Recommended links

1. Rogoff: 80% chance that Greece will leave the euro (Bloomberg)

2. More Greece love from Sarkozy: Greece should have been denied euro (BBC)

3. Nominal GDP targeting is unlikely to work (INET)

4. World power swings back to America (Telegraph)

5. Hugh Hendry at LSE Alternative Investment Conference (Greshman's Law). My writeup on Hugh's Jan. 2011 interview at the AIC can be found here. Hugh has agreed to come back to the 2012 AIC conference, which I look forward to attending.

6. Portugal enters the 'Grecian vortex' (Telegraph). AEP has been on a roll lately.

7. Italian 10-Year Yield Tops 6% in Auction, Setting Record (CNBC)

Photo of the Day: Angela Merkel Sizes Up the Eurozone Bailout

(click to enlarge)

h/t Barry

Video: Niall Ferguson Says Financial Repression Preventing Full-Scale Italian Bank Run

Niall's latest comments on the Eurozone crisis after the jump:

The Italian Job: An 'Explosion in Slow Motion'

While much of the damage control attention in the rapidly escalating Italian crisis has fallen on the ECB's purchases of Italian debt, German Profressor Hans-Werner Sinn points out how the Bundesbank (and other European central banks) have been conscripted into lending a neighborly hand:

The ECB directed the central banks of all Eurozone members to buy huge quantities of Italian government bonds during the crisis. While the national central banks have not revealed how much they bought, the aggregate stock of all government bonds purchased rose from €74 billion ($102 billion) on August 4, to €165 billion this month. Most of this increase was probably used to purchase Italian government bonds. 

The German Bundesbank, which was forced to buy most of the bonds, strongly opposed the program, but was unable to stop it. In response, ECB Chief Economist Jürgen Stark resigned. He followed Bundesbank President Axel Weber, who had resigned in February because of the earlier bond repurchases. Meanwhile, the new Bundesbank president, Jens Weidmann, openly objects to the program, while German President Christian Wulff has publicly accused the ECB of circumventing the Maastricht Treaty.

Not to be outdone the Banca d’Italia has started printing money:

But the bond purchases are just the tip of the iceberg. Equally important, but largely unknown, is the fact that the Banca d’Italia has resorted to the printing press to cover Italy’s gigantic balance of payments deficit. The extra money printing and lending, as measured by the so-called Target deficit, effectively means drawing a credit from the ECB. 

This credit replaces the private capital imports that had hitherto financed the country’s net purchases of foreign goods, but which dried up because of the crisis, and it finances a capital flight, i.e. the purchase of foreign assets. The ECB in turn draws the Target credit from the respective national central bank to which the money is flowing and which therefore has to accept a reduction in its scope for issuing refinancing credit. 

Until July, only Greece, Ireland, Portugal, and Spain had drawn Target credit, for a combined total of €330 billion. Italy was stable and did not seem to need the printing press to solve its financial problems. No longer. 

In August alone, Italy’s central bank drew €40 billion in Target credit, and it probably drew roughly another €50 billion in September, when the Bundesbank’s Target loans to the ECB system increased by €59 billion (after a €47-billion hike in August). This is the highest Target loan ever drawn from the Bundesbank in a single month, and in all likelihood it went primarily to Italy.

Full commentary here. 

Recommended links

1. Is there a shadowy plot behind gold? (FT)

2. Ray Dalio video interview (Charlie Rose). Ray doesn't have the most compelling television presence, but as the world's largest hedge fund manager he's clearly doing something right. Here is an interesting earlier read from the New Yorker on him and his firm, Bridgewater.

3. Eurozone summit - despair and backbiting in the corridors of power (Telegraph)

4. Steve Jobs Was Willing To 'Rip Off' Everyone Else... But Was Pissed About Android Copying iPhone? (TechDirt)

5. Michael Pettis Talks China (Infectious Greed)

6. €1.5bn Dexia loans used to buy shares in...Dexia (FT)

7. Generation X Doesn’t Want to Hear It (Emptypage)

Graphic: European Sovereign Debt Crisis - It's All Connected

This is a BIG graphic. The original NY Times version, which is easier to view, can be found here, with the interactive version here.

(click to enlarge)

What If We Paid Off The Debt? The Secret U.S. Government 'Life After Debt' Report

This secret report was obtained through a Freedom-of-Information request by NPR:

The copy of Life After Debt we obtained reads "PRELIMINARY AND CLOSE HOLD OFFICIAL USE ONLY." 

The report was intended to be included in the official "Economic Report of the President" — the final one of the Clinton administration. But in the end, people above Jason Seligman decided it was too speculative, too politically sensitive. So it was never published.

Here's more:

The report is called "Life After Debt". It was written in the year 2000, when the U.S. was running a budget surplus, taking in more than it was spending every year. Economists were projecting that the entire national debt could be paid off by 2012. 

This was seen in many ways as good thing. But it also posed risks. If the U.S. paid off its debt there would be no more U.S. Treasury bonds in the world. 

"It was a huge issue.. for not just the U.S. economy, but the global economy," says Diane Lim Rogers, an economist in the Clinton administration.

The U.S. borrows money by selling bonds. So the end of debt would mean the end of Treasury bonds. 

But the U.S. has been issuing bonds for so long, and the bonds are seen as so safe, that much of the world has come to depend on them. The U.S. Treasury bond is a pillar of the global economy.

Banks buy hundreds of billions of dollars' worth, because they're a safe place to park money. 

Mortgage rates are tied to the interest rate on U.S. treasury bonds. 

The Federal Reserve — our central bank — buys and sells Treasury bonds all the time, in an effort to keep the economy on track. 

If Treasury bonds disappeared, would the world unravel? Would it adjust somehow?
"I probably thought about this piece easily 16 hours a day, and it took me a long time to even start writing it," says Jason Seligman, the economist who wrote most of the report.
It was a strange, science-fictiony question. 

Full story and audio clip here.

h/t Barry.

What is Money? (or How is Money Created?)

I just did a Google search on 'what is money?' and 'how is money created?', and many of the top results are probably confusing for someone looking for a simple explanation of the broader concept of money.

(Note: this post is not about physical cash or coin, which I trust most people correctly understand to be minted by the government. It is instead about a more complete measure of money in all its physical and non-physical forms: cash, coin, demand deposits, savings, etc.)

Courtesy of Dan Hind here's a simply explanation of how money is created:

Banks create money through the act of lending it. They don't have to limit themselves to lending out the money deposited with them. In fact, they can end up lending huge multiples of the money they hold in reserve. 

When they authorise a loan or extend credit in the form of an overdraft, the money is conjured out of nowhere.

So there you have it. Banks create the vast majority of the money supply out of thin air (electronic bits these days) when they make loans. Simple, right? Here's Dan again:

The economist and ironist JK Galbraith once wrote that "the process by which banks create money is so simple that the mind is repelled. When something so important is involved, a deeper mystery seems only decent". Offered the unadorned truth, stripped of any technocratic flim-flam, we can scarcely believe it. It seems preposterous that money should have such humble origins, as though it is beneath money's dignity that it should begin life at a banker's keystroke.  

The truth about money creation is a bit like the end of The Wonderful Wizard of Oz, when it turns out that there is no all-knowing wizard, only an old man behind a curtain, making things up as he goes along.

A perhaps more interesting question is why the subject of how money is created is not taught in secondary school? The reason can't be that it's too complicated. But as one of the commenters on Dan's article notes:

 "it is truly preposterous how little the public knows about arguably the single most influential conception humanity has ever created."

Education Site: Educate yourself on various aspects of the financial industry with classes from accredited online colleges.

Video: Nassim Taleb On Occupy Wall Street

Video after the jump:

Ever Heard of Somaliland, the Peaceful and Democratic Neighbor of Somalia?

Somaliland's flag

Contrary to the piracy and kidnappings which the media tends to focus on positive things are happening in parts of the Horn of Africa.

Somaliland is one such example. President Ahmed Mohamoud Silyano describes his people's quest for international recognition here.

Here's the BBC's profile of Somaliland.

Though not internationally recognised, Somaliland has a working political system, government institutions, a police force and its own currency. The territory has lobbied hard to win support for its claim to be a sovereign state. 

The former British protectorate has also escaped much of the chaos and violence that plague Somalia, although attacks on Western aid workers in 2003 raised fears that Islamic militants in the territory were targeting foreigners. 

Although there is a thriving private business sector, poverty and unemployment are widespread. The economy is highly dependent on money sent home by members of the diaspora. Duties from Berbera, a port used by landlocked Ethiopia, and livestock exports are important sources of revenue.

Information about traveling in Somaliland, including guidance on safety, can be read about here.

Links to Chapters in Michael Lewis' New Book 'Boomerang'

Besides a new preface, which Zerohedge has done a nice job highlighting here, Michael Lewis' new book Boomerang is a collection of his previously written stories about the financial problems of various European countries and one U.S. state (California).

Below are links to each of those stories in the order of their publication. They're all worthwhile and still very relevant.

 1. Wall St. on the Tundra (Iceland)

2. Beware of Greeks Bearing Bonds (Greece)

3. When Irish Eyes Are Crying (Ireland)

4. It’s the Economy, Dummkopf! (Germany)

5. California and Bust (California)

Video: Kyle Bass on the Worldwide Problem of Too Much Debt

Link to Kyle's video presentation here.

Kyle, btw, is the protagonist in Michael Lewis' latest book, Boomerang. Zerohedge has posted some of the highlights about Kyle from the book here. 

Interactive Global Debt Clock

Courtesy of The Economist

The clock is ticking. Every second, it seems, someone in the world takes on more debt. The idea of a debt clock for an individual nation is familiar to anyone who has been to Times Square in New York, where the American public shortfall is revealed. Our clock shows the global figure for all (or almost all) government debts in dollar terms. 

Does it matter? After all, world governments owe the money to their own citizens, not to the Martians. But the rising total is important for two reasons. First, when debt rises faster than economic output (as it has been doing in recent years), higher government debt implies more state interference in the economy and higher taxes in the future. Second, debt must be rolled over at regular intervals. This creates a recurring popularity test for individual governments, rather as reality TV show contestants face a public phone vote every week. Fail that vote, as the Greek government did in early 2010, and the country can be plunged into imminent crisis. So the higher the global government debt total, the greater the risk of fiscal crisis, and the bigger the economic impact such crises will have.

h/t zerohedge

Video: Jim Chanos - China Real Estate Meltdown in the Early Innings

Video after the jump:

No, No, No: Erin Burnett, the Government Bank Bailouts Were Not 'Profitable'

Oh boy.

On location at Occupy Wall Street, CNN's Erin Burnett is perpetuating the myth that government bailouts for banks were profitable for taxpayers.

Here, here, here and here are my previous posts about why this is not true.

In short, it's misleading to claim that the bank, or Wall Street, portion of the government bailouts (called TARP) is profitable without referencing the trillions in other bailouts provided by the Fed, the ongoing support for Fannie Mae and Freddie Mac (which could cost taxpayers trillions), and other taxpayer support which directly and indirectly bailed out Wall Street beyond just TARP. The reason is that the recipients of the government bailouts are intricately connected. Wall Street had (still has?) vast real estate holdings, so the support provided to Fannie/Freddie and the Fed's purchase or mortgage backed securities were second and third bailouts, respectively, for Wall Street on top of TARP.

Erin, it is fallacious to promote a myopic view that the government got its money back and then some on the TARP tranche of the government bailouts.  You need to also look at where taxpayers have not yet received their money back (Fannie/Freddie) or are still exposed (Fed's nearly $3 trillion balance sheet). To do otherwise is to engage in an incomplete, inaccurate and deceptive accounting of the bailouts.

For those interested in more detail line-by-line accounting of the various government bailouts can be viewed here.

Video: Pimco's El-Erian Explains Financial Repression

Default Myth Busting: Sorry Simon and James, the U.S. is not a Default Virgin

Professor Simon Johnson and James Kwak of The Baseline Scenario have an article at Vanity Fair about the geopolitical importance of credit in late-18th century France, Great Britain, and (especially) the United States. Their article, however, fails to mention an important detail which also happens to contradict their claim that "the (U.S.) federal government would always honor its debt".

The consolidation/conversion of U.S. revolutionary state debt into federal debt, which took place in the early 1790s, and which the authors refer to in the paragraph prior to the above quote, represented a U.S. sovereign default. (For more on this event see Reinhart and Rogoff (click on the U.S. tab) or Sylla, et al, which describes the 'haircut' bondholders received (6% to 4%).)

The notion that the U.S. has never defaulted has unfortunately been repeated often enough that, like the incorrect claim that TARP was "profitable", otherwise well-informed people have come to believe it.

In terms of other U.S. defaults, Reinhart and Rogoff also count Franklin Roosevelt's 1933 prohibition on owning gold and the subsequent devaluation of the U.S. dollar vs. gold as a default.

It's not very surprising to see Vice President Biden promoting the myth that the U.S. has never defaulted (in his case following a visit to the U.S.'s largest creditor, China). Professor Johnson, however, should know better.

Bloomberg Article on Where to Hide Your Gold

Apparently four feet underground will defeat most metal detectors:

The notion of keeping one’s gold in a safety deposit box—inside the banks many gold aficionados find so untrustworthy—is anathema to many gold bugs. Venzke, who predicts "runaway inflation" and a crisis leading to a "new form of currency within this decade," worries that the boxes won't be accessible if banks shut down in a crisis. "How are you supposed to get your stuff out of there?" he asks. 

Metal detectors are a big worry. Basic detectors can find metal on the surface or in the first 12 inches to 14 inches below ground, depending on soil conditions, says Louis Mahnken Jr., a sales representative for Kellyco Metal Detectors in Winter Springs, Fla. That’s why Venzke advises burying it at least four feet deep. There are online debates about the best way to frustrate such thieves, including using scrap metal as decoys or hiding metal by covering it underground with asbestos or mirrors.

Full article here. 

Video: Michael Lewis on the New Third World

Video: Steve Jobs 2005 Commencement Address at Stanford

Video: Keynes on Britain's Departure from the Gold Standard

Steve Jobs RIP (1955-2011)

The King of the BHAG is dead.

Steve Jobs (1955-2011)

Official statement from the Apple Board:

We are deeply saddened to announce that Steve Jobs passed away today. 

Steve’s brilliance, passion and energy were the source of countless innovations that enrich and improve all of our lives. The world is immeasurably better because of Steve. 

His greatest love was for his wife, Laurene, and his family. Our hearts go out to them and to all who were touched by his extraordinary gifts.

For more reflections on Jobs recent resignation as CEO and some rare, early interview footage of the Apple co-founder see End of a Tech Era.

Michael Lewis on Bankrupt California

It's Michael Lewis week here at the PolyCapitalist.

His latest in a series of financial disaster pieces he's been penning for Vanity Fair is about his home state of California. The whole article is a must-read (here's a link to the full article) but below are a some of the highlights:

But when you look below the surface, he adds, the system is actually very good at giving Californians what they want. “What all the polls show,” says Paul, “is that people want services and not to pay for them. And that’s exactly what they have now got.” As much as they claimed to despise their government, the citizens of California shared its defining trait: a need for debt. The average Californian, in 2011, had debts of $78,000 against an income of $43,000. The behavior was unsustainable, but, in its way, for the people, it works brilliantly.

On the fiscal nightmare that is the City of San Jose...

The ex-Governator

The relationship between the people and their money in California is such that you can pluck almost any city at random and enter a crisis. San Jose has the highest per capita income of any city in the United States, after New York. It has the highest credit rating of any city in California with a population over 250,000. It is one of the few cities in America with a triple-A rating from Moody’s and Standard & Poor’s, but only because its bondholders have the power to compel the city to levy a tax on property owners to pay off the bonds. The city itself is not all that far from being bankrupt. 

By 2014, Reed had calculated, a city of a million people, the 10th-largest city in the United States, would be serviced by 1,600 public workers. “There is no way to run a city with that level of staffing,” he said. “You start to ask: What is a city? Why do we bother to live together? But that’s just the start.” The problem was going to grow worse until, as he put it, “you get to one.” A single employee to service the entire city, presumably with a focus on paying pensions. “I don’t know how far out you have to go until you get to one,” said Reed, “but it isn’t all that far.” At that point, if not before, the city would be nothing more than a vehicle to pay the retirement costs of its former workers. The only clear solution was if former city workers up and died, soon. But former city workers were, blessedly, living longer than ever. 

This wasn’t a hypothetical scary situation, said Reed. “It’s a mathematical inevitability.” In spirit it reminded me of Bernard Madoff’s investment business. Anyone who looked at Madoff’s returns and understood them could see he was running a Ponzi scheme; only one person who had understood them both­ered to blow the whistle, and no one listened to him. (See No One Would Listen: A True Financial Thriller, by Harry Markopolos.) 

“How on earth did this happen?” I ask him. 

“I think we’ve suffered from a series of mass delusions,” he says. 

I didn’t completely understand what he meant, and said so. 

“We’re all going to be rich,” he says. “We’re all going to live forever. All the forces in the state are lined up to preserve the status quo. To preserve the delusion. And here—this place—is where the reality hits.” 

...and the bankrupt hell that is the City of Vallejo:

On the way back to the elevators I chat with two of Mayor Reed’s aides. He’d mentioned to me that, as bad as they might think they have it in San Jose, a lot of other American cities have it worse. “I count my blessings when I talk to the mayors of other cities,” he’d said. 

“Which city do you pity most?” I ask just before the elevator doors close.

They laugh and in unison say, “Vallejo!” 

I notice on his shelf a copy of Fortune magazine, with Meredith Whitney on the cover. And as he talked about the bankrupting of Vallejo, I realized that I had heard this story before, or a private-sector version of it. The people who had power in the society, and were charged with saving it from itself, had instead bled the society to death. The problem with police officers and firefighters isn’t a public-sector problem; it isn’t a problem with government; it’s a problem with the entire society. It’s what happened on Wall Street in the run-up to the subprime crisis. It’s a problem of people taking what they can, just because they can, without regard to the larger social consequences. It’s not just a coincidence that the debts of cities and states spun out of control at the same time as the debts of individual Americans. Alone in a dark room with a pile of money, Americans knew exactly what they wanted to do, from the top of the society to the bottom. They’d been conditioned to grab as much as they could, without thinking about the long-term consequences. Afterward, the people on Wall Street would privately bemoan the low morals of the American people who walked away from their subprime loans, and the American people would express outrage at the Wall Street people who paid themselves a fortune to design the bad loans. 

The evolutionary explanation underpinning society's collective behavior:

The road out of Vallejo passes directly through the office of Dr. Peter Whybrow, a British neuroscientist at U.C.L.A. with a theory about American life. He thinks the dysfunction in America’s society is a by-product of America’s success. In academic papers and a popular book, American Mania, Whybrow argues, in effect, that human beings are neurologically ill-designed to be modern Americans. The human brain evolved over hundreds of thousands of years in an environment defined by scarcity. It was not designed, at least originally, for an environment of extreme abundance. “Human beings are wandering around with brains that are fabulously limited,” he says cheerfully. “We’ve got the core of the average lizard.” Wrapped around this reptilian core, he explains, is a mammalian layer (associated with maternal concern and social interaction), and around that is wrapped a third layer, which enables feats of memory and the capacity for abstract thought. “The only problem,” he says, “is our passions are still driven by the lizard core. We are set up to acquire as much as we can of things we perceive as scarce, particularly sex, safety, and food.” Even a person on a diet who sensibly avoids coming face-to-face with a piece of chocolate cake will find it hard to control himself if the chocolate cake somehow finds him. Every pastry chef in America understands this, and now neuroscience does, too. “When faced with abundance, the brain’s ancient reward pathways are difficult to suppress,” says Whybrow. “In that moment the value of eating the chocolate cake exceeds the value of the diet. We cannot think down the road when we are faced with the chocolate cake.”

Lewis concludes on an optimistic note:

When people pile up debts they will find difficult and perhaps even impossible to repay, they are saying several things at once. They are obviously saying that they want more than they can immediately afford. They are saying, less obviously, that their pres­ent wants are so important that, to satisfy them, it is worth some future difficulty. But in making that bargain they are implying that, when the future difficulty arrives, they’ll figure it out. They don’t always do that. But you can never rule out the possibility that they will. As idiotic as optimism can sometimes seem, it has a weird habit of paying off.

For more Michael Lewis, both past and present, simply click on the tag with his name at the bottom of this post.

Video: Micheal Lewis on Charlie Rose Discussing the Sovereign Debt Crisis

In addition to sovereign debt Michael covers the movie Moneyball, the ongoing Wall St. Occupation, and discusses his style of writing.

A link to the video interview is here.

Also, here is a roundup of the latest reviews of his new book, Boomerang, about the sovereign debt crisis. 

Video: Niall Ferguson on the Likelihood of a China Hard Landing

Video after the break.

"Dexia Has a Problem of Liquidity, Not Solvency"

In a move eerily reminiscent of 2008 Belgium and France have agreed to bailout Dexia, with a French official apparently claiming that Dexia "has a problem of liquidity, not solvency".

Ok, so it looks like Bear Stearns would have made for a better metaphor than Lehman.

But now that it's been decided to backstop the Brussels-based megabank (again) Belgium's caretaker government might have to explain in the not too distant future whether the country itself is having a liquidity or solvency problem. Per the below chart Dexia's assets are almost 200% of Belgian GDP.

(click to enlarge)

(Note: the above chart from ZeroHedge does not appear to include France's GDP in the calculation of Dexia's ratio, just Belgium's. However, it does give a sense of just how big Dexia is relative to the size of Belgium's economy, along with other large banks in Europe.)

As Predicted U.S.-China Economic War Heating Up

Another prediction which is coming in right on schedule: this Presidential political season the one thing Republicans and Democrats can agree upon (the generally conservative Senate voted 79-19) is that China is manipulating the value of its currency to make its exports more price competitive.

We're still in the early rounds of the latest Congressional flare-up over China's currency policy, so stay tuned.

Review Roundup for Michael Lewis' New Book - Boomerang: Travels in the New Third World

Below are a list of reviews published so far. And here are links to all the chapters in the book, which were previously published in Vanity Fair (except the book's preface on Kyle Bass).

NY Times

Telegraph

Forbes

Washington Post

Amazon customers

Video: The Teaching of Economics