'Why Do We Keep Indulging the Fiction that Banks are Private Enterprises?'

A good read over at Naked Capitalism that goes beyond the usual point made about “privatized gains and socialized losses”.

Bank of Japan Intervention: What Happened Last Time? What's Next?

On Tuesday the yen traded at ¥82.88 yen per dollar, its highest level since May 1995. As predicted the Japanese government decided it had seen enough and instructed the Bank of Japan (BOJ) to 'intervene in the currency market' (aka print money). This caused the yen to quickly fall back to ¥85 per U.S. dollar level.

The BOJ also confirmed that its intervention -- reported to be in the ¥300-¥500 billion range ($3.61-$6.02 billion) -- will go unsterilized, which means that the BOJ will not seek to withdraw the new yen it has 'printed'.

Currency Traders Now Have an ¥82 Yen Bullseye

Via Bloomberg, Japan’s Chief Cabinet Secretary Yoshito Sengoku communicated two very important pieces of information:

1. ¥82 yen per dollar is "the line of defense to prevent currency strength from harming the economy"
2. "The government is seeking to gain the understanding of the U.S. and Europe for the intervention"

We now know the Japanese government's pain point (¥82 yen per dollar). Providing the market with an exact target -- not unprecedented for Japan (see below) -- could prove to be a mistake.

We can also infer from the "seeking to gain the understanding" comment that the BOJ's intervention was not only uncoordinated, but also without the consent of other central banks. It would be surprising if the Fed and ECB signed off on the BOJ's intervention. Europe, the U.S. and other nations are mired in a slow recovery and seeking export led growth. Japan's currency intervention makes U.S. and European goods more expensive in Japan.

What Happened Last Time the BOJ Intervened?

It was six years ago when the Bank of Japan last intervened in the currency market. In 15 months through March 2004, the BOJ sold ¥35 trillion yen ($421.7 billion) for dollars. What was the BOJ trying to accomplish? As noted back then Economy Trade and Industry Minister Takeo Hiranuma said "a dollar at ¥115.00 is the ultimate life-and-death line for Japanese exporters".

Two comments:

True Cost of Government Bailouts

Watch the full episode. See more Need To Know.

Default Now or Default Later?

If you're following the ongoing European sovereign debt and banking crisis, expect to hear increasing discussion of whether eurozone countries should "default now or default later?"

Eurozone Up Against The Ropes (Again)

After a summer respite concerns about the solvency of European banks and several countries are once again rattling markets and the euro currency. Most recently news that Ireland appears to be insolvent has taken center stage. But not to be forgotten is Greece, the epicenter of the financial earthquake which rocked Europe this spring. 

In an article titled Beware of Greeks Bearing Bonds, author Michael Lewis makes a rather provocative claim: even if Greece could somehow soldier through years of IMF/EU prescribed economic austerity to muster the financial wherewithal to pay foreign creditors back, it's not in the Greek character to do so. In the article's accompanying Q&A Lewis states "paying off the debt implies the sort of resolve and collective purpose that they (the Greeks) lack."

Is Default Inevitable?

There is a premise behind the question of whether to "default now" or "default later" which is that default is not just probable, but inevitable.

While debate exists on how many eurozone countries will ultimately default, the consensus outside perhaps Germany and the IMF PR department is that at least Greece will need to "restructure" its debt (aka default) at some point. So if in fact default for one or more eurozone countries is inevitable, would it be better to default now or default later?

Default Later?

The big justification for "default later" is the ever ubiquitous systemic risk concern. Here's the argument: if Greece were to default now while the global economy is still fragile it could be worse than defaulting down the road when the financial system has had time to repair. The key assumptions underpinning this argument are a) the financial system will in fact grow stronger over time and b) default can be successfully delayed.

In the case of Greece, the argument to default later is especially strong among those concerned that default will result in Greece leaving the euro currency. With respect to the two above assumptions, b) will hold so long as the "shock and awe" team (Eurozone countries, ECB, IMF, and Fed) continue to prop up Greece's finances. 

Assumption a), however, is more of a question mark. For example, the IMF/EU austerity program prescribed for Greece will result in increased indebtedness. According to IMF projections, Greece's debt would rise to about 150% of GDP in 2013 despite large government cuts. Increasing Greece's debt levels can hardly provide confidence that the system is getting stronger. I expand later below on other reasons for why assumption a) may not hold up.

Default Now?

The argument for "default now" includes the opposite of the above "default later" assumptions, and a third reason: not allowing markets to clear. 

Simply put, the market clearing process is hindered when government policy and intervention prevents an insolvent country like Greece from going bust. This in turn inhibits the establishment of true market prices in the form of higher yields on Greek debt. 

Why could market clearing be important in the case of Greece? Two reasons. First, there is tremendous market uncertainty about default fallout for European financial institutions which hold Greek sovereign debt. And while the market may be expecting Greece to default, what's unknown is the size of a Greek default. Will Greek bondholders receive $0.80 on the dollar? $0.50? Even less? The final figure has major implications. 

Current default uncertainty is hindering European credit markets as banks are uncomfortable lending to each other, which is forcing the ECB to play an outsized role. And with government taking the place of the market, the growth of new loans and private sector economic activity is stunted.

A second reason market clearing is important is that the support provided to Greece potentially threatens both the solvency of larger European nations and confidence in the euro currency. The concern over the ECB's role is reflected in the decline in the value of the euro we've seen this year vis-a-vis the U.S. dollar, Swiss franc, etc. Extending credit and monetary support to delay default increases systemic risk, thereby preventing the system from growing stronger over time.

Default Later is a Political, Not Economical, Decision

Since the economic arguments don't hold up it's clear the decision to delay Greece's debt restructuring is political. Current European administrations are loathe to play the blame game over who's fault the sovereign debt crisis is near elections. There is also the issue of the "pot calling the kettle black". Greece is hardly the only eurozone member to run repeated deficits in excess of Brussels 3% rule. In short, it's not hard to see why Europe's politicians would prefer to put the inevitable off for another day.

Like the political decision to delay default, the euro has been referred to as a "political currency". Historically politics and a sound currency haven't mixed well.

Michael Burry of 'The Big Short' is Buying Farmland, Gold

Michael Burry, featured prominently in Michael Lewis' The Big Short, is one of the investors who got the housing crash right. Big time right.

In a Bloomberg interview he discusses his current investments (video below).



Here's more from Burry where he discusses his #1 concern and his current view on the housing market, which is similar to points raised in this recent NY Times article:

Ireland: Great Example of Why the Eurozone Crisis Isn't Over

Wondering whether the world has put the spring eurozone sovereign debt crisis behind it? Check out this succinct summary of the massive issues confronting Ireland.

The NY Times article written by Messrs. Simon Johnson (former IMF chief economist) and Peter Boone (research associate at the London School of Economics) clearly articulates the overwhelming obstacles faced by just one of the euro currency member countries.

In fact, Ireland had previously been highlighted by ECB President Jean-Claude Trichet as an exemplar. Southern european countries such as Greece, Portugal, and Spain may actually be in worse shape than Ireland.

One of the interesting points Johnson and Boone make is about the artificial GDP bump Ireland accumulates due to its tax haven status:

"Many years ago, Ireland cut corporate taxes to attract business. This created one of Europe’s most impressive tax havens — it is possible to set up a corporation in Ireland, channel sales through that head office (with some highly complicated links to offshore tax havens in order to avoid paying Irish tax) and then pay a minuscule corporate profits tax. Ireland boasts a large industry of foreign “tax minimizers” that do this, but these tax minimizers hardly employ any people. Nearly one-quarter of Irish G.D.P. comes from the profits of these ghost corporations."

"The likes of Google, Yahoo, Forest Labs and many others helped Ireland’s exports grow in the first quarter, but the domestic economy (when excluding their profits, as measured by G.N.P.) actually contracted, and so did Ireland’s tax revenues and employment. Today, Irish unemployment is estimated at 13.8 percent, up from 13.1 percent at the start of the year."

And Johnson and Boone also highlight what's in store for the people of Ireland:

"Under the current program, we estimate that each Irish family of four will be liable for 200,000 euros in public debt by 2015. There are only 73,000 children born into the country each year, and these children will be paying off debts for decades to come — as well as needing to accept much greater austerity than has already been put into force. There is no doubt that social welfare systems, health care and education spending will decline sharply."

In late July when I last wrote about the euro it was valued against the U.S. dollar at just under $1.30. It has recently been trading in a range around $1.26-1.28. Even more dramatic has been the recent strengthening of the Swiss franc vs. the euro, at one point below 1.29CHF.

Euro currency bears have indeed returned to the dinner table for another helping.

Trailer: Freakonomics The Movie

About The Film: FREAKONOMICS is the highly anticipated film version of the phenomenally bestselling book about incentives-based thinking by Steven Levitt and Stephen Dubner. Like the book, the film examines human behavior with provocative and sometimes hilarious case studies, bringing together a dream team of filmmakers responsible for some of the most acclaimed and entertaining documentaries in recent years: Academy Award® winner Alex Gibney (Enron: The Smartest Guys in the Room, Casino Jack and the United States of Money), Academy Award® nominees Rachel Grady and Heidi Ewing (Jesus Camp), Academy Award® nominee Morgan Spurlock (Super Size Me), Eugene Jarecki (Why We Fight) and Seth Gordon (The King of Kong).

Goldman Sachs Says Fed's Next Money Printing Move is Imminent: "No Point in Doing Anything Less Than $1 Trillion"

Goldman Sachs chief U.S. economist Jan Hatzius yesterday said that the Fed is going to have to eventually print more money to tune of $1 trillion+.

In other words, the Fed's recently announced 'QE Lite' simply won't cut it. Hatzius figures are in line with estimates for QE 2.0 (the term that has become attached to the next massive round of Fed money printing) that I've been pointing towards for awhile.

In terms of the timing of QE 2.0, Goldman Sachs Chief Global Economist Jim O’Neill said "September might be a little bit soon, but by October I would say for sure if the data carries on being as disappointing as it’s been."

Given that market confidence is clearly deteriorating, why won't the Fed act sooner? I've recently wrote about my ideas on timing here. Ken Rogoff, the Harvard economist and author of the only economic history bestseller This Time is Different, recently appeared on Charlie Rose. He suggests that the Fed is hesitating because they're "nervous about overshooting". Aiming for 3% inflation, the Fed may miss their target badly and wind up with 30% hyperinflation. However, Rogoff states the "Fed will have to take that chance".

The U.S. dollar has held its ground so far, but concerns are rising about ongoing record budget deficits and what the government will do about the massive mortgage market problem that is Fannie and Freddie. The terrible housing figures are coming in spite of record low mortgage rates, housing prices 33% off their peak, and federal government subsidized mortgages for even Manhattan condos that require only 3.5% down payment. Perhaps most importantly, the now all but certain QE 2.0 makes the future value of the dollar anything but certain.

From an investment perspective, any move by the Fed to print more money is bullish for gold.

Today's Feast for Bears

Stock market bears were handed ample fodder today:

• Comments from Nobel Prize winning economist Joseph Stiglitz on how Europe is at risk of a "double dip" recession due to ill-timed government budget cuts. Professor Stiglitz  has been supposedly advising Greek officials nearly every day since their debt crisis erupted this spring -- ignore this insider's words at your own risk.
• The safe haven Japanese yen rallied to a 15-year high versus the U.S. dollar at 83.59, well beyond the psychologically important 85 level. The yen also hit a nine-year high versus the euro at 105.43. If the yen appreciates further towards 80 vs. the Dollar, the Bank of Japan will probably be forced to intervene with or (more likely) without G7 coordinated action. 
• While the yen is rallying the Japanese stocks are in a bear market, with the Nikkei down over 20% and under the psychologically important 9,000 level.
• Another safe haven currency, the Swiss franc, just rallied to an all-time high against the euro at 1.30 as once again it appears money is flowing out of the EU and into Switzerland.
• Unless you've been hiding under a rock today -- understandable if you've got a lot of equity tied up in the value of your home -- you probably already saw that July home sales figures were abysmal and indicate room for a much further decline in housing prices. Further significant declines in housing -- some estimating another 10-30% down -- may trigger a significant increase in strategic defaults.
• Money continues to pour into bonds as the yield on the U.S. 10-year note punched all the way up to 2.47%, the lowest level since the stock market was pricing in financial armageddon in March 2009.

What does this all mean?

Merle Hazard's "Double Dippin" Music Video