Tag: finance

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Investors will be fleeing Europe, they’ll be moving from Russia, getting far away from the USA as they can get and they’ll be going where the sun shines longer: Africa. Why? Simply because it’s worth it and the investment prospects there are far greater than they are anywhere else right now.

If you look at the top ten of places to invest in the world in the worrying times of the Chinese economy and the Indian woes, Africa has six countries that are worth taking a look at. They include Kenya, Angola, South Africa and Nigeria. Africa is said to have a potential growth of 6% in years to come and money can be made by investing there. Capitalizing on African economies is no plain sailing though and the instability (despite the apparent improvement of that) means that money can be made but perhaps not quite in the circumstances as any other country. It’s full of risks but if you invest, there’s greater potential than elsewhere right now. But, where does no-risk investment exist?

OECD nations are failing to grow despite whatever we might be told by governments round the world and Western economies are failing dismally to provide good investment projects. Few are willing or ready to take the plunge, however. That might be something good if you have the guts to do it.

South Africa, for example has clearly suffered from the withdrawal of Quantitative Easing and the billions been poured into emerging markets around the world. Economic growth has been cut from 3.2% to 2.7%, but that’s a lot more than what is being experienced either in Europe or in the USA today. Economists predict that economic growth for the country will improve to about 3.4% by 2015. Global demand has increased for South African countries and local exports. What is aiding African countries is the fact that they have huge potential as a market and secondly that they have a growth in population. Naturally, everything will depend on whether or not the developed markets continue purchasing and whether they have enough to be able to do so. Naturally, there has to be improvement in South Africa’s infrastructure and its logistics costs as well as improved competition between companies there before things can get better in terms of economic growth.

Wherever there is a link with the global economy, turbulence has been felt and Africa is no exception. The forecasts for this year for the entire continent are at around 5.3%. There has been a steady increase in economic growth from 2012’s figure of 4.2% (after excluding Libya’s oil production, which had previously madeGDP shoot up to 6.6%). Growth in countries has occurred economically, but not in terms of reducing the poverty levels in the country and there is persisting unemployment. There is the potential to employ and a potential to create jobs and reap the rewards of that.

In 2011, it was the European Union that purchased one third of African exports (but that was already a reduction from 2006’s figure of 37%). 11% of exports went to the USA. China stands at roughly 10% today (up from 6% 5 years before). Everything depends on what happens in Europe and also in China. But, the continent of Africa has the internal potential of its own markets in the years to come and that might mean long-term investment in that continent. Despite the failing of the markets of the EU and China, with which the countries in Africa seem dependent, they have still managed to survive the financial crisis and have positive figures for growth.

Investors won’t be staying in Africa, but they’ll be there to exploit them just as long and as much as they can. Africa has been exploited by the West, by Europe and by the entire world over its history. But, it’s the investors that will make the biggest big-game killing by going there today.

This is a return-ticket to Africa, where the investors will be soaking up the sun while the masses slave away on the dusty roads to success for the West.

Originally posted: Return-Ticket Investment to Africa, Please

 

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The situation with Russia should give investors and traders a reason to brush up on their history, as current events take root in things that happened 50, 100, and 200 years ago.  To understand this, can provide perspective, during an information war, where it’s not easy for some to separate facts from beliefs and propoganda (on both sides).  The relationship between US and Russia has always been interesting, as we shall explore.

The cultural divide

The US and Russia have very similar cultures.  Both; superpowers, with a vast countryside, dominated mostly by white Christians.  Both have vast resources, difficult to invade, and both have been the victim of European and other external politics.  Of course Russian culture is much older, and has a different set of influences and experiences than the US, situated in North America.  

There’s probably more misinformation in between the two cultures than any other, because for 60 years both have spent significant effort in propoganda.  So it’s difficult for most Westerners to be objective on this topic.

One theory on the divide between the two similar cultures was the decision for Russia to accept Christian Orthodoxy, started by Peter the Great.  If you look the dividing lines of political and economic alliances in Europe, historically, there seems to be a correlation with the dominant religion.  

The American Revolution

One interesting fact not reported much was Russian support for America during the American Revolution, both directly and by financing France, and through diplomatic and trade ties.  Not that Russia was doing the US any favors in that time, it simply supported their situation, and that they had an interest to not support the British.  But it should not be forgotten, that Russian support was crucial for the Americans in their struggle against the British.

Alaska

Ironically, considering the current US policy about Crimea, the Alaska purchase happened due to circumstances during the Crimean war:

After the Crimean War (1853-1856) Russia felt concern that the British would seize Russian America if a war broke out, strengthening the British in the north Pacific. To avoid this and to raise money, Russia offered in 1859 to sell the territory. In 1867 the United States purchased the whole of Russian America (Alaska) in the Alaska Purchase. All the Russian administrators and military left Alaska but some missionaries stayed on because they had converted many natives to the Russian Orthodox faith.^[20]

US annexations

The larger territory of the current United States was largely purchased or annexed (skipping the original 13 colonies which is a whole different issue).  Since the Revolutionay War, the US has aquired most of its territory by this method.  In that time the US was a new country.  These new aquisitions were exploited by the US, and helped fuel the US industrial revolution, and finally, what enabled the US to build a war machine during the 1940’s.

World War 2

World War 2 was the defining moment in American history when the US rose to superpower status, eventually creating the US Dollar as the dominant currency for trade in the world.  Before World War 2 (and more so before WW1) the US was largely isolationist, not seeing the relevance of foreign affairs.  But due to a number of circumstances, and the influence of the British (again, ironically) the US entered WW2 which changed world history.  It should be remembered however, that this was a new idea.  Before WW2 the US Army was largely comprised of Calvary soldiers on horseback.  There was no real Army capable of fighting in that time, the US was not prepared for war.  There was not a significant Navy, and certainly no advanced military technology, and no nukes.  While most of the world was at war, the US was able to convert its industry, organized by powerful US corporations, to build munitions instead of consumer goods and other products (guns vs. butter).  This gave the US the advantage, finally ‘winning’ the war, and leaving many nations indebted to the US.  This is important because this is the origin of American power, and many of these relationships, such as US-German relations, and US-Japan relations, exist to this day, because of WW2.

Since WW2, most countries choose to use the US “Petrodollar” – for a number of reasons.  But the system is very fragile; as we can see from its origins.  For example the deciding factor of ‘winning’ WW2 was the Manhatten Project, composed of many refugee German scientists.  Historians have explored that Germany was in fact working on a similar bomb, but due to their extensive obligations in their operations, were not able to complete it.  That, and other advanced technology being developed by Nazi scientists, certainly would have created a different world, economically speaking.

European influence

Both the US and Russia have been largely influenced by Europe, both in trade and politics.  But differently, Russia has been invaded many times by aggressive forces, which the US has not (aside from Canadians burning down the White House but this was not militarily significant).  Yes, Japan bombed Pearl Harbor, but only because Roosevelt threatened to cut of their oil supply.  And it certainly was not an ‘invasion’ – such as happened to Russia during WW2.  In many ways, Russia is more the victim; or at least to say has experienced more hardship as a nation, due to circumstances beyond their control, mostly created by outside influences.  

Origins of the Cold War

Henry Kissinger had recommended to Nixon that one of the most important strategic alliances for the US to pursue was with Russia.  His logic was that both countries were culturally similar (more so than for example China) and that a deal with Russia would have cemted both countries long term supremacy and boosted trade.  This was never pursued (and maybe never considered) in favor of a hostile policy thus creating the cold war, but it allowed huge spending into the military industrial complex.  Since then, the US instead chose to have a special relationship with China, which is now on the verge of a major financial bubble.

During this era, the CIA did and intensive analysis of the potential military risk of Russian aggression.  The CIA concluded that the Russians have no intention and no capability of posing any risk to the US.  But in a press conference, Rumsfeld eloquently said that “Just because we didn’t find any threat or capability, doesn’t mean they don’t have one” and based on this reasoning, we entered the cold war.  

This information indicates, it was US hawks that initiated an aggressive policy against Russia first.  General Patton has pleaded with his commanders to fight the Russians in Germany.  Although the cultures are similar, there seems to be some genetic mistrust (or can be explained in a number of different ways, but its not rational).  In any case, billions have been spent on propoganda demonizing Russians that they are ‘criminals’ – according to one prominent propoganda film, Communism is an “International Criminal Conspiracy” (although it was Wall Street that financed the Bolshevik Revolution).

It would be extremely politically inappropriate to mention Israel in this context.

Nuclear Age

Since WW2, real war between two states has become impractical, between nuclear powers.  Even with other states, the alliance with a nuclear power then makes war just as impractical.  The new war can only involve minor tit for tat conflicts, or be economic.  Possibly for this reason, policy makers and scholars in Russia have started incorporating a policy of ‘tanks not banks’.  This also may explain why the US has not annexed any territory since WW2, and many other policy shifts.

Markets Politicized

Supposedly, free markets operate based on free and open trade.  By imposing sanctions, limiting the use of the SWIFT system, and blocking Visa transactions, it changes the dynamics of the market, irrespective of the potential harm to targeted parties (although many analysts conclude sanctions will harm the West more than Russia).  Russian banks and oligarchs probably own at least a few shares of almost all US issues.  A certain majority of Russians are NFA members, RAs, etc.  Our economies are intertwined, all economies are intertwined, a policy forwarded by those such as Thomas Friedman.  

If sanctions include the asset freezes of any company owned by a Russian, does that include Bank of America, Caterpiller, McDonalds, etc.?  What about holdings of the oligarchs, Russian banks, citizens, inside the US?

Russian position

As one commentator said, the US is playing marbles, and the Russians are playing Chess.  The following video is a must watch, vivid analysis of the Russian position.  It’s no indication that this will or will not happen, but in this case, they are holding all the economic cards:

The situation in Crimea, which has nothing to do with the west, is irrelevant for the West.  The relationship with Russia participating in the Western economic system is a net benefit to the West.  Russian businesses operate in the US, UK, Germany (not to mention supplying energy to the EU) and invest in the West.  They are great customers.  Obviously the current administration never worked in the real economy, learning the expression that “The customer is always right.”  Since Crimea was previously part of Russia, and its mostly Russian speaking, Russians living there, this is really a non-event.  

West position

Not understanding all this, the West has created a situation where many will question the legitimacy of Western markets.  Making the economy political changes the dynamics of the market.  If we traders and investors spend our energy analyzing the markets to make decisions, and then to have our assets seized or a company we invest in, then it seems we are all in the wrong business.  Certainly that is not the idea of capitalism, or free markets.  Like during the 2008 credit crisis, when we explored the idea of losses are socialized and profits privatized, this is a very bad omen for not only the asset values, but also the proper functioning of the market.  

Don’t forget 1991 and 1998

When the Soviet Union collapsed in 1991, trillions of dollars flowed into the West, creating and economic boom for a decade.  Oligarchs seized control of previously state owned assets and many of them invested in the West.  Trade opened, and the West did business in Russia.  One of the dominant Forex trading platforms is from Kazan, Russia (Meta Trader).  The economic effects of this event have only been slightly examined – however it can be said they were significant.

Then, in 1998, Russia devalued the Ruble and defaulted on some of its obligations, in a period of economic reorganization.  The 1998 event is significant because it almost collapsed the world financial system – not by intention, but because of volatility created, which the largest hedge fund in the world at that time, LTCM, was exposed to.  Specifically, LTCM was not exposed so much to Russia directly (they were) but it created a chain of events that created havoc in the derivatives market, opening but bond and option spreads to unseen levels, and destroying liquidity (similar to what happened in 2008 which was a US issue).

Conclusion

It would not be difficult for Russia to start pricing goods in non-USD.  Certainly, the US is not going to nuclear war to protect the Petrodollar, as was done in Iraq, Libya, and others.  Russia is a huge consumer of USD, not only for reserves, but for trade.  Russia has a very strong position, it likes the relationship with the USD, but if Russia feels that its becoming a net loser, it will not think twice about using Gold, Euros, Rubles, or some new Russian Bitcoin.  Also it will have a tremendous negative impact on US markets, as Russian money flows out, and trade encouters problems.

Any event such as this can create huge volatility in the USD and other US markets.  At that time, it’s possible the US will react with further political moves to protect the USD (such as Nixon did, not honoring payments in Gold for USD creating modern Forex) including but not limited to, limiting the sale of USD.

Clearly, none of the suggested policies would be profitable.  There’s more money to be made by trading, than through taxes and government restrictions, price controls, capital controls, and other regulations.  Dodd-Frank destroyed the retail Forex market in the US.  This situation can have far more damage.  But traders and investors should be vigilant, understand what’s at stake, and understand the potential market impacts; either to profit, or to protect their portfolios.

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A little over a month ago, we reported that following a year of record-shattering imports, China finally surpassed India as the world’s largest importer of physical gold. This was hardly a surprise to anyone who has been following our coverage of the ravenous demand for gold out of China, starting in September 2011, and tracing it all the way to the present.

 

China’s apetite for physical gold, which is further shown below focusing just on 2012 and 2013, has been estimated by Goldman to amount to over $70 billion in bilateral trade between just Hong Kong and China alone.

 

Yet while China’s gold demand is acutely familiar one question that few have answered is just what is China doing with all this physical gold, aside from filling massive brand new gold vaults of course. And a far more important question: how does China’s relentless buying of physical not send the price of gold into the stratosphere.

We will explain why below.

First, let’s answer the question what purpose does gold serve in China’s credit bubble “Minsky Moment” economy, where as we showed previously, in just the fourth quarter, some $1 trillion in bank assets (mostly NPLs and shadow loans) were created  out of thin air.

For the answer, we have to go back to our post from May of 2013 “The Bronze Swan Arrives: Is The End Of Copper Financing China’s “Lehman Event”?“, in which we explained how China uses commodity financing deals to mask the flow of “hot money”, or the one force that has been pushing the Chinese Yuan ever higher, forcing the PBOC to not only expand the USDCNY trading band to 2% recently, but to send the currency tumbling in an attempt to reverse said hot money flows.

One thing deserves special notice: in 2013 the market focus fell almost exclusively on copper’s role as a core intermediary in China Funding Deals, which subsequently was “diluted” into various other commodities after China’s SAFE attempted a crack down on copper funding, which only released other commodities out of the Funding Deal woodwork. We discussed precisely this last week in “What Is The Common Theme: Iron Ore, Soybeans, Palm Oil, Rubber, Zinc, Aluminum, Gold, Copper, And Nickel?”

We emphasize the word “gold” in the previous sentence because it is what the rest of this article is about.

Let’s step back for a minute for the benefit of those 99.9% of financial pundits not intimate with the highly complex concept of China Commodity Funding Deals (CCFDs), and start with a simple enough question, (and answer.)  

Just what are CCFDs?

The simple answer: a highly elaborate, if necessarily so, way to bypass official channels (i.e., all those items which comprise China’s current account calculation), and using “shadow” pathways, to arbitrage the rate differential between China and the US.

As Goldman explains, there are many ways to bring hot money into China. Commodity financing deals, overinvoicing exports, and the black market are the three main channels. While it is extremely hard to estimate the relative share of each channel in facilitating the hot money inflows, one can attempt to “ballpark” the total notional amount of low cost foreign capital that has been brought into China via commodity financing deals.

While commodity financing deals are very complicated, the general idea is that arbitrageurs borrow short-term FX loans from onshore banks in the form of LC (letter of credit) to import commodities and then re-export the warrants (a document issued by logistic companies which represent the ownership of the underlying asset) to bring in the low cost foreign capital (hot money) and then circulate the whole process several times per year. As a result, the total outstanding FX loans associated with these commodity financing deals is determined by:

the volume of physical inventories that is involved

commodity prices

the number of circulations

A “simple” schematic involving a copper CCFDs saw shown here nearly a year ago, and was summarized as follows.

As we reported previously citing Goldman data, the commodities that are involved in the financing deals include copper, iron ore, and to a lesser extent, nickel, zinc, aluminum, soybean, palm oil, rubber and, of course, gold. Below are the desired features of the underlying commodity:

• China is heavily reliant on the seaborne market for the commodity
• the commodity has relatively high value-to-density ratio so that the storage fee and transportation cost are relatively low
• the commodity has a long shelf life, so that the underlying value of the commodity will not depreciate significantly during the financing deal period
• the commodity has a very liquid paper market (future/forward/swap) in order to enable effective commodity price risk hedging.

Here we finally come to the topic of gold because gold is an obvious candidate for commodity financing deals, given it has a high value-to-density ratio, a well-developed paper market and very long “shelf life.” Curiously iron ore is not as suitable, based on most of these metrics, and yet according to recent press reports seeking to justify the record inventories of iron ore at Chinese ports, it is precisely CCFDs that have sent physical demand for iron through the proverbial (warehouse) roof.

Gold, on the other hand, is far less discussed in the mainstream press in the context of CCFDs and yet it is precisely its role in facilitating hot money flows, perhaps far more so than copper and even iron ore combined, that is so critical for China, and explains the record amount of physical gold imports by China in the past three years.

Chinese gold financing deals are processed in a different way compared with copper financing deals, though both are aimed at facilitating low cost foreign capital inflow to China. Specifically, gold financing deals involve the physical import of gold and export of gold semi-fabricated products to bring the FX into China; as a result, China’s trade data does reflect, at least partially, the scale of China gold financing deals. In contrast, Chinese copper financing deals do not need to physically move the physical copper in and out of China as explained last year so it is not shown in trade data published by China customs.

In detail, Chinese gold financing deals includes four steps:

1. onshore gold manufacturers pay LCs to offshore7 subsidiaries and import gold from bonded warehouses or Hong Kong to mainland China – inflating import numbers
2. offshore subsidiaries borrow USD from offshore banks via collaterizing LCs they received
3. onshore manufacturers get paid by USD from offshore subsidiaries and export the gold semi-fabricated products to bonded warehouses – inflating export numbers
4. repeat step 1-3

This is shown in the chart below:

 

As shown above, gold financing deals should theoretically inflate China’s import and export numbers by roughly the same size. For imports, they inflate China’s total physical gold imports, but inflate exports that are mainly related to gold products, such as gold foils, plates and jewelry. Sure enough, the value of China’s imports of gold from Hong Kong has risen more than 10 fold since 2009 to roughly US$70bn by the end of 2013 while exports of gold and other products have increased by roughly the same amount (shown below). This is in line with the implication of the flow chart on Chinese gold financing deals: the deals inflate both imports and exports by roughly equal size.

Given this, that the rapid growth of the market size of gold trading between China and Hong Kong created from 2009 (less than US$5bn) to 2013 (roughly US$70bn) is most likely driven by gold financing deals.

However, a larger question remains unknown, namely that as Goldman observes, “we don’t know how many tons of physical gold are used in the deals since we don’t know the number of circulations, though we believe it is much higher than that for copper financing deals.”

Recall the flowchart for copper funding deals:

1. Step 1) offshore trader A sells warrant of bonded copper (copper in China’s bonded warehouse that is exempted from VAT payment before customs declaration) or inbound copper (i.e. copper on ship in transit to bonded) to onshore party B at price X (i.e. B imports copper from A), and A is paid USD LC, issued by onshore bank D. The LC issuance is a key step that SAFE’s new policies target.
2. Step 2) onshore entity B sells and re-exports the copper by sending the warrant documentation (not the physical copper which stays in bonded warehouse ‘offshore’) to the offshore subsidiary C (N.B. B owns C), and C pays B USD or CNH cash (CNH = offshore CNY). Using the cash from C, B gets bank D to convert the USD or CNH into onshore CNY, and trader B can then use CNY as it sees fit.
3. Step 3) Offshore subsidiary C sells the warrant back to A (again, no move in physical copper which stays in bonded warehouse ‘offshore’), and A pays C USD or CNH cash with a price of X minus $10-20/t, i.e. a discount to the price sold by A to B in Step 1.
4. Step 4) Repeat Step 1-Step 3 as many times as possible, during the period of LC (usually 6 months, with range of 3-12 months). This could be 10-30 times over the course of the 6 month LC, with the limitation being the amount of time it takes to clear the paperwork. In this way, the total notional LCs issued over a particular tonne of bonded or inbound copper over the course of a year would be 10-30 times the value of the physical copper involved, depending on the LC duration.

In other words, the only limit on the amount of leverage, aka rehypothecation of copper, was limited only by letter of credit logistics (i.e. corrupt bank back office administrator efficiency), as there was absolutely no regulatory oversight and limitation on how many times the underlying commodity can be recirculated in a CCFD…. And gold is orders of magnitude higher!

Despite the uncertainty surrounding the actual leverage and recirculation of the physical, Goldman has made the following estimation:

We estimate, albeit roughly, that there are c.US$81-160 bn worth of outstanding FX loans associated with commodity financing deals – with the share of each commodity shown in Exhibit 23. To put it into context, the commodity-related outstanding FX borrowings are roughly 31% of China’s short-term FX loans (duration less than 1 year) .

Putting the estimated role of gold in China’s primary hot money influx pathway, at $60 billion notional, it is nearly three time greater than the well-known Copper Funding Deals, and higher than all other commodity funding deals combined!

Under what conditions would Chinese commodity financing deals take place. Goldman lists these as follows:

• the China and ex-China interest rate differential (the primary source of revenue),
• CNY future curve (CNY appreciation is a revenue, should the currency exposure be not hedged),
• the cost of commodity storage (a cost),
• the commodity market spread (the spread is the difference between the futures
• China’s capital controls remain in place (otherwise CCFD would not be necessary).

All of these components are exogenous to the commodity market, except one – the commodity market spread. This reveals an important point that financing deals are, in general, NOT independent of commodity market fundamentals. If the commodity market moves into deficit, or if the financing demand for the commodity is greater than its finite supply of above ground inventory, the commodity market spread adjusts to disincentivize financing deals by making them unprofitable (thus making the physical inventory available to the market).

Via ‘financing deals’, the positive interest rate differential between China and ex-China turns commodities such as copper from negative carry assets (holding copper incurs storage cost and financing cost) to positive carry assets (interest rate differential revenue > storage cost and financing cost). This change in the net cost of carry affects the spreads, placing upward pressure on the physical price, and downward pressure on the futures price, all else equal, making physical-future price differentials higher than they otherwise would be.

* * *

That bolded, underlined sentence is a direct segue into the second part of this article, namely how is it possible that China imports a mindblowing 1400 tons of physical, amounting to roughly $70 billion in notional, demand which under normal conditions would send the equilibrium price soaring, and yet the price not only does not go up, but in fact drops.

The answer is simple: the gold paper market.

And here is, in Goldman’s own words, is an explanation of the missing link between the physical and paper markets. To be sure, this linkage has been proposed and speculated repeatedly by most, especially those who have been stunned by the seemingly relentless demand for physical without accompanying surge in prices, speculating that someone is aggressively selling into the paper futures markets to offset demand for physical.

Now we know for a fact. To wit from Goldman:

From a commodity market perspective, financing deals create excess physical demand and tighten the physical markets, using part of the profits from the CNY/USD interest rate differential to pay to hold the physical commodity. While commodity financing deals are usually neutral in terms of their commodity position owing to an offsetting commodity futures hedge, the impact of the purchasing of the physical commodity on the physical market is likely to be larger than the impact of the selling of the commodity futures on the futures market. This reflects the fact that physical inventory is much smaller than the open interest in the futures market. As well as placing upward pressure on the physical price, Chinese commodity financing deals ‘tighten’ the spread between the physical commodity price and the futures price .

Goldman concludes that “an unwind of Chinese commodity financing deals would likely result in an increase in availability of physical inventory (physical selling), and an increase in futures buying (buying back the hedge) – thereby resulting in a lower physical price than futures price, as well as resulting in a lower overall price curve (or full carry).” In other words, it would send the price of the underlying commodity lower.

 

We agree that this may indeed be the case for “simple” commodities like copper and iron ore, however when it comes to gold, we disagree, for the simple reason that it was in 2013, the year when Chinese physical buying hit an all time record, be it for CCFD purposes as suggested here, or otherwise, the price of gold tumbled by some 30%! In other words, it is beyond a doubt that the year in which gold-backed funding deals rose to an all time high, gold tumbled. To be sure this was not due to the surge in demand for Chinese (and global) physical. If anything, it was due to the “hedged” gold selling by China in the “paper”, futures market.

And here we see precisely the power of the paper market, where it is not only China which was selling specifically to keep the price of the physical gold it was buying with reckless abandon flat or declining, but also central and commercial bank manipulation, which from a “conspiracy theory” is now an admitted fact by the highest echelons of the statist regime.

Which answers question two: we now know that of all speculated entities who may have been selling paper gold (since one can and does create naked short positions out of thin air), it was likely none other than China which was most responsible for the tumble in price in gold in 2013 – a year in which it, and its billionaire citizens, also bought a record amount of physical gold (much of its for personal use of course – just check out those overflowing private gold vaults in Shanghai.

* * *

This brings us to the speculative conclusion of this article: when we previously contemplated what the end of funding deals (which the PBOC and the China Politburo seems rather set on) may mean for the price of other commodities, we agreed with Goldman that it would be certainly negative. And yet in the case of gold, it just may be that even if China were to dump its physical to some willing 3rd party buyer, its inevitable cover of futures “hedges”, i.e. buying gold in the paper market, may not only offset the physical selling, but send the price of gold back to levels seen at the end of 2012 when gold CCFDs really took off in earnest.

In other words, from a purely mechanistical standpoint, the unwind of China’s shadow banking system, while negative for all non-precious metals-based commodities, may be just the gift that all those patient gold (and silver) investors have been waiting for.  This of course, excludes the impact of what the bursting of the Chinese credit bubble would do to faith in the globalized, debt-driven status quo. Add that into the picture, and into the future demand for gold, and suddenly things get really exciting.

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

Not only is GM facing record high inventories of slow-to-sell cars and the recall of million sof its cars (and a sale halt), Reuters reports that the terrible ignition switch problem – that has caused 13 deaths – may have been known about (and not disclosed) prior to the bankruptcy (and subsequent taxpayer bailout). The Justic Department is investigating whether GM understated (or hid) the information from regulators and committed bankruptcy fraud.

 

 

Via Reuters,

Federal authorities are investigating whether General Motors hid an ignition switch defect when it filed for bankruptcy in 2009, The New York Times reported on Saturday.

 

The Justice Department’s investigation of the automaker includes a probe of whether GM committed bankruptcy fraud by not disclosing the ignition problem, a person briefed on the inquiry told the Times on Friday, the paper said.

 

Authorities are also investigating whether GM understated the defect to federal safety regulators, the Times said.

 

…

 

The investigation is being run by FBI agents and federal prosecutors who worked on the fraud case against Toyota that ended in a $1.2 billion settlement last week, the paper said.

 

On Wednesday, GM was hit with a lawsuit demanding that the company be held liable for allegedly concealing ignition problems before its 2009 bankruptcy.

 

GM is a different legal entity than the one that filed the 2009 bankruptcy that shook the U.S. economy. The so-called new GM is not responsible under the terms of its bankruptcy exit for legal claims relating to incidents that took place before July 2009. Those claims must be brought against what remains of the “old” or pre-bankruptcy GM.

 

But the proposed class action, filed in federal court in California, said plaintiffs should be allowed to sue over the pre-bankruptcy actions “because of the active concealment by Old GM and GM.”

 

The lawsuit also said GM was responsible for reporting to the federal government any safety-related problems for cars made before its bankruptcy.

How long until we see May Barra plead da fif?

via Zero Hedge http://ift.tt/1gnSY2k Tyler Durden

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“To me, social media is the worst menace to society.”–Erdogan

 

 

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WB7: To me social media is the worst menace to Erdogan…

 

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By: @blumaberlin

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Submitted by Ted Butler via Gold Silver Worlds blog,

I’ve had some recent conversations with attorneys who were considering class-action lawsuits regarding a gold price manipulation stemming from reports about the London Gold Fix. I told them that while there is no doubt that gold and, particularly, silver are manipulated in price, I didn’t see how the manipulation stemmed from the London Fix. I wished them well and hoped that they may prevail (the enemy of my enemy is my friend), because you never know – if the lawyers dig deep enough they might find the real source of the gold and silver manipulation, namely, the COMEX (owned by the CME Group) and JPMorgan.

So I thought it might be constructive to lay out what I thought a successful lawsuit might look like, although I’m speaking as a precious metals analyst and not as a lawyer. I’ll try to put the whole thing into proper perspective, including the premise and scope of the manipulation as well as the parties involved.

The first thing I should mention is how unprecedented it is that I’m writing this in the first place. Here I am, directly and consistently accusing two of the world’s most important financial institutions of market manipulation (making sure I send each all my accusations) and I have received no complaint from either. I don’t think that has ever occurred previously. Now I am taking it one step further; presenting a guide for how and why JPMorgan and the CME should be sued for their manipulation of gold and silver (and copper, too).

Let me explain why I am doing this. I am still certain that the coming physical silver shortage will end the price manipulation, but I see nothing wrong with trying to hasten that day. Over the past quarter century, I petitioned the regulators incessantly to end the manipulation, but the CFTC refused to do so. Far from regretting my past efforts, I feel it has greatly advanced and legitimized the allegations of manipulation. After 25 years, however, one must recognize that the horse being beaten is dead and that the CFTC will never act.

So, instead of simply waiting for the silver shortage to end the manipulation, I thought it advisable to try a new approach that was completely compatible with the real silver story to date. Since I (we) couldn’t get the CFTC to do its job and end the manipulation; why not try a different approach? The truth is that I have long believed that the right civil lawsuit stood a good chance at ending the manipulation before a silver shortage hit. I had high hopes initially that the class-action suit that was filed against JPMorgan for manipulating the price of silver a few years ago might succeed; but it seemed to drift off track and I wasn’t particularly surprised that it was ultimately dismissed. My intent should be clear – I want to see the next lawsuit succeed.

The stakes in a COMEX silver/gold/copper manipulation lawsuit are staggering. Not only is market manipulation the most serious market crime possible, the markets that have been manipulated and the number of those injured are enormous. I don’t think it’s an exaggeration to say that any finding that JPMorgan and the COMEX did manipulate prices as I contend could very well result in the highest damage awards in history. That’s no small thing considering the tens of billions of dollars that JPMorgan has coughed up recently for infractions in just about every line of their business.

My point is that no legal case could be potentially more lucrative or attention getting than this one. Certainly, this also includes the pitfall that JPMorgan and the CME are legal powerhouses who are not likely to roll over easily. Because the silver manipulation has lasted so long and damaged so many, the stakes away from any monetary finding are staggering. It is no real stretch to suggest, with or without eventual criminal findings, the reputational and regulatory repercussions (from other countries) could threaten the existence of each institution in current form (or at least management).

What is the theory or premise of the legal case for market manipulation against JPMorgan and the CME? The COMEX has evolved into a trading structure that has allowed speculators to control and dictate the price of world commodities, like gold, silver and copper, with no input from the world’s real producers, consumers and investors in these metals. The CME has allowed and encouraged this development for the sole purpose of increasing trading fee income. Not only do the world’s real metal producers, consumers and investors have no effective input into the price discovery process on the COMEX; because the COMEX is the leading metals price setter in the world, real producers, consumers and investors are forced to accept prices that are dictated to them by speculators on the exchange.

Because so few of the world’s real producers, consumers and investors deal on the COMEX, the exchange has developed into a “bucket shop” or a private betting parlor exclusively comprised of speculators. Again, this is an intentional development as much more trading volume is generated by speculative High Frequency Trading (HFT) than by legitimate hedgers (like miners) transferring risk to speculators. Legitimate hedgers don’t day trade. It is no exaggeration to say that the COMEX has been captured by speculators and abandoned by legitimate hedgers.

In turn, JPMorgan has developed into the “King Rat” in the speculative bucket shop by virtue of its consistent market corners in COMEX gold, silver and copper futures. The COMEX market structure was already rotten when JPMorgan blasted onto the scene in March 2008 when the bank acquired Bear Stearns’ short market corners in gold and silver. Incredibly, the regulators engineered the Bear Stearns rescue, granting to JPMorgan a listed market control in addition to the OTC market share control that JPM held for years. Talk about a powerful manipulative combo – JPMorgan and the COMEX.

Perhaps the most compelling aspect of my premise for a legal case against the CME and JPMorgan for market manipulation is that it is based exclusively on public data available from the CFTC in the form of the agency’s weekly Commitments of Traders (COT) and monthly Bank Participation Reports. There is additional proof of JPM’s controlling market share in the Treasury Department’s OCC OTC Derivatives Report (please see my public comment to the Federal Reserve at the end of this piece). The CFTC data may seem somewhat complex at first, but there can be little question as to its general accuracy and government pedigree. In fact, the data is compiled from exchange information transmitted to the CFTC, so the CME can’t deny its accuracy. There’s no he said/she said or ambiguity in these data series. In short, it is type of data that will hold up in a court of law.

According to the CFTC’s data, there are two primary groups of speculators setting prices on the COMEX. One group are the technical funds, traders that buy and sell strictly on price movement. Also referred to as trend followers and momentum traders, the technical funds buy and continue to buy futures contracts as prices climb; and sell and continue to sell, including short sales, as prices fall until prices subsequently reverse. These traders are included in the Managed Money category of the disaggregated version of the COT report, primarily because they are investment funds trading on behalf of outside investors, also known as registered Commodity Trading Advisors (CTA’s).

One thing that can be said for certain about these technical funds is that they are pure speculators, as there is no mining company or user of metal in this category by CFTC and CME definition. By itself, there is nothing wrong with that as regulated futures exchanges need speculators to take the other side of the transaction when legitimate hedgers wish to lay off price risk in the normal course of their underlying business. This is the economic justification for why congress had authorized futures trading originally. The problem is that there are few, if any, legitimate hedgers involved on the COMEX nowadays; only other speculators that are falsely categorized as legitimate producers and consumers.

The second group of speculators are primarily categorized as commercials, mostly in the Producer/Merchant/Processor/User category, but also in the Swap Dealers category. Since these terms are quite specific and strongly suggest that only legitimate hedgers are included, most people automatically assume the traders in these commercial categories are just that – hedgers. But that is not the case, as most of the traders in these two categories are banks, led by JPMorgan, pretending to be hedging, but which are, in reality, trading on a proprietary basis strictly for profit. Simply put, JPMorgan and other collusive COMEX traders are just pretending to be commercially engaged in COMEX trading in gold, silver and copper when, in reality, they are nothing more than hedge funds in drag.

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The lynchpin of any legal case against JPMorgan and the CME revolves around whether the traders in the commercial categories of the COT report are, in fact, hedging or simply speculating, as are the technical funds. The CME and JPMorgan will go to the ends of the earth to show that the commercials are hedging, not speculating and will hide behind the twin concepts that the commercials are either trading on behalf of clients or are actively involved in market making and are thereby providing much needed liquidity. It will sound legitimate if you believe in make believe stories instead of facts.

JPMorgan has a history of proclaiming it is hedging when confronted with an unnecessarily large speculative position. The first thing the bank declared when the London Whale debacle surfaced was that it was part of a hedge against the bank’s portfolio. But that was openly scoffed at and quickly discarded as an excuse. JPM is likely to trot out the hedging or market making justification, but any competent attorney will blow that away. No one (openly or legitimately) granted JPMorgan the right to maintain market corners in COMEX gold and silver.

In December 2012, JPMorgan held market shares on the short side of COMEX gold and silver that amounted to 20% and 35% of the net open interest in each market respectively. It is not possible that a reasonable person would not consider those market shares in an active regulated futures market to constitute market corners. After rigging prices lower by historical amounts in 2013, JPMorgan flipped its short market corner in COMEX gold to a long market corner of as much as 25% and reduced its short market corner in COMEX silver to under 15% from 35%, pocketing more than $3 billion in illicit profits. I’d like to see JPMorgan explain some connection to hedging with regards to its position change.

Undoubtedly, JPMorgan will claim it was “making markets” to explain away its huge position shifts in COMEX gold and silver (and copper), proclaiming it was always a buyer on the downside and a seller on the upside of prices. True enough, but far from being the market hero it will pretend to be, a closer examination will reveal something else entirely. The purpose of market making is to provide market liquidity and price stability. Legitimate traders are given some leeway from regulations limiting speculative positions and market shares from growing too large in order to enhance liquidity and price stability which benefits everyone.

But the record clearly indicates that JPMorgan, in cahoots with the CME, has used its dominant market shares in COMEX gold, silver and copper to instead engage in an evil form of market making whose intent is to constrict liquidity and create disorderly pricing. What record indicates that? The price record. Twice in 2011, the price of silver fell more than 30% ($15) in a matter of days and last year gold fell $200 and silver by $5 in two days. These price declines were unprecedented, had no legitimate supply/demand explanation and the regulators, including the CME did or said anything.

For sure, JPMorgan was a buyer on those deliberate price smashes and every other COMEX gold, silver and copper price smash for the past six years, but how does that make them a hero? This crooked bank and the CME and others arranged every COMEX price smash in order to create chaos, drain liquidity and disrupt pricing; the exact opposite of what legitimate market making is supposed to be. JPMorgan and the CME violated public trust in our markets as proven by the price record. For that, they should be made to pay dearly.

The key question is how did (and does) JPMorgan and the CME pull this off repeatedly? It all has to do with market mechanics, of which JPM and the CME are absolute masters. Since there are, essentially, two separate and competing speculative groups setting prices on the COMEX, it comes down one group scamming the other. (I know this is old hat to subscribers, but please remember I’m writing this to convince the right attorney to take on these crooks). So how does JPM get positioned to profit from a price smash (or price rise) and then rig prices to go in their direction? Basically, by scamming the technical funds by getting those funds to do what is profitable for JPMorgan and other collusive commercial traders and including the CME in the form of extraordinarily large trading volume.

How the heck does JPMorgan and the CME pull that off? They can pull it off because they know how the technical funds operate and because JPM and the CME also know how to cause the funds to buy and sell when JPM wants them to buy and sell. Since the technical funds only buy as prices are rising and only sell as prices are falling, particularly when prices penetrate key moving averages, all JPMorgan and the other collusive commercials have to do is occasionally set prices above and below those key moving averages. And thanks to an array of dirty trading tricks developed over the past 30 years, the most recent being HFT, JPMorgan can set short term prices wherever it chooses, whenever it desires.

In a very real sense, JPMorgan and other collusive COMEX commercials have become the puppet masters controlling the technical funds’ movements. It is an exquisite racket – JPMorgan gets the technical funds to buy or sell in order to take the other side of the transaction as counterparties. This can be seen in almost every price move in COMEX gold, silver and copper over the years. Let me try to present the data in graphic form, courtesy of some charts by my Aussie friend, Nick Laird of sharelynx.com.

Depicted below are the three main metals of the COMEX, gold, silver and copper and the net positions of the traders in the managed money category – the technical funds over the past couple of years. If you plot when the technical funds buy or sell, there is almost a 100% correlation to price. In other words, when the technical funds buy, prices for gold, silver and copper rise and when the technical funds sell, prices fall. The correlation is almost uncanny, to the point where some pundits have recently claimed that it is the technical funds, not the commercials, which are manipulating prices. But those claims melt away once one considers the nature of this bucket shop fraud.

Sure, the technical funds move prices when they buy and sell, but that’s just what JPMorgan and the CME count on. If the technical funds weren’t mechanical and predictable there would be no scam possible. It is only because the technical funds can be counted on to do the same thing repetitively that allows JPMorgan and other collusive commercials to take counterparty positions. If the technical funds weren’t predictable, JPMorgan would never have made $3 billion+ last year in COMEX gold and silver and been able to flip a short market corner in COMEX gold to a long market corner. Or just ask yourself – why would the technical funds collude to harm themselves?

I also feel it is significant that I can now include copper in the JPMorgan/CME illicit scheme to manipulate. This broadens the manipulation in a systemically important way. If ever there was a case for the Racketeer Influenced and Corrupt Organizations Act (RICO), this must be it.

In one recent attorney conversation, I was asked to provide the name of a technical fund that was duped as I described and would like to seek legal redress. If I could have, I would have, but I don’t think that’s possible. It’s another reason I refer to this COMEX manipulation as almost the perfect crime. In this case, any technical fund would not likely seek redress as a victim (certainly not as the initiator of legal action) because to do so would involve having to admit being the mark at a crooked poker game, something not conducive to attracting additional investor funds. In fact, it would invalidate a technical fund’s core business and be tantamount to simply quitting a business that may have been in existence for decades. It just isn’t going to happen.

But that hardly matters because the nature of market manipulation means there are untold numbers of other victims, particularly considering the scope of the gold, silver and copper markets. Whereas the technical funds were both the enablers and sometimes victims of the scam I described above, there are many thousands of legitimate victims (including me and many of you) who did nothing to enable the scam.

I dare say that there are more potential victims of the JPMorgan/COMEX gold, silver and copper manipulations than in just about any previous financial fraud. Let’s face it, there is hardly a mining company or investor in gold and silver or mining company shares that hasn’t been damaged over the past six years to some extent. That’s when JPMorgan came to dominate COMEX trading. If a legitimate class-action lawsuit was initiated, I believe potential litigants would emerge in massive numbers. Then again, there’s only one way to find out for sure and that’s to have such a case filed.

On a number of occasions in the past, when there was still some slim hope that the CFTC might address the ongoing silver manipulation, I publicly requested that you should submit public comments on issues related to position limits. By my count, upwards of 10,000 comments were submitted collectively, for which I offered my profuse thanks. Unfortunately, because the agency appeared to be compromised on the issue, no real good came from it through no fault of our own. Therefore, I would hardly ask anyone to do that again.

But I was reminded by a subscriber that I should submit a comment in regard to the Federal Reserve’s open public comment period seeking input on whether banks should be allowed to deal in physical commodities and derivatives on such commodities. I had mentioned in a previous article that I was undecided whether to do so or not. The subscriber convinced me that it was the right thing to do in order to go on the record, to which I had to agree. I understand the comment period has been extended to April 14, for anyone wishing to submit comments for the record. There have been less than 80 comments posted thru today and mine are near the bottom

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Gold & Silver Market Manipulation: Fed Open Comment March 2014

via Zero Hedge http://ift.tt/1ldap80 Tyler Durden

It is widely known that Russia is owed billions by Ukraine for already-delivered gas (as we noted earlier, leaving Gazprom among the most powerful players in this game). It is less widely know that Russia also hold $3b of UK law bonds which, as we explained in detail here, are callable upon certain covenants that any IMF (or US) loan bailout will trigger. Russia has ‘quasi’ promised not to call those loans. It is, until now, hardly known at all (it would seem) that China is also owed $3bn, it claims, for loans made for future grain delivery to China. It would seem clear from this action on which side of the ‘sanctions’ fence China is sitting.

 

Via RBC Ukraine (Google Translate),

In 2012, The State Food and Grain Corporation and the Export-Import Bank of China agreed to provide Ukrainian corporation loan of $ 3 billion, which was planned to be on the spot and forward purchases of grain for future delivery to China.

 

…

 

Minister of Agrarian Policy and Food of Ukraine Igor Schweich confirmed that China has filed a lawsuit against Ukraine in a London court for the return of a loan of $3 billion.

The Ukraine minister disagrees with China’s case:

“filed false information that there are no claims to us from China. According to the contract have different interpretations, different interpretations, which led to the treatment of the Chinese side in court Gaft who works in London. Registered dispute between the parties exists,” – said Minister told reporters.

 

According to him, the parties agreed to take the following week a representative of the Chinese corporation for the possibility of peaceful settlement of the dispute.

 

“We, for our part, will do their steps to ensure that the other party or retract its announcement, or we found another way to a peaceful settlement,” – he said. According to Schweich, a meeting will be held on March 26.

Ukraine appears to claim that these loans were made by the previous administration

The Minister added that the main problem lies in the fact that some leaders of PJSC “State Food and Grain Corporation of Ukraine” incorrect information. “These people are now removed during the protest,” – said Schweich, noting that China “is relevant to understand.”

 

In February 2014. the current Prime Minister of Ukraine Yatsenyuk said that “location $ 3 billion is not found.”

While China has been relatively quiet in the background – though abstaining from the UN vote waqs a clear signal of relative support for Russia – this is a meaningful step in the direction of pressure against the West, as yet again, any bailout funds would flow straight to either Russia (gas bill sor callable bonds) or China (agriculture loans).

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

Submitted by Gail Tverberg of Our Finite World blog,

The two big stories of our day are:

(1) Our economic problems: The inability of economies to grow as rapidly as they would like, add as many jobs as they would like, and raise the standards of living of citizens as much as they would like. Associated with this slow economic growth is a continued need for ultra-low interest rates to keep economies of the developed world from slipping back into recession.

 

(2) Our oil related-problems: One part of the story relates to too little, so-called “peak oil,” and the need for substitutes for oil. Another part of the story relates to too much carbon released by burning fossil fuels, including oil, leading to climate change.

While the press treats these issues as separate stories, they are in fact very closely connected, related to the fact that we are reaching limits in many different directions simultaneously. The economy is the coordinating system that ties together all available resources, as well as the users of these resources. It does this almost magically, by figuring out what prices are needed to keep the system in balance—how much materials of which types are needed, given what consumers can afford to pay.

The catch is that the economic system is not infinitely flexible. It needs to grow, to have enough funds to (sort of) pay back debt with interest and to make good on all the promises that have been made, such as Social Security.

Energy use is very closely tied to economic growth. When energy consumption becomes slow-growing (or high-priced—which  is closely tied to slow-growing), it pulls back on economic growth. Job growth becomes more difficult, and governments find it difficult to get enough funding through tax revenue. This is the situation we have been experiencing for the last several years.

We might think that governments would be aware of these issues and would alert their populations to them.  But governments either don’t understand these issues, or only partially understand them and are frightened by the prospect of what is happening. The purpose of my writing is to try to explain what is happening in terms that people who are used to reading the Wall Street Journal or Financial Times can understand.

I am not an economist, so I can’t speak to the question of what economists are saying. I do know that what economists say tends to change from time to time and from researcher to researcher. For example, in 2004, the International Energy Agency prepared an analysis with the collaboration of the OECD Economics Department and with the assistance of the International Monetary Fund Research Department (Full Report, Summary only). That report said, “.  . . a sustained $10 per barrel increase in oil prices from $25 to $35 would result in the OECD as a whole losing 0.4% of GDP in the first and second year of higher prices. Inflation would rise by half a percentage point and unemployment would also increase.” This finding is consistent with the issues I am concerned about, but I expect that not all economists would agree with it. Oil prices are now around $100 per barrel, not $35 per barrel.

The Tie of Oil and Other Forms of Energy to the Economy

Oil and other forms of energy are used to power the economy. Historically, rises and falls in the use of oil and other types of energy have tended to parallel GDP growth (Figure 1).

There is disagreement as to which is cause and which is effect—does GDP growth lead to more oil and energy demand, or does the availability of cheap oil and other types of energy power the economy? In my view, the causality goes both ways. Oil and other types of energy are needed for economic growth. But if people cannot afford oil or other types of energy products, typically because they don’t have jobs, then energy use will drop. And if oil prices drop too low, we will be in real trouble because oil production will stop.

How Oil Limits Work

People tend to think of limits as working in the same manner as having a box with a dozen eggs. Once the last egg is gone, we are out of luck. Or a creek dries up from lack of rainfall. The water is no longer available, so we have lost our water source.

With the benefit of the economy, though, limits are more complicated than this. If we live in today’s economy, we can purchase another box of eggs if we run short of eggs, assuming markets provide eggs at a price we can afford. If the creek runs dry, we can figure out a different approach to getting water, such as buying bottled water or hiring a tanker to get water from a source at a distance and bringing it to where it is needed.

Oil limits are a kind of limit we often hear concerns about. Being able to drill oil wells at all and refine the oil into products of many kinds requires a complex economy, one that can educate engineers working in oil extraction and can build paved roads, pipelines, and refineries. The economy needs to be able to produce high tech equipment using raw materials from around the world. Thus, there must be an operating financial system that allows buyers at one end of the globe to purchase materials from the other end of the globe, and sellers to have the confidence that they will be paid for contracted products.

If a company wants to extract oil, it can almost always figure out places where this theoretically can be done. If a company can gather together all of the things it needs—trained workers; enough high tech extraction equipment of the right type; enough pollution-fighting equipment, to prevent oil spills and spills of radioactive water; and leases on land where drilling is to done, then, in theory, oil can be extracted.

In fact, the big issue is whether the extraction can be done in a sufficiently cost-effective manner that the whole economic system can be supported. Even if the cost of extraction “looks” fairly cheap, such as in Iraq, or in some of the older installations elsewhere in the Middle East, the vast majority of the revenue that is generated from oil extraction (often as much as 90%) goes to support the government of the country where the oil is extracted (Rogers, 2014). This revenue is needed for many purposes: desalination plants to provide water for the people; food subsidies, especially when oil prices are high because food prices will tend to be high as well; new ports and other infrastructure; and revenue to provide jobs and programs to pacify the people so that the government will not be overtaken by revolt.

A major issue at this point is the fact that most of the easy-to-extract oil is already under development, so companies that want to develop new projects need to move on to locations that are more difficult and expensive to extract (Bloomberg, 2007). According to oil industry consultant Steven Kopits, the cost of one major category of oil production expenses increased by an average of 10.9% per year between 1999 and 2013. In the period between 1985 and 1999, these same expenses increased by 0.9% per year (Kopits, 2014) (Tverberg, 2014).

When production costs are higher, someone loses out. It is as if the economy is becoming less and less efficient. It takes more people, more energy products, and more equipment to produce the same amount of oil. This leaves fewer people and less energy products to produce the goods and services that people really want, putting a squeeze on the economy. The economy tends to grow less quickly because part of the goods and services available are being channeled into less productive operations.

The situation of the economy becoming less and less efficient at producing oil is called diminishing returns. A similar problem exists with fresh water in many parts of the world. We can extract more fresh water, but it takes deeper wells. Or we have to ship in water from a distance, using a pipeline or trucks. Or we need to use desalination. Water is still available but at a higher per-gallon price.

Diminishing Returns is Like a Treadmill that Runs Faster and Faster

There are many ways we can reach diminishing returns. One easy-to-illustrate example relates to mining metals. We usually extract the cheapest-to-extract ores first. An important cost consideration is how much waste material is mixed in with the metal we really want–this determines the ore “grade.” As we are gradually forced to move from high-grade ores to lower-grade ores, the amount of waste material grows slowly at first, then dramatically increases (Figure 2).

We know that this kind of effect is happening right now. For example, the SRSrocco Report indicates that between 2005 and 2012, diesel consumption per ounce of refined gold has doubled from 12.7 gallons per ounce to 25.8 gallons per ounce, based on the indications of the top five companies. Such a pattern suggests that if we want to extract more gold, the price of gold will need to rise.

The economy is affected by all of the types of diminishing returns that are taking place (oil, fresh water, several kinds of metals, and others). Even attempting to substitute “renewables” for nuclear and fossil fuels electricity production acts as a type of diminishing returns, if such substitution raises the cost of electricity production, as it seems to in Germany and Spain.

If the total extent of diminishing returns is not very great, increased efficiency and substitution can act as workarounds. But if the combined effect becomes too great, diminishing returns acts as a drag on the economy.

Oil Increases are Already Higher than the Economy Can Comfortably Absorb

For oil, we can estimate the historical impact of increased efficiency and substitution by looking at the historical relationship between growth in GDP and growth in oil consumption. Based on the worldwide data underlying Figure 1, this has averaged 2.0% to 2.4% per year since 1970, depending on the period studied. Occasional years have exceeded 3%.

The problem in recent years is that increases in the cost of oil production have been much higher than 2% to 3%. As mentioned previously, a major portion of oil extraction costs seem to be increasing at 10.9% per year. To make this comparable to inflation adjusted GDP increases, the 10.9% increase needs to be adjusted (1) to take out the portion related to “overall inflation” and (2) to adjust for likely lower inflation on the portion of oil production costs not included in Kopits’ calculation. Even if this is done, total oil extraction costs are probably still increasing by about 5% or 6% per year—higher than we have historically been able to make up.

According to Kopits, we are already reaching a point where oil limits are constraining OECD GDP growth by 1% to 2% per year (Kopits, 2014) (Tverberg, 2014). Efficiency gains aren’t happening fast enough to allow GDP to grow at the desired rate.

A major concern is that the treadmill of rising costs will speed up further in the future. If it is hard to keep up now, it will be even harder in the future. Also, the economy “adds together” the adverse effects of diminishing returns from many different sources—-higher electricity cost of production, higher metal cost of production, and the higher cost of oil production. The economy has to increasingly struggle because wages don’t rise to handle all of these increased costs.

As one might guess, when economies hit diminishing returns on resources that are important to the economy, the results aren’t very good. According to Joseph Tainter (1990), many of these economies have collapsed.

Why Haven’t Governments Told Us About these Difficulties?

The story outlined above is not an easy story to understand. It is possible that governments don’t fully understand today’s problems. It is easy to focus on one part of the story such as, “Shale oil extraction is rising in response to higher oil prices,” and miss the important rest of the story—the economy cannot really withstand high oil (and water and electricity and metals) prices. The economy tends to contract in response to a need to use so many resources in increasingly unproductive ways. We associate this contraction with recession.

We have many researchers looking at these issues. Unfortunately, most of these researchers are focused on one small portion of the story. Without understanding the full picture, it is easy to draw invalid conclusions. For example, it is easy to get the idea that we have more time for substitution than we really have. Financial systems are fragile. The world financial system almost failed in 2008, after oil prices spiked. We are still in very worrisome territory, with many countries continuing a policy of Quantitative Easing and ultra low interest rates. We may have only a few months or a year or two left for substitution, not 40 or 50 years, as some seem to assume.

Of course, if governments do understand the worrisome nature of our current situation, they may not want to say anything. It could make the situation worse, if citizens start a “run on the banks.”

The other side of the issue is that if governments and citizens don’t understand the full story, they may inadvertently do things that will make the situation worse. They certainly won’t be looking long and hard at what collapse might look like in the current context and what can be done to mitigate its impacts.

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

In what many thought was a miracle of modern money-printing-driven yield-chasing, Puerto Rico managed to get $3.5 billion of bonds off last week with no problem (albeit at a 8.73% yield). The issue (while perhaps not as surprising as the low yield issues of Uganda we have reflected on previously) raised some eyebrows and in the trading since its release, FINRA noticed something concerning.  The bonds, as Bloomberg reports, are supposed to ‘minimum denomination $100,000’ blocks and yet 75 trades this week have been for no more than $25,000 violating regulations which deem these for “institutional purchasers” and strongly suggesting the heavy hedge fund demand was nothing more than a pump-and-dump scheme to unsophisticated retail investors. PR bonds have plunged from par to $92 this week.

• *PUERTO RICO SOLD $3.5 BLN OF GENERAL-OBLIGATION DEBT MARCH 11
• *FINRA SAYS IT’S EXAMINING TRADING IN NEW PUERTO RICO BONDS

 

 

 

Puerto Rico borrowed $3.5 billion at 8.73% yield maturing in 2035 – funding itself through June 2015 and staving off imminent default risk with the biggest ever high-yield muni offering! As Bloomberg notes,

Hedge funds made up the majority of buyers in the tax-exempt deal, according to David Chafey, chairman of the island’s Government Development Bank.

 

Sale documents stipulate that “the bonds shall be issued in the minimum denomination of $100,000 and any integral multiple of $5,000 in excess thereof,” unless one of the three largest rating companies raise Puerto Rico to investment grade.

However, once the bonds were free to trade March 11, things changed…

Since then, they changed hands in at least 75 transactions less than $100,000, data compiled by Bloomberg show. The bonds’ highest price, 100 cents on the dollar, was for a $25,000 trade at 10:47 a.m. in New York on March 12.

This is a problem that FINRA is looking into…

Trades below the minimum amount for investors that don’t already own at least $100,000 of the debt violate the Municipal Securities Rulemaking Board’s Rule G-15 subsection F, said Martha Haines.

 

The rule Haines referenced states that brokers and dealers can’t execute a trade of a municipal security that’s below the minimum denomination of the issue, according to the MSRB’s website.

 

“These are intended for institutional purchasers, or at least for people that can afford the risk by making it a minimum denomination of $100,000,” said Haines, who teaches municipal finance at the Maurer School of Law at Indiana University in Bloomington.

A glance at the chart shows both the illiquidity in the market (huge bid-offers) and the major drop on Friday as FINRA unveiled its probe (suggesting those wanting to get rid – hoping to find greater fools – dumped them fast).

However,

Given the commonwealth’s challenges, the debt should be held by investors who are aware of the possibility of default, said Sean Carney, a municipal strategist for New York-based BlackRock Inc., the world’s largest asset manager.

 

“It’s irresponsible,” Carney said about trades below $100,000. “It’s not what the deal was meant to do — to keep the risk with those who understand it.” 

Of course, this could be merely splitting across accounts (or smal lupsizing from already $100,000 accounts) and all be a big misunderstanding… you decide which is more likely.

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

Submitted by Doug French via the Ludwig von Mises Institute of Canada,

CNBC’s Rick Santelli used his “Santelli Exchange” segment on March 14th to highlight the wisdom of Hazlitt’s Economics in One Lesson written in 1946.

The financial network’s tea party rabble rouser and sparring partner to economist Steve Liesman said, Warren Buffett had talked that morning about reading Timothy Geithner’s new book Stress Test: Reflections on Financial Crisis and the Oracle of Omaha said maybe the government saved the world back in 2008.

Santelli highlighted chapter six from Hazlitt’s great work where he wrote that if government makes loans, that private lenders won’t make, to entities that can’t pay back, economic signals get destroyed, and chaos ensues. Hazlitt also emphasized that all credit is debt.

Another Hazlitt fan, Jim Grant of Grant’s Interest Rate Observer, delivered the Henry Hazlitt Memorial Lecture in Auburn, Alabama less than a week after Santelli’s comments.  Grant said, “I can’t imagine what the world would be like without Economics In One Lesson.”

Full Jim Grant presentation below

 

The  very witty Grant spoke in a humbled tone of being asked to provide the Hazlitt lecture at the Mises Institute, comparing it to a baseball journalist being asked to speak in Cooperstown.   Grant’s hero was one of the few giants in financial journalism where, Grants said, “the pinnacle, is still at sea level.”

At the young age of 22 Hazlitt figured out the future involves too many factors for anyone to predict, not to mention just knowing what the relevant factors are. Grant admitted it took him 40 years in the business to finally realize he couldn’t understand the future.

Unfortunately the folks working at the Eccles Building have not come to this realization. The PhDs believe they can depreciate the currency at the proper rate to cause everyone gainful employment and live happily ever after.

Hazlitt was on the job during a depression that no one ever mentions—the 1920-21 downturn. Christine Romer called the episode, “a bump in the road.” Grant disagrees. While Romer may use analytics to make her case, he mentions the song that came out in 1921, “Ain’t We Got Fun.” After reciting a few lines, Grant told the audience, “They don’t write songs about recessions. It was a depression.”

Prices plunged in 1920-21, but the Fed, having just been created a few years before was “not quite out of short pants.” Lord Keynes had not written The General Theory and there were no Bernankes or Yellens running the central bank. In response to deflation, the Fed raised interest rates.

Grant looked into the camera and asked, “How did we ever recover, Dr. Krugman? I know you’re watching.”

Of course no one has heard of this depression because it was over so quickly and they certainly don’t talk about it at the Fed’s monthly meetings. The government did not enable capitalism’s losers with low rates and bailouts. Before they knew it the economy was back on track. Murray Rothbard said the only way to treat depression is with laissez faire. “This experience would seem to prove Rothbard right,” Grant said.

The financial historian and wordsmith emphasized that it was not just crops and commodities that fell in price, but also stocks. Coca-Cola traded at just 1.7 times earnings and yielded 5 percent. Radio Company of America shares traded at one times earnings. At the time, the tender new Fed was not yet in the securities boosting business as it is today, where “a higher stock market is part of public policy.”

Like Santelli, Grant mentioned 1946 and a couple of Hazlitt columns that “could have been written yesterday.”    “Economic experts see deflation as the problem,” cracked Hazlitt snidely in one piece while titling another, “The Fetish of Low Interest Rates.” He explained that lowering rates by government fiat requires more money (inflation).

Today’s investors don’t realize artificially low rates make stocks artificially high in price as future earnings are capitalized at a lower than natural discount rate to create present values. The Fed’s stomping on rates has distorted this calculus making the market “a house of mirrors.” Valuations would be much different if interest rates were “organic, free-range, and local,” instead of being nurtured in the Fed’s “hothouse.”

While Grant and his audience of hard money true believers look with disdain on the Fed’s distorting rate policy, corporate executives are all for it. Executives for Homebuilder Toll Brothers thanked their banker on a recent earnings call for arranging a loan with a two percent rate. Grant pointed out the company should give credit where credit is due and thank Janet Yellen.

Hazlitt was not a trained economist, but as Lew Rockwell writes, “he was familiar with the work of every important thinker in nearly every field. At an early age, he lacked in formal education but ended in knowing more than most learned men of any age; and he certainly was more principled than most.”

Hazlitt would, by his estimation,  write 10 millions words, mostly about economics. He was surprised when Economics in One Lesson became his signature work. “He wrote it to expose the popular fallacies of its day,” Rockwell explains. “He did not know that those fallacies would be government policy for the duration of the century.”

What Janet Yellen is doing has been done time and time again since John Law’s system created the Mississippi Bubble in 1720. It never ends well. As long as there is an over-reaching government and ever-expanding central bank, Hazlitt will be looked to for guidance and inspiration.  He warned us then. He warns us now.

 

 

 

via Zero Hedge http://ift.tt/1f3MK2p Tyler Durden