The global financial and economic crisis
John Hussman clarifies that the European bailout last week was a loan,
not a printing effort. It will be sterilized. This could have direct implications for the
global stock market, as it may continue to head lower. Stay tuned this week,
as technically a follow through to the downside is crucial for the bear case.
We could also be at risk of yet another “flash crash” due to the lack of liquidity
in the global financial system.
John P. Hussman, Ph.D.
Last week, the European Central Bank pledged to spend as much as 750 billion euros (about a trillion US dollars) in an attempt
to discourage market concerns about European debt, particularly that of Greece, Portugal and Spain. The intended message
was to show the markets – particularly bond market “vigilantes” speculating against European debt – that the ECB has deep
enough pockets to thwart the mounting pressure on European debt and the euro itself.
ECB President Jean-Claude Trichet has been quick to deny concerns that the move by the ECB will be inflationary, emphasizing
that the intervention will be “sterilized” in order to prevent a major increase in the amount of euros outstanding. This is “totally
different,” he argued last week, from the massive increase in monetary base that has occurred as the U.S. Federal Reserve has
bought up over $1.25 trillion in debt obligations of Fannie Mae and Freddie Mac. A “sterilized intervention” is one where the
euros created through the purchase of distressed Euro-area debt will also be absorbed by selling other assets from the ECB’s
balance sheet, in order to take those euros back in.
In order to evaluate the arguments being made, it’s helpful to understand the balance sheet of a typical central bank. Whether
in the U.S., Europe, or elsewhere, the basic structure is the same. On the asset side, the central bank has government debt
that it has purchased over time. A small proportion of total assets might be held in “hard” assets such as gold, but primarily,
the assets of each central bank has traditionally represented government debt – mostly of its own nation (or in the case of the
ECB, euro-area governments). As a central bank purchases these securities, it creates an equal amount of liabilities, in the
form of “monetary base” (currency and bank reserves).
Notice, for example, that the pieces of paper in your wallet have the words “Federal Reserve Note” inscribed at the top.
Currency is a liability of the Federal Reserve, against which it has traditionally held assets such as Treasury securities, and prior
to 1971, at least fractional backing in gold.
In this context, consider the ECB’s proposed 750 billion euro line of defense. Essentially the ECB is saying “We stand ready to
buy as much as 750 billion euros of distressed Euro-area debt in order to defend the euro.” Simultaneously, despite the fact
that Euro area countries are running large fiscal deficits, the worst being in Greece, Portugal and Spain, the ECB is saying
“However, we intend to sterilize this intervention, which will ultimately require that we sell Euro-area debt into the market in
order to absorb the euros we create.” The only way that both statements can be true is for the ECB to admit “Therefore, we
are fundamentally promising to debase the quality of our balance sheet, by exchanging higher quality Euro-area debt with
lower-quality debt of countries that are ultimately likely to default.”
Far from being “totally different” from what the U.S. Federal Reserve has done, the ECB is essentially promising exactly the
same thing – to corrupt its balance sheet and debase its currency in order to protect the worst stewards of capital from the
consequences of bad lending and poor investment.
Yes, computers were blamed for May, 6 market meltdown
Here is some fun video from Josh Lipton on Minyanville on this subject.
Take a look, it is hillarious!
We have warned in recent months of upside risks to UK inflation, plus the risk
that the election will produce a hung parliament which is unable to quickly
establish a credible path back to fiscal sustainability. These worries have not
been calmed by the Budget and latest inflation data. Gilts and sterling remain
vulnerable, and the MPC may feel compelled to hike rather earlier than
markets project to cap inflation expectations.
Budget Fails to Establish Path Back to Fiscal Sustainability
The Budget acknowledged that this year’s deficit will undershoot the PBR
plans by about £11bn, largely because of a revenue rebound, but failed to
tackle the UK’s medium-term fiscal outlook, which is the key issue.
The government’s fiscal forecasts remain relatively unambitious compared to
other high deficit countries. The Budget projected that the fiscal deficit will fall
to 4-4.5% of GDP in 2014/15, whereas other high deficit EU countries expect
to get their deficits to 3% of GDP or less over that timeframe (and generally
before 2014). As a result, the UK government continues to forecast a more
extended rise in the public debt/GDP ratio than other EU countries, with the
debt/GDP ratio not peaking until 2013/14 – a year later than Portugal,
Ireland and Spain, two years later than Greece and three years later than Italy.
Moreover, the UK lacks credible plans to achieve even that relatively
unambitious fiscal path. The government’s fiscal forecasts rely chiefly on a
plunge in the public spending/GDP ratio from 48% in 10/11 to 42.5% in 14/15.
But, these are just forecasts. There are no plans for either total public
spending or for spending by individual government departments beyond the
10/11 fiscal year. Without these, the fiscal forecasts lack credibility.
See the full report here.
Billionaire George Soros says the derivatives behind the Securities and Exchange
Commissions’ case against Goldman Sachs “merely cloned existing mortgage-backed
securities into imaginary units that mimicked the originals.”
“Whether or not Goldman is guilty, the transaction in question clearly had no social
benefit,” Soros writes in the Financial Times. “The primary purpose of the transaction
was to generate fees and commissions.
“This synthetic collateralized debt obligation did not finance the ownership of any
additional homes or allocate capital more efficiently; it merely swelled the volume of
mortgage-backed securities that lost value when the housing bubble burst.”
Requiring derivatives and synthetic securities to be registered would be simple and
effective, Soros says, but the legislation currently under consideration won’t
Derivatives traded on exchanges should be registered as a class, Soros says. Tailor-
made derivatives would have to be registered individually, with regulators obliged to
understand the risks involved.
“Registration is laborious and time-consuming, and would discourage the use of over-
the-counter derivatives,” Soros notes. “Tailor-made products could be put together
from exchange-traded instruments,” he says.
“This would prevent a recurrence of the abuses which contributed to the 2008 crash.”
This video from inflation.us explains the problems US is currently facing. Is this
the beginning of US currency crisis or hyperinflation? The video is rather long,
but it is a must watch.
This article from the Huffington post blames Thursday sudden
market crash on Wall Street on High Frequency Traders. It is a must read.
BERNARD CONDON | 05/15/10 12:31 PM |
NEW YORK — If you saw a penny on the sidewalk, would you pick it up?
You may think it’s not worth the effort, but a breed of investors who have been in the news do. Using super-fast computers, high-frequency traders in effect bend down to pick up pennies lying about in the stock market – then do it again, sometimes thousands of times a second.
More than a week after the Dow Jones industrial average fell nearly 1,000 points, its biggest intraday drop ever, regulators are still sifting through buy and sell orders to figure out what sparked it. One big focus are orders placed by high-frequency traders, or HFTs, and for good reason. These quick-buck firms barely existed a few years ago but now account for two-thirds of all U.S. stock trading.
In other words, all those TV pictures of the stately New York Stock Exchange building on the evening news are an illusion. The real action on Wall Street is far away in Kansas City, Mo., and in New Jersey, in towns like Carteret and Red Bank, where HFTs named Tradebot and Wolverine and Tradeworx ply their trade.
High-frequency trading firms, which number over 100, use computers programmed with complex mathematical formulas to comb markets for securities priced too high or too low because traders haven’t had to time to react to the latest data. The computers then buy or sell in a split second, locking in a profit.
Recently I have become increasingly concerned about the stability of the markets,
because US Federal reserve ended their temporary liquidity measures (the “soup”
of emergency lending facilities that emerged during the financial crisis of 2008) in
late January, while the Quantitative Easing policy (lately mostly Fed purchases of
tainted MBS securities from banks using money created out of thin air, or “digitally
printed”) ended in late March 2010.
I believe the derivative Ponzi scheme grew so large, it is now entirely dependent
on newly printed money to feed it, otherwise it will collapse under it’s own huge
weight like all Ponzi schemes do. I think this is exactly what happened 2 weeks
ago, when the DOW plunged more than 1000 points intraday. News sources claimed
it was “fat finger” effect, or someone made a few orders of magnitude mistake while
placing a sell order.
Rather, I think computers that now dominate the trading volume, engaged in
indiscriminate selling and there were no bids under the market simply because
the new Fed liquidity, or printing, evaporated as of mid-April, when the last contracts
settled. Thus, the derivative bubble, which has already popped in 2008, ran completely
out of oxygen.
If this hypothesis is right and while the SEC and others try to figure out the reason
behind Thursday stock market meltdown, we may see more crashes shortly unless
Quantitative easing (money printing) resumes. Sovereign issues in Southern
Europe were blamed for the mess, and the market bounced on Monday following
the a huge European bailout. However, the bailout is a loan, not a printing effort.
Moreover, the loan money will not be injected overnight. Therefore, the danger of
more market mini-crashes or a big one due to derivatives and computers
malfunctioning from the lack of oxygen was not removed.
Stay tuned for May options expiration week, we may see a market meltdown!
See this earlier post for an explanation.
Deterioration of sovereign debt in Southern Europe has recently become
the key concern of financial markets.
Dr. Doom Nouriel Roubini predicted that this will become a concern in 2010.
He explains the problem in this Forbes article:
Nouriel Roubini and Arpitha Bykere
In 2009, downgrades and debt auction failures in countries like the UK, Greece, Ireland and Spain were a stark reminder that
unless advanced economies begin to put their fiscal houses in order, investors and rating agencies will likely turn from friends to
foes. The severe recession, combined with a financial crisis during 2008-09, worsened the fiscal positions of developed
countries due to stimulus spending, lower tax revenues and support to the financial sector. The impact was greater in countries
that had a history of structural fiscal problems, maintained loose fiscal policies and ignored fiscal reforms during the boom
years. Going forward, a weak economic recovery and an aging population is likely to increase the debt burden of many
advanced economies, including the U.S., Britain, Japan and several eurozone countries.
In 2008 and 2009, the decisions by these governments to do “whatever it takes” to backstop their financial systems and keep
their economies afloat soothed investor concerns. But if countries remain biased toward continuing with loose fiscal and
monetary policies to support growth, rather than focusing on fiscal consolidation, investors will become increasingly concerned
about fiscal sustainability and gradually move out of debt markets they have long considered “safe havens.”
Most central banks will withdraw liquidity starting in 2010, but government financing needs will remain high thereafter.
Monetization and increased debt issuances by governments in the developed world will raise inflation expectations. These
governments will have to offer higher real yields or investors will move to more attractive emerging markets. Some countries will
continue to witness increased credit default swaps. Higher yields and interest cost on debt will also hurt economic growth—by
crowding out private consumption and investment, and reducing government’s productive spending. Several factors will likely
influence investors’ perception about sovereign risk—a country’s debt financing ability, its status as a “safe haven” relative to
other developed economies, politicians’ commitment to undertake fiscal reforms, exchange rate movements, and the debt
The UK, Spain, Greece and Ireland will face sovereign risk pressures, especially if their fiscal imbalances are not addressed
immediately. Some eurozone members are quickly approaching their debt sustainability limits as deleveraging through
devaluation is not an option for these countries. Countries like Germany—whose fiscal imbalances have deteriorated largely due
to the economic and financial downturn—might have a greater capacity to stabilize their debt ratio. The U.S. and Japan might
be among the last to face investor aversion—the dollar is the global reserve currency and the U.S. has the deepest and most
liquid debt markets, while Japan is a net creditor and largely finances its debt domestically. But investors will turn increasingly
cautious even about these countries if the necessary fiscal reforms are delayed. The U.S. is a net debtor with an aging
population, weaker economic growth and risks of continued monetization of the fiscal deficit. Japan’s aging population and
economic stagnation will reduce domestic savings.
Developed economies will therefore need to begin fiscal consolidation as soon as 2011-12 by generating primary surpluses,
which can be accomplished through a combination of gradual tax hikes and spending cuts. However, an aging population, a
sluggish economic recovery and higher unemployment will keep governments’ entitlement spending high and revenues subdued.
These factors might also make tax hikes politically challenging. Fiscal consolidation efforts might not be strong until the bond
vigilantes signal shifting to safer assets. To achieve credibility, governments will need to pass binding legislation enforcing
tighter fiscal belts when their economies begin to recover on a sustained basis.
Nouriel Roubini, a professor at the Stern Business School at New York University and chairman of Roubini Global Economics
(RGE), is a weekly columnist for Forbes. (Read all of his columns here.) Arpitha Bykere is a Senior Research Analyst at RGE.
Sovereign defaults present serious risk for the stock market. Overall, stocks in
affected countries decline considerably, and the desease infects the rest of the
Globe. Here is a recent example, the currency crash in Iceland. While US is
much bigger, the problems in the US, the UK, and Southern Europe are all similar.
2008 proved that TBTF (too big to fail) do fail!
Be careful and prepared
While this web site was originally devoted to unhealthy imbalances
in the United States, these are currently present all over the globe.
As we have seen lately, as sovereign debt issues surfaced in Greece,
CDS market rapidly started pricing sovereign risk higher in other PIIGS
(Portugal, Italy, Ireland, Greece, Spain), the UK, Germany, and the US.
These imbalances in an isolated country normally occur after a financial
crisis, when the government attempts a Keynesian approach to fight
the crisis. If the fight is unsuccessful, the government assumes too
much debt, while the economy does not recover, a currency crisis
will follow (Argentina 2002, East Asia 1997, Russia 1998, Iceland 2008,
The financial crisis of 2008 was global in nature, and the Economist
has a wonderful discussion of what might follow if the global economy
does not recover due to too much debt. I believe this is coming –
perhaps, later in 2010 or in 2011, as a consequence of the global
financial crisis of 2008.
Sovereign-debt worries – the Economist.
Assessing the risk that Greece’s woes herald something far worse
HOW far is it from Athens to America and which
countries lie on the way? That may sound like an esoteric geography
question, but it is being asked by investors as Greece’s debt crisis
creates global jitters about the safety of sovereign debt. So far
Portugal, Ireland and Spain, the other high-deficit countries on the
periphery of the euro zone, are thought to be next in line. In most big
rich economies, yields have been stable and well below their long-term
average (see chart).
But nerves are fraying elsewhere. The cost of insuring against
sovereign default (see article) has risen in 47 of the 50 countries for
which these instruments exist. Dubai’s sovereign credit-default-swap
spreads soared to their highest level in a year this week, amid concern
about the terms of a debt restructuring by a state-owned
conglomerate. There is increasingly shrill commentary arguing that
Greece is the start of a far bigger problem. “A Greek crisis is coming to
America”, blared the headline on a recent Financial Times article by
Niall Ferguson, a financial historian.
The stakes are high. A sudden loss of confidence in all sovereign debt,
and especially in American Treasuries, the world’s benchmark “risk-free”
asset, would have calamitous consequences in a still-fragile recovery.
Equally, an exaggerated fear of sovereign risk could prompt
governments into premature fiscal austerity, which might itself push
the world economy back into recession…..