The Daily Reckoning November 10th
No doubt, most Daily Reckoning readers are aware of yesterday’s shocking headlines: Mariah Carey lost 70 pounds…and Taylor Swift won the Country Music Award for “Entertainer of the Year.”
Meanwhile, the European Union continued to unravel faster than a Kardashian marriage.
Because the European leaders have failed to contain the crisis within the economic boundaries of the Peloponnesian Peninsula, it is now fanning out across the Ionian Sea and up the Adriatic like a toxic plume…and is washing ashore in Italy.
Investors are terrified to wade into the water. Italian bond yields are spiking higher and stocks are plummeting worldwide.
The crisis didn’t seem so worrisome when it was just a “Greek thing” — when the story was just about the “lazy Greeks.” But now the story is also about “Big Greece,” or Magna Graecia — a.k.a. Italy.
Going back a couple of millennia, Greek settlements were so prolific in Italy and Sicily that the region was sometimes referred to as Magna Graecia, or “Big Greece.” The name stuck, but its meaning evolved. Magna Graecia became a kind of slur, referring to the southern half of Italy — home of the “lazy Italians.”
This meaning of this term may be in the process of evolving once again. Magna Graecia might as well refer to the all the heavily indebted nations of the Western world. We are all Greeks now.
When the very first sign of a potential crisis sprouted in Athens nearly 2 years ago, most investors dismissed it as a minor blight on an otherwise fertile economic landscape. One rescue package — or two — would take care of the problem and we’d be on our way.
Here at The Daily Reckoning, we don’t mind saying, we provided a dissenting point of view. We warned early and often that the Greek crisis would not simply “go away.” We warned that it would metastasize throughout the euro zone and would imperil the euro itself. (It’s true; we said it. You can look it up for yourself).
Here’s a little something we wrote a year and a half ago. Seems like just yesterday:
Rome wasn’t built in a day, of course. So we should not expect Athens to be rescued in a week…or ever. The country’s fiscal condition is beyond repair. Either Greece slips into the Mediterranean, figuratively speaking, or the euro does…or both…
In a worst-case scenario, the ECB will exhaust its cash, credit and credibility trying to save Greece…and will destroy the euro in the process. Best case, the “fix” will persuade a few Wall Street strategists that the “worst of the euro crisis is over” and will suck a few more suckers into the European sovereign debt markets before the situation gets REALLY ugly.
And it will get ugly…one way or another.
Many investors behave as if sovereign defaults are like polio: eradicated forever. These investors are half right. Polio has been eradicated.
Greece may not actually default, depending on the rescue measures that come its way. But Greece is already bankrupt. The creditors to Greece should understand that history is not on their side. In fact, the creditors to every sovereign borrower should understand that history is not on their side.
“While a European sovereign default has appeared inconceivable in recent history,” a recent Wall Street Journal article observes, “defaults and debt re-schedulings were actually a common feature of the European financial landscape throughout the nineteenth century and up until the end of World War II, according to the economists Carmen Reinhart and Kenneth Rogoff.
“Greece has defaulted or rescheduled its debt five times since gaining independence in 1829…”
Governments default. That’s what they do. They tax; they squander the tax revenues; they default. This is the established unnatural order of the governmental world. The Greek crisis may be the first sovereign debt debacle of recent times, but it won’t be the last.
Our caution remains. But you don’t have to take our word for it. Just “listen” to what the markets are saying. For example, as we suggested in the September 7, 2011 edition of The Daily Reckoning, pay attention to LIBOR rates.
The signs of credit distress are increasing.
These signs take various forms. But one of the most telling forms is the direction of LIBOR interest rates. LIBOR stands for “London Interbank Offered Rate.” It is the rate at which banks borrow unsecured funds from other banks in the London wholesale money market (or interbank lending market).
In most circumstances, LIBOR rates track short-term Treasury rates. But in the midst of crisis conditions, LIBOR rates tend to spike, while Treasury rates fall. That’s exactly what happened during the credit crisis of 2008, as the chart below illustrates.
In the depths of the crisis, LIBOR rates soared, reflecting the reluctance of banks to lend money to other banks. The more worrisome the crisis seemed to be, the higher LIBOR rates climbed. As such, the LIBOR rate functioned as a kind of “fear gauge.”
And so it remains…
During the last few weeks, LIBOR rates have been on the rise once again. They have not risen high enough to sound a distress signal, but they have risen high enough to raise an eyebrow.
Let’s call it an early warning sign.
This warning sign is still flashing amber. Since our warning in early September, LIBOR rates have continued their steady upward climb, which indicates that credit stresses are increasing.
Meanwhile, government bond yields in the PIIGS nations of Portugal, Italy, Ireland, Greece and Spain are also surging higher — another clear sign of distress.
In the July 12, 2011 edition of The Daily Reckoning, we observed:
The euro fell to its lowest level since May, the Italian stock market fell to its lowest level since 2009 and Spanish bond yields jumped to their highest level since 1997. This small sampling of distress in the European financial markets would suggest that a credit crisis is beginning, not ending.
Greek two-year yields soared to 31% yesterday, but that ridiculous number hardly seems newsworthy. Greece is broke and everyone knows it…except the EU and the IMF. Greek bond yields might as well be one billion percent. Does anyone really expect to receive interest payments for the life of the bond?
The new news is not Greece; it is that the Greek crisis is now a genuine European crisis. Throughout the PIIGS nations of Portugal, Italy, Ireland, Greece and Spain, bond yields have spiked sharply since July 5. On that fateful day, the Greek parliament voted to accept the austerity measures imposed by the E.U. and the IMF, thereby opening the door to the bailout funds that were supposed to make everything all better. On that same day, however, Moody’s downgraded the Portuguese government debt to “junk.”
One week later, the financial markets seem to have decided that the cold, hard facts inspiring the Portuguese downgrade are of greater significance than the smoke, mirrors and empty promises that underpin the “Greek rescue.”
The situation in Europe is becoming so frightening that, ironically, investors are dumping the debt securities of Europe’s most indebted nations in order to buy the debt securities of the world’s most indebted nation.
While Spanish and Italian bond yields are spiking to multi-year highs, US bond yields are falling (i.e. bond prices are rising). This “flight to quality” move into Treasurys seems laughable… But we don’t make the rules, dear investor, we merely mock them. If a Treasury bond is “quality,” Thalidomide deserves a Nobel Prize in Chemistry… “Quality” rarely rolls off a government’s printing press.
Again, these trends have been intensifying for the last several months…despite numerous official pronouncements along the way that the EU had devised a potent and credible rescue plan. Investors continue to dump PIIGS debt and to flock into the US Treasury market.
Net-net, the crisis is not over. It is gaining momentum. Therefore, we would repeat the observation we made on July 12:
Treasury bonds are not the sort of “quality” an investor wishes to hold long-term. The quality worth owning long-term is much more likely to ascend up a mine shaft — like gold and platinum — or sprout from the soil — like wheat and soy beans — or spring from the mind of enterprising innovators — like RCA Victor and Apple Computer.
Throughout crises and depressions and all other forms of economic adversity, enterprising innovators somehow find a way to succeed. The 1930s produced some of America’s greatest success stories. Perhaps, the 2010s will repeat the performance.
America has lagged behind much of the world in terms of digital wallets. Elsewhere, people routinely use phones instead of credit cards. There are several reasons for this.
Partly, it is because North America saw mobile phones so early. When other regions finally rolled out mobile phones, infrastructures were more modern. The larger reason, however, is that there is so much at stake.
Right now, there are a limited number of players in the lucrative payment network world. Visa, MasterCard and American Express would like to move to your phone. They fear, however, that enabling electronic wallets in phones would allow aggressive young players onto their turf. PayPal, Amazon and Google are, in fact, financial networks, and they would love to do your banking.
So far, progress has been slow, but the emergence of Android is opening up new possibilities. Work is being done by the Mobile Payments Industry Workgroup that would establish standards. What we know for sure is that the established payment networks will do their best to keep out upstarts. We also know they will fail.
Part of the reason for this is political. Part is cultural.
The politics are that Wall Street and the major banks have never enjoyed lower public regard and support. Consumers sense that the bailout profited rich bankers more than consumers. The customer base is not going to support politicians who continue to put the interests of favored banking institutions above those of consumers.
Eventually, market forces always win. Currently, retailers are capable of dealing with only a few credit and debit card companies. This limits competition and keeps prices higher than they would otherwise be. A sophisticated mobile payments infrastructure, which is inevitable now that the Android has broken free, will arise. In fact, it will arise before most people know it’s happened.
The cultural factor I referred to is the difference between the old-school financial institutions and the new electronic services. I have little confidence that Visa or MasterCard is going to do what’s necessary to exploit the convergence. They’re too habituated and institutionalized.
PayPal, Amazon and Google, however, are populated by people who want to transform the financial world. They will find a way to force themselves into an industry that has lost serious credibility and clout due to its participation in the ongoing subprime mortgage fiasco.
Fortunes will be made by financially sophisticated app developers. One of the companies covered in my investment service Breakthrough Technology Alert, is clearly in this category.
Finally, I’d like to get a little speculative and tell you what I think the real long-term consequences of the Linux/Android revolution will be.
It’s not well known, but Peter Thiel, one of the founders of PayPal, was motivated by quite subversive goals. His initial purpose was to create a mechanism for financial transaction outside the reach of governments. He has written about it.
As an entrepreneur and investor, I have focused my efforts on the Internet. In the late 1990s, the founding vision of PayPal centered on the creation of a new world currency, free from all government control and dilution — the end of monetary sovereignty, as it were.
Obviously, he has not succeeded. Nor do I think we’re going to see such a purely private system in the near future. However, we are moving very rapidly toward developing an electronic infrastructure that would enable brand-new forms of banking. Given our recent experience with the federally controlled financial system, the need is clear.
I won’t detail here how I think this new banking will function. For now, however, I’d just like to warn you that you shouldn’t be too surprised to see completely transformed financial institutions arise from the current rubble. Who knows? Maybe Thiel will be proved right. For extra credit, you can read F.A. Hayek’s Denationalisation of Money: The Argument Refined online here.
Security was unusually heavy at the Eurostar terminal in Paris yesterday. Police roamed the halls and corridors. Long lines formed as baggage and passports were inspected. In the executive lounge, plain-clothed cops eyed packages…and studied travelers.
Then, in London…on our way to the office we passed a melee of striking cab drivers and electricians. A scuffle had broken out. A man was on the ground, surrounded by Bobbies in phosphorescent green jackets.
Europe is on edge.
“While Rome burns the eurozone fiddles” says the headline in today’s Daily Telegraph.
At least, things are starting to go in the right direction; the Dow fell 389 points yesterday.
What’s that? The right direction is down. And apart. It’s the way to wash out years of built-up debt that can’t be repaid…and cleanse the system of zombie loans, zombie businesses, and zombie spending.
The right direction is to let the accumulated wisdom of willing buyers and sellers figure out what things are worth…let them destroy those that are worthless…and raise up those that have real value.
The right direction is to let Mr. Market do it. God knows he causes enough trouble. Let him sort out the mess he makes.
But the right way is not the only way. Obviously, it’s not the way the zombies want to do it. They want to fiddle…to meddle…to manipulate the system so that the rewards go to them and the costs are put on someone else. They want to sweep problems under the carpet…and continue spending!
But yesterday, investors began to realize that there was no carpet in the world big enough to hide Europe’s government debt.
Not that the debts are particularly huge. Some are bigger than the US. Some are smaller. Generally, European governments tried to provide more and more services by going deeper and deeper into debt. Generally, the US government enticed its own households into debt — with EZ credit, low rates and government-subsided loans for students and housing. And they’re both still at it…see below…
In other words, in both Europe and America, government used centrally-planned, bureaucrat-direct zombie capital investment to make up for real growth. And you know how that goes, dear reader.
Today, again, the world’s attention is focused on Italy. “Doomed by corruption, bloated by bureaucracy and poor productivity,” says the Telegraph. But hey…it could be describing any number of places.
The unemployment rate for people between 15 and 24 in Italy is 30%. Hospitals are overcrowded. Roads have potholes. And the “country has been spending more than it earns for years….” Italy’s national debt is 120% of GDP. US debt is 100%.
But at least the Italians are civilized. They have some of the highest tax rates in Europe. They just don’t pay them.
Poor Berlusconi. He’s being forced to resign. After so many years of public service. So many years of doing his level best on behalf of the Italian people…to create a better government…a better nation…and a better world. And now they cast him out like an empty cereal box. And the popolo minuto look on…gawk…and gloat.
But at least he has a tender shoulder to cry on…and a warm smile to greet him after a hard day’s work. The Telegraph reports that the aging politician spent the night with Francesca Pascale, 26. The woman is an angel, for sure…descending from the heavens to succor the embattled Italian prime minister in his hour of need.
But let’s not get distracted by Berlusconi’s trials and tribulations. We’ve got a financial crisis on our hands. The Italian 10-year note yield jumped over 7% yesterday. It was at 7.25% when we looked this morning. At that rate, say the experts, it’s too expensive for the Italians to borrow. And if they can’t borrow, they can’t pay their bills — including about 300 billion euros-worth of debt that they’re supposed to roll over in the next 12 months.
Naturally, the holders of the debt are a bit nervous. And who holds it? Banks. That’s right. The same banks that bought housing derivatives and brought the whole world’s financial system to the brink of collapse. Now, they’ve got government debt up the kazoo. And once again, the world’s financial system edges towards a fall.
The New York Times is on the story:
Europe’s efforts to stem financial contagion foundered on Wednesday as investors dumped their holdings of Italian government bonds, prompting a global stock market sell-off.
Investors drove up the cost of borrowing for Italy beyond 7 percent, a critical level that many economists see as unsustainable and that last year precipitated bailouts for the financially troubled nations of Greece, Ireland and Portugal.
“Wednesday’s surge in Italian government bond yields has catapulted the euro zone crisis into a dangerous new phase,” said John Higgins, a senior markets economist with Capital Economics, in a research note.
Italy faces important tests of investor confidence at an auction on Thursday of one-year bills to raise 5 billion euros, and an auction next week of five-year bonds when it hopes to raise up to 3 billion euros. About 48 percent of Italian debt is held by Italian investors; the rest, 52 percent, is held by investors outside Italy, mostly in Europe.
It is unclear who beyond the central bank will be providing demand for Italian debt in the coming weeks.
Who, beyond the central bank? Our guess is that, soon or late, they will not look much further. Hold onto your gold, dear reader. Sell stocks on rallies. Buy more gold on dips.
The feds continue to lure American households into debt with subsidized mortgage rates. Bloomberg reports:
So far this year, Ginnie Mae, a corporation wholly owned by the government that packages mortgages backed by the Federal Housing Administration and other agencies, has issued more mortgage bonds than Freddie Mac, making it the second-biggest funder of home loans.
Ginnie Mae today reported record earnings, with net income of almost $1.2 billion for the fiscal year ending Sept. 30. The profit surpasses the company’s previous high of $906 million in 2008. Ginnie Mae said it financed nearly 60 percent of all US home purchases during the year, reflecting the increasing role FHA has been playing in the market.
“We’ve done a really incredible job supporting the housing market,” Ginnie Mae President Ted Tozer said in an interview. “And the taxpayer makes a ton of money on it.”
Congress created Ginnie Mae in 1968 to generate capital for government mortgage programs. The company developed the first mortgage-backed security in 1970. Today, its bonds are populated with loans insured by the FHA, the Department of Agriculture, the Office of Public and Indian Housing and the Department of Veterans Affairs.
“Our model is something people don’t really understand,” Tozer said. “It’s the government having its cake and eating it, too.”
What do you think, dear reader? Do you think Ginnie Mae — inventor of the mortgage-backed derivative — has also invented a model that allows the government to have its cake and eat it too? Can the feds sell debt to American consumers…make a profit out of it…and also render a good service to the public?
Or is this just another zombie racket, run by an overpaid hack, that shifts resources to favored industries and leaves American households even deeper in debt?
Are Markets Finally Heading In the Right Direction? originally appeared in the Daily Reckoning. The Daily Reckoning provides over 400,000 readers economic news, market analysis, and contrarian investment ideas.
Mike told you yesterday about how the euro (EUR) had lost over 2-cents in the overnight markets, on fears that Italy, which is a much larger economy than Greece, is the next to visit the bailout doctor. The euro went up, when it was announced that the budget vote had passed, and it went down when it was announced that Berlusconi no longer had a majority government, and then it went right back up when it was announced that Berlusconi had stepped down. But that “relief rally” didn’t last long, as everyone began to imagine what it would cost to bailout Italy…
This morning, the euro has gapped up 1-cent after it was announced that Italy had successfully auctioned off 5 billion (euros) of bills… (At the highest rate in a month of Sundays). But since I came in, the euro has dropped again, thus wiping out most of that 1-cent gain earlier. Up and down, Up and down… Reminds me of that classic song by the Ohio Players, Love Rollercoaster…
But in the end, folks… The euro will continue to lose ground, as long as the markets and media carry on about the Eurozone debt… That’s not to say that I don’t think it’s not bad… For it is… But as bad as our debt? Hardly! Oh… To give you a sample of what I’m talking about…
How many people heard about the largest municipal bankruptcy in US history that took place yesterday? That’s right… Jefferson County, Alabama, declared bankruptcy after failing to gain support for a deal to reduce their debt… Now, here’s a classic statement by the County Commissioner, and one that will be repeated here in the US on a national platform one day…
“We’ve reached the last resort. We could continue and keep kicking this can down the road, but I think the people of Jefferson County have had enough.”
But for now… The markets and media want to focus on the Eurozone… They flip flop, though, as you may recall just last summer when the focus was on US debt 24/7. And personally, (this is my conspiracy hat, so if don’t want to go through this, skip ahead) I feel the media is directed by the government… So… As I’ve told you many, many times before, the US needs to have a cheaper dollar so that they can repay debt interest with cheaper dollars. But… They can’t have the dollar fall off a cliff… So, when things begin to get a little too much in dollar strength, oddly, the media and thus the markets begin to focus on US debt again, and the dollar loses ground until… It looks like the dollar is ready to fall off that cliff, then oddly, the media and markets focus on Eurozone debt…
OK… Glad you stayed along for the ride… Or if you skipped ahead, I’m ready to carry on my wayward son!
Yesterday, only Japanese yen (JPY) and Chinese renminbi (CNY) were able to post gains versus the dollar. Today, most currencies are seeing some sunshine versus the dollar, with the euro up slightly at this point. Gold is down $5 this morning… Which is odd to me… Again this is just Chuck’s opinion, but I think that any time it looks like the risk assets are going to have a bad day, the price manipulators take that time as an excuse to bring gold down again… For, if gold was trading on fundamentals only… The shiny metal would be shining even brighter during times like this, because there is so much uncertainty in the Eurozone right now… But it’s not… Sso what does that tell you? I told you what it tells me…
Of course those of you who go with the “flow” would say right off the bat that gold is down because the dollar is up… But there’s more to it than that, I’m afraid… And to that… I have this note from King World News… “Geopolitical analyst James G. Rickards, who spoke at GATA’s Gold Rush 2011 conference in London in August, told King World News yesterday that a second but secret London Gold Pool is being operated by Western central banks to suppress gold’s price…and that he doesn’t expect it to survive more than two more years.”
And going back to Japanese yen… It appears that the Bank of Japan (BOJ) has intervened at least three times since Halloween last week. The poor manufacturing sector of Japan has really taken the brunt of the 50% gain of yen in the past five years, right on the chin. They’ve seen China overtake them as the World’s second-largest economy, and now the latest blow to Japan is being seen by carmakers that are moving more and more production overseas… I know it’s probably not seen as a safe idea right now, but fundamentally, Japan is a mess, and the yen should not be as strong as it currently is… But, it is what it is… I would just say that buying yen at these current prices isn’t on terra firma, in my opinion.
The Swiss have already gone so far as to clamp the franc’s (CHF) rise (which was also not fundamentally supported) by placing a ceiling on it versus its biggest trading partner, the Eurozone’s euro. Will Japan be next? I think that it would be a “toward the end” type thing if they did, but Japan could very well follow Switzerland here…
In Australia overnight, they printed a jobs report that no one noticed, because of all the focus on the Eurozone… But I did… So, now you will! HA! Australia created 10,100 jobs in October. Not the kind of job growth they had there a few months ago, but still positive, and nothing to ignore for the island nation. Unfortunately, with all the focus on the Eurozone, the Aussie dollar (AUD) was not able to rally on the employment report… UGH!
So… If all the focus is on the Eurozone, we may as well head back there to see what else we can talk about… I saw this quote and thought it made sense… Jean-Claude Juncker, head of the Eurogroup, said that while some Eurozone countries are struggling with a sovereign-debt crisis, the currency is not in trouble. “The euro is not in crisis,” Juncker said. “I become filled with rage when people say the euro is in crisis. We have a crisis of public debt in certain Eurozone members, and one in particular, but the euro is not at stake.”
Then there was this… Yesterday Mike told you about the rot that’s still on Housing’s vine… To follow that up, we have a story on Adivsorone.com about loan delinquencies… Here’s a snippet from that story…
Loan delinquencies are on the rise again for the first time since the end of 2009, an ominous sign for a housing market that has yet to gain its footing in a battered economy. News of the 5.88% increase in delinquencies at the end of the third quarter came as a surprise to TransUnion, which compiles the data. The downturn spells more trouble for Fannie Mae and Freddie Mac.
The Chicago-based credit information provider said the housing market reversal came after six consecutive quarters in which the number of consumers making timely mortgage payments increased — a trend TransUnion executive Tim Martin expected to continue.
Martin blames economic shocks for the change in trend; in a TransUnion release issued Tuesday he cited “the US credit rating downgrade, stock price declines, European debt concerns, stubbornly high unemployment, more downward pressure on home values and low consumer confidence. All of this affects a borrower’s net worth and desire, or ability, to continue making house payments — especially if they are facing negative equity in their homes due to price depreciation.”
It is estimated that more than one-quarter of all households hold mortgages worth more than their houses. The TransUnion third quarter report shows that mortgage delinquencies rose in 40 states and in 64% of US metropolitan areas. Just 21% of US metropolitan regions saw an increase in delinquencies in the second quarter, a difference TransUnion called “significant.”
To recap… The euro has bounced around overnight, first rising 1-cent on the news that Italy had a successful bill auction, but then retreating when it was learned that Italy had to pay the highest rate in a month of Sundays on those bills. Focus right now is all about the Eurozone debt, but did anyone else see that the largest municipal bankruptcy in US history took place yesterday? Jefferson Co. Alabama, decided to stop kicking the can down the road… When will that happen on a national stage?