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I originally wrote this in September 2013. It is just as relevant now in December.

 

The big news in America is that the rate on the 10-year Treasury bond has risen dramatically from around 1.6% to over 2.9% [now on December 5, 2.84%]. This is 130 basis points from a starting point of 160, or an increase of more than 80%!

So naturally, the financial media are discussing the “essential” issues. They have commentators philosophizing about whether the tapering of Quantitative Easing is “priced in” (an invalid question, as I argue in my in the Theory of Interest and Prices). They credulously entertain the view that it signals “economic recovery”. If the economy were really recovering for four years, there would be no need for such hype.

On CNBC this week, Larry Kudlow’s guest was a sell-side analyst. He worried that either the absolute level of the rate, or the speed with which it has risen, will interrupt the bull market in stocks. Why is he concerned? Higher rates may discourage companies from borrowing to buy back their shares and issue dividends. I have previously written about this madness.

It is a strange politically correct world that makes it a taboo to say the simple truth. Unfortunately, freedom of speech in America is slipping—at least on controversial topics that matter. It may still be legal, but there is a very real chilling effect. In a crony system, one’s career is at risk to say the unpopular. So the gentlemen in the club safely confine their discussion to the M1 and M2 measures of the money supply, and the number of angels that can dance on the head of one pin.

Let’s take a step back from the noise. In the real world, every change in the interest rate destroys capital. To avoid this, firms hedge using derivatives. The good gentlemen in the club do sometimes acknowledge the derivatives problem, but never the cause, never why derivatives grow and grow and grow until they are now estimated to be approaching one quadrillion dollars. Those who sell these hedges must, themselves, hedge. They can push risk around and around in a circle of the big multinational banks. They cannot eliminate it.

Historically, the Federal Reserve has exhibited what I’ll call “bipolar interest rate disorder”. They vacillate between bingeing and purging. First they try to encourage the economy to “grow” by offering a buffet of too much credit, dirt-cheap. Then with pangs of regret if not guilt, they try to “fight inflation” by raising the price of credit. This leads to a bogus debate among economists: which evil should the Fed be pursuing at any given moment. Wall Street, of course, has a strong bias towards more credit, dirtier and cheaper. So do politicians seeking reelection.

Today, these two false alternatives are called “stimulus” and “austerity”. Fans of the latter sometimes fantasize about a mythological place, like Atlantis or El Dorado, called the “Exit”. Unfortunately, the Fed cannot sell their bonds. If they reversed from big buyer to even a small seller, it would reignite the very conflagration they fought in 2008. Leveraged market players would be unable to sell new bonds to pay their old bonds when due, and would therefore be forced into default. Talk of a Fed “exit” is a smokescreen.

Let’s take a further step back. The collapse of the Soviet Union proved that central planning doesn’t work. It can’t even deliver simple goods like food. The Fed is the central planner of something much bigger and vastly more complex. Money and credit are the foundation of our economy, and everything else depends on them.

The issue is not what the Fed should do next!

We should be discussing how to transition from irredeemable currencies to a free market based on gold without collapsing the financial system. I wrote a paper proposing how to do this. There may be others with good ideas. Let’s begin the discussion. Unfortunately, few want to risk their careers. I am not sure what would be worse: the cowardice of remaining silent in the face of a Big Lie, or the fact that saying the truth would indeed jeopardize one’s career in finance or economics.

We should be talking about the evolution of the Fed. Let’s not get distracted by conspiracy theories, stories about ancient banking families and creatures from islands with unfortunate names. And no, the Fed is not a “private cartel”.

The Fed began in 1913; it was the liquidity provider of last resort. If a bank needed gold, it could take Real Bills to the Fed, who would buy them at a discount. The government should have no role in the financial system at all, but Fed v1.0 was not the destroyer of markets as Fed v8.2 is today.

Subsequently, they began to buy government bonds. Incrementally, over many decades, the Fed evolved into the central planner it is today. Some of these steps were by presidential decrees, some were Acts of Congress, and of course the Fed took new powers for itself at opportune moments.

Today, there are many distribution channels, but the Fed is the only provider of credit of any resort. Should they cease issuing new credit, every bond market in the world would seize up followed immediately by the default of every bank, insurer, annuity, and pension. Despite the Fed’s record pumping of credit effluent, some bond markets are beginning to collapse anyway, along with the national currencies backed by those bonds.

We face a bitter dilemma. Without credit, large-scale production is not possible. The economy would devolve into medieval villages, with subsistence production done on family farms and workshops. On the other hand, continuing a system based on ever more counterfeiting will destroy more and more capital until the economy collapses.

Markets are being slammed back and forth between “austerity” and “stimulus”, between credit contraction and credit expansion. The number of units of the Fed’s credit paper required to buy an ounce of gold has long been rising. In other words, those units of credit were falling in value. But in the past few years, one has needed fewer of them to trade for gold. One day, traders are borrowing freely to speculate in the markets, driving prices up. The next, they are squeezed in a vice, desperate to roll over their liabilities, or if they cannot, to sell assets, especially assets that do not have a yield.

In conclusion, here is what I think the Fed should do. The Fed should go on buying bonds and doing what it has to do to keep the system going. No one wants the system to collapse. We should all be clear that the Fed is doing nothing more than buying time.

We need to use that time to transition to the gold standard, to begin the process of gold and silver to circulate, to develop a market for lending and borrowing gold. We need to repeal the capital gains, VAT, GST, and any other taxes that make it impractical to use gold. We need to repeal laws that force creditors to accept paper as payment in full. We need to develop the institutions such as gold banking and Real Bills.

via Zero Hedge http://feedproxy.google.com/~r/zerohedge/feed/~3/52YEtARhxi0/story01.htm Gold Standard Institute

Having discussed market microstructure and the parasitic impacts of high-frequency-trading for the last 5 years, it comes as no surprise that the block-trade-sniffing algos have had very significant impacts on the way institutional investors trade now. As WSJ reports, in fact the big boys are conducting more “upstairs trades,” in which deals are executed among big institutions, bypassing the broader market, because the proliferation of algorithmic trading and other structural issues, including the fragmentation of the market, are hurting their ability to get the best prices and execute large trades quickly. While the concerns aren’t all new, big investors say the cat-and-mouse games are growing more elaborate – and counterproductive – by the day.

 

Via WSJ,

Some of the world’s biggest investors are changing the way they trade in U.S. markets in response to what they say are rising risks for institutions of their size.

 

The strategies include conducting more “upstairs trades,” in which deals are executed among big institutions, bypassing the broader market, as well as other sophisticated order-routing techniques designed to avoid pitfalls that have become increasingly apparent to investment managers.

 

Investors say such measures are increasingly necessary because the proliferation of algorithmic trading and other structural issues, including the fragmentation of the market, are hurting their ability to get the best prices and execute large trades quickly.

 

A trade has the possibility of wending its way through 13 exchanges and more than 40 “dark pools,” off-exchange trading venues that don’t publicly display stock trades. A trade could also be executed inside a large broker-dealer that matches buyers and sellers from its own holdings.

 

…

 

The intricacy of the equity markets creates unnecessary steps for large investors and distracts portfolio managers from increasing returns, said Mr. Brooks of T. Rowe Price.

 

“It’s like trying to fill up your gas tank, but you have to go to 15 gas stations,” Mr. Brooks said. “By the time you get to the 15th one, they’ve increased the price because they’ve heard you were coming. Wouldn’t someone rather go to two or three stations and fill up the tank in blocks?”

Still believe HFT provides liquidity and makes the market ‘more’ efficient?

via Zero Hedge http://feedproxy.google.com/~r/zerohedge/feed/~3/Hby72OkKZhU/story01.htm Tyler Durden

With the balance of payments data released early today, Japan also reported a country breakdown of its portfolio investment flows.  Japanese investors stepped up their capital outflows in October to JPY1.324 trillion  or about $13.3 bln from JPY952 bln in September. 

Recall that, confounding expectations, Japanese investors were net sellers of foreign assets from January through June.  They repatriated roughly $150 bln.  In four months for which there is now data, Japanese investors have bought almost $55 bln of foreign stocks and bonds. 

Japanese investors bought JPY1.452 trillion of foreign bonds in October after JPY1.385 trillion in September.  Although the amount was broadly similar, the composition was radically different. 

In September, Japanese investors were large new buyers of US bonds and net sellers of rest of the world’s bonds.  In October, Japanese investors bought JPY148 bln US bonds compared with JPY1.732 trillion.  Japanese investors doubled the amount of French bonds they bought (JPY239 bln)  in October, over September (JPY117 bln).    Japanese investors also bought JPY65.3 bln of Italian bonds, the most since June 2011.  Overall, they bought JPY463.8 bln euro-denominated bonds. 

Japanese investors also scooped up bonds from the dollar-bloc.  They bought JPY130 bln of Australian government bonds and JPY189.2 bln over all, the most since June 2012 and is only the second month of net purchases since Nov 2012.   Japanese investors purchased almost five times more Canadian bonds in Oct (JPY108 bln) than in September (a little less than JPY23 bln).  

Another noteworthy development was that Japanese investors sold JPY36.1 bln of Singapore bonds.  This may not seem like a larger amount, but it is the largest sell-off since 1998.  We don’t see a fundamental change in the macro outlook for Singapore and suspect it may be a function of the low rates.  Yields out to five years are less than 1%.  The Singapore dollar has lost about 2.2%, though it did gain about 1.3% against the US dollar in October after a 1.5% rise in September.

Turning to equities, Japanese investors sold almost JPY198 bln in October.   Except for a minor JPY4.6 bln purchase in August, Japanese investors have been consistent sellers of foreign shares since July 2012.    Over this time they have sold about JPY7.256 trillion (~$73 bln) of foreign shares. 

US shares accounted for the bulk of the selling.  Over the 16-month period, Japanese investors sold JPY4.170 trillion US shares.  In October, US share sales were JPY138 bln (of the JPY198 overall net sales).  In September Japanese investors sold almost JPY254 bln, of which the US accounted for a little more than JPY177 bln.  

Japanese sales of European shares slowed, and there does appear to be a gradual shift toward booking purchases of euro area shares in Luxembourg.  According to MOF data, Japanese investors bought JPY44 bln of Luxembourg shares after JPY21 bln of purchases in September.  Over the 16-month period of selling, Japanese investors bought about JPy468 bln of “Luxembourg” shares, which as we say, likely reflects an account function and is better understood as a proxy for euro-denominated shares.

via Zero Hedge http://feedproxy.google.com/~r/zerohedge/feed/~3/QPKNzWI0jKY/story01.htm Marc To Market

The acknowledgment of the importance of Special Order Types highlights the asymmetry created from guaranteed economics by exchanges to HFTs that benefited from an uninformed public unaware that the game of checkers they thought they were playing was now, indeed, a game of chess with different pieces available and different rules….not publicly disclosed or not disclosed without any “reasonable effort” to “fairly inform” the industry of the new rules and pieces available to “play the game”.  Colin is saying DE didn’t need to disclose Hide-Not-Slide (HNS) because it was default behavior for the exchange.  Louis Marascio and O’Brein both highlighted a 2009 release with message coding instructions for using HNS, again, no document of Order Type Approval….Internet way-back machines will show exchange websites didn’t highlight these order types, they only covered what they wanted the “public” to know about.

When these guys come out (pro-HFTs attacking those highlighting the problems associated with HFT), now, 6 years after the guaranteed economics were created out of Reg NMS which was designed to improve micro-structure, they conflict each other regarding Order Types, like you saw with Colin and Louis tweets about HNS disclosure, it should painfully obvious that the only guys who know what they are talking about are the ones admitting they don’t have all the answers. An exchange CEO & creator makes “good faith efforts” to explain how his exchange works while another guy claims regulatory connections and electronic coding prowess at the exchange level highlights a release two years post Reg NMS and the re-branding of Knight’s Attain exchange as Knight, Citadel, and Goldman launch exchange Direct Edge in 2007 with the default behavior of HNS not approved by the SEC/NASD/FINRA and clearly structured to take advantage of Reg-NMS and the systematic restructuring of our National exchange economics. No longer were vanilla order types beneficial.  Note O’Brein likes to highlight Edge’s “Edge”, here’s an excert from Haim Bodek’s “The Problem of HFT”:

Market fragmentation in combination with the maker-taker market model, and in conjunction with a dramatic period of exchange “innovation,” had resulted in a new form of artificial edge. The net result was that unfair and discriminatory asymmetries in exchange order handling had been introduced into the marketplace. Special order types were the key to unlocking the advantages.

HFTs don’t use them (vanilla order types) either, the alpha is in their special order types and guaranteed economics that take advantage of the less informed orders that exchanges were telling customers to use on their websites (IE Limit, Market, Stop-Loss, etc).

Remember, it’s 6 years past Reg NMS and only now, post Wall Street Code, have we seen a coordinated effort to promote positive PR for HFT as proponents waste energy defending themselves against a growing sediment that questions the veracity of a trading strategy that Direct Edge exchange head can only try to explain in the limited knowledge hinted at when describing the Special Order Type Guide as a “Good Faith Effort”. It’s bullshit, admit it and stop rationalizing this in a similar destructive manner as the mice of the Utopia experiment from the mid 1900s.  I hope this better highlights the debate around HFT and disables the proponents ability to discredit me by merely highlighting hyperbole of my commentary 6 years into Reg NMS and a month after our release of Wall Street Code. At least I admit I don’t know exactly how every intricate part of the structure operates and that is the problem, no one can explain it because the HFT field IS manipulated, slanted, AND structured for a privileged few who never describe it publicly and surely wouldn’t desire for everyone to be trading with Special Order Types, the exchanges need dumb-flow. Note what Jamie Selway of ITG and of the BATS Board of Directors said about HFT in Trader Mag (also, side note, here’s why I’m bringing Jamie in now, aside from the quote you are about to read):

The post-only order is not particularly innovative, said Jamie Selway, head of liquidity management at agency broker Investment Technology Group. Plus, the focus on rebates “is not a good thing always. If you’re
a broker and you’re concerned more about the fee you pay than best execution, that’s sort of a conflict of interest.”

We continue to debate this on Twitter with no one choosing to set up a public debate with the most vocal adversary to the HFT practice.  Wonder why?

All this conflict of commentary shows the complexity and fucked up structure of our market post REG NMS, even SEC wasn’t ready as just a year ago they bought MIDAS from an HFT firm (can’t make this shit up guys) started by a guy who admitted HFT stole his lunch (first quote from HuffPost).  The pro HFT guys have no choice but to pay attention to us because we have been documenting, commenting, and highlighting the bullshit for years….consistently, while they have merely waited to hear what we say so they can adjust their behavior accordingly. 

Pay attention going forward, the discussion you will see from the Pro-HFT community will be starkly different than the behavior we’ve seen from them up to this date, they are feeling the pressure and are on a PR push to skew the facts of what they have done.  You have been warned yet again.

via Zero Hedge http://feedproxy.google.com/~r/zerohedge/feed/~3/gl4VJghbyBo/story01.htm CalibratedConfidence

Hidden deep inside the IRS’ most recent annual report focusing on just the Top 400 Individual Tax returns, titled “The 400 Individual Income Tax Returns Reporting the Largest Adjusted Gross Incomes Each Year, 1992-2009” we find the definitive confirmation of just where the Fed’s Wealth Effect has gone. As seen in the highlighted cell on the table below, just the top 400 individual tax returns account for a whopping 16% of the net Capital Gains tax paid in the US in all of 2009 (the most recent year recorded).

Putting this number in context, since 1992 the average percentage of the total capital gains attributable to the top 400 earners was “only” 8.69%. In 2009, or the year QE officially began, it was doulbe this or 16%.

One can’t wait for the 2010 update… or the 2011, 2012, 2013 and so on – all those “other” years in which the Fed’s “wealth effect” continued to benefit the capital gains of the Top 400…

via Zero Hedge http://feedproxy.google.com/~r/zerohedge/feed/~3/Iibvur8Qgl4/story01.htm Tyler Durden

Hidden deep inside the IRS’ most recent annual report focusing on just the Top 400 Individual Tax returns, titled “The 400 Individual Income Tax Returns Reporting the Largest Adjusted Gross Incomes Each Year, 1992-2009” we find the definitive confirmation of just where the Fed’s Wealth Effect has gone. As seen in the highlighted cell on the table below, just the top 400 individual tax returns account for a whopping 16% of the net Capital Gains tax paid in the US in all of 2009 (the most recent year recorded).

Putting this number in context, since 1992 the average percentage of the total capital gains attributable to the top 400 earners was “only” 8.69%. In 2009, or the year QE officially began, it was doulbe this or 16%.

One can’t wait for the 2010 update… or the 2011, 2012, 2013 and so on – all those “other” years in which the Fed’s “wealth effect” continued to benefit the capital gains of the Top 400…

via Zero Hedge http://feedproxy.google.com/~r/zerohedge/feed/~3/Iibvur8Qgl4/story01.htm Tyler Durden

It would be tragic if it wasn’t so hilarious. Nearly a year after we first suggested that Herbalife is the long of 2013, as a result of the epic short squeeze potential resulting from the Ackman announcement of his mega short,(promptly followed by the traditional Whitney Tilson piggyback) which it has been, rising from $25 to an all time high of $77.39 days ago, Herbalife has had enough of the so-called retail expert’s (coughJCPcough) repeated allegations of fraud, and after taking a well-deserved victory lap costing Ackman hundreds of millions, has decided to hit him where it truly hurts – his clients. Bloomberg reports that Herbalife is approaching investors in Ackman’s hedge fund, suggesting they pull their money from the $12 billion firm.

Herbalife’s argument: Ackman’s bet, which has lost as much as $500 million, is risky and irresponsible, said the people, asking not to be named because the campaign is private.” This is sheer brilliance on behalf of HLF, and one can’t wait to see just how successful the Moelis-run campaign concludes, because if there is one thing massively overinflated Wall Street egos (in this case belonging to epically overvalued “investment managers” – just ask Icahn) can’t stand, it is a drain of AUM. It would also mark a historic first time that a company marked for a shorting death strikes back at the hedge fund itself.

More from Bloomberg:

Moelis & Co., an investment bank working for Herbalife, arranged a meeting with Cliffwater LLC, which advises clients on hedge-fund investments, and Herbalife executives, according to two people with knowledge of the gathering. Moelis also reached out to New Jersey’s $76.7 billion pension fund, which has $207 million invested with Ackman, said the people. Executives of the New Jersey fund haven’t met with the Herbalife camp.

 

“Herbalife and Ackman have been fighting in one theater, and now the warfare has moved into an additional theater,” said John Coffee, professor of securities law at Columbia University in New York. “All’s fair in love and activism,” he said, adding that the tactic of putting pressure on activist investors through their clients is a new one.

 

Ackman, using chart-filled presentations with more than 300 pages, has waged a public campaign accusing Herbalife of generating most of its revenue from recruiting new distributors, rather than through sales to consumers. He’s urging U.S. regulators, elected officials and community activists to help shut it down. Even after the shares surged, the hedge-fund manager said in a November interview on Bloomberg Television that he “will take this to the end of the earth.”

He sure will. And speaking of Ackman’s presentation, this is what Whitney Tilson said about it last year, when he piggybacked on the losing trade:

Merry Christmas to all!

 

Pershing Square’s analysis of Herbalife is the most remarkable piece of investment analysis I have ever seen. Simply astonishing. And kudos to Pershing Square for making all of it public – not just the 300+ page slide presentation, but all the supporting materials. For the many young people on this email list who are looking for a job in this industry, study this carefully – if you can do analysis even a tiny fraction this comprehensive, there will always be a job for you…

Yup – with Whitney Tilson… where you may have to pay an “inverse Christmas Bonus” to keep your job.

The stated, politically-correct reason for the intervention is clear:

Herbalife and Moelis are trying to persuade Pershing Square investors and advisers such as Cliffwater that Ackman is acting irresponsibly and made the wager a personal issue, said this person. They argue that, by putting almost 10 percent of client assets into a short position against Herbalife, he was taking too much risk, the person said.

Still, none of this will compare to the sheer, epic humor that will result if and when Carl Icahn joins in, say, by telling every Pershing Square investor he would match every dollar pulled out with 50 cents of his own money. After all, for the 70+ year old billionaire it’s all a game at this point…

via Zero Hedge http://feedproxy.google.com/~r/zerohedge/feed/~3/w_Gp8C7SV4g/story01.htm Tyler Durden