Why am I holding Euros???

The most obvious question to oneself these days, especially if one's a fund or an institutional, is Why aren't we bailing out of Europe...If you're the client, the question to your advisor: Why are you holding on to Euros?  The obvious explanation is: cognitive dissonance. The hypothesis was advanced by  psychologist Leon Festinger (1957).It became popular among political pundits and business types quite rapidly when, years later,  Newell and Simon* integrated Festinger's insights into their own hypothesis concerning human problem-solving.

The Newell-Simon model as it is now labelled, named after Allen Newell and Herbert Simon,  describes how human beings make decisions, ie. solve problems. It becomes especially enlightening when it describes how people react during the intellectual logistics of problem-solving: the intelligence phase, design phase and choice phase.

How do investors react to conflicting attitudes: you hold Euros but everyone calls a crash.

Decision-makers, when in doubt,  will "listen" 'more' to information that supports their belief system than to information that disrupts or questions their belief system.  The underlying hypothesis is that the individual seeks to reduce dissonance or accompanying discomfort created by conflicting information that undermines his position. He will settle for 'satisficing' information without claim to making the optimal decision.

But in many cases, he will side with inputs that justify his original position. Of course, the more individuals are rationally bound (you don't have all the info) the more they will attempt to adjust in a timely satisficing way to the facts. If the former, You could be a die-hard and lose your pants and that of your clients, notwithstanding the information;  if the latter, you could be pragmatic, give yourself and others the benefit of the doubt, and bail-out. After all, the well-known economist and investor John Maynard Keynes evoked the perfect reaction to relieve the dissonance: "When the facts change, I change my mind. What do you do, sir?"

So why are some investors still holding on to the Euro securities...for the same reasons that some European leaders keep promoting austerity measures for public policy notwithstanding the adverse results being generated in  Greece, Spain and Italy.

The dissonance:
Firstly, even though things are difficult in Europe, they're difficult all-around the world. Some will argue that they're already overexposed in equities, in BRICs, in US and other sovereign currency-issuer securities, and even gold-it can collapse on a wind-shift....after which deliberation they move on and argue the next....

...Eurozone economies are not in as bad a condition as selected data suggest. It's quite reasonable to experience hiccups during 'policy transitions' after traveling over rocky roads. And Southern European roads are very rocky according to northern Europeans. Things will smooth themselves out over time. The worst case is if Greece defaults. Let it exit. Nudge Greece out gracefully. The Zone is saved.  This is the message that is being conveyed by European leadership as social tensions in certain countries become more forceful. If that doesn't work out as planned....they move on and argue the next....

...Europe is 'too big to fail'. (Remember Lehmann et al). The US and China won't let it happen- this is Europe, not some mismanaged bank. Some refer to this position as highly speculative; other would consider it quite realistic. Either way, their rationalization recalls Lord Byron's popular but mistranslated line found in his Childe Harolde's Pilgrimage :

   When falls the Coliseum, Rome shall fall;
   And when Rome falls--the World.'

The Eurozone rendition is "When falls the Euro, Europe shall fall; And when Europe falls---the World."

It would carry more credence if it was the US, however.

Here's my take:  If China's growth is projected downwards, if Germany's order book starts doesn't refill to 2010 levels (I don't think it will refill for a long while) and  growth in the US is revised downwards, then you should have bailed to liquid USD, until the facts change!!! If you didn't, think about it.

*I credit Fictional Reserve Barking, Oct 2, 2011, author (Circuit, ) and reader  (JHCraw) for the reference to Herbert Simon's work.

Equity Markets: Thank Heaven for Central Bankers

November 30, 2011 will be a day to remember for many Bourse firms.

It's never a pleasant to be wrong. But it's always a pleasure to be wrong when you called the only viable option that would have made you wrong.

Finally the Central Banks convened to lower USD swap costs and consequently ease tensions within the Euro-Area. Acknowledging that the ECB (and IMF-chuckle for those that conceived that piece of gossip) could do little on their own without frustrating donors, Mr. Draghi understood the problematic and the challenge. Europe needed help from its friends: The Fed and its allies, and the Bank of China. One signaled monetary comfort; the other signaled monetary stimulus. In both cases,  the better bankers realized that a demand for the USD could get out of hand and leave an even more fragile Euro begging for crumbs at untenable rates. That setting without improvement on the Chinese economic front, global economies were in trouble.

The best part of the staging is that China is becoming a beach-head participant in the world's financial system. Mr. Xiao's next challenge is to convince his stakeholders that assisting in the European bailout is a necessary condition to not losing out on everything else, and exercise the appropriate actions. Slowly but surely, Chinese pragmatism is waving a wand that signals a change in political directions towards western rhetoric.The only other adjustment China has to make is a concession on the yuan.

The swap arrangements agreed to (who knows when) are effective December 5, 2011 and will extend for 15 months into 2013. Is there anyone that still thinks that Europe has no problem when its own banks show appetite only for USD. Is Europe out of the woods? Not necessarily. This morning, Mr. Cameron et al, are you listening, European unemployment is on a record rise with the exception of Germany, and that will reverse. Mrs Merkel will see a reversal within three months as less and less demand go her way, and more and more constraints are put on businesses.

Well, US President Obama, Fed Chair Bernanke and Secretary of the Treasury Geithner were there again and maybe someday, some inspired filmaker will find a decent moment to direct  real drama. Europe has been saved for a second time by the United States and its credible allies. Bank of China dropped its reserve requirements by 50 basis points in order to help trigger some activity on a slowing economy. This monetary easing was the first sign that November 30, 2011 was going to be a V-Day.

At this moment, there is little left that the Central Banks and Chair Bernanke can do on the monetary front. US Republicans should analyze their own pundits' results on job creation by President's Obama spending initiatives, and improve on the solutions by fine-tuning timing and sectoral interventions rather than dismiss the spending option. Most of all, they should stop battering the US Public Service. The constituents of that sector represent the most faithful spending segment of the consumer population.

Don't knock down the walls that hold back the oceans.

To the many, stay the course.

Mellow Yellow Monday; Black the Week

Today we'll experience a cover-the-shorts rally and from all indications, we might get a 200pt lift. That's the best this week will bring. By week's end, regardless of mixed signals from the US economy, the week's cumulative should be down by 250points. The USD will gain another notch, and European malaise will continue to batter the credibility of the Euro-Area. Best to short the Euro.

What can the IMF do? What are its sources of income? Should one chuckle. Not really; it's pathetic that most of the market forget that both the ECB and the IMF are recipients from donor sovereigns.

Not a week to enjoy!

Black Monday? No. A BLACK WEEK!!

A regular reader to my favorite webpage FRB or Fictional Reserve Barking commented after a polemic that a squall is coming the likes of which we had never seen. The structure of that phrase clicked a neuron and plucked a memory chord. I'm still trying to figure out where I heard or saw it, and it keeps on slipping. This morning's opening on Wall Street affects in a like manner. Deja vu! but I can't remember when or where. Was I young or was it more recent? In any case, for the pundits that ponder their stats looking for a pattern, this time around there is no precedent from the regressions. It's the Mule breaking out the maths: the coeffcient of error that can't be contained systemically. There are only two players that can restrain the overflow, contain the explosion and both are trading partners, both have their own tensions and both are in search of an author.

One snickers listening to Mr. Cameron highlighting some punctual anomaly in the economic figures just released. It's unreal to finger out the semblance of sunlight amidst a hurricane. That's it, the phrase comes from Dune-the book and the movie!!! It's a variant in a dialogue when the Fremen note a 'wormsign'...

Well, Monday won't be Black, it'll be bleak. Losses will range between 250-325pts. Treasuries will gain and most commodities will fall. Gold, it should fall (except for those that see a backstop international standard on the horizon). Tuesday, some profit at the beginning of the day and then for another 'swerve...towards the bend of bay'. Wednesday figures will be mixed and by the end of this week, Wall Street will be flattening out with losses between 750-800 points, unless the FOMC minutes reveal some silver lining. There will be no Thanksgiving for most investors; there will be one for those holding CASH.

CASH is King!! and whether you like the sound or not, the USD is the only currency worth its logo. I guess there's something providential underscoring the dictum.

The Week will be Black!!!

Bernanke: Not Responsible for the Collapse of Markets of Sept 21-22, 2011

The announcement following the FOMC meetings of September 20-21, 2011 was expected. The infrequent decision to 'Twist'- swap short-dates Treasuries against longer date securities, particularly the very long dates, was expected.

Obviously, the respective underlying intention was to promote the consumer and housing sector with inexpensive mortgage financing, and flatten those yield curves and reward tradeoffs across the Treasury spectrum.  Whether those markets react will depend on whether or not the consumer generates demand for either new homes or refinancing existing homes. In both latter cases, the intended consequence is to alleviate pressure on household debt and unlock consumer spending into the economy.

Chairman Bernanke had nothing to do with the markets' collapse world-wide.

At first, the market reacted positively to the obvious, concluding that it had already discounted the Fed's intervention for all intents and purposes. That didn't last long. Some of the more enlightened participants realized that the most important statement had been skimmed over by the markets.  Mr. Bernanke had emphasized in explicit terms the dire prediction on the global economy that was unexpected in the announcement  and, de facto, lent a deaf ear, dismissing the GOP leadership's political rhetoric of the previous day.

Chairman Bernanke,  previously informed by Secretary of the Treasury  Mr. Tim Geithner's return from the meeting of European Finance ministers in Poland last week, characterized his caution on the world economy in the following manner: 

Moreover, there are significant downside risks to the economic outlook, including strains in global financial markets. 

The markets tumbled when players realized that the global economic situation was not tepid but turbid.  Financials leading the slide, dropped across the board, catalyzed by a Moody's downgrade of Bank of America, Citigroup and Wells Fargo on their debt. The only anomaly was Hewlett Packard rallying on a rumour that their CEO had been ousted. Talk about quality trading, as if a new, yet unidentified CEO will reverse macroeconomic circumstances. The morning should reverse the ridicule and ratify the quality of its governance.

All markets in Asia and Europe tumbled overnight. The additional information from Europe and China that the Purchasing Manager's Index (PMI) is contracting, followed by market commentaries that it may suggest deterioration in manufacturing output,  is sending signals globally to investors that the only viable route is away from equities for now- a rush to safety and US Treasuries. In fact, all currencies, except USD, all commodities including gold,  and Treasuries were down or short dates unchanged with the exception of the 6mth yield rising.

But why are BRIC indexes dropping? Fundamentally, there is no structural demand within those economies that can permeate the level of manufacturing and production that has been underlying their respective growths. Until further ado, BRIC depends on Western economies and spending. Suffice it to follow the Russian equity market this day after. Significant is to realize that BRIC cannot, at this moment of their development, drive the global economy out of its slowdown. If Japan could never act as the world engine, why should BRIC assume the role. The same is true of Europe; its lame-duck behaviour is unjustified under the conditions. Europe must put its condos in order, if the investment is to be successful.

What the headlines suggest as Mr. Bernanke's Market Debacle is absolute nonsense!

The nonsense was the GOP's leadership criticism of the Federal Reserve decisions. Boehner, Cantor & Associates' understanding of basic economic realities is unreliable and incomprehensible for that level of leadership. They should simply acknowledge that without employment there is no spending and there are no sources of Treasury revenue; and without revenue sources, there is no deficit reduction. If they persist on professing that deficit myth: that deficits matter for the US economy, they will make matters worse. They should recognize their own shortage of viable solutions, and grasp the moment to support fiscal spending programs. As for Rating Agency downgrades, they don't  matter at this moment.  Recently, they have been shrugged off by all sovereign levels.

Unless the US economy is activated, and this won't happen as a result of Federal Reserve monetary policy, the global economy will remain in a state of stagnation for a long time. It is obvious that any solution must come out of Washington. A reasonable start is to couple that  result from flattening long date yields with an aggressive mortgage refinancing program for the suffering homeowners and well-intentioned consumers.

US Sovereign Downgrade by S&P: Buffo!

On the evening of Friday, August 5, 2011, Standard and Poor’s, in an act of Bravura, downgraded United States Sovereign Debt rating to a AA+ from a AAA while reaffirming its A-1+ rating on US short term, notwithstanding their $2-trillion math-error! Bravura?  More Buffonata! than Bravura! This move had to some extent been discounted by global markets. Suffice to note the past week’s session drops in all major bourses. Those drops may also pre-empt the impending confusion and instability that will characterize the upcoming weeks' sessions on most security markets, especially from Asian and European markets which, opening after watching the announcement, should experience a tumble, but not a crumble.  

Todate, Moody’s and Fitch Rating have shown caution in this regard reserving their assessments for later.

The analysis by Mark Zandi of Moody's on fiscal sustainability,  tax reform and responsible compromise demonstrates the type of level headedness that is required by Credit Rating Agencies when they approach new paradigmatic scenarios, because de facto, the current US Debt situation invites paradigmatic shifts in methodology and optics.

Sovereign Balance Sheet is not a Corporate Balance Sheet. There are overwhelming incidences of political discretion that can neither be reduced to a quantitative measure nor can they be appreciated as stand-alone components for a measurement standard. The deficit cannot be isolated from the trade-off matrices that configure the US relationship to its broader sphere of influence within the domestic and  global political and economic network.   

Apart from a global audience whose appetite was partially satisfied by the Washington deal, the winners of the Washington tug-of-war will be investors. The basic premise that some investors will be precluded from future purchases is unrealistic. Most institutional players have portfolio criteria that permits purchases on any security rated a AAA to peers by at least one or two of the Big Three. Flight from US Treasuries is also very unlikely because there is no other safer investment haven in the world than the United States.

On the downgrade, markets will bid up the AA+ US Treasuries; many investors will pull out of equity markets leading to their decline resulting from the failure of corporate equities to compete with rising sovereign debt.  The US Dollar could appreciate for a time, as timely capital inflows into the US on purchases of US sovereigns dominate foreign exchange markets. At one point, given all things equal, markets will reach a state of equilibrium: the USD should subsequently  fall into a lethargy . How far down must the Dollar fall before the J-curve comes into play is anyone’s guess. US manufacturers are no longer very competitive on global markets. Marshall-Lerner conditions may no longer prevail in an orthodox manner- what previously worked and set precedents may no longer apply to current conditions.  Ultimately, a drop in the currency increases the existing deficits and dissembles interest for the de-facto guarantor of most of the world’s assets. Moreover,  core expenditures cuts may dramatically affect a large number of sectorial players in energy, financials, defense, health and transportation as well as state, municipalities and para-government agencies.

By 2012, unless deemed progress is made on the deficit front, markets may be confronted by another adverse assessment of the US Debt situation that could trigger another downward spiral and so on.

So returning to rational predicaments.
When is the Big Sell-Off.
How much has already been Shorted.
What is the option to a Big Sell-Off.

As with any rational and conceivable counterfactual scenario, the market must review the effects of the day-after.

Firstly, if a AA+ still attracts investors, then the S & P  Grid is substantively superfluous, because it does not deter investors, it merely panders a price peg.

Secondly, if it really considers US Sovereign Debt as relatively compromised in relation to other options (what similar options are there?), then S&P should be integrally considering a reassessment, if not a downgrade, of every major holder of US securities: reassessing the actuarial liability of every pension fund, the unit value of every mutual and the stability of every Bank in the world carrying US Treasuries especially the those of the UK, Canada and the Caribbeans, as well as the holdings of the Governments of China, Japan and Taiwan, since the integrity and liquidity of their respective financials are now compromised.

Thirdly, trading partners' current accounts may find themselves as compromised by the US deficit reduction plan as US domestic players. They, and their own nationals, may indeed have to envisage a weaker investment profile than anticipated in face of such a contagion as their own economic growth falters and begins staggering.   

Finally, the effect of contagion within the American political and administrative system is even more immediate. Municipal, state and other domestic secured borrowers will not only find their investments more expensive to finance, they may actually find themselves excluded from markets. The impact of the above is extremely onerous on regions and communities attempting to recover. It is even more onerous on the American people as households will be forced to pay more for their debt. What appeared as an enterprising improvement in household wealth in the last quarters may quite rapidly deteriorate into ephemera.

There appears to be no end to the downward spiral. The downgrade weakens the Dollar, and eventually adversely skews expectations on Dollar Assets, further defeating the Dollar Stability Paradigm. Why would anyone hold Dollar assets under such conditions.  It is somewhat irrational to advance a rational argument that impels an irrational decision. Theoretically, the world should dump dollars; but no coordinated action has been exercised yet. Is the premise false or are the components of the dilemma flawed. Probably a combination of both. As to the premise that the downgrade weakens the Dollar and the Stability Paradigm is weakened, there is some truth, but there is no  real dilemma since there is no credible option to the dollar, except for the esoteric: Gold, and that should experience an early surge next week, or short date moves to the Swiss Franc or Yen. If one buys into the Gold Niche, then the predicament is: should we not revert back to the Gold Standard.

Perhaps, the real issue is that no one cares about the one S & P evaluation in the case of US Debt because 'safe haven' should be given more value than the nature or size of the deficit. Or perhaps, as reality sets in, investors will realize that the US will continue refinancing its interest payments at a higher cost indefinitely, and the principal is far enough out that it will not affect their immediate results, and in turn will be itself refinanced. So enough for intergenerational considerations!Circuit theory  and modern monetary theory can certainly clarify the situation at hand and suggest reasonable solutions. We are de jure dealing with a perpetual money printing process.

As bond yields rise, equity markets sell-off,  and since interested liquidity is not abundant these days, the market promotes its own volatility, prefers the selloff to being hostage to an uncertain future 12 months down the line-the US debt-limit problem will resurface in 2012. One hears the snickers of a community of free-loaders and free-riders. In the end, one witnesses a run to les paradis artificiels of gold and similar glitters. Metals follow course and a manufacturing sector that had tolerated an adverse and unexplainable peak in prices, experiences once again a surge in commodity prices, a drop in demand -the combination of which dampens their recovery. Layoffs follow. Companies close and household wealth plummets. We are in the third phase of the Great Recession, or Phase One of the Great Collapse. For workers and their families, it is inconceivable that this happen in and to the United States.  

Did S&P cynically engage in a Marketing bravado of 'I was First' or 'We blew it last time, and we got hammered by the US Government-it's our turn now!!! '

If so, then it's ironic that Nemesis should be invoked in this farcical manner. Showmanship is not publicly responsible. To be sure, what the Rating Agency contends is that it is simply acting in accordance with its professional responsibility, intending Hayek and claiming unintended consequences  with respect to the outcomes in performing its mission.But markets have short memory spans; they were ready to crucify S&P a few years ago for negligence; now they'll take the free ride they offer.

---

Debt-Limit Impasse and US Credit Rating: Nonsense per Beckett


The high probability that a political stalemate between a trying President Obama and a headless GOP would unleash an economic nightmare in the global financial system was unprecedented in American politics. To observe this staging with its original cast, from showmanship through the intrigues of gamesmanship only to end in a display of outright irresponsible brinkmanship was more like unraveling Kahn's absurd than thinking the unthinkable.  There was nothing tolerable being rehearsed on the stage in Washington.

For some, the Republican House had little to lose: they may have shattered the image once and for all of an already tarnished and staggering President Obama, if not out of the White House, most probably out of some future Majority. There is now, in hindsight, a conversation within the GOP depicting the emergence of a ‘Republican moment’ that will define the party and establish its future credentials. For others,  this supposedly tactical moment may have sealed the coffin to the GOP's own demise for the upcoming election.

Yet, the debt-limit impasse between a Presidential vision and the GOP counterproposal  led most pundits to rethink public ethos and try to figure out which of the parties was more irresponsible: President Obama in failing to appreciate the tactical whims of a political adversary  or the Republicans failing to appreciate the gravity of the demise bearing on the American economy , and the unwarranted burden of malaise and suffering being wrought on seniors, children, the sparsely employed and the unemployed.

The actors lost themselves in their mimes. Both parties-the White House and the House have forgotten the nature of their primary obligations.

Who stands to lose?

There are over 14M unemployed in the land, disposable personal income has decreased since 2007 with the exception of the 2009 anomaly, household wealth although rising, is slowing down, is also largely mitigated by a rise in values of financial assets that could as easily reverse their course and plummet family balance sheets overnight, and finally poverty thresholds are being surpassed daily with over 45.8M, or about 15%, of Americans on food stamps. To further taint this cautionary tale, there is no clearing in that bleak vision that signals an abetting storm; quite to the contrary, a piebald horizon of weak data and weakening indicators omens more the fury of a squall than a desired calm.

One daresay that the world was witnessing a burlesque rendition of Waiting for Godot. Certainly, Samuel Beckett could not have construed better and original script for a more consequential tragicomedy in two acts, than the Washingtonians did with such a routine episode of American Domestic Politics as the Debt-Limit debate. Note Beckett's Vladimir underscoring Washington's lack of public accountability

"Let us not waste our time in idle discourse! (Pause. Vehemently.) Let us do something, while we have the chance! It is not every day that we are needed. But at this place, at this moment of time, all mankind is us, whether we like it or not. Let us make the most of it, before it is too late!"

and with the same breath, note again Vladimir underscoring Washington's lack of political responsibility

"But that is not the question. Why are we here, that is the question. And we are blessed in this, that we happen to know the answer. Yes, in this immense confusion one thing alone is clear. We are waiting for God [ot to come]"

Classic Drama, with all the classical elements, written for Washington!

Yet, Beckett's characters in waiting resonate within the absurd; Washington's characters await generational inspirations for having lacked the day's resolve- again Vladimir

"To-morrow, when I wake, or think I do, what shall I say of to-day?"

It seems that, if anything is to be recognized, it is that the debt-limit dateline should have been a moot issue; the grotesque impact will and could come from the evaluation of US Treasuries by the Credit Rating Agencies, in particular the Big Three,whose own records during the last three years have been less than commendable. The same process that lacked discernment with  an infinitely less complex file back in 2007 will now determine the demise of a AAA sovereign. If the fate of future generations rests with the hubris of a community of analysts whose only consequent is a pricing label - that influences the cost of capital that should be ultimately tagged to the sovereign’s Treasury, then we are inviting a systemic disarray.

Yet, the US is still the most secure investment haven in the world and the latter feature will not be justly embedded in the credit rating evaluation.

The embarrassment cannot be undermined; the economic and financial costs to the US Government and the American people must not be underestimated.  The Rating Agencies should defer their assessments in order to fine-tune their methodologies, to refine their presumptions of what constitutes default risk, and to review the values that constitute and embed appropriate fiscal and monetary management of public finances in the 21st century.