17 Mar 2012

Two Numbers That Matter: $15.564 Trillion And $8.354 Billion

Without wasting our readers' time, here are the only two numbers that matter today:
  1. $15,564,809,891,767.99 - This is how high record US federal debt is as of today. Although "record" and "US debt" in the same sentence is now redundant. So just debt. (source)
  2. $8.354 billionThis is how much net US tax revenues (net of refunds of course) are lower in fiscal 2012 to date compared to the same period in 2011. In this Bizarro world, economic recovery is apparently based on weaker numbers (source).
The chart below proves without doubt that converting one well-paying job into two jobs that combined pay less, is uber bullish for stocks.

When To Sell Gold: Dylan Grice

Following the latest temporary swoon in gold, the PM naysayers have once again crawled out of the woodwork, like a well tuned Swiss watch (made of 24K gold of course). Of course, they all crawl right back into their hole never to be heard of again until the next temporary drop and so on ad inf. Naturally, the latest incursion of "weak hand" gold longs is screaming bloody murder because the paper representation of the value of their hard, non-dilutable, physical gold is being slammed for one reason or another. Ironically, these same people tend to forget that the primary driver behind the value of gold is not for it to be replaced from paper into paper at some point in the future, but to provide the basis for a solid currency following the reset of a terminally unstable system, unstable precisely due to its reliance on infinitely dilutable currency, and as such any cheaper entry point is to be applauded. Yet it seems it is time for a refresh. Luckily, SocGen's Dylan Grice has coined just that with a brief explanation of "when to sell gold" which while having a modestly different view on the intrinsic value of gold, should provide some comfort to those for whom gold is not a speculative vehicle, but a true buy and hold investment for the future. And in this day and age of exponentially growing central bank balance sheets (chart), this should be everyone but the die hard CNBC fanatics. In brief: "Eventually, there will be a crisis of such magnitude that the political winds change direction, and become blustering gales forcing us onto the course of fiscal sustainability. Until it does, the temptation to inflate will remain, as will economists with spurious mathematical rationalisations as to why such inflation will make everything OK. Until it does, the outlook will remain favorable for gold. But eventually, majority opinion will accept the painful contractionary medicine because it will have to. That will be the  time to sell gold."
We would like to add that we disagree with this conclusion: we believe that painful contractionary medicine will never be taken, and instead the process of elimination of $20+ trillion in overhanging debt will simply take place via hyperinflation, as discussed here. Luckily, in that case gold will gain even more. However, as gold will only be convertible into worthless pieces of paper or 1 and 0s, something tells us the physical gold market will go offerless first slowly, and then very fast...
Grice "explains" what gold is:
It’s a lump of metal with no cash flows and no earnings power. In a very real sense it's not intrinsically worth anything. If you buy it, you're forgoing dividend or interest income and the gradual accumulation over time of intrinsic value since a lump of cold, industrially useless metal can offer none of these things. That forgone accumulation of wealth is like the insurance premium paid for a policy which will pay out in the event of an extreme inflation event.

Is there anything else which will do that? Some argue that equities hedge against inflation because they are a claim on real assets, but most of the great bear market troughs of the 20th century occurred during inflationary periods. A more obvious inflation hedge is inflation linked bonds, but governments can default on these too. More exotic insurance products like sovereign CDSs, inflation caps, long-dated swaptions or upside yield curve volatility all have their intuitive merits. But they all come with counterparty risk. Physical gold doesn’t. Indeed, during the “6000 year gold bubble” no one has defaulted on gold. It is the one insurance policy which will pay out when you really need it to.
And there you have it: no counterparty risk. Remember that the next time you look at a chart showing the $700 trillion ($1.3 quadrillion pre-revision) in total OTC derivatives, whose systemic disintegration is only a matter of time as actual cash flow, money good producing assets age, are confiscated and disappear. Oh yes, there is a reason why Bavaria Sachs is after the 107 tons of Greek gold...
Why does Grice own gold?
The reason I own gold is because I'm worried about the long-term solvency of developed market governments. I know that Milton Friedman popularised the idea that inflation is “always and everywhere a monetary phenomenon” but if you look back through time at inflationary crises – from ancient Rome, to Ming China, to revolutionary France and America or to Weimar Germany – you'll find that uncontrolled inflations are caused by overleveraged governments which resorted to printing as the easiest way to avoid explicit default (whereas inflation is merely an implicit default). It’s all very well for economists to point out that the cure for runaway inflation is simply a contraction of the money supply. It’s just that when you look at inflationary episodes you find that such monetary contractions haven't been politically viable courses of action.
Needless to say, "economists" are, for the most part, idiots:
Economists, we find, generally don’t understand this because economists look down on disciplines which might teach them it, such as history, because they aren’t mathematical enough. True, historians don’t use maths (primarily because they don’t have physics envy) but what they do use is common sense, and an understanding that while the economic laws might hold in the long run, in the short run the political beast must be fed.
The response of printing money is nothing new. Yes, one can come up with meaningless excuses that it is an asset swap which work great in theory, but when it comes to practice, forget one small thing. Money is and always has been first and foremost FUNGIBLE. Just ask the infinite asset rehypothecation accounts of all London-based companies.
I wrote about the Weimar Hyperinflation a few weeks ago and showed, for example, that Rudolf von Havenstein (Reichsbank president) was terrified of pursuing such a monetary contraction because he was so fearful of the social consequences rising unemployment and falling output would elicit. But the agonizing dilemma he faced, identical in principle if not in magnitude to that faced by policy makers today, is as old as money itself.
Dilution goes back further, as we have shown before.
In the 3rd century AD, as the Roman Empire became too large and unwieldy, its borders were consolidated and the great imperial expansion halted. Though necessary, this consolidation posed problems. While the Empire was in growth mode, driven by military conquest which strengthened public finances, the army paid for itself. It was an asset on the national balance sheet. But when that territorial growth was halted, a hole was created in the budget as while the army was still needed to defend the borders, it was no longer self-funding because there was no territorial expansion.

Roman emperors discovered that contracting expenditure to fit with new lower revenues was a difficult feat to pull off. So rather than contract military spending, public works or public entertainment – long-term necessities which were painful in the short run – they opted to buy time using successive currency debasements. Ultimately, this culminated in what would become the world’s first of many fiscally driven inflation crises (see charts below).

Two thousand years ago, the fiscal sobriety so clearly needed in the long run was subordinated to the short-run requirement to buy time. Hence the age-old short-term temptation to debase the currency and hope no one notices. Paring overstretched government balance sheets has never been easy. As the Romans should have done in the third century, developed market governments today will have to come clean to their citizens that since keeping the welfare promises they’ve made over the years will bankrupt them, those promises are going to have to be ‘restructured’ and government expenditure substantially tightened.
Where we find Grice's argument somewhat weak is his extrapolation that just because there are occasional examples where "leaders" have opted for short-term pain in exchange for long-term gain, we fail to see how this, in the current terminally corrupt and crony developed world system of governance which has been uZIRPed by banks through and through, is possible. After all short-term pain is no longer possible as even the smallest downtick leads to concerns of systemic collapse. Rememeber - the world is rapidly running out of money good collateral, a/k/aassets. That is all that matters.
Nonetheless, our view can be layered on top of that of Grice, as our conclusion would have far more stark implications for the real value of gold. In the meantime, those wondering if one should sell gold now, here is your answer.
What causes the political winds to change? A government crisis. In 2008, Ireland came very close to going the way of Iceland. They had their crisis. And historians today still refer to the “inflation fatigue” in Britain by the end of the 1970s. This was our crisis. So what we learn from these experiences and others like them is that a fiscal crisis is required to force a majority acceptance of the implications of an overleveraged government.

But the political winds in countries with central banks are a long way from blowing in the direction of fiscal rectitude. And while it’s true that more people are at least talking about it, talk is very cheap and no one is yet close to walking the walk. Such steps remain politically unpopular because we haven’t had our crisis yet. Given the clear unsustainability of government finances and the explosive path government leverage is on, a government funding crisis is both inevitable and necessary. Dubai and Greece are merely the first claps of thunder in what is going to be a long emergency.

Eventually, there will be a crisis of such magnitude that the political winds change direction, and become blustering gales forcing us onto the course of fiscal sustainability. Until it does, the temptation to inflate will remain, as will economists with spurious mathematical rationalisations as to why such inflation will make everything OK (witness the IMF’s recent recommendation that inflation targets be raised to 4%: IMF Tells Bankers to Rethink Inflation – WSJ). Until it does, the outlook will remain favorable for gold. But eventually, majority opinion will accept the painful contractionary medicine because it will have to. That will be the time to sell gold.

14 Mar 2012

Fed Stress Test Released: Citi, SunTrust, Ally And MetLife Have Insufficient Capital

When we announced the news of Jamie Dimon's surprising announcement, we said that "Since we are now obviously replaying the entire credit crisis, from beginning to end, must as well go all in. Now - who's next? And perhaps just as importantly, who isn't." Who isn't it turns out are 4 banks that did not pass the Fed's stress test results. These are SunTrust, naturally Ally, MetLife and... Citi. Way to earn that 2011 $15 million comp Vic! To summarize: across the 19 banks taking the test, the maximum losses are projected to hit a total of $534 billion. But at least Jamie Dimon gets to pay his dividend. Also, the European LTRO stigma comes to the US in the form of banks who do dividend hike/buyback, vs those that do not.. and of course the 4 unlucky ones that fail the stress test entirely.
Banks at or below 5% are ooopsie.

From the Fed:
The results of the stress scenario projections suggest that the 19 BHCs as a group would experience significant losses under the assumptions of the Supervisory Stress Scenario. Losses at the 19 BHCs are projected to total $534 billion over the nine quarters of the scenario, including losses across the loan portfolios, trading and counterparty credit losses from the global financial market shock, and losses on securities held in the BHCs’ investment portfolios. Losses related to operational risk events such as fraud, computer systems failure, and employee lawsuits, and losses related to mortgage repurchases, which are included in pre-provision net revenue (PPNR), add another $115 billion to this total. Projected PPNR at the 19 BHCs is $294 billion over the nine quarters of the scenario. Together, the high projected losses and low projected PPNR result in projected net income before taxes of $222 billion for the 19 BHCs. This is an extremely low level of net income relative to historical experience in the U.S. banking industry, even in periods of considerable economic and financial market stress.

Despite sometimes significant projected decreases, most of the BHCs maintain stressed regulatory capital ratios including all planned capital distributions above regulatory minimum levels over the course of the stress scenario horizon.24 Overall, 4 of the 19 BHCs have one or more projected regulatory capital ratios (including capital distributions) that fall below regulatory minimum levels at some point over the stress scenario horizon, including 3 BHCs with a stressed ratio of tier 1 common ratio below the 5 percent benchmark established in the capital plans rule. In interpreting these results, it is important to recall that the Federal Reserve’s stress scenario projections are deliberately stringent and conservative assessments under hypothetical, adverse economic conditions and the results are not forecasts or the most likely outcomes for these BHCs.

The minimum levels for BHCs to be considered adequately capitalized are 4 percent for the tier 1 ratio, 8 percent for the total capital ratio, and 3 or 4 percent for the tier 1 leverage ratio. Based on the U.S. capital adequacy guidelines, the tier 1 leverage minimum is 3 percent for BHCs with a composite BOPEC rating of "1" and for BHCs that have implemented the Board’s risk-based capital measure for market risk. The tier 1 leverage minimum is 4 percent for all other BHCs. The tier 1 leverage ratio minimum is 4 percent for Ally Financial Inc., American Express Company, Capital One Financial Corporation, and MetLife, Inc., and 3 percent for the rest of the 19 BHCs participating in CCAR 2012. The capital plans rule further stipulates that the BHCs must demonstrate their ability to maintain tier 1 common ratios above 5 percent.
This is what the economic conditions were in the worst case:


False Flags To Watch out for