GlobalIntelHub2

Can the Stock Market Get Any Better Than This? Korean Black Swan?

What in the world is going on?! As I write this letter from the Maine woods, the S&P 500 has just cleared 1,700 for the first time. The German DAX continues to set all-time highs above 8,400. The United Kingdom’s FTSE 100 is quickly approaching its 1999 record high of 6,930, and its mid-cap cousin, the FTSE 250, just broke through to its all-time level above 15,000. And last but not least, Japan’s Nikkei 225 is extending its gains once more, toward 14,500. This weekend I am sitting around with some of the smartest economic and trading minds in the country. At Leen’s Lodge, where we’re fishing and eating where our phones don’t work, the question on our minds is, how long can this run go on? The debates can get intense in a room full of strong opinions.
So, with a little help, I did some research on what our forward-looking prospects are for the markets. Let me take this opportunity to introduce a new name to readers, one that will become familiar over the next few years. I have gotten to know Worth Wray, a young economist (though I should say that, as I stare 64 in the face, a lot of people are looking young these days) who has really impressed me with the breadth of his knowledge and insights. He was the former portfolio strategist for my good friends at Salient down in Houston, and they were kind enough to let me entice him to come to Dallas to work with me. This is a big move for both of us, and I am finding that it’s one I should have undertaken a long time ago. Worth is really going to help me expand my abilities to do research and present my thoughts to you. I asked him a few questions, and he helped me tee up this week’s letter. Plus, we’ll look across the Pacific, and I’ll share some though ts I’ve had about an interesting black swan that could be developing in the Korean Peninsula. Let’s get started!

Can It Get Any Better Than This?

To many investors, developed markets appear healthier and stronger than they have in years. Major equity markets are rallying to record highs; corporate credit spreads are tight versus US Treasuries and getting tighter; and broad measures of volatility continue to fall to their lowest levels since 2007.
This kind of news would normally point to prosperity across the real economy and call for a celebration – but prices do not always reflect reality. Moreover, the combination of high and rising valuations, low volatility, and a weakening trend in real earnings growth is a proven recipe for poor long-term returns and market instability.
Let’s take the S&P 500 as an example. It returned roughly 42% from September 1, 2011, through August 1, 2013, as the VIX Index fell to its lowest levels since the global financial crisis. Over that time frame, real earnings declined slightly (down about 2% through Q1 2013 earnings season), while the trailing 12-month price-to-earnings (P/E) ratio jumped 44%, from 13.5x to 19.5x. That means the majority of the recent gains in US equity markets were driven by multiple expansion in spite of negative real earnings growth. This is a clear sign that sentiment, rather than fundamentals, is driving the markets higher.
Of course, the simple trailing 12-month P/E ratio can be misleading at critical turning points if you are trying to handicap the potential for long-term returns. For example, the collapse in real earnings during the global financial crisis sent the S&P 500’s trailing P/E multiple through the roof by March 2009. So, while trailing P/E is a useful tool for understanding what has already happened in the market, the “Shiller P/E” is far more useful for calculating a reasonable range of expected returns going forward. This approach won’t help you much with short-term market timing, but current valuations have historically proven extremely useful in forecasting long-term returns. In his book Irrational Exuberance (2005), Robert Shiller of Yale University shows how this approach “confirms that long-term investors – investors who commit their money to an investment for ten full years – did do well when prices were low rel ative to earnings at the beginning of the ten years. Long-term investors would be well-advised, individually, to lower their exposure to the stock market when it is high … and to get into the market when it is low.”
As you can see in Figure 6, compared to the more common trailing 12-month P/E ratio in Figure 5, the Shiller P/E metric essentially smooths out the series and helps us avoid false signals by dividing the market’s current price by the average inflation-adjusted earnings of the past ten years. Historically, this range has peaked and given way to major market declines at around 29x on average (or 26x excluding the dot-com bubble), and it has bottomed in the mid-single digits. Not only does today’s Shiller P/E of 24x suggest a seriously overvalued market, but the rapid multiple expansion of the last two years in the absence of earnings growth suggests that this market is also seriously overbought.
John Hussman helps us keep current valuations in historical perspective:
The Shiller P/E is now 24.4, about the same level as August 1929, higher than December 1972, higher than August 1987, but less extreme than the level of 43 that was reached in March 2000 (a level that has been followed by more than 13 years of market returns within a fraction of a percent of the return on Treasury bills – and even then only by revisiting significantly overvalued levels today). The Shiller P/E is presently moderately below the level of 27 at the October 2007 market peak. It’s worth noting that the 2000-2001 recession is already out of the Shiller calculation. Moreover, looking closely at the data, the implied profit margin embedded in today’s Shiller P/E is 6.3%, compared with a historical average of only about 5.3%. At normal profit margins, the current Shiller P/E would be 29.
While it may be impossible to accurately predict when this policy-driven market will break, history suggests it would be very reasonable for the secular bear to eventually bottom at a P/E multiple between 5x and 10x, opening up one of the rare wealth-creation opportunities to deploy capital at truly cheap prices. Some of these technical details are rather dry, but I hope you’ll focus on the main idea: We are not talking about the potential for a modest 20% to 30% drawdown in the S&P 500. If history is any indication, we are talking about the potential for a 50%+ peak-to-trough drawdown and ten-year average annual returns as bad as -4.4%, according to the chart above from Cliff Asness at AQR. Such a result would fall in line with somewhat similar deleveraging periods such as the United States experienced in the 1930s and Japan has experienced since 1989. There is no way to sugarcoat it: too much equity risk can be unproductive and even destructive in this kind of economic environment.
But where there is danger, there is also opportunity. This is a terrific time to take some profits and diversify away from the growth-oriented risk factors that dominate most investors’ portfolios. Instead of concentrating risk in one asset class or one country, investors can boost returns and achieve more balance by taking a global view, by broadening the mix of core asset classes, and by weighting those return streams to achieve balance across potential economic outcomes (rather than trying to predict the future). Since equities and credit are essentially a directional bet on positive economic growth and benign inflation, you have a lot to gain from diversifying into other core market risks: commodities, which thrive when inflation, or more specifically expected inflation, is rising; and nominal safe-haven government bonds, which thrive as inflation gives way to deflation and the oth er assets typically decline. While each group of asset classes responds to economic conditions differently and exhibits low correlations to the others, each of them tends to offer similar risk-adjusted returns over long periods of time, thus warranting constant inclusion in any core portfolio.
It also makes sense to embrace truly diversifying alternative strategies that are either less correlated or negatively correlated. When valuations are expensive across the board, momentum-based strategies like managed futures can be a fantastic addition to a portfolio. Aside from government bonds, momentum is the only easily accessible strategy that tends to become more negatively correlated with broader markets during times of extreme stress and tends to deliver outsized returns when your other investments are losing money.
Of course, combining the asset classes into one portfolio is the hard part, but research going back to the early 1970s suggests that broadening this mix of core assets – so that you have some element of your portfolio that responds positively to every potential economic season – and managing the relative allocations to each economic scenario may be your biggest opportunity to add value in the investing process.  
You have a lot to gain from diversifying as broadly as possible, eliminating unrewarded costs, reducing your reliance on equity risk, and reining in the emotional mistakes that often lead investors to dramatically underperform. Remember, in a world characterized by deleveraging, changing demographics in aging populations, financial repression, and increasingly experimental monetary policy, every basis point counts and anything can happen.
With that, let’s end our discussion with a few words of advice from the world’s largest and arguably most successful hedge fund manager, Ray Dalio:
What I’m trying to say is that for the average investor, what I would encourage them to do is to understand that there’s inflation and growth. It can go higher and lower and to have four different portfolios essentially that make up your entire portfolio that gets you balanced.  Because in every generation, there is some period of time, there’s a ruinous asset class, that will destroy wealth and you don’t know which one that will be in your life time. So the best thing you can do is have a portfolio that is immune, that is well diversified.  That is what we call an all-weather portfolio.  That means you don’t have a concentration in that asset class that’s going to annihilate you and you don’t know which one it is.

A Korean Black Swan?

Last week I was in Newport, Rhode Island, at the Naval War College, where I participated in a summer study group focused on possible futures and how they might affect the strategy of the US Defense Department. The discussions were wide-ranging and mind-expanding, at least for me. As readers know, I believe that Japan has begun a long-term process of continually devaluing its currency. For reasons I have written about at length in previous letters, I think the yen could go to 200 to the dollar in the next five years. I don’t see a precipitous move, simply a steady erosion as Japan tries to bring back inflation and export its deflation.
While the yen at its current valuation is not a particular problem for the rest of the world, when it hits 120 we will start to see raised eyebrows and political speeches from the countries most affected. At 140 we could start to see serious reactions.
One of the countries that I think is put into a most difficult situation is South Korea. Their options for responding to a weakening yen are quite limited. If they respond by printing more of their own currency, they are likely to engender a debilitating inflation, which is of course not a good thing. Protectionism will have little real effect vis-à-vis Japan. Remember that the Japanese yen was 357 to the dollar about 40 years ago. The Japanese watched their currency rise by almost 400% in the decades since. The only real response available to them was to simply become more competitive and more productive as their currency got stronger, and to their great credit they did.
Honing their competitive edge may also be the only real option for South Korea. But it is not an easy one, of course, and you will hear lots of complaints from Korean politicians and businessmen. Not an easy environment, to be sure.
Now let’s shift our focus to North Korea. Everyone (including your humble analyst) is worried about the isolationist regime in North Korea having access to nuclear weapons and the ability to deliver them on missiles. But a few conversations I had this past week led me to think there is another scenario we should consider.
A side conversation at the study group began with an observation by a senior officer about the ability of the North Korean military to actually project power. As this information is nothing more than what you can find in the newspapers, I feel comfortable discussing it here. Everyone knows that North Koreans have been malnourished for multiple decades. Studies suggest that North Koreans may be up to three inches shorter than South Koreans and have diminished IQs because of malnourishment as children. The latter is a known effect on human beings anywhere who are subjected to a starvation diet. The North Korean population has suffered from severe diet restriction for decades.
How capable is the North Korean military of actually mounting an offensive when their soldiers are simply not physically able to withstand the pressures of combat? I was also able last week to visit with one of the great geopolitical strategists of our time, Professor Ian Bremmer of Columbia, who is the president and founder of Eurasia Group, with some 100 geopolitical analysts working for him. I shared with him my concerns about the Korean peninsula. He immediately said that he was more worried about the Korean peninsula than any other part of the world, including the Middle East. One of the interesting things that he shared is that an increasing number of cell phones are being smuggled into North Korea from China and that the North Koreans are beginning to get the real story about the world rather than just the propaganda fed to them by their government.
While there is little ability for the North Korean population to actually stage a revolution, as they do not have the weapons and hungry people really have difficulty mounting military operations, there is the possibility of the country becoming increasingly difficult to manage. Combine that with the potential for a disastrous food-production year, and the potential for the collapse of the government is not all that far-fetched.
There were not many people forecasting the collapse of the USSR in 1987. Yet as we look back, the confluence of causes that resulted in its collapse seems rather obvious. Probably, the current dictatorship will maintain its stranglehold on North Korea. That is the tendency with repression and tyranny – witness Cuba and any number of other countries. But one cannot dismiss the possibility of a collapse of the North Korean state.
If that were to happen it would be a humanitarian disaster. In the long run it might be better for the North Korean people, but in the short run it would be catastrophic. It is not unreasonable to expect that South Korea would have to do the bulk of the heavy lifting, especially after the first year or so. And should the world no longer have to focus on the ability of North Korea to create mischief with nuclear weapons, North Korea could soon become page 16 news.
No matter how positively you would want to view Korean unification, the process would be enormously expensive for South Korea. Assimilating a population long challenged by hardship into a new reality, not to mention incorporating it into a modern economic model, is a daunting challenge. I think the task would be more difficult and more expensive on a per-capita basis than the unification of Germany.
And this could happen while the attention of South Korea is focused on dealing with the devaluation of the yen and the need to become progressively more competitive to maintain its export and business model. There is also the possibility of massive refugee movements into China. That is a significantly different issue than worrying about a million-man army crossing the DMZ into South Korea.
I’m not saying this will happen, but it is a possibility we need to keep an eye on.
Continue Reading
GlobalIntelHub2

Dallas Fed’s Fisher: “We Own A Significant Slice Of Critical Markets. This Is Something Of A Gordian Knot”

From “Horseshift! (With Reference to Gordian Knots [15])” – the prepared remarks by the Dallas Fed’s Dick Fisher released moments ago, in which the Fed president with GLD holdings, gets folksy with the Fed’s balance sheet.

Years of Extraordinary Measures

For six of my eight years at the Fed, we have been working to bring the nation’s economy out of recession. The fiscal authorities have for the most part been AWOL during this time, having left the parking brake on during their absence. This has placed the onus on the Bernanke-led Federal Reserve. We have undertaken extraordinary measures, first to get the economy out of the emergency room after the financial system seizure of 2008-09, and more recently, to goose up the private sector to expand payrolls. Toward this end, the Fed cut interest rates to their lowest levels in the nation’s 237-year history by initially cutting the base rate for overnight interbank lending—the “fed funds rate”—to near zero, and then by purchasing massive amounts of U.S. Treasuries and bonds issued or backed by U.S. government agencies (obligations of Fannie Mae, Freddie Mac and Sally Mae, and mortgage-backed securities).
This later program is referred to as quantitative easing, or QE, by the public and as large-scale asset purchases, or LSAPs, internally at the Fed. As a result of LSAPs conducted over three stages of QE, the Fed’s System Open Market Account now holds $2 trillion of Treasury securities and $1.3 trillion of agency and mortgage-backed securities (MBS). Since last fall, when we initiated the third stage of QE, we have regularly been purchasing $45 billion a month of Treasuries and $40 billion a month in MBS, meanwhile reinvesting the proceeds from the paydowns of our mortgage-based investments. The result is that our balance sheet has ballooned to more than $3.5 trillion. That’s $3.5 trillion, or $11,300 for every man, woman and child residing in the United States.
The theoretical mechanics behind QE are straightforward: When the Fed buys Treasuries and MBS, it pays for them, putting money into the economy. A key intent of this unprecedented program was to drive down interest rates to such a degree that businesses would achieve a financial comfort level that would induce them to put back to work the millions of Americans that were laid off in the Great Recession. Thus far, only 76 percent of the jobs lost during 2008-09 have been clawed back in the more than three and a half years of modest to moderate payroll gains. This 76 percent figure does not include the 3 million or so jobs that would normally be created to absorb growth in the working-age population.
The Challenge of Untying the Monetary Gordian Knot
The challenge now facing the FOMC is that of deciding when to begin dialing back (or as the financial press is fond of reporting: “tapering”) the amount of additional security purchases. In his press conference following our June FOMC meeting, speaking on behalf of the Committee, Chairman Bernanke made clear the parameters for dialing back and eventually ending the QE program. Should the economy continue to improve along the lines then envisioned by Committee, the market could anticipate our slowing the rate of purchases later this year, with an eye toward curtailing new purchases as the unemployment rate broaches 7 percent and prospects for solid job gains remain promising.
Kindly note that this does not mean that the Committee would envision raising the shorter term fed funds rate simultaneously; indeed, the Committee has said it expects this pivotal rate to remain between 0 and ¼ percent at least as long as the unemployment rate remains above 6.5 percent, intermediate prospects for inflation are reasonable, and longer-term inflationary expectations remain well anchored.
Having stated this quite clearly, and with the unemployment rate having come down to 7.4 percent, I would say that the Committee is now closer to execution mode, pondering the right time to begin reducing its purchases, assuming there is no intervening reversal in economic momentum in coming months.
This is a delicate moment. The Fed has created a monetary Gordian Knot. You can see the developing complexity of that knot in this sequence of slides tracing the change in our portfolio structure with each phase of QE.
Whereas before, our portfolio consisted primarily of instantly tradable short-term Treasury paper, now we hold almost none; our portfolio consists primarily of longer-term Treasuries and MBS. Without delving into the various details and adjustments that could be made (such as considerations of assets readily available for purchase by the Fed), we now hold roughly 20 percent of the stock and continue to buy more than 25 percent of the gross issuance of Treasury notes and bonds. Further, we hold more than 25 percent of MBS outstanding and continue to take down more than 30 percent of gross new MBS issuance. Also, our current rate of MBS purchases far outpaces the net monthly supply of MBS.
The point is: We own a significant slice of these critical markets. This is, indeed, something of a Gordian Knot.
Those of you familiar with the Gordian legend know there were two versions to it: One holds that Alexander the Great simply dispatched with the problem by slicing the intractable knot in half with his sword; the other posits that Alexander pulled the knot out of its pole pin, exposed the two ends of the cord and proceeded to untie it. According to the myth, the oracles then divined that he would go on to conquer the world.
There is no Alexander to simply slice the complex knot that we have created with our rounds of QE. Instead, when the right time comes, we must carefully remove the program’s pole pin and gingerly unwind it so as not to prompt market havoc. For starters though, we need to stop building upon the knot. For this reason, I have advocated that we socialize the idea of the inevitability of our dialing back and eventually ending our LSAPs. In June, I argued for the Chairman to signal this possibility at his last press conference and at last week’s meeting suggested that we should gird our loins to make our first move this fall. We shall see if that recommendation obtains with the majority of the Committee.

Horseshift!

We needn’t be condemned to the glue factory. As I said, American companies publicly held and private—large, medium and small—have taken advantage of the cheap and abundant money made available by the Fed’s hyper-accommodative monetary policy to create lean and muscular balance sheets. In response to the deep recession and the challenges of fiscal and regulatory uncertainty, they have rationalized their cost structures and ramped up productivity, leveraging IT, just-in-time inventory management and new production structures to the max. I believe American businesses today are, far and away, the most efficient operators in the world. We have countless businesses in every sector of goods and service production that are the equivalents of the Secretariats, Man o’ Wars, Citations, Seabiscuits or any great thoroughbred that has ever graced the track. They just need to be let out of the starting gate.
That gate is controlled by Congress, working with the president. If they would just let ’em rip, we would have an economy that would soar. We would experience what, tongue firmly but confidently in cheek, I would call “horseshift”: from being the stuff of an economic glue factory to becoming the wonder-horse that would outpace the rest of the world, putting the American people back to work and renewing the wonder of American prosperity. If you and your fellow citizens from whatever state you hail from insist upon it, it will be done.

But why “let them rip” when Congress and the president can continue the charade, and pretend they are doing their political roles of sticking to their ideologies (i.e., no consensus on anything) when at the end of the day it is the Fed whose all enabling monetary policy provides the necessary impetus to keep the economy if not growing, then at least keep it from imploding (for now) even if it means record daily S&P highs and unseen splintering between America’s uber rich and everyone else.
In other words good luck with all that…. folksy or not.
Continue Reading
GlobalIntelHub2

‘Havoc’ as HSBC prepares to close diplomatic accounts

HSBC bank has reportedly asked more than 40 diplomatic missions to close their accounts as part of a programme to reduce business risks.
The Vatican’s ambassadorial office in Britain, the Apostolic Nunciature, is among those said to be affected.
The head of the UK’s Consular Corps told the Mail on Sunday the decision has created “havoc”.
The Foreign Office has been in touch with HSBC, stepping in to help diplomats open other bank accounts.
HSBC said embassies were subject to the same assessments as its other business customers. They need to satisfy five criteria – international connectivity, economic development, profitability, cost efficiency and liquidity.
A spokesman said: “HSBC has been applying a rolling programme of “five filter” assessments to all its businesses since May 2011, and our services for embassies are no exception.
“We do not comment on individual customer relationships.”
The Mail on Sunday reported that the High Commission of Papua New Guinea and the Honorary Consulate of Benin have also been asked to move their accounts within 60 days.
Bernard Silver, head of the Consular Corps, which represents consuls in the UK, told the paper: “HSBC’s decision has created havoc.
“Embassies and consulates desperately need a bank, not just to take in money for visas and passports but to pay staff wages, rent bills, even the congestion charge.”
John Belavu, minister at the Papua New Guinea High Commission, said: “We’ve been banking with HSBC for 22 years and for them to throw us off in this way was a bombshell.”
Lawrence Landau, honorary consul of Benin, told the paper his mission had been having trouble finding a new bank.
He said: “We have been trying everyone but all the UK banks are clamming up.”

Suspicious accounts

Embassies are treated like business customers by banks as they generally use services like cash and payroll management and can take out loans.
They also have to pay for ambassadorial accommodation and costs such as school fees for the children of diplomats – expenses that are difficult to meet without a valid UK bank account.
They are sometimes considered to be at risk of money laundering activities because of their political exposure and banks have been warned in the past for failing to flag up suspicious accounts.
The Riggs National Bank in Washington was fined and later sold off after a 2004 US Senate report revealed executives in its embassy business had helped Chilean dictator Augusto Pinochet hide millions of dollars.
HSBC was fined $1.92bn (£1.26bn) by US authorities last year after it was blamed for alleged money laundering activities said to have been conducted through its Latin American operations by drug cartels.
The bank admitted at the time that it had failed to effectively counter money laundering.
Continue Reading
GlobalIntelHub2

The Snowden Time-Bomb

Authored by Harold James, originally posted at Project Syndicate,
In the aftermath of the global financial crisis, world leaders repeated a soothing mantra. There could be no repeat of the Great Depression, not only because monetary policy was much better (it was), but also because international cooperation was better institutionalized. And yet one man, the American former intelligence contractor Edward Snowden, has shown how far removed from reality that claim remains.
Prolonged periods of strain tend to weaken the fabric of institutional cooperation. The two institutions that seemed most dynamic and effective in 2008-2009 were the International Monetary Fund and the G-20; the credibility of both has been steadily eroded over the long course of the crisis.
Because the major industrial economies seem to be on the path to recovery – albeit a feeble one – no one seems to care very much that the mechanisms of cooperation are worn out. They should. There are likely to be many more financial fires in various locations, and the world needs a fire brigade to put them out.
The IMF’s resources were extended in 2009, and the organization was supposed to be reformed in order to give emerging markets more voice. But little progress has been made.
The Fund was the centerpiece of the post-1945 global economic system. It subsequently played a central role in the management of the 1980’s debt crisis and in the post-communist economic transition after 1989. But every major international crisis since then has chipped away at its authority. The 1997-1998 Asian financial crisis undermined its legitimacy in Asia, as many governments in the region believed that the crisis was being exploited by the United States and US financial institutions.
The post-2007 Great Recession discredited the IMF further for three reasons. First, the initial phase of the crisis looked like an American phenomenon. Second, the IMF’s heavy involvement in the prolonged euro crisis looked like preferential treatment of Europe and Europeans. In particular, the demand that, because the world was focused on Europe, another European (and another French national) should succeed the IMF’s then-managing director, Dominique Strauss-Kahn, was incomprehensible to the large emerging-market countries. Eventually, as in the Asian crisis, European governments and the European Commission fell out with the Fund and began to blame its analysis for having confused and unsettled markets.
On the big issues underlying the global financial crisis – the problem of current-account imbalances and deciding which countries should adjust, and reconciling financial reform with a pro-growth agenda – the IMF cannot say much more, or say it more effectively, than it could before the crisis.
The G-20 was the great winner of the financial crisis. The older summits (the G-7 or, with the addition of Russia, the G-8), as well as the G-7 finance ministers’ meetings, were no longer legitimate. They consisted of countries that had actually caused the problems; they were dominated by the US; and they suffered from heavy over-representation of mid-sized European countries.
The G-20, by contrast, brought in the big emerging markets, and its initial promise was to provide a way to control and direct the IMF. The new mood of global economic regime change was captured in the official photograph that was widely used in coverage of the most successful of the G-20 summits, held in London in April 2009.
In the short term, the London summit mitigated financial contagion emanating from southern Europe; gave the World Bank additional resources to deal with the problem of trade finance for emerging-market exports; appeared to give the IMF more firepower and legitimacy; and seemed to catalyze coordinated fiscal stimulus to restore confidence.
But only the more technical of these four achievements – the first two – stood the test of time. Everything else that was agreed at the London summit turned sour. The follow-up summits were lame. The idea of coordinated fiscal stimulus became problematic when it became obvious that many European governments could not take on more debt without unsettling markets and pushing themselves into an unsustainable cycle of increasingly expensive borrowing.
And yet, however limited the London summit’s achievements proved to be, the summit process itself was not fully discredited until Snowden’s intelligence revelations. It may be that leaders and their staffs were naive in believing that their communications were really secure. But Snowden’s revelations that the London summit’s British hosts allegedly monitored the participants’ communications make it difficult to imagine that the genuine intimacy of earlier summits can ever be recreated. And, with the espionage apparently directed mostly at representatives of emerging economies, the gulf between the advanced countries and those on the rise has widened further.
World leaders appear partly ignorant and partly deceptive in responding to the allegations. They are probably right to emphasize how little they really know about surveillance. It is in the nature of complex data-gathering programs that no one really has an overview.
But the lack of transparency surrounding data surveillance and mining means that, when a whistleblower leaks information, everyone can subsequently use it to build their own version of how and why policy is made. The revelations thus encourage wild conspiracy theories.
The substantive aftermath of the London summit has already caused widespread disenchantment with the G-20 process.The Snowden affair has blown up any illusion about trust between leaders – and also about leaders’ competence.By granting Snowden asylum for one year, Russian President Vladimir Putin, will have the bomber in his midst when he hosts this year’s summit in Saint Petersburg.
Continue Reading
GlobalIntelHub2

The Most Important Number In The Entire U.S. Economy

Submitted by Michael Snyder of The Economic Collapse blog [18],
There is one vitally important number that everyone needs to be watching right now, and it doesn’t have anything to do with unemployment, inflation or housing.  If this number gets too high, it will collapse the entire U.S. financial system.  The number that I am talking about is the yield on 10 year U.S. Treasuries.
When that number goes up, long-term interest rates all across the financial system start increasing.  When long-term interest rates rise, it becomes more expensive for the federal government to borrow money, it becomes more expensive for state and local governments to borrow money, existing bonds lose value and bond investors lose a lot of money, mortgage rates go up and monthly payments on new mortgages rise, and interest rates throughout the entire economy go up and this causes economic activity to slow down. 
On top of everything else, there are more than 440 trillion dollars worth of interest rate derivatives sitting out there, and rapidly rising interest rates could cause that gigantic time bomb to go off and implode our entire financial system.  We are living in the midst of the greatest debt bubble in the history of the world [19], and the only way that the game can continue is for interest rates to stay super low.  Unfortunately, the yield on 10 year U.S. Treasuries has started to rise, and many experts are projecting that it is going to continue to rise.
On August 2nd of last year, the yield on 10 year U.S. Treasuries was just 1.48%, and our entire debt-based economy was basking in the glow of ultra-low interest rates.  But now things are rapidly changing.  On Wednesday, the yield on 10 year U.S. Treasuries hit 2.70% before falling back to 2.58% on “good news” from the Federal Reserve.
Historically speaking, rates are still super low, but what is alarming is that it looks like we hit a “bottom” last year and that interest rates are only going to go up from here.  In fact, according to CNBC [20] many experts believe that we will soon be pushing up toward the 3 percent mark…

Round numbers like 1,700 on the S&P 500 are well and good, but savvy traders have their minds on another integer: 2.75 percent

That was the high for the 10-year yield this year, and traders say yields are bound to go back to that level. The one overhanging question is how stocks will react when they see that number.

“If we start to push up to new highs on the 10-year yield so that’s the 2.75 level—I think you’d probably see a bit of anxiety creep back into the marketplace,” Bank of America Merrill Lynch’s head of global technical strategy, MacNeil Curry, told “Futures Now” on Tuesday.

And Curry sees yields getting back to that level in the short term, and then some. “In the next couple of weeks to two months or so I think we’ve got a push coming up to the 2.85, 2.95 zone,” he said.

This rise in interest rates has been expected for a very long time – it is just that nobody knew exactly when it would happen.  Now that it has begun, nobody is quite sure how high interest rates will eventually go.  For some very interesting technical analysis, I encourage everyone to check out an article by Peter Brandt that you can find right here [21].
And all of this is very bad news for stocks.  The chart below was created by Chartist Friend from Pittsburgh [22], and it shows that stock prices have generally risen as the yield on 10 year U.S. Treasuries has steadily declined over the past 30 years…
CFPGH-DJIA-20 [23]
When interest rates go down, that spurs economic activity, and that is good for stock prices.
So when interest rates start going up rapidly, that is not a good thing for the stock market at all.
The Federal Reserve [24] has tried to keep long-term interest rates down by wildly printing money and buying bonds, and even the suggestion that the Fed may eventually “taper” quantitative easing caused the yield on 10 year U.S. Treasuries to absolutely soar a few weeks ago.
So the Fed has backed off on the “taper” talk for now, but what happens if the yield on 10 year U.S. Treasuries continues to rise even with the wild money printing that the Fed has been doing?
At that point, the Fed would begin to totally lose control over the situation.  And if that happens, Bill Fleckenstein told King World News [25] the other day that he believes that we could see the stock market suddenly plunge by 25 percent…

Let’s say Ben (Bernanke) comes out tomorrow and says, ‘We are not going to taper.’ But let’s just say the bond market trades down anyway, and the next thing you know we go through the recent highs and a month from now the 10-Year is at 3%. And people start to realize they are not even tapering and the bond market is backed up…

They will say, ‘Why is this happening?’ Then they may realize the bond market is discounting the inflation we already have.

At some point the bond markets are going to say, ‘We are not comfortable with these policies.’ Obviously you can’t print money forever or no emerging country would ever have gone broke. So the bond market starts to back up and the economy gets worse than it is now because rates are rising. So the Fed says, ‘We can’t have this,’ and they decide to print more (money) and the bond market backs up (even more).

All of the sudden it becomes clear that money printing not only isn’t the solution, but it’s the problem. Well, with rates going from where they are to 3%+ on the 10-Year, one of these days the S&P futures are going to get destroyed. And if the computers ever get loose on the downside the market could break 25% in three days.

And as I have written about previously [26], we have seen a huge spike in margin debt in recent months, and this could make it even easier for a stock market collapse to happen.  A recent note from Deutsche Bank explained precisely why margin debt is so dangerous [27]

Margin debt can be described as a tool used by stock speculators to borrow money from brokerages to buy more stock than they could otherwise afford on their own. These loans are collateralized by stock holdings, so when the market goes south, investors are either required to inject more cash/assets or become forced to sell immediately to pay off their loans – sometimes leading to mass pullouts or crashes.

But of much greater concern than a stock market crash is the 441 trillion dollar interest rate derivatives bubble [28] that could implode if interest rates continue to rise rapidly.
Deutsche Bank is the largest bank in Europe, and at this point they have 55.6 trillion euros [29] of total exposure to derivatives.
But the GDP of the entire nation of Germany is only about 2.7 trillion euros for a whole year.
We are facing a similar situation in the United States.  Our GDP for 2013 will be somewhere between 15 and 16 trillion dollars, but many of our big banks have exposure to derivatives that absolutely dwarfs our GDP.  The following numbers come from one of my previous articles entitled “The Coming Derivatives Panic That Will Destroy Global Financial Markets[30]“…

JPMorgan Chase
Total Assets: $1,812,837,000,000 (just over 1.8 trillion dollars)
Total Exposure To Derivatives: $69,238,349,000,000 (more than 69 trillion dollars)

Citibank
Total Assets: $1,347,841,000,000 (a bit more than 1.3 trillion dollars)
Total Exposure To Derivatives: $52,150,970,000,000 (more than 52 trillion dollars)

Bank Of America
Total Assets: $1,445,093,000,000 (a bit more than 1.4 trillion dollars)
Total Exposure To Derivatives: $44,405,372,000,000 (more than 44 trillion dollars)

Goldman Sachs
Total Assets: $114,693,000,000 (a bit more than 114 billion dollars – yes, you read that correctly)
Total Exposure To Derivatives: $41,580,395,000,000 (more than 41 trillion dollars)

That means that the total exposure that Goldman Sachs has to derivatives contracts is more than 362 times greater than their total assets.

And remember, the biggest chunk of those derivatives contracts is made up of interest rate derivatives.
Just imagine what would happen if a life insurance company wrote millions upon millions of life insurance contracts and then everyone suddenly died.
What would happen to that life insurance company?
It would go completely broke of course.
Well, that is what our major banks are facing today.
They have written trillions upon trillions of dollars worth of interest rate derivatives contracts, and they are betting that interest rates will not go up rapidly.
But what if they do?
And the truth is that interest rates have a whole lot of room to go up.  The chart below shows how the yield on 10 year U.S. Treasuries has moved over the past couple of decades…
10 Year Treasury Yield [31]
As you can see, the yield on 10 year U.S. Treasuries was hovering around the 6 percent mark back in the year 2000.
Back in 1990, the yield on 10 year U.S. Treasuries hovered between 8 and 9 percent.
If we return to “normal” levels, our financial system will implode.  There is no way that our debt-addicted system would be able to handle it.
So watch the yield on 10 year U.S. Treasuries very carefully.  It is the most important number in the entire U.S. economy.
If that number gets too high, the game is over.
Continue Reading
GlobalIntelHub2

NSA Spying Directly Harms Internet Companies, Silicon Valley, California … And the Entire U.S. Economy

Mass surveillance by the NSA may directly harm the bottom of line of Internet companies, Silicon Valley, California … and the entire national economy.
Money News points out:
The company whose shares you own may be lying to you — while Uncle Sam looks the other way.
Let’s step through this. I think you will see the problem.
Fact 1: U.S. financial markets are the envy of the world because we have fair disclosure requirements, accounting standards and impartial courts. This is the foundation of shareholder value. The company may lose money, but they at least told you the truth.
Fact 2: We now know multiple public companies, including Microsoft (MSFT), Google (GOOG), Facebook (FB) and other, gave their user information to NSA. Forget the privacy implications for a minute. Assume for the sake of argument that everything complies with U.S. law. Even if true, the businesses may still be at risk.
Fact 3: All these companies operate globally. They get revenue from China, Japan, Russia, Germany, France and everywhere else. Did those governments consent to have their citizens monitored by the NSA? I think we can safely say no.
Politicians in Europe are especially outraged. Citizens are angry with the United States and losing faith in American brand names. Foreign companies are already using their non-American status as a competitive advantage. Some plan to redesign networks specifically to bypass U.S. companies.
By yielding to the NSA, U.S. companies likely broke laws elsewhere. They could face penalties and lose significant revenue. Right or wrong, their decisions could well have damaged the business.
Securities lawyers call this “materially adverse information” and companies are required to disclose it. But they are not. Only chief executives and a handful of technical people know when companies cooperate with the NSA. If the CEO can’t even tell his own board members he has placed the company at risk, you can bet it won’t be in the annual report.
The government also gives some executives immunity documents, according to Bloomberg. Immunity is unnecessary unless someone thinks they are breaking the law. So apparently, the regulators who ostensibly protect the public are actively helping the violators.
This is a new and different investment landscape. Public companies are hiding important facts that place their investors at risk. If you somehow find out, you will have no recourse because regulators gave the offender a “get out of jail free” card. The regulatory structure that theoretically protects you knowingly facilitates deception that may hurt you, and then silences any
witnesses.
This strikes to the very heart of the U.S. financial system. Our markets have lost any legitimate claim to “full and fair disclosure.” Every prospectus, quarterly report and news release now includes an unwritten NSA asterisk. Whenever a CEO speaks, we must assume his fingers are crossed.
***
Every individual investor or money manager now has a new risk factor to consider. Every disclosure by every company is in doubt. The rule of law that gave us the most-trusted markets in the world may be just an illusion.
In a subsequent article, Money News wrote:
Executives at publicly traded companies are lying to shareholders and probably their own boards of directors. They are exposing your investments to real, material, hard-dollar losses and not telling you.
The government that allegedly protects you, Mr. Small Investor, knows all this and actually encourages more of it.
Who lies? Ah, there’s the problem. We don’t know. Some people high in the government know. The CEOs themselves and a few of their tech people know. You and I don’t get to know. We just provide the money.
Since we don’t know which CEOs are government-approved liars, the prudent course is to assume all CEOs are government-approved liars. We can no longer give anyone the benefit of the doubt.
If you are a money manager with a fiduciary responsibility to your investors, you are hereby on notice. A CEO may sign those Securities and Exchange Commission filings where you get corporate information with his fingers crossed. Your clients pay you to know the facts and make good decisions. You’re losing that ability.
For example, consider a certain U.S. telecommunications giant with worldwide operations. It connects American businesses with customers everywhere. Fast-growing emerging markets like Brazil are very important to its future growth.
Thanks to data-sharing agreements with various phone providers in Brazil, this company has deep access to local phone calls. One day someone from NSA calls up the CEO and asks to tap into that stream. He says OK, tells his engineers to do it and moves on.
A few years later, Edward Snowden informs Brazilian media that U.S. intelligence is capturing these data. They tell the Brazilian public. It is not happy. Nor are its politicians, who are already on edge for entirely unrelated reasons.
What would you say are this company’s prospects for future business in Brazil? Your choices are “slim” and “none.” They won’t be the only ones hurt. If the U.S. government won’t identify which American company cheated its Brazilian partners, Brazil will just blame all of them. The company can kiss those growth plans good-bye.
This isn’t a fantasy. It is happening right now. The legality of cooperating with the NSA within the United States is irrelevant. Immunity letters in the United States do not protect the company from liability elsewhere.
***
Shouldn’t shareholders get to know when their company’s CEO takes these risks? Shouldn’t the directors who hire the CEO have a say in the matter? Yes, they should. We now know that they don’t.
The trust that forms the bedrock under U.S. financial markets is crumbling. [A theme we frequently explore. ] If we cannot believe CEOs when they swear to tell the truth, if companies can hide material risks, if boards cannot know what the executives they hire are actually doing, any pretense of “fair markets” is gone.
When nothing is private, people and businesses soon cease to trust each other. Without trust, modern financial markets cannot function properly.
If U.S. disclosure standards are no better than those in the third world, then every domestic stock is overvalued. Our “rule of law” premium is gone.
This means a change for stock valuations — and it won’t be bullish.
CNN reports:
Officials throughout Europe, most notably French President Francois Hollande, said that NSA spying threatens trade talks.
***
For the Internet companies named in reports on NSA surveillance, their bottom line is at risk because European markets are crucial for them. It is too early assess the impact on them, but the stakes are clearly huge. For example, Facebook has about 261 million active monthly European users, compared with about 195 million in the U.S. and Canada, and 22% of Apple’s net income came from Europe in the first quarter of 2013.
***
In June 2011, Microsoft admitted that the United States could bypass EU privacy regulations to get vast amounts of cloud data from their European customers. Six months later, BAE Systems, based in the United Kingdom, stopped using the company’s cloud services because of this issue.
***
The NSA scandal has brought tensions over spying to a boil. German prosecutors may open a criminal investigation into NSA spying. On July 3, Germany’s interior minister said that people should stop using companies like Google and Facebook if they fear the U.S. is intercepting their data. On July 4, the European Parliament condemned spying on Europeans and ordered an investigation into mass surveillance. The same day, Neelie Kroes, the EU’s chief telecom and Internet official, warned of “multi-billion euro consequences for American companies” because of U.S. spying in the cloud.
***
Transparency is an important first step. Its absence only exacerbates a trust deficit that companies already had in Europe. And trust is crucial. Google’s chief legal officer recognized this on June 19 when he said, “Our business depends on the trust of our users,” during a Web chat about the NSA scandal. Some companies have been aggressive in trying to disclose more, and others have not. But unless the U.S. government loosens strictures and allows greater disclosure, all U.S. companies are likely to suffer the backlash.
***
The Obama administration needs to recognize and mitigate the serious economic risks of spying while trying to rebuild its credibility on Internet freedom. The July 9 hearing of the Privacy and Civil Liberties Oversight Board is a start, but much more is needed. More disclosure about the surveillance programs, more oversight, better laws, and a process to work with allied governments to increase privacy protections would be a start.
The European customers of Internet companies are not all al Qaeda or criminals, but that is essentially how U.S. surveillance efforts treat them. If this isn’t fixed, this may be the beginning of a very costly battle pitting U.S. surveillance against European business, trade, and human rights.
The Atlantic notes:
Most communications flow over the Internet and a very large percentage of key Internet infrastructure is in the United States. Thus, foreigners’ communications are much more likely to pass through U.S. facilities even when no U.S. person is a party to a particular message. Think about a foreigner using Gmail, or Facebook, or Twitter — billions of these communications originate elsewhere in the world but pass through, and are stored on, servers located in the U.S.
***
Foreigners … comprise a growing majority of any global company’s customers.
***
From the perspective of many foreign individuals and governments, global Internet companies headquartered in the U.S. are a security and privacy risk. And that means foreign governments offended by U.S. snooping are already looking for ways to make sure their citizens’ data never reaches the U.S. without privacy concessions. We can see the beginnings of this effort in the statement by the vice president of the European Commission, Viviane Reding, who called in her June 20 op-ed in the New York Times for new EU data protection rules to “ensure that E.U. citizens’ data are transferred to non-European law enforcement authorities only in situations that are well defined, exceptional and subject to judicial review.” While we cheer these limits on government access, the spying scandal also puts the U.S. government and American companies at a disadvantage in ongoing discussions with the EU about upcoming changes to its law enforcement and consumer-privacy-focused data directives, negotiations critical to the Internet industry’s ongoing operations in Europe.
Even more troubling, some European activists are calling for data-storage rules to thwart the U.S. government’s surveillance advantage. The best way to keep the American government from snooping is to have foreigners’ data stored locally so that local governments – and not U.S. spy agencies — get to say when and how that data may be used. And that means nations will force U.S.-based Internet giants like Google, Facebook, and Twitter, to store their user data in-country, or will redirect users to domestic businesses that are not so easily bent to the American government’s wishes.
So the first unintended consequence of mass NSA surveillance may be to diminish the power and profitability of the U.S. Internet economy. America invented the Internet, and our Internet companies are dominant around the world. The U.S. government, in its rush to spy on everybody, may end up killing our most productive golden goose.
San Diego Union-Tribune writes:
California and its businesses have a problem. It’s called the National Security Agency.
***
The problem for California is not that the feds are collecting all of our communications. It is that the feds are (totally unapologetically) doing the same to foreigners, especially in communications with the U.S. California depends for its livelihood on people overseas — as customers, trade partners, as sources of talent. Our leading industries — shipping, tourism, technology, and entertainment — could not survive, much less prosper, without the trust and goodwill of foreigners. We are home to two of the world’s busiest container ports, and we are a leading exporter of engineering, architectural, design, financial, insurance, legal, and educational services. All of our signature companies — Apple, Google, Facebook, Oracle, Intel, Hewlett-Packard, Chevron, Disney — rely on sales and growth overseas. And our families and workplaces are full of foreigners; more than one in four of us were born abroad, and more than 50 countries have diaspora populations in California of more than 10,000.
***
News that our government is collecting our foreign friends’ phone records, emails, video chats, online conversations, photos, and even stored data, tarnishes the California and American brands.
***
Will tourists balk at visiting us because they fear U.S. monitoring? Will overseas business owners think twice about trading with us because they fear that their communications might be intercepted and used for commercial gain by American competitors? Most chilling of all: Will foreigners stop using the products and services of California technology and media companies — Facebook, Google, Skype, and Apple among them — that have been accomplices (they say unwillingly) to the federal surveillance?
The answer to that last question: Yes. It’s already happening. Asian governments and businesses are now moving their employees and systems off Google’s Gmail and other U.S.-based systems, according to Asian news reports. German prosecutors are investigating some of the American surveillance. The issue is becoming a stumbling block in negotiations with the European Union over a new trade agreement. Technology experts are warning of a big loss of foreign business.
John Dvorak, the PCMag.com columnist, wrote recently, “Our companies have billions and billions of dollars in overseas sales and none of the American companies can guarantee security from American spies. Does anyone but me think this is a problem for commerce?”
***
It doesn’t help when our own U.S. Sen. Dianne Feinstein is backing the surveillance without acknowledgment of the huge potential costs to her state.
It’s time for her and House Minority Leader Nancy Pelosi, who has been nearly as tone-deaf on this issue, to be forcefully reminded that protecting California industry, and the culture of openness and trust that is so vital to it, is at least as important as protecting massive government data-mining. Such reminders should take the force not merely of public statements but of law.
California has a robust history of going its own way — on vehicle standards, energy efficiency, immigration, marijuana. Now is the time for another departure — this one on the privacy of communications.
***
We need laws, perhaps even a state constitutional amendment, to make plain that California considers the personal data and communications of all people, be they American or foreign, to be private and worthy of protection.
And see this.
The bigger picture is that a country’s economic health is correlated with a strong rule of law more than any other factor.
Yet America has rapidly fallen into a state of lawlessness, where fundamental rights – such as protection against mass spying by the government – have been jettisoned.
The government is spying on just about everything we do.  Even the government’s attempted denials of this fact confirm it.
Continue Reading