We sail tonight for Singapore

We’re all as mad as hatters here…

The captain is a one-armed dwarf

He’s throwing dice along the wharf

In the land of the blind, the one-eyed man is King…

Tom Waits, “Singapore,”

http://www.oldielyrics.com/lyrics/tom_waits/singapore.html

Once again confession is in order: communication overdue. We’ll do our best to be more consistent, but with the current manic markets, it can become difficult to know when to ‘freeze frame’ things, and offer some intelligent commentary. So, with the understanding that this effort is very much a fluid ‘work-in-progress,’ there are a few key points that are timely to share.

One of the obvious realizations, the full implications of which have yet to be fully realized by the financial markets, is that the Euro currency cannot now, nor will it likely ever be a rival reserve asset to the US Dollar. Think back a mere three years. Since its inception in 1999 it was presumed by many that the Euro was on its way to becoming roughly the equal to the dollar as a central bank reserve asset, as a store of value (short-term at least), as a denominator for long-term global debt financing – all the hallmarks that made the USD the indispensable financial medium of the post-WWII era.

The most significant indication of this relatively abrupt change – because in the realm of major currencies, change is rarely anything other than glacial – is the current state of China’s reserve position. It is estimated that just eighteen months ago, the percentage of China’s foreign reserves in Euro’s was 26-28% (1). Latest number reported: a mere 7%. This is an incredible change of direction for the world’s largest reservoir of liquidity.  

Again, think back only two summers ago. There was much talk about China coming to Europe’s “rescue,” buying Italian, Spanish debt, and so on. In fact, in the report cited above, it was estimated that China held as much as 13% of all Italian government debt (the world’s third largest debt market, BTW). Not anymore.

This has enormous implications for global capital flows, for the world’s debt markets, and also for equity markets, especially the US stock market. More on that in a moment.

The most eloquent and insightful observer of Europe’s condition and pending demise is the remarkable Nigel Farage. Many of you are likely familiar with his brilliant speeches in the European Parliament, as an United Kingdom delegate. The item below links to a brief video that is well worth your while.

From zerohedge.com: Nigel Farage on “Wholesale, Violent Revolution” In Europe, 05/01/2013

In a little under two minutes, Nigel Farage sums up the utter farce that “the religion” that Europe has become. He explains, his fear is that what will break up the Euro, “is not the economics of it, but wholesale, violent revolution,” in the Mediterranean, and that is “all so unnecessary!” Speaking at Simon Black’s Offshore Tactics workshop, the so-called modern day Cicero goes on to point out that France’s Hollande is “the number 1 among idiots running countries around the world,” and worries that Merkel’s pending election means there will be more and more ‘tough talk and action’ as she shows the people she is in charge. Simply put he warns, alongside Ron Paul, that if you have money in European banks, “Get your money out,” because, “when the next phase of the disaster comes, they will come for you.”

http://www.infowars.com/nigel-farage-on-wholesale-violent-revolution-in-europe/

[For another captivating overview of Mr. Farage’s understanding of Europe’s present and future, please see: http://www.youtube.com/watch?v=zaUYDeVtG0Q]

Without a common debt instrument and the sovereign authority to guarantee the obligation of such securities, it is now clear to all but the most “religiously” inclined, the Euro will pass into history as a tragically ill-founded experiment. Because they knew it was not politically saleable to the citizens of their countries, those who gave birth to the Euro (primarily German and French ‘visionaries’) very consciously refused to accept the essential requirement for this degree of unity, therefore hamstringing their creation from its inception. They recklessly forged ahead, assuming they would sort it out later. But the current crisis has not changed the essential calculus on these two key issues. And certainly Germany and the other “northern” countries (which include Austria) resist any inclination in that direction.

In short, the Euro, as a rival to the US Dollar, appears to be dead. Period! Thus the American greenback by default (Or design…? Fodder for more conspiracy spinning) effectively becomes the only game in town.

Many are very understandably confused as to how the dollar can serve as a satisfactory world reserve in the face of the explosion of the US money supply. For our part, we have been ‘taken to school’ on this question by Mr. Martin Armstrong. Selected excerpts from his recent “2013 Metals Report Part II” should be helpful:

With the dramatic increase in the [US] money supply…, 99% of the people are simply baffled saying – It’s got to be inflationary! But this is old school. Welcome to the new International Currency – the DOLLAR! The United States has emerged no different than Rome, Greece or Lydia in their day or Britain up until 1914. The US has in fact become the core economy that has provided the market for the rest of the world. It has the largest economy and its currency has transcended the traditional concept of money limited to its domestic economy. With Japan refusing to ever let go of its rein of power prohibiting the issue of any bond internationally denominated in yen, they successfully prevented the yen from ever becoming a world currency despite the fact that they had climbed to become the second largest economy in the world. The creation of the Euro was a disaster and refusing to consolidate the debts of all member states prevented the Euro from ever rising to become a global currency or even a reserve currency. The reserves of central banks are about $11 trillion. With no national bond issue, Europe could never emerge as a place to park serious money. Only the dollar can serve as a reserve currency BECAUSE ironically there is a debt market of about $17 trillion for the entire world to utilize.

The lack of understanding that the dollar has become the global currency of choice prevents most of the understanding necessary to cope with the drastic changes this has created in the economic performance of nations and assets. The Federal Reserve has assumed that it was stimulating the domestic economy by purchasing US government bonds. This is simply no longer possible to target the domestic economy. The plain reason is about 40% of the debt is held outside the USA. That means you cannot guarantee that the seller of those bonds to the Fed will be domestic. If a foreign investor sold the bonds to the Fed, they took the cash home. Hence, there was no domestic stimulation. Consequently, the dramatic rise in the money supply must be looked at INTERNATIONALLY and not purely from a domestic perspective. The Fed monetized those bonds creating dollars but the dollars were exported. Sorry – that is very old school where the theories no longer apply to the modern economy…

Here is an 1899 Mexican bond issued in British pounds when Britain was the Financial Capital of the World making the pound the dominant currency [Illustration of bond certificate]. Japan’s prohibition against issuing bonds in yen without their approval blocked the yen from emerging as a major free currency. The Euro failed to reach that level and cannot because there is NO single federal government bond issue. The Euro is indistinguishable from all 50 states in the USA who issue their debt in dollars (single currency) but also have completely different credit ratings as all member states in Europe. Nobody in their right mind would assert that all the debt of the states should be AAA suitable for bank reserves to support the entire financial system…

China also issued bonds in various currencies to relieve the buyer of currency risk. This included the dollar during the 1920s as well as in Belgium francs as…in a 1921 bond paying 8% in francs [Illustrated]. Today, numerous countries [as well as corporations] issue debt denominated in US dollars…

Despite all the ranting, screaming, yelling, prognosticating, and pontificating that the dollar will collapse – sorry! The dollar is the only game in town and BECAUSE of this international reliance on the dollar, the Federal Reserve cannot control the money supply…Now add to this the ability that anyone anywhere can create a contract in dollars or issue a bond in dollars such as many foreign governments and you further expand the global economic dollar base. The outstanding dollar loans and contracts among foreign nations and investors are huge…

Welcome to the new ONE WORLD CURRENCY – the DOLLAR!…

[Emphasis added above. To sign up for Martin Armstrong’s free blog, go to: www.armstrongeconomics.com.]

As trillions of dollar-denominated debt has been created, future demand for dollars has been assured – to make the interest payments on all this debt, at the very least. But there’s much more to this growing mountain of so-called euro-dollar debt. (The term euro-dollar was coined simply to identify debt denominated in dollars that originated outside the US financial markets.) These issuers don’t have the power of the Federal Reserve, so they’re paying real money, meaningful rates of interest, for the loans. Many are developing countries, or corporations domiciled in the third world. They have chosen to issue debt in dollars, because that is what is desirable in today’s market. In fact, in many cases that’s the only way they can access the capital markets. They have presumed (like so many others) that the Fed’s QE? program will assure that the dollar will remain relatively weak for the foreseeable future, the presumption of a “dollar-carry trade” phenomenon. Ah, the best laid plans…More in a minute.

With the Euro in the process of imploding as a meaningful international asset; with the ECB, EU, and IMF targeting bank deposits for future ‘bail-ins’ (the replacement for politically unpalatable bail-outs); and with BoJ aiming to double the yen monetary base in a mere two years, “safe money” throughout the world is destined to flood into the United States. This will aid the Fed’s effort to maintain US Treasury borrowing rates at negative real yields, but also, and most importantly for our purposes, will almost certainly fuel a bubble in other US financial assets, i.e., the stock market. Bubbles of course, naturally feed on themselves, and as US stocks continue on their way inexorably higher (no doubt with 5-7% dips interrupting the party), this will serve to draw more money to the US and yield a soaring US dollar, creating a devil’s brew for global financial markets, for the US economy, and especially for ‘religious’ bears.

The coming counterintuitive and seemingly perverse strength in the US dollar will indeed have numerous grave implications for the health of the US and the global economy, which we will explore in the future, but for a time, the euphoria of steadily rising stock prices will distract almost everybody’s attention.

Now back to those euro-dollar borrowers. They had counted on a relatively stable dollar when they entered into their debt agreements. As they dollar rises, their interest costs will also rise, in terms of the currencies in which they likely do business. And as debts mature, the problem for these second- and third-world borrowers will compound exponentially. The result: effectively a short-squeeze in the US dollar, which will make the bubble in greenbacks only more extreme, and more dangerous. Because bubbles always lead to busts and the more extreme the bubble the worse and more long-lasting the damage from the ensuing bust. But as Scarlett O’Hara might say: “I can’t think about that right now. If I do, I’ll go crazy. I’ll think about that tomorrow.”

The import of all this for us: we are much more favorably disposed to greater investment in US stocks than might have seemed reasonable some months back. It is also clear that a period of surprising (to us “hard-money” types) US dollar strength will result in a difficult climate for precious metals. But at the end of this dollar bubble and the climactic finale that will bring to the era of central bank fiat money schemes, the world will turn once again to time-tested stores of value, and the gold and silver bulls will resurrect mightily.

There’s been a lot of confusion and misinformation kicking around in the aftermath of gold’s sharp drop since April 12^th. No doubt there are many facts we can marshal to buttress conspiracy theories. Others can counter such arguments with rather convincing logic. To clarify some of the confusion we share an excerpt from a recent issue of Steve Saville’s “The Speculative Investor,” below.

Keep in mind, there’s only one thing we do know for certain when we go home each night: the price of gold and silver. And based on the price action of the precious metals and related stocks (i.e., the charts), over recent months as well as the last few years, the weight of the evidence strongly suggests – caution. As we have said to those with whom we have spoken – we should be prepared for $1100 gold and sub-$20 silver. The most likely course is that an important low will be made this year, 2013. But depending on numerous factors, either (1) that will be it, and gold will begin to grind out a bottom building a base for an eventual advance over $2000 and beyond, (2) the metals could see a vigorous (cyclical) bear market rally, with a final marginally lower low as late as 2015. Either way, we’ll be “on the case,” and ready to take advantage of trading and investment opportunities in the precious metals.

Steve Saville’s The Speculative Investor, 05/20/2013 [Excerpt]

When you read breathless commentary to the effect that the demand for physical gold is rocketing upward even as the gold price declines, remember:

1. Physical demand cannot be satisfied by paper supply.

2. Everyone making the claim that the demand for physical gold is surging relative to the supply of physical gold is fixating on one small part of the physical gold market.

3. At any given time, the total demand for physical gold equals the total aboveground supply of gold. This is basic economics. It has always been the case and will always be the case.

4. The gold demand numbers and charts that are often contained in articles and analyses, including the numbers/charts published by Gold Fields Mineral Services (GFMS) and the World Gold Council (WGC), represent flows of gold from one part of the market to another. These numbers/charts say nothing about overall demand and nothing about price…

5. If there really were widespread difficulty obtaining sufficient physical gold to satisfy demand it would be evident in the term structure of the gold futures market (there would be substantial and sustained “backwardation” in the futures market).

At no time over the past month has there been any market-wide inability of physical gold sellers to meet the demand of physical gold buyers; there has only been a temporary inability of sellers in one part of the market to meet the demand for certain items manufactured from gold (the coins and small bars favoured by the retail investor). Moreover, it’s very unlikely that there will ever be a bona fide shortage of physical gold. This is because the mining industry’s contribution to total supply is so small as to be almost irrelevant (gold mines shutting down wouldn’t have a big effect on overall supply) and because most of the world’s gold is held as a store of value. It should therefore always be possible for a change in price to bring the total demand for physical gold into line with the aboveground supply of gold.

Now, we admit that at some point in the distant future the US dollar could become so devalued and disliked that the existing holders of physical gold won’t sell for any amount of dollars. But in that situation it wouldn’t be possible to use dollars to buy anything of value. In other words, in that case the problem would be an inability to use dollars to buy any useful resource, asset, good or service, not just gold. However, it will always be possible to use something of value to buy physical gold.

As we end “Memo 3,” we await some (at least) modest setback in the broad market that will increase the likelihood of identifying lower-risk investment and trading opportunities.

Thank you for your patience through this transition. It ain’t easy, but it’s the only world we’ve got, so we better love and live well each day in it.

God bless and God speed!

Will Reishman and Chad Swanson

(1)http://www.china.org.cn/opinion/2011-10/11/content_23593520.htm

*************************************

For some additional insight into the heart-rending tragedy unfolding in Europe, let us recommend a few additional items for your attention. First, from the founder and Senior Editor of Stratfor, the excellent independent geopolitical analysis service:

Geopolitical Journey: An Empty Highway in Spain, George Friedman, www.stratfor.com, 05/21/2013

Spain invites endless historical considerations, but on this trip I was struck by something more immediate and prosaic. We were on the road from Granada, near the coast, to Madrid, the capital in the center of the country. It was a four-lane highway, what Americans would call an interstate. The road was clean, well maintained and, as we moved north, nearly empty. Every few kilometers a car would pass in the opposite direction, or we would run alongside another car heading north.

It was not the paucity of cars that struck me; it was the almost complete absence of trucks. This was, after all, the road from the coast to the capital, not the only road but still a significant one. It was early afternoon on a weekday. The oddest moment came when we reached a tollbooth not too far from Madrid. There was only one booth open and when we pulled up there was no one in it and no coin or credit card slot. We waited, then we left. Perhaps the attendant was in the bathroom. Perhaps the revenue didn’t justify paying a toll taker. Perhaps this was one of the austerity measures they had taken.

I will never know. What I do know is that the drive had a sort of post-apocalyptic feel, except that it was very clean. We marveled at it and then realized that there was nothing that ought to have surprised us about it. The unemployment rate in Spain is more than 27 percent. Gasoline costs 1.4 euros a liter (more than $6.50 a gallon). At that price, a drive is no longer a casual undertaking; it has to justify itself. As for trucks, when that many people are out of work — and have been for many months — the demand for goods declines to the point that trucks will be rare on the road.

Youth Unemployment and Desperation

I should have been prepared for this. We stayed in a very nice hotel in Granada. In the morning when we left the hotel, there was a beggar sitting on the sidewalk, his back to the wall, to our right. We paid little attention. Beggars are not uncommon in Europe or the United States. But there is an aesthetic to beggars. They look a certain way, owing to alcohol, madness or a very long time in trouble. When we returned in the late afternoon, he was still there. He was in his mid-to-late 20s, wearing glasses and reading a book. He was dressed in khakis and a decent shirt. He wasn’t mad, he wasn’t drunk and he wasn’t like the hippies of my youth. He wasn’t playing an instrument. He was sitting, absorbed in a book and begging. There were other beggars in Granada of the more conventional sort but also several more who looked like this one.

There is an argument that says Spanish unemployment is not as bad as it seems because a huge amount of it is youth unemployment. It is implied that youth unemployment has less social consequence. Certainly, it is more immediately destabilizing to have the head of a household with children out of work, but when — as some say — 57 percent of those under the age of 25 are unemployed, it also has consequences. Older people get bitter, despair and tend to be fatalistic with what life dealt them — or at least a lot of them do.

A 22-year-old becomes desperate. When a young man is unemployed because he is a musician or an artist awaiting discovery or because he has lived carelessly, that’s one thing. But this is different unemployment. It is a generation whose dreams are shattered. They may have hoped to be a businessman or a craftsman, but that’s not going to happen now. Unemployment of this sort doesn’t go away in a few months or years. This is the level of unemployment the United States experienced in the Great Depression, the kind of unemployment that scars an entire generation. World War II solved the unemployment problem in the United States, but there is no global war on the horizon for Spain. Imagine what would have happened in the United States if the war hadn’t come and the Depression had lasted 20 years.

No one knows how long this will last but everyone suspects that it will be a long time, and I share that suspicion. How do you accept a situation that says you, at the age of 22, will live on the margins of society along with half of your friends? More important, how do you live with that fact if you worked hard preparing for a career?

Failures that are caused by living carelessly can be managed. The very carelessness of the life makes the consequence nearly morally required. Some people in every generation fail and fall to the bottom rungs of society because, well, bad things sometimes happen. Those people do not constitute a social force. But when nearly half a generation, most from middle-class families, finds itself at the bottom, there is no explanation to provide solace. In its place there is, quite reasonably, a sense of victimhood. Whatever explanation one gives for the Spanish crisis — the stupidity of politicians, the laziness of the public, the greed of bankers or whatever else — the generation that is bearing the burden is the only one that is not guilty — at least not yet.

This — being the victim in personal calamity shared by half a generation — is the foundation not just of political instability but also for the politics of rage. The older middle-class citizens, with the lives they thought they had secured shattered, hurled into the ranks of the permanently impoverished, represent the vanguard, if you will. But those who will never live the lives they thought they would, they are the explosive mass.

European Denial

I think the reason things are so calm — occasional riots hardly count — is that no one really believes that they won’t awake from the nightmare. There is a firm belief that this period will end. The denial of what has happened is not confined to Spain. In speaking to a German, he declared my view that the European system is broken as “scandalous.” A moderate official in the European Union, he became choleric at my assertion that countries such as Spain are being plunged into the kind of hell that creates political monstrosities in Europe. For him, the critical thing was that the banks were no more stable than ever. He was simply dismissive of unemployment as the problem. Most people dismiss my views with aplomb, without breaking into a sweat. I have learned that on the rare instance when I cause apoplexy, it’s because what I have said is not too far from the other person’s fears.

Far more interesting than the German official was the Spanish official at the European Union. He was equally enraged when I argued that the social (it is not beyond either a financial or economic) crisis was not going to be solved in the current framework. In almost the same words — and the exact spirit — as the German, he insisted that the problem would not only be solved but that he was working on it day and night and was very close to a resolution. From this I conclude that it is perhaps not just the Germans but the entire EU apparatus that either really believes a solution is imminent or simply doesn’t want to consider the consequences of failure.

Another Spaniard, this one not a government official, said he missed Francisco Franco, the fascist dictator who won the Spanish Civil War and governed for decades. I was surprised to say the least, since Spain under Franco was even poorer than it is today. He explained that he missed Franco because he knew how to tell the Germans to go to hell. When Hitler asked Franco to join him in World War II, Franco refused. The Spaniards’ desire to tell the Germans to go to hell is too easy. Even if this was all Germany’s fault, which it isn’t, Spain’s problem wouldn’t be solved.

The German problem is the European problem and vice versa, and so it has been for a long time. Ever since 1871, when Germany was unified, Germany and Europe have been struggling with the question of how to live with each other. They thought they had found the answer in the European Union — and maybe they will, but not yet. Europe does not know how to live with a Germany that uses the free trade zone to surge its exports while blaming Europe for being lazy and shiftless. Germany does not know how to live with a Europe that does not see that all of its problems are due to its lack of industriousness.

Of course, to our 22-year-old in Spain, the debate has become irrelevant. He is broke, scared and bored — not something you want a mass of young men to be. That is the point at which history turns. Over time, they become men with nothing to lose; they become violent men, trying to reshape the order by any means necessary. Looking around the violent parts of the world, it is young men with nothing to lose and fantasies of glory, led by older men who understand them and their needs, who wage the civil wars that tear countries apart.

The same happened in Europe after World War I. Sometimes the disaffected youth turn to crime, sometimes they turn to political crime and sometimes they become a political party. In Europe, it was a generation that felt betrayed by World War I, then an older generation crushed by unemployment and inflation and finally a younger generation with nothing left to lose. Then came World War II and the stunned realization that there were indeed things left to lose.

Driving in Spain, things look quiet, neat and empty. But in that emptiness there is something ominous, perhaps not so much post-apocalyptic as pre-apocalyptic. Spain is still under control, and the European elite still believe an answer will be found. But I don’t see the path that leads to the redemption of a generation’s hopes. There is time, but in my mind there isn’t enough. And given the attitude of the Eurocrats I have met, there is no sense among the elite that time is running out.

Also, the fine British journalist, Ambrose Evans-Pritchard has written several recent pieces very sympathetic of the Spanish people’s agony. A few excerpts and the link from his latest:

Heroic Spain is damned if it does, and damned if it doesn’t

Ambrose Evans-Pritchard, 05/15/2013

http://www.telegraph.co.uk/finance/comment/ambroseevans_pritchard/10060597/Heroic-Spain-is-damned-if-it-does-and-damned-if-it-doesnt.html

If Euroland sticks to its grim path of synchronized contraction on all fronts – fiscal, monetary and bank deleveraging – and if it continues to impose all the burden of intra-EMU adjustment on the deficit states in a replay of the early 1930s, then it will push Spain, Portugal and others over a cliff…

Spain is making heroic efforts to adjust…For the first time in living memory, the country is clawing its way back to competitiveness without a devaluation. Total exports in January and February were up 5pc from a year before…

The elemental problem for Spain is that if does manage to pull off an “internal devaluation” by cutting wages back to parity, it will make its debt burden worse. It is damned if it does, and damned if it doesn’t.

“Even a believable rumour that Germany would exit the euro would result in a massive capital flight from the countries of southern Europe to Germany.”

The southern European banking system would then collapse, bringing down  entire economies with them, Schmieding said.  

The consequences for Germany would be severe. The crisis countries could no  longer pay back their debt and Germany’s important export markets would  drop off. On top of that German taxpayers would be burdened with immense   costs, he said.

On the other hand if you add up the expected growth advantages of euro  membership between 2013 and 2025 there would be a profit of nearly €1.2 trillion – or about half Germany’s gross domestic product in a year.

Thomas Straubhaar of the Hamburg HWWI economic institute thinks a return   to the D-mark would be “a worst possible scenario.”

“An upward valuation of the D-mark and an accompanying devaluation of the euro would result in a massive debt forgiveness of all other euro-countries –    with the costs of that picked up by Germany. This could lead to a currency      war and the end of monetary stability.”

Complete Rubbish

As is typically the case in such articles, the eurozone proponents ignore the costs of staying in the euro and overly trump up the benefits. The article perpetuates the myth that German taxpayers will suffer the consequences of a breakup, but suffer no costs if the eurozone stays intact.

Nothing could be further from the truth. As I have pointed out on many occasions, Germany is going to pay a steep price either way, and so will Europe.

The cost to Europe on the current path will be another decade of Southern European depression, resentment, and capital controls. Somewhere along the line, citizens in one or more countries will decide they have had enough, and vote to exit the Euro anyway.

It is a huge mistake to believe Germany can impose its will on Southern Europe forever while not paying through the nose with eurobonds or other transfer mechanisms. If Germany returns to the D-mark, it will get paid back in cheaper Euros, but it least its stands a chance of getting paid back.

On the other hand, target-2 imbalances are so great the cost of a destructive piecemeal splintering of the eurozone coupled with outright default, will be much higher.

Many economists don’t see this simply because they do not want to.

Should France Lead Breakup of Euro?

I have argued that the best way to breakup the eurozone would be a German exit. Politically speaking that could be doable once Merkel is gone. But then again, perhaps not.

The problem is Germany has been the biggest beneficiary of this failed experiment, and will not give up those benefits easily, even if mathematically it must eventually (and destructively) happen anyway.

In a Bloomberg column, authors Brigitte Granville, Hans-Olaf Henkel, and Stefan Kawalec argue France Must Lead Breakup of Euro

Many observers concede that the euro was a mistake but think there’s no       going back. They reckon that dissolving the monetary union would lead to   economic chaos, first in Europe, and then around the world. European leaders      are afraid that backtracking on the euro project would also be a lethal blow to the larger cause of European integration and could be the beginning of the           end of the EU and the single market. These fears give rise to what we regard    as the disastrous strategy of defending the euro at all costs.

Although a controlled segmentation of the euro system through the exit of the           most competitive countries would actually be the most effective way to help         the deficit countries, it could still be seen as a decision by the strong to      abandon the weak. Europe’s history makes it difficult for Germany’s leaders to           initiate such a move.
Protecting France

The deficit countries, struggling with recession and internal political divisions,    and trying to get better terms for assistance from the rest of the EU, might be   afraid of worsening their negotiating position by taking the lead. EU   institutions, such as the European Commission and the ECB, couldn’t propose   the solution we advocate.

French leadership in advancing this idea might work — and could be the only    thing that will. France has played the leading role in EU integration for more than 50 years. The euro is very much a French product.

In 1990, President Francois Mitterrand won Chancellor Helmut Kohl’s support    for the single European currency in exchange for France’s acceptance of German unification. Persuading Germany to give up the deutsche mark,        whose strength had given the Bundesbank de facto control of monetary policy           throughout Europe, was a remarkable French success — or so France   believed.

The euro was seen as the ultimate underpinning for the edifice of European     integration. The financial crisis and its aftermath have shown that the euro           instead has the potential to destroy the whole project. It impedes the reforms       necessary to restore France’s fading international competitiveness. Retaining   the present euro system whatever the cost will cripple the French economy,         undo French social cohesion, and weaken France’s position in Europe and the         world.

As Europe’s founding father, only France has the standing to advocate a         strategy of dismantling the euro system for the sake of the European Union.      The alternative is economic failure, deeper divisions and bitter resentments        among Europe’s nations, putting the most valuable achievements of European           integration at risk. One way or another, Europe’s house will be divided.

The question is how much, or how little, this division will sweep away.   Splitting the euro in the way we advocate is vital to the survival of the       European idea.

(Brigitte Granville is a professor of international economics and economic  policy in the School of Business and Management at Queen Mary University of   London. Hans-Olaf Henkel is a professor of international management at the University of Mannheim and a former president of the Federation of German  Industries. Stefan Kawalec is chief executive officer of Capital Strategy and a     former vice minister of finance in Poland. The authors are signatories of the    European Solidarity Manifesto.

Read Part One – Save Europe: Split the Euro. The opinions expressed are       their own.)

The authors present an interesting viewpoint, well worth a closer look.

May 9 – Wall Street Journal (Alex Frangos): “Central banks in Asia, Australia and New Zealand are ratcheting up moves to deal with an influx of capital that is keeping currencies strong and complicating efforts to manage growth. New Zealand’s central bank said Wednesday it intervened in foreign-exchange markets to blunt the rise of its currency and would continue to do so, a day after Australia’s central bank cut interest rates to a record low and noted the stubborn strength of the Australian dollar. Elsewhere, China is moving to curb bets on the rising yuan, while Thailand is considering efforts to curb the strongest baht since the 1997 Asian financial crisis.”

May 9 – Reuters (Luciana Lopez and Rodrigo Campos): “Wealthy money managers bashed Federal Reserve Chairman Ben Bernanke’s easy money policies at a closely watched annual investment conference… The Sohn Investment Conference, which raises money for pediatric cancer research, gets big name hedge fund managers to share their ‘best ideas’ with other wealthy investors. This year’s conference was sprinkled with criticisms of the Fed’s $85 billion in monthly purchases of Treasuries and mortgage securities… ‘Ben Bernanke is running the most inappropriate monetary policy in the history’ of the developed world, said Stanley Druckenmiller, the retired head of Duquesne Capital Management… Bernanke took a drubbing from the start, with the first speaker, Paul Singer, setting the tone. Singer… said the Fed’s monetary policies are distorting the prices of long-term bonds and the global recovery. ‘Everyone wants a safe haven… There is no such thing in today’s markets and that’s one of the elements of the distortion.’”

May 9 – Financial Times (Vivianne Rodrigues and Stephen Foley): “Global investors are venturing to the riskiest corners of the US corporate debt markets in greater numbers in a so-called dash for trash as the relentless search for higher yields shows no signs of abating. Bonds sold by companies with the lowest possible credit ratings have soared in popularity with investors, who have been diverted from top tier government and corporate debt where central banks are suppressing interest rates… Heavy buying has pushed down the average yield on CCC-rated bonds to 6.77% from 10.13% a year ago… ‘It’s a frenzy out there with these high yield bonds,’ said Jason Brady, a portfolio manager at Thornburg Investment Management. ‘We’ve been spending a lot of time trying to sort through an avalanche of new issuance which is, by and large, of terrible quality.”  

Money Notes:

One-month Treasury bill rates ended the week at one basis point and 3-month rates closed at four bps. Two-year government yields were up two bps to 0.24%. Five-year T-note yields ended the week nine bps higher to 0.82%. Ten-year yields jumped 16 bps to 1.90%. Long bond yields were up 14 bps to 3.10%. Benchmark Fannie MBS yields jumped 17 bps to 2.56%….

Italian 10-yr yields increased 7 bps to 3.89% (down 61bps y-t-d). Spain’s 10-year yields rose 16 bps to 4.18% (down 109bps). German bund yields jumped 14 bps to 1.38% (up 6bps), and French yields rose 13 bps to 1.95% (down 1bps). The French to German 10-year bond spread narrowed one to 57 bps. Ten-year Portuguese yields declined 3 bps to 5.38% (down 13bps). Greek 10-year note yields fell 19 bps to 9.36% (down 111bps). U.K. 10-year gilt yields were 17 bps higher at 1.89% (up 7bps)…

Freddie Mac 30-year fixed mortgage rates jumped 7 bps to 3.42% (down 41bps y-o-y). Fifteen-year fixed rates were up 5 bps to 2.61% (down 44bps). One-year ARM rates fell 3 bps to a 13-week low 2.53% (down 20bps). Bankrate’s survey of jumbo mortgage borrowing costs had 30-yr fixed rates up one basis point to 3.91% (down 47bps).

Federal Reserve Credit jumped $10.4bn to a record $3.276 TN. Fed Credit expanded $491bn over the past 31 weeks. Over the past year, Fed Credit expanded $431bn, or 15.2%.

Global central bank “international reserve assets” (excluding gold) – as tallied by Bloomberg – were up $629bn y-o-y, or 6.0%, to a record $11.102 TN. Over two years, reserves were $1.282 TN higher, for 13% growth.

M2 (narrow) “money” supply jumped $33.6bn to a record $10.535 TN. “Narrow money” expanded 6.5% ($645bn) over the past year.

Currency and ‘Currency War’ Watch:

May 8 – Bloomberg: “China’s central bank will resume bill sales for the first time in 17 months as overseas investors pump money into the country to take advantage of the yuan’s rise. The People’s Bank of China said it will issue 10 billion yuan ($1.6bn) of three-month notes… ‘Foreign capital inflows are too big,’ said Shi Lei… head of fixed-income research at Ping An Securities… ‘The central bank needs more tools to mop up excess liquidity.’”

May 7 – Bloomberg (Michael Heath): “The Reserve Bank of Australia cut its benchmark interest rate to a record low, driving down a currency that has damaged manufacturing and boosted unemployment. Governor Glenn Stevens reduced the overnight cash-rate target by a quarter percentage point to 2.75%, saying in a statement that the Aussie’s record strength ‘is unusual given the decline in export prices and interest rates.’”

May 9 – Bloomberg (Eunkyung Seo and Cynthia Kim): “The Bank of Korea cut interest rates, following the lead of policy makers in Australia, Europe and India this month, as strength in the won and weakness in the yen dim the outlook for the nation’s exports. Governor Kim Choong Soo and his board lowered the benchmark seven-day repurchase rate to 2.5% from 2.75%… As central banks around the world move to counter currency appreciation, the won’s 24% jump against the yen in six months is hampering South Korean exporters of autos and electronics and aiding their Japanese rivals. In Seoul, ruling New Frontier Party floor leader Lee Hahn Koo yesterday urged a ‘more active role’ for the BOK, adding to political pressure that the central bank resisted last month.”

The U.S. dollar index jumped 1.2% to 83.14 (up 4.2% y-t-d). For the week on the upside, the Norwegian krone increased 0.2%. For the week on the downside, the Australian dollar declined 2.9%, the New Zealand dollar 2.7%, the Japanese yen 2.6%, the South African rand 2.3%, the Swiss franc 2.2%, the Swedish krona 1.4%, the British pound 1.4%, the Danish krone 1.0%, the euro 1.0%, the South Korean won 0.8%, the Brazilian real 0.6%, the Taiwanese dollar 0.4%, the Singapore dollar 0.4%, the Canadian dollar 0.2%, and the Mexican peso 0.1%.

Commodities Watch:

The CRB index declined 0.5% this week (down 2.1% y-t-d). The Goldman Sachs Commodities Index slipped 0.3% (down 2.7%). Spot Gold fell 1.5% to $1,448 (down 13.6%). Silver was 1.5% lower to $23.66 (down 22%). June Crude dipped 43 cents to $96.04 (up 5%). June Gasoline was up 1.2% (up 4%), while June Natural Gas fell 3.2% (up 17%). July Copper gained 1.2% (down 8%). May Wheat fell 2.0% (down 10%), and May Corn declined 1.7% (down 1.5%).

U.S. Bubble Economy Watch:

May 9 – Bloomberg (Prashant Gopal): “Prices for single-family homes increased in 89% of U.S. cities in the first quarter as the housing market extends a recovery from a five-year slump. The median sales price rose from a year earlier in 133 of 150 metropolitan areas measured… A year earlier, 74 areas had gains… The national median price for an existing single-family home was $176,600 in the first quarter, up 11.3% from the same period last year. That was the biggest gain since the fourth quarter of 2005… ‘Some of the previously hard-hit markets like Phoenix, Sacramento and Miami continue to experience a dramatic turnaround, while a new set of areas like Atlanta, Minneapolis and Seattle have begun to show strong signs of upward momentum,’ Lawrence Yun, chief economist for the National Association of Realtors, said… At the end of the first quarter, 1.93 million previously owned homes were available for sale, 16.8% fewer than a year earlier…”

May 6 – Bloomberg (Joshua Zumbrun): “U.S. banks eased standards and terms on loans to businesses as commercial lending led a credit thaw, according to a Federal Reserve survey. ‘Domestic banks, on balance, reported having eased their lending standards and having experienced stronger demand in several loan categories over the past three months,’ the central bank said… The fraction of banks easing standards for business loans was described as ‘relatively large.’”

Federal Reserve Watch:

May 7 – Bloomberg (Joshua Zumbrun and Craig Torres): “A group of bankers that advises the Federal Reserve’s Board of Governors has warned that farmland prices are inflating ‘a bubble’ and growth in student-loan debt has ‘parallels to the housing crisis.’ …Their alarm adds to a debate on the Federal Open Market Committee about whether the benefits from their monthly purchases of $85 billion in bonds outweigh the risk of financial instability. While Chairman Ben S. Bernanke has argued the program is worth pursuing, Fed Governor Jeremy Stein and Kansas City Fed President Esther George are among those who have voiced concerns that an extended period of low interest rates is heightening the risk of asset bubbles. ‘Agricultural land prices are veering further from what makes sense,’ according to minutes of the council’s Feb. 8 gathering. ‘Members believe the run-up in agriculture land prices is a bubble resulting from persistently low interest rates.’”

May 8 – Bloomberg (Jeff Kearns and Aki Ito): “Federal Reserve Bank of Dallas President Richard Fisher said the Fed needs to set a limit on the size of its assets, and that he favors reducing purchases of mortgage-backed securities in any tapering of bond-buying. ‘There somewhere have to be practicable limits in terms of how far we build our balance sheet,’ Fisher said… ‘We’re moving in the direction of having a $4 trillion balance sheet so we know we can’t go on forever… ‘We’ve had a rebound in housing,’ Fisher… said of the impact from Fed purchases of mortgage bonds. ‘It’s done its job and we’re at risk of overkill. And we’re accumulating so much, the question is what do we do with it?’”

Fiscal Watch:

May 9 – Bloomberg (Gregory Mott): “Fannie Mae, the mortgage-financier seized by U.S. regulators in 2008, will pay the Treasury Department $59.4 billion after reporting a first-quarter profit driven by rising home prices and declining delinquencies. The government-sponsored enterprise, which is operating under U.S. conservatorship, had net income of $8.1 billion for the three-month period that ended March 31… The… company had net worth of $62.4 billion, and is required to turn over to Treasury everything above $3 billion. Fannie Mae’s net worth was boosted by release of a valuation allowance on deferred-tax assets…”

Central Bank Watch:

May 6 – Bloomberg (Jana Randow and Lorenzo Totaro): “European Central Bank President Mario Draghi said policy makers are ready to cut interest rates again if needed after reducing them to a record low last week. ‘We will be looking at all the data that arrives from the euro-area economy in the coming weeks and if necessary, we are ready to act again,’ Draghi said… ‘Monetary policy will remain accommodative.”

May 8 – Bloomberg (Jeff Black and Jana Randow): “European Central Bank Executive Board member Yves Mersch said interest-rate reductions become more ineffective as they approach zero. ‘The closer we get to zero, the bigger the inefficiency of a further rate cut,’ Mersch said… The ECB isn’t a ‘toothless tiger’ and will use ‘tools that are appropriate to the situation… We will perhaps securitize these loans so that banks in countries with surpluses can lend without fear that it won’t be paid back,’ Mersch said. ‘This is something we can’t do from one day to the next, at the push of a button.’”

Global Bubble Watch:

May 9 – Bloomberg (Simon Kennedy and Jennifer Ryan): “Global central bankers are poised to ease monetary policy even further after a wave of interest-rate cuts from India to Poland. As Group of Seven finance chiefs gather in the U.K. tomorrow, economists at Morgan Stanley and Credit Suisse Group AG are among those predicting policy makers will keep deploying stimulus amid weak global growth, slowing inflation and the need to thwart currency gains. ‘Most central banks in our coverage universe still have a bias to ease,’ Morgan Stanley economists led by… Joachim Fels said… ‘Given this disposition, it doesn’t take much in terms of downside surprises in growth or inflation to tip the balance for more central banks to pull the trigger for more easing.’ South Korea’s rate cut today was the 511th reduction worldwide since June 2007, according to Bank of America Corp.’s tally. While the tide of liquidity has sent stock markets surging, it has yet to prove as effective in generating economic growth.”

May 7 – Bloomberg (Sarika Gangar and Sridhar Natarajan): “JPMorgan… increased its forecast for issuance of junk bonds and leveraged loans by $250 billion… Companies will raise a record $500 billion this year in the loan market, up from a previous estimate of $300 billion, the bank’s top-ranked strategists led by Peter Acciavatti… wrote… High-yield bond offerings will total $325 billion, versus an earlier forecast of $275 billion. Investors are embracing riskier assets as the Federal Reserve holds benchmark interest rates near zero for a fifth year, sending junk-bond yields to a record low 6.04%… ‘You have got an imbalance in the market,’ Alex Jackson… of the bank loan group at Cutwater Asset Management, said… ‘There is a lack of new supply and tremendous demand that is driving issuers’ ability to refinance everything.’”

May 8 – Bloomberg (Lisa Abramowicz, Miles Weiss and Christine Harper): “Hedge funds using debt-trading strategies honed on Wall Street are expanding at a record pace as they profit from risks big banks are no longer taking… Hedge-fund firms are hiring from companies such as Deutsche Bank AG, Barclays Plc and Bank of America Corp. as their credit funds have attracted $108 billion since 2009, data compiled by… Hedge Fund Research Inc. show. The flow of funds and people is taking place as regulators demand banks curb proprietary trading and back riskier wagers with more capital to prevent another financial crisis. That has allowed so-called shadow-banking firms to expand in businesses contracting at the largest lenders… ‘The regulatory posture in the U.S. and in Europe is unequivocal: They want to transfer risk to the shadow-banking system,’ said Roy Smith, a finance professor at New York University’s Stern School of Business and former Goldman Sachs Group Inc. partner.”

May 10 – Bloomberg (Mary Childs): “Bearish investors are retreating from derivatives used to protect against corporate-bond losses, sending the cost of insurance to the lowest since 2007 as a central bank-fueled rally extends into a fifth year. The Markit CDX North American Investment Grade Index fell this week to as low as 68.3 bps, the least since Nov. 1, 2007… The credit- default swaps benchmark has dropped 19.9 bps since the end of March and is down from a peak of 280 in 2008. Rather than a referendum on credit quality, the drop is a byproduct of the $2.3 trillion that the Federal Reserve has pumped into the financial system since 2008, allowing even the riskiest borrowers to obtain financing. With easy access to capital, Moody’s… is projecting the global default rate for speculative-grade companies will fall to 2.5% by April 2014.”

May 9 – Bloomberg (Cordell Eddings): “Central banks and commercial lenders are crowding investors out of bond markets, pushing yields to record lows even as the amount of debt worldwide grows. Investors from pension funds to insurers hold 45% of the debt in Barclays Plc’s Multiverse Bond Index, below the average of 60% since 2002… At the same time, the share held by central banks and commercial lenders climbed to 55%. The value of debt in the index has soared 52% to $44.6 trillion since 2008. Unprecedented stimulus from the Federal Reserve to the Bank of Japan to boost the world’s economy and purchases by lenders complying with toughened capital rules are leaving investors with a smaller slice of the market.”

May 9 – Bloomberg (Julie Miecamp): “Less than a year after Eircom Group wrote down 1.8 billion euros ($2.37bn) of debt, the Irish phone company is back in the bond market seeking to borrow. Fundraising by Europe’s riskiest companies is accelerating as issuers take advantage of record-low borrowing costs and investor appetite for high-yielding assets… Kloeckner and KCA are among 12 borrowers that sold almost 6 billion euros of bonds ranked B or below last week, the busiest period of issuance for notes with those ratings since at least the start of 2011… The average yield on the securities has dropped to a record 6.46% from an all-time high of 30.7% in November 2008… ‘Issuers are refinancing their loans with cheap bonds,’ said Steven Mitra… at LNG Capital LLP. ‘The quality of deal issuance has deteriorated significantly across the board in this last flurry of issuers that have come to the market.’”

May 10 – Dow Jones (Alexandra Scaggs and Steven Russolillo): “Small investors are borrowing against their portfolios at a rapid clip, reaching levels of debt not seen since the financial crisis. The trend—driven by a combination of rising stock values and rock-bottom interest rates—is sparking a growing debate among market watchers… As of the end of March… investors had $379.5 billion of margin debt at New York Stock Exchange member firms… That is just shy of the record $381.4 billion in margin debt set in July 2007. In March, the level of margin debt stood 28% higher than one year earlier…”

Global Credit Watch:

May 8 – Bloomberg (Sridhar Natarajan): “Yields on junk-rated corporate bonds have fallen below loans that rank higher in the capital structure by the most ever, underscoring the anomalies being created by the Federal Reserve’s unprecedented monetary policies. At about 5.08%, yields on speculative-grade bonds are 51 bps less than rates on U.S. leveraged loans… Before this year, creditors had almost never accepted lower payments on junk bonds over loans, which get repaid first in a bankruptcy. Concerns that credit markets are overheating are rising as the Fed, which has pumped about $2.5 trillion into the financial system since the financial crisis, keeps its benchmark rate at about zero for a fifth year… ‘Junk-bond yields are in freefall, and every time that is pointed out, you look like an alarmist,’ Martin Fridson, chief executive officer of… FridsonVision LLC, said… ‘People think it’s okay as long as they are the first ones out when things change direction. Of course, everybody is not going to be the first one out.’”

China Bubble Watch:

May 10 – Bloomberg: “China’s new local-currency loans exceeded estimates last month while money supply expanded at a faster pace, as policy makers maintained credit support for the economy after first-quarter growth unexpectedly slowed. Lending was 792.9 billion yuan ($129bn) in April… That compares with the median estimate of 755 billion yuan… and 1.06 trillion yuan in March. M2 money supply rose 16.1% from a year earlier. Aggregate financing, a broader measure of credit, was 1.75 trillion yuan compared with a record 2.54 trillion yuan in March.”

May 8 – Bloomberg: “China’s export growth unexpectedly accelerated in April even as shipments to the U.S. and Europe fell, spurring Bank of America Corp. and Mizuho Securities Co. analysts to say the figures were inflated by fake reports. The 14.7% increase… was led by a 57.2% jump in shipments to Hong Kong that highlighted suspicions of false transactions used to mask capital flows into China… Today’s report showed a 0.1% drop in U.S. shipments and 6.4% decline in exports to the European Union.”

May 9 – Bloomberg: “China’s passenger-vehicle sales rose 13% in April on rising demand for new models in the world’s biggest vehicle market. Wholesale deliveries of cars, multipurpose and sport-utility vehicles climbed to 1.44 million units in April…”

May 8 – Bloomberg: “China refused to confirm that Okinawa belongs to Japan after two Chinese scholars suggested re-examining the ownership of the archipelago that includes the island, adding to tensions over a separate territorial dispute. Agreements between allied forces during World War II mean the ownership of the Ryukyu Islands may be in question, the researchers said… Asked if China considers Okinawa part of Japan, Foreign Ministry spokeswoman Hua Chunying said scholars have long studied the history of the Ryukyus and Okinawa. ‘It may be time to revisit the unresolved historical issue of the Ryukyu Islands,’ Zhang Haipeng and Li Guoqiang of the China Academy of Social Sciences wrote…”

May 7 – AFP: “China has sent one of its largest recorded fishing fleets to disputed islands in the South China Sea, state-run media said… amid tensions over Beijing’s assertion of its claims in the region. A flotilla including 30 fishing vessels set sail for the Spratly Islands, an archipelago claimed by China and other countries including Vietnam and the Philippines… The fleet left China’s southern province of Hainan for a 40-day trip to the region and includes two large transport and supply ships… China will make ‘every effort to guarantee the fleet’s safety,’ the report quoted an official from the department of ocean and fisheries as saying.”

Asia Bubble Watch:

May 6 – Bloomberg (Rachel Evans, Foster Wong and Kristine Aquino): “Cnooc Ltd.’s $4 billion bond sale marks the biggest defeat for the Chinese corporate dollar loan market as companies sell six times more notes in the U.S. currency this year to refinance debt… Chinese and Hong Kong issuers sold $18.8 billion of dollar- denominated bonds to refinance debt this year, more than six times similar issuance for the same period last year…”

Europe Watch:

May 6 – Bloomberg James Hertling): “French Finance Minister Pierre Moscovici declared the era of austerity over after his German counterpart offered flexibility on deficit cutting amid renewed bickering between Europe’s two biggest economies. ‘We’re witnessing the end of the dogma of austerity’ as the only tool to fight the euro debt crisis, Moscovici said… ‘We’ve been pleading for a growth policy for a year. Austerity on its own impedes growth.’”

May 7 – Bloomberg (Mark Deen): “French industrial output fell in March as President Francois Hollande struggled to keep Europe’s second-largest economy from falling into recession for the third time in four years. Production dropped 0.9% after climbing a revised 0.8% in February… ‘Business surveys continue to point to a contraction in industrial activity,’ said Pierre-Olivier Beffy, chief economist at Exane BNP Paribas… ‘Investment is due to decline further given poor confidence and low corporate margins.’”

May 6 – Bloomberg (Jones Hayden): “European services output shrank for a 15th month in April as the 17-nation currency bloc struggles to emerge from a recession.”

Italy Watch:

May 6 – Bloomberg (Lorenzo Totaro): “Italy’s economy will shrink this year more than the European Commission estimates as weak domestic demand and investment extend the country’s longest recession in more than two decades… Gross domestic product will decline 1.4% in 2013 before rising 0.7% next year, Rome-based Istat said… Household consumption and corporate investments will both decline this year.”

May 7 – Bloomberg (Alessandra Migliaccio, Chiara Vasarri and Dalia Fahmy): “Yasemin Rosenmaier has been selling homes in northern Italy since 2005 and she’s finding that there’s never been a better time to work for a German broker. ‘I’d say 60% of our closings are with Germans, which is much higher than in previous years,’ Rosenmaier said… from her Engel & Voelkers office in Cernobbio on Lake Como. ‘Why? Fear of inflation, the uncertainty on the financial markets, fear of what happened in Cyprus,’ the latest European country to get an international bailout. Foreign investment in Italian holiday properties is rising as Germans, Britons and Russians take advantage of a market where locals are struggling to purchase even a first home.”

Germany Watch:

May 10 – Bloomberg (Simon Kennedy and Rainer Buergin): “German Finance Minister Wolfgang Schaeuble signaled support for an easing of Europe’s austerity drive as he prepared to face pressure from global counterparts to do more to spur growth. On the eve of a meeting of Group of Seven finance ministers and central bankers in the U.K., Schaeuble told a conference… there’s ‘enough room to maneuver’ for euro-area governments to respond to the currency bloc’s recession. Such comments reflect the recent shift in stance from Europe’s powerhouse economy, which had previously hailed austerity as the main route to prosperity for the debt-strapped region.”

May 6 – Bloomberg (Jeff Black and Jana Randow): “German Finance Minister Wolfgang Schaeuble said the money to pay for the resolution of troubled European Union banks won’t come from a single pool until decision-making powers in the bloc are more centralized. Germany instead seeks a ‘network’ of national resolution authorities and backstop funds to deal with crisis-hit banks in the euro area, Schaeuble said… The resolution facility ‘can’t just be a European fund,’ Schaeuble said. ‘Because the European fund has to be fed by someone. And if we mutualize liability without fully mutualizing the decision-making power, we create the wrong incentive again. Therefore we’ll have to get by with a network in the first stage, or focus on a network, as long as we haven’t created further institutional improvements.’”

May 7 – Bloomberg (Rainer Buergin): “German Finance Minister Wolfgang Schaeuble said he’s worried about Germany’s image in Europe, as he signaled a readiness to listen to others on efforts to overcome the region’s economic troubles. Schaeuble, addressing students in Berlin today alongside French Finance Minister Pierre Moscovici, said they both agree on the need to hasten banking union and that no one country has a monopoly on how to resolve Europe’s woes. It’s ‘good’ that Germans show compassion for countries in southern Europe that are shouldering record youth unemployment, Schaeuble said. ‘It’s not the case in Europe, never, that some know it all and the others don’t,’ Schaeuble said.”

“Bubbles are at their core about a self-reinforcing over-issuance of mispriced finance. Major market misperceptions are integral to fueling Bubbles – and these misperceptions are often associated with some form of government support/backing of the underlying Credit financing the boom.”

Tepper stokes the melt-up: “I am definitely bullish. The budget deficit is shrinking massively. Guys who are short, they better have a shovel to get out of the grave.” Hedge fund manager David Tepper, CNBC, May 14, 2013

Mr. Tepper has every reason to be euphoric. His $7bn estimated net worth places him #53 on the Forbes U.S. Billionaires list (and ascending briskly). Few have profited more from central bank monetary largess and attendant asset inflation. Few are currently benefiting as much from the Fed’s $85bn monthly quantitative easing program.

I’ll view Tepper’s Tuesday CNBC appearance as confirmation of the U.S. stock market officially attaining “Financial Euphoria.” So it’s not an inopportune time to reread John Kenneth Galbraith’s little gem “A Short History of Financial Euphoria.” There is a long history of manias and, as Galbraith points out, there are common themes and common conclusions.

The commonly accepted view sees manias as episodes of irrational crowd behavior (i.e. a bunch of lunatics running around trading tulip bulbs). Mr. Galbraith sees the “mass escape from sanity by people in pursuit of profit.” Fair enough, though I tend to view perfectly rational behavior as the more typical yet unappreciated theme of major financial Bubbles. Bouts of irrationality would be far less dangerous.  

Sure, speculative episodes do in fact appear irrational; though, I would argue, mostly in hindsight. Mr. Tepper doesn’t seem to be a raving mad speculator. Now a full-fledged market legend of our gilded age, Tepper is a bit manic, sort of annoying, incredibly successful at speculating and definitely rational. He and those of his fortunate ilk are at the precipice of potentially adding billions more to their colossal treasure troves. And what if they’re wrong about the markets and the all-powerful cadre of global central banks? Well, they could lose an enormous amount of money and survive with more than ample resources for the “good life” (with, perhaps, fewer collectables and trophy properties). The point is, at this stage of a long inflationary asset market boom, it’s perfectly rational to double-down with the “house’s money” and play for the spectacular big win. They’re just electronic chips, for heaven’s sake.

Today, with markets at all-time highs, Tepper exudes unequivocal financial genius. Having enjoyed years to master their craft, it’s perfectly rational for the successful market operators these days to use this bout of unprecedented ultra-loose finance and government backstops to accumulate as much financial wealth as possible. That’s the norm for speculators going back centuries. It’s worth noting, however, that when filthy rich market speculators were in the past celebrated for their brilliance and extraordinary market acumen – well, it proved a decent juncture to start worrying about the future. This spectacular cycle of speculator wealth accumulation has been going on for so long now that everyone has simply stopped worrying.

Understanding the dynamics of market euphoria and crowd behavior remain a fascinating and worthwhile endeavor. From an analytical perspective, however, I’ve always focused more on the finance underpinning the boom. Show me a manic Bubble period in the markets and I’ll show you underlying monetary disorder. And perhaps it’s easy to see and perhaps it’s not. And throughout about every historic Bubble episode, there inevitably reaches a manic point of Financial Euphoria that corresponds to an unsustainable manic expansion of suspect finance. Financial Euphoria and unstable finance make dicey bedfellows.

Euphoria has reached the point where the markets have become largely immune to bad news and negative fundamental developments. Actually, negatives are nowadays welcomed to the party. On a macro basis, weak economic data ensures a longer period of aggressive global monetary stimulus. On a micro stock basis, deteriorating fundamentals equate with larger short positions. And right now, nothing has the equities markets more ebullient than squeezing the shorts. No reason to fret stagnant earnings, a stronger dollar, faltering global growth and myriad developments that could bring this party to a rapid conclusion.

Yet bullish market pundits these days argue that market speculation has not yet reached dangerous levels. Some admit to “pockets of froth.” “No sign of public exuberance.” Heck, the public hasn’t even succumbed yet. Market excess is “certainly not at 1999 levels.”

Well, one has to go all be way back to 1999 for an environment so rife with short squeezes. Indeed, no game in the markets these days is as remotely profitable as buying heavily shorted stocks and forcing the shorts to buy back their borrowed shares (and bonds?) at higher prices. Squeezing shorts has become the hot topic on day-trading discussion boards. It has become popular sport throughout the leveraged speculating community. And I suspect that buying baskets of heavily shorted stocks has become a hot venue for algorithmic (“algo”) trading. Why not just buy a basket of heavily shorted stocks at the open and then gun the S&P futures?

Short squeezes can play a major role in destabilizing markets – equities and fixed income. On the one hand, widespread buying (short covering) provides a powerful boost to marketplace liquidity. This is the proverbial “throwing gas on a fire” – for markets already gorging on liquidity and speculative excess. As for market psychology, having the bears on the run helps jolt sentiment past optimism to exuberance and then Euphoria. With the depleted bears largely out of the way, a potential source of selling pressure is removed from the marketplace. And as market dislocations see an increasing number of stocks experience spikes and upside gaps, long sellers are prone to think twice before selling. A short seller panic and attendant sellers’ strike is the stuff of Financial Euphoria.

Why did Nasdaq collapse in 2000? Because of several years of excess that culminated in a historic market squeeze and speculative free-for-all in 1999. It’s “funny” how market dynamics work. With industry fundamentals turning increasingly problematic in 1999 and stock prices diverging markedly from underlying fundamentals, short positions were expanding. But in the post-LTCM bailout backdrop the Fed was incentivizing long-side speculation, while impairing the bears.

With short positions in “weak hands,” a Fed-induced market rally evolved into a powerful short squeeze and precarious bout of Financial Euphoria. Along the way, myriad hedging strategies combined with leveraged long-side speculation in a bustling derivatives marketplace. As the market broke loose on the upside, those on the wrong side of derivative trades were forced to buy stocks into a frantically advancing market.

Deteriorating fundamentals were easily disregarded, as stocks marched ever higher on an almost daily basis. When the speculative Bubble eventually burst, the crisis of confidence in the market was exacerbated by virtually collapsing fundamentals. The gulf that had widened dramatically during Financial Euphoria was quickly rectified by a panic collapse in stock prices.

Abruptly, buyers disappeared and sellers were left wondering how the liquidity backdrop had been so transformed almost overnight. Well, the liquidity surge from short squeezes and panic covering had set the stage for payback time. Derivatives trading that had helped fuel market melt-up suddenly was fueling meltdown. And as it has accomplished so often in history, Financial Euphoria ensured that virtually everyone found themselves with too much long (not enough short) exposure come the inevitable abrupt market reversal. The technology stock crash was then exacerbated by shorts pouncing on what were clearly unsustainable stock prices and a bursting industry Bubble.

Investors, the equities marketplace, corporate debt, the technology industry and the U.S. economy were in a much weaker position because of 1999 market Euphoria. And at risk of blasphemy, it’s worth noting that some of the most sophisticated market operators were punished by a Bubble that had somehow burst prematurely.

I don’t mean to imply that today’s environment is comparable to 1999. The U.S. economy was sounder in 1999 – and the global economy was a whole lot more stable. Global imbalances in 1999 were insignificant compared to the present. The U.S. economic and Credit systems had yet to be degraded by a doubling of mortgage debt and a massive misallocation of resources. The federal government hadn’t doubled its debt load in four years. Europe had not yet terribly impaired itself with a decade of runaway non-productive debt growth. China and the “developing” economies had not yet succumbed to historic Credit booms, overinvestment and economic maladjustment. Central banks hadn’t yet resorted to really dangerous measures.

In “A Short History…,” Galbraith so eloquently describes the rebuke and vitriol lavished upon naysayers during periods of Financial Euphoria. These are the despicable folks who not only dare to challenge conventional wisdom – they simply refuse to accept that they’ve categorically been proven wrong. I will temporarily remove the dunce cap and calmly place it over in the corner – and then move to explain that I see nothing in this environment inconsistent with my view that this is the biggest, most precarious Bubble in history.

I’ve briefly addressed excesses that led to the 2000 collapse. Well, there’s a bevy of relatively recent (from a historical perspective) booms and busts to compare to: the stock market crash of 1987; the late-eighties Japanese Bubble; the 1992/3 bond Bubble; Mexico; SE Asia; Russia; Argentina, Brazil and Latin America; Iceland; U.S. mortgage finance; European debt, etc. Nothing, however, even remotely compares to the current global Bubble environment.

From my perspective, the global nature of excesses and fragilities is the most worrying aspect to the current Financial Euphoria. Essentially, the entire world faces acute financial and economic instability. The entire world suffers from a widening gulf between inflating asset prices and mounting economic vulnerabilities. Seemingly the entire world suffers from an increasingly protracted period of near-zero rates, aggressive central bank monetary stimulus and a desperate search for market returns. The entire global financial “system” is an over-liquefied speculative Bubble – stoked by central bankers responding desperately to acute financial and economic fragilities.

As noted above, find a speculative Bubble and there will be an underlying source of monetary disorder. From my perspective, Bubbles are at their core about a self-reinforcing over-issuance of mispriced finance. Major market misperceptions are integral to fueling Bubbles – and these misperceptions are often associated with some form of government support/backing of the underlying Credit financing the boom.

These days, the dynamic of over-issued, mispriced finance is a global phenomenon – the U.S., Europe, Japan, China, Asia and the “developing” economies. The perception that central bankers will ensure ongoing asset inflation is an unprecedented global phenomenon. The collapse in yields and risk premiums in debt markets across the globe is unlike anything I’ve ever witnessed or studied historically.

These days, asset inflation, speculation and Bubbles prevail virtually everywhere. Moreover, the gulfs between inflating assets and weakening economic fundamentals seemingly widen everywhere, as Financial Euphoria engulfs debt and equity securities markets around the world. As noted this week by the great market watcher and historian Art Cashin: This market is unlike anything we’ve ever experienced.

“History is replete with examples of how once the printing presses get revved up there’s no turning them down…”

“The contemporary electronic “printing press” is an altogether different animal [vs." traditional printing press inflation"]. It essentially feeds liquidity directly into the financial markets – first and foremost inflating securities prices. There is little generalized inflation…[A]sset inflation and Bubbles potentially have significantly more pernicious effects than traditional consumer price inflation.”

Indicators of serious market excess abound.

The yen was hit for 2.6% this week, with the dollar/yen breaking above 100 to the highest level since 2008. Gold was down 1.5%, silver 1.5%, and platinum 2.0%. Japan’s Nikkei jumped 6.7%, increasing 2013 gains to 40.5%. Japan’s 10-year government bond (JGB) yield jumped 13 bps to the highest level since February, as sovereign yields generally moved higher across the globe. Global equities generally added to recent gains. Meanwhile, currency markets have turned increasingly unsettled. The dollar index gained 1.2%. So called “commodities currencies” came under pressure. The South African rand fell 2.3%. The Australian dollar dropped 2.9%, falling below parity to the U.S. dollar for the first time in almost a year. The New Zealand dollar sank 2.7%. Other notable currency declines this week included the Swiss franc down 2.2%, the Indian rupee down 1.6%, and the Russian ruble 1.2% lower.

May 9 – Bloomberg (Simon Kennedy and Jennifer Ryan): “Global central bankers are poised to ease monetary policy even further after a wave of interest-rate cuts from India to Poland. As Group of Seven finance chiefs gather in the U.K. tomorrow, economists at Morgan Stanley and Credit Suisse Group AG are among those predicting policy makers will keep deploying stimulus amid weak global growth, slowing inflation and the need to thwart currency gains. ‘Most central banks in our coverage universe still have a bias to ease,’ Morgan Stanley economists led by… Joachim Fels said… ‘South Korea’s rate cut today was the 511th reduction worldwide since June 2007… While the tide of liquidity has sent stock markets surging, it has yet to prove as effective in generating economic growth. ‘Central banks are our best friends not because they like markets, but because they can only get to their macro objectives by going through the markets,’ Mohamed El-Erian, chief executive officer at Pacific Investment Management… said.”

Global central banks around the world continue to push monetary easing like never before. The Fed and Bank of Japan currently combine for almost $180bn of monthly quantitative easing, an historic experiment in monetary inflation. And as economies respond little to unprecedented monetary stimulus, global central banks resort to only more dramatic measures. In the face of virtually unlimited global liquidity, commodities prices trade poorly. It seems an appropriate market juncture to take a little deeper dive into contemporary “money printing.”  

To set the analytical backdrop, keep in mind core facets of my Global Credit Bubble thesis. First, the world is in the midst of a unique episode of unconstrained Credit on a global basis. There are today essentially no limits to either the quantity or the quality of debt issued, which I see as a multi-decade experiment in unanchored global electronic “money” and Credit.

Importantly, the evolution to non-bank marketable debt accelerated rapidly during the nineties. Facing an impaired banking system early in the decade, the Greenspan Fed accommodated an explosion of securitized lending, derivatives, securities finance and leveraged speculation. As financial Bubbles took root, Fed doctrine increasingly gravitated to backstopping vulnerable securities markets. In the process, monetary policy came to heavily incentivize financial speculation. As the world’s leading market – and the dominating central bank of the world’s “reserve currency” – U.S. financial and policy trends rapidly spread around the globe. Massive U.S. current account deficits, dollar devaluation and limitless liquidity for speculation helped export the U.S. Credit Bubble to financial and economic systems everywhere.

Predictably, a prolonged global Credit boom spurred epic imbalances and wreaked havoc on economic structures. Inflationary impacts have been uneven and notably disparate. Throughout Europe, years of maladjustment have created highly indebted, wealth-deficient economies dependent upon the ongoing expansion of non-productive Credit. In China and throughout Asia, unending Credit expansion and massive “hot money” flows have fueled an historic boom in manufacturing capacity (basic goods and technology). Especially since the post-2008 stimulus free-for-all, overheated “developing” Credit systems and economies have created acute vulnerabilities to any Credit slowdown, general tightening of finance or reversal of “hot money” flows.

In the U.S., many years of easy “money” and unstable Credit engendered an experimental consumption and services-based economic structure – along with an asset-inflation prone financial sector. As the U.S. deindustrialized and inflated Credit, massive global imbalances accumulated on an annual basis in the rapidly industrializing Chinese and “developing” economies. The Fed’s most recent QE measures ensured U.S. economic and financial systems develop an only more acute dependency on ultra-loose monetary conditions. Aggressive QE also ensured yet another bout of destabilizing financial flows for our Bubble cohorts in China and “developing” Asia.

In Japan, decades of loose monetary policy have accommodated an astonishing buildup in government debt. While different countries and regions suffer divergent ill-effects, financial and economic systems everywhere are today dependent on uninterrupted aggressive monetary stimulus. One would have to go back to the 1920’s to see any comparable period with such extreme maladjustment and imbalances on a global basis.

Over the years, I’ve remained focused on that nature of monetary inflations. In particular, there is the powerful dynamic whereby policymakers fall prey to the inflationary expedient – and they invariably find it impossible to break free. History is replete with examples of how once the printing presses gets revved up there’s no turning them down: the presses inevitably run for more hours – and when there become insufficient hours in the day the presses seamlessly shift to cranking out currency with additional zeros.

Yet each monetary inflation has its own dynamics and nuances. These days, we’re dealing with central banks and their electronic “printing press” – injecting liquidity into the marketplace as these banks acquire marketable debt securities (monetization). After a number of years of quantitative easing, we’re beginning to gain a better understanding of how these electronic printing presses actually operate.

The traditional printing press inflation worked generally to disburse currency throughout the real economy. Such currency devaluations would work to inflate prices generally, in the process reducing real purchasing power (nominal currency units buy less). This inflation would work to raise interest rates and impinge investment, while also working to boost wage demands throughout the economy. Inflation’s myriad negative effects would devalue the currency, especially on the foreign exchange market.

The contemporary electronic “printing press” is an altogether different animal. It essentially feeds liquidity directly into the financial markets – first and foremost inflating securities prices. There is little generalized inflation in nominal purchasing power, hence in prices throughout the real economy. Indeed, abundant marketplace liquidity actually works (unevenly) to stimulate investment. And with consumer prices in aggregate seemingly well contained, most will find justification for quite elevated stock and bond prices. And as securities markets boom and traditional inflationary risks stay seemingly nonexistent, one is easily enamored with the central banks’ new electronic toys.

It’s my view that asset inflation and Bubbles potentially have significantly more pernicious effects than traditional consumer price inflation. I would definitely argue that consumer price inflation is easier for central banks to rectify. As such, the electronic version is proving itself a more dangerous tool than the traditional currency printing press. In the end, asset market Bubbles are vehicles for wealth redistribution, resource misallocation and wealth destruction, although these heavy burdens remain masked by the boom-time perception of wealth creation and abundance.

The traditional overheated printing press worked to devalue currencies. How about the electronic version? Notably, gold and many commodity prices have been under pressure in the face of recent unprecedented QE. In one sense, an argument could be made that contemporary central bank “money printing” inflates debt and equities prices and, in effect, seemingly inflates the value of some currencies. Indeed, QE has significantly inflated tens of Trillions of U.S. stocks and fixed-income securities. In somewhat of a replay of late-nineties “king dollar” dynamic, the Federal Reserve’s market support operations have provided a competitive advantage to U.S. markets and, hence, the U.S. dollar. Essentially, Fed monetary inflation coupled with a financial mania is currently inflating U.S. securities markets relative to gold and commodities. This speculative dynamic is increasingly pressuring the “global reflation trade” more generally.

Traditional printing press or the newfangled version, monetary inflations always have unintended consequences. Incentivizing speculation is a prominent flaw in current (inflationist) central bank doctrine. And the larger and longer that speculative Bubbles are nurtured, the more precarious they become. This is a major part of the trap that global central bankers have fallen into. And the more fragile maladjusted global economies become the more aggressively they resort to the electronic printing press. The upshot has been increasingly unstable market Bubbles on a globalized basis – which translates into only greater systemic fragilities.

Highly speculative markets become really unpredictable affairs. Greed, fear and gamesmanship take over. Short squeezes, dislocations and melt-ups wreak havoc with market stability. “Greater fool” dynamics take on a life of their own. And never has there been such a massive pool of highly sophisticated speculative finance seeking to extract wealth from an equally massive pool of unsophisticated “money” searching for markets returns – on a global basis. On the one hand, years of manipulated interest rates, markets backstops and interventions ensured that sophisticated market operators accumulated astronomical wealth and assets under management. And, going on five years now, Fed zero interest rate policy has pushed the unsuspecting saver out into the risk market jungle.

To attempt to return to some semblance of monetary stability, the Fed and global central banks should be moving forcefully to remove excess market liquidity and dampen speculation. But instead of removing accommodation, the electronic printing press is providing highly speculative and unstable global markets with incredible amounts of additional liquidity.

More recently, Bank of Japan policymaking has set loose a major yen devaluation. This has opened the flood gates to God only knows how much “money” from Japanese institutions and retail investors – not to mention hot “carry trades” which sell yen instruments to speculate in securities markets around the world.

The way things have been shaping up, the Abe yen devaluation play could provide one of history’s most bountiful speculative forays. Actually, 2013 has all the makings for a historic year in speculative finance – a proliferation of global market Bubbles providing opportunities to make fortunes – that is, if gains can be retained throughout the year. On CNBC and elsewhere the airwaves are filled with bullish analysis. What I don’t see is discussion of what I see on my Bloomberg screens: wild and increasingly unstable markets dominated by speculation.

I see heightened instability in the currency and commodities markets, where yen weakness and dollar strength are feeding extraordinary marketplace uncertainties. In unsettled commodities markets, general weakness coupled with the potential for a dollar upside lurch has created uncertainty and instability. In bonds and throughout global fixed income, a historic issuance boom at record low yields – especially in the riskiest segments of the marketplace – is indicative of late-cycle froth now conspicuous throughout global Credit markets.

In equities markets, well, speculative dynamics have taken full command. The bears have been squeezed into oblivion, with a dearth of selling pressure now allowing speculators to easily push prices higher. Bringing back memories of 1999, heavily shorted Tesla Motors was up 41% this week and Green Mountain Coffee jumped 33%. It was a week where I was again contemplating “how crazy could things get?”

The Fed and global bankers should never have become such active players in the financial markets. Asset inflation is indeed more dangerous than consumer price inflation. Central banks will actively support asset prices, while refusing to remove the punchbowl. At all costs, Chairman Bernanke will avoid being a Bubble Popper. And when you read his comments from Friday morning (below), keep in mind that as Bubbles become more systemic they actually become less conspicuous. Today, Bubbles proliferate throughout the securities and asset markets. It’s all become one big historic global Bubble. Yet the Bernanke Fed won’t even begin tapering its $85bn monthly “money printing” operation in the midst of increasingly conspicuous market excesses.

Federal Reserve Bank of Chicago President Charles Evans: “You talked about monitoring markets at great length. A major cause of the recent financial crisis was the failure to identify the housing bubble, and you spoke on that. Could you expand a little bit more on what’s being done to identify current and future asset bubbles, and are you optimistic that we’ve identified them and nothing like that is going on at the moment?”

Chairman Bernanke: “Well, our monitoring — there’s really two parts to it. So the first is that we do, in fact, do what we can to try — I would say the word ‘bubbles’ is a freighted word. And let me just say we try to identify situations where asset valuations relative to fundamentals are historically anomalous, where, for example, in the case of housing, we would have seen house prices relative to rents as being much higher than historically normal.

So we have an extensive program to try to assess whether major asset classes are in fact within historically normal ranges… In the stocks and equities, we look at dividend rates and earnings and the equity premium, those various kinds of standard finance indicators. In corporate debt, we look at measures that would help us assess the amount of default risk and therefore to assess whether spreads are appropriate or not. In more complex instruments like structured credit products, we look at a variety of things, including the terms and conditions. Are we seeing, for example, as we are in some cases, covenant-lite types of agreements in certain kinds of structured credit products. So we do try to identify, much more so than in the past, whether major asset classes are deviating in terms of their price or valuation from historical norms.

Now, that being said, two comments. One is that I think it would be hubristic to believe that we could always identify such deviations. On the one hand, sometimes changes in price-to-earnings ratios are justified by some fundamentals. You know, Microsoft stock is worth more than it was some time ago, and this may still yet prove to be a bubble. But so far so good, right? At the same time — it’s not evident that having a misalignment or historically unusual relationship is a problem, though it may be. But of course, we can also miss changes in valuation that are, in some sense, not fundamentally justified.”

Selected Notes

May 9 – Wall Street Journal (Alex Frangos): “Central banks in Asia, Australia and New Zealand are ratcheting up moves to deal with an influx of capital that is keeping currencies strong and complicating efforts to manage growth. New Zealand’s central bank said Wednesday it intervened in foreign-exchange markets to blunt the rise of its currency and would continue to do so, a day after Australia’s central bank cut interest rates to a record low and noted the stubborn strength of the Australian dollar. Elsewhere, China is moving to curb bets on the rising yuan, while Thailand is considering efforts to curb the strongest baht since the 1997 Asian financial crisis.”

May 9 – Reuters (Luciana Lopez and Rodrigo Campos): “Wealthy money managers bashed Federal Reserve Chairman Ben Bernanke’s easy money policies at a closely watched annual investment conference… The Sohn Investment Conference, which raises money for pediatric cancer research, gets big name hedge fund managers to share their ‘best ideas’ with other wealthy investors. This year’s conference was sprinkled with criticisms of the Fed’s $85 billion in monthly purchases of Treasuries and mortgage securities… ‘Ben Bernanke is running the most inappropriate monetary policy in the history’ of the developed world, said Stanley Druckenmiller, the retired head of Duquesne Capital Management… Bernanke took a drubbing from the start, with the first speaker, Paul Singer, setting the tone. Singer… said the Fed’s monetary policies are distorting the prices of long-term bonds and the global recovery. ‘Everyone wants a safe haven… There is no such thing in today’s markets and that’s one of the elements of the distortion.’”

May 9 – Financial Times (Vivianne Rodrigues and Stephen Foley): “Global investors are venturing to the riskiest corners of the US corporate debt markets in greater numbers in a so-called dash for trash as the relentless search for higher yields shows no signs of abating. Bonds sold by companies with the lowest possible credit ratings have soared in popularity with investors, who have been diverted from top tier government and corporate debt where central banks are suppressing interest rates… Heavy buying has pushed down the average yield on CCC-rated bonds to 6.77% from 10.13% a year ago… ‘It’s a frenzy out there with these high yield bonds,’ said Jason Brady, a portfolio manager at Thornburg Investment Management. ‘We’ve been spending a lot of time trying to sort through an avalanche of new issuance which is, by and large, of terrible quality.”  

Money Notes:

One-month Treasury bill rates ended the week at one basis point and 3-month rates closed at four bps. Two-year government yields were up two bps to 0.24%. Five-year T-note yields ended the week nine bps higher to 0.82%. Ten-year yields jumped 16 bps to 1.90%. Long bond yields were up 14 bps to 3.10%. Benchmark Fannie MBS yields jumped 17 bps to 2.56%….

Italian 10-yr yields increased 7 bps to 3.89% (down 61bps y-t-d). Spain’s 10-year yields rose 16 bps to 4.18% (down 109bps). German bund yields jumped 14 bps to 1.38% (up 6bps), and French yields rose 13 bps to 1.95% (down 1bps). The French to German 10-year bond spread narrowed one to 57 bps. Ten-year Portuguese yields declined 3 bps to 5.38% (down 13bps). Greek 10-year note yields fell 19 bps to 9.36% (down 111bps). U.K. 10-year gilt yields were 17 bps higher at 1.89% (up 7bps)…

Freddie Mac 30-year fixed mortgage rates jumped 7 bps to 3.42% (down 41bps y-o-y). Fifteen-year fixed rates were up 5 bps to 2.61% (down 44bps). One-year ARM rates fell 3 bps to a 13-week low 2.53% (down 20bps). Bankrate’s survey of jumbo mortgage borrowing costs had 30-yr fixed rates up one basis point to 3.91% (down 47bps).

Federal Reserve Credit jumped $10.4bn to a record $3.276 TN. Fed Credit expanded $491bn over the past 31 weeks. Over the past year, Fed Credit expanded $431bn, or 15.2%.

Global central bank “international reserve assets” (excluding gold) – as tallied by Bloomberg – were up $629bn y-o-y, or 6.0%, to a record $11.102 TN. Over two years, reserves were $1.282 TN higher, for 13% growth.

M2 (narrow) “money” supply jumped $33.6bn to a record $10.535 TN. “Narrow money” expanded 6.5% ($645bn) over the past year.

Currency and ‘Currency War’ Watch:

May 8 – Bloomberg: “China’s central bank will resume bill sales for the first time in 17 months as overseas investors pump money into the country to take advantage of the yuan’s rise. The People’s Bank of China said it will issue 10 billion yuan ($1.6bn) of three-month notes… ‘Foreign capital inflows are too big,’ said Shi Lei… head of fixed-income research at Ping An Securities… ‘The central bank needs more tools to mop up excess liquidity.’”

May 7 – Bloomberg (Michael Heath): “The Reserve Bank of Australia cut its benchmark interest rate to a record low, driving down a currency that has damaged manufacturing and boosted unemployment. Governor Glenn Stevens reduced the overnight cash-rate target by a quarter percentage point to 2.75%, saying in a statement that the Aussie’s record strength ‘is unusual given the decline in export prices and interest rates.’”

May 9 – Bloomberg (Eunkyung Seo and Cynthia Kim): “The Bank of Korea cut interest rates, following the lead of policy makers in Australia, Europe and India this month, as strength in the won and weakness in the yen dim the outlook for the nation’s exports. Governor Kim Choong Soo and his board lowered the benchmark seven-day repurchase rate to 2.5% from 2.75%… As central banks around the world move to counter currency appreciation, the won’s 24% jump against the yen in six months is hampering South Korean exporters of autos and electronics and aiding their Japanese rivals. In Seoul, ruling New Frontier Party floor leader Lee Hahn Koo yesterday urged a ‘more active role’ for the BOK, adding to political pressure that the central bank resisted last month.”

The U.S. dollar index jumped 1.2% to 83.14 (up 4.2% y-t-d). For the week on the upside, the Norwegian krone increased 0.2%. For the week on the downside, the Australian dollar declined 2.9%, the New Zealand dollar 2.7%, the Japanese yen 2.6%, the South African rand 2.3%, the Swiss franc 2.2%, the Swedish krona 1.4%, the British pound 1.4%, the Danish krone 1.0%, the euro 1.0%, the South Korean won 0.8%, the Brazilian real 0.6%, the Taiwanese dollar 0.4%, the Singapore dollar 0.4%, the Canadian dollar 0.2%, and the Mexican peso 0.1%.

Commodities Watch:

The CRB index declined 0.5% this week (down 2.1% y-t-d). The Goldman Sachs Commodities Index slipped 0.3% (down 2.7%). Spot Gold fell 1.5% to $1,448 (down 13.6%). Silver was 1.5% lower to $23.66 (down 22%). June Crude dipped 43 cents to $96.04 (up 5%). June Gasoline was up 1.2% (up 4%), while June Natural Gas fell 3.2% (up 17%). July Copper gained 1.2% (down 8%). May Wheat fell 2.0% (down 10%), and May Corn declined 1.7% (down 1.5%).

U.S. Bubble Economy Watch:

May 9 – Bloomberg (Prashant Gopal): “Prices for single-family homes increased in 89% of U.S. cities in the first quarter as the housing market extends a recovery from a five-year slump. The median sales price rose from a year earlier in 133 of 150 metropolitan areas measured… A year earlier, 74 areas had gains… The national median price for an existing single-family home was $176,600 in the first quarter, up 11.3% from the same period last year. That was the biggest gain since the fourth quarter of 2005… ‘Some of the previously hard-hit markets like Phoenix, Sacramento and Miami continue to experience a dramatic turnaround, while a new set of areas like Atlanta, Minneapolis and Seattle have begun to show strong signs of upward momentum,’ Lawrence Yun, chief economist for the National Association of Realtors, said… At the end of the first quarter, 1.93 million previously owned homes were available for sale, 16.8% fewer than a year earlier…”

May 6 – Bloomberg (Joshua Zumbrun): “U.S. banks eased standards and terms on loans to businesses as commercial lending led a credit thaw, according to a Federal Reserve survey. ‘Domestic banks, on balance, reported having eased their lending standards and having experienced stronger demand in several loan categories over the past three months,’ the central bank said… The fraction of banks easing standards for business loans was described as ‘relatively large.’”

Federal Reserve Watch:

May 7 – Bloomberg (Joshua Zumbrun and Craig Torres): “A group of bankers that advises the Federal Reserve’s Board of Governors has warned that farmland prices are inflating ‘a bubble’ and growth in student-loan debt has ‘parallels to the housing crisis.’ …Their alarm adds to a debate on the Federal Open Market Committee about whether the benefits from their monthly purchases of $85 billion in bonds outweigh the risk of financial instability. While Chairman Ben S. Bernanke has argued the program is worth pursuing, Fed Governor Jeremy Stein and Kansas City Fed President Esther George are among those who have voiced concerns that an extended period of low interest rates is heightening the risk of asset bubbles. ‘Agricultural land prices are veering further from what makes sense,’ according to minutes of the council’s Feb. 8 gathering. ‘Members believe the run-up in agriculture land prices is a bubble resulting from persistently low interest rates.’”

May 8 – Bloomberg (Jeff Kearns and Aki Ito): “Federal Reserve Bank of Dallas President Richard Fisher said the Fed needs to set a limit on the size of its assets, and that he favors reducing purchases of mortgage-backed securities in any tapering of bond-buying. ‘There somewhere have to be practicable limits in terms of how far we build our balance sheet,’ Fisher said… ‘We’re moving in the direction of having a $4 trillion balance sheet so we know we can’t go on forever… ‘We’ve had a rebound in housing,’ Fisher… said of the impact from Fed purchases of mortgage bonds. ‘It’s done its job and we’re at risk of overkill. And we’re accumulating so much, the question is what do we do with it?’”

Fiscal Watch:

May 9 – Bloomberg (Gregory Mott): “Fannie Mae, the mortgage-financier seized by U.S. regulators in 2008, will pay the Treasury Department $59.4 billion after reporting a first-quarter profit driven by rising home prices and declining delinquencies. The government-sponsored enterprise, which is operating under U.S. conservatorship, had net income of $8.1 billion for the three-month period that ended March 31… The… company had net worth of $62.4 billion, and is required to turn over to Treasury everything above $3 billion. Fannie Mae’s net worth was boosted by release of a valuation allowance on deferred-tax assets…”

Central Bank Watch:

May 6 – Bloomberg (Jana Randow and Lorenzo Totaro): “European Central Bank President Mario Draghi said policy makers are ready to cut interest rates again if needed after reducing them to a record low last week. ‘We will be looking at all the data that arrives from the euro-area economy in the coming weeks and if necessary, we are ready to act again,’ Draghi said… ‘Monetary policy will remain accommodative.”

May 8 – Bloomberg (Jeff Black and Jana Randow): “European Central Bank Executive Board member Yves Mersch said interest-rate reductions become more ineffective as they approach zero. ‘The closer we get to zero, the bigger the inefficiency of a further rate cut,’ Mersch said… The ECB isn’t a ‘toothless tiger’ and will use ‘tools that are appropriate to the situation… We will perhaps securitize these loans so that banks in countries with surpluses can lend without fear that it won’t be paid back,’ Mersch said. ‘This is something we can’t do from one day to the next, at the push of a button.’”

Global Bubble Watch:

May 9 – Bloomberg (Simon Kennedy and Jennifer Ryan): “Global central bankers are poised to ease monetary policy even further after a wave of interest-rate cuts from India to Poland. As Group of Seven finance chiefs gather in the U.K. tomorrow, economists at Morgan Stanley and Credit Suisse Group AG are among those predicting policy makers will keep deploying stimulus amid weak global growth, slowing inflation and the need to thwart currency gains. ‘Most central banks in our coverage universe still have a bias to ease,’ Morgan Stanley economists led by… Joachim Fels said… ‘Given this disposition, it doesn’t take much in terms of downside surprises in growth or inflation to tip the balance for more central banks to pull the trigger for more easing.’ South Korea’s rate cut today was the 511th reduction worldwide since June 2007, according to Bank of America Corp.’s tally. While the tide of liquidity has sent stock markets surging, it has yet to prove as effective in generating economic growth.”

May 7 – Bloomberg (Sarika Gangar and Sridhar Natarajan): “JPMorgan… increased its forecast for issuance of junk bonds and leveraged loans by $250 billion… Companies will raise a record $500 billion this year in the loan market, up from a previous estimate of $300 billion, the bank’s top-ranked strategists led by Peter Acciavatti… wrote… High-yield bond offerings will total $325 billion, versus an earlier forecast of $275 billion. Investors are embracing riskier assets as the Federal Reserve holds benchmark interest rates near zero for a fifth year, sending junk-bond yields to a record low 6.04%… ‘You have got an imbalance in the market,’ Alex Jackson… of the bank loan group at Cutwater Asset Management, said… ‘There is a lack of new supply and tremendous demand that is driving issuers’ ability to refinance everything.’”

May 8 – Bloomberg (Lisa Abramowicz, Miles Weiss and Christine Harper): “Hedge funds using debt-trading strategies honed on Wall Street are expanding at a record pace as they profit from risks big banks are no longer taking… Hedge-fund firms are hiring from companies such as Deutsche Bank AG, Barclays Plc and Bank of America Corp. as their credit funds have attracted $108 billion since 2009, data compiled by… Hedge Fund Research Inc. show. The flow of funds and people is taking place as regulators demand banks curb proprietary trading and back riskier wagers with more capital to prevent another financial crisis. That has allowed so-called shadow-banking firms to expand in businesses contracting at the largest lenders… ‘The regulatory posture in the U.S. and in Europe is unequivocal: They want to transfer risk to the shadow-banking system,’ said Roy Smith, a finance professor at New York University’s Stern School of Business and former Goldman Sachs Group Inc. partner.”

May 10 – Bloomberg (Mary Childs): “Bearish investors are retreating from derivatives used to protect against corporate-bond losses, sending the cost of insurance to the lowest since 2007 as a central bank-fueled rally extends into a fifth year. The Markit CDX North American Investment Grade Index fell this week to as low as 68.3 bps, the least since Nov. 1, 2007… The credit- default swaps benchmark has dropped 19.9 bps since the end of March and is down from a peak of 280 in 2008. Rather than a referendum on credit quality, the drop is a byproduct of the $2.3 trillion that the Federal Reserve has pumped into the financial system since 2008, allowing even the riskiest borrowers to obtain financing. With easy access to capital, Moody’s… is projecting the global default rate for speculative-grade companies will fall to 2.5% by April 2014.”

May 9 – Bloomberg (Cordell Eddings): “Central banks and commercial lenders are crowding investors out of bond markets, pushing yields to record lows even as the amount of debt worldwide grows. Investors from pension funds to insurers hold 45% of the debt in Barclays Plc’s Multiverse Bond Index, below the average of 60% since 2002… At the same time, the share held by central banks and commercial lenders climbed to 55%. The value of debt in the index has soared 52% to $44.6 trillion since 2008. Unprecedented stimulus from the Federal Reserve to the Bank of Japan to boost the world’s economy and purchases by lenders complying with toughened capital rules are leaving investors with a smaller slice of the market.”

May 9 – Bloomberg (Julie Miecamp): “Less than a year after Eircom Group wrote down 1.8 billion euros ($2.37bn) of debt, the Irish phone company is back in the bond market seeking to borrow. Fundraising by Europe’s riskiest companies is accelerating as issuers take advantage of record-low borrowing costs and investor appetite for high-yielding assets… Kloeckner and KCA are among 12 borrowers that sold almost 6 billion euros of bonds ranked B or below last week, the busiest period of issuance for notes with those ratings since at least the start of 2011… The average yield on the securities has dropped to a record 6.46% from an all-time high of 30.7% in November 2008… ‘Issuers are refinancing their loans with cheap bonds,’ said Steven Mitra… at LNG Capital LLP. ‘The quality of deal issuance has deteriorated significantly across the board in this last flurry of issuers that have come to the market.’”

May 10 – Dow Jones (Alexandra Scaggs and Steven Russolillo): “Small investors are borrowing against their portfolios at a rapid clip, reaching levels of debt not seen since the financial crisis. The trend—driven by a combination of rising stock values and rock-bottom interest rates—is sparking a growing debate among market watchers… As of the end of March… investors had $379.5 billion of margin debt at New York Stock Exchange member firms… That is just shy of the record $381.4 billion in margin debt set in July 2007. In March, the level of margin debt stood 28% higher than one year earlier…”

Global Credit Watch:

May 8 – Bloomberg (Sridhar Natarajan): “Yields on junk-rated corporate bonds have fallen below loans that rank higher in the capital structure by the most ever, underscoring the anomalies being created by the Federal Reserve’s unprecedented monetary policies. At about 5.08%, yields on speculative-grade bonds are 51 bps less than rates on U.S. leveraged loans… Before this year, creditors had almost never accepted lower payments on junk bonds over loans, which get repaid first in a bankruptcy. Concerns that credit markets are overheating are rising as the Fed, which has pumped about $2.5 trillion into the financial system since the financial crisis, keeps its benchmark rate at about zero for a fifth year… ‘Junk-bond yields are in freefall, and every time that is pointed out, you look like an alarmist,’ Martin Fridson, chief executive officer of… FridsonVision LLC, said… ‘People think it’s okay as long as they are the first ones out when things change direction. Of course, everybody is not going to be the first one out.’”

China Bubble Watch:

May 10 – Bloomberg: “China’s new local-currency loans exceeded estimates last month while money supply expanded at a faster pace, as policy makers maintained credit support for the economy after first-quarter growth unexpectedly slowed. Lending was 792.9 billion yuan ($129bn) in April… That compares with the median estimate of 755 billion yuan… and 1.06 trillion yuan in March. M2 money supply rose 16.1% from a year earlier. Aggregate financing, a broader measure of credit, was 1.75 trillion yuan compared with a record 2.54 trillion yuan in March.”

May 8 – Bloomberg: “China’s export growth unexpectedly accelerated in April even as shipments to the U.S. and Europe fell, spurring Bank of America Corp. and Mizuho Securities Co. analysts to say the figures were inflated by fake reports. The 14.7% increase… was led by a 57.2% jump in shipments to Hong Kong that highlighted suspicions of false transactions used to mask capital flows into China… Today’s report showed a 0.1% drop in U.S. shipments and 6.4% decline in exports to the European Union.”

May 9 – Bloomberg: “China’s passenger-vehicle sales rose 13% in April on rising demand for new models in the world’s biggest vehicle market. Wholesale deliveries of cars, multipurpose and sport-utility vehicles climbed to 1.44 million units in April…”

May 8 – Bloomberg: “China refused to confirm that Okinawa belongs to Japan after two Chinese scholars suggested re-examining the ownership of the archipelago that includes the island, adding to tensions over a separate territorial dispute. Agreements between allied forces during World War II mean the ownership of the Ryukyu Islands may be in question, the researchers said… Asked if China considers Okinawa part of Japan, Foreign Ministry spokeswoman Hua Chunying said scholars have long studied the history of the Ryukyus and Okinawa. ‘It may be time to revisit the unresolved historical issue of the Ryukyu Islands,’ Zhang Haipeng and Li Guoqiang of the China Academy of Social Sciences wrote…”

May 7 – AFP: “China has sent one of its largest recorded fishing fleets to disputed islands in the South China Sea, state-run media said… amid tensions over Beijing’s assertion of its claims in the region. A flotilla including 30 fishing vessels set sail for the Spratly Islands, an archipelago claimed by China and other countries including Vietnam and the Philippines… The fleet left China’s southern province of Hainan for a 40-day trip to the region and includes two large transport and supply ships… China will make ‘every effort to guarantee the fleet’s safety,’ the report quoted an official from the department of ocean and fisheries as saying.”

Asia Bubble Watch:

May 6 – Bloomberg (Rachel Evans, Foster Wong and Kristine Aquino): “Cnooc Ltd.’s $4 billion bond sale marks the biggest defeat for the Chinese corporate dollar loan market as companies sell six times more notes in the U.S. currency this year to refinance debt… Chinese and Hong Kong issuers sold $18.8 billion of dollar- denominated bonds to refinance debt this year, more than six times similar issuance for the same period last year…”

Europe Watch:

May 6 – Bloomberg James Hertling): “French Finance Minister Pierre Moscovici declared the era of austerity over after his German counterpart offered flexibility on deficit cutting amid renewed bickering between Europe’s two biggest economies. ‘We’re witnessing the end of the dogma of austerity’ as the only tool to fight the euro debt crisis, Moscovici said… ‘We’ve been pleading for a growth policy for a year. Austerity on its own impedes growth.’”

May 7 – Bloomberg (Mark Deen): “French industrial output fell in March as President Francois Hollande struggled to keep Europe’s second-largest economy from falling into recession for the third time in four years. Production dropped 0.9% after climbing a revised 0.8% in February… ‘Business surveys continue to point to a contraction in industrial activity,’ said Pierre-Olivier Beffy, chief economist at Exane BNP Paribas… ‘Investment is due to decline further given poor confidence and low corporate margins.’”

May 6 – Bloomberg (Jones Hayden): “European services output shrank for a 15th month in April as the 17-nation currency bloc struggles to emerge from a recession.”

Italy Watch:

May 6 – Bloomberg (Lorenzo Totaro): “Italy’s economy will shrink this year more than the European Commission estimates as weak domestic demand and investment extend the country’s longest recession in more than two decades… Gross domestic product will decline 1.4% in 2013 before rising 0.7% next year, Rome-based Istat said… Household consumption and corporate investments will both decline this year.”

May 7 – Bloomberg (Alessandra Migliaccio, Chiara Vasarri and Dalia Fahmy): “Yasemin Rosenmaier has been selling homes in northern Italy since 2005 and she’s finding that there’s never been a better time to work for a German broker. ‘I’d say 60% of our closings are with Germans, which is much higher than in previous years,’ Rosenmaier said… from her Engel & Voelkers office in Cernobbio on Lake Como. ‘Why? Fear of inflation, the uncertainty on the financial markets, fear of what happened in Cyprus,’ the latest European country to get an international bailout. Foreign investment in Italian holiday properties is rising as Germans, Britons and Russians take advantage of a market where locals are struggling to purchase even a first home.”

Germany Watch:

May 10 – Bloomberg (Simon Kennedy and Rainer Buergin): “German Finance Minister Wolfgang Schaeuble signaled support for an easing of Europe’s austerity drive as he prepared to face pressure from global counterparts to do more to spur growth. On the eve of a meeting of Group of Seven finance ministers and central bankers in the U.K., Schaeuble told a conference… there’s ‘enough room to maneuver’ for euro-area governments to respond to the currency bloc’s recession. Such comments reflect the recent shift in stance from Europe’s powerhouse economy, which had previously hailed austerity as the main route to prosperity for the debt-strapped region.”

May 6 – Bloomberg (Jeff Black and Jana Randow): “German Finance Minister Wolfgang Schaeuble said the money to pay for the resolution of troubled European Union banks won’t come from a single pool until decision-making powers in the bloc are more centralized. Germany instead seeks a ‘network’ of national resolution authorities and backstop funds to deal with crisis-hit banks in the euro area, Schaeuble said… The resolution facility ‘can’t just be a European fund,’ Schaeuble said. ‘Because the European fund has to be fed by someone. And if we mutualize liability without fully mutualizing the decision-making power, we create the wrong incentive again. Therefore we’ll have to get by with a network in the first stage, or focus on a network, as long as we haven’t created further institutional improvements.’”

May 7 – Bloomberg (Rainer Buergin): “German Finance Minister Wolfgang Schaeuble said he’s worried about Germany’s image in Europe, as he signaled a readiness to listen to others on efforts to overcome the region’s economic troubles. Schaeuble, addressing students in Berlin today alongside French Finance Minister Pierre Moscovici, said they both agree on the need to hasten banking union and that no one country has a monopoly on how to resolve Europe’s woes. It’s ‘good’ that Germans show compassion for countries in southern Europe that are shouldering record youth unemployment, Schaeuble said. ‘It’s not the case in Europe, never, that some know it all and the others don’t,’ Schaeuble said.”

I.) Damaged Real Economy

It’s clear that the US economy has significant burdens apart from the Fed’s misguided monetary policy:

(1) One of the worst corporate tax policies in the world, including double taxation of dividends which recent tax changes have made worse for high-net worth individuals;

(2) An increasingly hostile regulatory climate, starting with the Obama EPA and a notoriously pro-labor union Dept of Labor;

(Neither of these headwinds for US business are all that new,

but they’ve clearly deteriorated under the current regime.)

(3) Add to these now the uncertainty about the real cost of health care. Costs might be one thing for starters in 2014, but who can say what the true burden will be on companies, and the economy in a few more years.

So, risk tolerant investors are less likely to consider direct capital investments, and more likely to direct dollars to the money game on Wall St. This is where the best and brightest are drawn, as this is the locus of personal wealth creation for those with reasonable talent, but no special genius, or brilliant creative breakthrough. Investment capital is most definitely flowing in the same direction.  

An obvious symptom of the state of US business:  weak revenue growth. For S&P 500 companies in Q1 ‘13, overall sales were flat, though profits were up 5.7%. Companies buy back stock to increase reported share earnings. They borrow money at super-cheap rates, and employ other financial engineering tactics, to win at Wall St’s earnings derby, but they are actually presiding over diminishing enterprises as revenues gradually slip lower year after year (IBM is the poster child for this type of corporate governance).

But since hireling corporate managers get a lot of their compensation through option grants and other incentives based on stock performance, it’s all good, and CNBC can tell happy tales with smiling and earnest faces during earnings season.

The cheaper and more plentiful credit is, the more pronounced this trend has become, until Wall St finance has come to dominant economic activity in the United States, becoming a parasite on the body economic, and a very counter-productive force for the welfare of the United States, the free market system, and our political liberties – because it is concentrating wealth in the hands of fewer and fewer powerful individuals, who will use that power to perpetuate the easy money policies that are fundamental to the system that enables them to secure grandiose wealth, and further entrench that power and its accompanying privilege.

II.) Fundamentally Impaired Labor Market

The burdened US business sector, from all but the most favored mega-corporations to the self-employed business owners on Main St, simply are not hiring as many employees as they would in a more vibrant economy with more risk-taking entrepreneurial capital flowing freely. Now with Obama Care, they are even more inclined to hire cautiously, and a much higher percentage of hires are part-time, or in fact work for temp agencies.

The state of the US labor market was well represented by last week’s jobs report. It was trumpeted as not bad, with 165k jobs created, and unemployment dropping to 7.5%. But below the surface it was in fact the worst jobs report in 4 years. Why? Because the average work week declined, and total hours worked were almost 21.5 million hours less, the worst (hours lost report) since April 2009. This is the obvious result of more part-time workers as a percentage of all those employed. More jobs, but less hours worked. More serfs, less wealth in the hands of “We the people.”

Another tragic and very troubling facet of the current labor market – the effective unemployment rate for 18-29 age group is over 16%. God help us!, as the large segment of our young people, are not active in productive, rewarding endeavor.

Now for the third of our featured subterranean disastrous impacts of the Fed’s ZIRP policy. Don’t forget: we already know that the Fed’s unprecedented crisis-style zero interest rate policy (ZIRP) is horrific for savers, especially older folks who presumed they could earn some interest to supplement other retirement assets from a lifetime of thrift – nope, not at the Bernank. This is impoverishing many senior citizens and making them more dependent on government programs, and more likely to support AARP-style socialism. It’s also all too true that the Fed’s policies subsidize the profligate spending of the reckless juveniles who generally make up our national legislature.

Now, about that third less apparent ZIRP-created time bomb:

III.) Increasingly Weakened and Vulnerable Banking Sector

Banks are making so little return on investment in this environment from what would

normally represent prudent investments, that they are reaching well beyond conventional vehicles to achieve their profit targets, and get acceptable returns on capital. Isn’t this the same sector that needed the $700B “don’t ask, just say ‘yes’” emergency bailout rammed through Congress by then Treasury Secr Henry Paulsen. Of course, US taxpayers footed Paulsen’s blank check for the likes of Citigroup, BancAmerica, and Goldman Sachs…

But today a greater share of financial assets are held by this handful of US mega-banks than before the Great Financial Crisis, and they’re taking on imprudent levels of risk again, confident that they’re too big to fail, and driven by the Fed’s reckless money-printing. When interest rates inevitably rise, long-term low-interest loans will tank in value, and the potential economic bust accompanying the higher rates will bankrupt many strapped borrowers creating the 2015 version of the sub-prime crisis.

God help us – will we never learn?

May 1 – Bloomberg (Alan Bjerga): “When dry weather destroyed Leonard McKissick’s soybeans last year, U.S. government-backed insurance paid him $40,000, the bulk of his loss.   Across the Arkansas Delta this spring, farmers such as McKissick are sowing fields that suffered the worst drought in more than half a century. Even though crops may fail again, landowners are shielded by taxpayers from the full burden of their bad bets. Drought helped drive the cost of crop insurance to a record $17.2 billion…”

May 1 – Bloomberg (Sarah Mulholland): “Automakers are giving subprime buyers the most long-term loans in at least eight years, sparking concern losses will curtail returns in the $149 billion U.S. market for packaging the debt into bonds. The average maturity for car loans to borrowers with blemished credit contained in asset-backed securities surpassed 70 months last year for the first time since at least 2005, according to Moody’s… All loans longer than 72 months more than doubled to 14% as of April 20 from 6% in 2010…   Lenders are loosening loan terms, giving buyers more time to pay off debt and enabling U.S. households to purchase cars at the fastest pace in more than five years. Asset-backed sales linked to auto debt are surging…”  

Money Notes:

One-month Treasury bill rates ended the week at one basis point and 3-month rates closed at 5 bps. Two-year government yields were little changed at 0.22%. Five-year T-note yields ended the week up about 5 bps to 0.73%. Ten-year yields increased 8 bps to 1.74%. Long bond yields were up 10 to 2.96%…Corporate bond spreads narrowed to multi-year lows. An index of investment grade bond risk fell 7 to a five-year low 71bps. An index of junk bond risk sank 30 to 352 bps (low since 9/07). An index of emerging market debt risk fell 17 to 270 bps…

Debt issuance remained strong. Investment grade issuers included Apple $17.0bn, IBM $2.25bn, Texas Italian 10-yr yields sank 24 bps to 3.81% (down 69bps y-t-d). Spain’s 10-year yields dropped 24 bps to 4.02% (down 125bps). German bund yields increased 3 bps to 1.24% (down 8bps), and French yields jumped 8 bps to 1.81% (down 19bps). The French to German 10-year bond spread widened 8 to 57 bps. Ten-year Portuguese yields sank 37 bps to 5.41% (down 134bps). Greek 10-year note yields sank 163 bps to 9.54% (up 93bps). U.K. 10-year gilt yields were up 5 bps to 1.72% (down 10bps)…

Freddie Mac 30-year fixed mortgage rates dropped 5 bps to a 17-week low 3.35% (down 49bps y-o-y). Fifteen-year fixed rates were down 5 bps to 2.56% (down 53bps). One-year ARM rates fell 6 bps to a 12-week low 2.56% (down 14bps). Bankrate’s survey of jumbo mortgage borrowing costs had 30-yr fixed rates 2 bps lower to 3.90% (down 52bps).

Federal Reserve Credit declined $4.8bn to $3.266 TN. Fed Credit expanded $481bn over the past 30 weeks. Over the past year, Fed Credit expanded $420bn, or 14.8%…M2 (narrow) “money” supply dropped $49.6bn to $10.501 TN. “Narrow money” expanded 6.8% ($667bn) over the past year…

Global central bank “international reserve assets” (excluding gold) – as tallied by Bloomberg – were up $637bn y-o-y, or 6.1%, to $11.093 TN. Over two years, reserves were $1.315 TN higher, for 13% growth.

Currency and ‘Currency War’ Watch:

The U.S. dollar index slipped 0.5% to 82.13 (up 3.0% y-t-d). For the week on the upside, the South African rand increased 2.2%, the South Korean won 1.4%, the Swedish krona 1.0%, the Norwegian krone 0.9%, the Canadian dollar 0.9%, the Swiss franc 0.8%, the Danish krone 0.7%, the British pound 0.7%, the euro 0.6%, the New Zealand dollar 0.6%, the Mexican peso 0.6%, the Australian dollar 0.4%, and the Singapore dollar 0.2%. For the week on the downside, the Brazilian real declined 0.5% and the Japanese yen fell 1.0%.

Commodities Watch:

The CRB index rallied 1.7% this week (down 1.6% y-t-d). The Goldman Sachs Commodities Index recovered 1.4% (down 2.4%). Spot Gold increased 0.6% to $1,471 (down 12.2%). Silver was up 1.0% to $24.01 (down 21%). June Crude jumped $2.61 to $95.61 (up 4%). May Gasoline was little changed (up 2%), while May Natural Gas dropped 4.3% (up 21%). July Copper rallied 4.1% (down 9%). May Wheat jumped 4.1% (down 9%), and May Corn surged 8.6% (unchanged).

U.S. Bubble Economy Watch:

April 30 – Bloomberg (Alex Kowalski): “Residential real-estate prices increased in February by the most since May 2006, showing the U.S. housing market is strengthening.  The S&P/Case-Shiller index of property values in 20 cities rose 9.3% from February 2012… Compared with the prior month, prices rose the most since October 2005.”

April 30 – New York Times (Terry Pristin):  “Of the 22,000 condos created in downtown Miami during the boom years, only about 600 remain unsold — thanks mainly to an influx of Latin American investors seeking a safe haven for their money.  Developers are reacting to the unexpectedly swift condo recovery in a predictable way: they are building more condos.   The most ambitious project by far is the $1.05 billion Brickell CityCentre, a 5.4-million-square-foot mixed-use development that will add about 800 condo units in two 43-story towers to the central business district, a hotel, a luxury movie theater, and a wellness center aimed at tourists from Latin America…  Prices of condos in downtown Miami increased to $440 a square foot in the last quarter, compared with $400 in the same quarter a year ago, according to Condo Vultures…”

April 30 – Bloomberg (Shobhana Chandra): “Business activity in the U.S. unexpectedly shrank in April for the first time in more than three years, a sign manufacturing may be a smaller contributor to economic growth this quarter.  The MNI Chicago Report’s business barometer fell to 49 in April, the lowest since September 2009, from 52.4 last month.”

April 30 – Bloomberg (John Gittelsohn): “U.S. residential vacancy rates declined in the first quarter as housing demand rebounded faster than new construction after the five-year real estate slump…   The rate for rented homes dropped to 8.6% from 8.8% a year earlier, while vacancies for owner-occupied houses fell to 2.1% from 2.2%. The share of Americans who own their homes was 65.0%, down from the 15-year low of 65.4% in the fourth quarter and a year earlier…  Builders broke ground on new homes at an annual pace of 1.04 million in March, the first time housing starts have exceeded a million since 2008…”

Federal Reserve Watch:

May 3 – Bloomberg (Steve Matthews): “Federal Reserve Bank of Richmond President Jeffrey Lacker voiced opposition to bond purchases by the Fed, saying the buying probably won’t spur growth beyond 2% while making an exit from stimulus more challenging. ‘The benefit-cost trade-off associated with further monetary stimulus does not look promising… The Fed seems to be unable to improve real growth, despite striving mightily over the last few years, and further increases in the size of our balance sheet raise the risks associated with the ‘exit process’ when it’s time to withdraw stimulus.’”

May 1 – Bloomberg (Fergal O’Brien): “Harvard Economics Professor Martin Feldstein comments on Federal Reserve in CNBC interview:  The Fed has ‘stopped talking about early exits or slowing down but frankly I think they’re not accomplishing very much and they are adding to risks in economy… There’s good reason — not in the way they think about it there’s good reason to be slowing down this process.  There are some serious bubbles developing in this economy.’ Feldstein says 10-year Treasury yield not sustainable. ‘I think it has risks and it’s spreading over into things like the stock market.’”

April 29 – Bloomberg (Willow Bay, Jeff Kearns and Jeanna Smialek): “Former Federal Reserve Governor Kevin Warsh said the central bank will probably press on with its ‘aggressive’ easing as growth this year may fall short of the pace needed to put millions of Americans back to work.  Job growth requires a 3% to 3.5% expansion that won’t be in reach for the world’s largest economy this year, Warsh said…”

April 29 – Bloomberg (Susanne Walker): “Federal Reserve policy makers may shift discussion away from when to reduce monetary stimulus, given data showing the economy is weakening, according to Pacific Investment Management Co.’s Mohamed A. El-Erian.  ‘The inherent momentum of the economy is still weak and you don’t want to taper off too quickly,’ El-Erian said… ‘They are going to try to change the narrative away from the Fed is taking its foot off the accelerator, to the Fed is maintaining its foot on the accelerator. It could even press it harder.’”

Central Bank Watch:

May 3 – Bloomberg (Simon Kennedy and Jana Randow): “European Central Bank President Mario Draghi is signaling he may go negative in his campaign to rescue the euro-area economy.  With the ECB cutting its benchmark interest rate to a record low yesterday as the euro-area recession deepens, Draghi said policy makers have an ‘open mind’ on reducing their so-called deposit rate below zero for the first time. Forcing banks to pay when parking cash at the central bank would be aimed at spurring them into lending rather than saving, yet economists say the step may backfire. That it’s even being considered highlights the weakness of the 17-nation economy and rekindles Draghi’s reputation for unorthodoxy.  Draghi has shifted the ECB’s stance on the potential floor for interest rates,’ said Marchel Alexandrovich, senior European economist at Jefferies International…”

Global Bubble Watch:

May 3 – Bloomberg (Victoria Stilwell): “A gauge of U.S. corporate credit risk declined to the lowest level in more than five years… The Markit CDX North American Investment Grade Index, a credit-default swaps benchmark that investors use to hedge against losses or to speculate on creditworthiness, decreased 2.9 bps to a mid-price of 71.4 bps… The index is closing at the lowest level since Nov. 6, 2007, when it reached 68.8.”

April 30 – Bloomberg (Sarika Gangar): “Corporate bond sales are approaching the fastest pace on record as central bank stimulus from the U.S. to Japan and Europe stokes demand and prompts economists to scale back forecasts for interest-rate increases.   …Offerings from the most creditworthy to the riskiest borrowers surge to $1.39 trillion this year, topping last year’s $1.38 trillion tally in the same period and exceeding every year apart from the $1.47 trillion in the first four months of 2009… Sales of bonds from the U.S. to Europe and Asia exceeded 2012’s pace after offerings surged this month to at least $304 billion, compared with $205.3 billion in the similar period last year…  The S&P/LSTA U.S. Leveraged Loan 100 Index rose to the highest level since July 2007…”

May 3 – Bloomberg (Peter Burrows): “Apple Inc. avoided as much as $9.2 billion in taxes by financing part of a $55 billion stock buyback with debt rather than offshore cash that would have been billed by the U.S. government, Moody’s… estimates.  Based on current rates, Apple will pay interest of about $308 million a year on the $17 billion bond offering, said Gerald Granovsky, a senior vice president at Moody’s.  ‘From a pure corporate-finance theory perspective, this was a no-brainer,’ Granovsky said.

April 29 – Bloomberg (Anchalee Worrachate): “At a time when politicians are squeezing budgets to cut borrowing, the bond market is clamoring for more debt, pushing yields on almost $20 trillion of government securities to less than 1%.  The average yield to maturity for the Bank of America Merrill Lynch Global Broad Market Sovereign Plus Index fell to a record-low 1.34% last week from 3.28% five years ago. Even though the amount of bonds in the index has more than doubled to $23 trillion — bigger than the gross domestic product of the U.S. and China combined — countries from Germany to Rwanda sold debt in the past month at their lowest yields.”

May 3 – Bloomberg (Abigail Moses): “The cost of insuring against losses on corporate debt fell to the lowest in three years after European Central Bank President Mario Draghi cut the benchmark rate to a record 0.5%.  The Markit iTraxx Europe Index of credit-default swaps on 125 companies with investment-grade ratings dropped 3 bps to 92, the lowest since May 2010. The decline follows the biggest monthly fall since January 2012.”

May 2 – Bloomberg (David Wilson): “Borrowing to buy U.S. stocks is close enough to a record to cause concern that prices may not rise much longer, according to Cullen Roche, founder of Orcam Financial Group LLC…  Margin debt amounted to $379.5 billion in March… The total was the second-highest in the history of the NYSE’s figures, going back to 1959. The highest was the $381.4 billion recorded in July 2007.”

April 29 – Bloomberg (Scott Hamilton): “London homes changed hands at the fastest pace since 2007 in April as the capital’s property market drove a third month of U.K. house-price increases, according to Hometrack Ltd… ‘The real driver of price rises in April has been the London market where demand has grown three times faster than supply over the last quarter,’ said Richard Donnell, director of research at Hometrack. In the city, ‘key market indicators, such as the time on the market, are now back to levels last seen’ during the peak in 2007, he said.”

May 1 – Bloomberg (Neil Callanan): “Investors bought more commercial real estate in central London last year than in the rest of Britain for the first time as buyers from the U.S. to Malaysia favored the U.K. capital, according to broker DTZ.   Investors purchased a record 16.1 billion pounds ($25bn) of income-producing office buildings, stores, and warehouses in London last year, a 48%…

Global Economy Watch:

May 1 – Bloomberg (Michael Heath): “A gauge of Australian manufacturing slumped to a four-year low in April as the sustained strength of the nation’s currency weighed on exporters.   The manufacturing index plunged 7.7 points to 36.7 last month…  The export index was the lowest since 2004…”

China Bubble Watch:

May 1 – Financial times (Jamil Anderlini): “Growth in China’s manufacturing sector slowed in April, providing further evidence of weakness in the world’s second-largest economy.  China’s official purchasing managers’ index (PMI) fell to 50.6 in April from 50.9 in March, indicating a slowdown in manufacturing activity that was led by a slump in new export orders…  Some analysts took the disappointing PMI reading as a positive signal for future growth prospects, arguing that it could prompt the government to introduce more policies to boost growth. But others pointed to a flood of credit in the economy in the first quarter of 2013 that did not help to pump up growth, suggesting Beijing will not be able to stimulate growth through looser monetary policy.  ‘The most worrying aspect of this is not that growth is weak, but that growth is weak despite a torrent of new credit issuance,’ said Alistair Thornton, economist at IHS Global Insight.  In the first quarter, the Chinese government’s measure of overall credit in the economy known as ‘total social financing’ increased 58% from the same period a year earlier.”

May 2 – Bloomberg:  “China’s new home prices jumped in April by the most since December, defying the government’s tightened property curbs, according to SouFun Holdings Ltd.  Prices jumped 5.3% from a year earlier last month, 1.4 percentage points faster than March and the biggest gain since housing costs ended eight months of declines in December… Home prices in March rose in the most cities tracked by the government since September 2011 and housing sales jumped 69% in the first quarter, even as the government has accelerated implementing curbs to control prices.”

May 2 – Bloomberg: “Growth in China’s less-developed inland provinces weakened last quarter while expansion in some coastal areas picked up and all regions reported faster gains than nationwide figures…  Expansion in southwestern Sichuan was 10.2% in the first quarter, compared with 2012 full-year growth of 12.6%, while neighboring Guizhou’s gross domestic product gains eased to 12.6% from 2012’s 13.6%. Eastern Zhejiang reported 8.3 % growth in the first three months after 8% in 2012 and export-dependent Guangdong showed 8.5%, up from 8.2% last year.”

India Watch:

May 3 – Bloomberg (Kartik Goyal): “India cut interest rates for a third straight meeting to revive growth, extending the only reduction in borrowing costs among major emerging nations this year.  Governor Duvvuri Subbarao lowered the repurchase rate to 7.25% from 7.50%…”

Asia Bubble Watch:

May 1 – Bloomberg (Nichola Saminather): “China led a jump in investment in Asia-Pacific commercial properties to $4.2 trillion in 2012 as economic growth drove up capital values and supported new construction, according to London-based broker DTZ.   Investors bought $300 billion of commercial property across the Asia-Pacific region, an 8% increase from 2011 in U.S.  dollar terms…  China overtook Japan to become the region’s largest market with $1.5 trillion of investments, up from $1.3 trillion in 2011…  Tenant demand for high-quality offices in Beijing led to a 23% increase in rents in 2012, while in Shanghai, rising demand from global companies pushed some companies to outer areas in search of lower rents…”

Latin America Watch:

May 1 – Bloomberg (Jonathan Levin and Ben Bain): “Arturo Sandoval, a 25-year-old homeowner in one of Mexico’s low-income developments outside the capital, commutes two hours each way to his job at a Mexico City soap factory.   In the Parque San Mateo community where Sandoval bought his home from builder Desarrolladora Homex SAB for about 350,000 pesos ($29,000), neighbors play soccer in the street between rows of abandoned properties. His commute starts with a van to the station, then a bus into the city…  Life in the housing development ‘isn’t everything they said it would be,’ he said.  San Mateo’s deserted homes are evidence of the exodus from commuter towns that sprang up across Mexico during the last six-year presidential administration as a record 3 million government-backed mortgages and housing credits helped turn builders into billionaires.”

April 30 – Bloomberg (Veronica Navarro Espinosa): “Mexico’s highest-rated junk bonds are saddling investors with the biggest losses in emerging markets as the nation’s homebuilders collapse.  Dollar-denominated notes sold by Mexican companies in the BB category have lost 10.5% this month, versus a 0.82% return for similarly rated developing-nation debt, according to Credit Suisse… Homebuilder bonds sank an average of 31.7 cents on the dollar in April as Urbi Desarrollos Urbanos SAB and Corp. Geo SAB defaulted on debt payments.  The homebuilder rout, coupled with phone company Maxcom Telecomunicaciones SAB’s warning it may seek bankruptcy protection, threatens to damp Mexican junk bond sales that are off to their fastest start in two years, according to Aberdeen Asset Management and Oppenheimer & Co.”

Europe Watch:

May 3 – Bloomberg (Rebecca Christie): “The euro-area economy will shrink more than previously estimated in 2013 as part of a two-year slump that has pushed up unemployment to a record, according to the European Commission.  Gross domestic product in the 17-nation currency bloc will fall 0.4% this year, compared with a February prediction of 0.3%… France, now projected to shrink 0.1% instead of growing by the same amount, joined seven other euro-area economies expected to contract this year.”

April 30 – Bloomberg (Angeline Benoit): “The euro-area jobless rate rose to a record in March, increasing pressure on the European Central Bank to take additional measures to boost growth.  The euro-area unemployment rate advanced to 12.1% from 12% in the previous two months… Today’s report showed that 19.2 million people were jobless in the euro area in March, up 62,000 from the previous month.  Youth unemployment was at 24%.”

Italy Watch:

May 1 – Bloomberg (Andrew Davis): “Italian Prime Minister Enrico Letta pledged measures to boost economic growth in his first speech to parliament that would cost the government more than 10 billion euros ($13 billion) in lost revenue this year, newspaper La Republicca supported.  Possible elimination of IMU tax on primary residences for this year would cost EU4b…”

April 30 – Bloomberg (Lorenzo Totaro): Italy’s unemployment rate remained near a 20-year high in March as companies refrained from hiring amid political gridlock and the longest economic recession in two decades.   Joblessness was unchanged at 11.5% after the February reading was revised down from an initial 11.7%…  The euro region’s third-biggest economy will shrink 1.8% this year amid rising unemployment and low consumer and investor confidence, Moody’s… forecast April 26.”

April 29 – Bloomberg (Lorenzo Totaro): “Italian banks’ corporate loan book will worsen this year as the euro region’s third-biggest economy remains mired in its longest recession in two decades, according to the nation’s central bank.  Non-performing loans as a proportion of total corporate lending will keep rising, the Bank of Italy said…  ‘Leading indicators suggest that a further deterioration is under way,’ the report said… The deterioration, especially in ‘the construction sector,’ is mainly linked to the decline in the economy, the central bank said.”

Germany Watch:

April 29 – Bloomberg (Patrick Donahue): “Europe may accelerate a shift away from its austerity-first agenda this week as the new Italian government changes course and a German-Spanish investment pact underscores a renewed focus on combating record unemployment.   Yesterday’s swearing in of Italian Prime Minister Enrico Letta ends a political deadlock nine weeks after voters rejected the country’s budget-cutting course. German Finance Minister Wolfgang Schaeuble, a champion of austerity, will travel to Spain today to unveil a plan aimed at spurring investment in Spanish companies…  ‘You have to react to economic developments — we do so in Germany,’ Schaeuble told members of Chancellor Angela Merkel’s Christian Democratic Union… ‘We are not bureaucratic; we are not stupid.’”

April 29 – Bloomberg (Stefan Riecher and Jana Randow): “Germany’s inflation rate slumped to the lowest in more than 2 1/2 years in April, just days before the European Central Bank is due to decide on interest rates.  The inflation rate in Europe’s largest economy, calculated using a harmonized European Union method, fell to 1.1% from 1.8% in March. That’s the lowest since August 2010.”