Robert Wenzel warns US citizens to move their money out of the banking system

The US banking system appears to be in preparation for a Cyprus like deposit bail-in/capital controls by making withdrawals in the banking system more difficult.

Writes Austrian economist Bob Wenzel at the Economic Policy Journal: (hat tip Lew Rockwell)

I am now advising that your money be moved outside the US banking system. Within the last 24 hours, I have learned of two major banks that are making it difficult for you to send international wires or draw out large amounts of cash. Both JPMorganChase and HSBC USA have instituted new policies which will make it difficult for you to withdraw your funds in certain ways. This is not good. There are apparently some workarounds relative to these policies, but just try setting up those workarounds when you want to move your money during some kind of panic.

This is what you will face:

Bank line in California in 2008 at IndyMac Bank

Totalitarians don't take away all your freedoms at once. They do it in incremental measures. Watch the movie The Pianist to understand how many Jews ended up in gas chambers by shrugging off early totalitarian measures.

The prevention or delaying of certain customers from sending international wires, and JPMorganChase stopping some accounts from withdrawing large amounts of cash,  is a serious signal that we are well along the way to a banking sector that doesn't respect its customers and has no compunctions about preventing customers from pulling out their money, if the banks deem it in their interest to prevent such withdrawals.

Bottom line: You are playing with fire if you keep any serious amount of money in a US bank.

The above echoes Sovereign Man’s Simon Black’s warning on the imposition by the Consumer Financial Protection Bureau (CFPB) to “limit cash withdrawals and ban business customers from sending international wire transfers” as I earlier posted here.

If the US economy has indeed been booming, then why has US political authorities been resorting to discreet imposition of capital controls? Don't be misled by the market melt-up, the above are signs of desperation rather than of optimism.  

UPDATED TO ADD: To my US based readers, pls take all the necessary precaution.

Many Americans Opt Out of the Banking System

Perhaps mostly as a result of bad credit ratings from lingering economic woes, many Americans have turned into alternative means to access credit financing.

The following report from the Washington Post,

In the aftermath of one of the worst recessions in history, more Americans have limited or no interaction with banks, instead relying on check cashers and payday lenders to manage their finances, according to a new federal report.

Not only are these Americans more vulnerable to high fees and interest rates, but they are also cut off from credit to buy a car or a home or pay for college, the report from the Federal Deposit Insurance Corp. said.

Released Wednesday, the study found that 821,000 households opted out of the banking system from 2009 to 2011 and that the so-called unbanked population grew to 8.2 percent of U.S. households.

That means that roughly 17 million adults are without a checking or savings account. Another 51 million adults have a bank account, but use pawnshops, payday lenders or rent-to-own services, the FDIC said. This underbanked population has grown from 18.2 percent to 20.1 percent of households nationwide.

The study also found that one in four households, or 28.3 percent, either had one or no bank account. A third of these households said they do not have enough money to open and fund an account. Minorities, the unemployed, young people and lower-income households are least likely to have accounts.

This serves as proof that despite the lack of access through the conventional banking system, substitutes will arise to replace them. Demand for credit has always been there. Such dynamic resonates with the post bubble bust era known as the Japan’s lost decade.

I may add that people opting out of the banking system may not at all be about bad credit ratings, they could also represent manifestations of an expanding informal economy in the US. Chart below from Bloomberg-Businessweek includes undocumented immigrant labor, home businesses, and freelancing that escape the attention of tax authorities.

Over the past decade, the informal economy has been gradually ascendant even for developed nations. Advancement in technology may have partly contributed to this.

Although the recession of 2001 (dot.com bust) and the attendant growth in regulations, welfare and ballooning bureaucracies may have been the other principal factors.

My guess is that the post-Lehman era, which highlights governments desperate to shore up their unsustainable fiscal conditions, may only intensify the expansion of the informal economies even in the developed world.

Add to this the growing concerns over the economic viability of the banking system and continued innovation in technology (e.g. P2P Lending, Crowd Sourcing and etc…), the traditional banking system will be faced with competition from non-traditional sources.

Indian Banks Reduce Exposure on US Banks

More signs of anxiety in the global financial markets: Indian banks reportedly reduced deposits with US Banks

From Financial Chronicle (mydigitalfc.com)

India banks’ deposits with US banks dipped in June, reflecting heightened risk aversion. This showed up in a fall in custodial liabilities of American banks to counterparties in India, which shrank by over $2 billion in June.

According to the US treasury data released, custodial liabilities of American banks payable in US dollars in June was $13.059 billion. A year ago, the holdings were $15.288 billion.

The custodial liabilities included foreign currency deposits by Indian banks in American banks. Indian banks hold dollar deposits with US counterparts for settlement of international liabilities.

Andhra Bank currency trader Vikas Babu said, “There is some risk aversion on US banks. So, banks have shifted to short-term US treasuries for less than one year for liquidity purposes.”

The shift to US treasuries, however, was not necessarily driven by interest earnings. Short-term holdings in US treasuries earned barely 0.5 per cent. Correspondent account balances, that are technically current accounts, earned zero interest. But the shift was partly on account of the fact that foreign institution balances in US banks are not covered by the US federal deposit insurance company (FDIC). FDIC provides insurance cover for bank deposits only to US entities and residents.

The shift to US treasuries was also apparent from a steep $9.5 billion rise in holdings to $50.8 billion by Indian institutions, including the RBI. The increase in holdings was despite compression in India’s external reserves by $26.5 billion in June from the corresponding period of the previous year.

Aside from possible concerns over the health of the US banking sector, the shift to short term securities could also mean that Indian banks may be expecting a spike in US interest rates, perhaps in anticipation of another round of asset purchases by the US Federal Reserve.

Also Indian banks may be under pressure from the recent economic slowdown. Indian banks have been required to raise 1.75 trillion capital by 2018 in order to comply with Basel III capital adequacy standards (yahoo)

US Federal Home Loan Banks Exposed to Europe’s Debt Crisis

From the Bloomberg/Businessweek

The U.S. Federal Home Loan Banks’ unsecured lending to foreign institutions skyrocketed last year as the European sovereign debt crisis intensified, raising concerns about their risk management, an auditor’s report said today.

The Federal Housing Finance Agency, which oversees the 12 regional Home Loan Banks, should tighten limits on such lending and improve monitoring of whether that lending exceeds the limits, the FHFA Office of Inspector General said in the report.

“FHFA’s current regulation continues to permit FHLBanks to build large unsecured credit portfolios that may produce unreasonable risk,” wrote Richard Parker, director of the auditor’s Office of Policy, Oversight and Review. “FHFA should, therefore, reassess the counterparty risk limits associated with its existing regulation.”

Several Home Loan Banks last year made short-term loans totaling about $3 billion to two European banks that had received government bailouts and were on a credit watch, according to the report.

Federal Home Loan Banks’ unsecured lending to foreign banks peaked in April of 2011 at $101 billion before falling to $41 billion at the end of the year, the audit found.

The US banking system has likely more exposure to the Eurozone than disclosed. This could be just one example.

US Banks are Exposed to the Euro Debt Crisis

Recently I wrote about how US banks have been dependent on Bernanke’s QEs, where the unfolding Euro debt crisis could heighten risks a contagion on the US banking industry.

Also given that US banks have substantial exposures to European banks, it isn't farfetched to perceive a potential contagion from any further deterioration in the latter's banking sector.

The Huffington Post gives some numbers (bold emphasis mine)

If European politicians are unable to contain their sovereign debt problems, Wall Street could be on the brink of another financial crisis, according to economists.

Although U.S. banks have limited their direct exposure to Greece, they have loaned hundreds of billions of dollars to European banks and governments that may not be able to pay them back, according to the Bank for International Settlements. If some European governments and banks are forced to default on at least part of their debt, American banks could lose a significant amount of money on that account alone.

The resulting panic from investors could compound the losses. Short-term borrowing costs would spike, bank stock prices would plummet and investors could demand their money from banks, several economists say. In a repeat of the liquidity crisis of 2008, some U.S. banks could run out of the money necessary to fund their day-to-day operations…

Some predict that a European financial crisis would spread quickly to U.S. shores. The pain would not come directly from government defaults; U.S. banks have loaned just $36.2 billion to the five European governments that are in danger of defaulting: Greece, Ireland, Portugal, Spain and Italy. But U.S. banks have also loaned $60.6 billion to banks in those five countries, and $275.8 billion to banks in Germany and France, according to data from the Bank for International Settlements.

A string of sovereign debt defaults would endanger the survival of major European banks, including those in France and Germany, which hold a large amount of troubled sovereign debt on their books, some economists note. According to Bryson, French banks' exposure to the five European countries that are in danger of defaulting amounts to 25 percent of France's gross domestic product, and the exposure of German banks to those countries is worth 15 percent of Germany's total output…

It remains largely unknown which U.S. banks are particularly exposed to the risks in Europe, so investors have drawn their own conclusions. The insurance market reveals that investors believe Morgan Stanley is most at risk, followed by Bank of America, Goldman Sachs and Citigroup, respectively, according to market data provider CMA. Bank of America's debt now is more than three times more expensive to insure than during the height of the financial crisis in October of 2008.

Morgan Stanley and Goldman Sachs are particularly vulnerable to the crisis in Europe because they rely largely on short-term borrowing from other banks and do not have a large deposit base, according to an economist who requested anonymity because he is not allowed to comment on specific banks. During a financial crisis, short-term borrowing costs could spike as banks cut back on short-term lending to protect themselves, putting banks such as Morgan Stanley and Goldman Sachs in danger of running out of money, the economist said.

The cartel like existence and the depth of interconnectedness of the banking system of major economies makes them highly vulnerable to any shocks which the current Euro crisis has been exhibiting.

And that’s why bailout policies will likely continue and may even become coordinated with increased participation from outsiders, particularly the IMF and some of the major emerging markets.

The US Banking Sector’s Dependence on Bernanke’s QEs

Is the US banking sector having a déjà vu of 2008?

The Economist suggests so (bold emphasis mine)

Wild gyrations in stockmarkets; banks' share prices falling like stones; politicians stepping in to back-stop lenders for fear of collapse. The echoes of 2008 are alarming. Morgan Stanley is one of the big casualties: fears apparently caused by its exposure to European assets led its share price to fall by 17% over the past two days of trading. You have to go back to December 3rd 2008 to find the last time the bank's stock closed at the same price as it did yesterday, even if it still sits 36% above its 2008 nadir. A French bank, Société Générale, has already breached its 2009 low, hitting €15.31 in late September, although it has bounced back by 24% since then. Bank stocks may now be approaching levels seen in the depths of the financial crisis but broader stockmarket indices still have a long way to go to reach that mark. That won't last if the banks get into real difficulties.

Bank stocks have not been only suffering from depressed share prices but have likewise seen their default risks surging.

According to Bespoke Invest (chart above from Bespoke)

“a gain in CDS prices is a bad thing, as it means that default risk has gone up. And it has gone up significantly for financial companies once again this year. For the majority of financials, CDS prices are still not as high as they were during the financial crisis, but they're starting to get close. And interestingly, while the European banking system is the one that is supposedly in trouble, two US financials are up the most this year -- Morgan Stanley and Goldman Sachs.”

I’d further add that banking sector looks highly dependent on Bernanke's Quantitative Easing (QEs) programs.

I previously noted of the timeline for the previous QEs,

The timeline for QE 1.0 is officially from March 2009 to March 2010, and QE 2.0 from November 2010 to June 2011

The Philadelphia Bank Index exhibits that since the closure of the previous two quantitative easing programs by the US Federal Reserve, shown by the green ellipses, the banking index either wobbled (as in post QE 1.0) or has been in decline (post QE 2.0).

What this implies is that despite the trillions thrown by the US Federal Reserve, the balance sheets predicaments of the banking system have not gone away. Think of all the resources wasted just to save the Bernanke's most preferred sector.

To add, the still foundering property sector continues to weigh on the banking sector’s balance sheets.

Such dynamic seems no different with the Dow Jones Financial Index.

This means that interventions had only masked the problems, which resurfaces everytime such government support ended.

Also given that US banks have substantial exposures to European banks, it isn't farfetched to perceive a potential contagion from any further deterioration in the latter's banking sector.

So either we see the team Bernanke redeploying the modified version of the 'helicopter option' through QE 3.0, to bolster the flagging US banking and financial sector soon, or we will see many bankruptcies and mass liquidations that would exacerbate the current pressures on the global financial markets.

My guess is Ben Bernanke won’t like to have his hands bloodied and would rather resort to the “kick the can" option.

US Derivative Time Bomb: Five Banks Account for 96% Of The $250 Trillion Exposure

From Zero Hedge (bold emphasis mine)

The latest quarterly report from the Office Of the Currency Comptroller is out and as usual it presents in a crisp, clear and very much glaring format the fact that the top 4 banks in the US now account for a massively disproportionate amount of the derivative risk in the financial system. Specifically, of the $250 trillion in gross notional amount of derivative contracts outstanding (consisting of Interest Rate, FX, Equity Contracts, Commodity and CDS) among the Top 25 commercial banks (a number that swells to $333 trillion when looking at the Top 25 Bank Holding Companies), a mere 5 banks (and really 4) account for 95.9% of all derivative exposure (HSBC replaced Wells as the Top 5th bank, which at $3.9 trillion in derivative exposure is a distant place from #4 Goldman with $47.7 trillion). The top 4 banks: JPM with $78.1 trillion in exposure, Citi with $56 trillion, Bank of America with $53 trillion and Goldman with $48 trillion, account for 94.4% of total exposure. As historically has been the case, the bulk of consolidated exposure is in Interest Rate swaps ($204.6 trillion), followed by FX ($26.5TR), CDS ($15.2 trillion), and Equity and Commodity with $1.6 and $1.4 trillion, respectively. And that's your definition of Too Big To Fail right there: the biggest banks are not only getting bigger, but their risk exposure is now at a new all time high and up $5.3 trillion from Q1 as they have to risk ever more in the derivatives market to generate that incremental penny of return.

At this point the economist PhD readers will scream: "this is total BS - after all you have bilateral netting which eliminates net bank exposure almost entirely."

True: that is precisely what the OCC will say too. As the chart below shows, according to the chief regulator of the derivative space in Q2 netting benefits amounted to an almost record 90.8% of gross exposure, so while seemingly massive, those XXX trillion numbers are really quite, quite small... Right?

...Wrong. The problem with bilateral netting is that it is based on one massively flawed assumption, namely that in an orderly collapse all derivative contracts will be honored by the issuing bank (in this case the company that has sold the protection, and which the buyer of protection hopes will offset the protection it in turn has sold). The best example of how the flaw behind bilateral netting almost destroyed the system is AIG: the insurance company was hours away from making trillions of derivative contracts worthless if it were to implode, leaving all those who had bought protection from the firm worthless, a contingency only Goldman hedged by buying protection on AIG. And while the argument can further be extended that in bankruptcy a perfectly netted bankrupt entity would make someone else whole on claims they have written, this is not true, as the bankrupt estate will pursue 100 cent recovery on its claims even under Chapter 11, while claims the estate had written end up as General Unsecured Claims which as Lehman has demonstrated will collect 20 cents on the dollar if they are lucky.

The point of this detour being that if any of these four banks fails, the repercussions would be disastrous. And no, Frank Dodd's bank "resolution" provision would do absolutely nothing to prevent an epic systemic collapse.

...

Lastly, and tangentially on a topic that recently has gotten much prominent attention in the media, we present the exposure by product for the biggest commercial banks. Of particular note is that while virtually every single bank has a preponderance of its derivative exposure in the form of plain vanilla IR swaps (on average accounting for more than 80% of total), Morgan Stanley, and specifically its Utah-based commercial bank Morgan Stanley Bank NA, has almost exclusively all of its exposure tied in with the far riskier FX contracts, or 98.3% of the total $1.793 trillion. For a bank with no deposit buffer, and which has massive exposure to European banks regardless of how hard management and various other banks scramble to defend Morgan Stanley, the fact that it has such an abnormal amount of exposure (but, but, it is "bilaterally netted" we can just hear Dick Bove screaming on Monday) to the ridiculously volatile FX space should perhaps raise some further eyebrows...

Such immense risk exposure by ‘Too Big to Fail’ (TBTF) US banks entail that political actions or policy making will likely be directed towards the prevention of a massive deflationary banking sector collapse from a derivatives meltdown.

And problems at the Eurozone could just be the pin that could ‘pop the bubble’.

This implies greater likelihood of persistent bailout policies which mostly will be coursed through inflationism. It’s an “inflate or die” for politically privileged TBTF banks in the US or in the Eurozone.

Again political leaders appear to be using the financial markets as leverage to negotiate for the passage of such policies.

Proof?

From today’s Bloomberg article, (bold emphasis mine)

U.S. Treasury Secretary Timothy F. Geithner warned at the annual meeting of the IMF failure to combat the Greek-led turmoil threatened “cascading default, bank runs and catastrophic risk.”

German Chancellor Angela Merkel said euro-region leaders must erect a firewall around Greece to avert a cascade of market attacks on other European states that would risk breaking up the currency area.

Expanding the powers of the region’s rescue fund, the European Financial Stability Facility, as agreed by European leaders in July is necessary to avoid Greece’s problems from spilling over to other countries, Merkel said late yesterday on ARD television. The fund’s permanent successor, due to take effect in mid-2013, is needed “so we can in fact let a state go insolvent” if it can’t pay its bills, she said.

Policy makers can make the EFSF more “efficient” by leveraging it without involving the ECB, German Finance Minister Wolfgang Schaeuble said over the weekend. He also raised the prospect of bringing in the permanent backstop before 2013.

Bank of Canada Governor Mark Carney estimated 1 trillion euros ($1.3 trillion) may have to be deployed while U.K. Chancellor of the Exchequer George Osborne said a solution is needed by the time that Group of 20 leaders meet in Cannes, France, on Nov. 3-4.

Policymakers have been intensifying their jawboning or mind conditioning of the public of the exigencies of more bailouts.

They will come. But, perhaps, only after the markets endure more pain.

Regulatory Arbitrage: Some Banks In The US Circumvent The New Capital Rule

The major flaws of the interventionist ideology are that they seem to always figuratively “fight the last war”, treat symptoms rather than the source of the disease and starkly misjudge market dynamics in adapting to a new regulatory environment.

A good example of the last condition, largely known as regulatory arbitrage, can be defined as, according to moneyterms.co.uk, “financial engineering that uses differences between economic substance and regulatory position to evade unwelcome regulation. The term is also sometimes used to describe firms structuring or relocating transactions to choose the least burdensome regulator, but this is better described as regulator shopping.”

The essence is that in search of profits, private enterprises tend to look for loopholes which circumvent unfavourable regulations from where they can operate.

It’s fundamentally a cat-mouse game between authorities and the markets.

Below is a good example.

From the Wall Street Journal, (bold highlights mine)

Some foreign banks are moving to restructure their U.S. operations to avoid one of the most-burdensome requirements of the new Dodd-Frank law.

In November, Barclays PLC quietly changed the legal classification of the U.K. bank's main subsidiary in the U.S. so that the unit would no longer be subject to federal bank-capital requirements. Several other banks based outside the U.S. are considering similar moves, according to people familiar with the matter.

The maneuver allows them to escape a provision of the financial-overhaul law that forces the pumping of billions of dollars of new capital into the U.S. entities, known as bank-holding companies.

"It's just not worth it to have all that capital trapped" in the holding company, said a New York lawyer who is advising banks on how to restructure.

The moves are the latest example of how banks are scrambling to cushion the impact of new laws and rules around the world.

Policy makers are demanding banks hold more capital and cash to help prevent a repeat of the financial crisis. But bank executives are worried that all the changes will crimp profits without making the financial system safer.

Last summer's Dodd-Frank law beefed up rules governing the quantity and types of capital banks must keep to protect themselves from potential losses. The provision also closed a loophole that allowed foreign banks to run their U.S. subsidiaries with thinner capital buffers than those of their local rivals.

All these simply show how markets are much superior to governments and how government regulations may lead to unintended consequences.

Will A Weak US Dollar Boost The US Economy?

Conventional thinking says that a weak currency should boost the economy via promoting exports.

But the Wall Street Journal Blog argues otherwise. (bold highlights mine)

The financial markets are focused on how nations, including the U.S., would prefer weaker currencies in order to make their exports cheaper on global markets. Indeed, multinational companies Caterpillar and McDonald’s reported Thursday that their bottom lines benefited from stronger international sales.

The flip side of that weak-currency strategy, however, is that imports into the U.S. become more expensive. If so, that will be a problem for millions of companies that don’t have an export presence. These companies, especially small and medium-sized firms, will see their profit margins squeezed because of higher costs…

Michael Trebing, senior economist who oversees the survey at the Philly Fed, says that in the past, respondents have said the prices-received index is weak because of competition and the inability of businesses to pass along cost increases. As a result, profitability is under attack.

“Accounting 101 tells us that if a company’s input costs go up, and they are unable or unwilling to pass those costs on to the consumer, their margins get squeezed,” says Dan Greenhaus, chief economic strategist at Miller Tabak.

The squeeze could get worse as import prices adjust to a weaker dollar because U.S. business depends on imported supplies. Excluding energy commodities, industrial materials and supplies account for 14% of all U.S. imports. In the first eight months of 2010, nominal shipments of these imports increased 30% compared with the same period in 2009.

To be sure, many global contracts are priced in U.S. dollars. But as the dollar weakens, foreign producers themselves will soon come under margin pressure when the dollars are translated into local currency. Over time, new contracts will carry higher prices for the components and materials that are important inputs for U.S. manufacturers and service-providers.

In one respect, higher import prices would please the Fed because bank officials want to see overall U.S. inflation head higher.

Some quick stats: (all charts from Google's public data explorer)

Exports make up only 12% of the US economy (above chart) compared to imports at 17% (below chart)

Overall, US merchandise trade constitutes only 24% of the US economy.

A weak dollar policy not only punishes imports, which ironically represents a much larger component of the US economy, importantly, it would hurt domestic trade which comprises 76% of the GDP.

So when Fed officials say they would like to see higher inflation through a weaker currency, they are simply implying that exporters should be subsidized, shouldered by the rest of the economy, at the cost of vastly lowered standard of living through higher consumer prices.

Of course, as mentioned above, instead of adding jobs, a profit squeeze on domestic non-export enterprises, through higher prices of inputs, would translate to high unemployment.

And an environment of high prices and stagnating economy is called stagflation, a dynamic the US had encountered during the 70s to the 80s.

Yet that’s how ‘subtle’ protectionism works, the rhetoric and ‘noble’ intentions depart from real events, where a few politically handpicked winners would emerge at the cost of everyone else.

Update: I forgot to add: There is another unstated beneficiary here, i.e. holders of financial assets. And the sector that requires an asset boost is no more than the banking sector, which have been severely distressed by the recent crisis. And this is why I think that a weak dollar isn't directed mainly at bolstering exports but to keep the banking system afloat.

US Financial Profits Explode: More Evidence of the Bubble Cycle

More proof why today's "recovery" is no more than serial bubble blowing by people who believe they know more of what's good for us.

This from the Bloomberg's chart of the day:

"Record low U.S. interest rates are boosting the profitability of financial companies, creating the same kind of imbalances that fueled the credit crisis, according to Jim Reid, a Deutsche Bank AG strategist in London.

More from Bloomberg,

``The CHART OF THE DAY tracks finance industry profit in billions of dollars, measured by the yellow line, against earnings for non-finance companies in green and nominal U.S. gross domestic product, shown by the red dotted line.

``“It seems incredible that financials are now scaling their 2006/2007 heights again,” Reid wrote in a research note published yesterday. “The dramatic imbalances are re- occurring.”

Here is Murray Rothbard on the Austrian Business cycle,

``The answer is that booms would be very short lived if the bank credit expansion and subsequent pushing of the rate of interest below the free market level were a one-shot affair. But the point is that the credit expansion is not one-shot; it proceeds on and on, never giving consumers the chance to reestablish their preferred proportions of consumption and saving, never allowing the rise in costs in the capital goods industries to catch up to the inflationary rise in prices. Like the repeated doping of a horse, the boom is kept on its way and ahead of its inevitable comeuppance, by repeated doses of the stimulant of bank credit. It is only when bank credit expansion must finally stop, either because the banks are getting into a shaky condition or because the public begins to balk at the continuing inflation, that retribution finally catches up with the boom. As soon as credit expansion stops, then the piper must be paid, and the inevitable readjustments liquidate the unsound over-investments of the boom, with the reassertion of a greater proportionate emphasis on consumers' goods production."

We never seem to learn.

Reasons Why The US Could Play A Major Role In Greece's Bailout

In last week's report Why The Greece Episode Means More Inflationism, we conjectured that perhaps the US taxpayers could play a tacit role in the Eurozone's efforts to bailout Greece.

Then came recent news reports which revealed that Wall Street seem to have had lent a hand in the shielding of Greece's liabilities via the use of currency swaps since Greece joined the EU.

According to the New York Times, ``In 2001, just after Greece was admitted to Europe’s monetary union, Goldman helped the government quietly borrow billions, people familiar with the transaction said. That deal, hidden from public view because it was treated as a currency trade rather than a loan, helped Athens to meet Europe’s deficit rules while continuing to spend beyond its means."

David Kotok of Cumberland Advisors suspects that perhaps there is more than meets the eye, (bold highlights mine)

``It appears that Greece clandestinely attempted to use currency swaps as a deferral technique to project their payment obligations into the future and to hide them. Greek officials claim to the contrary; they say the transactions were reported. But an initial scan of the reports that were used in the early part of this decade does not find them. Hmmmm?

``Let’s make this clearer for readers: the use of this type of swap accomplishes the movement of debt off the balance sheet and into the currency balances. There can be legitimate economic reasons for this type of transaction as an offset to trade flows. And the same transaction can be used for outright deception if the user wants to hide a rising debt ratio.

``Now an investigation is underway by Europe’s statistical office, Eurostat. News reports have also been confirmed that Greece has a history of using this allegedly deceptive technique in the past. We now know it was done in 2001 and was contemporaneous with other actions that Greece was taking so it could become the twelfth member of the Eurozone.

``It also appears that these transactions were arranged through Goldman Sachs and that subsequently GS hedged its position to a neutral one by shorting or constructively shorting Greek debt. Did Goldman act improperly? That now also is a subject of debate. Investigations are certainly coming. Witch-hunting about Goldman Sachs and their book of derivatives is very popular these days. We expect to see more of it on both sides of the Atlantic Ocean.

``There will be much EU political outcry about this transaction which currently is measured at 1 billion euro. The key question for markets revolves around whether or not this is a single event or if there are more such transactions that will be revealed in the books of Greece or other EU member states."

Based on the above, there could be three reasons that would prompt for the US via the US Federal Reserve to intervene:

one, Wall Street has more exposure (perhaps indirectly) to the Greek (PIIGS) than is publicly known or declared and

two, there could be official efforts to cover the tracks of Wall Street's subterfuge.

three, to ensure the US dollar hegemony (by ensuring the survival of Wall Street who serve prime agents of the Federal Reserve and their alternate egos in Europe)

Congressman Ron Paul raised the same concerns; (bold highlights mine)

``Is it possible that our Federal Reserve has had some hand in bailing out Greece? The fact is, we don’t know, and current laws exempt agreements between the Fed and foreign central banks from disclosure or audit.

``Greece is only the latest in a series of countries that have faced this type of crisis in recent memory. Not too long ago the same types of fears were mounting about Dubai, and before that, Iceland. Several other countries (Spain, Portugal, Ireland, Latvia) are approaching crisis levels with public debt as well. Many have strong ties to Goldman Sachs and the case could easily be made that default could have serious implications for big US banking cartels. Considering the ties between the Fed and these big banks, it is not outlandish to wonder if the US taxpayer is secretly bailing out the entire world, country by country, even as our real unemployment tops 20 percent...

``This global financial crisis is a predictable result of secretive central banking and unsound fiat currency. Governments are entirely committed to this system of fiat money and fractional reserve banking for obvious reasons: it enables them to do what they love most, namely, spend hoards of money with near impunity. Without the limitations of sound money, governments will spend without limit. They will spend money to hire their cronies, pay off special interests, give out favors, create dependence and generally distract from the terrible job they do at their chief mandate, which is to protect the liberties of the people. Fiat money is a blank check to government, which is very dangerous, and we are witnessing the death throes of the system as the bills come due and the underlying capital is squandered away."

The ramifications of which appear to be headed in the direction of our much feared 'Mises Moment'.

US Trembler: Volcker Rule or Bernanke Confirmation?

``What we do want, what we insist upon, is that no longer will decisions that carry so much economic weight be made in absolute secrecy. We want to know what arrangements the Fed makes with other governments and central banks. We want to know who is benefitting from the actions of the Fed and what deals are being made. The Fed is already reacting to pressure by scaling back its liquidity facilities and returning to more traditional monetary policy through direct asset purchases. With nearly $800 billion in mortgage-backed securities on its books already, $800 billion in Treasury securities, and no real limit to what the Fed can acquire, there is a tremendous opportunity for malfeasance. We need to know who the Fed deals with, what they buy, how much they spend, and who benefits. As good as any step towards Federal Reserve transparency is, anything less than full disclosure at this point is unacceptable.”-Congressman Ron Paul, Anything Less Than Full Disclosure is Unacceptable

The meltdown in the US market’s have largely been attributed to the proposed Volcker Rule, where US President Barack Obama endorsed Former Fed Chair Paul Volcker plan to overhaul the banking sector’s risk taking activities by restricting in house trading activities or proprietary trading and by preventing them from also investing in hedge funds or private equity operations.

While reducing the banking system to its original function of warehousing (deposit safekeeping) and loan services (acts as intermediary to finance business undertaking) would seem pretty ideal, the radical approach to “cleanse” the banking system of the so-called “greed” appears to be in reaction to the massive political capital loss suffered by President Obama at the hands of Republicans in the recent Massachusetts senatorial election, reportedly one of the main bailiwicks of liberal forces in the US.

The electoral loss signaled Obama’s health reform bill as losing popular support, which may likewise translate to a mighty comeback for the GOP (Grand Old Party) in the upcoming 2010 senatorial elections. The prospects of the Republicans back at the helm of the Senate risks enervating Pres. Obama’s programs, hence like all politics, desperate times calls for desperate measures.

The massive loss of political capital meant that President Obama had to piggyback on a popular issue, which at this point has been no less than to bash on the highly unpopular banking sector to regain some points.

Nonetheless while we mentioned that reducing the banking sector to its basic function should have been ideal, the Obama-Volcker tandem has merely been passing the buck.

They’ve fundamentally ignored the role of government failure that led to the recent two boom bust cycles, which essentially had been due to easy money policies, albeit for the recent housing bust these should have included the skewed capital regulations that encouraged excess leverage and regulatory arbitrage, housing policy that pushed home ownership by subsidizing mortgages and regulators sleeping at the wheel or in cahoots or captured by the industry, as well as, tax policies that encouraged debt take up.

Policymakers frequently deal with the superficial, it has never addressed the roots of “too big to fail” which is largely a product of crony capitalism emergent from bubble policies.

As per Constantino Bresciano-Turroni as quoted by Gerard Jackson ``The increase in banking business was not the consequence of a more intense economic activity. The work was increased because the banks were overloaded with orders for buying and selling shares and foreign exchange, proceeding from the public which, in increasing numbers, took part in speculations on the Bourse. The banks did not help in the production of new wealth; but the same claims to wealth continually passed from hand to hand.”

In other words, the so-called banker’s greed is a result of policy based support to the banking sector, and it’s kindda obvious where this leads to-another Potemkin village or poker bluff.

Unfortunately these desperate attempts by the US President risks unforeseen consequences, considering that major banks engage in these activities have been supported by the US government.

This translates to policy contradictions which increase the overall risk environment thereby heightening uncertainty, and thus, perhaps the market’s sharp reactions.

Figure 6: stockcharts.com: S&P ETFs By Sector

Well based on the sectoral performance by the S&P ETFs, the materials, financials and energy took the brunt of the recent selloffs, these implies that since China has emerged as a major force in the demand for commodities then the fall in materials and energy could have been construed as China related and the fall of the Financials as imputed on the Volcker Fund issue.

Figure 7: Danske: US treasuries

Moreover, this week’s meltdown didn’t come with higher interest rates. Therefore the issue wasn’t about funding, interest rate and or rollover risks. Instead the lower yields signaled a supposed flight to safety as Danske Team indicates above (right window) which has been corroborated by a rising US dollar.

Considering that the net supply of bonds have shriveled due to Fed QE purchases, the selloff wasn’t also indicative of concerns over exit plans.

One analyst offered a conspiracy theory and wrote that for the US to be able fund its intractable deficits she would need to engineer a stock market crash, as the frightened public (domestic and foreign) will likely buy into US treasuries. Although I would tend to dismiss this as normally outrageous, as any short term benefits will offset by medium to long term losses, desperate politicians may embrace almost anything silly for as long as it could preserve their privileges or power.

Lastly there is also the issue of the Ben Bernanke’s reconfirmation as the Federal Reserve chairman. Considering Mr. Bernanke needs 60 votes in the Senate to extend his term, the current anti-bank sentiment has prompted several Senators to cross partylines and move against extending Bernanke’s tenure which expires on January 31^st.

``According to a Dow Jones Newswires tally, 26 senators have said they will back him; 15 have said they will oppose him. The remaining 59 haven't said what they will do. Under Senate rules, the earliest a vote could come is Wednesday,” notes the Wall Street Journal.

So why could the market crash with Bernanke’s confirmation in the line?

Perhaps Connecticut Democrat Senator Christopher Dodd, a Bernanke backer, gives us an inkling of what Ben Bernanke may or may not do, "I think if you wanted to send the worst signal to the markets right now in the country and send us in a tailspin, it would be to reject this nomination."

In other words, there seems no easy or better way to get reconfirmed than by holding the market hostage!

Yet all these political muddling makes us wonder, why would US debt get supported when regime uncertainty appears to be snowballing? Why should the US dollar become the safe haven when the pillars of central banking appear to be in jeopardy?

Other than all three variables-China’s efforts to quash a homegrown bubble, the US Volcker Fund brouhaha or the Bernanke confirmation controversy and fears of default Greece default-the markets could be looking for an excuse to correct.

So who says the markets are solely about the economy?

Following The Money Trail: Inflation A Key Theme For 2010

``Strategy without tactics is the slowest route to victory. Tactics without strategy is the noise before defeat”-Sun Tzu

WAY past the self imposed $300 billion and October deadline, the US Federal Reserve continues to load up on long dated US treasuries this week.

Figure 1 Cleveland Federal Reserve: Credit Easing Policy Tools

Notably the amount of purchases has doubled to $ 7 billion from last week’s $2.8 billion. These Quantitative Easing activities have coincided with a new watermark high among global equity benchmarks (see figure 2).

Importantly, US Treasury purchases by the US Federal Reserve which commenced in the week of March 18^th of this year, has nearly been concomitant with the March 6^th lows of the US stock market.

Figure 2: Stockcharts.com and Cleveland Fed: Inflection Points Coincide With QE

This posits that after the US markets set a floor in March of this year (vertical blue line left window), the subsequent long dated Treasury purchases (light green arrow left window) by the US central bank combined with the earlier and larger purchases of agency debts have been tightly correlated with the revitalized actions in global stock markets which has likewise been reflected on the inverse price movement of the US dollar Index! (see figure 2)

Evidence and logical argument tells us that this has been more than just a tight correlation but one of causational influence.

So while the “desperately looking for normal” camp continues to pattern their analytics to the conventional economic sphere to predict for a “normalization”, the movements in the markets have increasingly been detached from the underlying motions in the real economy. And the evolving events have repeatedly and derisively contravened such expectations.

For instance, unemployment rates have soared to 10.2% in October (yahoo Finance) with the growling bear camp predicting unemployment rates to reach 12-13% (WSJ Blog) yet US markets continue to crescendo.

And such blatant disparity between surging stocks and improving but tepid economic growth activities has left the mainstream deeply discombobulated.

US Government’s Primary Political Goal: Save The Banking System

Two principal reasons for such confusion:

One, imprisoned by walls of conventionalism, this camp obstinately refuses to acknowledge and or reckon with the political objectives of the incumbent political leadership and their respective bureaucratic authorities, and their consequent actions or measures thereof.

This camp also refuses to digest or internalize on the reality that political objectives have NOT been primarily directed at rehabilitating unemployment, output gaps (excess capacity), idle resources or economic growth, which appears to be secondary, but on the PRESERVATION of the banking system!

The morbid fear out of a massive wave of near simultaneous banking closures or banking collapse (ala the Great Depression) that would lead an eventual systemic deflation has prompted the US Federal Reserve to engage in a massive and unprecedented scale of operations to buttress its banking system.

And it is for this reason that the Federal Reserve has reconfigured bank earnings from its traditional “deposit and lend” operating model, in the face of a disinclined market hobbled by over indebtedness, to a “bank as trader” model.

The Fed has engaged in a massive manipulation of market conditions to the benefit of the “Too Big To Fail” Banks in order to attain such goals [see our expanded explanation in 5 Reasons Why The Recent Market Slump Is Not What Mainstream Expects].

A recovery in earnings is sine qua non to ensure the industry’s survivability and so far the financial sector appears to have positively responded to the Fed’s programs in terms of ameliorating the industry’s balance sheets via earnings growth (See figure 3)

Figure 3: Bespoke Invest: The Financial Sector’s Explosive Earnings Recovery

The bank as trader model has singlehandedly turbocharged the earnings of the S & P 500 despite a broad based sectoral decline in the third quarter on a year on year basis (left column). This is a concrete evidence of the outcome of state capitalism, where political officialdom selects the beneficiaries of its actions.

Meanwhile elevated stock prices appear to have somewhat reanimated the animal spirits that seem to have filtered into the earnings expectations of some sectors as the Technology and Materials in the 4^th quarter.

To quote Bespoke Investment, ``The Financial sector is currently expected to see growth of 133.8% in Q4 '09 versus Q4 '08. This high estimate in the Financial sector helps put estimates for the entire S&P 500 at +65.2% in the fourth quarter. Ex-Financials, the S&P 500 is expected to see Q4 earnings actually decline by 7.6%. Technology is expected to see growth of 21.5% in Q4, while estimates for the Materials sector are currently at 97.5%.”

As you can see stock prices have been on an overdrive while earnings have only gradually begun to recover, except for the Financial sector. This unique market-real economy divergence has long been prompting bears to call for a reversion to the mean. Unfortunately for them the market continues to scathingly defy their convictions.

Following The Money Trail Analytics

Moreover, the “desperately seeking normal camp” which mainly sees current policies as a “one size fits all” remedial approach to both the banking sector and the US economy is a highly misguided diagnostic.

The fact that the US has spent more and provided gargantuan guarantees for its banking system than for the economy conspicuously reveals of its political priorities.

As we previously quoted a Bloomberg report, `` The U.S. has lent, spent or guaranteed $11.6 trillion to bolster banks and fight the longest recession in 70 years, according to data compiled by Bloomberg. That’s a 9.4 percent decline since March 31, when Bloomberg last calculated the total at $12.8 trillion.”

For the real economy only $132.5 billion or roughly 17% of the $787 US fiscal stimulus have been spent as of November 10^th (recovery.gov)

Yet what seems obvious based on evidence hasn’t been given an appropriate weighting. Instead, experts have opted to selectively choose or data mine facts based on a preferred conclusion.

On our part analysis based on “follow the money trail” has been more effective.

And the money trail tells us that political reality translates to inflation as having been the chosen recourse to salvage the US dollar standard system pillared by the US banking system. The economy, despite the official pronouncements, is a secondary concern.

For as long as economic strains poses as threat to the survival of its banking system, the US political leadership will err on the side of an inflation risk and public sector credit risk than with the risk posed by deflation from a banking collapse. Hence, the sustained QE purchases on long dated treasuries, in spite of the self declared deadline and equally the sustained guarantees on the market mechanism conditioned by the US Federal Reserves that would allow the earnings of the banking system to recover.

This renders talks of “exit strategies” as mainly some sort of communication signaling ruse-meaning central bankers feign interest aimed at controlling the surge in asset prices. As we have been repeatedly saying, economic ideology and recent policy triumphalism has boosted the confidence of policymakers to undertake policies in the same direction. Any proposed “tightening” changes will likely be conservative.

Yet, in contrast to mainstream expectations, QE or “money printed from thin air” buying of US treasuries and US agency debt instruments from private institutions, have been flowing into commodities and equity markets and has likewise exerted pressure on the US dollar-giving a semblance of a US dollar carry.

Nonetheless misreading effects as a cause would seem like a sign of incomprehension or outright denial as a result of either economic ideological zealotry or blind spot biases.

The Folly Of Money’s Neutrality

The second reason for such confusion is the widespread or popular fallacious wisdom of the neutrality of money.

Conventionalism treats money has having a minor impact on its purchasing power or in the economy as transmitted by such inflationist policies. This is the reason why the mainstream can’t seem to reconcile on the dynamics behind rising asset prices and the divergence seen in the real economy.

Professor Mr. Ludwig von Mises explains the flaw in populist wisdom (bold emphasis mine), ``It is a popular fallacy to believe that perfect money should be neutral and endowed with unchanging purchasing power, and that the goal of monetary policy should be to realize this perfect money. It is easy to understand this idea as a reaction against the still-more-popular postulates of the inflationists. But it is an excessive reaction, it is in itself confused and contradictory, and it has worked havoc because it was strengthened by an inveterate error inherent in the thought of many philosophers and economists.”

``These thinkers are misled by the widespread belief that a state of rest is more perfect than one of movement. Their idea of perfection implies that no more perfect state can be thought of and consequently that every change would impair it. The best that can be said of a motion is that it is directed toward the attainment of a state of perfection in which there is rest because every further movement would lead into a less perfect state.”

In short, economic activity is seen as fundamentally independent from money supply growth.

Furthermore, asset prices have been deemed to operate on the premise of ‘efficient’ market price signaling brought about by disparate entrepreneurial assessments, estimates and evaluation. This is hardly true today.

And such perceptions of market efficiency will unlikely reflect on the same performances of yesteryears, as global governments have taken to the center stage in the propping up of financial markets.

The Periphery As Global Economic Locomotive

A recent rundown on the performance of global stock markets can be seen in Global Stock Market Performance Update: BRICs Firmly In Command. What seems obvious is the relativity or the variability of performances from the collective pace of global reflationary activities.

Major emerging markets have monstrously been outperforming developed economies equities for several crucial reasons: a largely unimpaired banking system, low systemic leverage and high savings, from which monetary and fiscal policies seem to have generated a visible efficacy-read my lips-seminal bubbles.

This also means that the transmission mechanism of inflation has been segueing from the core (developed economies) to the periphery (emerging markets) -where the periphery is now expected to lift the economic conditions of the core.

Figure 4: World Bank Asia Pacific Update: China’s Powerlifting The Developed Economies

The recent crisis has triggered the reshuffling economic might. China’s economy offset the economic losses from developed economies as shown in figure 4.

According to the World Bank, ``Thanks to China, East Asia remains the fastest growing developing region in the world. Although China’s economy accounts for less than a tenth of the global economy, the increase in China’s GDP in 2009 will offset three-fourths of the decline in G3’s GDP. This number underlies China’s markedly increased global role, but also reveals the limits to what China alone can do, because this year’s outcome was achieved through a huge monetary and fiscal stimulus that the authorities will find neither prudent nor necessary to sustain for an extended period of time. Take China out of the equation, however, and the remainder of the region is set to expand at a slower pace than the Middle East and North Africa, South Asia, and only modestly faster than Sub-Saharan Africa (Table 4). This reflects the openness of East Asia and the fast transmission of shocks through production networks serving the U.S., Japan and other global markets.” (bold highlights mine)

In short, conventionalism continues to embrace myopically a US centric world, even as global growth dynamics appears to be shifting to a very important theme: the periphery as the world’s economic growth locomotive.

In addition, conventionalism can’t seem to grasp the encompassing dynamics where government has practically been THE market. The US Government has been the market because the political authorities deem the “Too Big To Fail” segment of its banking system as indispensable to the economy or for unspecified purposes (known only to the authorities-saving friends perhaps?).

This means that when government as policy, prints money to buy assets from private institutions that owns these securities to shore up its financial sector; money from the proceeds of the sale of assets circulates in the economy or is imbued by the financial market.

Why? Because according to Professor Mises, ``Money is an element of action and consequently of change. Changes in the money relation, i.e., in the relation of the demand for and the supply of money, affect the exchange ratio between money on the one hand and the vendible commodities on the other hand. These changes do not affect at the same time and to the same extent the prices of the various commodities and services. They consequently affect the wealth of the various members of society in different ways.”

In short, inflationism is fundamentally a redistribution of wealth.

From the US perspective, since the advent of the crisis, US taxpayers have been funneling wealth into its financial sector, which is being precariously upheld by the government policies.

On a global scale, the ongoing QE process by the US government has been facilitating for capital outflows from the US. Conversely, such outflows have translated to influx into emerging markets channeled via a vastly weakening US dollar-ergo, the immense disparity in the equity performances between emerging markets and developed economies.

So while we may not have seen generalized inflation yet, what we are seeing today has been a colossal flow of money into assets or “asset inflation” mostly in terms of rising prices of stock markets and possibly in real estate markets of some emerging economies aside from commodity inflation.

Myths and Fallacies, Inflation A Predominant Theme For 2010

Figure 5: Danske Bank: Euroland Loans Picking Up

In addition the vast excess reserves held by the banking system in the developed economies, given today’s buoyant sentiment, is NOT a guarantee that the reserves won’t be converted into private sector loans (see figure 5)

Even as money supply year on year change on the Euroland has been on a decline (right window) since 2007, the loans to non-financial institutions and households have been resurgent (left window). Given the fractional reserve nature of our banking system, sustained loan growths would eventually translate to a surge in money supply growth.

Essentially, more of the continued central bank money printing activities and circulation credit from global zero interest rate regime will transpose to even more systemic inflation.

Remember, it would be a fallacious argument to read ‘deflation’ as contracting money supply in debt plagued economies and apply a different definition to emerging markets (mostly in terms of surplus capacity).

Such inconsistency makes the global deflation theme highly vulnerable or flawed.

Figure 6: World Bank: Different Structures, Different Impact

As seen in figure 6, credit growth has been relatively nuanced among Asian economies and has impacted the region’s economies distinctly.

Therefore, oversimplifying inflation or deflation without fully understanding the fundamental individual political economic constructs of each nation would seem nebulous.

Moreover, it is likewise another fallacious argument to predicate the “containment” of inflation on lofty bond prices alone. As earlier discussed, applied to the US, US treasuries have been one of the key markets supported and manipulated by the US government aimed at bolstering its banking system.

Where price controls can create temporary conditions favorable to policymakers, imbalances from market distortions are fostered from within that would eventually unravel once the system can’t absorb more of these at the margins.

Yet, to assume that current market conditions accurately paint today’s economic environment would be a monumental folly. To be sure, this view critically fails to contrast on the political dynamics from economic metrics.

Moreover, this view seems like a perilous miscomprehension on the operating dynamics of inflation. Inflation does not just randomly pop up where central banks can do a whack-a-mole. Inflation is a political process that operates and is manifested on the markets in stages. [see What Global Financial Markets Seem To Be Telling Us]

Hence, market action is conditional on the direction of global government policies where so far political authorities have been predisposed towards the global reflation context.

This, in essence, also suggests that inflation, as expressed in mainstream definition as higher consumer prices, will likely surprise to the upside and will be a key theme for 2010.