Too Big To Flail - January 31, 2011 - The Streets of Cairo

‘I was bruised and battered and I couldn’t tell what I felt, I was unrecognizable to myself, I saw my reflection in a window, I didn't know my own face, Oh brother are you gonna leave me, Wasting away, On the streets of Philadelphia’ (Bruce Springsteen – 1993)

‘The Streets of Philadelphia’, it really should have been ‘The Streets of Cairo’ or maybe I should’ve gone with ‘Winds of Change by The Scorpions. What’s transpiring in Egypt or Northern Africa for that matter is extraordinary. Regimes that have been in place for 25+ years are all of a sudden being challenged by the people on a large scale. Not only in Tunisia and Egypt, but also in Syria, Yemen and even in Libya, on a smaller scale, people are taking to the streets, demanding their freedom, their dignity and above all affordable food. It’s extraordinary because no one could have predicted the swiftness or tenacity with which it all takes place, but it is by no means unprecedented. Rewind 20 odd years and here in Europe we experienced the same with the break-up of Russia and the demise of the dictators of Eastern Europe.

It took the Tunisians a couple of weeks to get rid of their once fearless leader and see him fly off in his private airplane, filled with gold (if he had ridden into the sunset through the desert on a horse with a couple of gold-bars it would have been a scene straight out of a medieval Hollywood blockbuster, but, this is, regrettably, fact and not fiction). The Egyptian protests have gone into day 7 now and even though thousands are defying the curfew, they have far from succeeded in chasing away President Mubarak. It shows that it’s really helpful to be backed by the U.S. Government. The biggest question is whether the protests will actually work and if so, what will be the implications for the region.

Let’s assume the ‘million man march’ scheduled for tomorrow is the final straw that breaks Mubarak’s proverbial back then a new government will have to be formed. Mohammed El-Baradei, the former International Atomic Agency chief and a prominent political opposition figure in Egypt, has already announced that he is willing to form a new government with the other opposition parties such as the Muslim Brotherhood. As good as it may sound that a new structured government will be formed (or at least an attempt will be made) within the weeks following Mubarak’s dismissal, the chances for a lasting new government are actually not that big. As history has taught us, the transition from a dictatorial form of government to one of democracy has often been met with violence. It’s just that, a transitional government. If we look at the analogy with Eastern Europe and the former U.S.S.R., most former republics are now ruled by a dictator, there’s a decade long war raging in Chechnya, the economic turn-around in most of Eastern Europe never took place and the former Republic of Yugoslavia went through a major civil war.

My girlfriend, who studied Political Science, told me on Saturday: ‘With Democracy comes responsibility’ and that is more than true. For us living in the West democracy is something so obvious, we often forget we have responsibilities, instead we rely on the government to take care of us. So how can we expect people that have been living in poverty, in fear, people who have been suppressed all their lives, who have never known democracy, how can we expect them to start to take responsibility out of the blue?  For all their good intentions, it just doesn’t work that way. It will get better, but they have to take baby steps, they have to restrain themselves and not think they will achieve tomorrow all that they have been denied for so long, that, in itself, will be the biggest task ahead.

The fall of Mubarak will have implications for the entire region. Seeing as he has been a prominent moderate voice in the Arabic community (the main reason why he is backed by the U.S.) for over 30 years, his resignation will no doubt have a big impact.

  

It will instill fear in other regimes, and most countries in the Middle East are just that: non-democratic governments, and fill the hearts of the people with courage and belief that they too can make a change. Already Moammar al-Qadhafi in Libya (wedged between Tunisia and Egypt) has announced emergency measures in the hope he will keep the people off the streets. Protest demonstrations, albeit really small, were held in Yemen and Syria and so it seems to be spreading to the east bit by bit.

The crucial question is: will the unrest reach Saudi Arabia? Besides their vast oil reserves, Saudi Arabia plays an important geo-political role in the region as they are the biggest U.S. allies, the U.S. has a large military presence there and the Saudis are an opposing voice to Iran. There already have been protests in the past, but so far the security forces of the Kingdom have been able to control them. It’s my understanding that the people are comparatively wealthy (compared to the rest of the region) so their impetus to revolt is much lower. That being said, I don’t believe Saudi Arabia will become a problem anytime soon.

Although Egypt has already been marked by some in the financial markets as a ‘Black Swan’ event, they seem to be ignoring it for the most part. Last Friday there was a mild sell off on the European and U.S. markets (1% - 2% down) but there is little to no spillover effect today. It seems strange on the surface, since there could be some major geo-political shifts as a consequence of what’s happening right now, it could affect the price of Oil in a structural way, but for now people seem unwilling to gamble on such an extreme outcome. Apparently the inflow of ‘cheap -FED-money’ is still more important than tens of thousands of protestors on the streets of Cairo, than regimes being toppled. Obviously the FED can keep printing money longer than the protestors can stay in Taharir-Square. Business as usual. There has to be a POMO somewhere we can front-run.

Happy Hunting & Let’s Be Careful out there!!!

TBTF January 26, 2011 - State of the Union

‘He shall from time to time give to Congress information of the State of the Union and recommend to their Consideration such measures as he shall judge necessary and expedient.’ (Article II, Section 3 of the U.S. Constitution)

So today I did not start off with a song but with that all important sentence in the U.S. Constitution that led to what we call today: ‘The State of the Union’

Yesterday, Tuesday January 25, President Obama delivered his State of the Union for 2011. As expected the state of the economy took center stage, but there was also emphasis on clean energy and more important education.

Some key statements from the speech (full transcript & video):

 “Over the next 10 years, nearly half of all new jobs will require education that goes beyond a high school degree. And yet, as many as a quarter of our students aren’t even finishing high school.”

“The future is ours to win. But to get there, we can’t just stand still. As Robert Kennedy told us, ‘The future is not a gift. It is an achievement.’”

“But if we want to win the future – if we want innovation to produce jobs in America and not overseas – then we also have to win the race to educate our kids.”

"We are living with a legacy of deficit-spending that began almost a decade ago. And in the wake of the financial crisis, some of that was necessary to keep credit flowing, save jobs, and put money in people's pockets."

"But now that the worst of the recession is over, we have to confront the fact that our government spends more than it takes in. That is not sustainable.

"We need to get behind this innovation. And to help pay for it, I'm asking Congress to eliminate the billions in taxpayer dollars we currently give to oil companies. I don't know if you've noticed, but they're doing just fine on their own. So instead of subsidizing yesterday's energy, let's invest in tomorrows."

"Now it's our turn. We know what it takes to compete for the jobs and industries of our time. We need to out-innovate, out-educate, and out-build the rest of the world. We have to make America the best place on Earth to do business. We need to take responsibility for our deficit, and reform our government. That's how our people will prosper. That's how we'll win the future."

"To help businesses sell more products abroad, we set a goal of doubling our exports by 2014 - because the more we export, the more jobs we create at home. Already, our exports are up. Recently, we signed agreements with India and China that will support more than 250,000 jobs in the United States."

"We will put more Americans to work repairing crumbling roads and bridges. We will make sure this is fully paid for, attract private investment, and pick projects based on what's best for the economy, not politicians."

To be honest, it felt like more of the same. Not many new economic policies announced, no new stance with regards to India or China and certainly no ground breaking fiscal reforms to bring the budget deficit under control. As to how he is going to try and change the state of the American educational system, no concrete plans there either. Unfortunately ‘it’s the economy, stupid’ has been replaced by ‘it’s education, stupid’.  In a report out last month the U.S. now ranks 25^th in math, 17^th in science and 14^th in reading out of 34 countries as compiled by the OECD. Without a skilled workforce there will be no sustainable economic growth, perhaps it’s time for a new approach, re-build the economy from the ground up and start with the education system.

So much for the ‘We can’t win the future if we stand still’ – quote. I guess it’s hard to start running when you have become complacent and have been standing still for so long already.

So that was yesterday, today across the street Mr. Ben Bernanke and his open market committee members voted on monetary policy. Guess what, they don’t like change either and decided to leave interest rates on hold (for an extended period of time) and QE2 in place.

Some key points from the statement (full text):

 “The economic recovery is continuing, though at a rate that has been insufficient to bring about a significant improvement in labor market conditions. Growth in household spending picked up late last year, but remains constrained by high unemployment, modest income growth, lower housing wealth, and tight credit.”

“Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. Currently, the unemployment rate is elevated, and measures of underlying inflation are somewhat low, relative to levels that the Committee judges to be consistent, over the longer run, with its dual mandate.”

“In particular, the Committee is maintaining its existing policy of reinvesting principal payments from its securities holdings and intends to purchase $600 billion of longer-term Treasury securities by the end of the second quarter of 2011.”

In other words: anemic economic growth, no job growth and no inflation whatsoever. No inflation, it must be good to be Ben Bernanke and to live in a bubble. At least he let go of his fear of deflation.

The one thing that was different about this statement was the fact that it was a unanimous decision. Where Mr. Hoenig dissented on each and every occasion last year, his successor (Philly Fed president and arch-hawk) Mr. Plosser decided to sit this one out and vote for instead of against Mr. Bernanke. It will be interesting to see if and when he starts voicing his opposing views.

With Obama saying nothing new and Bernanke being stuck in last year’s groove, is there nothing for to the markets to take their cue from you might ask.

Actually there’s an event coming that holds some predictive value and therefore might cause some upheaval in the next week and a half. It’s Super Bowl time. I won’t get into the Super Bowl indicator right now, because I want to devote next week’s blog exclusively to the Super Bowl and the predictive value of the Super Bowl indicator.

The markets today did next to nothing. The Dow Jones hovered around the 12.000 mark all day long, the S&P 500 could not break 1.300 and the Nasdaq flat lined just before lunchtime and could not be revived over the remainder of the session.

Dow 11.985 (+ 0.07%) S&P 500 1.296 (+ 0.42%) Nasdaq 2.739 (+ 0.74%) WTI $87.30 EURUSD 1.3680 Gold $ 1.346

I would like to end my blog with an interesting ‘statistic’ (I say statistic, but these are in fact the lives of real people) tweeted yesterday by Nicole Lapin (CNBC):

‘99ers hit a new milestone- 1.4 million people have been of work for 99 weeks (the limit for unemployment benefits)’

Oh, and the other milestones we're looking at -- 12k on Dow, 1300 on S&P...Thanks, Helicopter Ben - but your job was also, um, JOBS!

Enough said !

Happy Hunting & Let’s Be Careful out there!!!

TBTF January 23, 2011 - Back To Life, Back To Reality

‘Back to life, Back to reality, Back to the here and now, I live on top of the block, No more room for trouble or fuss, Need a change, a positive change look, Look it’s me writing on the wall’ (Soul II Soul – 1989)

It’s been a long time since my last blog, much too long. But I am back, I am back to stay. I will however, change the format. I will blog bi-weekly and do day to day updates via twitter @toobigtoflail and facebook.

So what has happened in the world of finance and geo-politics since the last time I wrote this blog:

China has been dominating the market headlines as of late, lending a helping hand to Europe while tightening their monetary policies because of inflationary pressures. Rates in the United States have gone up even though the FED is monetizing all the debt that the Treasury department issues weekly, Republicans took over the House of Representatives and threatening to NOT raise the debt ceiling. And oh yes, a government in Tunisia has been toppled after social unrest broke out because of ever higher food prices. There is much to talk about, so let’s get started.

Inflation

Inflation in most of the developed world has been subdued. The latest CPI numbers in the U.S. put inflation (including Food & Energy) at a modest 1.5% (YoY) while the CPI in the Euro zone came in at a benign 2.0% (YoY). Nothing to worry about you would say, well in China the CPI came in at 4.5% (YoY) and in Tunisia food prices shot up so high there was a public uprising which eventually chased the President out of the country. Apparently the inflation numbers in the ‘modernized’ world always undershoot the real inflation as experienced by day-to-day purchases. I guess our bureaus of statistics are cleverer in manipulating the facts.

Let’s take a look at agricultural prices (S&P Agricultural Index):

As you can see from this graph, prices advanced by 36%, from Jan 1st 2010 to last Friday, with Wheat +38% YoY and Corn +44% YoY leading the way.

The same can be seen when we look at oil prices +17% YoY and Heating Oil + 20.5%

In countries where people don’t spend most of their disposable on luxury items as IPads, Ferraris or Apartments, but where they barely have enough money to put food on the table or heat their homes (if they are not re-possessed), the impact of skyrocketing food and energy prices are undeniable and cannot magically disappear by tweaking the basket of goods used to measure inflation. And those are the countries where the public uprising appears first, but let’s be clear about it, for a lot of people in the U.S. (and to a lesser degree in Europe) rising food and oil prices do matter, so I wouldn’t be surprised if it is just a matter of time until we see demonstrations in the Western World as well, no amount of statistical manipulation can prevent that.

As of October 2010 43.2 mln people in the US were using the Supplemental Nutrition Assistance Program, also known as Food Stamps. This is up from 37.6 mln a year earlier, an increase of almost 15% which is almost 11% of all Americans. I say that’s a fairly high percentage to say the least.

I can imagine the leadership in China is worried about the food and energy inflation. The social and economic inequality between is so huge between many of their regions (most of the wealth is concentrated in the South East) that even though their per capita income was up 13% in 2010 (2010 data from the IMF and 2009 data from the World Bank, so the 13% might not be completely true, but is probably a good guesstimate) something tells me most Chinese did not get a 13% rise in their paycheck but they were however exposed to sky rocketing food prices, making the economic inequality even bigger. After what happened in Tiananmen Square 21 years ago, I don’t think President Hu Jintao is particularly fond of a public uprising in the Chinese heartland, so he is doing whatever he can to stop the inflation from rising further which means slamming on the economic breaks. In the mean time the FED keeps flooding the world with cheap money to get the U.S. economy back on its feet (or at least stop it from sliding further), which of course works contrary to what the Chinese are trying to achieve.

And this is precisely why Geo-politics is so much fun.

Financial Markets

What do the various financial markets make of all this:

While the U.S. and European markets have been rising on an almost daily basis since the FED hinted at a new quantitative easing program, the Shanghai stock market has been falling ever since China started their monetary tightening campaign, trading down over 10% since the beginning of November.

Shanghai:

S&P:

DAX:

What is really interesting has been the fact that the equity markets kept being strong, while interest rates in the U.S. started to move up during the last month of 2010. Some of the move can be explained by the fear that the now Republican Congress voiced concerns over raising the debt ceiling. The treasury secretary, Mr. Timothy Geithner, had asked congress to vote yes to raising the debt ceiling, as this magical number of $ 14.3 trillion will most likely be reached by April 1st, maybe even sooner. If the ceiling is not raised, the U.S. can do nothing but start to default on its debt, thereby forcing credit agencies to cut their triple-A rating.

Also not helping was the sell-off in municipal bonds when it became clear President Obama would not extend the Build America Bonds program, which was part of the recovery act, in exchange for republican support of an extension of the ‘Bush tax cuts’. Meaning it will be harder for cities and states to raise much needed capital.

U.S. 10 Year Rate:

Europe

Europe is still having problems of its own. In December Ireland was ‘forced’ to accept financial support from the EFSF. My guess is they came begging for money, but to keep up appearances it was decided to have them accept the money reluctantly.

2 down, 4 to go.....

I say 4, since not only Portugal, Spain and Italy are slowly getting into more and more trouble, but Belgium was also suddenly thrown to the wolves. General elections were held more than 7 months ago in Belgium and they are still unable to form a new government. Not very surprisingly, since the party that won the elections is pro the segregation of Flanders from Wallonia (i.e. the Dutch speaking from the French speaking part). For now it proves that a government is not always necessary, since the country still exists, but bondholders are getting more and more restless.

Portugal and Spain were given a new lifeline as China vouched they would keep on buying their debt, as does the ECB on a daily basis. Even with the Chinese guarantee, both Portugal, Spain and the ECB thought it wise to introduce a new way to raise money, a private offering. It’s a simple way to keep alive the Ponzi scheme that is the Mediterranean part of Europe. How does it work?

Spain’s treasury needs 4 billion euro. What can they do? They can auction the debt in a public auction, but then the outside world knows the exact participation rate of direct and indirect bidders, i.e. how eagerly investors want Spanish debt. They can also issue the debt through a private auction, where they call up Santander, Banco Popular and Banco Bilbao Vizcaya, force them to take the entire 4 bln euro issue at a reasonable rate. Why would these banks do this? Because they can turn around, call Jean Claude Trichet, deposit those bonds as collateral and get more liquid instruments in return.

But wait, isn’t this exactly what the FED is doing every single day with their POMO’s? Well yes it is, but here in Europe we don’t call it printing money or monetizing, because our central bank is not allowed to do that.

Long story short, Portugal managed to raise about 2.5 billion euro in their last public offering (at least for the time being), Spain just around 4 billion euro and a sigh of relief was felt throughout Europe. I guess it wasn’t so much the relief that they raised the cash as much as it was the relief of nothing having to endure the global panic that would have ensued if they hadn’t been able to raise a measly 7 billion euro combined.

Well, I guess there is always next time.

That’s all for today, I will write the next blog Wednesday evening and will use twitter and facebook for updates during the week.

Happy Hunting & Let’s Be Careful out there!!!