitly backed by the army, followed by fresh elections. Other options include an outright military takeover (the army has run the country for half of its existence since 1947). Or Pakistanis could endure a long period of instability as a weakened Mr Sharif hangs on to power.
* * *
Senior government sources believe the army, or at least a section of it, is seeking to destabilise Mr Sharif’s government and wants fresh elections to oust or weaken him.
"There is a strong belief that they [the demonstrators] can’t continue doing what they’re doing without support from certain sections of the army.
via Zero Hedge http://ift.tt/1qVhRm8 Tyler Durden
The day that Banco Espirito Santo finally crashed and was liquidated nationalized under the weight of its countless criminal “inside the family” fund transfers, money losing loans, and off balance sheet activities, we pointed out to something amusing: the Goldman trail. Because not only was it revealed that in mid-July, two weeks before the Portuguese bank conglomerate failed, Goldman had invested several hundred million into the broken business, but that all through 2014, Goldman had done its best to drag the muppets down with it.
Recall from January 14, 2014 where Goldman said:
Buy BES: Winner at home, recovering abroad
In our view, BES is (1) optimally positioned to gain from Portugal’s banking market evolution and (2) likely to benefit from improving margins in Angola. With the stock trading at a 29% discount to peers’ 2015E P/TBV and with 28% upside to our 12m target price of €1.55, we upgrade BES to Buy.
* * *
Positioning: Looking beyond the crisis – BES best placed
Resilience to asset quality deterioration determined banks’ ability to withstand the effects of the economic and financial crisis. Those effects, however, have their cause in macroeconomic imbalances that led Portugal to ask for financial assistance from the EU/IMF. Addressing those causes will determine the future shape of the Portuguese banking market and the relative positioning of the banks. In this context, we develop a theoretical (and severe) scenario to assess relative positioning in a deleveraging economy: under this scenario, we estimate that Portuguese banks would need to delever by a further €35 bn domestic loans (or 15%) by 2020 to partially reverse the imbalances that contributed to the crisis. This is a top-end assumption and depends heavily on the country’s future macroeconomic performance. In this negative scenario, we show that BES would be best positioned to gain from a “race to the bottom”. Our estimate is harsh, but we still believe that it is a good proxy for the underlying trends in the lending market. In this context, even under more benign scenarios, BES is best placed.
Goldman had BES at a Buy until, well, just before the default.
The crashing stock price rose briefly on July 23 after it was revealed that such “deep value investors” as Baupost and quant algos as D.E.Shaw, but most importantly, Goldman, had become substantial holders of the BES common, with Goldman controlling just under 3% of the equity. Surely if anyone would have done their due diligence it would be Seth Clarman, David Shaw and the Squid. Well, ten days later it became abundantly clear that not only had nobody done any homework, but that the investors were merely piggybacking on each other, hoping that the “other guy” had actually analyzed the situation.
But while Baupost and DE Shaw, hedge funds which have deep-distrssed investing pockets, are logical buyers of a pre-bankruptcy stock and can assess the risks of a full wipe-out, why did Goldman feel compelled to chase a falling knife?
As Bloomberg reported on July 23, Goldman Sachs said today that it “entered into positions in Banco Espirito Santo by virtue of its facilitation of client transactions,” according to an e-mail sent to Bloomberg News. “This purchase passes on some security to the market and can open the door for other institutional investors,” said Juan Dieste, a trader at Orey iTrade in Lisbon.
Turns out as usual there was much more to the story, and – not unexpectedly – the squid had its tentacles all over Europe’s latest bank failure.
As the WSJ reported this morning, in addition to all the previously documented tentacles, Goldman had one more money-sucking contingency when it comes to the heretofore Portuguese cookie jar: it turns out that “through a Luxembourg financing vehicle created by Goldman, Banco Espírito Santo received $835 million in July, according to a prospectus reviewed by The Wall Street Journal, a time when it was nearly impossible for the troubled lender to borrow directly in the capital markets… The transaction with Goldman is the latest instance of a Wall Street firm helping finance the Espírito Santo empire via off-balance-sheet vehicles before its demise. Portuguese regulators, for example, are investigating special-purpose vehicles, administered by Credit Suisse Group AG, that bought debt from Espírito Santo companies, the Journal reported last month.”
So what: just another insolvent Europen bank funding itself entirely off the books with the help of the world’s most opportunistic banks (one wonders how many trillions in such SPVs are currently floating around Europe funding the banking sector’s €1+ trillion non-performing loan deficiencies, but that is a topic for another day). But unlike the “plain vanilla” Spivs of the first credit bubble, the complexity of this one was truly impressive:
At least some of that money was earmarked for an unusual destination: helping finance a refinery-construction project that a troubled Chinese company was running for Venezuela’s state oil company. That oil company was a major creditor of companies in the Espírito Santo group. The previously unreported Goldman deal offered a fleeting respite for Portugal’s second-largest bank, which was struggling with a cash crunch and a month later was bailed out and broken up by the Portuguese central bank.
The latest twist in the Espírito Santo saga started last September, when Venezuela’s state oil company, PDVSA Petroleo SA, known as PDVSA, awarded an $834 million contract to a Chinese company named Wison Engineering Services Co.
The contract, awarded just days after Chinese police detained Wison’s controlling shareholder in an oil-industry corruption crackdown, was to help build an oil refinery in Puerto la Cruz on Venezuela’s coast. It marked the biggest such contract in Latin America for a Chinese company and a rare international foray for Wison.
Banco Espírito Santo at the time had a substantial presence in Venezuela. It had opened a Caracas branch in January 2012, part of an ambitious global growth strategy, and served as banker to the Venezuelan government and PdVSA on multiple projects. A Banco Espírito Santo marketing presentation this year touted Venezuela as “an important market,” noting the large community of Portuguese expatriates there.
PDVSA, meanwhile, held significant sums of Espírito Santo debt, making it one of the family-owned conglomerate’s largest creditors, according to a person familiar with the relationship.
So a Chinese criminal entity investing in Venezuela, using money from a soon to be insolvent Portuguese bank that wouldn’t be around in one year’s time. And who ties it all together? Why the bank that was telling its clients to invest in the insolvent Portuguese bank all along.
Then things accelerated: in May, Banco Espírito Santo approached Goldman to set up a special-purpose vehicle named Oak Finance Luxembourg SA. Banco Espírito Santo wanted to use the vehicle to raise dollar-denominated funding, which was growing scarce due to the bank’s financial troubles, according to the person familiar with the relationship.
On July 3, locked out of bond markets and bleeding cash, Banco Espírito Santo borrowed $835 million from Oak Finance, according to the prospectus. The borrowed funds were for purposes including trade financing for Wison Engineering on PDVSA’s Deep Conversion Project, according to the loan agreement included in the Oak Finance prospectus.
The problem is that at just about that time, a Chinese crackdown on Wison’s controlling shareholder Hua Bangsong, about to be arrested on bribery charges, meant that the key player was about to drop out of the picture. Somewhat symmetrically, Wison announced on July 21 that the investigation casts doubt on its ability to stay in business, noting last week that it is in default on some of its bank obligations.
By this time, however, Goldman was furiously spinning the damage control machine, seeking to offload as much risk as possible knowing that the end is insight.
The same day that Banco Espírito Santo tapped the Oak Finance loan, Oak Finance issued $785 million of debt with annual interest rates of up to 3.5%. Goldman, which served as arranger and dealer for the transaction, bought the debt and hoped to sell it at a profit to outside investors.
What Goldman did not anticipate is how quickly the situation would spin out of control: “At first, the arrangement appeared lucrative for Goldman. It stood to collect fees from Oak Finance that “will be materially higher than the fees and/or commissions typically charged in vanilla bond transactions,” according to the prospectus. But Banco Espírito Santo’s financial difficulties made it hard for Goldman to attract buyers. During July, customers and creditors of the Portuguese lender yanked €3.35 billion ($4.4 billion) of funds, leaving the bank with “a severe liquidity shortfall,” according to Portugal’s central bank. The bank’s shares plunged 80% before its Aug. 3 bailout.
So what did Goldman do to make it seem it was in control? It invested a token amount in the BES equity for one simple reason: to offload as much of its SPV exposure to clueless invesotrs, as fast as possible. Because after all, why would Goldman be buying a chunk of the bank if it didn’t expect it to survive.
Well, it didn’t, but the whole point was to give just this impression, and in the fog of confusion, to dump as much of the 3.5% yielding paper to yield starved managers experiencing career risk and “Fear Of Missing Out”, and glutted with other people’s money.
Sadly it failed, and this time around Goldman’s double down bluff blew up in its face, with the 200 West bank suffering losses on both its SPV exposure and its equity investment. To be sure, not total losses:
Goldman eventually sold a slug of the Oak Finance debt, at a loss, to hedge funds that specialize in distressed debt, according to a person familiar with the market activity. Goldman is still holding some of the debt, which has lost value, this person said.
The fate of the Oak Finance debt is unclear. The sole collateral on the bonds is Oak Finance’s $835 million loan to Banco Espírito Santo. Despite the bank’s collapse, that loan is supposed to be repaid. It was among the liabilities transferred to Novo Banco, the “good bank” that Portugal carved out of Banco Espírito Santo when it was bailed out in August, according to Moody’s Investors Service.
Perhaps the take home message here is that in the New Normal, a truly distressed security yields a tiny 3.5%.
Or maybe, the lessons is that if Goldman is involved, someone will always end up suffering massive losses.
No matter what the lesson may be, if there even is one, here is what years of “macroprudential policies” have yielded:
And that ladies and gentlemen, is precisely how the New differs from the Old Normal. Oh wait…
via Zero Hedge http://ift.tt/1qVhRlS Tyler Durden
Submitted by Ben Hunt via Salient Partners' Epsilon Theory blog,
If names be not correct, language is not in accordance with the truth of things.
– Confucius, “The Analects of Confucius” (551 – 479 BC)
Give me a lever long enough and a fulcrum on which to place it, and I shall move the world.
– Archimedes (287 – 212 BC)
Call him Voldemort, Harry. Always use the proper name for things. Fear of a name increases fear of the thing itself.
– J.K. Rowling, “Harry Potter and the Sorcerer's Stone” (1997)
Do you know why hurricanes have names instead of numbers? To keep the killing personal. No one cares about a bunch of people killed by a number. '200 Dead as Number Three Slams Ashore' is not nearly as interesting a headline as 'Charlie kills 200.' Death is much more satisfying and entertaining if you personalize it.
Me, I'm still waitin' for Hurricane Ed. Old Ed wouldn't hurt ya, would he? Sounds kinda friendly. 'Hell no, we ain't evacuatin'. Ed's comin'!
– George Carlin, “Brain Droppings” (1998)
I have been pronounced by the Holy Office to be vehemently suspected of heresy, that is to say, of having held and believed that the Sun is the center of the world and immovable, and that the earth is not the center and moves.
Therefore, desiring to remove from the minds of your Eminences, and of all faithful Christians, this vehement suspicion, justly conceived against me, with sincere heart and unfeigned faith I abjure, curse, and detest the aforesaid errors and heresies, … and I swear that in the future I will never again say or assert, verbally or in writing, anything that might furnish occasion for a similar suspicion regarding me.
– Galileo Galilei (1564 – 1642)
|
William of Baskerville: |
|
|
Adso of Melk: |
What happened then? |
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William of Baskerville: |
The man was burned at the stake and I am still alive. |
– “The Name of the Rose” (1986)
|
Adso of Melk: |
And what was the word you both kept mentioning? |
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William of Baskerville: |
Penitenziagite. |
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Adso of Melk: |
What does it mean? |
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William of Baskerville: |
It means that the hunchback undoubtedly was once a heretic. Penitenziagite was a rallying cry of the Dolcinites. |
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Adso of Melk: |
Dolcinites? Who were they, master? |
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William of Baskerville: |
Those who believed in the poverty of Christ. |
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Adso of Melk: |
So do we Franciscans. |
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William of Baskerville: |
But they also declared that everyone must be poor, so they slaughtered the rich. Ha! You see, Adso, the step between ecstatic vision and sinful frenzy is all too brief. |
– “The Name of the Rose” (1986)
Every battle against heresy wants only this: to keep the leper as he is.
– Umberto Eco, “The Name of the Rose” (1980)
“The Name of the Rose” was an under-rated movie in the mid-1980’s with an in-his-prime Sean Connery and a young Christian Slater (not to mention some great scene-stealing by Ron Perlman), based on an under-rated novel by one of my favorite authors, Umberto Eco. To be sure, Eco is prone to the occasional bout of overwrought ego-stoking prose (but aren’t we all!), and my take on “The Name of the Rose” is that while Eco intended it as a work of great literature masquerading as a murder mystery, it’s really a great murder mystery masquerading as literature. But as a highly entertaining yet wise examination of the power of ideas, the implacable opposition of status quo institutions to “heresy”, and the role of language in that struggle, “The Name of the Rose” has no equal in my library.
I thought of Eco’s book last week when I read the WSJ’s breathless article about the San Diego County pension fund (SDCERA), Salient Partners, and the use of … gasp! … “leverage” and “derivatives” as part of Salient’s recommended allocation strategy. In terms of public Narrative, the words “leverage” and “derivative” have become so mushy and ill-used that they have lost almost all meaning except as a weapon, as a tool to cast doubt on someone’s motives, competency, and ethics. It’s the modern equivalent of accusing someone of witchcraft or heresy, and it’s what status quo institutions and their apologists have done for centuries with insurgent ideas. They use language – or rather, they intentionally misuse language – to paint the insurgent idea as heretical. It’s like Dana Carvey’s Church Lady interviewing someone on Saturday Night Live, only with the tagline shifted from “Could it be … Satan?” to “Could it be … Leverage?”.
Anyone with public accountability or transparency bears the brunt of this linguistic warfare, particularly the investment board or staff of any public pension plan. In my experience these are almost always very smart people who are “there for the right reasons” to use the catch-phrase of “The Bachelorette”. But like William of Baskerville, they find themselves in an untenable position, where even considering an unorthodox idea, much less defending it, is cause for public attack, ridicule, and excommunication. At least being raked over the coals today is a figurative rather than literal punishment, but frankly I think I might prefer the latter.
Modern torture-by-comment may be more psychological than physical, but it’s no less vicious, and it’s growing exponentially in power and scope. How many of you, like me, go straight to the comment area of an ESPN article? It’s not that I care at all what any single commenter says about Johnny Manziel or Tim Tebow, but I am fascinated by the outpouring of effort, the tens of thousands of voices who apparently believe that others really do care about their opinion. It’s entertainment for me. But imagine that you’re the target of this outpouring of know-nothing vitriol, that you’re a pension board member who hears a virtual mob saying that you’re obviously either an idiot or a criminal to use “leverage” – whatever that means – in your investment strategy. It is very difficult to maintain the courage of your convictions or even an open mind to consider new ideas under the onslaught of this modern day Inquisition, and that’s the real damage that’s done here. William of Baskerville recanted. Galileo recanted. And we expect anything more from public pension officials than CYA?
The unfortunate truth in all this is that, as Eco wrote, “every battle against heresy wants only this: to keep the leper as he is.” There are many status quo institutions – particularly political institutions like parties and media institutions like newspapers, but also more than a few large market institutions – who are delighted to keep public pension funds in this perpetual state of retributive fear and defensive under-performance. It has nothing to do with “keeping them honest” or whatever other bromide is trotted out for public consumption. It has everything to do with maintaining a mute whipping boy for political or economic gain.
This is why newspaper hacks and political wannabes all over the country lick their chops whenever some new idea is proposed by a public agency, whether it’s a local zoning board in a small town or a multi-billion dollar pension investment board. There is zero downside to making these attacks, no matter how simple-minded or misleading. The target is usually defenseless. The political upside is usually significant. And the economic beneficiaries, of course, other than the stalwart media defenders of orthodoxy, are the entrenched financial service providers.
We’re all familiar with the Indiana Jones knife fight, where a fierce turbaned warrior dressed all in black challenges Harrison Ford with his sword, only for Ford to pull out his gun and shoot the guy cold. Our current political and media system forces public pension funds into the turbaned warrior role. They are competing directly with the most advanced institutional investment firms in the world, firms that have an arsenal of weapons at their disposal. But God forbid that a public pension fund use “leverage” – again, whatever that means – in its investment strategy. Oh no, can’t have that. Better to fail conventionally than to succeed unconventionally. Better to arm yourself with that simple sword and be gunned down before the fight even starts.
Enough. Leverage and derivatives are not inherently demonic and aren’t exclusively the purview of dark wizards. If you say the words out loud I promise you won’t call forth a horde of Deatheaters.
Can leverage, however defined, be used in Voldemort-ian fashion for evil rather than good? Of course. As Eco writes in one of my favorite quotes, “the step between ecstatic vision and sinful frenzy is all too brief”, and as a risk manager that’s certainly something I watch for in any strategy or any investment manager. Can derivatives, however defined, be used as “financial weapons of mass destruction”, to quote Warren Buffett? You bet, although I find this quote mighty odd for a guy who wrote close to $15 billion of equity index puts and credit default swaps in 2006 to help fund Berkshire Hathaway. It all depends on what actual activity is being described by the words “leverage” and “derivatives”. It all depends on calling things by their proper names. To use the same word – “derivative” – for both exchange-traded futures in gigantically deep markets and a bespoke swap on some highly structured mortgage securitization is ludicrous, but that’s exactly what the modern Inquisition does intentionally for its own political and economic interests.
Properly understood – which means properly named – many common uses of leverage and derivatives aren’t that scary. They’re also not inherently instruments of risk creation. On the contrary – and this is the entire point of the risk-balancing “heresy” within the public pension world – using leverage and derivatives wisely can reduce the risk of an unlevered portfolio without reducing its long-term potential return or conversely may increase the long-term potential return of the portfolio without increasing its risk.
How? By using the age-old investment idea of balance, of not putting all of your eggs in one basket like the stock market. A risk-balancing strategy argues that you should put your money into multiple baskets – stocks, corporate bonds, commodities, and government bonds – and that you should balance between those baskets on the basis of historical risk, not simple dollar amounts. Also, most risk-balancing strategies have some mechanism to adapt to changing market conditions by letting the market tell you when something is working or not working. There, that’s it. Pretty scary, huh?
But you can’t execute a risk-balancing strategy without using leverage (properly defined) and derivatives (properly defined). Three reasons. First, to be adaptive you need to be quick on your feet. Not millisecond fast, but one or two days fast. With the massive amounts of money that pension funds invest today, it’s impossible to be sufficiently nimble if you’re locked into individual stocks and bonds. Second, if you want to put some of your investment eggs into the commodity basket, you have to use leverage and derivatives because that’s the only way to control them directly. Third, to balance out the risk between the baskets, as opposed to simply the dollars, you’re going to need to control a lot more dollars in your bond baskets than in the stock basket. Why? Because the historical risk to bonds, particularly government bonds, is so much less than the historical risk to stocks. To get an equivalent amount of risk you either have to get rid of almost all of your stocks, which would be a mathematically correct but financially ill-advised solution, or you have to control a lot more bonds. I think it’s wise to choose the latter … with limits, within reason, and constantly adapting to changing market conditions.
What a risk-balancing strategy means by “leverage” is the same as Archimedes meant the word 2,500 years ago, or that generals on the battlefield mean the word today: it’s controlling a lot with a little by using a force multiplier. It’s not borrowed money. It’s not “doubling down” or “turbo-charging” or whatever other misleading phrase your local genius columnist or comment troll throws out there as Gospel. It’s buying an exchange-traded, liquid contract that controls a lot of stocks or bonds or commodities for a little bit of money for a defined amount of time. These contracts are necessary because they are by far the most effective way of implementing what I think is an important new twist on an important old idea – balance your investments across several different asset baskets, but balance by risk (not dollars) and adapt to a changing market.
Does the use of leverage (properly defined) and derivatives (properly defined) create trading risks that wouldn’t be there if you just bought the Vanguard 60/40 fund and called it a day? Sure. But I believe risk-balancing strategies mitigate far more dangerous risks to a public pension portfolio – particularly an over-reliance on equity markets. Public pensions are complex entities whose liability structures are often many times greater than the size of their investment portfolios. The common practice to resolve this dilemma has been to pursue an equity-dominated asset structure that has greater chances of achieving the required return to make the entire structure work. The problem is that equities are themselves leveraged, but it’s hidden leverage and thus hidden risk.
What does this mean, to say that equities embody hidden leverage? It means that the assets of S&P 500 operating companies are nearly five times as large as the equity that finances them. It means that, by definition, the gulf between assets and equity can only be bridged by various forms of leverage. This is the alchemy that transformed a paltry 3.27% return-on-assets for S&P 500 operating companies in 2013 to an impressive 15.01% return-on-equity. For all the equity enthusiasts out there who shake their heads and tut-tut the idea of a few turns of leverage on a liquid portfolio of government bonds, I’d ask why you’re so confident in a 5x equity leverage on the 3.27% unlevered ROA of the S&P 500, but so fearful of, say, a 2x leverage on the 3.44% average interest paid on 30-year government bonds. That’s not a slam on equities. I love equities. Nor is it to say that there’s no risk in government bonds. My point is simply that as an investor you must take risk to achieve a return that is higher than the risk-free rate. There is no way around this, no free lunch, no way to get something for nothing. The question, at least for an investor like most public pensions, is not how to eliminate risk. The relevant questions are: do you know what risks exist in your portfolio, and which of these risks do you want to embrace?
Maybe you just don’t like a risk-balancing allocation strategy, for whatever reason. That’s fine. Or maybe you have a concern or an objection to the strategy or its implementation. That’s fine, too, and believe me, there are plenty of reasonable concerns you could raise or I could raise about ANY investment strategy. But don’t just shout out “Leverage!” as if it were a self-evident condemnation of the strategy or its adopters. It’s like the scene in Steve Martin’s wonderful movie Roxanne, where a heckler in a crowded bar shouts out “Big nose!”. Martin’s response? He’s insulted by the triviality of the insult, and proceeds to whip out 20 superior insults that the heckler could have made (my personal fave – “Obscure: whoa! I’d hate to see the grindstone.”). In this case, I would suggest “Looming: if you thought your leverage and derivative exposures were big, just wait till you see your liabilities.” or “Clairvoyant: if you’re so smart, why use diversification at all?”.
I’ll close with two quotes from Will Rogers, who not only never met a man he didn’t like but also had an amazing knack for communicating advanced investment insights without resorting to three syllable words or mathematical equations.
You’ve got to go out on a limb sometimes because that’s where the fruit is.
Don't gamble; take all your savings and buy some good stock and hold it till it goes up, then sell it. If it don't go up, don't buy it.
– Will Rogers (1879 – 1935)
I love these quotes because they encapsulate why Salient recommends a risk-balancing core allocation strategy. We want to embrace risk as an ally rather than treat it as the Great Satan. We do it for the same reason, as Will Rogers said, that you go out on a limb. Because that’s where the fruit is. Risk and reward are entirely inseparable. They are two sides of an unsplittable coin, and you can’t have one without the other. But you need to think about that relationship between risk and reward smartly. More importantly, you need to think about that relationship wisely. What’s the difference? Smart thinks that he can model the future. Wise knows that she doesn’t know what the future holds. Smart is intellectually sharp. Wise is intellectually honest.
Being wise about risk and reward means you don’t claim to own a magical crystal ball that predicts where risk will be low and reward will be high in the future. It means being intellectually honest enough to say that you don’t know. That’s the hardest thing in the investment world to admit, because there is no shortage of smart people who will tell you that they have just such a crystal ball. And maybe they’re right. If you have that crystal ball or you know someone who does … if you are able, as Will Rogers advised, to avoid buying stocks that don’t go up in the future … then you don’t need a risk balancing strategy. Otherwise, let’s have a conversation, or at least listen in by reading Epsilon Theory.
I’m not suggesting that we have a monopoly on new ideas for investing – we don’t – or that our ideas are right for everyone – they’re not. But we believe we are part of an insurgent movement to change the way investors think about asset allocation, and we are buoyed by a consistent lesson from history. The struggle between status quo and insurgent ideas can take a long time and it’s never an easy road for the truth-seekers caught in the middle, but eventually … the Inquisition always loses.
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Seventy-five years ago
today, Nazi Germany invaded Poland, kicking off World War II in
Europe. Two weeks later, the Soviet Union would join and invade
Poland too. In 1941, Adolf Hitler would turn on the Soviet Union,
driving that country to the Allied powers. Today, Russia, the
successor state to the Soviet Union, still uses its role in the
latter part of World War II to frame its wider foreign policy.
Putin once said World War II
gave Russia a “great moral right” to a “security strengthening”
foreign policy because of the Soviet Union’s role in defeating Nazi
Germany.
In the United States, meanwhile, politicians don’t tend to
invoke World War II in the same way. Nevertheless, America’s role
in World War II (which began in December 1941 after the Japanese
attack on Pearl Harbor), for better or worse, also shapes America’s
foreign policy today. It’s commitments to the United Nations, and
to the North Atlantic Treaty Organization (NATO), are directly
linked to World War II. Those commitments haven’t been revisited
even though the war ended nearly 70 years ago.
NATO may have been useful
during the Cold War, too, but the Soviet Union collapsed 25 years
ago. Since then, NATO’s been used to enrich Western military
interventions in places like Kosovo and Libya, the latter of which
has contributed to a deteriorating security situaiton in North
Africa and the Middle East, but hasn’t appeared necessary as a
strictly self-defense alliance. Recent events in Ukraine, where
Russia, NATO’s historical nemesis, has seized Crimea and generally
treated Ukraine’s sovereignty as optional while operating in and
near the country, have led NATO to announce the creation of a
“rapid
response force.” Yet while Russia’s actions in Ukraine may
threaten the interest of the European Union, they have nothing to
do with the security of any NATO country. Ukraine has warned that
its conflict with Russia could be the biggest since World War II,
but several months into the crisis it continues to directly involve
only two countries, Ukraine and Russia.
The notion that the U.S. “ought” to be concerned about Russia in
Ukraine isn’t based on any contemporary political configuration but
on the legacy of World War II (which happened to start when an
aggressive country began seizing land it said its countrymen lived
in) and the Cold War that followed. So the United States’
commitment in 1941 to defeat Japan, which attacked it, and its
allies Germany and Italy, has led to Europe, which was on the verge
of being overwhelmed by the Nazis before the U.S. entered World War
II, to continue to rely on American military power and expenditures
to advances its own agendas. It’s an arrangement that ought to have
been revisited decades ago. More than 100,000 U.S. troops remain in
Germany and Italy.
World War II didn’t just
have a lasting impact on international politics, it had a profound
effect on the people who lived through it, as all wars do. My
81-year-old dad, whose novel about life in post-war Poland we
adapted into a
graphic novel about jazz, sex, money, and dodging the American
draft, talks about World War II every day. He spent the first two
years of the war living under Soviet occupation. You can download
the first two issues free here.
When the United States and its allies, including the Soviet
Union, won World War II those people living in areas “liberated” by
the Soviet Union lost. The countries of the eastern bloc spent the
next 40+ years under communist rule if not occupation. None of them
were communist before World War II, and a number, like Poland, had
been invaded by the Soviet Union when it was allied with the Nazis.
One of the unintended consequences of World War II was the burden
of a half century of communism over half of Europe.
I uploaded a six-page selection from the third issue of Skyliner
about “War Criminals” that illustrates what some of the aftermath
of World War II looked like in places like Poland. You can check
out the pages
here.
As you may or may not know, last week I launched a Kickstarter
to print Skyliner as a graphic novel. You can
check that out here and watch the video with my dad below:
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Everywhere…
Welcome To The New Normal Crusades…
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September 1, 2014
Dallas, Texas
Imagine this scene:
“Everyone in the country was in shock. People’s net worth had devalued more than 53% overnight.”
“The value in savings accounts dropped in half and neither merchants nor consumers knew how to react because they had never been through something like it before…”
This is how an American business executive described living through Mexico’s devaluation of the peso exactly 38 years ago on September 1, 1976.
Looking back, it was so obvious.
Mexico had a mounting debt, destructive policies, and a woefully unsustainable fixed exchange rate with the US dollar. All the writing was on the wall.
But most people ignored the warning signs and kept their money in pesos.
Mexican President Luis Echevarria even went out on the radio to reassure people that the currency was safe.
Finally, under intense fiscal pressure, the government reached its breaking point. And on August 31, 1976, they made the decision to devalue the peso.
People woke up the next morning on September 1st to a 50%+ decline.
Coincidentally today is also the 75th anniversary of the Nazi invasion of Poland, the event that ultimately dragged the world into war.
Germany had already invaded Austria and Czechoslovakia in the months before.
By May 1939 Hitler had stated very plainly, “the decision remains to attack Poland at the first opportunity.”
Even a week before the invasion, Hitler told his military commanders, “I have prepared . . . my ‘Death’s Head’ formations with orders to kill without pity or mercy all men, women, and children of Polish descent or language.”
Germany had 60 divisions massed on the Polish border ready to invade.
Yet people in Poland were told to keep calm, remain in place, and have confidence in their leaders.
Finally, on August 30, the Polish government ordered a partial mobilization to meet the German threat.
Needless to say, it was too little, too late. Germany invaded only hours later.
This is a familiar story that repeats across history. Despite obvious warning signs, people almost universally allow themselves to ignore reality.
It’s human nature to want to believe that everything is going to be OK. And when our political leaders whisper soothing words of hope and optimism, we take the bait.
Looking back, it was plain as day that Mexico was going to devalue the peso. Everything about the economy and currency was totally unsustainable. Deep down people knew it.
Similarly, it was plain as day that Hitler was going to decimate Poland. And people knew it.
Yet millions allowed their confidence to be misplaced in leaders who assured them that everything was OK.
Are we so different today?
The raw numbers tell us that most banks in Europe are insolvent. Bank in the US are dangerously illiquid.
Most western governments are bankrupt. Pension and social security funds are insolvent.
Financial markets are at precarious valuations. And the dollar is beginning to unravel as the dominant reserve currency.
These are data-driven assertions. And my guess is, deep down, your instincts are also telling you that something is seriously wrong with the system.
Yet we’re all told to keep calm by our leaders. There’s nothing to see here, nothing to worry about.
Looking back, it’s all going to seem so obvious. If a major, global currency crisis hits within the next 12-months, people will think, “duh, how did I not see that coming?”
Unfortunately by then it will be too late.
It takes only a little foresight and planning to insulate yourself from an event that can have disastrous consequences.
If you knew the Mexican peso was at an unsustainable level, why would anyone continue to hold pesos?
Similarly, if all the objective data suggests that the dollar is in store for an epic decline… and that the entire world is on a path to shift away from the dollar, why in the world would any rational person base his entire life savings in dollars?
It takes little effort to actually do something about it. Hold stronger currencies overseas. Own real assets. Move your retirement account abroad where your bankrupt government can’t steal it.
These are common sense steps, just like putting on a seatbelt when you get into a car.
The time to act is now. Why play Russian roulette when the odds are clearly in favor of the house?
Don’t try to time it. Nobody has a crystal ball. It’s irrelevant whether the trend unfolds over weeks, months, or years. It’s pretty clear where this is all headed.
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Just 3 months ago, as Americans celebrated Memorial Day, the spot price of gold jerked $20 higher (then plunged) as gold futures closed. Today, as Americans celebrate Labor Day, the liquidity-less market for spot gold just dropped $6, ripped back and settled lower in the space of a few minutes (with bids and offers fully crossed for a few minutes) as someone clearly forgot to tell the machines that the market is closed…
Makes perfect sense…
as bids and offers crossed…
* * *
Unrigged markets for all… because nothing says “Sell Gold into an illiquid market” like NATO preparing to launch an offensive against Russia who ‘everyone’ now cliams is fully invading Ukraine…
* * *
Charts: Bloomberg
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