Just take a look:

In Greece, the latest parliamentary elections ushered in a wave of anti-austerity candidates. They’re threatening to tear up agreements with richer euro-zone members that took several months to negotiate, and that formed the basis of the country’s $307 billion bailout.

German officials are strongly hinting that this could be the straw that breaks the camel’s back — meaning Greece could become the first country to be officially booted out of the euro!

Already, the country’s citizens have been stampeding to their local banks to pull out deposits as fast as possible — nearly 6.4 BILLION dollars in the past several days alone — with snaking lines at ATMs from Athens to Thessaloniki!

And that’s likely just the beginning … because I’ve seen estimates that peg the cost of an all-out Greek exit from the euro at hundreds of billions of dollars — spread throughout the European financial system!

Meanwhile, Greece Is Just the Epicenter of
This Impending Crash in European Banks …

In Spain, the government was just forced to commit ANOTHER $6 billion in bailout money to save one of its major banks from collapse.

There’s just one problem: Spain ITSELF doesn’t have the money to fund these bailouts!

Investors know this, and that’s why they’re dumping Spanish bonds like mad. The cost of financing the government for the next 10 years just surged above 6.3%, rapidly approaching the panic highs set in the fall of 2011. And the cost of Spanish default insurance also just hit an all-time record!

Translation: Even without the ripples from Greece, Spanish banks will probably drop like rocks!

Then there’s Italy, where Moody’s Investors Service just took the axe to its ratings on 26 major banks.

The cuts ranged from one notch to four notches, and in a classic case of understatement, the firm’s outlook on those banks remained “negative.”

If this sad, sorry process looks eerily similar to you, it should …

This is precisely the kind of “snowball rolling downhill” financial crisis we saw in the U.S. during the housing and mortgage crisis of 2007-2009!

That banking and financial crisis ultimately crushed global stock markets, and led to the failure or bailout of banks and brokers around the world.

Many investors lost fortunes.

And make no mistake — I think the same thing is going to happen this time around. In fact, I believe spillover from the European crisis will quickly come rolling back onto our shores, too.

Trade safe until then

Erik

What’s most surprising about the breakdown of Europe is not how swiftly it’s happening, but how complacently US investors and others are responding …

This is what happens when you only
paper over a problem, rather than cure it!

How can this be happening? Didn’t central bankers print trillions of yen, euros, pounds, and dollars in the past couple of years to prevent and “cure” these problems? Weren’t we told repeatedly by both European and U.S. policymakers that the problems in the debt markets were contained?

Yeah, we were.

But hopefully, you’ve learned your lesson from the U.S. mortgage debacle. Some policymakers will outright lie to keep you from selling stocks, bonds, or otherwise taking steps to protect yourself from the fallout of a serious debt crisis. Others are just woefully ignorant of the severity of the underlying problems.

Think I’m off base?

Then look at what former U.S. Treasury Secretary Hank Paulson and Federal Reserve Chairman Ben Bernanke did during the subprime meltdown! They gave speech after speech saying the problem was “contained” and that it wouldn’t have a major impact on the U.S. economy. But you don’t need me to tell you those predictions weren’t just off by a small degree.

They were 100% dead wrong!!

Now we’re getting the same song and dance from Europe. The ESM. EFSF. LTRO. We’ve been told that all of these whiz-bang money printing and bailout programs would prevent a crisis, and that the crisis itself really isn’t that bad.

But try telling that to a Greek investor, who has now lost every single penny of gains he racked up in the last TWENTY YEARS! Here’s the chart of the Athens Stock Exchange General Index. You can see it’s trading around 610, a level last seen in November 1992.

It’s not just the Greek exchange getting hammered though. Spain’s main index is now at its lowest level since March 2009, while markets across Europe are slumping fast.

This just goes to show that when you paper over a crisis, rather than try to solve it directly, you might be able to gain a week, a month, or even a quarter or two of calm. But ultimately, your efforts will prove futile if you don’t get rid of the underlying problems!

Until next time, good trading

Erik

———–

The nearly three-year old crisis appears to be entering a new phase as the respite in global financial markets, which came after the European Central Bank flooded the banking system with cash, has faded.

The focus has once again shifted to politics, long a source of agita for investors, with elections in several key nations set to change the balance of power in the eurozone.

As the economy slides toward recession, there is renewed debate over the wisdom of austerity, which Germany has made a priority, versus policies aimed at boosting growth.

This debate could decide the outcome of elections in France, Greece and now possibly the Netherlands. It could also determine the fate of Portugal, Spain and Italy, which are all struggling to regain credibility in the bond market.

“The emergence of these new coalitions will make crisis management more acrimonious,” wrote Eurasia Group analysts in a note.

Europe: ‘Dark clouds on the horizon’

While policy makers have taken steps to contain the crisis, many of the longer term problems have yet to be resolved.

Meanwhile, the uncertain political and economic outlook is making investors nervous, putting pressure on the ECB to do even more to stabilize the financial markets.

Here are a few things to keep an eye on in the weeks ahead.

Merkozy’s days are numbered

In France, socialist candidate Francois Hollande narrowly defeated incumbent Nicolas Sarkozy in the first round of the nation’s presidential elections last weekend.

Hollande is favored to win the final round of voting on May 6, although the race could be tighter than expected.

France and Germany have been the main players in the response to the crisis to date, so much so that Sarkozy and German Chancellor Angela Merkel have become known as “Merkozy.”

The Merkozy doctrine, such as it is, has been to demand austerity measures from eurozone nations that have requested bailouts from the EU and International Monetary Fund.

The two leaders have also been pushing for more political and economic “integration” as the main proponents of the “fiscal compact” that euro area leaders signed late last year.
5 things to know about the French election – CNN

Hollande, however, has suggested that he would renegotiate the fiscal compact before recommending that France ratify the proposed budget rules and penalties.

He has also called for more growth-oriented policies, suggesting that Hollande could have a complicated relationship with Merkel, who favors spending cuts.

Budget fight breaks Netherlands government

Meanwhile, the Netherlands has emerged as another source of political uncertainty after an impasse over budget cuts caused the nation’s prime minister to resign.

Prime Minister Mark Rutte resigned after far-right party leader Geert Wilders withdrew his support for cuts needed to meet EU budget rules.

It was not immediately clear what will happen next, but Wilders and other Dutch politicians have reportedly called for elections as soon as possible.

The political turmoil raised worries that the Netherlands, one of the few AAA-rated eurozone nations, could have its credit rating downgraded.

Greece is still in bad shape

Amid a shrinking economy and deepening austerity, Greek voters are scheduled to elect a new government on May 6.

Greece has been run by a caretaker government since Prime Minister George Papandreou resigned late last year, under pressure from France and Germany.

Lucas Papademos, the interim prime minister, orchestrated the largest sovereign debt default in history and secured a second €130 billion bailout program during his six months in office.

To qualify for the bailout, Greece was required to enact a raft of austerity measures and agree to a program of structural reforms that will be overseen by the IMF for the next few years.

Greece has already endured years of austerity, which many economists say has worsened the nation’s recession. In addition, Greece’s debt load will still be very high and may require further restructuring even if it completes the reforms under its bailout program.

This suggests that Greece will either be forced out or will decide to abandon the euro currency union later this year, according to Capital Economics.

Domino effect: Portugal, Spain and Italy

After Greece, investors see Portugal as the most likely candidate for another bailout.

Portugal’s borrowing costs shot higher earlier this year amid fears the nation could seek to restructure its debts. Investors were also rattled after Standard & Poor’s downgraded Lisbon’s credit rating to junk in January.

In its most recent review, the IMF said that Portugal was “broadly on track” with the €78 billion bailout program the nation tapped nearly a year ago.

While the Portuguese economy is comparatively small, the nation’s woes have highlighted the challenges facing larger eurozone economies, such as Spain and Italy.

Spain recently disclosed that its 2011 budget deficit was much larger than expected and warned that the government may not meet its fiscal targets for 2012.

Prime Minister Mariano Rajoy, in power since December, has proposed a €27 billion austerity program. But the Spanish economy, which is suffering from high unemployment and problems in the banking sector tied to the real estate market, has slipped back into recession.

While the authorities say Spain can avoid a bailout, yields on Spanish bonds have risen sharply recently as investors fear the nation will require some sort of external support.

Investors are also worried about Italy, the eurozone’s third-largest economy, despite progress made by Prime Minister Mario Monti on labor and other market reforms.

The concern is that if Spain needs to be bailed out, there will not be enough money left over to support Italy in the event that Monti’s reforms fall short.

Monti, who was appointed after Silvio Berlusconi stepped down late last year, has also been pushing back against austerity and emphasizing the need to stimulate growth as Italy’s economy has stagnated for years.

ECB’s options are limited

The ECB stepped up its efforts to prevent a credit crisis late last year when it offered European banks unlimited access to cheap, long-term loans.

In two separate operations, the ECB pumped over €1 trillion into the banking system.

ECB president Mario Draghi has said the goal was to help banks struggling to fund themselves amid concerns about exposure to sovereign debt. But the flood of liquidity also appeared to help drive down borrowing costs for troubled eurozone governments.

As yields move back into the danger zone, investors are again looking to the ECB to save the day.
Investors to ECB: 1 trillion euros is not enough

There is speculation that the ECB could resume limited purchases of government debt under its controversial securities market program.

Some analysts have also suggested that the ECB could move to full-blown quantitative easing, a strategy used by the Federal Reserve, to help boost the economy.

However, such steps would violate the ECB’s mandate, which is to maintain price stability, and the bank has already stepped way out of its comfort zone. In addition, intervening in the bond market raises thorny questions of “moral hazard.”

Instead, Draghi has stressed that governments must push ahead with fiscal consolidation and reforms to increase economic competitiveness.

Compiled source from: Ben Rooney – CNNmoney

Interesting article I read the other day about interest rates and how the money flows towards alternative markets to achieve higher yield on the investment capital.

Foreign-exchange traders, faced with lower volatility and record-low interest rates in the U.S., Europe, the U.K. and Japan, are searching for returns as far afield as Kazakhstan and Nigeria.

Investec Asset Management Ltd., which trades currencies of nations from Colombia to Uganda, said demand for assets in so- called frontier markets increased in the past six months. The Cambridge Strategy (Asset Management) Ltd. invested in the Nigerian naira from December to February. Money manager Adrian Lee & Partners will add positions in six currencies, including Kazakhstan’s tenge and the Kenyan shilling by the end of the second quarter.

Investors are pouring cash into countries rich in commodities or with high growth rates after Europe’s debt crisis prompted them to seek the safety of the dollar and the yen in 2011. Kenya’s shilling is up 29 percent since October from a record low and Chile’s peso has advanced 6.2 percent against the dollar this year. Now, traders risk central-bank action to counter currency appreciation as nations become overwhelmed by a market that dwarfs their economies.

“We have seen an increase in demand and interest in frontier currencies and emerging market currencies versus the majors,” Thanos Papasavvas, head of currency management in London at Investec, which oversees about $88 billion, said in a March 21 phone interview. “It’s not just a search for yield that has led to the increase in demand for these currencies, it’s also about stronger and improving fundamentals and better valuations.”
Colombian Rally

Investec trades the currencies of Chile, Colombia, Kazakhstan, Kenya, Nigeria, Pakistan, Sri Lanka, Uganda, Ukraine, Vietnam and Zambia, Papasavvas said.

Colombia, where mining helped the economy expand 5.9 percent last year and the benchmark interest rate is 5.25 percent, saw its peso strengthen more than 10 percent this year, tied with Poland’s zloty for the most among more than 170 currencies tracked by Bloomberg.

Its government said last month it will keep at least $1 billion of dividends from state-run oil producer Ecopetrol SA abroad to avoid adding to gains in the peso. It doesn’t rule out further steps to curb currency strength, Finance Minister Juan Carlos Echeverry told reporters in Bogota March 20.
‘Destabilizing’ Flows

Countries from Brazil to Switzerland have already taken steps to weaken exchange rates to protect exports and domestic industry. Brazil, Latin America’s largest economy, has sold dollars and broadened taxes on foreign loans and bonds issued outside the nation as part of measures to shield the real from foreign inflows. The Swiss National Bank introduced a cap of 1.20 francs per euro in September to limit its strength.

“Short-term capital flows can be destabilizing and I wouldn’t be surprised to see more countries fight that,” Dale Thomas, head of currency management in London at Insight Investment Management Ltd., which oversees about $267 billion in assets, said in a telephone interview on March 19. “You can get an asset bubble when money flows in and when money flows out it collapses.”

Investment is being channeled into alternative markets as profits from the largest currencies prove harder to come by. Deutsche Bank AG’s gauge of foreign-exchange returns, which includes the most-actively traded currencies, slipped 0.3 percent this year after a 3.8 percent drop in 2011, the worst performance in two decades. The currency-returns index had climbed 47 percent over seven years ended Dec. 30, 2005.
Falling Volatility

The JPMorgan G7 Volatility Index (JPMVXYG7) has tumbled to 10.14 percent from 15.46 percent in September, reducing money managers’ ability to exploit price moves. The 3.5-cent difference between the euro’s high this month of $1.3357 and its low at $1.3004 is the narrowest trading band since July 2007. The shared currency traded at $1.3228 at 11:59 a.m. in New York today.

Optimism that Europe’s debt crisis is stabilizing after the European Central Bank boosted bank liquidity with about 1 trillion euros ($1.3 trillion) of three-year loans and private investors forgave more than 100 billion euros of Greek debt has boosted demand for higher-yielding assets such as stocks. The Stoxx Europe 600 Index (SXXP) has climbed 8.6 percent this year.

Low rates, austerity and stimulus measures in the U.S., the U.K., Europe and Japan — known as the G-4 — have strategists forecasting little change.

The euro will fall to $1.30 by year-end, the median estimate of more than 50 strategists surveyed by Bloomberg shows. The yen will trade at 83 per dollar by year-end from 82.65 today and Britain’s pound will be at $1.57, from $1.5869, separate surveys show.
Emerging-Market Volumes

Futures-trading data from CME Group Inc., the world’s largest futures exchange, shows that volumes in emerging-market currencies jumped 42 percent in 2011 from the prior year, while those in the yen, euro and Swiss franc stagnated.

“There clearly has been more activity in the emerging markets — there are greater opportunities for investors,” said Ed Baker, executive chairman of London-based The Cambridge Strategy, which specializes in emerging-market currencies and equities and has $850 million under management. “No doubt it has been harder with the G-4 to make money,” he said in a March 20 telephone interview.

Baker said his company has profited in Nigeria’s naira and the United Arab Emirates dirham, while Serbia’s dinar was the best-performing currency in 2011 in its $65 million Apollo strategy fund, which had gross returns of 15.9 percent on an annualized basis since it was set up in May 2009.

Trade safe

Erik

Source: Bloomberg – Emma Charlton and Paul Dobson on March 26, 2012

The degree to which central banks around the world are printing money is unprecedented.

The first eight charts below show the balance sheets of the largest central banks in the world. They are the European Central Bank (ECB), the Federal Reserve (Fed), the Bank of Japan (BoJ), the Bank of England (BoE), the Bundesbank (Germany), the Banque de France, the People’s Bank of China (PBoC) and the Swiss National Bank (SNB).  Noted on the charts are significant events or growth rates.

Shown is the size of each respective balance sheet in its local currency.  Note that all are exploding higher as every chart goes from the lower left to the upper right.  Most are still making new all-time highs. If the basic definition of quantitative easing (QE) is a significant increase in a central bank’s balance sheet via increasing banking reserves, then all eight of these central banks are engaged in QE.

Click to enlarge:

˜˜˜

Comparing Central Bank Balance Sheets

For comparison’s sake, we converted the eight balance sheets above into dollar terms.  The four largest, the PBoC, the Fed, the BoJ and the ECB are shown in the first chart below.  The second four, the Bundesbank, Banque de France, the BoE and SNB are shown in the second chart below.   We split them up because of their vastly different scales.

In the first chart, note that the balance sheets of the PBoC and the ECB are larger than the Federal Reserve when converted to dollars.  The BoJ used to be the largest balance sheet in dollar terms until 2006.

When shown in dollar terms below, the Bundesbank is the largest of the “second four” central banks.  Further, its growth rate over the last five years has been among the highest.  This is surprising since the Bundesbank is considered the “hard money” central bank.

Combining Central Bank Balance Sheets

The next chart below adds up the eight largest central bank balance sheets in dollar terms.  It is only current through October as that is the latest number from the PBoC.

The combined size of these eight central banks’ balance sheets has almost tripled in the last six years from $5.42 trillion to more than $15 trillion and is still on the rise!

Central Banks Equal To One-Third Of World Equity Values

As noted above, QE is an expanding of balance sheets via increasing bank reserves.  The purpose of QE, as explained by this Bank of England video,  is to increase bank reserves through purchases of fixed income securities in order to lower interest rates.  This makes fixed income securities relatively unattractive/overvalued and pushes investors out the risk curve.  This should increase buying for riskier assets such as stocks, pushing them higher in price.  Theoretically these higher prices should lead to a wealth effect and increased economic activity.

Given this definition and purpose, it is fair to compare the size of these balance sheets (now $15 trillion) to the capitalization of the world’s stock markets (now $48 trillion).  This is shown in the chart below.

Prior to the 2008 financial crisis, the eight central bank balance sheets were less than 15% the size of world stock markets and falling.  In the immediate aftermath of Lehman Brothers’ failure, these eight central bank balance sheets swelled to 37% the capitalization of the world stock market.  But keep in mind that the late 2008/early 2009 peak was due to collapsing stock market values combined with balance sheet expansion via “lender of last resort” loans.

Recently, the eight central bank balance sheets have spiked back to 33% of world stock market capitalization.  This has come about not by lender of last resort loans, but rather by QE expansion (buying bonds with printed money) even faster than world stock markets are rising.

What Does It All Mean?

2011 was so difficult because all stocks seemingly moved together.  It was as if every S&P 500 company had the same chairman of the board that knew only one strategy, resulting in a high degree of correlation between seemingly unrelated companies.

Massive central bank involvement in the markets risks returning us to a de facto centrally planned economy. Those S&P 500 companies all have the same chairman; it is Ben Bernanke because his policies are affecting everybody. That is what makes money management so difficult. Correlations will ebb and flow; they always do. But what makes them go away? This will only happen when governments and central banks go away.

But if they go away, then does that not mean things get ugly? Maybe they do get ugly, but it also means that we sort out the excesses in the market. We reward the people that do the right thing and we punish the people that do the wrong thing. And we have an adjustment process that may be ugly, but then we have a period of long expansion.

Central banks are ruling markets to a degree this generation has not seen.  Collectively they are printing money to a degree never seen in human history.

So how does this process get reversed?  How do central banks pull back trillions of dollars of money printing without throwing markets into a tailspin?  Frankly, no one knows, least of all central banks as they continue to make new money printing records.

Until a worldwide exit strategy can be articulated and understood, risk markets will rise and fall based on the perceptions and realities of central bank balance sheets.  As long as this is perceived to be a good thing, like perpetually rising home prices were perceived to be a good thing, risk markets will rise.

When/If these central banks go too far, as was eventually the case with home prices, expanding balance sheets will no longer be looked upon in a positive light.  Instead they will be viewed in the same light as CDOs backed by sub-prime mortgages were when home prices were falling.  The heads of these central banks will no longer be put on a pedestal but looked upon as eight Alan Greenspans that caused a financial crisis.

The tipping point between balance sheet expansion being bullish for risk assets versus bearish is impossible to know.  Given the growth rate of central bank balance sheets around the world over the past few years, we might not have to wait too long to find out.  Enjoy it while it is still bullish.

Future will show where the giant ship is heading, stay tuned and trade safe.

Erik

Source: Bianco Research

Investors and pundits hailed it as proof positive that the housing market was finally on the mend … that blue skies and rainbows were here to stay! But what happened next? The index flopped and chopped around for a while … then fell off the table. Ultimate loss through October for anyone who bought the hype? 39 percent!

In late 2010, just a few months before the 2011 spring selling season, it happened again! The HGX rallied from 94 in late November to 121 in late February — a rise of 29 percent.

So did THAT signal a lasting turn for the housing market’s fortunes? Er … no! The index imploded 34 percent shortly thereafter.

And wouldn’t you know it? Investors are at it again!

They’ve been buying housing stocks, construction stocks, home improvement retailers, cabinet and faucet makers, paint companies, and more like they’re going out of style!

Stocks like Valspar (VAL), Sherwin-Williams (SHW), Stanley Black & Decker (SWK), A.O. Smith (AOS), Masco (MAS), Home Depot (HD) are putting even high-momentum Internet companies to shame with their recent gains!

Me? I can’t shake the feeling it’s déjà vu all over again — and that the 2012 version of this annual rite is going to end badly too!

What the latest housing figures do —
and DON’T — show

Why is there so much optimism about these stocks and the housing market in general? I don’t know if it’s the fact it’s 80 degrees in Chicago and New York City. I don’t know if it’s just the innate optimism that prevails on Wall Street, or the happy talk from housing company executives.

But whatever it is, it sure doesn’t seem justified to me. We have undoubtedly seen some improvement from the depths of the 2007-2009 recession. Home sales, home construction activity, and builder optimism have taken a modest turn for the better.

But even with that slight improvement, housing starts remain a whopping 69 percent below their bubble peak! A key measure of home builder optimism is still down 61 percent. Existing home sales? They’re off 37 percent. Home prices? Down 34 percent … STILL!

More recently, we’ve seen mortgage rates shoot higher along with Treasury yields. That couldn’t come at a worse time, considering we’re entering the heart of the home selling season. Is that why the National Association of Home Builders confidence index just registered 28 in March, instead of rising to 30 as expected? Hmmm.

And what about housing starts? They slumped slightly to 698,000 in February instead of rising as expected. Moreover, single-family starts plunged 9.9 percent — the biggest drop in a year!

“Look out below” time for housing sector?
Sure looks like it to me!

Long story short: It’s been a heck of a rally in the housing and construction sector. Some sector stocks are trading at all-time highs. Not 52-week highs, mind you. Highs they didn’t even hit during the peak of the bubble — when home prices were rising at double-digit rates and construction activity was running at the fastest rate in U.S. history!

Does that make sense to you? Because it sure doesn’t to me!

In fact, I believe the combination of that strong rally … the recent rise in interest rates … and the potential for activity to slow going forward will prove toxic to investors. If you own these stocks and have enjoyed the rally, I urge you to sell now.

I would also take gains off the table in other stock market sectors. If the recent housing strength fades, the economy will likely cool, and I don’t believe the broad market is prepared for that.

Until next time and good trading,

Erik

All what is happening so far is extending the pain for the country to default later, with the expense of other countries tax payers hard earn money.

Good trading and trade safe !

Erik

The Greek government, European Central Bank and euro-zone leaders are in meetings with investors who own Greek bonds, trying to shove massive losses down their throats.

Unsurprisingly, the private bondholders — mostly other governments, banks and hedge funds — are fighting any “haircut” tooth and nail.

At this point, only one of two things can happen:

They could announce that they have come to an agreement …

OR, they could announce that they have failed to reach an agreement — in which case, the Greek government will be forced to default on its debt.

Which way will it go? Nobody knows for sure, of course. I’m guessing that the bondholders will ultimately relent and a deal will be reached.

But here’s the thing: The announcement could come at any moment. It may have already happened before you see this post!

And when it does, it will almost surely hit stocks like a ton of bricks: If last year is any guide, a deal could send stocks screaming higher. On the other hand, if there is no deal, stocks could plunge.

But agreement or no agreement, this situation perfectly highlights the #1 question you need to answer in the year ahead …

How do you invest in a crazy world like this one?

The great news is, there is a way for prudent, safety-conscious investors to grow wealth consistently today.

I will touch base later on with more info’s until then for now

Good trading

Erik

Most everyone thinks they know where China is headed — that is, toward world domination thanks to having the most-vibrant large economy in the world.

Of course, whenever we project from the recent past, we usually end up disappointed. And for many, their expectations for China will be no exception.

There are many obstacles along the way before China rules the economic world, and one of them is what we have dubbed “The Japanese Parallel.” This would be a game-changer, one with major implications for all global asset markets, especially currencies.

The credit crunch that happened circa 2008 took a big bite out of the U.S. consumer and has drained a lot of dollar credit out of the global system. In the aftermath, the Chinese government stepped up in a big way — replacing U.S. consumer demand with direct stimulus, to the tune of approximately half the size of the country’s GDP, in an effort to keep the music playing.

The song should be a familiar one because, interestingly, we saw a similar scenario play out before in the global economy. China’s future is on a seemingly eerie parallel with Japan’s global macroeconomic history.

The Parallel in Play

During the 1980s, it appeared Japan — as the “Creditor Superpower” — was going to gobble up the world with its powerful export machine and massive current account surpluses rolling in.

Then a little thing called the U.S. stock market crash in 1987 changed the game.

Dollar credit flowed from the global system, triggering an improvement in the U.S. current account balance (see the top-left gold box in the chart below) that was followed by a U.S. recession. This came as the Japanese yen was appreciating in value, thanks to the G-7 Plaza Accord to pressure the yen higher because of all those Japanese exports.

Source: Black Swan Capital

Here’s a brief history on what happened to Japan:

1. Japan’s very hot stock market broke in 1989.
2. Then its extremely overpriced real-estate bubble started its collapse. (Remember when the Imperial Palace in Tokyo was worth more than the entire state of California?)
3. Japanese authorities did all they could in the form of stimulus to try to keep air in the bubble. They …
1. Pumped more money into the stock and property markets in order to revive the wealth effect for domestic consumers.
2. Subsidized export companies to keep exports flowing (but the world’s major consumer — the U.S. economy — was entering recession and therefore wasn’t there to buy).
3. Lowered interest rates to zero.
4. Continued massive fiscal stimulus by building infrastructure across the country.

But, it didn’t work.

The massive dislocations were caused by the artificial channeling of credit within the Japanese economy in order to focus almost entirely on building a global export machine.

In turn, these dislocations created the malinvestment that has taken years to work off, precisely because the Japanese economy was so imbalanced when it came to production versus consumption.

Attempts to change this model were scant at best; instead, they kept morbid companies alive and forced consumers to save money, thanks to artificially low interest rates.

7 Reasons Why the China Story
Might Not Have a Happy Ending

Fast-forward to China today … and you can witness the parallels …

Instead of the U.S. stock market crash being the triggering event, we have the credit crunch in its place — arguably a much-bigger and more-powerful global event.

Secondly, global leverage — i.e., debt in the system — was massively larger in 2007 than it was in 1987. (In other words, the world was hooked on massive dollar-based credit spewed out by the trillions of dollars in derivatives production.)

Mr. U.S. consumer has pulled in his horns much more quickly and to a greater degree than he did back in 1987. This takes much more global demand for goods out of the market — demand that China was and still is so highly addicted to.

And interestingly, now we also have the Chinese currency starting to rise in value, albeit at a much-slower pace than the Japanese yen did in the 1980s.

So what has China done to overcome this sea change in the global economy that’s evidenced by the improvement in the U.S. current account? The country has done many of the same things Japan has done, and we are seeing a replay of events to a degree.

Here’s where those parallels really come into play:

1) China’s very hot stock market topped out in October 2007 and is now 59 percent off its old high. (That is a major drag on the so-called “wealth effect.”) The Chinese government owns or controls most of the stocks on its exchange and, yet, it has been unable to keep them pumped up.

2) China’s real estate prices have started falling and the “bubbly conditions” are becoming quite apparent to all. But now, with tightening credit in China, the bubble is in jeopardy. As a recent Financial Times article reported:

“The number of property transactions in China’s largest cities has fallen to dangerously low levels, according to regulatory documents obtained by the Financial Times.

“According to the documents, the China Banking Regulatory Commission earlier this year ordered domestic banks to weigh the impact of a 30% decline in housing transactions in ‘stress tests’ aimed at determining the health of the Chinese financial system.”

3) China’s real estate market, especially on the commercial side, is extremely overbuilt. A massive amount of speculative credit has poured in that could come rushing out; already there are signs that the hot money is running from China.

Interesting point here: Despite Western pressure on China’s currency policy, country leaders have made it clear there will not be any type of one-time ramp-up revaluations; this adds to the momentum of hot money (that had poured into China) to leave.

Part of that hot money was specifically positioned in real assets to benefit from such a large one-off revaluation.

4) The country pumped more money into the stock and property markets in order to revive the wealth effect for domestic consumers. It hasn’t worked, just as it didn’t in Japan.

And just as Japan found out, there is no fallback to local demand if international demand disappears for their exports. This is already in play.

5) They subsidized export companies to keep exports flowing. (But the world’s major consumer is taking the goods to the degree that it did before the credit crunch.)

China has managed to push some of the pain of domestic adjustment off its trade partners thus far. But if the U.S. consumer does not materialize, trade frictions will grow for China — not just in the West, but also from its Asian-bloc competitors. This is already in play as well.

6) China’s interest rates are not at zero, but they are extremely low for a country supposedly growing as fast as it has. This low interest rate policy is similar to what Japan did. This leads to forced savings and smothers local consumer demand at a time when domestic consumption is most needed.

7) They continued massive fiscal stimulus by building infrastructure across the country. China’s infrastructure development is legendary. It has led to extreme overcapacity across many sectors.

If global demand is not there to take the final goods all this capacity can produce, then much of that capital will be wasted (i.e., malinvestment). This is what happens when a government determines investment policy instead of letting the market do its job.

Officially, China sports quite a low debt-to-GDP ratio. But if you consider that Chinese banks are effectively government conduits, some have estimated debt-to-GDP in China is somewhere between 70 percent and 80 percent.

Could China Get Hit
Harder Than Japan?

The credit crunch is the market’s way of starting to rebalance a very imbalanced global world that has at the heart of it:

• A flawed world reserve currency system;
• Inordinate demand and depth of capital markets concentrated in one place (i.e., the United States); and
• A beggar-thy-neighbor — by which the country attempts to help itself by using measures that negatively impact other countries — export policy (Asia), leading to massively suppressed relative currency values.

This potential global macro replay shows that policymakers have either learned little, or are unwilling to do the heavy lifting, when it comes to real global monetary reform.

If the Chinese economy plays out like Japan’s did when its credit bubble burst, the implications for the global economy would be dire, as we are still in the midst of massive private deleveraging. This is already overwhelming the public debt being poured into the system, and it has created the nasty byproduct of shaky sovereign credits across all Western nations.

So, we continue to watch as China ticks off the historical markets that crushed Japan’s growth and economic leadership. And we hope that the part about history repeating in another form is wrong. Otherwise, it could be even uglier this time around.

Good trading

Erik

Ps. Source: Jack Cook – Senior Currency investor and market analyst

Even if you’re not interested in investments or finance … and no matter where in the world you may live, this news will in fact change your life, one way or the other. It marks the end of government bailouts and the beginning of a new Great Depression – not only in Europe but also in America …Read below…

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German Chancellor Angela Merkel again ruled out joint euro-area borrowing and an expanded role for the European Central Bank in fighting the debt crisis.

Euro bonds are “not needed and not appropriate,” Merkel said today at a press conference with Italian Prime Minister Mario Monti and French President Nicolas Sarkozy in Strasbourg, France. She said euro bonds would “level the difference” in euro-region interest rates. “It would be a completely wrong signal to ignore those diverging interest rates because they’re an indicator of where work still needs to be done.”

Merkel, the leader of Europe’s biggest economy, has so far backed a focus on debt reduction and closer economic coordination, calling for a revision of European Union treaties, a move that threatens to bog down in a multiyear negotiation, as core euro economies risk succumbing to the contagion that began in Greece in 2009.

German analysts, newspaper editorials and opposition politicians stepped up calls for Merkel to shift from an incremental approach after the government sold a fraction of the bonds it auctioned yesterday.

“As the crisis deepens with yesterday’s bond auction, the veil has been torn off Merkel’s policy of muddling through,” Sebastian Dullien, a senior fellow at the European Council on Foreign Relations in Berlin, said in a telephone interview. “It’s only got us closer to the end-game, either the breakup of the euro or euro bonds. The strategy has failed.”

Losing ‘Sex-Appeal’

“The flop shows that bunds are losing their sex-appeal as an extremely secure investment,” Germany’s Handelsblatt business newspaper said in a commentary today. “This shows the crisis has reached the entire euro-zone core. France, Finland, the Netherlands and Austria have to pay more interest for their bonds than just a few months ago.”

German bunds fell a second day. The 10-year bund yield rose as much as 12 basis points, or 0.12 percentage point, to 2.26 percent, the highest since Oct. 28, and was at 2.19 percent at 12:55 p.m. London time. Bids at yesterday’s auction of 10-year securities amounted to 3.889 billion euros ($5.2 billion), out of a maximum target for the sale of 6 billion euros.

Handelsblatt said the shortfall was a “wake-up call” for Merkel’s government, which opposes both issuing bonds for the entire 17-member euro region and allowing the ECB to buy unlimited amounts of euro-nation bonds.

Germany Rejects

The German government stood by its rejection of any common bonds for the euro bloc following a report in Bild newspaper that Merkel’s coalition is concerned it may have to agree to euro bonds under certain conditions. The newspaper didn’t say where it got the information.

“We say ‘no’ to euro bonds,” Economy Minister Philipp Roesler, who is also vice chancellor, said today in parliament in Berlin. “A transfer union would be wrong because it would mean German taxpayers pick up the costs. Euro bonds are wrong because they would mean a rise in interest rates for Germany.”

That contrasted with Handelsblatt’s view. “The ECB remains the only investor that can keep down the interest rates of bonds from euro states in the short-term,” Handelsblatt said. “In the long-term, there’s no getting around the necessity of creating fiscal union with at least partial euro bonds.”

The Frankfurter Allgemeine Zeitung newspaper said that while the low demand for German bunds was “no reason to panic” it shows that “around 2 percent interest for investors in these uncertain times is simply not enough.”

‘Moment of Truth’

“Pressure is growing on Merkel,” said Die Welt newspaper. “Up until now she managed to steer the nation through the crisis so that the people didn’t really notice the turbulence.”

Merkel now faces a “moment of truth” in the crisis as her opposition to ECB bond purchases and euro bonds “is being challenged,” Die Welt said.

German opposition parties ratcheted up calls for euro bonds. Frank-Walter Steinmeier, parliamentary leader of the Social Democratic Party in parliament, said on Nov. 21 that his party wants euro bonds as part of a solution to the crisis.

“A model using euro bonds that links European bonds to a reform program is the better alternative,” Juergen Trittin, a co-leader of the opposition Greens party, said in an N24 television interview today.

In Paris, the French government underlined calls for giving the ECB a bigger role in fighting the crisis.

“What’s not working is confidence and that’s what we must restore,” French Foreign Minister Alain Juppe said today in an interview on France Inter radio. “I hope that reflection will move forward that the ECB should have an essential role to restore confidence.”

Have a Good & Safe Trading

Erik

Main Input Source: Bloomberg, Tony Czuczka