Archives for November 2014

How Could It Happen?

Things That Make You Go Hmmm: How Could It Happen?

By Grant Williams

“How could it happen, Grandad?”

The old man’s eyes misted over as he looked down at his grandson, who sat at his feet, his young eyes alive with questions as he turned the heavy gold bar over in his hands.

”I’ve told you the story too many times to count,” said the man, half-pleading, but knowing full-well he’d soon be deep into the umpteenth retelling of a story he’d lived through once in reality and a thousand times more through the eager questioning of the young man now tugging at his trouser leg. “Why don’t I tell you the story of how I met your Grandma instead?”

“Because that’s boring.” The reply was borne of the honesty only a ten-year-old possesses.

“OK, OK,” said the old man, a smile creeping into the corners of his mouth, “you win.”

“It began in early November of 2014, when a man called Alasdair Macleod published a report on how the Chinese had been secretly buying gold for 30 years.

“Most people believed what the Chinese Central Bank had been telling the world — that they owned just 1,054 tonnes. That number, first published in 2009, had remained unchanged for over five years; but there was a group of people who refused to accept that the People’s Bank of China were telling the truth, and those people set about diligently doing their own analysis to try to determine what the real number might be.

“In early November of 2014, Macleod’s report — which went largely unnoticed because most people were busy celebrating new highs in the stock market and the fact that a newly strengthening dollar was forcing down the price of gold — laid out the case for there having been an astounding amount of gold bought by the Chinese over the previous three decades.

“According to Macleod, China saw an opportunity at a crucial time and, with a view on the longer term, they took it.”

Grandad dipped his thumb and forefinger into his vPad, which hovered just above the table, and pinched and cast a paragraph into the air before them. At the same time, they heard the voice of Alasdair Macleod himself read the words aloud:

(Alasdair Macleod): China first delegated the management of gold policy to the People’s Bank by regulations in 1983. This development was central to China’s emergence as a free-market economy following the post-Mao reforms in 1979/82. At that time the west was doing its best to suppress gold to enhance confidence in paper currencies, releasing large quantities of bullion for others to buy. This is why the timing is important: it was an opportunity for China, a one-billion population country in the throes of rapid economic modernisation, to diversify growing trade surpluses from the dollar.

“Macleod explained why what he was about to explain to the world was going to come as something of a surprise to most people.” Grandad dipped his fingers and cast again:

To my knowledge this subject has not been properly addressed by any private-sector analysts, which might explain why it is commonly thought that China’s gold policy is a more recent development, and why even industry specialists show so little understanding of the true position. But in the thirty-one years since China’s gold regulations were enacted, global mine production has increased above-ground stocks from an estimated 92,000 tonnes to 163,000 tonnes today, or by 71,000 tonnes; and while the west was also reducing its stocks in a prolonged bear market all that gold was hoarded somewhere.

“But Grandad, why was the West selling its gold? That’s just stupid!” the young boy interjected, right on cue.

Again the old man smiled. Every time he told the story, his grandson would pepper him with the same questions, with a regularity that brought a familiar rhythm to this very private dance the two of them had performed so many times.

He paused, as he always did, to create just the right amount of dramatic tension before answering.

“I know it seems stupid NOW, but don’t forget, you know what you know. Back then, the people in charge in the West weren’t really all that smart; and, besides, when the Golden Domino finally fell, it became obvious that they had been…” — the old man paused, choosing his words carefully, almost theatrically; but when they came, they were the same carefully chosen words he used every time — “… a little less than honest about a few things.

“Now,” he continued with mock indignation, “if you’ll allow me to get back to the story…”

The boy smiled, and his grandfather pushed on.

“Macleod’s report concentrated on the period between 1983 and 2002, because in 2002 two important things happened: the Chinese people became free to own gold, and the Shanghai Gold Exchange was established. He wrote that the reason they allowed these two events to take place was that they’d already accumulated ‘enough gold’ for what he called ‘strategic and monetary purposes,’ and they were happy to keep adding to their stockpile from their domestic mine production and scrap, rather than buy more in the market…”

The old man held up a hand to head off the question he knew was coming — “I know, I know… you want to know how much the Chinese would have had to accumulate in order to be able to do this, don’t you? Well, Mr. Macleod told us, remember?” He reached once more into vPad space, waggled his fingers a bit, and cast the following:

(Alasdair Macleod) Between 1983 and 2002, mine production, scrap supplies, portfolio sales and central bank leasing absorbed by new Asian and Middle Eastern buyers probably exceeded 75,000 tonnes. It is easy to be blasé about such large amounts, but at today’s prices this is the equivalent of $3 trillion. The Arabs had surplus dollars and Asia was rapidly industrialising. Both camps were not much influenced by Western central bank propaganda aimed at side-lining gold in the new era of floating exchange rates, though Arab enthusiasm will have been diminished somewhat by the severe bear market as the 1980s progressed. The table and chart below summarise the likely distribution of this gold:

SIMPLIFIED GOLD SUPPLY 1983-2002 Tonnes
Official Sales by Central Banks 4,856
Estimated Leasing (Veneroso) 14,000
Mine Production 41,994
Net Western divestment (bullion, jewelry & scrap (est.) 15,000
TOTAL 75,850

 

The old man clipped his last sentence short to allow his young audience to make the (quite grown-up, the man thought) point that he always did at this juncture:

“But Grandad, you can’t just say things like ‘probable’ and make assumings like that. We always get told at school that you have to show your workings-out.”

His grandfather let the grammatical error slide — one more time.

“Ah yes, but THAT was the problem, wasn’t it? Everybody wanted proof that numbers like Macleod’s were accurate, but NOBODY wanted proof that the official figures were true, and THAT turned out to be the key lesson that the world learned from this whole sorry debacle.”

“But Grandad, YOU didn’t get hurt, did you?”

The old man looked through the window and out at the snowflakes settling on the tall pines that surrounded the ski field not 40 yards from where he sat, and smiled.

“That’s true,” he said, “but only because I was willing to think for myself and allow for possibilities that most people wouldn’t believe for a moment could actually happen. It wasn’t easy, and it wasn’t fun for many years, believe me. Now, where was I?”

“You were at the part where Mr. Macleod explained where all that gold had gone and…”

“Might have gone,” the man interrupted. “Remember, back then we didn’t know for sure.”

He smiled again and went on with the story.

“Macleod’s work suggested that, while a huge amount of gold had gone flooding into the Middle East during the oil boom of the 1970s (much of it ending up in Switzerland, which, back then at least, was famous around the world as being a safe haven for financial assets), in the mid-’90s, after the gold price had languished for many years, sentiment had changed.”

(Alasdair Macleod): In the 1990s, a new generation of Swiss portfolio managers less committed to gold was advising clients, including those in the Middle East, to sell. At the same time, discouraged by gold’s bear market, a Western-educated generation of Arabs started to diversify into equities, infrastructure spending and other investment media. Gold stocks owned by Arab investors remain a well-kept secret to this day, but probably still represent the largest quantity of vaulted gold, given the scale of petro-dollar surpluses in the 1980s. However, because of the change in the Arabs’ financial culture, from the 1990s onwards the pace of their acquisition waned.

By elimination this leaves China as the only other significant buyer during that era. Given that Arab enthusiasm for gold diminished for over half the 1983-2002 period, the Chinese government being price-insensitive to a Western-generated bear market could have easily accumulated in excess of 20,000 tonnes by the end of 2002.

“Now, I know this is all back-of-the-envelope stuff — assumings, as you call them — but remember, back then, in 2014, none of the other stuff had been exposed.”

“But, Grandad, why were the Chinese buying all that gold? And why did the Westerns let them have it? I mean, it’s worth so much. Why didn’t they just keep it?”

This was always the old man’s favourite part, and he leaned forward in his seat as his enthusiasm for the story returned. With a twinkle in his eyes, he beckoned the boy closer.

“Strategy,” he said, then, after a pause (and with what even he felt was a little more relish than usual) “… and STUPIDITY!

“The Chinese had become very rich during those years, but most of that wealth had come in the form of dollars…”

“What, US dollars?” the boy asked, incredulously. “But why would they ever have wanted lots of those?”

“Because,” the old man chuckled, “there was a time — long before you were born — when everybody wanted US dollars. I know that’s hard to believe NOW, but it was true. If I may…?”

“So-rry Gran-dad,” the boy answered rhythmically and with mock apology.

“Anyway, the Chinese were great students of history and knew that, over thousands of years, what used to be called ‘fiat currency’ had always ended up worthless; and so they planned for the day when that fate would befall the dollar. They began accumulating euros instead of dollars — not because the euro was better but because they didn’t want to own too much of any one currency.”

“Whatever happened to the euro, Grandad?” inquired the boy.

“One story at a time, little fella!” replied the old man. “Now, where was I? Oh yes, then, in the mid-2010s, China began signing all sorts of agreements with other countries, like Iran, Turkey, Russia…”

“And Switzerland!” the boy eagerly interjected.

“… and Switzerland,” his grandfather agreed.

“Those agreements enabled them to swap goods and services for currencies other than the US dollar — all so they could eventually break their ties to what they saw as a doomed currency. And all the while, quietly, in the background, they were swapping as much of that paper money as they could for…?”

“GOLD!!!” Right on cue the boy blurted out the answer, raising both hands in triumph.

“Gold,” the old man said, softly. “Remember what Mr. Macleod wrote?” He cast it up:

(Alasdair Macleod): Following Russia’s recovery from its 1998 financial crisis, China set about developing an Asian trading bloc in partnership with Russia as an eventual replacement for Western export markets, and in 2001 the Shanghai Cooperation Organisation was born. In the following year, her gold policy also changed radically, when Chinese citizens were allowed for the first time to buy gold and the Shanghai Gold Exchange was set up to satisfy anticipated demand.

The fact that China permitted its citizens to buy physical gold suggests that it had already acquired a satisfactory holding.

Since 2002, it will have continued to add to gold through mine and scrap supplies, which is confirmed by the apparent absence of Chinese-refined 1 kilo bars in the global vaulting system. Furthermore China takes in gold doré from Asian and African mines, which it also refines and probably adds to government stockpiles.

Since 2002, the Chinese state has almost certainly acquired by these means a further 5,000 tonnes or more. Allowing the public to buy gold, as well as satisfying the public’s desire for owning it, also reduces the need for currency intervention to stop the renminbi rising. Therefore the Chinese state has probably accumulated between 20,000 and 30,000 tonnes since 1983, and has no need to acquire any more through market purchases, given her own refineries are supplying over 500 tonnes per annum.

“A man called Simon Hunt, who had extremely good connections in China and, more importantly perhaps, a willingness to entertain possibilities most people couldn’t, told a fascinating story once about a visit paid by a friend of his to an army base in China…”

(Simon Hunt, Nov 14, 2014): China is in the process of making the RMB acceptable as an international currency. It wants its trading partners and others to see the RMB as a stable currency that does not play the game of devaluation when difficulties arise. It is the long-game in which Beijing hopes that their currency not only becomes acceptable in financing trade but that central banks can feel secure in adding the RMB to their reserves, as some are now doing.

As we have discussed in earlier reports, China, not just the PBOC, holds far more gold than the market has been assuming, probably in the region of 30,000 tonnes, compared with the USA holding very little of its reported 8,300 tonnes.

Whilst in Japan we were told an interesting if not amusing story that supports this contention. A friend of ours has several factories in China and thus knows many senior people in different disciplines, one of which is a senior PLA officer. He was invited down to their HQ for drinks. After a few hours, his friend suggested they take a walk around the compound ending up at the entrance of a large warehouse. The door was opened and to my friend’s astonishment the warehouse was stacked from floor to ceiling with gold bars.

One day, when the timing suits Beijing best, the PBOC will link the RMB to gold. The West may dislike gold, or at least some of their central banks [do], preferring to operate with fiat currencies, but Eastern governments have a history of seeing gold as a store of value.

“NOW, of course, it seems that what Simon said should have been completely obvious; but all the way back in 2014, believe it or not, the idea that the Chinese would peg their currency to gold was something that most people here in the West just couldn’t even comprehend. I can’t even begin to tell you the number of times I talked to people about this stuff. For years it was obvious how things would end, but only a small group of people listened. Mostly, people just laughed and told me I was a fool. They said I should be buying shares and that a return to ANY kind of gold standard was a ridiculous idea. Do you know what I did?”

“Bought more gold?” The boy phrased it like a question even though he knew the answer. He just liked to let his grandfather have his moment.

“Bought more gold,” the old man said matter of factly. He threw up a chart they both knew well:

“But, but, you’ve jumped ahead, Grandad! The part where the Chinese link their currency to gold isn’t for ages yet. You skipped the bit about the Swiss gold! AND you left out the best part — the missing gold?”

“Sheesh!” the old man said in mock exasperation, “I’m coming to that part now! You are one impatient little fella, aren’t you?”

“But this is the best bit!” the boy replied excitedly.

Click here to continue reading this article from Things That Make You Go Hmmm… – a free newsletter by Grant Williams, a highly respected financial expert and current portfolio and strategy advisor at Vulpes Investment Management in Singapore.

3 Things Worth Thinking About

Courtesy of Lance Roberts of STA Wealth Management

Data And Surveys Continue To Part Company

Last Friday, I discussed the growing gap between economic reports particularly when they measure the same basic areas of the overall economy. For example, how can the Markit Manufacturing PMI Index be negative for three months while the ISM PMI has surged higher during the same period. Both cannot be right.

Well, the same thing happened yesterday with the release of the Chicago Fed National Activity Index (CFNAI) which is arguably one of the most important economic indicators available. While the recent release of the Philidelphia Fed manufacturing survey surged to its highest level in years, the CFNAI fell to .14 from .29 last month.

(Note: The Chicago Fed National Activity Index (CFNAI) is a monthly index comprised of 85 subcomponents that provide a broad measure of economic activity nationwide.)

More importantly, while the Federal Reserve and ISM surveys have been showing strong increases in recent months; the production, income and consumption and housing components of the CFNAI have declined.  The chart below shows the CFNAI index broken down into the 3-month average of supply (production, income, employment) and demand (consumption, housing, sales).

CFNAI-Supply-Demand-112514

There are TWO very important things to take away from the chart above. First, supply and demand have had an extremely tight correlation prior to the financial crisis. However, since the last recession demand has underperformed supply to a significant extent which confirms the weak economic underpinnings for the majority of the country. 

Secondly, while government related survey's are showing a vast improvement in economic activity, there has been little marginal improvement in the CFNAI. In fact, as shown in the chart below, the 3-month average has turned significantly lower in the second and third quarters of this year which suggests that real economic activity is slowing.

CFNAI-3month-Growth-112514

With the economic recovery now more than six years into recovery it has become a "footrace" to the finish line. With asset prices at elevated levels in anticipation of an economic revival, the failure of such a resurgence could lead to a significant disappointment for investors. With extremely cold weather threatening a large chunk of the population, there are risks to both corporate earnings expectations as well as to economic growth.

While there are indeed some very encouraging economic reports, it is important to remember that many are "sentiment surveys" that are subject to quick reversals.

Lastly, how is it the sentiment survey's are rising so strongly when CEO confidence is plunging. As Markit reports:

“This survey is a timely reminder that the U.S. economy has not been immune from weakening global business conditions, with euro area woes and heightened geopolitical risk weighing on firms’ business outlook and job hiring intentions for 2015."

Markit-US-Expectations-112514

“U.S. companies reported the lowest degree of confidence since the survey began in late 2009, reflecting domestic concerns and a subdued external demand environment."

 

Like I said in the beginning, most of the hard data suggests a much weaker economic environment than the current sentiment does. Both sets of data cannot be right.

 The Charge Of The Large Caps

One of the early warning signs of late stage bull market cycles is a narrowing of leadership in the markets. As the bull ages money tends to chase fewer and fewer stock into the peak. The chart below shows the S&P 600 small-cap, Russell 2000, S&P 400 mid-cap, S&P 100, Nasdaq 100 and S&P 500 large-cap indicies.

 Market-Capitalization-Performance-YTD-112514

As you can see, since the beginning of the year money has continued to chase fewer and fewer stocks with the large cap technology-heavy Nasdaq 100 leading the charge.

Of course, the last time that the Nasdaq 100 took a rather stellar lead in performance over the vast majority of other stocks was heading into 2000. While I am certainly not suggesting that the recent narrowing of performance is a sign that a market crash is imminent, it is important to understand that a narrowing of leadership has historically been attributed to an "aging bull market."

As Keith Jurow recently penned:

"Advisors must consider the possibility that what is assumed may not be true. This means challenging common perceptions. While not an easy task, it is absolutely essential for any investment advisor whose clients have large asset portfolios at risk."

Are We Taking Liquidity For Granted

Tracy Alloway recently penned:

"To be clear, the lack of liquidity just exacerbates market moves. The underlying problem is that complacent investors have been in the same (long) positions for the past five years, selling volatility and levering up to boost returns."

This is an important point. Investors have come to take a flood of liquidity by Central Banks as a given. However, what investors have come to take as a "given" may, in fact, be a mirage. The Federal Reserve has recently stopped its most recent innovation of direct liquidity injections. Furthermore, the BoE's Mark Carney recently gave a speech suggesting:

"It is particularly notable how the search for yield has compressed liquidity premia across markets. This is unlikely to be sustainable over the medium term because it exists against a backdrop of much-reduced market-making activity. Fundamentally, liquidity has become more scarce in secondary fixed income markets. It just appears that it hasn’t."

However, as investors continue to chase yield in a low interest rate environment, the push has primarily been focused in the riskiest of bond issuances. For example, Spanish bonds recently traded with a yield of below 2%. Since interest rates are a function of the "risk" that is undertaken by the lender, is this a suggestion that Spain is a more credit worthy borrower than the U.S. Hardly. It is, however, a sign that investors believe that whatever happens a central bank will gladly bail them out.

Bonds-UST-Spain-112514

Carney comments suggests that the belief of infinite liquidity may be flawed.

"New prudential requirements have reduced incentives for banks to warehouse risk positions. Dealer inventories in fixed income have declined by 70% since the pre-crisis period, while the stock of fixed income assets outstanding has doubled. And the Value-at-Risk in banks’ trading books has retreated to 2002 levels.

The time to liquidate a given position is now seven times as long as in 2008, reflecting much smaller trade sizes in fixed income markets. In part the current liquidity illusion is a product of the risk asymmetries implied by the zero lower bound on interest rates, excess reserves in the system, and perceived central bank reaction functions. However, interest rates in advanced economies won’t remain this low forever. Once the process of normalization begins, or perhaps if market perceptions shift, and it is expected to begin, a re-pricing can be expected.

The orderliness of that transition is an open question."

This is a hugely important statement. While Central Banks globally have gone "all in" on keeping the current environment stable in the face of global deflationary pressures, they cannot control the "psychology" of the market if, or when, something breaks.

The rise of illiquidity in the fixed income markets is a byproduct of the bond buying schemes run by Central Banks globally. The problem comes when someone, somewhere, decides to sell.

Google vs. Sun vs. France: Too Big, Too Powerful, Too Free

Courtesy of Mish.

I happen to like the sun. By definition, the earth would not even be a planet without the sun. No one on earth would be alive without free sunshine.

I happen to like Google. I could survive without Google, but like the sun, much of what Google provides is free.

Free Google Things

  • Free internet services including the best search engine in the world
  • Free Gmail
  • Free research on self-driving cars
  • Free research on other robotics
  • Free blog software
  • Free hosting and storage for blogs
  • Free ads on my blog (and those ads make me money)

For a discussion of the implications of a self-driving car, please see Google Unveils Self-Driving Car, No Steering Wheel, No Accelerator, No Brake Pedal; Self-Driving Taxi Has Arrived. Who, other than city bureaucrats with their taxi licensing scheme will not want lower taxi fares?

For a discussion of other Google robotic research, please see More Robots: Google’s “Atlas” Robot Mimics “Karate Kid”; Flying Defibrillator “Ambulance Drone” Unveiled; Fed Has No Answer.

Green Energy Handouts vs. Google

Unlike “green energy” parasites that could not exist without government subsidies (taxpayer dollars), Google, like the sun does what it does for free. Google does not ask for money from the government to promote autonomous cars, robots, or anything else.

Instead, Google research has created thousands of very high-paying jobs. Those job-holders pay taxes.

What’s not to like?

Enter the French

France does not like Google. Yesterday, Yahoo! reported on France’s Desperate Battle to Erase Google, Netflix and Uber from Existence. …

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For The World’s Largest Rig Operator, The “Recovery” Is Now Worse Than The Post-Lehman Crash

Courtesy of ZeroHedge. View original post here.

Submitted by Tyler Durden.

The last time the world's largest oil and gas drill operator, Seadrill, halted its dividend payment was in 2009, shortly after Lehman had filed and the world was engulfed in a massive depression. Retrospectively, this made sense: the company was struggling not only with depressionary oil prices, but with a legacy epic debt load as can be seen on the chart below.

 

So the fact that the stock of Seadrill collapsed by 20% today following a shocking overnight announcement that it had once again halted its dividend…

… despite what is a far lower debt load than last time, indicates that when it comes to energy companies, the current global economic "recovery" – if one believes the rigged US stock market – is actually worse than the Lehman collapse.

Some more details from FT, on what is said to be a Seadrill "perfect storm" involving the declining oil price and Russian sanctions, and which is why the company just went into cash clampdown mode:

Seadrill’s shares fell as much as 18 per cent on Wednesday morning following the announcement of its third-quarter results, in which the Oslo-listed company reported a 40 per cent fall in net income. The shares recovered somewhat by early afternoon, and were down 10 per cent.

The sharp fall in the oil price since June, plus an oversupply of drilling rigs, has coincided with uncertainty over the future of an Arctic exploration deal involving Seadrill subsidiary North Atlantic Drilling and Rosneft, the Russian state owned energy company.

“It has almost been a perfect storm for Seadrill this quarter,” said Rune Magnus Lundetrae, chief financial officer, “in terms of downward pressure on the oil price, the demand-supply balance for rigs, increasing cost focus from the oil companies and then geopolitical uncertainty surrounding the Rosneft deal, the biggest offshore contact we have ever signed.”

Seadrill is controlled by billionaire John Fredriksen. Both Seadrill and NADL – which specialises in the Arctic and harsh offshore drilling environments – are listed in New York.

From Perfect storm to no more dividend:

By suspending the dividend, the company was “acting responsibly, before we are forced to”, Mr Lundetrae said. Seadrill instead intends to strengthen its balance sheet by cutting debt, putting itself in a position to consider possible acquisitions.

….

Mr Fredriksen said the decision to suspend the dividend had been a difficult one for the board. “However, taking into consideration the significant deterioration in the broader offshore drilling and financing markets over the past quarter, the board believes this is the right course of action for the company,” he added.

And while we know that Obama's Russian "costs" pushed Europe into a triple-dip recession (sorry, but those benefits from hookers and blow will soon run out), it appears now Obama has taken aim at shareholders of publicly-traded companies:

Mr Lundetrae said the uncertainty around Rosneft – which has been affected by western sanctions imposed on Russia over the Ukraine crisis – had added to negative sentiment in the energy industry.

US sanctions on Russia “look very challenging to operate within . . . given all the US equipment on our rigs”. But Mr Lundetrae said Seadrill is still working with Rosneft, having just extended a walkaway clause to May next year.cd

But the worst news is for bondholders of energy Junk here in the US: because at least according to SDRL that default wave among high yield energy companies that DB warned about is about to strike:

Mr Lundetrae said Seadrill was not convinced the market would revive in the next 18 to 24 months, with next year likely to be worse than this year. Meaningful recovery was more likely in 2017, he added.

As they just warned:

  • *SEADRILL SAYS SOME FINANCING MARKETS HAVE BECOME UNATTRACTIVE

Which is clear as 5Y bonds trade well above 9.5% yields…

Perhaps this is an opportune time to reread the warnings from 2 weeks ago about what may and likely will happen to the US junk bond market unless OPEC pulls a miracle out of a hat tomorrow: If WTI Drops To $60, It Will "Trigger A Broader HY Market Default Cycle"

But fear not: those same bondholders who are about to be wiped out will soon be allowed to sell their worthless bonds to the ECB's latest monetization contraption and use the proceeds to buy stawks at recorder all time highs, because just like CYNK, unless the S&P 500 keeps exponentially rising on ever lower volumes, it has only one other, far less pleasant, option.

Why Do So Many John Wiley Authors Want You to Trade the Markets?

Courtesy of Pam Martens.

9781118650059_cover.indd

The way the 200-year old publishing house, John Wiley & Sons, is pumping out books enticing average folks to trade the markets, one might be inclined to forget that 2014 will go down in history as the year when there were more charges of rigged markets on television, in courtrooms, at Senate hearings, and in prosecutors’ offices than at any time in the history of markets. If ever there was a time less conducive to trying your hand at trading, I can’t think of it, although October 29, 1929 might be a contender.

Wiley says it “provides everything the trader needs to survive and succeed in every kind of market.” But if every market is rigged against even highly sophisticated traders, how could a rookie with a little book learning succeed?

Let’s review what we’ve learned so far this year. On March 30, author Michael Lewis, who previously worked on the iconic trading floor of Salomon Brothers, went on 60 Minutes with professional trader Brad Katsuyama to explain to the world that “The United States stock market, the most iconic market in global capitalism is rigged.”

When asked by interviewer Steve Kroft who it is that’s rigging the market, Lewis replied: “By a combination of these stock exchanges, the big Wall Street banks and high-frequency traders…” Lewis goes on to explain that “High-frequency traders, big Wall Street firms and stock exchanges have spent billions to gain an advantage of a millisecond for themselves and their customers, just to get a peek at stock market prices and orders a flash before everyone else, along with the opportunity to act on it.”

With that knowledge, according to Lewis, these traders are able to front run your order. Katsuyama, a professional trader at the Royal Bank of Canada who later started his own firm, said the market would seem willing to sell him a stock but when he went to buy it, the price went up. It felt like someone knew what he was going to do – because they did. High frequency traders who could afford to spend millions to gain a millisecond advantage at seeing market prices faster could front run the slower trader’s order.

If the stock market is rigged, maybe you could use some of those Wiley books on trading the futures’ markets instead. According to three veteran traders who have filed a lawsuit in Chicago, the futures market is rigged also. Their court filing explains how the rigging works:

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The REAL Looting Is Happening On Wall Street … Not In Ferguson

Courtesy of ZeroHedge. View original post here.

Submitted by George Washington.

LOOTERS

LOOTERS AT THE FED

ANOTHER LOOTER

Images by William Banzai … OBVIOUSLY!

The looting in Ferguson, Missouri is bad.    The looters are giving the peaceful protesters against the shooting of Michael Brown a bad name, and provoking an armed (and over-militarized) response by the police.

But let’s put things in perspective …

Wall Street’s crimes and fraud have cost the economy tens of trillions of dollars.

The big banks are still engaged mind-blowing levels of manipulation and crime.

Nobel prize winning economist Joe Stiglitz and well-known economist Nouriel Roubini say that we’ve got to jail – or perhaps even hang – some bankers before they’ll stop looting the economy.

Nobel prize winning economist George Akerlof has demonstrated that failure to punish white collar criminals – and instead bailing them out- creates incentives for more economic crimes and further destruction of the economy in the future.

We explained in 2009:

As Examiner.com pointed out in May (it is worth quoting the essay at some length, as this is an important concept), looting has replaced free market capitalism:

Nobel prize-winning economist George Akerlof co-wrote a paper in 1993 describing the causes of the S&L crisis and other financial meltdowns. As summarized by the New York Times:

In the paper, they argued that several financial crises in the 1980s, like the Texas real estate bust, had been the result of private investors taking advantage of the government. The investors had borrowed huge amounts of money, made big profits when times were good and then left the government holding the bag for their eventual (and predictable) losses.

In a word, the investors looted. Someone trying to make an honest profit, Professors Akerlof and Romer

[co-author of the paper, and himself a leading expert on economic growth] said, would have operated in a completely different manner. The investors displayed a “total disregard for even the most basic principles of lending,” failing to verify standard information about their borrowers or, in some cases, even to ask for that information.

 

The investors “acted as if future losses were somebody else’s problem,” the economists wrote. “They were right.”

The Times does a good job of explaining the looting dynamic:

The paper’s message is that the promise of government bailouts isn’t merely one aspect of the problem. It is the core problem.

Promised bailouts mean that anyone lending money to Wall Street — ranging from small-time savers like you and me to the Chinese government — doesn’t have to worry about losing that money. The United States Treasury (which, in the end, is also you and me) will cover the losses. In fact, it has to cover the losses, to prevent a cascade of worldwide losses and panic that would make today’s crisis look tame.

But the knowledge among lenders that their money will ultimately be returned, no matter what, clearly brings a terrible downside. It keeps the lenders from asking tough questions about how their money is being used. Looters — savings and loans and Texas developers in the 1980s; the American International Group, Citigroup, Fannie Mae and the rest in this decade — can then act as if their future losses are indeed somebody else’s problem.

Do you remember the mea culpa that Alan Greesnspan, Mr. Bernanke’s predecessor, delivered on Capitol Hill last fall? He said that he was “in a state of shocked disbelief” that “the self-interest” of Wall Street bankers hadn’t prevented this mess.

He shouldn’t have been. The looting theory explains why his laissez-faire theory didn’t hold up. The bankers were acting in their self-interest, after all…Think about the so-called liars’ loans from recent years: like those Texas real estate loans from the 1980s, they never had a chance of paying off. Sure, they would deliver big profits for a while, so long as the bubble kept inflating. But when they inevitably imploded, the losses would overwhelm the gains…

What happened? Banks borrowed money from lenders around the world. The bankers then kept a big chunk of that money for themselves, calling it “management fees” or “performance bonuses.” Once the investments were exposed as hopeless, the lenders — ordinary savers, foreign countries, other banks, you name it — were repaid with government bailouts.

In effect, the bankers had siphoned off this bailout money in advance, years before the government had spent

it…Either way, the bottom line is the same: given an incentive to loot, Wall Street did so. “If you think of the financial system as a whole,” Mr. Romer said, “it actually has an incentive to trigger the rare occasions in which tens or hundreds of billions of dollars come flowing out of the Treasury.”

In fact, the big banks and sellers of exotic instruments pretended that the boom would last forever, siphoning off huge profits during the boom with the knowledge that – when the bust ultimately happened – the governments of the world would bail them out.

As Akerlof wrote in his paper:

[Looting is the] common thread [when] countries took on excessive
foreign debt, governments had to bail out insolvent financial institutions, real estate prices increased dramatically and then fell, or new financial markets experienced a boom and bust…Our theoretical analysis shows that an economic underground can come to life if firms have an incentive to go broke for profit at society’s expense (to loot) instead of to go for broke (to gamble on success). Bankruptcy for profit will occur if poor accounting, lax regulation, or low penalties for abuse give owners an incentive to pay themselves more than their firms are worth and then default on their debt obligations.

Indeed, Akerlof predicted in 1993 that the next form the looting dynamic would take was through credit default swaps – then a very-obscure financial instrument (indeed, one interpretation of why CDS have been so deadly is that they were the simply the favored instrument for the current round of looting).

Is Looting A Thing of the Past?

Now that Wall Street has been humbled by this financial crash, and the dangers of CDS are widely known, are we past the bad old days of looting?

Unfortunately, as the Times points out, the answer is no:

At a time like this, when trust in financial markets is so scant, it may be hard to imagine that looting will ever be a problem again. But it will be. If we don’t get rid of the incentive to loot, the only question is what form the next round of looting will take.

Indeed, one of America’s top experts on white collar fraud – the senior S&L prosecutor who put more than 1,000 top executives in jail for fraud (Bill Black)- says that we’ve known for “hundreds of years” that failure to punish white collar criminals creates incentives for more economic crimes and further destruction of the economy in the future. And see this, this, this and this.

Review of the data on accounting fraud confirms that fraud goes up as criminal prosecutions go down. Indeed, extensive evidence shows that failing to prosecute looting by Wall Street is killing our economy.

And yet the U.S. government admits that it refuses to prosecute fraud … pretty much as an official policy. Indeed, the government helped cover up the crimes of the big banks, used claims of national security to keep everything in the dark, and changed basic rules and definitions to allow the game to continue. See this, this, this and this.

Indeed, Wall Street – with the help of Washington – has robbed (and raped) America.

The Fish Is Rotting from the Head Down

Moreover, corruption at the top leads to lawlessness by the people. As we noted in 2011, in the middle of the London riots:

Corruption and lawlessness by our “leaders” encourages lawlessness by everyone else. See this, for example.

Peter Oborne – the Daily Telegraph’s chief political commentator – wrote yesterday:

The criminality in our streets cannot be dissociated from the moral disintegration in the highest ranks of modern British society. The last two decades have seen a terrifying decline in standards among the British governing elite. It has become acceptable for our politicians to lie and to cheat. An almost universal culture of selfishness and greed has grown up.

 

It is not just the feral youth of Tottenham who have forgotten they have duties as well as rights. So have the feral rich ….

***

The so-called feral youth seem oblivious to decency and morality. But so are the venal rich and powerful – too many of our bankers, footballers, wealthy businessmen and politicians.

***

The sad young men and women, without hope or aspiration … have caused such mayhem and chaos over the past few days. But the rioters have this defence: they are just following the example set by senior and respected figures in society. Let’s bear in mind that many of the youths in our inner cities have never been trained in decent values. All they have ever known is barbarism. Our politicians and bankers, in sharp contrast, tend to have been to good schools and universities and to have been given every opportunity in life.

Something has gone horribly wrong in Britain. If we are ever to confront the problems which have been exposed in the past week, it is essential to bear in mind that they do not only exist in inner-city housing estates.

The culture of greed and impunity we are witnessing on our TV screens stretches right up into corporate boardrooms and the Cabinet. It embraces the police and large parts of our media. It is not just its damaged youth, but Britain itself that needs a moral reformation.

Osborne also gives specific examples of corruption, such as the prime minister’s involvement in the Murdoch scandal, and members of parliament abusing expense accounts.

Indeed, the rioters themselves agreed. As Reuters notes:

Speaking to Reuters late on Tuesday, looters and other local people in east London pointed to the wealth gap as the underlying cause, also blaming what they saw as police prejudice and a host of recent scandals.

Spending cuts were now hitting the poorest hardest, they said, and after tales of politicians claiming excessive expenses, alleged police corruption and bankers getting rich it was their turn to take what they wanted.

They set the example,” said one youth after riots in the London district of Hackney. “It’s time to loot.”

As Max Keiser noted at the time, harshly cracking down on British youth looting a $1 bottle of water or a candy bar while letting the financial looters go free is hypocritical.

As we noted in 2011, failing to prosecute financial fraud – on either side of the Atlantic – is extending the economic crisis. In 2012, we pointed out that European (and American) governments were encouraging bank manipulation and fraud to cover up insolvency … trying to put lipstick on a pig.

As a result, Europe is still in a depression … and America has the highest levels of inequality in history. And that’s killing our economy.

Postscript: Perverse money incentives are what led to the distrust in Ferguson police in the first place.

 

Merkel Will Blink First, Not Putin

Courtesy of Mish.

The cold war took another twist last week when a Senior German Politician Endorsed Russian Takeover of Crimea.

Former state premier Matthias Platzeck, chairman of the German-Russian Forum business lobby and erstwhile Social Democrat (SPD) chief, is the first high-ranking German to say the West should endorse the annexation as a way to help resolve the Ukraine crisis.

Platzeck, 60, told the Passauer Neue Presse newspaper: “A wise man changes his mind – a fool never will… The annexation of Crimea must be retroactively arranged under international law so that it’s acceptable for everyone.”

Platzeck, Brandenburg’s popular state premier from 2002 to 2013, struck a nerve in eastern Germany where there is far less support for sanctions against Russia than in the West.

“We have to find a resolution so that Putin won’t walk off the field as the loser,” said Platzeck, whose career was nurtured by ex-Chancellor Gerhard Schroeder – a friend of Putin. He said areas held by separatists will never be part of Ukraine.

Political Infighting

Platzeck’s statement shocked a lot of people including German Foreign Minister Frank-Walter Steinmeier who stated Germany will Never Accept Crimea Annexation.

We don’t accept what has happened and we don’t accept Europe’s borders being changed again 70 years after the war,” said Steinmeier.

Cracks Form

Der Spiegel reports Cracks Form in Berlin Over Russia Stance.

A political solution is more distant than ever in the Russia conflict, with the German government and EU having exhausted their diplomatic options. A rift may now be growing between Chancellor Merkel and her foreign minister over Berlin’s tough stance against Moscow.

Dead End for Merkel

Today, Reuters reports Merkel Hits Diplomatic Dead-End With Putin.

Since February, when the pro-Russian president of Ukraine, Viktor Yanukovich, fled Kiev amid violent protests on the Maidan square, Germany has taken the lead in trying to convince Putin to engage with the West.

Merkel has spoken to him by phone three dozen times. Her Foreign Minister Frank-Walter Steinmeier, a member of the Social Democrats (SPD), traditionally a Russia-friendly party, has invested hundreds of hours trying to secure a negotiated solution to the conflict….

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Follow The Sand To The Real Fracking Boom

Follow The Sand To The Real Fracking Boom

By James Stafford of OilPrice.com

When it takes up to four million pounds of sand to frack a single well, it’s no wonder that demand is outpacing supply and frack sand producers are becoming the biggest behind-the-scenes beneficiaries of the American oil and gas boom.

Demand is exploding for “frac sand”–a durable, high-purity quartz sand used to help produce petroleum fluids and prop up man-made fractures in shale rock formations through which oil and gas flows—turning this segment into the top driver of value in the shale revolution.

“One of the major players in Eagle Ford is saying they’re short 6 million tons of 100 mesh alone in 2014 and they don’t know where to get it. And that’s just one player,” Rasool Mohammad, President and CEO of Select Sands Corporation told Oilprice.com.

Frack sand exponentially increases the return on investment for a well, and oil and gas companies are expected to use some 95 billion pounds of frack sand this year, up nearly 30% from 2013 and up 50% from forecasts made just last year.

Pushing demand up is the trend for wider, shorter fracs, which require twice as much sand. The practice of downspacing—or decreasing the space between wells—means a dramatic increase in the amount of frac sand used. The industry has gone from drilling four wells per square mile to up to 16 using shorter, wider fracs. In the process, they have found that the more tightly spaced wells do not reduce production from surrounding wells.

This all puts frac sand in the drivers’ seat of the next phase of the American oil boom, and it’s a commodity that has already seen its price increase up to 20% over the past year alone.

Frac sand is poised for even more significant gains over the immediate term, with long-term contracts locking in a lucrative future as exploration and production companies experiment with using even more sand per well. 

Pioneer Natural Resources Inc. (NYSE:PXD) says the output of wells is up to 30% higher when they are blasted with more sand.

Citing RBC Capital Markets, The Wall Street Journal noted that approximately one-fifth of onshore wells are now being fracked with extra sand, while the trend could spread to 80% of all shale wells.

Oilfield services giants such as Halliburton Co. (NYSE:HAL) and Baker Hughes Inc. (NYSE:BHI) are stockpiling sand now, hoping to shield themselves from rising costs of the high-demand product, according to a recent Reuters report. They’re also buying more sand under contract—a trend that will lead to more long-term contracts and a longer-term boost for frac sand producers.

In this environment, the new game is about quality and location.

Frac sand extraction could spread to a dozen US states that have largely untapped sand deposits, but the biggest winners will be the biggest deposits that are positioned closest to major shale plays such as Eagle Ford, the Permian Basin, Barnett, Haynesville and the Tuscaloosa marine shale play.

The state of Wisconsin has been a major frac sand venue, with over 100 sand mines, loading and processing facilities permitted as of 2013, compared to only five sand mines and five processing plants in 2010.

Raw Frac Sand Price

But with the surge in demand for this product, companies are looking a bit closer to shale center to cut down on transportation costs and improve the bottom line.

One of the hottest new frac sand venues is in Arkansas’ Ozark Mountains, which is not only closer by half to the major shale plays, saving at least 25% per ton on transportation costs, but also allows for year-round production that will fill the gap in shortages when winter prevents mining in northern states.

“In the southern US, we can operate year round, so there is no fear of a polar vortex like that which we saw last year with some other producers,” says Mohammad of Select Sands, which has two known producing frac sand mines in northeastern Arkansas, in the Ozark Mountains, and sells the bulk of its frac sand to producers in the Eagle Ford, Barnett and Haynesville shales, as well as in the new marine shale, Tuscaloosa.

Chicago-based consulting company Professional Logistics Group Inc. found in 2012 that transportation represented 58% of the cost of frac sand, while Select Sands (TSX.V:SNS), estimates the costs between 66-75% today.

The competition is stiff, but this game is still unfolding, while increased demand is reshaping the playing field.

US Silica Holdings Inc. says demand for its own volumes of sand could double or triple in the next five years, and its three publicly-traded rivals—Emerge Energy Services (NYSE:EMES), Fairmount Santrol (NYSE:FMSA) and Hi-Crush Partners (NYSE:HCLP), have also made strong Wall Street debuts over the past two years.

Benefit From the Latest Energy Trends and Investment Opportunities before the mainstream media and investing public are aware they even exist. The Free Oilprice.com Energy Intelligence Report gives you this and much more. Click here to find out more.

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Rents Heading Up? Will the CPI Follow?

Courtesy of Mish.

Rents are up 6.5% in San Francisco, and 4.5% in numerous other cities. Is this a leading indicator for a stronger inflation as measured by the CPI.

Please consider the Variant Perception article Higher Rents in the US are a Strong Support for CPI.

Despite the subdued nature of US CPI, some large components are turning up.  Owners’ equivalent rent and rent of primary residence, which together account almost of a third of the CPI basket, are turning up strongly. A low vacancy rate and a relatively resilient US economy is helping to drive rents higher, with San Francisco seeing the greatest rent increases, at 6.4% over the last year, and with many other cities, such as Nashville, Seattle, Denver and Houston, all seeing increases of over 4.5%

Furthermore, our leading indicator for US Shelter CPI, which includes apartment vacancy rates and the growth in the working-age population among its inputs, shows that the trend should continue. Higher rents are a strong support for headline CPI in the US.

Owners’ Equivalent Rent

Owners Equivalent Rent vs. CPI Shifted 18 Months

The red line in the above chart is not the CPI, but rather a “leading indicator for US Shelter CPI, which includes apartment vacancy rates”

I took the above chart, clipped out the red CPI line, made a layer out of it in Photoshop, and then shifted the line back 18 months with reduced opacity so you can see both lines. Here is my result.

Owners Equivalent Rent vs. CPI Shifted 18 Months and Not Shifted


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Jon Stewart Regrets Abusing Jim Cramer

Jon Stewart Regrets Abusing Jim Cramer

Courtesy of 

“You begin to believe your own responsibility to ‘get this guy’ – even though that’s complete bullshit….I think the Cramer thing was one of those that negatively impacted me like that because that came out of alchemy but it became such a big deal.”

– Jon Stewart on the The Howard Stern Show, 11/18/2014

Jon Stewart feels bad about the massive railroading that happened to Jim Cramer on The Daily Show in the aftermath of the crisis.

During an hour-long interview on the Howard Stern show this past week, Stewart and Stern got into a discussion about the trouble with viewer expectations that come along with doing a news show on important issues. Jon Stewart explains that it’s not really his role to have every moment be cathartic for everyone or for every interview to result in a gotcha moment. He brings up the Cramer example – wherein he essentially blamed a TV host for the entirety of the nation’s worst financial crisis in 70 years. In my book, Clash of the Financial Pundits, I take Jim’s side in calling the moment completely unfair, even though I’ve been a fan of The Daily Show and Jon Stewart’s since day one.

My take is that the people wanted blood and Jim basically served himself up for a crucifixion. Stewart had a target he could rage against who was willing to do it – but what The Daily Show didn’t count on was Jim Cramer not fighting back. The segment comes off as atrociously one-sided owing to Cramer’s lack of defense. This despite the fact that the Mad Money host is just one person and had absolutely nothing to do with the actual causes of the crisis in real life. Had Cramer pushed back and brought up his vigorously alerting the Federal Reserve to the markets’ problems in advance, it would have been entirely justified. But he didn’t bother. Like any trader, he saw what the story was on-set and simply cut his losses.

Full audio of the Howard Stern interview with Jon Stewart in the embed below, the Cramer stuff is discussed at the 35 minute mark.

Outside the Box: Notes on Russia

 

Outside the Box: Notes on Russia

By John Mauldin

Russia and its redoubtable president, Vladimir Putin, have been much in the news lately. The latest flurry came when Putin was taken out behind the woodshed at the G20 conference in the Philippines last weekend over his recent moves to inject more Russian troops and arms into Ukraine.

For today’s Outside the Box we have two pieces that deliver deeper insights into the situation with Russia and Putin. The first is from my good friend Ian Bremmer, President of the Eurasia Group and author of Every Nation for Itself: Winners and Losers in a G-Zero World. You probably caught my mention of Ian’s presentation at the institutional fund manager conference where we both spoke last weekend. He had some unsettling things to say about Russia; and so when he followed up with an email to me on Monday, I asked if he’d let me share the section on Russia with you. Understand, Ian is connected, and so what you’re about to be treated to here is analysis from way inside. (He’ll be presenting at our Strategic Investment Conference again next April, too.)

Then we turn to a piece that my friend Vitaliy Katsenelson published last week in his monthly column in Institutional Investor. I need to preface this one by mentioning that Vitaliy was born in Murmansk, Russia, where he lived until age 18, when his family emigrated to the US. Fast-forward 23 years, and today Vitaliy is Chief Investment Officer for Investment Management Associates in Denver and author of the highly successful Active Value Investing: Making Money in Range-Bound Markets and The Little Book of Sideways Markets. That’s quite a journey, and Vitaliy has some very strong feelings about the country he left as well as the one he came to. In his intro to today’s piece he admits,

[This is] one of the most emotionally taxing things I ever wrote. A few days ago my wife looked at me and said, “When are you going to be done with it; this article is bringing you down.” She was right.

But I think you’ll agree that when Vitaliy recently subjected himself to a 7-day news diet of nothing but Russian media, the better to comprehend current Russian attitudes, he resurfaced with some valuable insights.

And I can’t leave our deliberations on all things Russia and Putin without mentioning again Marin Katusa’s new book, The Colder War, which I featured in Outside the Box two weeks ago. It’s a compelling survey of the history and dynamics of world energy markets and the role that Putin seeks to play in them.

Geopolitically, the world seems to be a calmer place as we head into the Christmas season, with the significant and glaring exception of Russia. And remember, falling oil prices will seriously impact an already stressed Russian economy.

But before we turn to the eye-opening if somber notes below, I want to share with you a fabulous story from my friend Art Cashin, who is one of the world’s great raconteurs. I make sure to have dinner with Art whenever I’m in New York. In addition to his wisdom concerning the markets, he simply has the best stories. The last dinner (also attended by Barry Ritholtz and Josh Brown) was at an establishment called Sparks, an old New York watering hole and famous steakhouse not far from Grand Central Station.

Art shared the following story with us and had us in tears. Back in the day, the New York Stock Exchange was a mighty interesting place with a very curious cast of interesting and interlocking personalities. It has calmed down some over the decades, but the stories … well, let’s just let Art tell it.

For years, one of the communal tables at the Luncheon Club would issue a group challenge. They would all set a target for losing weight by some date a couple of months out. The one who weighed up furthest from their target had to buy dinner for the others.

In 1985, the loser was Maurice (Monk) Meyer of Henderson Brothers. Among the others were Jack (Jackie D) D’Alessandro, Pat McCarthy, Bill Fitzpatrick, and Roger Hochstin.

They decided to turn the event into a sort of a Christmas party and scheduled the dinner for the week before Christmas. They made reservations at Sparks Steakhouse.

As the day approached, there was an unexpected development. Mafia kingpin Paul Castellano was gunned down, along with his driver, on the sidewalk outside Sparks.

Nevertheless, the show must go on.

When the fated date arrived, the group decided to meet at the Luncheon Club bar for some rehearsal cocktails. They rehearsed for a couple of hours and then headed for Sparks.

As they arrived, around 7:00, there were some early hints it might be a bumpy evening. When they walked in, the hostess asked if they had reservations. “Only about the food,” snapped Pat McCarthy. That was followed by the maître d’ asking where they’d like to sit, only to hear Roger say, “In the non-shooting section, please.”

Once they were seated, they ignored the menu and ordered more cocktails and several bottles of wine. For the next three hours, they ignored the pleas of several waiters and the maître d’ to order some food to go along with the wine and drinks.

In the meantime, Roger may have been getting bored. He noticed another table with six Japanese men in their twenties and one older man, who looked maybe 60.

Somehow, Roger found a Chinese takeout menu from Chou Lu in his pocket. He put his napkin over his arm as though he were a waiter and went over to the table of Japanese men and began reading the menu in a form of broken Chinglish that would have embarrassed even the producers of the old Charlie Chan movies. Things like “Pork Flied Lice.”

Ironically, only the older man spoke English, and he seemed to think it was a wonderful joke. He told Roger that Roger’s table seemed to be having a wonderful time and asked if he might join it briefly.

Roger brought him over and introduced him around. There was a pleasant exchange for about 15 minutes and then Jackie D asked him where in Japan he came from. They man replied – “Actually, I’m from Okinawa.” Bill Fitzpatrick darkened and said, pointedly, “My favorite uncle was killed on Okinawa by you people during the war.” The man quickly excused himself.

Pat McCarthy reminded Bill that he had not had an uncle in the war. Jack turned to Pat and said, “That doesn’t matter; Bill went through the barrier about two drinks ago.”

Anyway, the waiter finally prevailed upon the boys to order entrees by 10:00. Meanwhile, Maurice was sinking fast. He had come out despite a bad case of the flu, since he was the designated payer. It quickly became evident that Meyer would not make it much past 10:30. He called for the check.

As they were about to help Meyer to his feet, Jackie D noticed that McCarthy had had his untouched entrée put into a doggie bag. Not wanting to be outdone, Jackie reached down and put his medium rare petite filet in his inside jacket pocket without benefit of a doggie bag.

At the coatrack, Jackie attempted to help Meyer get his overcoat on. In doing so Jack lifted his own hand high and out. That swept his jacket off to the side, revealing a shirt dripping with blood from the medium rare filet in his pocket.

Perhaps recalling Castellano’s recent fate, one woman at a table spotted Jack’s shirt and screamed, “My God! He’s been shot!”

Everybody in the restaurant hit the deck, including the maître d’ and our adventurous group. When everyone got back to their feet, the maître d’ told the boys they were never allowed back – collectively or individually.

In a huff, the boys headed off to the John Barleycorn.

Art can go on all night with stories like that. You really should put them into a book, Art.

You have a great week. I am off to the gym, where The Beast will continue to try to whip this poor old body into some similitude of shape.

Your still smiling from all the great stories analyst,

John Mauldin, Editor
Outside the Box 
subscribers@mauldineconomics.com

***

Notes on Russia

By Ian Bremmer
Nov. 17, 2014

the russians are taking every opportunity to escalate an already plenty hostile relationship with the united states and some selected allies. the g20 summit was particularly negative on that front, with russian president putin bringing along some warships to australia, while canadian prime minister stephen harper led a rope line of western leaders calling putin a scoundrel and a liar. putin left early, claiming a need to catch up on sleep and some other business to attend to.

like in ukraine.

i had a chance to talk with some senior russians last week, including two advisors to the kremlin. they explained that putin expected his offer of a ceasefire in southeast ukraine would be sufficient to get the americans to tolerate a status quo, while bringing the europeans to the table with some sanctions reductions. that didn’t happen: instead a coordinated harder line policy stayed in place, while the americans and germans looked set to put more sanctions in place unless the russians actively backed down. despite mounting economic pressure on the europeans, the frozen conflict/long game the kremlin was playing didn’t look like it was going to succeed.

and so the kremlin moved backed to escalation, dramatically expanding their direct military presence in the region – confirmed by nato and the typically-conservative osce, denied by the russian government – and announcing plans to build up troops in crimea. they’re preparing both sides to consolidate their territory, initially through taking the port city of mariupol…potentially then a land-bridge between eastern ukraine and crimea and beyond (odessa being the most obvious place). the most likely path is the kremlin now looking for provocations to “go further” – they’ve already expressed a level of outrage around the ukrainian government severing economic ties to the separatist region – then the fiction of ceasefire is erased and the russians/separatists take more territory. ultimately, whatever the formalized “governance” structure, the kremlin is moving towards making crimea and southeast ukraine a single place.

there’s very little the ukrainians can do. the ukrainian military will remain badly outgunned, and the local populations in the region remain fairly anti-kiev, even if they’re skittish about the notion of russian takeover. we’ll see a pickup in international calls to provide arms for the ukrainian military, but they’ll be rejected, most particularly by the united states. at best we’ll see a step up in intelligence and training support, to little consequence.

putin’s military efforts are also stepping up outside ukraine: the “unknown” but clearly russian submarine off sweden, a russian nuclear armed exercise during an intelligence meeting in denmark; bomber patrols in the gulf of mexico. they’re all bluster, but a clear message to america and its allies…and pose a far higher potential for accidents – one scandanavian airlines flight recently made an emergency alteration to its flight path when a russian military jet suddenly appeared in front of it.

the likelihood of moscow backing down in this environment is near zero. the sanctions aren’t having a meaningful impact on the russian economy (yet) and the popularity of the kremlin isn’t taking a hit. the speech from former soviet general secretary mikhail gorbachev – no fan of putin, but clearly pointing the finger at the west for russia’s troubles – makes that clear. and it’s getting harder for the americans to find an out. german chancellor angela merkel continues to be the best opportunity for compromise, but her relationship with putin is now only barely functional (the kremlin advisors i spoke with said this was the single biggest misstep from putin to date – they believed his bilateral conversations with her were too aggressive and led merkel to feel misled; neither believed the relationship could be salvaged near-term). and so russians are now presuming the sanctions environment will be there for the long haul, and are thinking about the longer term economic implications.

i’d now say that’s meaningful before we get to russia’s 2018 elections: further sanctions causing steep recession leading to unrest in the regions, which begins to metastasize to the cities. that would spook russian elites, some of whom could split from the kremlin. the key early warning indicator would be meaningful defections of any insiders to the west. but critically, we’re at least a year or two away from that. by which time ukraine has been economically devastated, while the strategic shift of russia-china is thoroughly entrenched.

Putin’s World: Why Russia’s Showdown with the West Will Worsen

By Vitaliy Katsenelson
Institutional Investor, Nov. 17, 2014

My father, Naum Katsenelson, painted this watercolor, “Dolls Become Humans,” two years after we came to the United States in 1993. This is the only “thematic” picture my father ever painted.

If you look at the picture carefully you’ll see the silhouette of Lenin in the clouds (representing the past). On the far left there is a Stalin doll and a line of people going to prison. Across from Stalin on the right there is a doll of Brezhnev (you’ll recognize him by his large, distinct eyebrows). On the building on the right there is an image of Gorbachev. Look carefully at the faces in the foreground (representing the present and the future): as they get closer to you they become more humanized – transforming from dolls into humans. The man in front of the woman draped in the American flag is my father; the boy with the Star of David on his chest is me.

This was an aspirational picture. In 1993 the Soviet Union fell apart. Russia’s future looked bright – although it was in chaos, it was a democracy. The dolls here are an analogy for robots, suggesting uniformity of thought. As I was composing this I called my father and asked him if he’d paint the same picture today. He said, “No. Today’s picture would look very different.”

I spent three months aggravating over the following article. It was one of the most emotionally taxing things I ever wrote. A few days ago my wife looked at me and said, “When are you going to be done with it; this article is bringing you down.” She was right.

I grew up hating America. I lived in the Soviet Union and was a child of the cold war. That hate went away in 1989, though, when the Berlin Wall fell and the cold war ended. By the time I left Russia in 1991, the year the Soviet Union collapsed, America was a country that Russians looked up to and wanted to emulate.

Twenty-three years later, a new version of cold war is back, though we Americans haven't realized it yet. But I am getting ahead of myself.

After Russia invaded Crimea and staged its referendum, I thought Vladimir Putin's foreign excursions were over. Taking back Crimea violated plenty of international laws, but let's be honest. Though major powers like the U.S. and Russia write the international laws, they are not really expected to abide by those laws if they find them not to be in their best interests. Those laws are for everyone else. I am not condoning such behavior, but I can clearly see how Russians could justify taking Crimea back – after all, it used to belong to Russia.

I was perplexed by how the Russian people could possibly support and not be outraged by Russia's invasion of Ukraine. But I live in Denver, and I read mostly U.S. and European newspapers. I wanted to see what was going on in Russia and Ukraine from the Russian perspective, so I went on a seven-day news diet: I watched only Russian TV – Channel One Russia, the state-owned broadcaster, which I hadn't seen in more than 20 years – and read Pravda, the Russian newspaper whose name means "Truth." Here is what I learned:

If Russia did not reclaim Crimea, once the new, illegitimate government came to power in Ukraine, the Russian navy would have been kicked out and the U.S. navy would have started using Crimean ports as navy bases. There are no Russian troops in Ukraine, nor were there ever any there. If any Russian soldiers were found there (and there were), those soldiers were on leave. They went to Ukraine to support their Russian brothers and sisters who are being abused by Ukrainian nationalists. (They may have borrowed a tank or two, or a highly specialized Russian-made missile system that is capable of shooting down planes, but for some reason those details are not mentioned much in the Russian media.) On November 12, NATO reported that Russian tanks had entered Ukraine. The Russian government vehemently denied it, blaming NATO for being anti-Russian.

Malaysia Airlines Flight MH17 was not downed by Russia or separatists. It was shot down by an air-to-air missile fired by Ukraine or a NATO plane engaged in military exercises in Ukraine at the time. The U.S. has the satellite imagery but is afraid of the truth and chooses not to share it with the world.

Ukraine was destabilized by the U.S., which spent $5 billion on this project. As proof, TV news showed a video of Senator John McCain giving a speech to antigovernment protesters in Kiev's Maidan Square. It was followed by a video of Vice President Joe Biden visiting Ukraine during the tumult. I wasn't sure what his role was, but it was implied that he had something to do with the unrest.

Speaking of Joe Biden, I learned that his son just joined the board of Ukraine's largest natural gas company, which will benefit significantly from a destabilized Ukraine.

Ukraine is a zoo of a country, deeply corrupt and overrun by Russian-haters and neo-Nazis (Banderovtsi – Ukrainian nationalists who were responsible for killing Russians and Jews during World War II).

Candidates for the recent parliamentary election in Ukraine included Darth Vader (not kidding), as well as a gay ex-prostitute who claims to be a working man's man but lives in a multimillion-dollar mansion.

I have to confess, it is hard not to develop a lot of self-doubt about your previously held views when you watch Russian TV for a week. But then you have to remind yourself that Putin's Russia doesn't have a free press. The free press that briefly existed after the Soviet Union collapsed is gone – Putin killed it. The government controls most TV channels, radio and newspapers. What Russians see on TV, read in print and listen to on the radio is direct propaganda from the Kremlin.

Before I go further, let's visit the definition of propaganda with the help of the Oxford English Dictionary: "The systematic dissemination of information, especially in a biased or misleading way, in order to promote a political cause or point of view."

I always thought of the Internet as an unstoppable democratic force that would always let the truth slip out through the cracks in even the most determined wall of propaganda. I was wrong. After watching Russian TV, you would not want to read the Western press, because you'd be convinced it was lying. More important, Russian TV is so potent that you would not even want to watch anything else, because you would be convinced that you were in possession of indisputable facts.

Russian's propaganda works by forcing your right brain (the emotional one) to overpower your left brain (the logical one), while clogging all your logical filters. Here is an example: Russian TV shows footage of schools in eastern Ukraine bombed by the Ukrainian army. Anyone's heart would bleed, seeing these gruesome images. It is impossible not to feel hatred toward people who would perpetrate such an atrocity on their own population. It was explained to viewers that the Ukrainian army continued its offensive despite a cease-fire agreement.

Of course if you watched Ukrainian TV, you would have seen similar images of death and despair on the other side. In fact, if you read Ukrainian newspapers, you will learn that the Ukrainian army is fighting a well-armed army, not rebels with Molotovs and handguns, but an organized force fully armed by the Russian army.

What viewers were not shown was that the cease-fire had been broken before the fighting resumed. The fact that Putin helped to instigate this war was never mentioned. Facts are not something Russian TV is concerned about. As emotional images and a lot of disinformation pump up your right brain, it overpowers the left, which capitulates and stops questioning the information presented.

What I also learned is that you don't have to lie to lie. Let me give you an example. I could not figure out how the Russian media came up with the $5 billion that "America spent destabilizing Ukraine." But then I found a video of a U.S. undersecretary of State giving an 8.5-minute speech; at the 7.5-minute mark, she said, "Since Ukrainian independence in 1991 … [the U.S. has] invested more than $5 billion to help Ukraine." The $5 billion figure was correct. However, it was not given to Ukraine in three months to destabilize a democratically elected, corrupt pro-Russian government but over the course of 23 years. Yes, you don't have to lie to lie; you just have to omit important facts – something Russian TV is very good at.

Another example of a right-brain attack on the left brain is "the rise of neo-Nazism in Ukraine." Most lies are built around kernels of truth, and this one is no different. Ukraine was home to the Banderovtsi, Ukrainian nationalists who were responsible for killing tens of thousands of Jews and Russians during World War II.

Putin justified the invasion of Crimea by claiming that he was protecting the Russian population from neo-Nazis. Russian TV creates the impression that the whole of Ukraine is overrun by Nazis. As my father puts it, "Ukrainians who lived side by side with Russians did not just become Nazis overnight."

Though there may be some neo-Nazis in Ukraine, the current government is liberal and pro-Western. Svoboda – the party whose members are known for their neo-Nazi and anti-Semitic rhetoric – did not get even 5 percent of the votes in the October election, the minimum needed to gain a significant presence in parliament. Meanwhile the TV goes on showing images of Nazis killing Russians and Jews during World War II and drawing parallels between Nazi Germany and Ukraine today.

What also makes things more difficult in Russia is that, unlike Americans, who by default don't trust their politicians – yes, even their presidents – Russians still have the czarist mentality that idolizes its leaders. Stalin was able to cultivate this to an enormous degree – most Russians thought of him as a father figure. My father was 20 when Stalin died in 1953, and he told me that he, like everyone around him, cried.

I keep thinking about what Lord Acton said: "Power corrupts, and absolute power corrupts absolutely." The Putin we scorn today was not always like this; he did a lot of good things during his first term. The two that stand out the most are getting rid of the organized crime that was killing Russia and instituting a pro-business flat tax system. The amount of power Russians give their presidents, however, will, with time, change the blood flow to anyone's head. Come to think of it, even Mother Teresa would not have stood a chance in Russia.

A few weeks ago Putin turned 62, and thousands of people took to the streets to celebrate his birthday. (Most Americans, including this one, don't even know the month of Barack Obama's birthday.)

In my misspent youth, I took a marketing class at the University of Colorado. I remember very little from that class except this: For your message to be remembered, a consumer has to hear it at least six times. Putin's propaganda folks must have taken the same class, because Russian citizens get to hear how great their president is at least six times a day.

We Americans look at Putin and see an evil KGB guy who roams around the country without a shirt on. Russians are shown a very different picture. They see a hard-working president who cares deeply about them. Every news program dedicates at least one fifth of its airtime to showcasing Putin's greatness, not in your face but in subtle ways. A typical clip would have him meeting with a cabinet minister. The minister would give his report, and Putin, looking very serious indeed, would lecture the minister on what needed to be done. Putin is always candid, direct and tough with his ministers.

I've listened to a few of Putin's speeches, and I have to admit that his oratory skills are excellent, of a J.F.K. or Reagan caliber. He doesn't give a speech; he talks. His language is accessible and full of zingers. He is very calm and logical.

Russians look at the Putin presidency and ask themselves a very pragmatic question: Am I better off now, with him, than I was before he came into power? For most the answer is yes. What most Russians don't see is that oil prices over the past 14 years went from $14 to more than $100 a barrel. They are completely responsible for the revival of Russia's one-trick petrochemical economy. In other words, they should consider why their economy has done better the past decade, and why it may not do as well going forward. Unless Putin was the one who jump-started China's insatiable demand for oil and other commodities that drove prices higher, he has had very little to do with Russia's recent "prosperity."

I place prosperity in quotes because if you take oil and gas riches away from Russia (lower prices can do that with ease), it is in a worse place today than it was 14 years ago. High oil prices have ruined Russia. They have driven its currency up, making its other products less competitive in international markets. Also, capital gravitates toward higher returns; thus oil has sucked capital from other industries, hollowing out the economy. After the Soviet Union collapsed, Russia had a chance to broaden its economy; it had one of the most educated workforces in the world. Sadly, it squandered that opportunity. Name one noncommodity product that is exported from Russia. There aren't many; I can think only of vodka and military equipment.

But most Russians don't look at things that way. For most of them, their lives are better now: No more lines for toilet paper, and the stores are full of food. Their personal liberties (such as freedom of speech and freedom of the press) have been taken away from them, but many have so much trust in their president that they don't mind, whereas others are simply complacent.

Today we see three factors that influence oil prices and are working against Russia: Supply is going up with U.S. shale drilling; demand growth will likely decline if the Chinese economy continues to cool; and the dollar is getting stronger, not because the U.S. doing great but just because the rest of the world is doing worse. If oil prices continue to decline, this will expose the true state of the Russian economy.

When I visited Russia in 2008, I sensed an anti-American sentiment. NATO – which in Russia is perceived as a predominantly American entity – had expanded too close to Russian borders. Georgia tried to join NATO, but Russia put a quick end to that. Russians felt they extended a friendly hand to the U.S. after 9/11, but in response America was arraying missiles around its borders. (The U.S. says they are defensive, not offensive; Russians don't see the distinction. They are probably right.)

The true colors of this new cold war came to light recently. In August 2008, according to Henry Paulson, the U.S. Treasury secretary at the time, "top level" Russian officials approached the Chinese during the Olympics in Beijing and proposed "that together they might sell big chunks of their GSE (Fannie Mae and Freddie Mac) holdings to force the U.S. to use its emergency authorities to prop up these companies."

This incident took place just weeks before the collapse of Lehman Brothers. The U.S. economy was inches from revisiting the Stone Age. The proposed Russian-Chinese maneuver could have made such an outcome more likely. The Federal Reserve would have had to step in and buy Fannie's and Freddie's debt, and the dollar would have taken a dive, worsening the plunge in the U.S. economy. Our friend Putin wanted to bring the U.S. economy down without firing a single shot, just as he annexed Crimea from Ukraine.

Today anti-American sentiment is much greater in Russia. European sanctions are seen as entirely unjustified. Here is why: Crimea had a "democratic referendum," and the Ukrainian conflict is believed to be not of Russia's doing but rather an American attempt to destabilize Russia and bring Ukraine into NATO. In his annual speech at the Valdai conference last month, Putin said America had pushed an unwilling Europe into imposing sanctions on Russia. America is perceived as an imperialistic bully that, because of its economic and military power, puts its own self-interest above everyone else's, and international law.

Putin uses anti-Americanism as a shiny object to detract attention from the weak Russian economy and other internal problems. In the short run, sanctions provide a convenient excuse for the weakening Russian economy and declining ruble. They have boosted Putin's popularity (at least so far). As the Russian economy gets worse, anti-American sentiment will only rise.

This new version of the cold war has little in common with the one I grew up in. There are no ideological differences, and there is no arms race (at least not yet, and let's be honest: Today neither country can afford one, especially Russia). At the core of it, we don't like what Russia is doing to its neighbors, and Russia doesn't like what we do to the rest of the (non-EU) world.

The criticisms of U.S. foreign policy voiced by Putin in his latest Valdai speech are shared by many Americans: The U.S. is culpable in the unresolved, open-ended Afghanistan adventure; the Iraq War; the almost-bombing of Syria, which may have destabilized the region further; and the creation of the Islamic State, which is in large part a by-product of all of the above. Yet Putin's abominable Ukrainian excursion and the thousands of lives lost were never mentioned.

But there is also something less tangible that is influencing Russia's behavior: a bruised ego. During the good old Soviet Union days, Russia was a superpower. It mattered. When it spoke, the world listened. The Russian people had a great sense of pride in their Rodina (Mother Russia). Today, if Russia did not have nuclear weapons, we'd pay much less attention to it than we do. Pick a developing country without oil whose president you can name. (Okay, we Americans can't name the president of almost any other country, but you get the point.)

Anti-Americanism and Putin's popularity will both rise as the Russian economy weakens. For instance, Putin took his own people hostage when he imposed sanctions on imports of European food. The impact on Europe will not be significant (the Russian economy is not very large in comparison to the European Union), but Russia is very dependent on these imports. In the U.S. consumers spend about 13 percent of their earnings on food, but in Russia that number is almost three times larger. Therefore, food inflation hurts Russians much more. Yet as food inflation spiked, so did Putin's popularity and anti-Americanism. Even declining oil prices will be explained as a anti-Russian manipulation by the U.S.

Unfortunately, the only thing Russia has going for it today is its nuclear weapons. Russia has started to remind us of its military recently. According to NATO, the alliance "has conducted over 100 intercepts of Russian aircraft in 2014 to date, which is about three times more than were conducted in 2013."

Every article needs a conclusion, but this one doesn't have one. I am not sure what this new cold war means for the world. Will Russia start invading other neighboring countries? Will it test NATO resolve by invading Baltic countries that are part of NATO? I don't know. Economic instability will eventually lead to political crises. We have plenty of economic instability going on around the world.

I'll leave you with this thought: On March 7, 1936, the German army violated the Treaty of Versailles and entered into the Rhineland. Here is what Hitler later said:

"The forty-eight hours after the march into the Rhineland were the most nerve-racking in my life. If the French had then marched into the Rhineland, we would have had to withdraw with our tails between our legs, for the military resources at our disposal would have been wholly inadequate for even a moderate resistance."

Those two days determined what Germany would do next – build out its army and start World War II.

Comparing Putin with Hitler, as one of my Russian friends put it, is "absolutely abominable" because it diminishes Hitler's atrocities and overstates by a mile what Putin has accomplished to date. Yet it feels as if we are at a Putin-of-1936 moment. Will he turn into a Putin of 1939 and invade other countries? I don't know. But the events of the past nine months have shown Putin's willingness to defy international law and seize the advantage on the ground, betting – correctly so far – that the West won't call his bluff.

As Garry Kasparov put it, while the West is playing chess, responding tactically to each turn of events, Putin is playing high-stakes poker. We ignore Putin at our own peril.

Vitaliy Katsenelson, CFA, is Chief Investment Officer at Investment Management Associates in Denver, Colo. To receive Vitaliy’s future articles by email or read his articles, click here.

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Important Disclosures

Interview with James Grant

Here's an interview with Jim Grant in the Graham & Doddsville newsletter, edited by the Students of Columbia Business School. The interview begins on page 1 and then continues on page 52:  INTERVIEW WITH JAMES GRANT

Excerpt:

G&D: Given the current state of the economy and the low interest rate environment, it sounds like you perceive risks that others do not. What facts, measures, or indications bother you most? 

JG: Here’s a fact: China’s banking assets represent one-third of world GDP, whereas China’s economic output represents only 12% of world GDP. Never before has the world seen the likes of China’s credit bubble. It’s a clear and present danger for us all. And here’s a sign of the times: Amazon, with a trailing P/E multiple of more than 1,000, is preparing to build a new corporate headquarters in Seattle that may absorb more than 100% of cumulative net income since the company’s founding in 1994. Now, there are always things to worry about. Different today is the monetary policy backdrop. Which values are true? Which are inflated? In a time of zero percent interest rates, it’s not always easy to tell. 

G&D: Where can the average investor find income? 

JG: The average, risk-averse investor can’t. There’s none to be had, at least none in natural form. To generate yield, you must apply leverage. This is the stuff of businessman’s risk. A pair of examples: Annaly Capital Management (NYSE:NLY), a mortgage real estate investment trust, which changes hands at 83% of book value to yield 11.4%; and Blackstone Mortgage Trust (NYSE:BXMT), a new real estate finance company, which trades at 113% of book value to yield 6.43%. We judge both to be reasonable risks. More speculative, but—we think, also priced appropriately for the risk—are long-dated Puerto Rico general obligation bonds. The 5s of 2041 trade at 65.40 to yield a triple tax-exempt 8.18%. Widows and orphans stand clear. 

G&D: What about the great debate over tapering?

JG: Grant’s is on record as saying that the Fed won’t taper. Or, that if it does taper, it will likely de- taper—i.e., reverse course to intervene once more— because the economic patient is hooked on stimulus.

The source of the Fed’s problem (which, of course, is everyone’s problem) is that there ought to be deflation. In a time of technological wonder, prices ought to fall, as they fell in the final quarter of the 19th century. As it costs less to produce things (and services), so it should cost less to buy them. In an attempt to force the price level higher by an arbitrary 2% a year, the central bank inevitably creates too much money. Those redundant dollars don’t disappear. 

Nothing Has Changed – And That’s The Problem

Nothing Has Changed–and That's the Problem

Courtesy of Charles Hugh-Smith of OfTwoMinds

Playing monetary games has done nothing to eliminate moral hazard.

If we step back and look at the past six years since the global financial meltdown of 2008, we see that in terms of financial and political power, nothing has changed–and that's the problem. If nothing has changed structurally, then none of the problems that caused the meltdown have truly been addressed.

All that's changed is the vast expansion of monetary games has masked the dysfunctional reality that the same old vested interests that had a death-grip on wealth and power in 2008 have tightened their death-grip in the past six years.

Here's the problem facing every nation and trading bloc:

1. Vested interests institutionalized moral hazard, separating their gains from the consequences of taking risks. This is also known as privatized gains, socialized losses: vested interests reaped the gains from risky speculative bets, but then passed the staggering losses onto the central banks and taxpayers while keeping the gains.

2. The vested interests control the machinery of governance, so there is no way the central state will force the vested interests to absorb the losses that are rightfully theirs. Instead of de-institutionalizing moral hazard, governments have spewed thousands of pages of complicated regulations, in effect, grudgingly nudging the barn door half-closed after the horses of systemic risk galloped away in 2008.

3. With moral risk still institutionalized, nothing has changed: all the gains from subprime auto loans, selling sovereign bonds issued by insolvent governments, etc., are private, and all the risk is being transferred to the central banks and taxpayers.

The money-printing of quantitative easing–central banks printing money to purchase sovereign bonds and mortgages–is actually a form of money-laundering, as all this expansion of central bank balance sheets, debt and liquidity enables the vested interests to expand their control of the financial and political power centers at the expense of everyone else.

Take a look at the vast expansion of debt and the modest impact of that debt on GDP

Look at the unprecedented expansion of the Fed's balance sheet and ask cui bono— to whose benefit?

Since moral hazard–the disconnect of risk and consequence–is the fundamental cause of the global meltdown of 2008, the only solution is to eliminate moral hazard. By this I mean de-institutionalizing moral hazard.

But de-institutionalizing moral hazard means smashing the vested interests' primary engine of wealth and political power.

The only way forward is to assign the losses that have been piled up in the shadows to those who created and bought the risk for their own gain. That means the investment banks that originated the subprime mortgages and auto loans, etc., and the mutual funds, pension funds, wealth funds, etc. that bought them as "low-risk" investments.

Right now, we're bailing out the con-artists (the banks) and their credulous marks— the suckers who foolishly trusted the grifters of Wall Street, London, Shanghai, etc.

This re-linking of risk and consequence is not only the only moral way forward–it's also the only political and financial way to clear the poison of moral hazard from the system.

Saving vested interests from the losses they earned and they deserve poisons the entire financial system. When the poisoned system finally collapses, it will destroy everyone with a stake in the system–including the vested interests who reckoned that their political power would save them from the losses that are rightfully theirs.

Playing monetary games has done nothing to eliminate moral hazard; indeed, playing monetary games cannot possibly eliminate moral hazard, as monetary policy enforces moral hazard.

Those playing monetary games–Kuroda, Draghi, Yellen et al.–will discover this, but only after it's too late to stop the slide into the abyss.

For Whom The Consumer Confidence Bell Tolls

Courtesy of Lee Adler of the Wall Street Examiner

The trend is your friend, but maybe not when it extends to meet a secular downtrend. That’s what the Consumer Conference Board’s ConsumerConfidence (aka the ConCon Con) Index showed today. It shocked Street conomists, whose consensus guesstimate was a reading of 96. Instead it came in at 87.

I see little value in this number. While the secular trend has been down for 14 years, reflecting ever worsening conditions for an increasing number of Americans, over the short to intermediate term the index follows stock prices. If memory serves, wasn’t there a sharp market break in October that had everyone in a panic? I suspect that this influenced the “consumers” who were surveyed by the Conference Board in early November.

The mainstream media dutifully reports this number as if it means something in the short run, and even occasionally will post a chart that goes back a few years showing the uptrend in place since 2009. But you almost NEVER see a long term chart in the Wall Street Journal, on Bloomberg, or CNBC. Gee I wonder if they’re trying to con us?

Consumer Confidence Long Term Trend- Click to enlarge

Consumer Confidence Long Term Trend- Click to enlarge

We should also note that the last two peaks in 2000 and 2007 coincided with stock market tops. Does slightly breaking this trend mean that we’ve broken out? Or is it just a little overshoot, a final burst of “optimism” before the secular trend reasserts itself. If the Con Con Con drops below 86 next month, that could be the ringing of the bell. We need not ask not for whom the bell would toll. It would toll for us.

Get regular updates on the machinations of the Fed, Treasury, Primary Dealers and foreign central banks in the US market, in the Fed Report in the Professional Edition, Money Liquidity, and Real Estate Package. Click this link to try WSE's Professional Edition risk free for 30 days!

Senate Report: Scale of Wall Street Holdings Are “Unprecedented in U.S. History”

Courtesy of Pam Martens.

Senator Carl Levin Conducts a Hearing Into Vast Industrial Commodity Holdings by Wall Street Mega Banks

Senator Carl Levin Conducts a Hearing Into Vast Industrial Commodity Holdings by Wall Street Mega Banks

Last Thursday, the U.S. Senate’s Permanent Subcommittee on Investigations, chaired by Senator Carl Levin, released an alarming 396-page report that details how Wall Street’s too-big-to-fail banks have quietly, and often stealthily through shell companies, gained ownership of a stunning amount of the nation’s critical industrial commodities like oil, aluminum, copper, natural gas, and even uranium. The report said the scale of these bank holdings “appears to be unprecedented in U.S. history.”

Adding to the hubris of the situation, the Wall Street banks’ own regulator, the Federal Reserve, gave its blessing to this unprecedented and dangerous encroachment by banking interests into industrial commodity ownership and has effectively looked the other way as the banks moved into industrial commerce activities like owning pipelines and power plants.

For more than a century, Federal law has encouraged the separation of banking and commerce. The role of banks has been seen as providing prudent corporate lending to facilitate the growth of commerce, not to compete with it through unfair advantage by having access to cheap capital from the Federal Reserve’s lending programs. Additionally, the mega banks are holding trillions of dollars in FDIC insured deposits; if they experienced a catastrophic commercial accident through a ruptured pipeline, tanker oil spill, or power plant explosion, it could once again put the taxpayer on the hook for a bailout.

The Levin report addresses the element of catastrophic risk, noting:

“While the likelihood of an actual catastrophe remained remote, those activities carried risks that banks normally avoided altogether.  Goldman, for example, bought a uranium business that carried the risk of a nuclear incident, as well as open pit coal mines that carried potential risks of methane explosions, mining mishaps, and air and water pollution…Morgan Stanley owned and invested in extensive oil storage and transport facilities and a natural gas pipeline company which, together, carried risks of fire, pipeline ruptures, natural gas explosions, and oil spills.  JPMorgan bought dozens of power plants whose risks included fire, explosions, and air and water pollution.  Throughout most of their history, U.S. banks have not incurred those types of catastrophic event risks.”

Continue Here

Zero Hedge: Ferguson In Flames…

Courtesy of ZeroHedge. View original post here.

Submitted by Tyler Durden.

Protests have gone nationwide

 

New York Live Feed:

And in LA… blocked I-10

Oakland protest gettng violent… and have blocked I-580


Broadcast live streaming video on Ustream

 

And Ferguson is in flames…

And a CNN reporter just got hit in the head with a rock live on air

UPDATE:

  • *U.S. DEPT. OF JUSTICE PROBE OF BROWN SHOOTING CONTINUES: HOLDER
  • *FEDERAL INQUIRY IS INDEPENDENT OF LOCAL FERGUSON PROBE: HOLDER
  • *ATTORNEY GENERAL ERIC HOLDER CALLS FOR END OF VIOLENCE

*  *  *

UPDATE: Live Reaction Feed in Ferguson:

*  *  *

Tiananmen Square?

Response in NYC

Officer Wilson's response…

*  *  *

The Grand Jury result will be announced at 9ET…

  • *WILSON WON'T BE CHARGED, MICHAEL BROWN'S FAMILY SAY: USATODAY
  • *FERGUSON POLICE OFFICER AVOIDS INDICTMENT FOR TEEN'S KILLING
  • *GRAND JURY RETURNS NO TRUE BILL ON ALL 5 POSS. CHARGES
  • *OFFICER DARREN WILSON SHOT UNARMED BLACK TEENAGER IN MISSOURI

*  *  *

AG McCullough appeared to blame social media…

For those wondering why release the decision so late

Live Feed (via NBC)

*  *  *

Crowds are gathering

Just in case…

UPDATE: The Ferguson School District has been closed for tomorrow.

 

And protests are spreading

And citywide Tactical alert…

*  *  *

Having quietly got married this weekend, the 28-year-old Ferguson police officer Darren Wilson – who fatally shot unarmed black teen Michael Brown in August – will discover shortly after 5pmET today if he will stand trial for Brown's death after the grand jury verdict is released by the St.Louis prosecutors office. As Brown's lawyer previously noted "ninety-nine percent of the time the police officer is not held accountable for killing a young black boy," Crump said. "The police officer gets all the consideration." Dragging the decision out over the weekend has some fearing it has merely stoked tensions, and protests have already been arranged for later this evening. Police, as we previously noted, are prepared; and the White House has reiterated their call for calm. After-school activities in Ferguson have been cancelled (somewhat suggesting the outcome is not what Ferguson residents are hoping for).

We shall see shortly…

*  *  *

Some background color from ABC


More ABC US news | ABC World News

The Grand Jury

 

Locals are preparing

The White House has reiterated its calls for peaceful protest…

Perhaps something to consider…

*  *  *

Could be a long night…

 

Maybe the preparation was worth it…

* * *

Media is in Ferguson en masse

Not everyone agrees with the decision…

* * *

A timeline of key events following the fatal police shooting of 18-year-old Michael Brown in the St. Louis suburb of Ferguson. (via FOX)

___

AUG. 9 — Brown and a companion, both black, are confronted by an officer as they walk back to Brown's home from a convenience store. Brown and the officer, who is white, are involved in a scuffle, followed by gunshots. Brown dies at the scene, and his body remains in the street for four hours in the summer heat. Neighbors later lash out at authorities, saying they mistreated the body.

AUG. 10 — After a candlelight vigil, people protesting Brown's death smash car windows and carry away armloads of looted goods from stores. In the first of several nights of violence, looters are seen making off with bags of food, toilet paper and alcohol. Some protesters stand atop police cars and taunt officers.

AUG. 11 — The FBI opens an investigation into Brown's death, and two men who said they saw the shooting tell reporters that Brown had his hands raised when the officer approached with his weapon and fired repeatedly. That night, police in riot gear fire tear gas and rubber bullets to try to disperse a crowd.

AUG. 12 — Ferguson Police Chief Thomas Jackson cancels plans to release the name of the officer who shot Brown, citing death threats against the police department and City Hall.

AUG. 14 — The Missouri Highway Patrol takes control of security in Ferguson, relieving St. Louis County and local police of their law-enforcement authority following four days of violence. The shift in command comes after images from the protests show many officers equipped with military style gear, including armored vehicles, body armor and assault rifles. In scores of photographs that circulate online, officers are seen pointing their weapons at demonstrators.

AUG. 15 — Police identify the officer who shot Brown as Darren Wilson, 28. They also release a video purporting to show Brown robbing a convenience store of almost $50 worth of cigars shortly before he was killed, a move that further inflames protesters.

AUG. 16 — Missouri Gov. Jay Nixon declares a state of emergency and imposes a curfew in Ferguson.

AUG. 17 — Attorney General Eric Holder orders a federal medical examiner to perform another autopsy on Brown.

AUG. 18 — Nixon calls the National Guard to Ferguson to help restore order and lifts the curfew.

AUG. 19 — Nixon says he will not seek the removal of St. Louis County prosecutor Bob McCulloch from the investigation into Brown's death. Some black leaders questioned whether the prosecutor's deep family connections to police would affect his ability to be impartial. McCulloch's father was a police officer who was killed in the line of duty when McCulloch was a child, and he has many relatives who work in law enforcement.

AUG. 20 — Holder visits Ferguson to offer assurances about the investigation into Brown's death and to meet with investigators and Brown's family. In nearby Clayton, a grand jury begins hearing evidence to determine whether Wilson should be charged.

AUG. 21 — Nixon orders the National Guard to begin withdrawing from Ferguson.

SEPT. 25 — Holder announces his resignation but says he plans to remain in office until his successor is confirmed.

SEPT. 25 — Ferguson Chief Tom Jackson releases a videotaped apology to Brown's family and attempts to march in solidarity with protesters, a move that backfires when Ferguson officers scuffle with demonstrators and arrest one person moments after Jackson joins the group.

OCT. 10 — Protesters from across the country descend on the St. Louis region for "Ferguson October," four days of coordinated and spontaneous protests. A weekend march and rally in downtown St. Louis draws several thousand participants.

OCT. 13 — Amid a downpour, an interfaith group of clergy cross a police barricade on the final day of Ferguson October as part of an event dubbed "Moral Monday." The protests extend beyond Ferguson to sites such as the nearby headquarters of Fortune 500 company Emerson Electric and the Edward Jones Dome in downtown St. Louis, site of a Monday Night Football game between the St. Louis Rams and the San Francisco 49ers.

OCT. 21 — Nixon pledges to create an independent Ferguson Commission to examine race relations, failing schools and other broader social and economic issues in the aftermath of Brown's death.

NOV. 17 — The Democratic governor declares a state of emergency and activates the National Guard again ahead of a decision from a grand jury. He places the St. Louis County Police Department in charge of security in Ferguson, with orders to work as a unified command with St. Louis city police and the Missouri Highway Patrol.

NOV. 18 — Nixon names 16 people to the Ferguson Commission, selecting a diverse group that includes the owner of construction-supply company, two pastors, two attorneys, a university professor, a 20-year-old community activist and a police detective. Nine of its members are black. Seven are white.

NOV. 24 – Grand Jury finds…

War on Terror: Drones Target 41 but Kill 1,147 Mostly Innocent men, Women, and Children

Courtesy of Mish.

The US calls it a war on terror. In reality it's a war of terror. And for every innocent person killed, hundreds of friends and family members hold it against the US.

The Guardian reports 41 Men Targeted but 1,147 People Killed in US Drone Strikes.

New analysis of data conducted by human rights group Reprieve shared with the Guardian, raises questions about accuracy of intelligence guiding ‘precise’ strikes.

The drones came for Ayman Zawahiri on 13 January 2006, hovering over a village in Pakistan called Damadola. Ten months later, they came again for the man who would become al-Qaida’s leader, this time in Bajaur.

Eight years later, Zawahiri is still alive. Seventy-six children and 29 adults, according to reports after the two strikes, are not.

However many Americans know who Zawahiri is, far fewer are familiar with Qari Hussain. Drones first came for Hussain years before, on 29 January 2008. Then they came on 23 June 2009, 15 January 2010, 2 October 2010 and 7 October 2010. Finally, on 15 October 2010, Hellfire missiles fired from a Predator or Reaper drone killed Hussain, the Pakistani Taliban later confirmed. For the death of a man whom practically no American can name, the US killed 128 people, 13 of them children, none of whom it meant to harm.

The human-rights group Reprieve, indicates that even when operators target specific individuals – the most focused effort of what Barack Obama calls “targeted killing” – they kill vastly more people than their targets, often needing to strike multiple times. Attempts to kill 41 men resulted in the deaths of an estimated 1,147 people, as of 24 November.

Some 24 men specifically targeted in Pakistan resulted in the death of 874 people. All were reported in the press as “killed” on multiple occasions, meaning that numerous strikes were aimed at each of them. The vast majority of those strikes were unsuccessful. An estimated 142 children were killed in the course of pursuing those 24 men, only six of whom died in the course of drone strikes that killed their intended targets.

There is nothing precise about intelligence that results in the deaths of 28 unknown people, including women and children, for every ‘bad guy’ the US goes after,” said Reprieve’s Jennifer Gibson, who spearheaded the group’s study.

In Yemen, 17 named men were targeted multiple times. Strikes on them killed 273 people, at least seven of them children. At least four of the targets are still alive.

Available data for the 41 men targeted for drone strikes across both countries indicate that each of them was reported killed multiple times.

An analytically conservative Council on Foreign Relations tally assesses that 500 drone strikes outside of Iraq and Afghanistan have killed 3,674 people.

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Global Business Confidence Collapses To Post-Lehman Lows

Courtesy of ZeroHedge. View original post here.

Submitted by Tyler Durden.

As we noted here, despite record high stock prices and talking-heads imploring investors to believe CEOs are confident, they are not (consider the clear indication of a lack of economic confidence from tumbling capex and soaring buybacks), That is further confirmed today as Markit's survey of over 6000 firms showed optimism falling sharply in October, dropping to the lowest seen since the survey began five years ago. Hiring and investment plans were also at or near post-crisis lows, while price expectations deteriorated further. More worrying, perhaps, is the US is not decoupled whatsoever, with future expectations of US business activity at the lowest since the financial crisis.

 

The Markit Global Business Outlook Survey, which looks at expectations for the year ahead across 6,100 companies, showed optimism falling sharply in October, dropping to the lowest seen since the survey began five years ago. Hiring and investment plans were also at or near post-crisis lows, while price expectations deteriorated further.

Long list of worries

The surveys highlight a growing list of concerns among companies about the outlook for the year ahead that led to a cooling of business optimism in recent months.

Key threats include fears of a worsening global economic climate, and notably a renewed downturn in the Eurozone, the prospect of higher interest rates in countries such as the UK and US next year, geopolitical risk emanating from crises in Ukraine and the Middle East, plus growing political uncertainty in many countries, notably the US, UK and Japan.

“Clouds are gathering over the global economic outlook, presenting the darkest picture seen since the global financial crisis. Companies’ hiring and investment intentions have both fallen to post-crisis lows alongside the bleakest outlook for future business activity seen over the past five years.

“Inflationary pressures are expected to ease further, meaning central banks will have leeway to keep policy looser for longer to help support economic growth, especially as the risk of deflation remains a major worry.

“Of greatest concern is the slide in business optimism and expansion plans in the US to the weakest seen over the past five years. US growth therefore looks likely to have peaked over the summer months, with a slowing trend signalled for coming months.

“There’s also little sign of the Eurozone’s malaise ending any time soon, as companies have become even less optimistic about the outlook. Confidence is weakest in the core countries of Germany and France, with the gloomy mood in the latter being highlighted by France being the only country in the survey in which companies expect to cut staffing levels over the coming year on average.

“The Eurozone’s ongoing weakness remains one of the major concerns seen in the global survey, and especially in the UK, where optimism waned further from the post-crisis high seen at the start of the year. However, firms in the UK remain more optimistic than in any other major developed or emerging country, suggesting the UK will continue to outperform its peers in 2015, albeit with growth slowing from that seen in 2014.

“Optimism in Japan continued to lag behind that of the US, UK and even the Eurozone, dropping to a twoyear low to suggest companies have become increasingly disillusioned with the potential for ‘Abenomics’ to boost growth, although there are signs that Japan’s recent deflation-beating policies will continue to drive prices higher next year.

“A key factor that has held back economic growth in recent years has been the disappointing performance of major emerging market economies, and this looks set to continue, and perhaps even intensify, over the coming year. Across the four ‘BRIC’ emerging markets, business optimism has sunk to the lowest seen since the financial crisis. Russia is the biggest concern, with sanctions, a spiralling currency and uncertainty driving business expectations down sharply to a new low. A slight upturn in business expectations in China provides some hope that companies there are at least not expecting a hard landing.”

As Markit reports, the US is not immune…

“This survey is a timely reminder that the U.S. economy has not been immune from weakening global business conditions, with euro area woes and heightened geopolitical risk weighing on firms’ business outlook and job hiring intentions for 2015.

“U.S. companies reported the lowest degree of confidence since the survey began in late 2009, reflecting domestic concerns and a subdued external demand environment.

*  *  *
So QE managed to surge inequality, did nothing for wages, and achieved nothing in sparking animal spirits… but apart from that it was a great success.

No indictment in Ferguson case

No charges to be filed against police officer Darren Wilson for offenses ranging from involuntary manslaughter up to first degree murder (not indicted). Not surprisingly, the news sparked a night of rioting, looting and gunfire in Ferguson and protests across the nation. In Ferguson, businesses burned, 61 people were arrested, protesters threw bricks at police officers and set police cars on fire. The St. Louis police claimed the violence was worse than in August. (Source).

News first appeared on USA Today:

FERGUSON, Mo. — A white police officer will not face charges for fatally shooting an unarmed black teenager in a case that set off violent protests and racial unrest throughout the nation, an attorney close to the case said Monday night.  (Full article) 

Hopes for peaceful demonstrations vanished quickly as violence erupted right after the announcement. 

FERGUSON, Mo., – Violent protests erupted here Monday after demonstrators learned there would be no criminal indictment of police officer Darren Wilson for the August shooting death of unarmed teen Michael Brown.

Demonstrators taunted police, shattered windows and set fire to two St. Louis County police cars. Scattered, intermittent gunfire was also reported. Scores of police officers, armed with riot gear, dispersed a crowd of about 300 with volley after volley of tear gas, pepper spray and bean bags. Looters plundered a Walgreen and Autozone store, while a Little Casears pizza restaurant and local beauty shop were set ablaze. (Keep reading: Violence erupts following Ferguson grand jury announcement)

How did officer Wilson escape further inquiry?  argues that his story makes no sense in Officer Darren Wilson's story is unbelievable. Literally.

So Brown is punching inside the car. Wilson is scrambling to deflect the blows, to protect his face, to regain control of the situation. And then Brown stops, turns to his left, says to his friend, "Here, hold these," and hands him the cigarillos stolen from Ferguson Market. Then he turns back to Wilson and, with his left hand now freed from holding the contraband goods, throws a haymaker at Wilson.

Every bullshit detector in me went off when I read that passage. Which doesn't mean that it didn't happen exactly the way Wilson describes. But it is, again, hard to imagine. Brown, an 18-year-old kid holding stolen goods, decides to attack a cop and, while attacking him, stops, hands his stolen goods to his friend, and then returns to the beatdown. It reads less like something a human would do and more like a moment meant to connect Brown to the robbery.

(my emphasis in bold)

Cartoon and planned protest maps via Zero Hedge.

 

Fed “Mystified” Why Millennials Still Live at Home; My Answer May Surprise You (It Isn’t Jobs, Student Debt, or Housing)

Courtesy of Mish.

A New York Fed research paper wonders What’s Keeping Millennials at Home? Is it Debt, Jobs, or Housing?

The paper says “it’s a mystery” why the housing recovery did not have a bigger impact on millennials living at home.

The research paper, written by Zachary Bleemer, Meta Brown, Donghoon Lee, and Wilbert van der Klaauw notes correlations to debt, jobs and housing.

Yet, “student debt only explains about 10% of the increase in parental coresidence since 2004, with another 10% being explained by house prices during the mid-2000s“.

I have the answer below, but first a few charts and notes on the charts.

Notes:

  • CCP is the Federal Reserve Bank of New York’s Equifax-Sourced Consumer Credit Panel
  • CPS is the Current Population Survey, a joint effort between the Bureau of Labor Statistics and the Census Bureau

Coresidence 25-30 Year-Olds 1999-2013

Coresidence 25 Year-Olds 1999-2013 Census Corrected

Coresidence 30 Year-Olds 1999-2013 Census Corrected

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The 2014 Oil Price Crash Explained

Courtesy of The Automatic Earth


NPC Capitol Refining Co. plant, Relee, Alexandria County 1925

This is an article by our good friend Euan Mearns at the University of Aberdeen. It was originally published here .

  • In February 2009 Phil Hart published on The Oil Drum a simple supply demand model that explained then the action in the oil price. In this post I update Phil’s model to July 2014 using monthly oil supply (crude+condensate) and price data from the Energy Information Agency (EIA).
  • This model explains how a drop in demand for oil of only 1 million barrels per day can account for the fall in price from $110 to below $80 per barrel.
  • The future price will be determined by demand, production capacity and OPEC production constraint. A further fall in demand of the order 1 Mbpd may see the price fall below $60. Conversely, at current demand, an OPEC production cut of the order 1 Mbpd may send the oil price back up towards $100. It seems that volatility has returned to the oil market.

Figure 1 An adaptation of Phil Hart’s oil supply demand model. The blue supply line is constrained by data (see Figure 4). The red demand lines are conceptual. Prior to 2004, oil supply was fairly elastic to changes in price, i.e. a small rise in price led to a large rise in production. This is explained by OPEC opening and closing the taps. Post 2004, oil supply became inelastic to price, i.e. a large change in price led to marginal increase in supply. This is explained by the world pumping flat out. Demand tends to be fairly inelastic and inversely correlated with price in that high price suppresses demand a little. Supply and price at any point in time is defined by the intersection of the supply and demand curves. 72 Mbpd and $40 / bbl in 2004 became 76 Mbpd and $120 / bbl in 2008 as demand for oil soared against inelastic supply.

 

Figure 2

Followers of the oil market will be familiar with the recent evolution of oil supply and price shown in Figure 2.

Figure 3

What is less widely appreciated is that a cross plot of the data shown in Figure 2 results in the well-ordered relationship shown in Figure 3. Oil supply and price are clearly following some well established rules. This relationship led to Phil Hart developing his model shown as Figure 1.

Figure 4

Separating the data into two time periods brings more clarity to the process at work. The data define a fairly well-ordered time series beginning at January 1994 at the bottom left rising slowly to January 2004 and then steeply to the Olympic Peak of July 2008. The financial crash then caused the oil price to give up all of its gains returning to 2004 levels by December 2008.

Figure 5

The second time period from January 2009 to the present shows some different forces at work. Starting in 2009 some new production capacity was built. This was not in OPEC and is concentrated in N America where the light tight oil (LTO) boom took off supplemented by steady expansion of tar sands production. Prior to 2009, the production peaks were of the order 74 Mbpd. Post 2009 peaks of the order 77 Mbpd were achieved. About 3 Mbpd new capacity has been added. In May 2011 there is a significant and curious excursion to lower production not accompanied by a fall in price. This coincides with Libya coming off line for the first time and the loss of 1.6 Mbpd production. It seems possible that this coincided with weak demand and the fortuitous loss of production cancelling weak demand leaving price unchanged.

The EIA are always running a few months behind with their statistics these days, not ideal in a rapidly changing world. Thus we do not yet have the data to see the recent crash in the oil price. But we know the price has fallen below $80 and production is unlikely to be significantly changed. So, how do we explain production of roughly 77 Mbpd and a price below $80?

Figure 6

Figure 6 updates Phil Hart’s model (Figure 1) to take account of the oil supply and price movements of the last 5 years. Capacity expansion is achieved by adding 3 Mbpd to the former, well-defined supply-price curve (blue arrow). There is no a-priori reason that this curve should hold in the new supply-price regime, but for the time being that is all I have to work with. The red lines, as described in the caption to Figure 1, conceptually represent inelastic demand where high price marginally suppresses demand for oil. The recent past has seen oil priced at $110 with supply running at about 77 Mbpd as defined by the right hand red coloured demand curve. Reducing demand by about 1 Mbpd brings the price below $80 / bbl (red arrow).

The Recent Past and the Future

Old hands will know that it is virtually impossible to forecast the oil price. The anomalous recent price stability of $110±10 I believe reflects great skill on the part of Saudi Arabia balancing the market at a price high enough to keep Saudi Arabia solvent and low enough to keep the world economy afloat. The reason Saudi Arabia has not cut production now, when faced with weak global demand for oil, probably comes down to their desire to maintain market share which means hobbling the N American LTO bonanza. Alternatively, they could be conspiring with the USA to wreck the Russian economy? But Saudi Arabia is not the only member of OPEC and the economies of many of the member countries will be suffering badly at these prices and that ultimately leads to elevated risk of civil unrest. It is not possible to predict the actions of the main players but it is easier to predict what the outcome may be of certain actions.

  1. If demand for oil weakens by about a further 1 Mbpd this may send the price down below $60 / bbl.
  2. If OPEC cuts supply by about 1 Mbpd at constant demand this may send the price back up towards $100 / bbl.
  3. Prolonged low price may see LTO production fall in N America and other non-OPEC projects shelved resulting in attrition of non-OPEC capacity. This may take one to two years to work through but with constant demand, this will inevitably send prices higher again.
  4. Prolonged low price may see many specialist LTO producers default on loans, risking a new credit crunch and reduced LTO production. This would likely lead to a major consolidation of operators in the LTO patch where the larger companies (the IOCs) pick up the best assets at knock down prices. That is the way it has always been.
  5. Black Swans and elephants in the room – with conflict escalation in Ukraine and / or Syria-Iraq and a new credit crunch, all bets will be off.

[Ilargi:] And this comment to the article from Euan’s friend and collaborator Roger Andrews certainly warrants attention as well. (check the grey dots!):

Hi Euan:

I put this XY plot of the data together from the data links you supplied. It shows the same trends as your Figures except that I’ve plotted all the points on one graph and segregated them into five periods, with trend lines and arrows showing the overall “direction of travel” for each (arrows in both directions for October 2004-May 2009, which as you noted goes zooming up and then comes right back down again).

I’ve also projected production data for the missing months since May 2014 (shouldn’t be too far off) so that we can at least get an idea of how the latest trend might compare with the old ones. We seem to be in uncharted territory.

Bitcoin Mining

Bitcoin Mining

Courtesy of Global Economic Intersection

By Rod Garratt and Rosa Hayes – Liberty Street Economics, Federal Reserve Bank of New York

In June 2014, the mining pool Ghash.IO briefly controlled more than half of all mining power in the Bitcoin network, awakening fears that it might attempt to manipulate the blockchain, the public record of all Bitcoin transactions. Alarming headlines splattered the blogosphere. But should members of the Bitcoin community be worried?

Blog_Bitcoin_iStock_000039182710_450x331

Miners are members of the Bitcoin community who engage in a process that validates new additions to the blockchain in exchange for a reward that comes in the form of newly issued bitcoins. The process is essentially a tournament, where the likelihood that a miner receives a reward is proportional to the amount of computing power he or she employs. Mining pools are groups of miners that pool their computational resources together and split the rewards. An individual or group of miners that provides more than 50 percent of computational power to the validation process can manipulate the blockchain, but this power is limited by the fact that blockchain is, as mentioned above, a public record; no one can add false transactions to the blockchain.

There are only two manipulations a controlling pool could attempt: refusing to validate specific transactions (which prevents people from sending bitcoins between addresses) or reversing transactions the pool sends during the time it is in control. Such actions would likely lead to a huge decline in the value of bitcoin, if not a complete collapse of the entire system. So would it be worth it for a pool of miners to manipulate the blockchain?

Think of the situation as an infinitely (or indefinitely) repeated game. Is there a one-shot manipulation that will earn the controlling mining pool more than its expected future earnings? If not, then the pool has little incentive to manipulate the blockchain, as doing so would destroy its source of future income. We argue that the incentives for a 51 percent attack are low given the current conditions of the bitcoin market, but that the incentive for such an attack may increase in the future.

The Current Situation

In order to evaluate the costs and benefits of a manipulation one needs to perform a few calculations. The current market price of bitcoin is approximately $400, and twenty-five bitcoins are made available approximately every ten minutes to the miner or pool that solves the required hash problem. Thus, a group that controls 51 percent of all Bitcoin mining revenue would earn .51*25*6*24*$400 or $734,400 per day.

In calculating mining profit, we assume that all miners want to buy the best mining chips currently available. However, there are a number of reasons why miners may not retire old chips immediately when new, more efficient chips become available, for example, if they believe the difference in efficiency between new and old chips is negligible or if there are delays in shipping new chips. Thus, it is likely miners use an array of chips with different efficiencies, as long as the average efficiency of the mining rig is good enough to be profitable.

The website Tradeblock lists fifty-two mining chips in current or recent use. In calculating the total electricity use of the Bitcoin network, we use the average wattage of the top twenty chips listed on Tradeblock, 0.73 Joules/gigahash (J/GH), to estimate the average wattage of the bitcoin network. The current hash rate of the Bitcoin network is about 250 million gigahashes per second (GH/s), according to Blockchain.info. If all mining is done via an average-wattage 0.73 J/GH chip, then the bitcoin network would draw 182,500 kilowatts, using 4.38 million kWh/day at the current hash rate.

According to a 2012 report from the International Energy Agency, the average price of electricity in the OECD was $0.1109/kWh for industrial energy use and $0.158/kWh for household use. It is unclear what proportion of bitcoin miners are industrial versus individual; however, many bitcoin startups presumably receive industrial energy pricing. Using the simple assumption that half of all electricity used by the Bitcoin network is used by industrial users and half is used by household users, the total electricity cost of the entire Bitcoin network is equal to .5*($0.158/kWh+$0.1109/kWh)*4.38 million kWh/day or $588,891.

The electricity cost for a group controlling 51 percent of all mining power is thus $300,334 per day, so the group’s mining profit is $434,066 a day. If the group discounts its future earnings with discount factor d, the cost of a one-shot manipulation is $434,066*d + $434,066*d2 + $434,066*d3 + … =$434,066*d/(1-d). Therefore, the group’s incentive for throwing away a profit of $434,066 a day will be low unless either the profit from the one-shot manipulation or the group’s discount rate is very high. Low market interest rates and very high profits suggest that a group’s incentive to defect should be low given present market conditions.

Bitcoin Mining in the Future

The monetary rule of the Bitcoin protocol stipulates that the block reward halves every 210,000 blocks, or roughly every four years. The most recent reward halving occurred in 2012, putting the estimated time of the next halving in 2016. When this occurs, mining revenue will decrease by 50 percent per block. All else equal, a group controlling 51 percent of mining power could continue to profit with a reduced block reward. At 12.5 bitcoin per block, the pool’s share of daily revenue will be equal to .51*12.5*6*24*$400 or $367,200. This exceeds the estimated electricity cost per day of $300,334, so the group will continue to have a positive profit ($66,866 per day). Although the cost of a one-shot manipulation will have decreased by nearly 85 percent, it is unlikely that there exists a manipulation that would make defection profitable in the near term. Of course, this conclusion might change at future dates when the reward is halved yet again.

As the block reward decreases, some Bitcoin users argue that transaction fees will make up for the revenue miners currently earn as the block reward. Transaction fees are optional bitcoin-denominated fees that users can attach to their transactions in order to speed processing time; the miner that wins the block reward also receives the transaction fees included in the block. According to Blockchain.info, transaction fees currently make up about 0.34 percent of miner’s revenue. However, even if users begin to attach larger transaction fees to their bitcoin purchases once block-reward revenue drops below electricity costs, the majority of users will have little incentive to pay transaction fees in excess of the electricity cost of processing their transaction. In this case, the cost of a defection will be fairly low and possibly profitable for a group that controls 51 percent of mining power.

Another issue to consider is free entry. Given the positive profits of existing miners, there is belief that more miners will enter the market. An increase in the number of miners will cause the hash rate of the bitcoin network to increase, as more mining rigs are simultaneously employed to solve hashes. As long as the value of the block reward remains constant, the entry of new miners should cause per-person profits to fall to zero, or at least below the value of a one-shot deviation. If this occurs, a mining group controlling 51 percent of computing power will have a larger economic incentive to manipulate the blockchain.

What about improvements in mining technology? Might this improve the profitability of mining and mitigate the threat of a 51 percent attack? No. The protocol adjusts so that coins are released at the same rate regardless of the aggregate hash rate. In other words, the size of the pie miners compete over stays the same when a new technology emerges. The only thing that might change, temporarily, is the way it is sliced. There can be a shift in how profits are distributed towards early adopters. But ultimately all miners will be forced to adopt the new technology and no one will have an advantage. The situation is a standard prisoner’s dilemma.

Suppose there are two miners, Alice and Bob, who both currently use the same type of chip. Each miner controls the same proportion of total mining power, and thus has an equal chance of winning the block-reward, R. Now imagine that a new chip becomes available, with the same wattage as preexisting chips, but a hash rate that is 50 percent faster and costs C. If either Alice or Bob uses the fast processor and the other uses the slow processor, then the person with the fast processor will have a 60 percent chance of winning the reward and the person who uses the slow processor will have a 40 percent chance of winning the reward. The situation can be summarized by the following normal form game.

Table

In each box, the payoffs shown are for Alice and Bob, respectively, if the action pair is as shown in the row/column headings. If the increase in revenue from switching from a slow chip to a fast chip is greater than the increased cost of the fast chip (that is, if 0.1R>C), then Fast is a dominant strategy for each player. The result is that both players buy the fast chip and earn the same revenue as before the new chip was introduced. So the introduction of the new chip makes both players worse off. The point is that because of the way the protocol works, faster chips do not increase aggregate profits, and because of strategic incentives, miners are forced to adopt costly, but nonbeneficial technologies. Innovations in mining technology are something that miners as a whole would prefer to do without.

Disclaimer

The views expressed in this post are those of the authors and do not necessarily reflect the position of the Federal Reserve Bank of New York or the Federal Reserve System. Any errors or omissions are the responsibility of the authors.

Source: Liberty Street Economics – Bitcoin how likely is a 51 percent attack

Juncker’s €315bn EU Slush Fund is €299bn Sleight of Hand Magic

Courtesy of Mish.

Last week France asked for a "New Deal" with "Real Money" not fake EU promises.

France was a bit wary (and rightly so) over sleight of hand math from Jean-Claude Juncker, the new head of the European Commission.

Today we have the facts.

Juncker's €315bn EU Slush Fund looks like this.

95% Leveraged Magic, 5% Fund

  • €16bn from the EU budget
  • €5bn in guarantees from the European Investment Bank (EIB)
  • €299bn is magic.

Supposedly, private money will come up with €299bn based on €5bn in guarantees.

Of course someone has to administer this action plan. So Juncker unveiled a new “investment advisory hub” run by "financial professionals" with direction from the European Commission and EIB.

After padding their own pockets, the group will decide which projects to undertake, no doubt based on kickbacks, bribes, and political favoritism to friends.

To make the deal even sweeter for their political cronies, the EU will offer a “first-loss” guarantee, where the EU money would absorb any initial investment losses in an effort to “crowd in” private investors looking for more secure upside.

Given that it's all funny money anyway, I have a question: Why not provide €50bn in guarantees raising €2.99 trillion in the process?

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com

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U.S. Senate Tries Public Shaming of New York Fed President Dudley

Courtesy of Pam Martens.

New York Fed President William Dudley Got a Dose of Public Shaming at the Hands of the U.S. Senate Last Week

New York Fed President William Dudley Got a Dose of Public Shaming at the Hands of the U.S. Senate Last Week

Last Friday, the Senate Subcommittee on Financial Institutions and Consumer Protection, chaired by Sherrod Brown, effectively put William Dudley, President of the Federal Reserve Bank of New York, in stocks in the village square and engaged in a rather brilliant style of public shaming. With each well-formed question posed by the panel, Dudley’s jaded leadership of a hubristic regulator came into ever sharper focus.

There were a number of elephants in the room during the lengthy session that were only briefly touched upon but deserve greater scrutiny by the press. First, Congress knew that the New York Fed was a failed, crony regulator during the lead up to the financial collapse in 2008, but it granted it an even greater supervisory role under the Dodd-Frank financial reform legislation in 2010. This Congress has also failed to engage in public shaming of President Obama for brazenly ignoring the Dodd-Frank’s statutory mandate that calls for him to appoint, subject to Senate confirmation, a Vice Chairman for Supervision at the Federal Reserve Board of Governors, who could have shaped and monitored a more credible policing role for the New York Fed.

Senator Sherrod Brown Questions the New York Fed President During Senate Hearing , Novemer 21, 2014

Senator Sherrod Brown Questions the New York Fed President During Senate Hearing

Section 1108 of Dodd-Frank requires: “The Vice Chairman for Supervision shall develop policy recommendations for the Board regarding supervision and regulation of depository institution holding companies and other financial firms supervised by the Board, and shall oversee the supervision and regulation of such firms.” President Obama was required to nominate this individual once the Dodd-Frank Wall Street Reform and Consumer Protection Act became effective; that was July 21, 2010 – more than four years ago. The President has simply ignored this provision of the law – no doubt to the extreme satisfaction of Wall Street.

The final elephant is that as a result of giving a failed regulator enhanced power and failing to appoint a person to a leadership role in supervision, the U.S. Senate has effectively become Wall Street’s cop on the beat, doing the job the New York Fed’s cronyism prevents it from doing.

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