Central Perk: Mish's Global Economic Trend Analysis

marți, 20 decembrie 2011

Mish's Global Economic Trend Analysis

$30 Billion Fund Manager Makes Case for Being Totally on Sidelines in Treasuries and German Bonds
Japan Proposes Nonsensical Deal to China: "I'll Loan You a Nickel if You Loan Me a Nickel"; Japan Worries About Servicing Its Debt
Dysfunctional Politics: Both Sides Champion Tax Cuts, Obama Agrees - Result: No Tax Cut
Capital Account Video: Mish on Malfunctioning Bureaucrats, Gold's Recent Decline and Chinese Chicken Feet

$30 Billion Fund Manager Makes Case for Being Totally on Sidelines in Treasuries and German Bonds

Posted: 20 Dec 2011 11:13 PM PST

Michael Platt, CEO and founder of BlueCrest Capital, a $30 billion hedge fund, states the case in an interview on Bloomberg for being totally on the sidelines in short-term US Treasuries and German Bonds.

Link if video does not play: Euro Crisis - Hedge Fund CEO Mike Platt - Bloomberg 15-12-2011

The video is 15 minutes long and well-worth watching. Platt is not a permabear by any means. He caught the rebound nicely in 2009 but now believes the prudent thing to do is completely avoid risk for the time being as better opportunities will come down the road for those who stay liquid.

Partial Transcript

Michael Platt: We distill it down to one really essential fact. If you look at the debt of Italy at 120% of GDP, which is increasing at a real rate of 5% where they have to fund these days, and if you look at GDP which is now forecast to be declining at 1.5%, arithmetically that debt is going to blow up. We don't see anything that is happening at the policy level that gives us any indication that there's going to be anything to convert this situation from where it is now to a much more substantial and real crisis in the future.

If Italy and Spain are forced to roll their debt over which this year is going to be on the order of 600 billion euros, if they have to pay rates between 5 and 7 percent, then the situation in Europe is unsustainable.

We are not going to have any Eurobond. We are not going to have a full political and fiscal union where the transfers can take place. It seems that what we are going to have is an attempt to control the European situation through continued austerity which is a process that is pro-cyclical. More austerity creates more slowdown. To raise more capital we are looking for a three trillion take-down in European balance sheets. There is nowhere I can see to get any growth from.

Bloomberg: It's all about economics and not a cultural and political divide?

Michael Platt: Absolutely it's about a cultural and political divide. The reality is there is no willingness within the Eurozone to share wealth.

I want to make something very clear, the market price says the probability of a eurozone breakup is distinctly non-zero, despite what the politicians say.

Bloomberg: Is it going to get worse?

Michael Platt: We are going into 2012 and the problem is going to get worse.

The actual process that this has been unfolding under as been extremely gradual and there has been a lot of optimism in the markets that some kind of solution will be found. But unfortunately, the process of bond markets selling off, driving funding costs higher, has been absolutely continual and now as debt rates go up to 7% it becomes a self-fulfilling prophesy.

Bloomberg: Most of the banks in Europe are insolvent now?

Michael Platt: repeating ... If banks were hedge funds and you marked them to market properly, I would say most most of them are insolvent.

Bloomberg: How do you feel about banks as counterparties?

Michael Platt: I do not take any exposure to banks at all if I can avoid it. All the money at BlueCrest Capital is in 2-year US government debt or 2-year German debt. We have segregated accounts with all our counterparties. We are absolutely, radically concerned about the credit quality of our counterparties.

Bloomberg: Are you afraid of taking risk right now?

Michael Platt: Absolutely. We are not interested in taking any peripheral debt risk at all.

Bloomberg: You are looking for all of the potential opportunities out there in the world, not to perform.

Michael Platt: The most important thing to remember about crises is: you don't make your money going into the crisis. Because when you go into a crisis like 2008, markets trade against positions. People have positions on. People need to get risk off. All the things that people thought were a good idea, start going into reverse.

The big money is made in the aftermath of the crisis.

Bloomberg: Are you looking at opportunities in illiquid assets? A lot of hedge funds are saying man, there is a lot of yield to be had in some of these illiquid products.

Michael Platt: I would not touch illiquid assets. We are going into an environment in which banks are going to delever. Illiquid assets are going to be coming out on the street everywhere. The price of liquidity is going to go up.

Bloomberg: You're not temped? Just as were hearing, banks are shedding assets, we are hearing from many investors this stuff is too cheap to ignore.

Michael Platt: It would have been the end of my business in 2008 if I had done such a thing. Ayone that had illiquid positions in their hedge funds, there were runs on those hedge funds because people wanted to get the cash out. In 2008 I paid out $9.5 billion to the street. I was up a lot and completely liquid.

Bloomberg: Do you expect we are going to see a repeat of 2008? There's going to be something akin to a credit crunch and anybody holding illiquid assets is going to get crushed the same way they were three years ago?

Michael Platt: That's what I think. Yeah. What's going on now is significantly worse than 2008.

End Transcript

That is one of the best interviews I have heard in a while. Platt stated his position very well and I am in essential agreement with the overall message about risk.

Those who avoid risk now will be rewarded later. Those who take risk now will regret it.

Upside is limited, and global economic fundamentals are horrendous. Better opportunities will come for those who are patient.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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Japan Proposes Nonsensical Deal to China: "I'll Loan You a Nickel if You Loan Me a Nickel"; Japan Worries About Servicing Its Debt

Posted: 20 Dec 2011 05:59 PM PST

Circular lending theories have spread from Europe to Asia.

Please consider Japan Talking to China About Buying Yuan Government Bonds

Japan is discussing with China possible purchases of Chinese government bonds, Finance Minister Jun Azumi said, a sign the nation is diversifying foreign- exchange holdings by tapping into the world's second-largest economy.

"I think it's mutually beneficial" for the two countries to be investing in one another's debt, Azumi said at a press conference in Tokyo today. "We're not abandoning the dollar or euro, but we're adding the yuan to deepen our relationship."

Japan Scared to Death

As I was reading the article it was immediately apparent what the problem is. The last paragraph explains nicely.

China, which is also Japan's largest trading partner, sold the second-biggest net amount of Japanese debt on record as the yen headed for a postwar high against the dollar and benchmark yields approached their lowest levels in a year. It cut Japanese debt by 853 billion yen ($11 billion) in October, Japan's Ministry of Finance said on Dec. 8. China sold a net 2.02 trillion yen of Japanese debt in August 2010, a record based on data going back to January 2005.

Japan Records Trade Deficit in October

The above chart from Trading Economics.

Japan's Exports Collapse

Bloomberg reports Japan's Exports Fall More Than Estimated as Yen Gains

Japan's exports fell for the first time in three months, indicating that the yen's appreciation and financial turmoil in Europe are slowing the nation's recovery from the March disaster.

Shipments dropped 3.7 percent in October from a year earlier, the Ministry of Finance said today in Tokyo, worse than all 29 estimates of economists surveyed by Bloomberg News.

Exports to China, Japan's biggest market, slid 7.7 percent, the largest drop since May, today's report showed. Weakening overseas demand has led companies including Toshiba Corp. and Nippon Yusen K.K. to call on the government to follow up on last month's yen intervention with steps to prevent the currency from appreciating further.

Function of Math

As I have talked about numerous times before, foreign debt buying is a function of math: Countries that run current account surpluses accumulate foreign currency and bonds.

As trade deficits or surpluses change so will accumulation of foreign reserves.

Thus the discussion between Japan and China is complete silliness, although it clearly highlights Japan's concern as to servicing its enormous national debt.

If China has a trade surplus with Japan, then over the long haul China is likely to buy Japanese bonds, just as Japan and China buy US treasuries today.

However, everyone cannot be a net exporter to everyone else. Please see Another Preposterous Proposal to "Fix the Unfixable"; Political, Economic, and Mathematical Realities for the latest proposal from Europe on how to save the euro by increasing exports.

It is mathematically impossible for every country to have a trade surplus, not matter how hard they all attempt to export themselves to nirvana.

Moreover, and more importantly, yields on Japanese bonds are unlikely to remain low if Japan's vaunted export machine takes a sustained hit and Japanese corporations and banks slow their buying of Japanese bonds as a direct consequence.

All hell will break loose when Japanese bond yields rise high enough that Japan struggles to service its debt.

How Can Japan Service its Debt?

I have written about Japan's debt problem on numerous occasions, most recently on August 9, 2011, in Worst Demand on Record for Japanese 40-Year Bonds; Can Japan Service its Debt? How?

Inquiring minds may be wondering "With a Debt-to-GDP ratio exceeding 200%, how is Japan going to service its national debt?"

I have been wondering that for years. Adding fuel to the debate, please consider Worst 40-Year Bond Sale Shows Cash King as Investors Flinch

The worst demand on record for 40- year Japanese bonds sold yesterday signals growing concern about Japan's ability to service the world's biggest debt pile and the risk of holding long-term securities while markets are volatile.

The 400 billion yen ($5.2 billion) sale drew bids valued at 2.03 times the amount on offer, the weakest since the Ministry of Finance began selling the securities in 2007.

Japan's Ministry of Finance said that every 1 percentage- point increase in 10-year yields above 2 percent would add 1 trillion yen in debt-servicing costs to a projection of 22.9 trillion yen for the fiscal year starting April 2012. The nation's total debt may reach 219 percent of gross domestic product next year, according to the Organization for Economic Cooperation and Development.

Double-Edged Sword

Please note that was not a failed auction. Indeed it was oversubscribed. However, nearly all of that demand is internal.

Internal demand is a double-edged sword. Right now it is still sufficient. However, when (not if), Japan ever needs foreign buyers for its bond market, rates will not be 2.3% on 40-year bonds.

On account of miserable and worsening demographics, bond redemptions have started. However, those redemptions are a still a trickle. That trickle will at some point turn into a torrent.

Balance of Trade a Key Issue

People have been talking about this for years, although I have not seen discussion of the trade angle before.

Here is the key: If Japan does not maintain a trade surplus covering both interest on its national debt and bond redemptions, all hell will break loose. This gives rise to the question as to how long Japan's vaunted export machine can remain intact. I do not have the answer to that question, but China and the rest of Asia are nibbling away bits and pieces now. The tsunami sure did not help.

Trade issues and demographics explain Japan's paranoia regarding a strengthening Yen. It is also another one of those global imbalances that "does not matter, until it does, and it will" kind of things.

It is mathematically impossible for every country to maintain a trade surplus and increase exports, yet every country wants to do just that.

Rising interest rates would crucify Japan, and that is why Japan is courting China, hoping China will buy Japanese debt.

Europe did the same, for the same reason. Such pleas are useless. If Japanese exports and corporate profits sink, and Japan needs external financing to service its massive pile of debt, interest rates on Japanese bonds will head North, likely in a major way.

Japan is in deep trouble if its export machine breaks down. That time may be at hand.

Addendum:

In regards to my statement "foreign debt buying is a function of math: Countries that run current account surpluses accumulate foreign currency and bonds" Aaron Krowne at ML-Implode responds ...

You should also mention that this is only true so much as net trade deficits are not settled with gold (which would be the smart way to handle this, and the one based on thousands of years of history up until a few decades ago).

Aaron is correct and I have discussed this previously on several occasions.

Please see Hugo Salinas Price and Michael Pettis on the Trade Imbalance Dilemma; Gold's Honest Discipline Revisited for the solution to the trade imbalance dilemma.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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Dysfunctional Politics: Both Sides Champion Tax Cuts, Obama Agrees - Result: No Tax Cut

Posted: 20 Dec 2011 11:52 AM PST

Political maneuvering has taken on the theater of the absurd. Republican House Speaker John Boehner openly sings the praises of President Obama, as both want to extend tax cuts and unemployment benefits. That is odd enough in and of itself.

Moreover, the Senate has already passed a bill, yet the measure died in the House.

What happened?

Obama and House Republicans want a 1-year deal, the Senate passed a 2-month deal. Adding to the confusion, the Senate packed their bags and left Washington for the holidays while the House voted to kick the bill back to the Senate to negotiate with Senators who will not even be in town.

Deal Rejected

The New York Times reports Republicans in House Reject Deal Extending Payroll Tax Cut

House Republicans on Tuesday soundly rejected a bill approved by the Senate that would have extended the payroll tax cut for most Americans beyond the end of the year and allowed millions of unemployed people to continue receiving jobless benefits.

The House vote, which passed 229 to 193, also calls for establishing a negotiating committee so the two chambers can resolve their differences. Seven Republicans joined Democrats in opposition.

It was far from clear whether the two sides would be able to bridge the gap by year's end. If they fail to do so, payroll taxes for 160 million Americans will rise to 6.2 percent, from 4.2 percent, in January, for an average annual increase of roughly $1,000.

Republicans said the two-month extensions provided by the Senate bill left too much uncertainty at a time of deep economic vulnerability and would leave Congress facing the same thorny issues early in the new year. They said it was a deeply inadequate half-measure that represented the old ways of Congress.

Immediately after the vote, Speaker John A. Boehner released a letter to the president, saying that he agreed with Mr. Obama on the need for a full-year extension of the tax cut and unemployment benefits.

"There are still 11 days before the end of the year, and with so many Americans struggling, there is no reason they should be wasted," Mr. Boehner wrote. "You have said many times that Congress must do its work before taking vacation. Because we agree, our negotiators and the House stand ready to work through the holidays. I ask you to call on the Senate to return to appoint negotiators so that we can provide the American people the economic certainty they need."

But the White House spokesman, Jay Carney, insisted that the burden to act was on House Republicans.

Senate Majority Leader Rejects Bargaining

Please consider House GOP rejects 2-month payroll tax cut

If Congress doesn't pass a bill by the end of the year, payroll taxes will go up for 160 million workers on Jan. 1. Almost 2 million people could lose unemployment benefits in January as well.

The House vote, 229-193, kicks the measure back to the Senate, where the bipartisan two-month measure passed on Saturday by a sweeping 89-10 vote. The Senate then promptly left Washington for the holidays. Senate Majority Leader Harry Reid, D-Nev., says he won't allow bargaining until the House approves the Senate's short-term measure.

The Senate's short-term, lowest-common-denominator approach would renew a 2 percentage point cut in the Social Security payroll tax, plus jobless benefits averaging about $300 a week for the long-term unemployed, and would prevent a 27 percent cut in Medicare payments to doctors. The $33 billion cost would be financed by a .10 percentage point hike in home loan guarantee fees charged by mortgage giants Fannie Mae and Freddie Mac, which the administration says would raise the monthly payment on a typical $210,000 loan by about $15 a month.

The House passed a separate plan last week that would have extended the payroll tax cut for one year. But that version also contained spending cuts opposed by Democrats and tighter rules for jobless benefits.

Both the House and Senate bills included a provision designed to force Obama to make a decision on construction of the controversial Keystone XL pipeline, which would deliver up to 700,000 barrels of oil daily from tar sands in Alberta, Canada, to refineries in Texas. The provision requires him to issue the needed permit unless he declares the pipeline would not serve the national interest.

Both sides were eager to position themselves as the strongest advocates of the payroll tax cut, with House Republicans accusing the Senate of lollygagging on vacation and Senate Democrats countering that the House was seeking a partisan battle rather than taking the obvious route of approving the stopgap bill to buy more time for negotiations.

Dysfunctional Politics at its Finest

For starters, I strongly suspect the Senate bill will add to the deficit and is not revenue neutral as claimed. At the same time I struggle to believe that some compromise will fail to pass this year or early next year.

However, there is so much political posturing for the sole purpose of election engineering that perhaps nothing is done, on purpose, ironically for the explicit reason it will allow both Republicans and Democrats to claim they were "more for" a bill that did not pass than the other party.

This is dysfunctional politics at its finest.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
Click Here To Scroll Thru My Recent Post List

Capital Account Video: Mish on Malfunctioning Bureaucrats, Gold's Recent Decline and Chinese Chicken Feet

Posted: 20 Dec 2011 09:10 AM PST

On Monday, I had the pleasure of doing a live video for Capital Account with Lauren Lyster. I come in at about the 2:45 minute mark for much of the rest of the 30 minute session.

Discussion is about the Eurozone, trade with China, regulations, gold, and alleged "malfunctioning markets".