Some headlines from today

- John Paulson not only wastes his investors money, he apparently also likes to waste his own: Buys Saudi Prince's Aspen Palace for a cool $49M

- Goldman Sachs cuts managing director jobs

- Mainstream media catching up to ZH, speculates $4bn loss at CIO office

- Blankfein testifies in Gupta case, says none of your business

- Iran's special forces are in Syria

On a long enough timeline

- Record number of U.S. households on foodstamps

- Margin Stanley is now the dirtest cheapest stock on Mad Money

- Egan Jones downgrades the U.K. to AA-

- American Progressive "think tank" begs Bernanke to bail out Europe (can't make this up)

- Cashin on Ctrl + P

- The President presents: the thingamajig plan... because coming up with ridiculous ways to piss money away never gets old

Congress will vote tomorrow on auditing the Federal Reserve.

The Federal Reserve says that an audit will interfere with it’s “independence”. For example, in Congressional testimony on 2009, the vice chair of the Fed used the “i” word 30 times.

Democratic whip Steny Hoyer is urging Dems to vote no on auditing the Fed in order to preserve the Fed’s “independence”:

This bill impedes the independence of this critical institution. In order for the Federal Reserve to do its job effectively, it should not be subject to short-term political pressures.

Hoyer doesn’t speak for the wishes of Democrats.  The overwhelming majority of Americans favor a full and complete audit, and disagree with the “independence” argument.  For example, Bloomberg noted in 2010:

A majority of Americans are dissatisfied with the nation’s independent central bank, saying the U.S. Federal Reserve should either be brought under tighter political control or abolished outright, a poll shows.

 

***

 

Americans across the political spectrum say the Fed shouldn’t retain its current structure of independence. Asked if the central bank should be more accountable to Congress, left independent or abolished entirely, 39 percent said it should be held more accountable and 16 percent that it should be abolished. Only 37 percent favor the status quo.

Are the Fed and Congressman Hoyer right and the people wrong? Do we need to protect the Fed against a short-sited Congress which cares only about political concerns?

What the Last Audit Showed

Let’s start by looking at what information was revealed in response to the previous, watered-down version of Ron Paul’s  Fed audit bill:

• The Fed gave huge bailouts to foreign banks, including Gaddafi’s Libyan bank, the Arab Banking Corp. of Bahrain, and the Banks of Bavaria, Korea and Mexico

• The Fed bailed out hedge funds, McDonald’s and Harley-Davidson

• The Fed threw money at “several billionaires and tens of multi-millionaires”, including  Christy Mack, the wife of Morgan Stanley’s John Mack, billionaire businessman H. Wayne Huizenga, and Michael Dell, co-founder of Dell Computer, hedge fund manager John Paulson and private equity honcho J. Christopher Flowers

Moreover, there is strong evidence that the Fed’s decisions are often influenced by conflicts of interest.  The non-partisan Government Accountability Office calls the Fed corrupt and riddled with conflicts of interest.   Nobel prize winning economist Joseph Stiglitz agrees, saying that the World Bank would view any country which had a banking structure like the Fed as being corrupt and untrustworthy.

As Senator Sanders noted last October:

A new audit of the Federal Reserve released today detailed widespread conflicts of interest involving directors of its regional banks.

 

“The most powerful entity in the United States is riddled with conflicts of interest,” Sen. Bernie Sanders (I-Vt.) said after reviewing the Government Accountability Office report. The study required by a Sanders Amendment to last year’s Wall Street reform law examined Fed practices never before subjected to such independent, expert scrutiny.

 

The GAO detailed instance after instance of top executives of corporations and financial institutions using their influence as Federal Reserve directors to financially benefit their firms, and, in at least one instance, themselves. “Clearly it is unacceptable for so few people to wield so much unchecked power,” Sanders said. “Not only do they run the banks, they run the institutions that regulate the banks.”

 

***

 

The corporate affiliations of Fed directors from such banking and industry giants as General Electric, JP Morgan Chase, and Lehman Brothers pose “reputational risks” to the Federal Reserve System, the report said. Giving the banking industry the power to both elect and serve as Fed directors creates “an appearance of a conflict of interest,” the report added.

 

The 108-page report found that at least 18 specific current and former Fed board members were affiliated with banks and companies that received emergency loans from the Federal Reserve during the financial crisis.

 

[T]here are no restrictions in Fed rules on directors communicating concerns about their respective banks to the staff of the Federal Reserve. It also said many directors own stock or work directly for banks that are supervised and regulated by the Federal Reserve. The rules, which the Fed has kept secret, let directors tied to banks participate in decisions involving how much interest to charge financial institutions and how much credit to provide healthy banks and institutions in “hazardous” condition. Even when situations arise that run afoul of Fed’s conflict rules and waivers are granted, the GAO said the waivers are kept hidden from the public.

(Indeed, the Fed routinely allows favored bankers to make billions of dollars from inside information.)

The Fed also picks winners and losers.  in an interview this weekend with Der Spiegel, Paul Volcker – while trying to support the Fed’s argument for independence – actually undermines it:

SPIEGEL: Lawmakers on Capitol Hill are thinking about tougher controls over the Federal Reserve.

 

Volcker: I think the loss of independence and authority of the Federal Reserve would be a very serious matter for the United States. Not just in terms of monetary policy but in terms of our place in the world. People look to strong, credible institutions and I think the Federal Reserve has been such an institution. If that’s lost or too hamstrung by legislation I think we will regret it.

 

SPIEGEL: But is the Fed still the same kind of institution as during your tenure as chairman? Or is it now more of a governmental instrument? The Fed is managing the TARP program and is also buying government bonds.

 

Volcker: In some sense the Federal Reserve is always an instrument of the government. It is a government body but it is independent within government. But you are right in the sense that part of the concern is that they have involved themselves quantitatively in entering markets and in that process, you are supporting some markets and not others. That is an area in which the Federal Reserve has never wanted to get into and one that most central banks don’t want to get into. If you are going to maintain your independence you have to avoid that. To intervene in particular sectors of the market is not the proper role for the central bank over time. It could be justified only by extreme emergency.

Intervening and supporting some market players (Goldman, AIG, etc.) and not others (Lehman, etc.) is precisely what Bernanke has been doing. Whatever can be said for the Fed in the past, picking winners and losers is “not the proper role for the central bank”, in Volcker’s words. Without an audit, we will never know which “winners” were saved and which “losers” were left to die, or why. Nor do we really currently know which bailouts and other actions were truly performed under emergency conditions – to stave off catastrophe – and which were done to help out financial companies for other reasons.

Moreover, Bernanke gave many billions to private foreign banks and foreign central banks (and see this).    While Fed apologists say that the bank’s “independence” must be preserved, the fact that the Fed has sent trillions overseas shows the Fed is somewhat independent of American interests.

And the question has to be asked:  Has the Fed been picking winners and losers among countries? Among private banks?

Current Audits Are Inadequate

The Fed and its cheerleaders pretend current audits are sufficient.

For example, Steny Hoyer argues today:

Congress already conducts regular and robust oversight of the Federal Reserve and actually expanded GAO’s audit authority two years ago in the Dodd-Frank Wall Street Reform and Consumer Protection Act. It expanded the types of audits GAO may conduct of the Federal Reserve, as well as the data that must be disclosed to the public. The Federal Reserve’s financial accounts have long been subject to audit both by the GAO and an outside, independent audit firm.

But Robert D. Auerbach – an economist with the U.S. House of Representatives Financial Services Committee for eleven years, assisting with oversight of the Federal Reserve, and now Professor of Public Affairs at the Lyndon B. Johnson School of Public Affairs at the University of Texas at Austin – points out that current audits are wholly inadequate:

A 1997 Gonzalez investigation, assisted by the GAO, found extensive corrupt accounting at the cash section of the Los Angeles branch of the San Francisco Fed Bank with dire possibilities at other Fed vault facilities. Greenspan informed Gonzalez that nearly $500 thousand had been stolen from Fed vaults by Fed employees from 1987 to 1996. The Gonzalez/GAO investigation indicated this was an understatement.

 

The Fed Banks’ vaults contain uncirculated currency and coin transferred from the Bureau of Engraving and Printing and cash from banks throughout the country. The Fed district banks and branches need to be audited with GAO personnel who are trained and experienced in central bank operations and auditing. When will these audits be done and reported to the Congress or will Bernanke dismiss this national security problem as an urban legend?

Former Federal Reserve economist William Bergman writes:

The appearance of extensive auditing authority doesn’t mean audits are effective. Good auditing requires the willingness and ability of auditors to do their jobs. Some people view the Inspectors General, generally, and the Federal Reserve Board’s Office of Inspector General, specifically, as less than effective or independent in pursuing their mandates. In turn, some people question whether the Board’s oversight of the Reserve Banks, including the Federal Reserve Bank of New York, might be less than arms-length. More fundamentally, from the point of view of the supporters of the recently introduced legislation, there are a variety of restrictions on the ability of the GAO to audit the Fed. There are significant exceptions for monetary policy and transactions with foreign central banks and international organizations like the Bank for International Settlements and the IMF.

Would They Fight Against Transparency If they Had Nothing to Hide?

The former Vice President of Dallas Federal Reserve said that the failure of the government to provide more information about the bailout signals corruption.  ABC reports:

Gerald O’Driscoll, a former vice president at the Federal Reserve Bank of Dallas and a senior fellow at the Cato Institute, a libertarian think tank, said he worried that the failure of the government to provide more information about its rescue spending could signal corruption.

 

“Nontransparency in government programs is always associated with corruption in other countries, so I don’t see why it wouldn’t be here,” he said.

Thomas Woods said in 2009:

There is no good reason for Americans not to know the recipients of the Fed’s emergency lending facilities. There is no good reason for them to be kept in the dark about the Fed’s arrangements with foreign central banks. These things affect the quality of the money that our system obliges the American public to accept.

 

The Fed’s arguments against the bill are unlikely to persuade, and will undoubtedly strike the average American as little more than special pleading. Perhaps the most frequent of the claims is that a genuine audit would jeopardize the alleged independence of the Fed. Congress could come to influence or even dictate monetary policy.

 

This is a red herring. The bill is not designed to empower politicians to increase the money supply, choose interest-rate targets, or adopt any of the rest of the Fed’s central planning apparatus, all of which is better left to the free market than to the Fed or Congress. It seeks nothing more than to open the Fed’s books to public scrutiny. Congress has a moral and legal obligation to oversee institutions it brings into existence. The convoluted scenarios by which merely opening the books will lead to an inflationary catastrophe at the hands of Congress are difficult to take seriously.

 

At the same time, as we hear this objection repeated time and again, we might wonder just how independent the Fed really is, what with its chairman up for reappointment by the president every four years. Have these critics never heard of the political business cycle? Fed chairmen have been known to ingratiate themselves into the president’s favor close to election time by means of loose monetary policy and the false (and temporary) prosperity it brings about. Let us not insult Americans’ intelligence by pretending this phenomenon does not exist…

 

If there is any truth to the idea of Fed independence, it lay in precisely this: the Fed may reward favored friends and constituencies with trillions of dollars in various kinds of assistance, while keeping the public completely in the dark. If that is the independence we’re talking about, no self-respecting American would hesitate for a moment to challenge it.

 

A related argument warns that the legislation threatens to politicize lender-of-last-resort decisions. Again, this is untrue. But even if it were true, how would that represent a departure from current practice? I hope we are not asking Americans to believe that the decisions to bail out various financial institutions over the past two years, and in particular to allow them to become depository institutions overnight that they might qualify for assistance, were made on the basis of a pure devotion to the common good and were not political at all. Most Americans, not unreasonably, seem convinced of another thesis: that Goldman Sachs, for instance, might be just a little bit more politically well connected than the rest of us…

 

If our monetary system were really as strong, robust, and beyond criticism as its cheerleaders claim, why does it need to rely so heavily on public ignorance? How can it be a sound banking system that depends on keeping the public in the dark about the condition of its financial institutions?

 

Let me also make clear that supporters of this legislation are strongly opposed to a watered-down version of the bill – which, incidentally, would only increase public suspicion that someone is hiding something.

 

If the Federal Reserve Transparency Act passes and the audit takes place, the American people will have achieved a great victory. If the legislation fails, more and more Americans will begin to wonder what the Fed could be so anxious to keep hidden, and the pressure for transparency will simply intensify. A recent poll finds 75 percent of Americans already in favor of auditing the Fed. The writing is on the wall.

 

The Federal Reserve may as well get used to the idea that the audit is coming. That would be a far more sensible approach than the counterproductive and condescending one it has adopted thus far, in which the peons who populate the country are urged to quit pestering their betters with all these impertinent questions. The Fed should take to heart the words of consolation the American people are given whenever a new government surveillance program is uncovered: if you’re not doing anything wrong, you have nothing to worry about.

 

The superstitious reverence that Americans have been taught to have for the Federal Reserve is unworthy of the dignity of a free people. The Fed enjoys a government-granted monopoly on the creation of legal-tender money. It is not an unreasonable imposition for Americans to demand to know about the activities of such an institution. It is common sense.

“Independence” … a Scam

The senior S&L prosecutor (and professor of economics and law) Bill Black notes:

The sad fact is that very few Americans will be surprised that the Fed represented the interests of the SDIs [too big to fails, or "Systemically Dangerous Institutions"] even though they were directly contrary to the interests of the nation. The Fed’s constant demands for (and celebration of) “independence” from democratic government, combined with slavish dependence on and service to the CEOs of the SDIs has gone beyond scandal to the point of farce. I suggest organized “laugh ins” whenever Fed spokespersons prate about their “independence.”

(Indeed, the Fed has now agreed to backstop the derivatives exposure of American and foreign entities, which could result in multi-trillion dollar losses to the American people.)

Bill Bergman says:

How independent is the Fed, right now, to begin with? The Fed is not an apolitical beast. It has had politicians working there in formal leadership positions as well as staffing roles. The Fed’s regulatory performance matters for the conduct of monetary policy, and the Fed’s relationships with the banks it regulates and bails out deserve scrutiny. Recently, we’ve been through a financial calamity, and have endured the biggest spike in the unemployment rate since World War II. Investment returns crumbled in 2007 and 2008, and Federal Reserve monetary and other regulatory policy played a significant role in this calamity. Looking back a little further, how effective has the ‘independent’ Fed been as source of stable prices? Congress passed the law first mandating ‘stable prices’ as a goal for Fed monetary policy in 1977, and the CPI has tripled since then.

 

The FOMC [the Federal Open Market Committee] conducts monetary policy under authority delegated by the Congress. It seems reasonable to allow for some form of stronger inquiry in this area, especially after the worst financial and economic crisis since the Great Depression. One facet of a possible future investigation could deal with individual monetary policy ‘transactions.’ Under the quantitative easing posture adopted by the Fed in recent years, with a wider range of financial instruments bought to liquify the banking system and promote monetary and credit growth, the question arises – at what price were those instruments bought? Were they ‘market’ prices, or were they another way to apply public resources to overpay for bad assets and help large financial firms that got into trouble?

 

That may or may not be a valid avenue of inquiry, but it seems like we could benefit greatly from learning about the broader range of issues that could be tackled.

 

Audit the Fed? Sounds good to me.

We noted in 2010:

In March 2004, when Alan Greenspan was Fed chairman, he suppressed the opinions of those Fed officials who knew that there was a housing bubble.

 

Congressman Alan Grayson points out that – because the Fed unilaterally decided to hand out half a trillion to foreigners without any Congressional oversight, and that Bernanke testified that he didn’t know who got the loot – the Fed must be subject to an audit.

 

Yves Smith and Tom Adams – in analyzing the Fed’s lack of full disclosures regarding its extraordinary rescue operations – conclude:

Even a cursory inspection of the Fed’s disclosures of its extraordinary rescue operations shows them to have been made only under duress, and then to be incomplete and deliberately unhelpful.

 

The reason this matters, is that, contrary to the Fed’s claims of independence, it has been operating as an extra-legal off balance sheet entity of the Treasury, circumventing normal Constitutionally-stipulated budget processes. And rather than make adjustments in its practices to reflect its enlarged and now overtly political role, the Fed has instead been engaging in cynical, blatant misrepresentation, giving lip service to the idea of greater transparency in public, while fighting disclosure tooth and nail.

 

Since the Fed has entered into an openly political stance (and this dates back to Greenspan) and cannot be relied upon to make truthful and complete disclosures, the only recourse is to put it on a much shorter leash, which includes greater scrutiny, including third party validation. The Fed has brought on the audit demands via the unabashed and repeated abuse of its privileged role.

 

***

 

The Fed seems awfully keen to steer clear of the fate that befell Lehman. Lehman was grossly and verifiably misvaluing some investments, namely Archstone and SunCal, that confirmed doubts about the veracity of its accounting. If you can’t check any particular valuations, it’s a lot harder to ask difficult questions. And unlike Lehman, the Fed can continue to account to no one.

 

The Fed is engaging in same practices that caused the crisis: failure to make timely disclosures, obfuscation, use of off balance sheet vehicles to distance itself from losses. This posture alone should disqualify the central bank from assuming a greater regulatory role.

 

The Fed and Treasury’s three card monte operation is anti-democratic and possibly illegal, and to add insult to injury, voters are treated as if they have no right to know when they are ultimately footing the bill. The Fed’s persistent stonewalling and deep seated hostility toward the public provide ample proof of the need for an audit.

The Fed argues that an audit would interfere with its monetary policy decisions. That is incorrect for at least two reasons.

Initially, the bills to audit the Fed specifically provide that no outside agency will interfere with the Fed’s monetary policy decisions.

 

More importantly, decisions about what toxic assets should be accepted by the Fed as collateral, how such assets should be valued, and who bailout funds should be given to are wholly separate from the Fed’s core monetary policy decision: raising or lowering interest rates.

 

Adjustment of interest rates has been the primary lever the Fed has applied to the economy since it’s formation in 1913.

 

The Fed has also recently started using a radical new tool: replacing the money multiplier with interest payments for excess reserves deposited with the Fed. Personally, I strongly disagree with this as a policy tool because I believe that – in the name of preventing inflation – the Fed is guaranteeing prolonged deflation and the lack of a sustainable recovery. However, this is arguably an exercise of core monetary policy by the Fed.

 

But funneling hundreds of billions to foreign nations and foreign banks, accepting worthless junk from the too big to fails and marking it at unrealistic valuations, and doing the other things which the Fed has been doing recently are not core monetary functions. Congress never authorized these actions when they passed the Federal Reserve Act.

 

Therefore, the Fed’s actions must be made transparent and subject to the light of day.

Imagine you are driving to work this morning in Las Vegas (yes, you are one of the select few locals who has a job that does not involve relying on the strip's ever declining gambling revenues or flipping a house to John Paulson in the second, and far shorter, coming of the regional housing bubble, with poppage imminent), and you observe what appears to be a man who hung himself below a billboard saying "Dying for Work."

Confused, you continue, only to drive by another billboard with what seem to be a man hanging off, this one saying "Hope you're happy Wall St."

Slowly it all clicks: the man is not real, and this is not a suicide done in protest by some depressed unemployed person, instead it is merely a mannequin, part of some grotesque attempt at a statement. Would this be considered shocking, and will the thousands of commuters who saw this feel any worse or better toward Wall Street and its denizens - America's bankers - having seen this, or will they merely continue with their lives?

What if the dummy was a real person? And is this merely a foreshadowing of things to come in a country in which class warfare has not been as violent in decades if not centuries, and in which the divide between the haves and the have nots has never been as wide?

And what happens when the next such "stunt" involves a real person - perhaps someone depressed enough to copycat what they saw on the 5 o'clock news? More importantly, what happens if a depressed jobless person takes their life but first takes out some of those he thinks are responsible for his plight - say Wall Streeters?

What happens then?

We don't know, but sadly we, as well as everyone else, may find out very soon.

What we do know is what happened today. From the AP:

Even by Las Vegas standards, it was a shocking billboard: A mannequin dangling on a hangman's noose below a black sign with the ominous words "Dying for Work."

 

Nevada Highway Patrol Trooper Jeremie Elliott says the 911 calls started coming in as the sun came up early Wednesday, with drivers worried the stiff, black-suited dummy swaying at the end of a rope along Interstate 15 near Bonanza Road was a real person.

 

"It's a publicity stunt, obviously done in bad taste," said Elliott, adding that officials were focused on getting it down quickly to avoid distracting drivers during the morning commute.

The graphic display along the interstate was one of at least two unauthorized signs spotted Wednesday morning in the Las Vegas area. Another found on Highland Avenue and Desert Inn Road was white with black lettering that read, "Hope You're Happy Wall St.," and a similar mannequin hanging off the edge.

 

A woman who answered the phone at Lamar Advertising Co., which owns one of the billboards, labeled the act vandalism and said the display was being removed. She did not provide her name.

 

Clear Channel Outdoor, which owns another sign that was affected, said they pulled the display immediately and plan to work with law enforcement to punish whoever is responsible.

 

"We condemn the destructive behavior against one of our billboards because it is illegal and punishes our advertisers," Clear Channel Outdoor spokesman Jim Cullinan said in a statement. "This is not an innocent protest, but it is illegal and dangerous behavior that Clear Channel Outdoor and the industry will not accept."

Not everyone is filled with remorse over this act:

While nobody has publicly claimed responsibility for the signs, the Occupy Las Vegas group, which is affiliated with the larger Occupy Wall Street movement, posted photos of the displays on its website. Its caption says the Nevada governor's budget has slashed social programs and aid to suicidal adults.

 

Sebring Frehner, an Occupy supporter who posted the photos, told The Associated Press he didn't know who put the hangmen up, but applauded the message behind it.

 

"People saying it's in bad taste are living sheltered lives and don't pay attention to what affects the working class," he said.

Fair enough. But how does one escalate in order to truly capture the attention of those "living sheltered lives." Will the next fake person be all too real?

Or will America's "working class", having been taken over the edge in its class hatred, decide to pay Wall Street a visit, and bring some mobile guillotines with it for good measure?

And is this really America any more, or is it France circa 1789?

And who will take the place of Louis XVI?

Two years in and they are only starting now? What took them so long. Also, absolutely nothing new here, but merely the latest attempt to shift public opinion and EUR viability perceptions ever so slightly by one of Germany's most respect magazines. Those whose agenda it is to spook Germany with images of fire, brimstone, and 3-page mutual assured destruction termsheets if the Euro implodes, are now free to take the podium. One wonders: if it wasn't for the inevitable collapse of the EUR.... the inevitable collapse of the EUR.... the inevitable collapse of the EUR.... the inevitable collapse of the EUR, and of course Paul Ryan, would there be absolutely no news today?

From Spiegel:

Investors Prepare for Euro Collapse

Banks, investors and companies are bracing themselves for the possibility that the euro will break up -- and are thus increasing the likelihood that precisely this will happen.

There is increasing anxiety, particularly because politicians have not managed to solve the problems. Despite all their efforts, the situation in Greece appears hopeless. Spain is in trouble and, to make matters worse, Germany's Constitutional Court will decide in September whether the European Stability Mechanism (ESM) is even compatible with the German constitution.

There's a growing sense of resentment in both lending and borrowing countries -- and in the nations that could soon join their ranks. German politicians such as Bavarian Finance Minister Markus Söder of the conservative Christian Social Union (CSU) are openly calling for Greece to be thrown out of the euro zone. Meanwhile the the leader of Germany's opposition center-left Social Democrats (SPD), Sigmar Gabriel, is urging the euro countries to share liability for the debts.

On the financial markets, the political wrangling over the right way to resolve the crisis has accomplished primarily one thing: it has fueled fears of a collapse of the euro.

. . .

Banks are particularly worried. "Banks and companies are starting to finance their operations locally," says Thomas Mayer who until recently was the chief economist at Deutsche Bank, which, along with other financial institutions, has been reducing its risks in crisis-ridden countries for months now. The flow of money across borders has dried up because the banks are afraid of suffering losses.

According to the ECB, cross-border lending among euro-zone banks is steadily declining, especially since the summer of 2011. In June, these interbank transactions reached their lowest level since the outbreak of the financial crisis in 2007.

In addition to scaling back their loans to companies and financial institutions in other European countries, banks are even severing connections to their own subsidiaries abroad. Germany's Commerzbank and Deutsche Bank apparently prefer to see their branches in Spain and Italy tap into ECB funds, rather than finance them themselves. At the same time, these banks are parking excess capital reserves at the central bank. They are preparing themselves for the eventuality that southern European countries will reintroduce their national currencies and drastically devalue them.

"Even the watchdogs don't like to see banks take cross-border risks, although in an absurd way this runs contrary to the concept of the monetary union," says Mayer.

* * *

Unicredit is an ideal example of how banks are turning back the clocks in Europe: The bank, which always prided itself as a truly pan-European institution, now grants many liberties to its regional subsidiaries, while benefiting less from the actual advantages of a European bank. High-ranking bank managers admit that, if push came to shove, this would make it possible to quickly sell off individual parts of the financial group.

In effect, the bankers are sketching predetermined breaking points on the European map. "Since private capital is no longer flowing, the central bankers are stepping into the breach," explains Mayer. The economist goes on to explain that the risk of a breakup has been transferred to taxpayers. "Over the long term, the monetary union can't be maintained without private investors," he argues, "because it would only be artificially kept alive."

The fear of a collapse is not limited to banks. Early last week, Shell startled the markets. "There's been a shift in our willingness to take credit risk in Europe," said CFO Simon Henry.

* * *

One person who has long expected the euro to break up is Philipp Vorndran, 50, chief strategist at Flossbach von Storch, a company that deals in asset management. Vorndran's signature mustache may be somewhat out of step with the times, but his views aren't. "On the financial markets, the euro experiment is increasingly viewed as a failure," says the investment strategist, who once studied under euro architect Issing and now shares his skepticism. For the past three years, Vorndran has been preparing his clients for major changes in the composition of the monetary union.

They are now primarily investing their money in tangible assets such as real estate. The stock market rally of the past weeks can also be explained by this flight of capital into real assets. After a long decline in the number of private investors, the German Equities Institute (DAI) has registered a significant rise in the number of shareholders in Germany.

Particularly large amounts of money have recently flowed into German sovereign bonds, although with short maturity periods they now generate no interest whatsoever. "The low interest rates for German government bonds reflect the fear that the euro will break apart," says interest-rate expert Burkert. Investors are searching for a safe haven. "At the same time, they are speculating that these bonds would gain value if the euro were actually to break apart."

The most radical option to protect oneself against a collapse of the euro is to completely withdraw from the monetary zone. The current trend doesn't yet amount to a large-scale capital flight from the euro zone. In May, (the ECB does not publish more current figures) more direct investments and securities investments actually flowed into Europe than out again. Nonetheless, this fell far short of balancing out the capital outflows during the troubled winter quarters, which amounted to over €140 billion.

"We notice that it's becoming increasingly difficult to sell Asians and Americans on investments in Europe," says asset manager Vorndran, although the US, Japan and the UK have massive debt problems and "are all lying in the same hospital ward," as he puts it. "But it's still better to invest in a weak currency than in one whose structure is jeopardized."

* * *

investors are increasingly speculating directly against the euro. The amount of open financial betting against the common currency -- known as short positioning -- has rapidly risen over the past 12 months. When ECB President Mario Draghi said three weeks ago that there was no point in wagering against the euro, anti-euro warriors grew a bit more anxious.

One of these warriors is John Paulson. The hedge fund manager once made billions by betting on a collapse of the American real estate market. Not surprisingly, the financial world sat up and took notice when Paulson, who is now widely despised in America as a crisis profiteer, announced in the spring that he would bet on a collapse of the euro.

Paulson is not the only one. Investor legend George Soros, who no longer personally manages his Quantum Funds, said in an interview in April that -- if he were still active -- he would bet against the euro if Europe's politicians failed to adopt a new course. The investor war against the common currency is particularly delicate because it's additionally fueled by major investors from the euro zone. German insurers and managers of large family fortunes have reportedly invested with Paulson and other hedge funds. "They're sawing at the limb that they're sitting on," says an insider.
So far, the wager by the hedge funds has not paid off, and Paulson recently suffered major losses.

* * *

And so on - more here

What is ironic is that the worse Europe gets, and the greater the threat of redenomination risk which has yet to be address properly by the ECB, the higher the S&P will go regardless of any macro, micro data, or even broad liquidity injection expectations, simply because as equity capital flows out of Europe, since it seeks equity-like returns, it will merely end up in US equities, not bonds or gold, where it will merely marinate until another Europe emigrating "greater fool" is found.

From GoldCore

Soros Gold Action Speaks Louder Than Trumpeted 'Bubble' Words

Today's AM fix was USD 1,594.75, EUR 1,293.60, and GBP 1,016.74 per ounce.
Yesterday’s AM fix was USD 1,614.50, EUR 1,305.60 and GBP 1,028.34 per ounce.

Silver is trading at $27.70/oz, €22.65/oz and £17.74/oz. Platinum is trading at $1,401.25/oz, palladium at $571.75/oz and rhodium at $1,060/oz.

Gold dropped $8.70 or 0.54% in New York yesterday and closed at $1,599.60/oz. Silver climbed higher before retreating to $27.64, but it then rallied back higher to end with a gain of 0.14%.

Gold is under pressure today despite the likelihood of more QE from the FED, ECB and other central banks and despite the very uncertain and poor macroeconomic outlook.

Positive US data, retail sales grew for the first time in 4 months, may have led to gold weakness and scaled back hopes that the US Fed will take action soon.

On Tuesday, Gold ETF interest increased to its highest level in nearly a month at 2,190.583 tonnes showing how investment demand in the gold ETF is far more ‘sticky’ and long term in nature.

This means that there is a fundamental pillar of support below the gold market which did not exist in the 1970’s.

An important positive development for the gold market is billionaire financiers George Soros and John Paulson have again increased their allocations to gold as seen in the latest SEC filings.

George Soros more than doubled his shares in the SPDR gold trust ETF.

He increased his position in SPDR Gold to $137.3 million in the second quarter from $52 million previously. SEC filing for the second quarter showed Soros Fund Management more than doubled its investment in the SPDR Gold Trust from 319,550 shares to 884,400 shares at the end of June.

In September 2010 (see chart), Soros called gold "the ultimate bubble" and largely dumped his stake in the ETF before gold recorded annual gains in 2010 and 2011 and rose to a nominal high of $1,920.30 per ounce in September. 

There was speculation at the time that he may have sold the SPDR trust in order to own far safer allocated gold bars.

Another billionaire investor respected for his financial acumen is John Paulson and Paulson & Co increased its holdings by 26% by purchasing an additional 4.53 million shares of the SPDR Gold Trust to bring entire holding to 21.8 million shares. 

It was the first time Paulson & Co had increased its position in the SPDR Gold Trust since the first quarter of 2009, when the investment firm initially acquired 31.5 million shares. It means that Paulson's $21 billion hedge fund now has more than 44% of the company's assets allocated to gold.

Paulson, who became a billionaire in 2007 by betting against the US subprime mortgage market, lost 23% in his gold fund through July as lower bullion prices and slumping mining stocks led to losses.

The increased allocation by Paulson shows that he has much confidence that his allocation to gold will pay off in the long term. 

Gold Prices/Rates/Fixes /Volumes – (Bloomberg)

According to Bloomberg, Vinik Asset Management, the Boston-based hedge fund founded by Jeffrey Vinik, who formerly ran the Fidelity Magellan Fund (FMAGX), cut its entire stake in the gold ETF. On March 30, the fund held 2.3 million shares, SEC data show. Eric Mindich’s Eton Park Capital also sold all of its 739,117 shares last quarter, a filing showed.

Moore Capital Management LP acquired 120,000 shares of SPDR Gold Trust in the second quarter, a filing showed yesterday. The hedge fund held no shares in the gold fund as of March 31. Moore was also aggressive in selling financial and bank shares such as JP Morgan (JPM), Wells Fargo and US Bancorp.

Gold fell 4% in Q2 but the increased allocations show that some of the smartest money in the world continues to see gold as a buying opportunity. With the Fed having bought $2.3 trillion of debt in two rounds of 'quantitative easing' and all major central banks keeping borrowing costs at a record low gold's fundamentals remain very sound. 

Soros' recent renewed allocation to gold has been far less trumpeted than his gold 'bubble' remark and much trumpeted liquidation of gold holdings in May 2011. Some have suggested that Soros was misinterpreted regarding his gold bubble remark and may have meant that gold will in time become the "ultimate bubble".

Cross Currency Table – (Bloomberg)

Alternatively, Soros wishes to accumulate a large position in gold prior to prices rising even further and was happy to help dissuade the retail public from entering the gold market until he owns a significant amount of gold. 

Some hedge fund managers have been known to talk down an investment while in the process of accumulating.

It could simply be that Soros has changed his opinion regarding gold and does not now view it as a "not safe," "ultimate bubble". This seems likely as he has warned that there is a real risk of a euro break up and is on record regarding having deep concerns regarding the US fiscal situation - both of which are of course bullish for gold.

Paulson told clients in February that gold is his best long term bet, serving as protection against currency debasement, rising inflation and a possible breakup of the euro. 

Given Soros awareness of financial risk it is likely that he also owns physical bullion and not just the more high risk shares in the very public SPDR trust.

Other highly respected managers such as Kyle Bass, Greenlight Capital's David Einhorn and Third Point LLC's Daniel Loeb are on record as favouring more discrete ownership of actual physical gold bullion bars - in an allocated format in a secure vault.

We advise our clients – retail, pension and institutional – to do likewise and own physical gold bullion in the safest way possible.

For breaking news and commentary on financial markets and gold, follow us on Twitter.

NEWS

Gold edges up on Europe stimulus hopes; US data weighs - Reuters

ECB - Gold Reserves Unchanged In Week to Aug 10 - Reuters

Royal Canadian Mint Unveils New Gold and Silver Bullion Coins – Coin Update

Gold Fund's Collapse Rattles Poland – Wall Street Journal

COMMENTARY

Aaaand It's Gone: This Is Why You Always Demand Physical – Zero Hedge

Which Way Will the Pendulum Swing for Gold? - GoldSeek

Silver Hoard Near Record High Has Transnational Silver Abusers Concerned – Silver Vigilante

“They’re Going to Put the Old System In a Coma”! - CNBC

Ron Paul – “U.S. Treasury Guilty of Counterfeiting Dollars” – Gold and Silver Blog

The market may have found itself in the purgatory of the summer doldrums, where unlike last year this time, not only are volumes over 50% lower, but volatility is non-existent, but that doesn't mean that investors are sleeping easy. In fact, quite the opposite because as the following chart from MS confirms, the lack of market volatility merely mimics the complete chaos and lack of decisiveness in Congress, where each passing day brings America not only closer to the most contentious presidential election in ages, but to another debt ceiling hike debate, and, of course, the fiscal cliff. All of these combined have brought US policy uncertainty to the third all time highest level, on par with September 11 and the collapse of Lehman/TARP, and just short of last year's imminent European collapse, which was only staved off courtesy of the coordinated global central bank intervention on November 30.

As for Europe, fughedaboutit

MS' commentary:

In the US, the main uncertainty is about the upcoming elections in November and the related resolution (or non-resolution) of the fiscal cliff, the 5% of GDP automatic fiscal tightening that would result from current legislation. This has led our US team, which does not expect the issues to be resolved before the election and sees increasing evidence that the uncertainty is affecting corporate and consumer spending decisions, to downgrade its 2H12 growth forecast twice over the past two months. The renewed recent rise in uncertainty is illustrated in a new measure of policy uncertainty constructed by academics from Stanford University and Chicago University, which combines the intensity of press coverage of policy-related uncertainty, the extent of disagreement among professional forecasters on inflation and government spending, and the frequency of scheduled tax code expirations. The authors show a strong link between their uncertainty measure and economic outcomes.

 

In the euro area, the main uncertainty is over if and how the current debt crisis can be resolved and whether a break-up of the euro can be avoided. This form of uncertainty rose strongly during 2Q, following the LTRO-induced sugar-rush early in the year, and induced our European economists to slash their outlook for 2H12 and 2013 in late July, with the euro area entering a renewed recession as we write. Exhibit 4 shows the European Economic Policy Uncertainty Index from the same source as the US one, with a sharp rise in the middle of last year after the Greek PSI decisions and a renewed rise in recent months.

And as we said before, anyone hoping that the Fiscal cliff issue will be resolved cleanly, clinically and efficiently, is advised to invest in Las Vegas real estate alongside John Paulson because "housing has bottomed."

Submitted by Chris Martenson of Peak Prosperity

What to Do When Every Market Is Manipulated

Hint: cut the strings

If you don't know who the sucker at the card table is, it's you.

~ old gambler's saying

What do the following have in common?

LIBOR, Bernie Madoff, MF Global, Peregrine Financial, zero-percent interest rates, the Social Security and Medicare entitlement funds, many state and municipal pension funds, mark-to-model asset values, quote stuffing and high frequency trading (HFT), and debt-based money?

The answer is that every single thing in that list is an example of market rigging, fraud, or both.

How are we supposed to make decisions in today’s rigged and often fraudulent market environment? Where should you put your money if you don’t know where the risks lie? How does one control risk when control fraud runs rampant?

Unfortunately, there are no perfect answers to these questions. Instead, the task is to recognize what sort of world we happen to live in today and adjust one’s actions to the realities as they happen to be. The purpose of this report is not to stir up resentment or anger -- although those are perfectly valid responses to the abuses we are forced to live with -- but to simply acknowledge the landscape as it is so that we can make informed decisions.

In this report I connect the dots on the fraud, noting both what we already know about and what we'd better prudently suspect is happening (but not yet revealed).  In Part II, we talk about ways to operate, make decisions, and control risk given the sorry state of affairs in our financial markets.

Swimming Naked

As Warren Buffet said, "It’s only when the tide goes out that you learn who’s been swimming naked."

What he meant was that poorly-run companies can appear healthy during boom times but are later exposed as hollow shells when the economic tide retreats. Naturally it's a lot easier to make money when times are booming, but much more difficult when the economic pie is stagnant or shrinking. The dot-com companies of the late 1990s are the poster children for this phenomenon.

My corollary to Buffet’s naked swimming quote is this: It’s only when the pie stops expanding that you find out who’s been running a Ponzi scheme.

The global pie is no longer expanding, and the relentless parade of disquieting economic and financial news can be laid right upon that fact.

Sure, there are the prosecutable examples, such as Bernie Madoff, but state and municipal pensions and the Social Security entitlement program also fit the definition. So does the practice of expanding public debt at a faster pace than GDP, which many nations, provinces, and states have done for many years running. These are all Ponzi schemes in the sense that they require constant growth to remain 'healthy' (or hidden, more accurately) and are therefore mathematically certain to fail. Now that the economic pie is no longer growing like it used to and most likely will not for decades to come (if ever), all of these schemes are rapidly falling apart.

The insolvency of Greece, which is now in a full-bore depression, is simply a reflection of a multi-year Ponzi scheme that has now run its course and fallen apart. It is simply not possible to borrow forever at a faster rate than your income growth, and Greece is now a harbinger of things to come for every country in a similar position. That includes all of the PIIGS, Japan, and the US.

Now that the pie has stopped expanding, all of the countries that have been swimming naked are exposed. Timing will vary, as in this metaphor some were in shallower water (Greece) than others (the US), but timing aside, there really isn't much of a difference between any of them.

Illegal and Condoned Fraud

Where does one even begin with a discussion of all of the rampant fraud that has been revealed of late? Should we suspect that there is suddenly a lot more fraud in the system? Or is the lack of growth simply revealing the extent to which fraud and Ponzi schemes are a significant feature of our political-financial-regulatory-banking landscape? I lean towards the latter view.

I suppose we need to begin this discussion with the fact that any exponential, debt-based monetary system is, at its very core, a Ponzi scheme. It simply has to keep expanding so that there’s enough money and credit manufactured today to meet yesterday's principal and interest loads. Without endless growth, sooner or later the debt pile collapses, and truly extraordinary losses are taken by somebody.

If our entire money system is itself a Ponzi scheme, then it follows that much of what will be based on that monetary superstructure will, almost by definition, share that characteristic.

The garden-variety illegal schemes, such as those run by Bernie Madoff and Peregrine Financial, are easier to cover up and keep running when money and credit are readily available and expanding rapidly. Their early demise just means that they were in the weakest positions and therefore unable to survive the first rounds of crediting/money stagnation.

Next in line is the practice of borrowing at a faster rate than economic growth. That process is already well underway for Greece, Spain, Italy, and Portugal -- but just barely. An enormous gap exists between any practical level of funding and the desired levels of spending, and closing that gap will be a long and painful process.

Following this will be the state-sponsored schemes. Woefully underfunded pensions and entitlement programs will take longer to unravel, but it will happen too in one form or another, most likely by cutting benefits.

The simple truth is that when credit and money expansion stops, all of the various schemes that relied upon the illusion of growth supplied by that dynamic are exposed as unworkable propositions. One summary of the current crisis is this: Credit growth stalled and there simply wasn't enough 'juice' left in the system to cover the various 'legal' and illegal Ponzi schemes.

Socially speaking, as long as the pie is expanding, there is virtually zero public or political support to call out the schemes for what they are. If anything, the opposite is true. It is only once some limit to growth is reached -- the most recent case being the bursting of a multi-decade credit bubble in 2008 -- that the party ends, heads groggily lift, and the painful lack of standards and critical thinking are finally revealed.

The fraud has always been there, often in plain sight, but very few really cared as long as the status quo was being maintained. Obviously and mathematically unworkable municipal and state pension plans are a prime example of this dynamic. For as long as the fiction could be maintained, very few challenged the system, even though they were quite obviously going to be an eventual fiduciary train wreck.

The recent spate of municipal bankruptcies indicates that the ‘eventual’ train wreck has begun and the first few cars of a very long train are off the rails.

Officially Supported Fraud

As bad as the private frauds are, and as corrosive as they are to public trust, they pale in comparison to those perpetuated at the very highest levels. The fact that some frauds are supported and encouraged by the regulatory bodies and official institutions should render them no less palatable to the rational mind. In fact, the opposite should be true.

Recently it has become clear that various regulatory bodies can be counted on to look the other way when certain frauds are aligned with the aims and goals of the state while punishing other frauds selectively and grudgingly. There are many recent examples to support this view.

The LIBOR scandal is a perfect example of regulators ‘looking the other way when it suits us.’ Because a LIBOR rate that was manipulated to inappropriately low levels created the appearance of robust bank health, the Fed and other central banks and regulatory authorities were more than happy to look the other way. Not just briefly, but over many years.

That the manipulation of LIBOR also happened to pad the profits of big, well-connected banks (another prime goal of the central authorities) was just one more reason to tacitly support the manipulation. It’s important to note that LIBOR was and is the main determinant for the rate of interest paid on tens of trillions of loans and hundreds of trillions in derivatives.

If the central authorities are willing to overlook fraud on that scale, how far are they willing to go in other areas? Asked another way, just how serious is the predicament we face, and what are we not being told?

The painfully clear message from all of this is that lying, cheating, and stealing are all just fine, as long as they support the main policy aims of the times (and perhaps a few current or prospective colleagues). That is a main lesson of LIBOR-gate, and it is ugly.

Which Brings Us to Gold

One of the prime reasons that I support the notion that the price of gold is neither free nor fair is that I think there is an incentive for the US and UK central banks (and the others, too) to have no serious questions raised about fiat money. Gold is the only monetary barometer that exists outside of the world of fiat money.

If the Fed was willing to look the other way while banks colluded to keep LIBOR artificially low because that sent the 'right' signal about bank health and boosted profits, do you really think they would not also look the other way if banks could make money by manipulating the gold market into a more stable or even lower price band than it otherwise might occupy?

To me, it is a given that the Fed, et al., would condone literally any and all activities that would boost the apparent health of major banks (their prime clients) and the apparent health of fiat money (their only product). Said more directly, it is unthinkable that they do not have gold squarely in their sights on a daily basis.

The second point I want to make about gold is that with every revelation of fraud and/or price manipulation, I grow more convinced that gold should play an increasing role as an anchor to your portfolio. The lessons of LIBOR-gate suggest a haphazard approach to enforcing the rules and reinforce the idea that perhaps things are a bit worse off under the surface than we’ve been told.

Beyond the regulatory and process lapses (like the oil trading story below) that contribute to both illegal and sanctioned fraud, the most grotesque mispricing of everything begins with the mispricing of money itself. Thanks to three years of money priced at zero percent, the entire system is riddled with distorted prices, especially the price for risk. For example, virtually every pension fund is now essentially forced to lend money to the US government for ten years at 1.5% interest, a ridiculous rate given the risks of inflation and even default that a free market would price very differently.

A final thought here is that we simply cannot trust the prices we see around us as much as we used to. I know that one of the central axioms of traders and reasonable people everywhere is that the market is always right. If the price of gasoline is $3.50/gallon or the price of gold is $1,550/ounce, then those are the correct and right prices.

However, it now seems likely that most of the prices we see are simply reflections of something at once more mundane and sinister: central planning.  First they are distorted by the pernicious effects of mispriced money, and second by selective lack of enforcement.

An Unfortunate Lack of Accountability

The many years that Bernie Madoff was able to continue his fraud despite ample and clear proof supplied to the US Securities and Exchange Commission (SEC), coupled with the complete lack of consequences for the named regulators known to have actively ignored the evidence, tell us simply that above certain levels, accountability has all but disappeared.

Can anyone provide a compelling reason why Jon Corzine is not behind bars or charged with something…anything?

Most recently, the SEC declined to press charges against Goldman Sachs for their role in misleading clients about the riskiness of the toxic mortgage products they manufactured and sold.

Goldman dodges SEC bullet over bum mortgage deal

Aug 9, 2012

 

(MoneyWatch) The Securities and Exchange Commission has ended an investigation into whether Goldman Sachs misled investors in a $1.3 billion sale of residential mortgage-backed securities arranged by the investment bank in 2006, shortly before the housing crash.

 

The agency notified Goldman in February that it was looking into whether the company misrepresented the riskiness of a mortgage deal dubbed "Fremont Home Loan Trust 2006-E." Goldman disclosed in a regulatory filing Thursday that the SEC does not intend to recommend any enforcement action against the company over the deal.

If ever there were a more open and shut case, I would be hard pressed to imagine what it might be. The rules over financial disclosure are quite clear, and everything I understand about Goldman's actions in selling these securities crossed that line. Recall that in some cases Goldman was packaging these things specifically so that one client (John Paulson) could short them, while selling the other side of the deal to someone else, while failing to disclose that these particular items had been designed to fail.

Further, in 2010 Goldman paid a $550 million fine to settle federal charges that it misled investors and that a Congressional panel had concluded that Goldman had deceived investors. Yet despite all that, the SEC just can't figure out how to find that any laws have been broken by Goldman here.

Similarly:

Standard Chartered to pay $340 million to settle with N.Y. over Iran charges

Aug 14, 2012

 

London-based Standard Chartered Bankagreed to pay $340million to settle New York state charges that it illegally funneled hundreds of billions of dollars to Iran, even as other probes by federal regulators are continuing.

 

New York’s Department of Financial Services surprised fellow regulators last week when it unveiled a blistering report accusing Standard Chartered of conspiring with Iran to launder $250billion from 2001 to 2007 to bypass U.S. economic sanctions.

Note that no criminal charges apply here, just a fine of $340 million (with an “m”) to settle up on a conspiracy where over $250 billion (with a “b”) was involved. Even the idea of ‘punitive’ seems to be beyond the grasp of current regulators and enforcers. Crime does pay and is virtually risk-free from a criminal perspective, but it has to be really big crime and it has to involve a bank.

Meanwhile, the US Commodity Futures Trading Commission (CFTC) is reportedly set to drop a four-year investigation (mainly held in private meetings) into silver manipulation, concluding -- surprise! -- that no such manipulation exists. Heading up the panel is ... wait for it ... wait for it ... Gary Gensler, a former Goldman executive.

Here we might not be overly impressed with the CFTC for having already missed both the MF Global and Peregrine Financial debacles that happened right under their ineffective regulatory noses, but the real damage is the constant erosion of faith in their obviously broken and sometimes crooked model that selectively enforces rules depending on whether or not the alleged miscreant is a very large institution.

Listen, it is really simple and has always been true: If someone can scam a market and make money, they will. Here's another potential example:

Was the petrol price rigged too?

Jul 15, 2012

 

Motorists may have been paying too much for their petrol because banks and other traders are likely to have tried to manipulate oil prices in the same way they rigged interest rates, an official report has warned.

Concerns are growing about the reliability of oil prices, after a report for the G20 found the market is wide open to “manipulation or distortion”.

 

Traders from banks, oil companies or hedge funds have an “incentive” to distort the market and are likely to try to report false prices, it said.

 

Petrol retailers use oil price “benchmarks” to decide how much to pay for future supplies.

 

The rate is calculated by data companies based on submissions from firms which trade oil on a daily basis – such as banks, hedge funds and energy companies.

 

However, like Libor – the interest rate measure that Barclays was earlier this month found to have rigged – the market is unregulated and relies on the honesty of the firms to submit accurate data about all their trades.

I have no idea if or to what extent the oil markets have been manipulated, but given the fact that the system apparently relies to some degree on the “honesty of the firms to submit accurate data,” I will have to reiterate that anything that can be rigged for profit will be rigged for profit.

While we might gnash our teeth, or become enraged or depressed at this state of affairs and lack of accountability, I think it’s just as healthy to observe that it is what it is and plan accordingly.

In Part II: Protecting Your Wealth, we focus on the strategies and steps we as individuals can take to decrease our vulnerability to the dysfunction, manipulation, and sleight of hand discussed above. The positive reality here is that there are alternatives to playing the game in the casino by the casino's rules.

Click here to access Part II of this report (free executive summary; paid enrollment required for full access).

Michael Snyder tends to be extreme in his pessimism, but he presents arguments that are hard to dismiss. ~ Ilene

Jacob Rothschild, John Paulson And George Soros Are All Betting That Financial Disaster Is Coming

Because redemption requests are like cockroaches: once one appears, assume many, many more:

• CITIGROUP'S PRIVATE BANK SAID TO PULL $500M FROM PAULSON FUNDS - BBG
• CITIGROUP SAID TO REDEEM FROM PAULSON ADVANTAGE, ADVANTAGE PLUS - BBG

Is this the beginning of the end for the former Bear Stearns M&A banker and once infallible hedge fund manager? And to think he could have saved himself all the deep fundamental work telling him Las Vegas real estate is "cheap" and just bought Apple. Hey, everyone else is doing it. And everyone else can't possibly be wrong. As for Paulson, whose GLD holdings, which are not an investment but merely a gold denomination share class, will likely quite soon see a substantial hit as he is forced to unwind GLD holdings as more and more external investors redeem until finally JP is just left running his own and his employees' money.

Finally, recall what we said three days ago when we broke the Goldman report that only 11% of HFs are outperforming the S&P: "the day of redemption reckoning at the end of the year (and just after September 30 for that matter as well) could be the most painful yet. it also explains why, just like every other quarter in which career risk is at all time highs, HFs are dumping everything not nailed down and buying up AAPL, which as of June 30 was held by an all time high 230 hedge funds (more on that later)."

For Paulson D-Day may have arrived. It is also coming for hundreds of other underperforming funds who will now have to shift from net buyer to gross liquidator as their LPs demand their cash back ahead of the September 30 redemption deadline. Add that technical consideration to all the other September sell off woes.

In short - he who redeems first, redeems best.

From GoldCore

Gold Option Traders Most Bullish Since Bottom In October 2008

Today’s AM fix was USD 1,657.00, EUR 1,320.21 and GBP 1,046.48 per ounce.

Yesterday’s AM fix was USD 1,664.25, EUR 1,325.04 and GBP 1,051.66 per ounce.

Silver is trading at $30.78/oz, €24.63/oz and £19.50/oz. Platinum is trading at $1,528.25/oz, palladium at $631.80/oz and rhodium at $1,025/oz.

Gold fell $11.10 or 0.67% in New York yesterday and closed at $1,656.10. Silver slipped to a low of $30.55 and rallied back and forth then finished the day with a loss of 0.58%.

Gold Rose 67% Between October 2008 And February 2009

Gold is mostly unchanged as investors gear up for the US Fed chairman, Ben Bernanke’s speech tomorrow.

Market participants are focussed again on the short term and the silly “will he, won't he?” debate re Bernanke at the Jackson Hole symposium. 

Bernanke may again obfuscate and not give clear guidance regarding monetary policy and further QE.

However the smart money such as PIMCO's Bill Gross, Jim Rogers, John Paulson and others believe that further QE and money printing remain inevitable. We would concur and advise investors to fade out the short term noise emanating from Jackson Hole and from assorted policy makers on both sides of the Atlantic and focus on the reality that further monetary easing and currency debasement will continue for the foreseeable future.

There are continuing hopes that the ECB will deliver concrete plans next week that will help diminish the borrowing costs in Spain and Italy and an interest rate decrease is also being mooted.

The German Constitutional court decision on September 12th may finally put to bed whether Germany will allow the ECB to print euros in order to bailout periphery nations thereby debasing the euro.

The 6.5 billion euro Italian sovereign bond sale went well today but the auction again spotlights the country's massive debt burden and still high and rising borrowing costs.

A new and important bullish indicator for the gold market is that gold calls are at highs not seen since the October 2008 low as option traders go long gold in the belief that it will go higher.

It suggests that option traders believe that U.S. Federal Reserve Chairman Ben Bernanke will hint at or announce additional money printing and monetary easing at the Jackson Hole, Wyoming, symposium.

Alternatively, it suggests that they are bullish on gold due to the risks posed to the dollar and the risk of inflation taking off.

XAU/GBP 5 Year Chart – (Bloomberg)

The ratio of outstanding calls to buy the SPDR Gold Trust versus puts to sell jumped to 2.69 to 1 on August 24th and reached 2.76 earlier this month, the highest level since October 2008, according to data compiled by Bloomberg. 

Ownership of calls is up 26% since the July 20th options expiry. Ten of the most owned actively owned ETF option contracts are bullish.

Option traders are regarded as savvier and tend to be more sophisticated then the more speculative futures traders.

XAU/EUR 5 Year Chart – (Bloomberg)

Gold in October 2008 was trading at below $725/oz (see charts above). In the less than 5 months that followed gold rose 67.8% - from mid October 2008 to the high on February 12th 2009 at $1,215/oz.

A similar move today is quite possible given the long period of consolidation in the last 12 months and the strong fundamentals.

This could see gold rise from below $1,660/oz today to $2,785/oz in the first quarter of 2012 (see chart above).

For breaking news and commentary on financial markets and gold, follow us on Twitter.

Cross Currency Table – (Bloomberg)

NEWSWIRE
(Bloomberg) -- U.S. Mint Gold-Coin Sales in August at 32,500 Ounces Top July
The U.S. Mint’s sales of American Eagle gold coins were 32,500 ounces so far in August, according to figures from the Mint’s website. The total for all of July was 30,500 ounces.

(Bloomberg) -- U.S. Mint Silver-Coin Sales in August Exceed July Total
The U.S. Mint’s sales of American Eagle silver coins have reached 2.52 million ounces so far in August, according to figures from the Mint’s website. Sales totaled 2.28 million ounces in July.

(Bloomberg) -- Gold ETP Holdings Rise to Record for Seventh Straight Session
Gold holdings in exchange-traded products backed by the metal rose to a record for the seventh straight session.

The amount increased 3.49 metric tons, or 0.1 percent, to 2,460.46 tons, data tracked by Bloomberg showed.

(Bloomberg) -- Ahmadinejad Says Capitalism Is on ‘Threshold of Collapse’
Iranian President Mahmoud Ahmadinejad urged countries to barter and use their own currencies for trade instead of the U.S. dollar and said capitalism was about to end.

“Domineering capitalism is on the threshold of collapse,” Ahmadinejad said told delegates at a Non-Aligned Movement meeting in Tehran today.

(Philstar) -- Central Bank of Philippines may buy gold abroad 
The Bangko Sentral ng Pilipinas (BSP) has warned it may be forced to purchase gold abroad for its reserve requirements should local sales of the metal continue to drop due to taxes levied by the government, a central bank official said.

“If nothing happens, we might be forced to downsize our gold refinery. The effect is that the BSP will not be able to buy gold using pesos,” BSP Deputy Governor Diwa Guinigundo told The STAR in a text message late Monday.

“While gold can be bought from the international market, this will have to be done using (foreign exchange). Foreign exchange reserves will not be increased in the process,” he added.

When asked when the BSP can say that it needs to buy gold abroad, Guinigundo replied: “This is a question of timing policy and therefore not for public consumption.”

Gold is considered as a safe haven in times of foreign exchange volatility, meaning, investors flock to it when currencies around the world are plunging in value to protect their investment. BSP, by law, is supposed to be the sole purchaser of gold from local small-scale miners.

(Bloomberg) -- Platinum May Rally to $1,735 on South African Output Loss: UBS
Platinum may climb to $1,735 an ounce within three months because of production losses in South Africa, which represents almost 75 percent of world mine supply, said Dominic Schnider, head of commodity research at UBS AG’s wealth management unit.

Global supply may drop 4 percent this year, returning the market to balance, Schnider said today at a briefing in Singapore. The surplus was 430,000 ounces in 2011, UBS data show. Spot platinum was at $1,523.25 at 11:39 a.m. local time.

NEWS

Gold stuck in tight range before Fed speech - Reuters

Asian Stocks Erase Monthly Gain on Growth Concern; Oil Declines - Bloomberg

Growth worries dent shares ahead of Bernanke speech - Reuters

Turkey’s Gold Sales To Iran Largely In Bullion – Hurriyet Daily News

COMMENTARY

Gross: QE3 is Coming `Relatively Soon' - Bloomberg

$16 TRILLION ... "Banana Republic Stuff Plain And Simple" ... "Smart, Thinking People Ought To Be Planning..." – Zero Hedge

The Gold Standard Goes Mainstream‎ - Wall Street Journal

Willie: Firestorms & Currency Twisters - GoldSeek

David Morgan bullish on gold and silver - saw ‘bottom' in May - Mineweb

Via Paul Mylchreest of Seymour Pierce,

Is Gold a Giffen good?

We are at a critical point for gold and the gold equities.

With regard to the latter, the long running underperformance versus bullion may be over for the time being with the recent double bottom in the chart of the HUH Index of large cap. gold stocks versus the gold price:

During the Summer, a portfolio manager from a large UK fund in a CNBC interview commented that "I wish I'd never met a gold miner." That kind of abandonment of hope can obviously be typical of market bottoms.

Time will tell, but the investment case for gold equities has received a boost from recent M&A transactions. This week saw the announcement of Minera Frisco's US$750m acquisition of the Mexican Ocampo mine from Au Rico Gold. Minera Frisco is majority owned by Carlos Slim, touted in the media as the world's richest man. Other recent announcements should have raised eyebrows due to the (very) obvious theme:

• 7 August 2012 - Zijin Mining, the largest Chinese gold miner, acquired a majority stake in the Australian gold miner, Norton Gold Fields, for US$180m;
• 16 August 2012 - China National Gold announced that it was in preliminary discussion regarding an offer for Barrick's 73.9 percent stake in African Barrick Gold;
• 4 September 2012 - China's SEFCO Group announced the acquisition of the Zara gold project in Eritrea for US$80m;
• 19 September 2012 - China's Shandong Gold announced the acquisition of a 51% stake in the Australian gold miner, Focus Minerals, for US$238m; and
• 27 September 2012 - Zhongrun Resources announced the acquisition of a 42% stake in the Australian gold miner, Noble Mineral Resources, for US$88 million.

Gold itself has had a strong move up since mid-August as the expectation of further QE became baked into expectations. We have moved into a new era of open-ended money printing across the developed world. Surprisingly, many people are prepared to believe that this will not be inflationary - but all in good time.

The failure of the gold price to breech US$1,800/oz so far can be attributed to aggressive short selling of various forms of "paper gold" by bullion banks. If we take the more transparent COMEX futures market, the CFTC's Bank Participation Report shows that between 7 August and 2 October 2012, almost the entire increase in open interest has been accommodated by an 86,486 contract increase in the net short position of the reporting banks. The total net short position is now 184,748 contracts, i.e. 18.47m oz of gold or 574.6 tonnes. The latter is the paper equivalent of 20.4% of world gold mine production and more than 50% of China's reported gold reserves...just on COMEX!

The London gold market (LBMA) is much bigger, but far more opaque. What most commentators fail to appreciate is that the convention for gold trading on the LBMA is in "unallocated" gold. This is an unsecured claim against a pool of gold held in the vaults of clearing members of the LBMA. In keeping with banking practice, it is a fractional reserve system. Smart money has been buying gold on the LBMA and specifying delivery of "allocated" bullion, i.e. where specific gold bars are segregated in the vault in the name of the purchaser, or (increasingly) removed by the purchaser from the banking system altogether.

In August 2011, S&P downgraded the US sovereign credit rating from AAA to AA+ which was the catalyst for the gold price to rise US$270/oz to hit an all-time high of US$1,920/oz on the morning of 6 September 2011. Beginning the following month, reports of heightened demand for physical gold in the London market began to filter through which have continued in 2012. For example:

21 October 2011 - King World News' "London Trader"
"We had a major, major physical buy order today. The Chinese bought a massive amount of physical today at the lows."

17 January 2012 - King World News' "London Trader"
"They (the Chinese) have recently taken another roughly 150 tons away from the Western central banks."

18 March 2012 - Jim Willie of the Hat Trick Letter
"My best gold trader source..The Chinese are the principal buyers, but he swears that China is not alone.. The battle is being won in the vaults, where the gold cartel is being depleted"

19 June 2012 - TF Metals Report
"London Good Delivery bars are being delivered to Eastern buyers. Instead of being vaulted inside the LBMA system, these bars are being sent directly to refiners. The bars are then being melted and recast in 1 kilogram sizes."

8 October 2012 - Egon Von Greyerz of Zurich-based Matterhorn Asset Management on King World News
"I would also note, Eric, that some of the refiners we are talking to, they are seeing business strongly increasing now, and in this environment they are actually increasing their margins and prices. So there is clearly an increase in short-term demand."

Whether the reported Chinese buying is "official" or not is unclear. However, it is worth remembering the surprise Chinese announcement in April 2009. This was from a China Daily news article at the time:

"China, owner of the world's biggest forex reserves, said Friday its gold reserves had risen to 1,054 tonnes by the end of 2008. China is now the fifth biggest holder of gold reserves in the world, with only six countries having a holding of more than 1,000 tonnes, Hu Xiaolian, head of the State Administration of Foreign Exchange, told Xinhua in an interview. The new figure represents an increase of 454 tonnes from 600 tonnes in 2003, the last time China announced an adjustment of its gold holdings."

What's happening in the gold market reminds me of something I speculated could happen back in 2007 i.e. whether gold would some day exhibit the characteristics of a "Giffen good"?

Economists (I am not one) define a Giffen good as one which violates the normal laws of supply and demand, i.e. instead of falling, demand rises as the price increases. Wikipedia explains the paradox as follows:

"In normal situations, as the price of a good rises, the substitution effect causes consumers to purchase less of it and more of substitute goods. In the Giffen good situation, the income effect dominates, leading people to buy more of the good, even as its price rises."

 

According to Wikipedia, the evidence for the existence of Giffen good is:

"limited, but microeconomic mathematical models explain how such a thing could exist."

Please note that Giffen goods should not be confused with "Veblen goods". This is Wikipedia on the latter:

"people's preference for buying them increases as their price increases (as greater price confers greater status)... decreasing their prices decreases people's preference for buying them because they are no longer perceived as exclusive or high status products."

Super cars and high-end luxury goods are examples of Veblen goods

In searching for examples of Giffen goods, the focus has normally been on low quality staple foods, i.e. as the price rises, people can't afford to buy better quality foods and are forced to purchase more of the staple.

For many years, the oft-cited example of a Giffen good was the potato during the Irish Potato Famine of 1845-52. When the famine broke out, approximately one third of the Irish population was believed to have been dependent on the potato as their major source of food. Subsequently, this example was discredited when it was realized that more potatoes could not have been consumed even by the poorest one third of the population since there was such a severe shortage of potatoes - at its nadir the potato blight caused an 80% reduction in the potato crop.

More recently, it has been suggested that rice and wheat in parts of China show the characteristics of Giffen goods. In "Giffen Behaviour and Subsistence Consumption", a 2008 paper by Robert Jensen and Nolan Miller of Brown and Harvard universities, the authors claim:

"This paper provides the first real-world evidence of Giffen behavior, i.e. upward sloping demand. Subsidizing the prices of dietary staples for extremely poor households in two provinces of China, we find strong evidence of Giffen behavior for rice in Hunan, and weaker evidence for wheat in Gansu."

The amusing thing is that I saw a real time example of "Giffen behaviour" on Bloomberg News last week without needing to analyse consumption surveys from the Chinese hinterland. Before I get to that, when Alfred Marshall first publicized the idea of a Giffen good in 1895 he noted that:

"As Mr. Giffen has pointed out, a rise in the price of bread makes so large a drain on the resources of the poorer labouring families and raises so much the marginal utility of money to them, that they are forced to curtail their consumption of meat and the more expensive farinaceous foods: and, bread being still the cheapest food which they can get and will take, they consume more, and not less of it."

In light of those remarks, let's turn our attention to the current hyper-inflation in Iran and a section from a Bloomberg News' article "Iranians Abandon Meat for Bread as Protests Flare" on 4 October 2012:

"Iran's free-falling currency is turning meat into a luxury, sparking overnight price surges and spurring shoppers to stockpile goods.

 

'Most of my customers just look at products behind the window and pass,' said Behrouz Madani, 42, who owns a butcher shop in northwest Tehran. 'I see them going to the next store, which is a bakery, to feed their families with bread."

This is a perfect example of Giffen behaviour, but what about gold?

The lows in the gold price - there was a double bottom in 1999 and 2001 - were in the range US$250-300/oz:

We are currently in the eleventh year of rising prices. What about demand for gold?

When it comes to the supply and demand for gold, many people don't understand that it is IMPOSSIBLE to measure accurately, as almost all of the physical gold ever mined is still available as theoretical supply in the form of bars, coins or (scrap) jewellery. This is reflected in gold's stock-to-flow ratio, i.e. the ratio of above ground stocks to annual mine production. The ratio for gold is between 60-70 and is FAR higher than any other metal or commodity. Silver is the only one other one which even troubles the scorers. While the high stock to flow ratio is one reason for gold's suitability as money, it also makes estimating supply and demand problematic:

The flows between the buyers and sellers of the existing above ground stock of gold held for investment purposes CANNOT be measured;

 

The supply and demand models created by the World Gold Council, industry consultants and banks are only estimates of the end demand for INCREMENTAL ANNUAL PRODUCTION; and

 

In some of these models, the demand for gold for "Investment" purposes is just a balancing figure.

The difficulties don't end there. It is well known that India's demand for gold is a significant factor impacting supply and demand for gold. This is Sandeep Jaitly in his October 2012 "Gold Basis Service" newsletter:

"India remains the largest market for gold and silver by many magnitudes. What is not commonly appreciated is that whilst the recorded numbers for gold imports are big, the unrecorded are far larger. The 'black economy' of India is larger than that of any other country. Reported gold transactions courtesy of the well-known bullion organisations should always be taken with a pinch of salt."

However, there are some objective measures of key components of overall gold demand. Firstly, the aggregate amount of gold held in all known gold Exchange Traded Funds (ETFs). Bloomberg data goes back to October 2003 and is summarized in the following chart:

The current level is an all-time high at 82.958m oz (2,580.3 tonnes) - which is consistent with Giffen behaviour - demand for gold rising as the bull market in gold plays out.

Another source of measurable demand is from central banks, at least in terms of their reported activity. These venerable institutions have had an almost Damascene conversion as they have changed from sizeable net sellers to sizeable net buyers. We probably shouldn't be surprised that a) they were late joining the party and b) the inflection point was in 2008 - when the Great Financial Crisis hit - 7 years into the bull market.

Once again, this is evidence of Giffen behaviour with respect to gold. The data above obviously doesn't take account of likely additional purchases by China's central bank as per the discussion above. I use the term "Giffen behaviour" deliberately. Some economists argue that there are three necessary pre-conditions for a Giffen good:

• Firstly, there should be a lack of close substitutes. This is certainly true for gold as there are only two monetary metals - the other being silver - and the latter is both a monetary AND industrial metal. In contrast, other types of money, like paper currency and electronic credit, have no intrinsic value;
• Secondly, it should be an "inferior good" - a good that people buy more of when their income goes down. Once again, gold scores well here as gold's attraction increases in response to a rise in inflation/inflation expectations which have a negative impact on real incomes; and
• Thirdly, the good should constitute a substantial percentage of the consumer's income. This is much harder to argue in gold's favour. There is no doubt that growing numbers of people are allocating a larger slice of their savings (past income/future consumption) to gold, but that's about as far as the argument can be taken.

While two out of three "ain't bad", we'll stop short of attaching the term Giffen good to gold and instead focus on clear evidence of gold's Giffen behaviour.

Another point which shouldn't go unnoticed is the growing roll call of portfolio and hedge fund managers who, like the central banks, have been high profile gold advocates since the Lehman collapse in 2008. Here are a few relevant quotes:

Kyle Bass on CNBC on 12 March 2012:
You can call it what you want to call it..I call it money creation out of thin air and, therefore, gold has a lot further to go."

 

From WSJ's Market Watch on 15 August 2012:
"Hedge-fund managers John Paulson and George Soros boosted their gold holdings during the second quarter"

 

The "paper king" Bill Gross of Pimco, the world's largest bond fund, on Bloomberg TV on 5 September 2012:
"I just think it (the gold price) would be higher than it is today and certainly a better investment than a bond or a stock which will probably only return 3-4% over the next 5-10 years."

 

Ray Dalio when asked by whether he owns gold on CNBC on 21 September 2012:
"Oh yeah. I do. ..There's no sensible reason not to have some. If you're going to own a currency, it's not sensible not to own gold."

 

David Einhorn in the Huffington Post on 3 May 2012:
"I will keep a substantial long exposure to gold -- which serves as a Jelly Donut antidote (his characterisation of Bernanke's QE strategy) for my portfolio. While I'd love for our leaders to adopt sensible policies that would reduce the tail risks so that I could sell our gold, one nice thing about gold is that it doesn't even have quarterly conference calls."

Besides avoiding the quarterly conference calls, two other factors spring to mind:

We are in the midst of the biggest debt crisis in history and there is only one financial asset which doesn't have COUNTER-PARTY RISK; and

 

From Philip Barton's "The Dawn of Gold":

"A stock of anything has to be started at a moment in time. A stock of 170,000 tonnes does not just suddenly appear. At some point, long ago, the decision was made to begin to hoard gold. No one hoards something that will not hold its value over time. No one would put a dozen eggs or an iron bar in the back shed and expect it to have value fifty years later. The crucial point to understand is that when the original decision was made to begin to acquire and hoard gold, it must have already been regarded as a store of stable value over time, otherwise the decision to store it would not have been made."

Imagine if in 2007, Ben Bernanke, Mervyn King, Jean Claude Trichet et al, had actually possessed the analytical foresight to see what was coming, organised a meeting with the world's media and explained how, using their collective wisdom, they would solve the problem.

"There's going to be a massive global crisis, but there's no need to worry. We're just going to print money."

 

"Is that it?"

How would most people have reacted then? I think they would have laughed out loud. Why are so many of us reacting differently now?

For some reason, what's happening reminds me of a skiing holiday years ago when one of my friends, after putting on skis for the first time, was persuaded to take the chairlift to the top of the mountain with the immortal words "Don't worry, you'll be fine." He wasn't.

The nature of markets is that they periodically forget the lessons of history. One of them is that low interest rates (how about ZIRP?) and extreme monetary stimulus cause financial bubbles. Confidence in the status quo seems as entrenched now as it was in 2007. In 2009, I remember talking to a former colleague and, having been bullish on gold, he had turned bearish, arguing that everybody was bullish and that it was a crowded trade. My response was that if that was the case, then "everybody" wasn't bullish enough. Needless to say, he wasn't convinced.

With the star (and legend) of John Paulson long dead and buried, and his Disadvantage Minus fund an embarrassment, wrapped in a monkeyhammering, inside a humiliation, there are few "groupied" HF managers left. One of them is Dan Loeb, who still manages to generate positive Alpha regardless of how Beta does, another one used to be William Ackman (not so much anymore, especially not with the whole JCP fiasco), some others are David Tepper, Seth Klarman, and a few others, but nobody has quite the persistent clout and following of young master, and poker maestro, David Einhorn, and his fund Greenlight. Below we breakdown his latest just released 13F, which as a reminder shows, his holdings as of September 30. Key changes: Einhorn cut his holdings in Best Buy, Carefusion, Compuware, Expedia, Hess and UnitedHealth, and started new, small, positions in Yahoo, Babcock and Wilcox, Aecon and Knight Capital. More importantly, he cut his top position, Apple, by nearly 30% from 1.45 million to 1.09 million shares, cut modestly his second biggest position Seagate, added materially to GM, making it his third position, added to Cigna at #4 and added modestly to the GDX Gold Miners ETF. Sad to say, unless he has changed his portfolio dramatically since September 30, Einhorn is likely not doing too hot, especially in the last week or two.

Source: SEC

And as a bonus here is Dan Loeb's Q3 equity holdings. Obviously this does not include bond positions such as his (not quite so) recent foray into Portugal, and (his far more recent) purchase of Greek bonds on hopes of either a distressed buy back (not happening) or an OSI cramdown (Germany just said 9-9-9).

From GoldCore Gold Bullion

Silver To Climb 38% In 2013 - "Possibly Over $50/oz" Say GFMS

Today’s AM fix was USD 1,710.00, EUR 1,342.76, and GBP 1,077.91 per ounce. 
Yesterday’s AM fix was USD 1,723.50, EUR 1,351.45, and GBP 1,087.66 per ounce.

Silver is trading at $32.32/oz, €25.48/oz and £20.46/oz. Platinum is trading at $1,554.50/oz, palladium at $624.80/oz and rhodium at $1,095/oz.

Gold fell $11.00 or 0.64% in New York yesterday and closed at $1,714.00. Silver slipped to a low of $32.166 and finished with a loss of 0.15%.

 Silver ETP Holdings Climb 0.4% to Record 18,853.6 Metric Tons

Gold and silver have traded a bit lower on Friday and are both heading for a loss of 1% on the week in dollar terms. This is to be expected after the 3% and 5% returns of last week and the trading action this week has all the hallmarks of consolidation.

Interestingly, the sharp falls seen in the Japanese yen this week have created the unusual situation of gold and silver prices being nearly 1% higher in yen terms while lower in most fiat currencies.

The jobless claims numbers were higher than expected (439K vs 338K) yesterday and Superstorm Sandy’s wrath may have worsened an already weakening US economy. Unemployment benefits grew by 78K for the week ending November 10th.  

Many of those who lost their jobs were unable to immediately file claims due to the dislocation caused by the storm.  Sandy led to over 100 deaths, left no power in many homes, curtailed rail or subway services and insurance losses estimated are between $20 billion and $50 billion.

US industrial output figures for October are published at 1415 GMT.

If the US fiscal cliff isn’t sorted out it will weigh on the dollar and benefit gold however the fiscal cliff is just the preliminary bout in many challenges facing the $16.15 trillion indebted US economy.

The CME Group cut margins on gold and silver futures contracts in a bid to ignite trading interest which is bullish from a contrarian perspective.

Gold demand is still strong.  The SPDR Gold Trust holdings grew to 1,339.616 tonnes by Nov. 15, just a tad off the record high of $1,340.521 tonnes hit in October.

John Paulson kept a major stake in gold in Q3 2012, a confidence boost to bullion's appeal as a hedge against economic uncertainty, a US regulatory filing showed on Thursday. 

While John Paulson kept his current stake in the SPDR Gold Trust (NYSE:GLD), Soros increased his holding in the gold trust by 49% to 1.32 million shares.

Soros and his team, unlike many “experts”, clearly believe gold is not a bubble and will protect and grow his wealth in the coming years.

 
Silver in USD 5 Years – (Bloomberg)

Paulson, who became a billionaire in 2007 by wagering against the subprime mortgage market, owns about 5% of the SPDR Gold Trust, according to data compiled by Bloomberg. 

U.S. Securities and Exchange Commission filing for third- quarter holdings showed that Paulson & Co., the largest investor in the ETP, kept its stake at 21.8 million shares. While Bacon’s Moore Capital Management LP acquired 1.8 million shares in Sprott Physical Gold Trust last quarter.

While buying shares in the Sprott Physical Gold Trust, Moore Capital cut holdings in the SPDR Gold fund by 20,000 shares to 100,000 last quarter.  Patrick Clifford, a spokesman for New York-based Moore, declined to comment on the filing. Michael Vachon, a spokesman for Soros, did not reply to an e- mail sent by Bloomberg.

Their liquidation of the SPDR Gold Trust is an interesting development and one which might be seen more often of in the coming months due to concerns about the counter party risk in the SPDR Gold Trust.

Scout Capital Management LLC boosted holdings in the SPDR Gold Trust by 525,000 shares to 1.14 million shares, a filing showed yesterday.

Global ETP holdings reached a record 2,596.1 metric tons on Nov. 8 amid speculation that stimulus efforts will increase as the U.S. faces a so-called fiscal cliff of $607 billion in tax gains and spending cuts next year should Congress fail to act.

Gold Silver Ratio Quarterly – (Bloomberg)

Thomson Reuters GFMS has published research that says they project silver prices to rise 38% in 2013 from current levels, as a sluggish global economy increases safe haven demand.

The bullish silver GFMS forecast was published on the Silver Institute website yesterday and is unusual as the GFMS have been quiet bearish on silver in recent years despite rising prices.

Philip Klapwijk of GFMS said that “a rebound in investment demand stemming from continuing loose monetary policies is expected to drive silver prices towards and possibly over $50 during 2013.” 

Spot silver has risen over 17% this year overtaking gold’s 10% gain, and paving the way for its third consecutive rise in four years.

"Strong investment demand, higher gold prices on the back of monetary easing, rising inflation expectations and the persistence of ultra-low interest rates," are among the factors that will lure buyers to the safety of silver,” said Philip Klapwijk of GFMS.

"We are thinking prices will trend higher next year. I'm not convinced that we are going to $50. I think we will definitely see $40 to $45 prices."

Strong silver demand is seen by the increase of 4.5% in holdings of the iShares Silver Trust, the largest silver backed ETF (see chart above).

Klapwijk said, "In China, for example, jewellery demand is growing at a double digit pace," and predicts silver prices to trade between a low of $30.90 and a high of $36 for the rest of 2012.

Weaker industrial fabrication demand for silver is due to cuts in solar power subsidies in Europe which decreased demand from the electronics field and photovoltaic end users hence increasing the silver supply. In addition mine production has climbed 4% in 2012 said Klapwijk.

Cross Currency Table – (Bloomberg)

NEWSWIRE
(Bloomberg) -- IShares Silver Trust Holdings Fell 45.17 Tons as of Yesterday
Silver holdings in the iShares Silver Trust, the biggest exchange-traded fund backed by silver, declined to 9,985.18t, according to figures on the company’s website.

(Bloomberg) -- Gold Set for Record in India on Trend Signal: Technical Analysis 
Gold futures in India are poised to advance to a record in two to three months as the Raff Regression Channel indicates a rally, according to technical analysis by Kotak Commodities Services Ltd.

“It is time to buy as gold is trading within C1 and C in the channel, which shows positive trend,” said Mumbai-based Dharmesh Bhatia, associate vice president at Kotak, referring to the two trend lines which define the regression channel. Futures may touch 32,600 rupees ($593).

NEWS

Gold inches down; global economic uncertainty weighs - Reuters

CME lowers gold, silver, copper, natgas margins - Reuters

Swiss firm to build $18m gold refinery, bullion plant in Singapore– Asia One

State won't pay in gold or silver - Politico

COMMENTARY

VIDEO: Smart Money Billionaires Buy Gold; "Small Investors Have Spent Their Money" - Bloomberg

VIDEO: Gold Council: Middle Class Will Boost Gold Demand: Video - Bloomberg

Fiscal Cliff, Asian Currency Wars, Buoys the Gold market - GoldSeek

High gold prices push many Indians to silver - Mineweb

• More QE could distort rather than deliver (FT)
• Soros Buying Gold as Record Prices Seen on Stimulus (BBG)
• EU Leaders Face Greek Aid Gap in Brinkmanship With IMF (BBG)
• Weak data point to bigger economic drag from Sandy (Reuters)
• Shirakawa Pushes Back With Criticism of Abe Unlimited Easing (BBG) But... but... Bernanke??
• French Downgrade Widens Gulf With Germany as Talks Loom (BBG)
• Japanese Poll Shows LDP Advantage Ahead of Election (WSJ)
• BOJ in the Balance as Next Government Picks Top Posts (BBG)
• Exchanges Get Closer Inspection (WSJ)
• Greece edges closer to €44bn bailout (FT)
• Japan Government to Spend 1 Trillion Yen on Next Stimulus (BBG)
• China’s Richest Woman Divorces Husband, Fortune Declines (BBG)
• Judge Tosses Suit Over AIG - Ex-CEO Claimed New York Fed Breached Fiduciary Duty to Insurer's Shareholders (WSJ)

Overnight Media Digest

WSJ

* Moody's stripped France of its triple-A rating, following in the footsteps of Standard & Poor's and delivering a stinging critique of President Hollande's attempts to turn the economy around.

* Intel Corp was hit with the surprise departure of its longtime Chief Executive Paul Otellini as the company, which makes most of the chips found in personal computers, pushes to restore its sway over the high-tech sector amid an industry shift to smartphones and other mobile devices.

* JPMorgan Chase named finance executive Marianne Lake to succeed Douglas Braunstein as chief financial officer of the largest U.S. bank. The appointment, effective early next year, makes Lake one of the most powerful women on Wall Street.

* Honeywell International Inc said on Monday it expects the bulk of looming U.S. defense cuts to be implemented, and in a sharp break with rivals said it welcomes the reductions.

* U.S. hedge fund Jana Partners LLC launched a proxy battle for change at Canada's Agrium Inc naming five candidates for election to the company's board, including Jana managing partner Barry Rosenstein.

FT

INTEL CHIEF OTELLINI TO RETIRE IN MAY

Paul Otellini is stepping down from the top job at Intel , leaving no clear successor in place for the first time at the world's biggest chipmaker.

TERRA FIRMA ADVANCE ON MOD LANDLORD

Buyout group Terra Firma agreed to buy Annington Homes from Nomura in a deal worth 3.2 billion pounds.

CAMERON TARGETS CULL OF EU CIVIL SERVANTS

The EU's much-maligned civil servants are facing a cull and renewed pay restraint as the price of possible British support for an agreement on the bloc's long-term budget.

OSBORNE CASTS EYES ON PENSIONS OF RICH

George Osborne is considering a new tax raid on the pension contributions of richer voters, after rejecting the idea of a "wealth tax."

JP MORGAN REPLACES CHIEF FINANCIAL OFFICER

JPMorgan Chase & Co on Monday named Marianne Lake, financial chief of its retail banking unit, as chief financial officer of the company.

MOODY'S DOWNGRADES FRANCE FROM TRIPLE A

France suffered the second downgrade of its sovereign debt rating this year when Moody's, the U.S. rating agency, removed its triple A ranking on Monday night.

US BANKS IN RUSH TO PLUG CAPITAL SHORTFALL

U.S. banks are racing to fill a little-noticed capital shortfall by issuing billions of dollars of preferred shares.

HSBC IN TALKS OVER SALE OF PING AN STAKE

HSBC is weighing a sale of its $9.5 billion stake in Ping An Insurance, as the bank withdraws from non-core businesses amid a global drive to improve profitability.

NYT

* The president and chief executive of Intel Corp, Paul Otellini, is retiring after 40 years with the company. Intel said it would prepare to transition to a new leader over the next six months.

* JPMorgan Chase named a new chief financial officer on Monday, the latest management shake-up by the bank after a multibillion-dollar trading blunder earlier this year. Marianne Lake, will replace Douglas Braunstein as CFO early next year.

* Moody's Investors Service downgraded France's sovereign debt rating by one notch, to Aa1 from Aaa, the agency said on Monday, citing the country's uncertain fiscal outlook as a result of "deteriorating economic prospects."

* News Corp is starting to look like its old self again. The media conglomerate, which had been on its heels for more than a year because of the phone hacking scandal in Britain, is looking to make acquisitions again.

Canada

THE GLOBE AND MAIL

* Three of Canada's largest provinces are leading a revived effort to create a single agency to oversee the country's securities markets, an initiative that comes nearly one year after the Supreme Court's rejection of a national regulator.

Ontario has long been the closest provincial ally of the federal government in its fight to reform the country's patchwork system of securities regulation. But British Columbia and Alberta are also expressing a new openness to replacing Canada's 13 provincial and territorial regulators with a single entity that would police the buying and selling of securities.

* The pressure is on Ontario's Education Minister to avert further labour strife and approve five tentative deals that secondary school teachers say are within the stringent financial parameters dictated by the province.

The agreements, which Laurel Broten insisted must be "substantively identical" to terms agreed with the English Catholic teachers' union in July, came this weekend after school boards asked the Minister to define the phrase.

Reports in the business section:

* A new private equity firm, backed by members of Atlantic Canada's McCain and Sobey families, looked at 100 Canadian companies in a search for its first investment - but, in the end, it didn't travel far for its inaugural deal.

The McCain-Sobey vehicle, SeaFort Capital Inc, is buying A.W. Leil Holdings Ltd, a crane rental business based in New Glasgow, Nova Scotia, the home community of the Sobey supermarket family and not far from the McCains' New Brunswick frozen food base.

* Agrium Inc says a U.S. hedge fund's efforts to replace much of its board and spin off its retail unit is not supported by most shareholders, and is doomed to failure.

"We listen to our shareholders and the overwhelming majority continue to support the company's position," Mike Wilson, Agrium's president and chief executive officer, said as Jana Partners LLC launched a proxy battle to replace five of the company's 11 board members.

NATIONAL POST

* Documents show the sister of Alberta Premier Alison Redford used her position as a health board executive to attend and hold Progressive Conservative party events on the taxpayers' dime. There was money for liquor, travel, hotels, flowers and bug repellent.

Wildrose party Leader Danielle Smith, while releasing the documents Monday, said a bigger investigation is needed since Lynn Redford and those who signed off on those expenses remain executives with Alberta's health superboard.

FINANCIAL POST

* Amid growing investor discontent at Rona Inc, its U.S. suitor is retreating backstage as the battle for control of the Canadian company plays out in the weeks ahead.

Lowe's Companies Inc on Monday reaffirmed its interest in a Canadian acquisition as a way to build size. The comment was important because it means it still wants to do a deal after failing to win the backing of Rona's board and withdrawing in September its C$14.50 ($14.56) per share offer.

* A decision that killed BCE Inc's multibillion dollar bid for Astral Media Inc may have, ironically, helped pave the way for the deal's completion.

The country's largest telecommunications and media company filed a fresh offer for Astral with broadcast regulators on Monday, outlining changes and concessions it will make in order to win approval. The amendments are based on the lengthy and detailed decision issued by the Canadian Radio-television and Telecommunications Commission on Oct. 18 that flatly rejected BCE's original C$3.38 billion offer.

China

SHANGHAI SECURITIES NEWS

-- China's large tyre companies are looking to create a stabilisation fund aimed at stabilising the prices of natural rubber, the Shanghai Securities News reported on Tuesday quoting sources from an official rubber industry body.

CHINA DAILY (www.chinadaily.com.cn)

-- The company that equipped China's first aircraft carrier is ready to build more seagoing carriers, said Hu Wenming, chairman of China State Shipbuilding Corp, during the 18th National Congress that ended last week.

-- Police from China and the United States have arrested 73 suspects for running a joint operation to sell fake bags internationally. The police seized more than 20,000 counterfeit bags with fake Louis Vuitton, Hermes and Coach tags and destroyed 37 production and sales sites in May. The gang was believed to have sold more than 5 billion yuan of fake bags.

PEOPLE'S DAILY

-- China's communist party must empathise with the people and adhere to the spirit of the 18th National Congress to promote social harmony and improve the livelihood of the people.

Fly On The Wall 7:00 am Market Recap

ANALYST RESEARCH

Upgrades

AK Steel (AKS) upgraded to Neutral from Sell at Goldman
American Axle (AXL) upgraded to Hold from Underperform at Jefferies
Archer Daniels (ADM) upgraded to Outperform from Market Perform at BMO Capital
Boardwalk Pipeline (BWP) upgraded to Outperform from Neutral at Credit Suisse
Expedia (EXPE) upgraded to Equal Weight from Underweight at Barclays
Joy Global (JOY) upgraded to Market Perform from Underperform at BMO Capital
Penn National (PENN) upgraded to Neutral from Sell at Goldman
Pentair (PNR) upgraded to Outperform from Neutral at RW Baird
Peoples Bancorp (PEBO) upgraded to Outperform from Market Perform at Raymond James
Realty Income (O) upgraded to Buy from Neutral at Janney Capital
Research in Motion (RIMM) upgraded to Hold from Underperform at Jefferies
SVB Financial (SIVB) upgraded to Buy from Neutral at Citigroup
Vantiv (VNTV) upgraded to Buy from Hold at Jefferies
Whiting USA Trust (WHZ) upgraded to Neutral from Underperform at RW Baird
Whole Foods (WFM) upgraded to Buy from Neutral at Goldman
Zipcar (ZIP) upgraded to Buy from Neutral at Goldman

Downgrades

Cliffs Natural (CLF) downgraded to Sell from Neutral at Goldman
Emerson (EMR) downgraded to Perform from Outperform at Oppenheimer
Greif (GEF) downgraded to Market Perform from Outperform at Wells Fargo
Intel (INTC) downgraded to Neutral from Buy at UBS
Laredo Petroleum (LPI) downgraded to Market Perform from Outperform at BMO Capital

Initiations

Aetna (AET) initiated with a Buy at Lazard Capital
Boston Scientific (BSX) initiated with a Buy at Stifel Nicolaus
CareFusion (CFN) initiated with a Buy at Stifel Nicolaus
Christopher & Banks (CBK) initiated with a Buy at Capstone
Coach (COH) initiated with an Outperform at Wells Fargo
Columbia Banking (COLB) initiated with an Outperform at Credit Suisse
Covidien (COV) initiated with a Buy at Brean Capital
Deckers Outdoor (DECK) initiated with an Outperform at Wedbush
Geospace (GEOS) initiated with a Buy at Dahlman Rose
Intuitive Surgical (ISRG) initiated with a Hold at Stifel Nicolaus
Johnson & Johnson (JNJ) initiated with a Hold at Stifel Nicolaus
MPLX (MPLX) initiated with a Neutral at UBS
MPLX (MPLX) initiated with an Overweight at Morgan Stanley
Millennial Media (MM) initiated with a Buy at Janney Capital
Realogy (RLGY) initiated with a Neutral at Goldman
Realogy (RLGY) initiated with an Outperform at Wells Fargo
Realogy (RLGY) initiated with an Overweight at JPMorgan
The Medicines Co. (MDCO) initiated with an Outperform at Oppenheimer
Umpqua Holdings (UMPQ) initiated with an Underperform at Credit Suisse
UnitedHealth (UNH) initiated with a Buy at Lazard Capital

HOT STOCKS

Bayer (BAYRY) won’t increase bid for Schiff Nutrition (SHF)
Schulze reportedly seeking 30-day extension for bid on Best Buy (BBY), Bloomberg reported
JPMorgan (JPM) named Marianne Lake CFO
Atlas Resource Partners (ARP) to acquire DTE (DTE) unit for $255M
SandRidge Energy (SD) adopted stockholder rights plan, issued share dividend
Credit Suisse (CS) to combine asset management unit with private bank
Quanta Services (PWR) announced agreement to sell telecom units to Dycom (DY) for $275M
UnitedHealth (UNH) acquired 60% of Amil's outstanding shares in October
SunCoke Energy (SXC) and VISA Steel announced Indian joint venture
Statoil (STO) and Wintershall signed strategic gas supply agreement
Syngenta (SYT) to acquire Sunfield Seeds, details not disclosed
CBRE Group (CBG) acquired EA Shaw
Valmont (VMI) acquired manufacturing assets of Katana Summit
Sunshine Heart (SSH) received unconditional FDA approval for U.S. pivotal trial
Jack in the Box (JACK) provided 2014-2016 long-term goals, including targeting SSS sales growth of 2% to 3% annually at JITB company restaurants and 3% to 4% annually at Qdoba company restaurants

EARNINGS

Companies that beat consensus earnings expectations last night and today include:
Hormel Foods (HRL), Dycom (DY), Krispy Kreme (KKD), Brocade (BRCD), Shoe Carnival (SCVL), Agilent (A)

Companies that missed consensus earnings expectations include:
ShangPharma (SHP), Trina Solar (TSL), Navios Maritime (NM), America's Car-Mart (CRMT), Jack in the Box (JACK), Xueda Education (XUE), Urban Outfitters (URBN), Bob Evans (BOBE)

NEWSPAPERS/WEBSITES

Federal labor officials said  their top priority is to decide whether to seek an injunction on behalf of Wal-Mart Stores (WMT) which filed a complaint last week to stop worker protests at its stores over the Thanksgiving holiday, the Wall Street Journal reports
The SEC is stepping up oversight of stock exchanges as they scramble to catch up to trading advantages that some say have developed for sophisticated clients at the expense of ordinary investors, the Wall Street Journal reports
Shareholders in commodity trader Glencore (GLNCY) voted overwhelmingly in favor of its  $31B takeover of miner Xstrata (XSRAY), Reuters reports
Germany and France reached agreement under which each government would hold a 12% stake in EADS (EADSY) moving forward, according German newspaper Handelsblatt, Reuters reports
Exxon Mobil (XOM), Royal Dutch Shell (RDS.A) and their partners in Kazakhstan’s Kashagan oil field face a delay of at least two years on a plan to boost output 20% percent, reducing the time they have to recoup costs in the $46B project that’s already running eight years late, sources say, Bloomberg reports
The 12 year rally in gold is set to continue next year as central bank stimulus spurs investors from John Paulson to George Soros to accumulate the highest combined bullion holdings ever, Bloomberg reports

SYNDICATE

Alon USA Partners (ALDW) 10M share IPO priced at $16.00
Atlas Resource Partners (ARP) commences offering of 6.8M common units
C&J Energy (CJES) files to sell 3.297M shares of common stock for holder
Martin Midstream Partners (MMLP) commences offering of 3M common units
Memorial Production (MEMP) files to sell $205M common units for limited partners
Northfield Bancorp (NFBK) commences stock offering
Primerica (PRI) files to sell 3.6M shares for Warburg Pincus
Superconductor Technologies (SCON) files to sell common stock

ACTIVIST/PASSIVE FILINGS

1Globe capital reports 7.09% passive stake in Aeterna Zentaris (AEZS)
Carl Icahn raises stake in Chesapeake (CHK) to 8.89%
Master Global Assets reports 5.35% passive stake in GAIN Capital (GCAP)
SAC Capital reports 5% passive stake in The Medicines Co. (MDCO)
Tiger Global reports 9.9% passive stake in Groupon (GRPN)

Nobody can doubt that (in)famous short seller Muddy Waters, whose initial research pieces received broad distribution on the virtual pages of Zero Hedge, does sufficient due diligence on the companies they designate as targets of their ire. And just for humiliating John Paulson with the utter debacle that was Sino Forest they will forever live in the pantheon of "out of the blue", ad hoc bearish research analysts with a chip on their shoulder. Furthermore, right or wrong, Muddy Waters and their fraudcap peers do a great benefit to the investing society by testing, often repeatedly, the weakest links in the "story" of any one company (especially those out of the increasingly more criminal orient) - if right, it merely precipitates the bankruptcy of what will be a dead end corporate story and thus the misallocation of capital by lazier investors; if wrong, they allow management to generate higher IRRs by buying back their stock in the open market (a far better use of funds for honest management teams than suing independent third party research analysts who may or may not have a short stake). Yet sooner or later, everyone peaks. Has Muddy Waters? This is perhaps a relevant question now that the shorters have taken up another campaign, this time against Singapore agri-processor Olam. The raw data, compiled by Bloomberg is below: decide for yourselves.

Presented in chronological order:

• Orient Paper down 77% (ONP - June 28, 2010)
• RINO International down more than 99% (RINO - Nov. 10, 2010)
• China MediaExpress delisted after losing more than 99% (CCME - Feb. 3, 2011)
• Duoyuan Global Water down 96% (DGWIY - April 4, 2011)
• Sino-Forest delisted after falling 74% (TRE CN - June 2, 2011)
• Focus Media down 3.8% (FMCN - Nov. 21, 2011); FMCN then gained 59% since plunging 39% on day Muddy Waters issued report
• New Oriental up 32% (EDU - Muddy Waters report dated July 18, 2012);  EDU has more than doubled since falling 35% on day Muddy Waters issued report; that followed 34% drop the previous day, when co. said it was subject of SEC investigation

To not beat around the bush, was the June 2011 Sino Forest thesis MW's last magnum opus, and has all the low hanging fruit been picked already?

We have every confidence that Carson Block and company have only the purest of intentions (facilitated by a variety of incentives of course, monetary and otherwise), but perhaps it is time to reevaluate the business model. Because the last thing Muddy wants is to become the "fade" itself. One or two more flops, and the work product of the company, that may or may not be trying to raise capital to become a hedge fund, could easily become counterproductive.

And just a thought: China has more than enough fraud but how about targeting some US-based fraudcaps and criminal management teams for a change. There are plenty. And with cash flows imploding, and the bulk of US companies relying on GAAP tinkering and balance sheet shenanigans to carry them over until free cash flow "returns" (which in the New Normal won't happen), we are confident they will only increase, and that shifting MW's focus to the US may yield far greater results, both monetary and in terms of visibility, than persisting with the status quo.

• LA port workers to return Wednesday (AP)
• Iran says extracts data from U.S. spy drone (Reuters)
• Obama to stress need to raise debt limit "without drama" (Reuters)
• Big Lots Chief Probed by SEC (WSJ)
• NATO missiles to be sent to Turkey, Syria clashes rage (Reuters)
• Japan Can End Deflation in Months, Shirakawa Professor Says (BBG) ... almost as good as Bernanke ending inflation in 15 minutes.
• GOP Deficit Plan Irks Conservatives (WSJ)
• Osborne Prepares to Breach Fiscal Rules Amid U.K. Growth Slump (BBG)
• Global Banking Under Siege as Regulators Guard National Interest (BBG)
• Freeport plans return to energy (FT)
• Serbian NATO envoy jumps to death at Brussels airport (Reuters)
• Tide Turns After a Flood of Chinese Listings (WSJ)
• Australian economy loses steam (FT)
• Euro Crisis Feeds Corruption as Greece Slides in Rankings (BBG)
• Tesco signals end of American dream (FT)
• EU imposes record $1.92 billion cartel fine on Philips, five others (Reuters)
• Paris Faces Darkness as City Set for Illumination Ban (BBG)

Overnight Media Digest

WSJ

* The Securities and Exchange Commission launched an inquiry into a $10 million sale of stock by Big Lots Inc Chief Executive Steven Fishman before the company announced news that sank its stock, a person familiar with the inquiry said.

* Conservatives on Tuesday took aim at House Speaker John Boehner's deficit-reduction proposal in the fiscal cliff talks, a dispute that was aggravated by Boehner's decision to remove some conservatives from prized committees.

* Netflix Inc signaled that it is ready to rumble with traditional pay-TV channels such as HBO and Showtime. The Internet video company outbid Liberty Media Corp's Starz for the exclusive right to show Walt Disney Co movies about eight months after they hit theaters, establishing Netflix as a legitimate competitor to premium cable-TV channels by offering additional popular content for its Internet video streaming service.

* HSBC Holdings Plc said on Wednesday it is selling its entire stake in Ping An Insurance (Group) Co to Thailand's Charoen Pokphand Group for 72.74 billion Hong Kong dollars (US$9.39 billion).

* Samsung Electronics Co on Wednesday promoted the grandson of the company's founder to the position of vice chairman, a widely expected move that puts Jay Lee a step closer to eventually heading the electronics firm.

* Computer-chip giant Intel Corp is borrowing $6 billion in part to buy back stock, as U.S. companies continue to make use of forgiving debt markets to make bigger payouts to their shareholders.

* Detroit auto makers are piling up big stocks of passenger cars at dealers despite brisk new-vehicle sales in the U.S. - a problem that executives vowed to avoid since their painful downturn three years ago.

FT

UK FINANCE MINISTER TO EXTEND AUSTERITY INTO 2018

George Osborne will be forced to extend austerity deep into the next parliament, as he presents a bleak Autumn Statement against the backdrop of weaker growth and a larger deficit.

TESCO SIGNALS END OF AMERICAN DREAM

Philip Clarke, chief executive of Britain's biggest retailer, is expected to announce a strategic review of Fresh & Easy, alongside its third-quarter trading update on Wednesday.

HOPES RISE OF CUTS IN PENSION DEFICITS

Companies might be able to slash the deficits on their pension schemes at the stroke of a pen after a consultation to be unveiled by chancellor George Osborne on Wednesday.

PANEL PILLORIES FORMER HBOS CHAIRMAN

Lord Stevenson, former chairman of HBOS, was pilloried by Parliament after letters emerged in which he assured the City watchdog that the bank was secure just six months before its collapse.

SCHAUBLE PUTS BANKING UNION IN DOUBT

Plans to create a eurozone banking union stalled on Tuesday after Germany's finance minister cautioned over moving too quickly, casting doubts over whether the EU would seal a deal in 2012.

ABRAMOVICH BUYS NORILSK STAKE TO END STRIFE

Roman Abramovich, the Russian billionaire owner of Chelsea football club, has agreed to buy a 7.3 percent stake in Norilsk Nickel in a deal to end the company's long-running shareholder conflict.

BUFFET SEEKS $1BLN IN DAMAGES FROM SWISS RE

Warren Buffett's Berkshire Hathaway is claiming as much as $1bn in damages from Swiss Re, the reinsurer it propped up during the financial crisis with an emergency capital injection.

FED EYES MORE LONG-TERM DEBT FOR BANKS

US bank regulators are joining fellow bank supervisors in examining proposals to force the largest and most complex financial institutions to fund themselves with more long-term debt.

INTERSNACK HUNGRY FOR KP SNACKS DEAL

KP Snacks is about to be sold to German snacks maker Intersnack, paving the way for a possible disposal of the rest of United Biscuits' brands, including McVitie's Jaffa cakes next year, people familiar with the matter said.

NYT

* HSBC Holdings, one of Europe's biggest banks, said on Wednesday it would sell its entire stake in a leading Chinese insurer to a Thai conglomerate for 72.7 billion Hong Kong dollars ($9.4 billion.)

* Walt Disney Studios said on Tuesday that it had completed a deal to show films from its Disney, Pixar and Marvel banners on Netflix, replacing a less lucrative pact with Starz.

* Baxter International agreed on Tuesday to buy the Swedish medical equipment manufacturer Gambro for 18.3 billion Swedish crowns ($2.77 billion). Under the terms of the deal, Baxter will gain access to the Swedish company's lineup of medical equipment to expand its own range of dialysis products and build global market share.

* Former Goldman Sachs director, Rajat Gupta, may remain free on bail while he challenges his insider-trading conviction, a federal appeals court ruled on Tuesday. Gupta, 64, was found guilty in June of leaking Goldman's boardroom secrets to his friend, the former hedge fund manager Raj Rajaratnam.

* Republicans and Democrats are struggling to find common ground on a long-term debt deal. But as economic growth has weakened this quarter, they are at odds over what the flagging recovery needs in the immediate future, too.

* Finance ministers of the European Union were deadlocked on Tuesday over how to create a single banking supervisor for the euro zone, delaying a decision on a new system that is supposed to prevent future financial crises.

* Smartphone apps that use the Internet, rather than cell networks, to send messages among users, often free of charge, are forcing wireless providers to change their pricing models.

* Students are demanding that university endowment funds rid themselves of coal, oil and gas stocks in hopes of bringing climate change onto the national political agenda.

Canada

THE GLOBE AND MAIL

* The Ontario government is sending in a team to advise the Toronto District School Board on how to fix its operations following revelations of overspending on routine maintenance and major construction projects along with a growing deficit.

* Human resources minister Diane Finley said on Tuesday that many jobless Canadians who have been denied Employment Insurance benefits are waiting too long for appeals of those decisions to be heard.

Reports in the business section:

* Malaysia's state owned Petronas has made an 11th-hour public commitment to dramatically expand its proposed natural gas export plant on Canada's West Coast if Ottawa approves its C$6 billion ($6.04 billion) takeover of Progress Energy Resources Corp.

* Residential sales in Greater Vancouver's housing market tumbled in November, though sellers aren't panicking. Sales of single-family detached homes, condos and townhouses were down nearly 29 per cent from a year earlier, the Real Estate Board of Greater Vancouver said on Tuesday.

NATIONAL POST

* The Harper government pledged on Tuesday night to preserve hundreds of millions of dollars in Canadian humanitarian aid to the Palestinians.

FINANCIAL POST

* Three of Canada's largest oil companies have posted cautious budgets for 2013 amid uncertain pipeline plans, volatile oil and gas prices and efforts to keep costs from rising.

China

SHANGHAI SECURITIES NEWS

--China's consumer price index (CPI) could rebound to 2.3 percent year-on-year in November due to a rebound in food prices, analysts said.

CHINA SECURITIES JOURNAL

--Twelve listed companies have bought back a total of 9 billion yuan ($1.45 billion) in shares so far this year.

--Inner Mongolia Baotou Steel Rare-Earth (Group) Hi-Tech Co LTD said in a statement that it plans to pay 805 million yuan to buy 6 million tons of rare earths from its unlisted parent company.

21st CENTURY BUSINESS HERALD

--China's energy consumption per unit of GDP fell 3.4 percent in the first nine months of 2012, said Xie Zhenghua, deputy director of the National Development and Reform Commission.

PEOPLE'S DAILY

--China published a pamphlet showing the islands known as Senkaku in Japan and Diaoyu in China as sovereign Chinese territory, according to the State Oceanic Administration. The island chain is claimed by both China and Japan.

Overnight Media Digest

ANALYST RESEARCH

Upgrades

DST Systems (DST) upgraded to Equal Weight from Underweight at Evercore
Digital Realty (DLR) upgraded to Hold from Sell at Cantor
DuPont Fabros (DFT) upgraded to Buy from Hold at Cantor
PNC Financial (PNC) upgraded to Buy from Neutral at Compass Point
Republic Services (RSG) upgraded to Conviction Buy from Buy at Goldman
VeriFone (PAY) upgraded to Buy from Neutral at UBS
Waste Management (WM) upgraded to Buy from Neutral at Goldman

Downgrades

Adtran (ADTN) downgraded to Sell from Neutral at Citigroup
Altera (ALTR) downgraded to Neutral from Buy at ISI Group
Cliffs Natural (CLF) downgraded to Sector Perform from Outperform at RBC Capital
Darden (DRI) downgraded to Hold from Buy at Jefferies
Echo Therapeutics (ECTE) downgraded to Market Perform from Outperform at Northland
HEICO (HEI) downgraded to Sector Perform from Outperform at RBC Capital
Intel (INTC) downgraded to Underperform from Market Perform at Raymond James
NVIDIA (NVDA) downgraded to Perform from Outperform at Oppenheimer
TIBCO (TIBX) downgraded to Neutral from Buy at BofA/Merrill
WESCO (WCC) downgraded to Market Perform from Outperform at FBR Capital

Initiations

Bankrate (RATE) initiated with a Buy at Needham
Cobalt (CIE) initiated with a Buy at UBS
Concho Resources (CXO) initiated with a Buy at UBS
Continental Resources (CLR) initiated with a Buy at UBS
Cummins (CMI) initiated with an Outperform at RW Baird
Honeywell (HON) initiated with a Buy at Stifel Nicolaus
Kodiak Oil & Gas (KOG) initiated with a Buy at UBS
Limited (LTD) initiated with a Market Perform at FBR Capital
Rackspace (RAX) initiated with an Overweight at JPMorgan
Sanchez Energy (SN) initiated with a Sector Perform at RBC Capital
WhiteWave Foods (WWAV) initiated with an Overweight at JPMorgan
Whiting Petroleum (WLL) initiated with a Buy at UBS

HOT STOCKS

Canadian Pacific (CP) plans to cut 4,500 positions by 2016, 1,700  by year end
Sees compound annual revenue growth of 4%-7% through 2016
Still sees Q4 pre-tax charge of $180M
Trinity Industries (TRN) subsidiary acquired certain operations of Texas Industries (TXI)
Texas Industries to acquire ready-mix concrete business from Trinity Industries
Chemtura (CHMT) announced joint development agreement with Caterpillar (CAT)
Goldman Sachs (GS) in pact to sell First Marblehead (FMD) stake
Tesco PLC (TSCDY) announced strategic review of Fresh & Easy
Nokia (NOK) partners with China Mobile (CHL) to launch Lumia 920T in China
Nokia Siemens Networks (NOK, SI) to sell Business Support Systems to Redknee
Teekay LNG (TGP) to acquire 50% of Exmar as result of joint venture
Eli Lilly (LLY), Strides Arcolab enter strategic partnership agreement
AOL's (AOL) Advertising.com Group acquired Buysight, terms not disclosed
NCI Building Systems (NCS) said FY13 should be a year of "significant growth"
Altera (ALTR) cited lower sales in 'older products' for lower Q4 revenue guidance
Sees FY13 gross margin 69%-70%
WESCO (WCC) received clearance to acquire EECOL Electric
Oil-Dri Corp. of America (ODC) declared accelerated cash dividends
Chelsea (CHTP): FDA previously said 306B unlikely to provide enough evidence for NDA
Jazz Pharmaceuticals (JAZZ) announced issuance of patent related to Xyrem
American Axle (AXL) announced new business backlog of $1.25B for 2013-2015
AECOM Technology (ACM) expects to generate at least $1B free cash flow in next five years
PSEG (PEG) sees costs associated with Hurricane Sandy of $250M-$300M

EARNINGS

Companies that beat consensus earnings expectations last night and today include:
Phototronics (PLAB), Powell (POWL), AeroVironment (AVAV), Envivio (ENVI), SeaChange (SEAC), Pandora (P), Mattress Firm (MFRM)

Companies that missed consensus earnings expectations include:
Mitcham Industries (MIND), Oxford Industries (OXM)

Companies that matched consensus earnings expectations include:
Vitesse (VTSS), NCI Building Systems (NCS)

NEWSPAPERS/WEBSITES

The SEC launched an investigation into a $10M stock sale by Big Lots (BIG) CEO Steven Fishman before the company announced news that sank its stock, sources say, the Wall Street Journal reports
U.S. crude-oil production reached its highest level in nearly 15 years in September, thanks in large part to the drilling method known as hydraulic fracturing, said the U.S. Energy Information Administration. Daily production averaged about 6.5M barrels, an increase of 16%, or about 900,000 barrels, over September 2011, the Wall Street Journal reports
The Federal Reserve is set to announce a new round of Treasury bond purchases when it meets next week, avoiding monetary policy tightening to maintain support for the weak U.S. economy amid uncertainty over the looming year-end "fiscal cliff," Reuters reports
The Pentagon approved a plan that will allow the U.S. Air Force to buy up to 36 rocket launches for government satellites from a joint venture of Lockheed Martin (LMT) and Boeing (BA), while opening up to 14 launches to competition from other companies, Reuters reports
The SEC’s move to sanction auditors for blocking investigations at China-based companies, have set a course that jeopardizes the listing of more than 100 stocks from China, Bloomberg reports
Paulson & Co.’s John Paulson, manager of $20B in hedge funds, told investors that the bulk of his losses this year came on bets that the European sovereign-debt crisis would worsen, sources say, Bloomberg reports

SYNDICATE

AcelRX (ACRX) files to sell 10M shares of common stock
Atlas Pipeline Partners (APL) 9.75M share Secondary priced at $31.00
Colony Financial (CLNY) commences offering of 10M shares of common stock
First Business Financial (FBIZ) 1.1M share Secondary priced at $23.00
LyondellBasell (LYB) announces offering of 21M ordinary shares for holders
Parkway Properties (PKY) 13.5M share Secondary priced at $13.00

Authored by Lee Quaintance and Paul Brodsky of QBAMCO,

Gold bugs can’t understand how the public can be so unaware, how highly intelligent policy makers can be so immoral, and how the mainstream media can be so incurious. We can’t understand why more men and women in the investment business haven’t joined some of the more successful ones that have come around to precious metals and have taken substantial positions in them for their funds and personal accounts. The list of high profile independent-minded investors that have come out of the proverbial closet is impressive and growing: Kyle Bass, John Paulson, David Einhorn, George Soros, Bill Gross and Paul Singer, to name only a few.

Conventional financial asset selection guidelines for professional investors are becoming increasingly uneconomic and problematic. Current macroeconomic conditions leave little doubt as to why. A zero-bound rate structure across developed economies, heavy monetary policy intervention, guaranteed negative real returns of benchmark financial assets and cash, impossible discount cash flow models,cacophonous (and economically meaningless) fiscal political wrangling diverting attention from legitimate budget arithmetic ($800 billion over ten years when we’re running $1 trillion-plus annual deficits?), dubious short and intermediate-term prospects in already-emerged emerging economies, and non-trending financial markets, all suggest something has changed.

Regardless of whether one is investing personally or as a fiduciary, conventional financial asset allocation models and procedures are obviously failing and the reason is simple: the currencies in which financial assets are denominated are gravely flawed– levered beyond reconciliation and incapable of generating positive real returns for assets denominated in them, or ongoing consumer and business confidence while the leverage is being transferred from banks to central banks, and from central banks to government balance sheets. The political/policy dimension is boxed. We think prudence demands stepping away from conventional financial asset allocation models.

Here is what matters...

Qbamco - It's Time

Following up on our recent discussion of the worst-is-first rally that we have all been witness to in the last few weeks, we thought it noteworthy that the 'most-shorted' names in the Russell 3000 and the index itself have now recoupled from their epic divergence post-QE3. We have seen five large short squeezes 'engineered' since the lows in March 2009 - and given Citi and BofA's 17% gains in December alone, we suspect (and have heard from more than a few funds) that year-end is bringing some forced buy-ins as SecLend desks become a little more activist.

The 'Squeezes'

QE3's Epic Fail (and Win)... as the index and its shorts have now recoupled post QE3

And despite the fact that half BofA's market cap is at risk in 60+day delinquent mortgage loans, it has scaled the epic ranks of a 17% gain in December alone... all makes perfect sense...

Was John Paulson really Short Financials and Long Gold / Silver - perhaps?

Charts: Bloomberg

Submitted by Dave Collum via Peak Prosperity,

Background

I was just trying to figure it all out.

~ Michael Burry, hedge fund manager

Every December, I write a Year in Review that has now found a home at Chris Martenson’s website PeakProsperity.com.^1,2,3 What started as a simple summary intended for a couple dozen people morphed over time into a much more detailed account that accrued over 25,000 clicks last year.⁴ 'Year in Review' is a bit of a misnomer in that it is both a collage of what happened, plus a smattering of issues that are on my radar right now. As to why people care what an organic chemist thinks about investing, economics, monetary policy, and societal moods I can only offer a few thoughts.

For starters, in 33 years of investing with a decidedly undiversified portfolio, I had only one year in which my total wealth decreased in nominal dollars. For the 13 years beginning 01/01/00—the 13 toughest investing years of the new millennium!—I have been able to compound my personal wealth at an 11% annualized rate. This holds up well against the pros. I am also fairly good at distilling complexity down to simplicity and seem to be a congenital contrarian. I also have been a devout follower of Austrian business cycle theory—i.e., free market economics—since the late 1990s.⁴

Each review begins with a highly personalized analysis of my efforts to get through another year of investing followed by a more holistic overview of what is now a 33-year quest for a ramen-soup-free retirement. These details may be instructive for those interested in my approach to investing. The bulk of the review, however, describes thoughts and observations—the year’s events told as a narrative. The links are copious, albeit not comprehensive. Some are flagged with enthusiasm. Everything can be found here.⁵

I have tried to avoid themes covered amply in my previous reviews. There is no silver bullet, however, against global crises, credit bubbles, and feckless central bankers. Debt permeates all levels of society, demanding comment every year. Precious metals and natural resources are a personal favorite. This year was particularly distorted by the elections; I offer my opinions as to why. Sections on Baptists, Bankers, The Federal Reserve, and Bootleggers describe the players in Jack Bogle’s Battle for the Soul of Capitalism.⁶ Special attention is given to a financial crime diaspora fueled by globally overreaching monetary policies. Everything distills down to a relentlessly debated question: What is the role of government? I finish light with the year’s book list that shaped my thinking. I acknowledge individuals who have made pondering capitalism a blast through direct exchanges over the years. They brought wisdom; I brought the chips and dip. You already know who you are. And then there are those characters whose behavior is so erratic, sociopathic, criminal, or just plain inexplicable—you guys are central to the plot. I leapfrog Rome and Titanic metaphors and go straight to the Lusitania.

One last caveat: I subscribe to the Aristotelian notion that one can entertain ideas without necessarily endorsing them, often causing me to color way outside the lines. With trillions of dollars circumnavigating the globe daily, nefarious activities are not only possible but near certainties. If you are prone to denounce conspiracy theories and conspiracy theorists to avoid unpleasant thoughts, you should stop reading now. I’m sure there’s another Black Something sale at Walmart. If you are a bull, you should also bail out or buckle up. This is the bear case. I will remain a permabear until some catharsis knocks me off my stance and they find a cure for my market- and politics-induced PTSD.

As this review was being completed, Lauren Lyster and Demetri Kofinas recently uploaded a companion interview on the Year in Review I did with Capital Accounts on RT_America (to be aired on December 21st and posted on Youtube.)⁷ In this context I offer wisdom from the Master:

If there is ever a medium to display your ignorance, television is it.

~ Jon Stewart

Footnote superscripts appear extensively throughout this review. The actual footnotes and associated hyperlinks can be found here.

Contents

• Background
• Contents
• Investing
• Thinking About Capitalism
• Election Year
• Events
• Broken Markets
• Precious Metals
• Resources and Energy
• The Baptists
• The Bankers
• The Federal Reserve
• The Bootleggers
• Personal Debt
• Mortgage Debt
• Student Debt
• Municipal and State Debt
• Corporate Debt
• Sovereign Debt
• Pension Crisis
• Roth IRAs: A Bad Idea
• Europe
• Asia
• Government Corruption
• Civil Liberties and the Constitution
• Limits of Government
• Books
• Acknowledgements
• Links

Investing

The elevated prices of financial assets have already eaten the future.

~ John Hussman, CEO of Hussman Funds

With rebalancing achieved only by directing my savings, I have changed almost nothing consequentially in my portfolio year over year. The total portfolio as of 12/15/12 is as follows:

Precious Metals et al.: 52%

Energy: 15%

Cash Equiv (short-term): 30%

Other: 3%

Most asset classes lurched off the starting line in January like Lance Armstrong. My portfolio eventually settled down and spent most of the year snorkeling slightly up or slightly underwater. In a relatively rare instance, an overall return on investment (ROI) of 4% was beat handily by both the S&P 500 (13%) and Berkshire Hathaway (17%), although nearly the entire return of the S&P was p/e expansion.⁸ A majority of hedge funds struggled to beat the S&P this year as well.⁹

My precious metals are distributed in approximately three equal portions to the gold-silver holding company Central Fund of Canada (CEF), Fidelity’s precious metal fund (FSAGX), and physical metals (Figure 1). Gains in gold (17%) and silver (8%) were offset by a horrendously lagging performance for the second year in a row by the corresponding precious metal-based equities (-10%). The metal-equity divergence began in January 2011 and continues to baffle the hard-asset crowd (Figure 2). A plot of the ratio of the silver ETF (SLV) versus the world’s largest silver miner, Pan American Silver (PAAS), is striking (Figure 3). In May I emailed a dozen gurus for opinions about arbitraging (swapping) an SLV position for PAAS. Realizing that collectively these folks controlled billions of dollars, I felt I had to move on the idea pronto (my only portfolio change for the year). After a few weeks of an overwhelming sense of superiority, gyrations eventually left the arbitrage at about break-even. I’m guardedly optimistic about the precious-metal equities, but they have been widowmakers for two years.

Figure 1. Precious-metal-based indices (GLD in green, XAU in red, SLV in brown, and XAU in red) versus the S&P 500 (in blue) for 2012.

Figure 2. Relative performance of gold-based equities (XAU in red) vs. gold (GLD in blue).

Figure 3. SLV/PAAS ratio over three years.

A basket of Fidelity-based energy and materials funds afforded 2-16%. They are represented emblematically by the XLE spider (3%) and XNG Amex natural gas index (1%) in Figure 4. I am wildly bullish on natural gas for reasons discussed in detail two years ago.² Unfortunately, Fidelity’s natural gas fund (FSNGX) foisted upon me by Cornell got crushed in 2009 and subsequent years relative to its peers. Making the right calls is hard enough without that kind of headwind. New management as of 2010 seems to be finally tracking the XNG. I keep adding to an already chunky position. Friends deeply embedded in the energy complex suggest that the fracking glut will take 2-3 years to burn off. (It is also claimed that the derivatives traders are whacking out the price discovery; what else is new?)¹⁰ A global shift toward natural gas should reward patience.

Figure 4. Energy-based indices (XLE in red and XNG in green) versus the S&P 500 (in blue) for 2011.

Cash was in a U.S. Treasury-backed money-market bunker returning 0%. I had a $25K money market fund that failed to reach the IRS taxable threshold! I could care less what risky gangplank Bernanke wishes that I walk. Buying ten-year Treasurys returning <2%, with or without your finger quivering over the sell command, is a fool’s game: I’ll take the yield hit. The bond market will eventually become a killing field. Those who are pair trading—long bonds/short brains—will get their organs harvested. This seems like a near certainty.

The most disappointing part of the year was a personal savings equivalent of only 11% of my gross income compared with 29% last year and 20-30% in typical years. Unusual expenses in the form of a year of college education, a serious violin upgrade, and very large landscaping costs don’t excuse the fact that we chose lower savings over lower consumption. This troubles me deeply. Profound austerity is not a cause but an effect, something the Europeans may be just now figuring out.

To understand my lifetime returns, you must understand two unusual premises that have dominated my thoughts and actions. First, you must become wedded to an investment. Did I just say that? Yep. You’ve got to be a true believer to resist being shaken out of good investments or suckered into bad ones. Many say it’s never a bad time to take a profit. Total hooey. Those ten-baggers—the miracles of compounding—will never materialize if you bail after 20%. Just ask the Microsoft investors who exited in 1990 for a handsome profit.

My second premise is that you have to get it right only about once a decade. One of my favorite bloggers and an e-pal, Grant Williams, illustrated how daisy-chaining four secular bull markets—Gold, Nikkei, NASDAQ, and Gold—could have produced a virtual return of 640,000%—a 6400-bagger (Figure 5).¹¹ Admittedly, this kind of luck is only found in Narnia. Statistically, somebody might have done this, although not likely in such a Texas Hold’em all-in fashion.

Figure 5. Sequential investments in secular bull markets starting in 1970.¹¹

My variant of such a sequential trek via imbalanced portfolios changed in decadal rhythms as follows:

1980-88: exclusively bonds (100%)

1988-99: classic 60:40 equities:bonds

1999-2001: cash, precious metals, shorts (minor)

2001-2012: cash, precious metals, energy, tobacco (minor)

My total wealth accumulated through a combination of savings and investment as shown in Figure 6. (I redacted the dollar amounts along the y-axis.) Avoiding 1987 and 2000 equity crashes and capturing the bull market in precious metals proved fortuitous. You can see that 2008 was the only down year. Berkshire has dropped five years since 1991. A 13-year accumulation rate beginning 01/01/00 of 11% annualized compares favorably to an annualized return on the S&P of -0.03% and on Berkshire of 7%.

Figure 6. Total wealth accumulated (ex-housing) versus year of employment. Absolute dollar values have been omitted.

I also monitor overall progress by what I call a salary multiple, which is defined as the total accumulated investable wealth (excluding my house) divided by annual salary (line 22 of the 1099 form excluding capital gains). Over 33 years my salary (actually total income) rose twelve-fold, which I can fairly accurately dissect into a fourfold gain resulting from inflation and a threefold gain (relative to starting salaries of newly minted assistant professors) due to increasing sources of income and merit-based pay raises. My accumulated wealth normalized to the moving benchmark of a rising income is plotted versus time in Figure 7. The fluctuations visible in Figure 7 not apparent in Figure 6 result from income variations.

Figure 7. Total wealth accumulated measured as a multiple of annual salary versus years of investing.

To clarify the origins of a 13-year return of 11% per year I offer Figure 8. By plunging into the precious-metal and energy sector early and avoiding all other forms of investments (S&P in particular), I was able to capture the entire hard-asset bull market. According to Money magazine’s calculator,¹² I can spike the ball in the endzone and dance. They are wrong. My ultimate target—a valid target—is to accumulate 20 salary equivalents over the next 12 years (age 70). This will require an inflation-adjusted (real) annual growth of 4-5%. Some of that will come from savings. As you can tell by the Hussman quote and discussions below, however, such gains are not assured.

Figure 8. Plot of Central Fund of Canada (CEF; 1:1 gold:silver by value), XLE, and S&P.

Thinking About Capitalism

When the blind lead the blind get out of the way.

~ First grader

I realize that is what I do—I think about capitalism. It’s not deep stuff; more like taking a weed whacker to a hay field of information. This year, however, there was something askew—something corrupting the information flow. It was the presidential elections. This is a good starting point.

Election Year

No serious person would question the integrity of the Bureau of Labor Statistics. These numbers are put together by career employees.

~ Alan Krueger, White House Council of Economic Advisers

To a news and economic data junkie, presidential elections are profoundly distorting. The news feeds are inundated by election analyses that are mundane at best and nauseating on a bad day. It’s a variant of Gresham’s Law—bad information pushes out good. The pundits are either talking about the elections explicitly or couching potentially credible news stories in the context of the election. Terrorist attacks in Benghazi mutate into Obama’s Big Screw Up. The news feeds are further corrupted by billions of campaign dollars spent to deceive us. Frank Rich, award-winning New York Times journalist, estimates that George Bush had 120 “journalists” on payroll. They get overtime and hazard pay during elections. The shenanigans go deeper.

There have been numerous accusations of voter fraud. From my recollection, it was mostly the left accusing the right (the CEO of Diebold in particular). A window opened when the mischievous computer hackers, Anonymous, did a smash-and-grab on Stratfor’s server, obtaining over 5 million emails. Stratfor provides confidential intelligence services to large corporations and government agencies, including the U.S. Department of Homeland Security, U.S. Marines, and U.S. Defense Intelligence Agency. From 971 emails released to date (by Wikileaks), we find that Democrats stuffed the ballot boxes in Pennsylvania in 2008 that went unchallenged by McCain. Jesse Jackson shook down Obama for a six-digit payoff.¹³ Emails detailing the Bin Laden capture are worth a peek.

The most insidious election year distortion may be the tainting of economic data feeds that the marketplace relies on. Data coming from career statisticians in the federal government are always suspect. The inflation numbers, for example, are widely believed to be cooked beyond recognition using corrections recommended by the Boskin Commission.^14,15 This year, however, the data massaging morphed into an all-out rub ‘n’ tug to ensure a happy ending for the Democrats.

The data from the Bureau of Labor Statistics (BLS) are especially susceptible to corruption. The Birth-Death Model, for example, estimates new jobs being created that nobody can detect.¹⁶ Apparently, the absence of data demands that some get fabricated. These embryonic jobs have reached epidemic proportions—hundreds of thousands per month—oftentimes overwhelming the detectable jobs. Curiously, no administration ever fabricates undetectable job losses.

Another trick is a very simple iterative process for reporting statistics: Step 1—Announce inflated economic statistics as good news; Step 2—correct the inflated statistics at some later date to a very deflated number, hope nobody notices, and call it “old news anyway”; Step 3—Report new inflated numbers that are spectacular improvements relative to the recently deflated statistics. Rinse, lather, repeat.¹⁷

The fibbing gets serious during an election year. When pre-election unemployment numbers plummeted by 0.4%—a monumental drop—the response was immediate, visceral, and seemingly uncontestable disbelief. David Rosenberg expressed it well:

I don't believe in conspiracy theories, but I don't believe in today's jobs report either.

~ David Rosenberg, Gluskin Sheff and ex-Merrill Lynch

Well, Rosie, apparently you do believe in conspiracy theories. Within minutes of the report Jack Welch, no neophyte to creative bookkeeping, released his now-infamous Tweet:

Unbelievable jobs numbers...these Chicago guys will do anything... can't debate so change numbers.

~ Jack Welch, former CEO of General Electric

It was an election year, however, so the goofy employment numbers morphed into a hot-button issue. Right-wing pundits accused the Obama administration of cooking the books. Left-wing pundits fired back with the shrill accusation, “Conspiracy theorists!” Few remembered that the GOP accused the Democrats of cooking the same numbers back in 2003.¹⁸

The whole sordid affair took a strange turn when Zero Hedge noted an odd mathematical relationship between the two carefully measured employment statistics:

Measured employment numbers:

fully employed/partially employed = 873,000/582,000 = 1.5000…

Gosh. What are the odds that those numbers were actually measured? I would say about 2.000…%.¹⁹

Counting those who no longer receive unemployment benefits as no longer unemployed, an accounting gimmick that became chronic once the crisis began, by no means was invented by Team Obama. None of this is new. LBJ was rumored to send economic statistics back to the kitchen for more cooking. The U-6 unemployment numbers account for that mechanical engineer who is now a part-time “deposit bottle recycling engineer and firewood procurement officer.” U-6 is a more accurate measure of the employment stress and is staying persistently above 14%.²⁰

Election year pandering may contribute to a very odd stock cycle.^21,22 If you break the 20th and 21st century into 27 four-year fragments corresponding to the election cycle—2009-2012 being the most recent—and average the returns, you get what is called the Presidential Election Cycle (Figure 9). What causes this cycle? One cannot exclude the role of friendly central bankers (sado-monetarists) juicing the markets. Mitt Romney, when he promised to fire Bernanke, may have sealed his fate.

Figure 9. Four-year election stock cycle throughout the 20th century.²¹

Maybe the four-year cycle in Figure 9 is a statistical anomaly and, even if real, we may not have a clue why it occurs. Nevertheless, it suggests that “Sell in May and go away” has a longer wavelength variant: “Buy the midterm and sell the Presidential.” Urban legend or not, 2013 is looking dangerous.

Events

Dan, quit embarrassing yourself.

~ Caroline Baum of Bloomberg Tweeting to a money guru who claimed that Hurricane Sandy will be stimulative

Acts of God—force majeure—tantalize market watchers and sophists alike but seem to have little effect on even the intermediate term: Economies and markets just keep marching forward. Katrina took its toll and irreparably altered lives, but it primarily illustrated government doing a heckuva job. Hurricane Sandy also exacted revenge against the civilized world (and New Jersey). It may portend things to come, should global warming live up to its billing. There is no doubt that corporations will use Sandy as an excuse for anything and everything. Q4 and year-end reports will have more Sandy-derived debris (including kitchen sinks) than dumpsters along the Jersey shore. Sandy also ushered in like clockwork the absurd claims that Frédéric Bastiat was wrong and that smashing windows and destroying infrastructure is good for the economy. Sandy will increase the GDP, but that is not economic gain. Sandy will be a bump in the road for the nation at large.

As I write this paragraph, cremnophobia—fear of cliffs—is sweeping the land. I submit that base-jumping the Fiscal Cliff may be exciting but doubt it will be some proximate trigger that causes cascading failure. The move to substantially greater austerity seems inevitable and likely to be painfully protracted—think Japan. The Fiscal Cliff would be a fumble on our own ten-yard line. It is just one down in a very, very long game. Regardless of outcome, this will be a topic for my 2013 Year in Review.

Broken Markets

A strange game. The only winning move is to not play.

~ The W.O.P.R. computer on “Wargames”

Since Cro-Magnon Man began trading flint, furs, and women, there have been nefarious activities in the marketplace. Painting the tape—moving markets at the end of a quarter to dupe customers—is tolerated. The pop icon Jim Cramer spilled his guts describing how players of even modest means can push prices around.²³ I bet Jim would like a do-over on that video. Options expiration week is always exciting, as the options dealers purportedly move the equities to minimize payouts on the heavily leveraged options to maximize pain on the plebeians. Insider trading is a death sentence for a nobody, but is a misdemeanor for the big bankers. When caught, the going rate on the punishment of investment banks is a 3-5% surcharge on the profit from the illicit trade. One can only imagine how much it would cost us in punitive rebates if the criminal behavior caused a loss.

In general, however, blaming markets for your losses is a fool's game. Nonetheless, something has changed. The Federal Reserve—the Fed—has explicitly stated a vested interest in both the magnitude and direction that markets move, abandoning all willingness to let markets determine prices. These guys are playing God, taking full possession of our hopes and dreams. In analogy to global warming, their loose monetary policy jacks up prices with markedly increased volatility and enormous social costs. Kevin Phillips’ 2005 American Theocracy is a brilliant account of the demise of Western empires. He notes that the final death rattle is the financialization of the economy. When moving money becomes the primary economic activity, the end is near. Let’s look at some of the symptoms.

The high frequency traders (HFTs a.k.a. “algos” or cheetah traders) have really upped their game. The title of this section stems from Sal Arnuk’s and Joe Saluzzi’s book Broken Markets, which describes the seedy world of supercomputers skimming enormous profits. It is consensus that HFT’s are profitable for the trading platforms but of little merit otherwise. They gum up the system intentionally to garner advantage and dump millions of fake quotes to be cancelled within milliseconds.²⁴ None of this is legal, but all is tolerated. They are now trading for razor-thin profit margins of as little as $0.00001 skim per share but making it up on volume—dangerously large volume. One Berkshire Hathaway trade—a $120,000 per share stock—is rumored to have netted $10 total (0.8 cents per share).²⁵

The markets are now at great risk. We should not expect that profiteers benefit society. We can demand that they don’t bring the entire system to its knees. I got my ten seconds of fame in an article describing the consequences of the legendary Flash Crash on May 6th, 2010:²⁶

Wall Street is a crime syndicate, and I am not speaking metaphorically... The banking system is oligarchic and the political system has metastasized into state capitalism. The most important market in the world—the market in which lenders and borrowers meet to haggle over the cost of capital—is the most manipulated market in the world.

~ David Collum, WSJ

Flash crashes are now daily occurrences, as thoroughly documented by market research firm Nanex, and are not restricted to any one market. India tanked 15% in a few minutes.²⁷ The precious metals appear to be a favorite playground: “At 1:22 p.m. SLV was forced down by rapid-fire machine-generated quotes—more than 75,000 per second.”²⁸ Berkshire Hathaway—Berkshire Hathaway!—dropped from $120,000 a share to $1 for a few milliseconds.²⁹ Commodity Futures Trading Commission (CFTC) commissioner Bart Chilton says that the “third largest trader by volume at the Chicago Mercantile Exchange (CME) is one of these cheetah traders in Prague."³⁰ (Bart appears to be a supporter of clean markets, though I remain distrustful.) On August 1st, 150 stocks swung wildly. In a heavy dose of irony, the wildest—a 40% swing—was a company called Bunge.³¹ The monstrous oil market flash crashed when a 50-fold spike in trade volume hit the tape.³² Some fear a flash crash in the unimaginably large U.S. Treasury market.³³

Irony reached a fevered pitch when BATS Global Markets (BATS), the third largest trading platform behind NYSE and NASDAQ, listed their own IPO.³⁴ Their primary customers—the cheetah traders—drove the share price from $16 to 1 cent in 900 milliseconds, forcing the cancellation of the IPO. Knight Trading, while beta-testing their own HFT algo, released it to the wild. While the traders snarfed down celebratory mochaccinos, a pesky sign error caused the HFT algo to buy high-sell low for a very long 45 minutes.³⁵ One of the most respected trading firms in the business was shopping itself to potential buyers within 24 hours. The standard excuse for erratic market behavior—Disney-like “fat-fingered traders” hitting the wrong key on a trade—became comical alibis for deep-seated structural flaws in the markets.

We have a huge problem. Don’t take my word for it. Let’s listen to what some of the pros have to say:

All this trading creates nothing, creates no value, in fact, subtracts from value.

~ John Bogle, inventor of the index fund

Essentially, the for-profit exchanges are approving their own rule changes. The lunatics are now running the asylum.

~ Joe Saluzzi, cofounder of Themis Trading

 High-speed trading, if we may get our two cents in, is a dubious activity to label as a technological advance.

~ Alan Abelson, Former Editor of Barrons

Not all IPOs flash-crashed; some simply beat investors like rented mules using more traditional methods. I had an entertaining Twitter exchange with Sal Arnuk, cofounder of Themis Trading and coauthor of Broken Markets, on May 18th just hours before the now-infamous Facebook IPO:

David Collum:

@nanexllc@joesaluzzi@themisSal A Facebook flashcrash to $0.01 would be fun and educational for the whole family.

Sal Arnuk:

@DavidBCollum doubt that....prepping for weeks

The rest is history. Facebook didn’t flash crash, but weeks of prepping were inadequate. Facebook crashed the NASDAQ market for 17 very long seconds, which is a lifetime when measured in algo years.³⁶ The high-profile Facebook IPO—technically a secondary offering—managed to maximize Facebook’s capital by selling shares into the market near its all-time high. Underwriter Morgan Stanley took a beating (possibly billions) defending the opening price of $38 before watching it drop, eventually reaching the teens. Isn’t “defending shares” illegal? While Morgan Stanley was getting hammered, the other underwriters, Goldman Sachs and JP Morgan, were loaning shares into the market for shorting.³⁷ Despite a huge outcry from those hoping for an IPO opening day bounce, I found this all highly entertaining and a good lesson in risk management. Investors hoping for easy money discovered that IPO stands for “it’s probably overpriced.” Facebook also spawned a cottage industry of Mad Libs (Fraudbook, Faceplant, Farcebook…)

A lesser known IPO failure causing a stir was Ruckus (RKUS), dropping 20% on the opening and blaming it on Hurricane Sandy.³⁸ Splunk’s (SPLK) IPO was halted after it hovered at $32 and then plummeted to $17 on a 500-share trade.³⁹ They eventually dropped 30% in an orderly slide. IPOs from the not-so-distant past that continue to inflict pain include post-IPO losses for ZYNGA (-80%), Groupon (-90%), and Pandora (-60%). Investment-grade Beanie Babies and CPDOs sound good by comparison.

The markets are broken. It’s only a matter of time before the vernacular phrases FUBAR and SNAFU will reassert into our language. The Tacoma Narrows Bridge as a metaphor for instability has been around the web for years, but is well worth a peek.⁴⁰

Precious Metals

They (gold investors) want everybody to be so scared they run to a cave with gold. Caves might be a better investment than gold. At least they’re not producing new caves all the time.

~ Warren Buffett

Those elements here and abroad who are getting rich from the continued American inflation will oppose a return to sound money.

~ Howard Buffett

Let’s stay on the theme of broken markets as a transition into a discussion of precious metals. Bill Murphy and the folks at the Gold Antitrust Action Committee (GATA) obsess over powerful and dark forces. Declassified documents showing overt attempts to restrain the price of gold provide a few smoking guns.^41,42,43,44 The Hunt brothers grotesquely misjudged the silver market and willingness of bankers to trigger margin calls and drive them to bankruptcy.⁴⁵

By the early 2000s even novice market watchers could see that central bank selling into the open market could have price suppression as a motive. Chancellor of the Exchequer Gordon Brown participated in the most famous market timing fiasco by emptying much of Britain’s gold stash below $300 per ounce.⁴⁶ That got him promoted to Prime Minister.

Then there is the very strange phenomenon of central bank leasing of gold. I surmise that the idea was presented to the populace as a way to make money from the shiny yellow metal that just sits there in vaults. Why not lease it? The gold carry trade commenced, but lease rates are fractions of a percent per annum.⁴⁷ No profit motive there. Central bank leasing of gold to the large bullion banks—the Too Big to Fail group—at a fraction of a percent interest seems to serve two purposes: (1) provide essentially free capital to the banks, and (2) apply downward pressure on the gold price. Rumor has it they are going to stop publishing the leasing rates.

The game began to falter in 2001 when neither the announcement of British bullion sales nor the actual sales dropped the price, commencing a decade-long run in the metals. That is not to say the central banks have given up. Sudden and repeated margin hikes at the COMEX trapped the levered longs, and affiliated mob-like hits by insiders became commonplace. A rumored huge silver short position by JP Morgan-Chase (JPM) may lurk beneath the London Whale saga. JPM’s commodity guru, Blythe Masters, began denying the silver short as the whale story started to surface, claiming that JPM’s silver positions were simply hedges for their customers.⁴⁸ Why would silver bulls hedge their investments? Data from the Office of the Comptroller of the Currency brought to light by Rob Kirby eventually showed that JPM has a whopping $18 billion naked short position in silver,^49,50 corresponding to 50% of the estimated global above-ground silver supply.⁵¹ Is it any wonder that silver gets “monkey hammered” with some regularity by the invisible hand? Naked shorting on such a scale is both illegal and reckless.⁵² To the extent that JPM is at risk, taxpayers are at risk. CFTC Commissioner Bart Chilton unabashedly claims that big money with outsized short positions are moving the silver market, although he won’t name names yet and hasn’t done squat.⁵³ Let me help you out Bart: Start with JPM.

I am wildly bullish about the metals going forward. Gold and silver’s returns look like a normal year within a secular bull market [editor's note: this section was written by David  prior to this week's smackdown of the precious metals]. Precious metals investors waited with baited breath as a descending triangle starting in mid-2011—a classic chart pattern recognized in technical analysis (TA)—marched to judgement day (Figure 10). Folklore says when the highs and lows converge, the price will resolve boldly to the upside or downside. OK. That sounds really stupid, but that’s state-of-the-art TA. In any event, it seems like gold took the 50% probability route to the upside thanks to an auspicious goose from more quantitative easing (QEIII). But that’s just T&A (chart porn) for the gold bugs.

Figure 10. Descending triangle and “resolution.”

The future is unknowable, yet $85 billion per month of QE IV is most definitely bullish for tangible assets. Central bankers around the World are printing around the clock. Of course, the usual cast of top callers were braying about a top. Notable gold bears included Warren Buffett hammering gold in the Berkshire Hathaway annual report, quickly followed by a show of support from his poker buddy Bill Gates. Buffett wrote an article entitled “Why Stocks Beat Gold and Bonds” and then promptly bought a gold-mining company.⁵⁴ Charlie Munger again displayed his tin ear with a decidedly anti-Semitic quote about gold (not worthy of repeating, only criticizing). There are credible arguments against gold, some better than others. An optimist might believe that central bankers will begin to behave themselves…but only in the land of unicorns and Skittles rainbows. Some claim it is a crowded trade. Many argue that gold has been a horrible inflation hedge. To this I note that shovels and bulldozers both move dirt but are very different tools. Equities and gold have similarly differentiated roles as inflation hedges.

Secular (multi-year) bull markets are said to attract investors in three specific phases: (1) first arrivals are wing nuts and whack jobs and precede anybody in their right mind, (2) the smart money arrives once the bull offers evidence there is serious money to be made, and (3) retail investors—the rabble—show up in the final phase. Once group (2) sells to group (3) in what is euphemistically called “distribution,” the invisible hand of the market throws a toaster oven in the pool and the bodies start floating to the surface. This year was dominated by smart-money gold supporters with gravitas and serious bucks. Hedge fund managers supporting gold with dire warnings of monetary chaos included luminaries George Soros, John Paulson, David Einhorn, Jim Rogers, Ray Dalio, and Kyle Bass. Einhorn and Dalio both took special care to condemn Buffett’s gold bash.^51,52 Bill Gross, head of PIMCO with almost two trillion dollars under management, noted gold “will be higher than it is today and certainly a better investment than a bond or stock, which will probably return only 3% to 4% over the next 5 to 10 years.”⁵³ Bill has caught the fever. Billionaires Hugo Salinas Price and Eric Sprott are avid precious metal investors and devout believers in organized price suppression.

Central banks became net buyers starting in 2009 after years of selling and have been increasingly aggressive (Figure 11).⁵⁴ (I call central bankers both “smart money” and “feckless”; I’m still working on resolving that paradox.) Chinese and Korean central bankers have explicitly stated gold is the only safe asset.⁵⁵ Such reports are picking up in intensity. Other events seemed new to 2012. The International Monetary Fund (IMF) has flipped to net buyer.⁵⁶ South Korea, Paraguay, Turkey, Vietnam, and Russia all increased their gold holdings. Iran swaps oil for gold with China and Turkey.^57,58

Figure 11. Central bank gold purchases

What made this year so interesting was the part occurring below the surface. Gold may soon be designated a Tier 1 asset.⁵⁹ Banks are required to maintain minimum balances of Tier 1 assets to ensure the safety of the system. (They need to work on that.) When the next credit crisis arrives, rather than selling gold to raise Tier 1 assets, banks will be incented to buy gold. It is beginning to act like a currency. The ramifications are multifold.

For the first time, we are beginning to hear discussions of some form of gold standard. It would probably be a variant of the gold-exchange standard of the early 20th century. I would be satisfied if gold was simply allowed to compete for supremacy in the open market. The most important step would be to pass gold legal-tender laws, which are at various stages in a dozen states.⁶⁰ (This could elicit a states’-rights battle.) Rendering gold’s price change denominated in dollars as a non-taxable event would be the big move. Bernanke tried to take on the push for a gold standard in a series of lectures at George Washington University.⁶¹ I found his arguments unpersuasive, exactly what you would expect from a guy who believes that profound monetary injections and inflation are valid monetary tools. The gold standard seems like a distant possibility given the Republicans endorsed the idea in their platform; we know they lied—their lips moved. The counter argument stems from a survey showing 37 prominent economists all opposed a gold standard; 37 economists couldn’t possibly be right.⁶²

One could dismiss discussions of a gold standard if it were not for the second really interesting topic—global gold movements. Let’s be clear, this story is muddled. There are three variants of gold conspiracy theory that may (or may not) lay the foundations:

(1) Thesis 1: Gold exists in the vaults of the Fed and Fort Knox, but we don’t own it anymore. We are told that the gold possession is as simple as a forklift moving a pallet from one wall to the next within the same vaults. Doubts about ownership are exacerbated by the unwillingness of the authorities to independently audit the gold since the 1950s despite calls for it from Congress. This is odd by any standard.⁶³

(2) Thesis 2: The gold in the vaults is of a substandard quality. This idea is way out there but cannot be summarily dismissed. What does low quality actually mean? Supposedly we have delivered sub-standard gold on a number of occasions.⁶⁴ There were rumors years ago that the gold in the bank of England was reported to be “flaking,” leading one intrepid analyst to declare that it doesn’t matter “provided they don’t try to sell it.”⁶⁵ Oh, I just wet myself. As a chemist, I can assure you if it flakes it ain’t gold and that analyst-dude is a perma-doofus. Tungsten-impregnated gold surfacing in retail gold markets has fueled speculation that the central banks are hoarding tungsten.⁶⁶ The conspiracy theorist in me wonders if the occasional fake gold bar would be good for tamping down an incipient gold mania.

(3) Thesis 3: There is no gold.⁶⁷ The claim that the gold is missing holds a certain logic. If the Fed leased physical gold to the bullion banks and these banks sold it into the open market for beer money, then it’s gone.⁶⁸ It is very odd that the Fed pools the physical metal and the leased metal on a single line of their self-reported balance sheet (to save space, I guess).⁶⁹

The status of sovereign gold stashes is unclear. Here’s where it gets really interesting. Sovereign states are starting to repatriate their gold—they want to bring it home. It started in 2011 when our close friend and ally Hugo Chavez requested 100 tons returned to Venezuela, with a correlated spiking of the spot-price of gold and gold backwardation. (Backwardation is a grammatical abomination indicating that short-term demand for a commodity is high and commodity traders flunked English.) Demand began in earnest starting in the Netherlands and spreading to other postage-stamp-size countries Paraguay, Ecuador, Vietnam, Switzerland, and Germany.^70,71Germany? Germany may be growing weary of sharing a fiat currency with the PIIGS—Portugal, Italy, Ireland, Greece, and Spain (vide infra).

It seems like gold is coming out of the closet. My concern is that we will quickly move from fear of deflation to disquieting inflation culminating in uncontrolled inflation. If the dollar goes south fast, do you think investors will seek safe-haven in another fiat currency? Those who headed to Swiss Francs got their heads handed to them this year in an instantaneous 10% debasement.⁷² There must have been some forex traders doing laps around the drain that morning. I cannot rule out a run on fiat currencies—a collapse of the entire Bretton Woods currency system. Mitigating such tail risks would not be completely irrational. Am I saying that this time it’s different? No. I am saying our fiat currency will join the other fiat currencies as historical footnotes.⁷³ As the insane posters at Zero Hedge like to say about gold, BTFD (buy the dips).

Resources and Energy

I'd put my money on the sun and solar energy. What a source of power! I hope we don't have to wait until oil and coal run out before we tackle that.

~ Thomas Edison (1931)

Eventually the point is reached when all the energy and resources available to a society are required just to maintain its existing level of complexity.

~ Joseph Tainter, author of Collapse of Complex Societies

The resource sector provides me with a potential inflation hedge and represents a bet on a secular change in energy availability, all the while allowing me to pretend to be normal. In previous years I have endorsed Chris Martenson’s Crash Course with unbridled enthusiasm—a must see,⁷⁴ which emphasized the case for increasingly constrained oil production, and delineated my enthusiasm for natural gas equities.^1,2,3 Many of my views have not changed.

Investment giant Jeremy Grantham continues to actively warn of acute resource depletion. He submits that rapidly rising raw material prices are not a bubble but rather a civilization-altering paradigm shift.⁷⁵ Simply put, we are depleting everything. The CEO of Gulf Oil, in a decidedly ambiguous statement, noted that “oil consumption in the next seven years is not going to grow and could drop off as much as 15%."⁷⁶

Suggestions of constrained oil supply continue to work their way into the mainstream. Data shows Saudi production has remained remarkably constant. Many doubt they can ramp it or even sustain it. The former vice president of Saudi Aramco warns of unwarranted optimism that price hikes stem from “the reality that the oil sector has been pushed to the limit of its capabilities.”⁷⁷ There are claims that the Saudis will be net importers by 2030 but from whom?⁷⁸ David Greely of Goldman Sachs indicated that it is only a matter of time before “OPEC spare capacity become[s] effectively exhausted, requiring higher oil prices to restrain demand.”⁷⁹

Other Goldmanites suggest that “a disturbing pattern has emerged where each tentative recovery in the world economy sets off an oil price jump that, in turn, aborts the process… Oil has become an increasingly scarce commodity. A tight supply picture means that incremental increases in demand lead to an increase in prices, rather than ramping up production. The price of oil is in effect acting as an automatic stabilizer.”⁸⁰ A hyperbole-free interview of prominent oil economist James Hamilton sheds light on a world facing tighter supplies.⁸¹

A counter-argument to all these gloomy views came in a report via Bloomberg stating that the U.S. will pump “11.1 million barrels of oil a day in 2020 and 10.9 million in 2025.”⁸² This may be true, but anybody who projects oil production a dozen years from now to three significant figures has credibility issues. That did not stop viral dissemination across the Twittersphere.

Some suggest that natural gas will fuel our economy for hundreds of years. Others say the case is wildly overstated: Bakken wells lose 90% production within five years.⁸³ Still others focus on the environmental catastrophes and legal boondoggles affiliated with fracking. It seems clear that, come hell or high water, we are going to frack, and we are going to witness a secular shift to a natural-gas-dependent economy. It would be great if this works and does so without environmental calamity. I am agnostic on both. The equity valuations are tame, especially given the current razor-thin profit margins that are projected to expand.⁸⁴ I continue buying the equities betting that powering the globe will be profitable.

Fresh water and, by direct correlation, food face huge supply issues in China, the U.S., and emerging markets around the world. Staying close to home on this one, the Ogallala Aquifer under the Great Plains was reported to be down to one third of its original depth and is projected to “run dry in two to three decades given recent withdrawal rates.”⁸⁵ Atlanta is in a legal battle with Florida and Alabama over 20% of the flow from Lake Lanier.⁸⁶ No matter how you cut it, this is foreshadowing trouble ahead. I looked into water-sector investments a decade ago but couldn’t tease out opportunities.

The blogosphere has made the case for highly constrained rare-earth elements crucial to wind turbines and solar cells.⁸⁷ The bulls note that China controls 95% of the market and suggest that building alternative energy programs based on the rare earths will drive the price to the moon. I had dinner with the CEO of Chemetall, a major dealer in metals and metal catalysts. He assured me that rare earths are not rare, and that China has driven competitors out of the marketplace; higher prices will fix that when needed. I could detect no agenda in his answers.

The Baptists

The lapse of time during which a given event has not happened is…alleged as a reason why the event should never happen, even when the lapse of time is precisely the added condition which makes the event imminent.

~ George Eliot in Silas Marner

We were all worried about these issues in 1927, but you can only worry about things for so long.

~ Anonymous

Prior to any financial dislocations there are many who preach of the coming crisis. In 1924, Roger Babson warned of credit excesses that would lead to catastrophe. Charlie Merrill of Merrill Lynch fame sought psychiatric help due to his inexplicable bearish views; as legend goes, he and his psychiatrist emptied their investment accounts and dodged the carnage. The stock futures speculation in the 1920s was so obvious that Congress held hearings to discuss it well before the crash.⁸⁸ The crash and subsequent multi-decade global devastation arrived to the total shock of many. Town criers could be heard screaming of a coming tech crash in the late ‘90s by those who listened. We had congressional hearings on derivatives speculation wherein Brooksley Born methodically laid out the plotline for the coming storm in unregulated derivative markets.⁸⁹ I wrote a 2002 email describing the coming subprime crisis and banking collapse.^3,90 Prescient? Not really. I was simply parroting ideas scattered over the Internet. The few who played the housing bust with leverage get the limelight; countless thousands saw the housing excesses in the years leading up to 2007.

This year had its share of preachers of unassailable credibility telling us of more trouble to come. Are they farsighted or fooled? I haven’t a real clue. I can say, however, that their advice demands your attention.

Let’s begin with the most prolific of doomers, David Stockman, former Wall Street insider and Reagan budget genius. Stockman was omnipresent, telling anybody who would listen of a coming mayhem in the bond market and accompanying pension crisis, labeling our current economic status as “the end of a disastrous debt super cycle that has gone on for the last thirty or forty years.”^91,92,93

David places blame squarely on the Fed by suggesting “if we don't drive the Bernankes and the Dudleys and the Yellens and the rest of these lunatic money-printers out of the the Fed and get it under the control of people who have at least a modicum of sanity, we are just going to bury everybody deeper.” Somewhat paradoxically, he noted, “if the Fed doesn't keep printing, it's game over.”

John Hussman undermines the very foundations of monetary easing in one of the most cogent arguments that I have read.⁹⁴ He is a deep-value guy whose analyses have refreshingly long-time horizons and whose portfolios have been bludgeoned in the short term.

George Soros rattled Newsweek readers when he suggested the global credit retrenchment is “about as serious and difficult as I’ve experienced in my career…comparable in many ways to the 1930s. We are facing now a general retrenchment in the developed world, which threatens to put us in a decade of more stagnation, or worse. The best-case scenario is a deflationary environment. The worst-case scenario is a collapse of the financial system.”⁹⁵ He predicts a collapse of social order, suggesting that “it is about saving the world from a downward economic spiral." George is known for talking his book, but what position is he talking up? This is not a trick question...well maybe it is. (Answer: Gold. Lots and lots of gold.)

Bill Gross suggests that "a 30-50 year virtuous cycle of credit expansion which has produced outsized paranormal returns for financial assets—bonds, stocks, real estate and commodities alike—is now delevering because of excessive ‘risk’ and the ‘price’ of money at the zero-bound.”⁹⁶ He concludes that “we are witnessing the death of abundance and the borning of austerity, for what may be a long, long time." Detractors like to pick on Bill’s DOW 5000 call years ago. With inflation adjustment—accurate inflation adjustment—that decade-old call is approaching spot on.

Jim Rogers predicted that some of the Ivy League institutions would go bankrupt.⁹⁷ Harvard had a terrible credit seizure in 2007-09 due to their hedge-fund-like endowment, but Jim’s prediction was made in 2012. Jim doesn’t think we are done yet.

Nomura's Bob Janjuah is always good for brutal assessments.^98,99 Bob noted that "markets are so rigged by policy makers that I have no meaningful insights to offer.” Bob goes on to note in a later piece that “central bankers are intentionally mispricing the cost of capital, in an attempt to push the private sector to misallocate capital into consumption and into asset purchases at the wrong time and at the wrong price.” He blames Greenspan and Bernanke explicitly for tens of millions of American citizens who are “either homeless and/or on food stamps.” Bob can really turn a phrase. “Financial anarchy” is always good for a few chuckles. Say what you really think, Bob. The world’s central bankers are reserving their own special place in hell.

Ray Dalio, head of Bridgewater Associates—the largest hedge fund in the world—has been bearish for awhile and is becoming quite the gold bug. In January he noted that he was bearish “through 2028.”¹⁰⁰ In subsequent presentations, he seemed to change his tune by referring to our global state of affairs as a “beautiful deleveraging ,” which he defines as some sort of optimal inflation/deflation cross-dresser operating through a combination of defaults and debt monetization.¹⁰¹ I guess beauty is in the eyes of the beholder. One prominent market watcher—me—suspected that Ray had an eye on a Romney-cabinet-level appointment. We’ll never know.

Legendary investor Jeremy Grantham with $150 billion under management, Thomas Brightman of Research Affiliates, and Robert Gordon of NBER lit up the blogosphere late in the year with conclusions that global growth would drop to the 1% zone.^102,103,104 Their predicted durations—decades or more—were newsworthy. Grantham suggests that demographics and resource depletion will cause us to never regain our previous growth rates. He had previously amplified a notion first presented by Adam Smith in The Wealth of Nations by showing that a sustainable 3% compounded growth rate, rather than the “greatest invention of all time,” is total mathematical nonsense.¹⁰⁵ A cubic meter of physical wealth expanding at 3% over the Egyptian dynasty—admittedly a long time—would fill ten solar systems—a large volume.

Billionaire Richard Branson joins Grantham in predicting that capitalism is destroying the planet, focusing in particular on the perpetual growth model that will consume everything. The great story about Richard is that he is rumored to have tried to hit up Obama for some weed in a recent trip to the White House.¹⁰⁶ We don’t know if Obama’s “Choomwagon”¹⁰⁷ was in the shop.

Richard W. Fisher, President and CEO of the Federal Reserve Bank of Dallas Texas, was a buzzkill for the fluffers at the Fed, noting that there is “a frightful storm brewing in the form of un-tethered government debt.”¹⁰⁸ He says that he chose the phrase "frightful” to “deliberately avoid hyperbole.” Fisher suggests that the long-term fiscal situation of the federal government will be unimaginably more devastating to our economic prosperity than the subprime debacle and the recent debauching of credit markets that we are working so hard right now to correct.

2012 was a big year for taking the bear case to the Halls of Power. Jim Rickards, author of Currency Wars, presented his concerns about currency debasement to Congress.¹⁰⁹ James Grant and Robert Wenzel in speeches at the Federal Reserve both hammered the Fed for horrendous monetary policies that are destroying our currency and capitalist system.^110,111,112 Jim is a total genius, and he is very attention-worthy.^113,114,115

Legendary hedge fund manager and cherished confidant David Einhorn poked at the Fed with his “jelly donut” speech.¹¹⁶It was Silence of the Lambs at the Buttonwood Conference when he pointed out what they should have known: Artificially low interest rates drive up commodities and reduce income streams to a trickle, forcing consumers to save more and spend less.¹¹⁷ He throws in a little money multiplier logic and—voilà!—stimulus is totally negated.

Einhorn accuses the Fed of “offering some verbal sleight-of-hand worthy of a three-card Monte hustle.” David wonders out loud: “We have just spent 15 years learning that a policy of creating asset bubbles is a bad idea, so it is hard to imagine why the Fed wants to create another one.” I wonder out loud: How much did Fed policy have to degenerate to force the Einhorns of the world to focus on monetary theory rather than investing?

We had several bootleggers-turned-Baptists. The technical term is “tranny.” John Reed confessed his sins while CEO of Citibank, explaining how Citibank and Travelers, with the aid of a very friendly administration, destroyed the Glass-Steagall safeguards that had protected consumers from financial disaster since the ‘30s.¹¹⁸ Sandy Weill, the next CEO of Citigroup, shocked the world by suggesting that big banks “be broken up so that the taxpayer will never be at risk.” What’s gotten into these Citi-boys? Would it be too much to ask for a mea culpa from Robert Rubin? Yes.

William Cohan, former Wall Street investment banker and author of several best sellers including a comprehensive history of Goldman Sachs, pointed out the cracks in the seams—the omerta—at Goldman, flaws in the FINRA arbitration system, the mathematically nonsensical $100 million IRA of Mitt Romney, the SEC’s lack of oversight on nefarious activities at Citigroup, and a striking exposé of Robert Rubin’s deep-seated political power.^{119,120,121,122}

These guys are some of the sharpest knives in the drawer. They view the world through darker lenses than most. Whether they are right or not, you’ve been warned.

The Bankers

It is well enough that people of the nation do not understand our banking and monetary system, for if they did, I believe there would be a revolution before tomorrow morning.

~ Henry Ford

The most newsworthy story about Goldman Sachs may be that they weren’t in the news that much. Of course, there were a few skirmishes. Disgruntled employee Greg Smith took his best shot at the Goldman Death Star, but both his interview and book proved toothless.¹²³ Smith told us that Goldman employees showed scorn as they ripped the faces off their clients called “Muppets.” Anybody who read Michael Lewis’s Liar’s Poker knows that clients are chum for the brokerages. Goldmanites had to run out the back door without putting their pants on when it was discovered that they were part-owner of a website focusing on the sex-trafficking of underaged girls.¹²⁴ It also was reported that many Goldman folks were tipping off Rajaratnam, although that story is now passé. Most importantly, however, JPM managed to knock Goldman below the fold.

Problems for JPM began in 2011. As noted in my 2011 summary, MF Global—a reincarnation of the formerly bankrupted and scandal-riddled Refco—had collapsed, segregated funds had been rehypothecated (rehypothecate = used repeatedly; see also, “stolen”), and the money was lost speculating at the track. Remaining funds (including stored gold bars, if they weren’t already rehypothecated) were quickly snarfed up by JPM under the arcane principle of law referred to as “finders keepers, losers weepers.” We finished 2011 knowing that Corzine was a weasel and in a world of trouble and serious money had “vaporized”—not to be confused with “stolen”—to use language from a planted story.¹²⁵ Vaporized money brings to mind the must-see South Park episode, “And It’s Gone.”¹²⁶ The authorities were handed a Madoff-quality scandal to finally prove they are the best regulators money can buy. Twitter hound Mark Melin was posting hourly updates on nefarious activities while legal beagle James Koutoulis was gearing up for a big class action suit.

Just as night follows day, 2012 brought us…crickets. Nothing but chirping crickets. The case was dropped. How the hell did this happen? The JPM legal team exploited the chaos and rushed MF Global into bankruptcy. Chris Whalen explains that bankruptcy gave JPM “first dibs” creditor status whereas a fraud charge would have diverted the funds to less worthy folks—the rightful owners.¹²⁷

To ensure the transition went smoothly, former FBI Director and political hack Louis Freeh was put in charge of overseeing this mess. Freeh promptly asked the bankruptcy court to allow payouts to MF global executives for the long hours spent cleaning up.¹²⁸ (I'd give them free room, three square meals, and snappy orange jump suits.) Freeh then diverted funds from clients to legal defense funds of MFG execs.¹²⁹ The other MFG trustee named Giddens—the other MFG trustee?—pressured litigants to release the banks of all liability to receive reimbursement, suggesting that (1) the money didn’t really vaporize, (2) stealing money and then giving it back when caught should not be a crime, and (3) extortion is legal if you are a trustee.¹³⁰ Within a week it was announced that the Rule of Law had been downgraded to a guideline.

As often used in comedies, we use an epilogue to track the fates of the major players. Jon Corzine bought himself a “Get Out of Jail Free” card by remaining a major fundraiser (a bundler, to be exact) for Team Obama.¹³¹ The Department of Justice (DOJ) stood ready to indict Corzine if he missed a payment. Immunity to Corzine’s consigliere would have revealed some serious dirt, but the DOJ declared there was no case and walked.¹³² Corzine is exiled in the Hamptons sans ankle bracelet on an OJ-esque quest for the lost funds and a new job as a hedge fund manager. Rumors that Corzine’s life insurers put his policy in a risk pool have not been confirmed. Team Obama got a second term in the White House, and nobody in the administration has been indicted for racketeering. The sordid story of MFG has been relegated to case studies in MBA ethics classes. (Evidence aside, they do have such courses.) The main character, Jamie Dimon, landed a leading role in the next scandal and was put on the shortlist for Secretary of the Treasury.

As the replacement regulators and DOJ were playing Pull My Finger, rumors among the blognoscenti surfaced of a big London-based commodity trader who was in trouble.¹³³ The trader was originally referred to as “The Caveman” but soon became “The London Whale.” Mike Mayo, one of the elite banking analysts, downgraded JPM a day or so before the story broke and later attributed the problem to “negative incentives and the revolving door” (corruption from the unholy alliance of banking-government).¹³⁴ Jamie Dimon initially claimed it was “a tempest in a teapot ,” but then JPM announced burgeoning losses in the billions. Eventually, even CNBC bought a ticket on the London Whale Watching Tour. Those guys are sleuths.

JPM was in very big trouble. (Just kidding; of course they weren’t.) Damage control was swift and effective. JPM liquidated an estimated >$25 billion of assets to both clean up the mess and book enough profits to guarantee that their reported earnings would show that this was not a BFD (big deal).¹³⁵ The London Whale, aka Bruno Iksil, was labeled a rogue trader, which is a technical term for a “rainmaker turned patsy.” With dripping irony, Bruno’s boss is named Achilles Macris.

Normally, the story would end there, but the Greatest Banker in the Universe—Jamie Dimon—faced a stark choice: Either claim that he screwed the pooch—uniquely so—or admit that the banking system is still hopelessly corrupted. The forthcoming mea culpas were slathered with gobs of sincerity. “We were total idiots. We can’t pour water out of a boot with the directions on the heel.” (paraphrased, of course) Jamie testified to Congress for no apparent reason, getting grilled by Congressman Tim Johnson who, because of a massive stroke in 2006, was not particularly threatening. Spencer Bachus, Chair of the Financial Services Committee, treated Dimon with kid gloves and let him testify not under oath because JPM is his second biggest donor. What’s appalling is that Bachus sold us down the river for a take of $119,000 over the congressman’s career.¹³⁶ That was money well spent. Supposedly, the entire Financial Services Committee cost a little over $800,000.¹³⁷ Peter Schweizer’s book, Throw Them All Out (vide infra) documents in lurid detail that congressmen and congresswomen are prostitutes, but cheaper. In an interview in Davos, Dimon was able to put the problems to rest, noting that “most of the bad actors are gone." You betcha.

Of course, other banks wanted a piece of the action. Barclays made a feeble grab for fame by taking the lead in the Libor scandal.¹³⁸ Libor, the London Interbank Offered Rate, is a compilation of self-reported lending rates that influence interest rates throughout the $500 trillion global credit markets.¹³⁹ Self reported? Whatever could go wrong? It turns out Barclays was cheesing the numbers. The retribution was swift and severe: Barclays was fined a whopping $200 million,¹⁴⁰ which cut into some of their profits on the scam. The British Banking Society, using language right out of Casablanca, said that they were “shocked.”¹⁴¹

Meanwhile, journalists around the globe, scrambling to figure out what Libor meant, spouted scholarly analysis like Milli Vanilli. It soon became evident, however, that all of the banks were fudging their numbers.¹⁴² The scandal was promptly downgraded three levels to an embarrassment when 2008-vintage articles by Mark Gilbert and Gillian Tett surfaced that described the rate rigging.^143,144 The Fed knew about it in 2008.¹⁴⁵ Liborgate could clog the courts for awhile as borrowers lawyer up hoping to identify damages.

The blogosphere thinks Liborgate is “huge.” I find the scandal oddly anticlimactic given that central banks around the globe openly rig rates on a daily basis. James Grant concurs with this minority view. It is galling, however, that the scandal seems to reach the highest levels of the banking cartel—the central banks. For me, it is profoundly disturbing that global capital has been fully sequestered from price discovery.

The British Banking Association was shocked again when Standard Chartered Bank got accused of illegally laundering $350 billion for Iran.¹⁴⁶ Rogue New York banking regulator Benjamin Lawsky filed his charges as the Justice Department was on the verge of declaring that Standard Chartered’s trades “complied with the law.”¹⁴⁷ Standard Chartered promptly entered settlement talks with everybody. A Deloitte partner involved with the scandal offed himself. For him, the scandal was a big deal.

The hits just kept coming. HSBC got charged with money laundering for terrorists, drug cartels, and organized crime syndicates. It seems that HSBC must have picked up BCCI’s clients after their scandal-induced collapse in the late ‘90s. This ‘affiliation’ with organized crime is silly: Banking is organized crime. Reuters reported that HSBC could be fined over $1.5 billion for money laundering and face criminal charges.¹⁴⁸ Of course they could, but they won’t.

US Bancorp got charged $55 million for scamming customers with overdraft fees by illegally maximizing the number of checks put into overdraft.¹⁴⁹ In a possible script for the MFG sequel, Cantor Fitzgerald was accused of “undersegregating” funds.¹⁵⁰ This is like “kind of pregnant.” The whole thing seems “sort of criminal.”

The more generic thieves and scoundrels returned with an encore when CEO of Peregrine Financial Group (PFG) stole rehypothecated customer funds for several years.¹⁵¹ The CEO of Attain Asset Management (AAM) captured the spirit of the outrage against PFG, noting “This time it’s personal.”¹⁵² PFG CEO Wasendorf attempted suicide, presumably hoping to front run the AAM CEO to (paraphrased) “put a cap in his ass.” Jeffries promptly began a Chapter 7 liquidation of PFG positions after a failed margin call. Once again, Chris Whalen explained the nuances.¹⁵³ Apparently, this time they did it right by sending PFG into receivership to the advantage of the customers; Reuters reported depositors got 30 cents on the dollar.¹⁵⁴ I imagine that debt subordination by big money folks somehow played a role.

Whistleblowers took a serious beating this year. FINRA, Wall Street’s self-policing arbitrators, managed to bankrupt a Morgan Stanley broker with a fine of $1.2 million after he accused Morgan Stanley of adding hidden fees to retirement accounts.¹⁵⁵ When the case was followed up, nearly half of the 18 hrs of tape, mandated to be saved, “disappeared.” The transcript of an anonymous whistleblower testifying to CFTC was a great read. The CFTC removed it from their website, but a copy was saved.¹⁵⁶ A lawsuit by Securities and Exchange Commission (SEC) whistleblower David Weber alleges that the SEC is involved in all sorts of nefarious activities, including specifically tracking potential whistleblowers.¹⁵⁷ David Einhorn also presents the SEC as profoundly corrupt in his book, Fooling Some of the People All of the Time.

We found out this year that Deutsche Bank had been accused by three independent whistleblowers of hiding $12 billion in losses to avoid a bailout during the bailouts (if that makes any sense).¹⁵⁸ This scandal is a dog’s breakfast: (1) the whistleblowers—one of them a risk officer—got fired within days of the complaint; and (2) the current SEC’s chief enforcement officer was in charge of the legal compliance at Deutsche Bank and was its general council during the cover up.

I have painted the banking industry with an ugly brush. I’m sure most bankers are good, honest people. If so, it’s time you guys start cleaning up your profession. When you find yourself saying, “Somebody should do something,” that somebody is you. If you stay silent, it’s just a Sandusky sequel.

The Federal Reserve

I simply do not understand most of the thinking that goes on here at the Fed, and I do not understand how this thinking can go on when in my view it smacks up against reality…Do you believe in supply and demand or not?...Let’s have one good meal here. Let’s make it a feast. Then I ask you, I plead with you, I beg you all, walk out of here with me, never to come back. It’s the moral and ethical thing to do. Nothing good goes on in this place. Let’s lock the doors and leave the building to the spiders, moths, and four-legged rats.

~ Robert Wenzel, in a speech at the NY Federal Reserve

Well that pretty much captured my sentiments. The Fed gets their pick of the litter coming out of PhD programs. They are a politically (in)dependent group with a dual mandate of supporting the banks and maximizing bank profits. The dozen or so members of the Federal Open Market Committee (FOMC), by virtue of arrogance and hubris, have become intellectually neutered and are now menaces to society. Why listen to an organic chemist—an academic, to boot? Let’s see what the pros have to say.

A first year investment banking associate knows more about credit creation than the entire FOMC combined…. Our colleagues at the Fed have consistently failed to understand the operations of financial markets and how credit operates in our society. This may surprise some of you, but it doesn't surprise me at all.

~ Chris Whalen, Founder of IRA Risk Analytics

I have to say the monetary policies of the U.S. will destroy the world.

~ Marc Faber, Elite Barrons Round Table Member

The little sliver of remaining hope was officially pronounced dead [with QEIII]….we are witnessing the greatest monetary fiasco ever.

~ Doug Noland, Federated Investors

The Chinese aren't loaning to us anymore. The Russians aren't loaning to us anymore. So who's giving us the trillion? And the answer is we're just making it up. The Federal Reserve is just taking it and saying, ‘Here, we're giving it.' It's just made up money, and this does not augur well for our economic future.

~ Mitt Romney, unemployed

When I read direct quotes and commentary about Bernanke's policy of driving up asset prices in general and equity prices in particular, I almost want to cry over the ludicrousness of this position. The Fed is pursuing the same road to ruin as it did between 2003-2007.

~ Albert Edwards, Societe Generale

Bernanke, and his MIT ilk, has made monetary policy into a laboratory for monetary theoreticians.

~ Kevin Warsh, former Federal Reserve governor

It’s the general global landscape where you have an incredible mispricing of risk that’s being delivered at the hands of academics at the central banks of the world.

~ Wellington Denahan-Norris, CEO of Annaly Capital

I am a little—maybe more than a little bit—worried about the future of central banking. We've constantly felt that there would be light at the end of the tunnel, and there'd be an opportunity to normalize but it’s not really happening so far.

~ James Bullard, President of Saint Louis Federal Reserve

Let’s briefly break away from 2012 condemnations and snag a quote from my favorite book on Austrian economics and the Great Depression:

The end result of what was probably the greatest price-stabilization experiment in history proved to be, simply, the greatest and worst depression.

~ Phillips et al. in Banking and the Business Cycle (1937)

Of course, the big news was the third wave of debt monetization referred to as QE IV, QEtc, QEInfinity, or Cash for Clunkers II. The Fed is jamming over $80 billion of high-powered money per month into the economy. Initial promises to monetize aggressively until 2015 have been extended to infinity and beyond. The Fed pretended it was sterilized—the long-term debt purchases were being offset by short-term debt sales. “Operation Twist” (QE II), however, recycles the short-term debt right back into long-term debt. Problem solved.

There is some room for debate as to why they are pushing monetary policy to the edge of the known universe. They tell us that it is to improve the economy and help the little guy by throwing savers under the bus with repressively low interest rates. Last I looked, the savers are the little guys. It has been estimated that if interest income as a percentage of total personal income had remained at its 2008 level, the total would now be an additional $1.5 trillion.¹⁵⁹

To achieve their goal of stabilizing the banks—not all the banks, just the really big ones—the Fed has completely dismissed any notion that the debt markets should be allowed to clear, which is Austrian-speak for establishing market-based pricing. James Grant calls it “waging war on the pricing mechanism.” The Fed does this via purchases of 60-80% of all the newly issued federal debt because our foreign creditors have gone on a buyers’ strike.¹⁶⁰ Without the Fed’s unprecedented interventions, bond prices would plummet (sponsored by Red Bull, no doubt), affiliated interest rates would spike, bond holders would get crushed, and the federal government would have to borrow at rates that would completely choke our already auto-asphyxiated federal budget. We’re now homing in on why the Fed is monetizing debt. (Note to readers: When you read an article stating some variant of “low rates show everything is rosey,” that person is an idiot.)

The irony here is that the Fed’s zero interest rate policy (ZIRP) is choking the savers, as noted by David Einhorn (vide supra). Similar cases have been made by Chris Whalen and others.¹⁶¹ William R. White, former Head of the Monetary and Economic Department at the Bank for International Settlements (BIS), wrote a must-read paper entitled, Ultra Easy Monetary Policy and the Law of Unintended Consequences.¹⁶² The Fed’s policies are Soviet-style stupidity and a short trek to financial perdition. Even worse, Daniel Kahnemann, Nobel Laureate and expert in behavioral psychology, would probably argue that the Fed’s decision making is no more accurate than “monkeys throwing darts.” Milton Friedman indirectly made a similar case against central planners in an interview with macroeconomist Phil Donohue.¹⁶³

The Bootleggers

Why does the New York Times hate the banks?

~ Jamie Dimon, CEO of JP Morgan

It’s not the New York Times, Mr. Dimon. It really isn’t. It’s the country that hates the banks these days.

~ Joe Nocera, New York Times

I have beaten on the bankers hard and will continue to do so until somebody can say their house is clean. I should, however, let these bootleggers and affiliates—the Baghdad Bobs of Finance—speak for themselves. As you read these quotes, ask yourself: Did they really say that? Really?

Low Fed rates didn’t fuel the housing bubble.

~ Alan Greenspan, former Chair of FOMC

This is the United States of America. That's what I remember. Guess what.... It's a free f***ing country.

~ Jamie Dimon, CEO of JPM

Hanging bankers won’t help…Public anger over the financial crisis is wrong.

~ Tony Blair, former Prime Minister of England

Large numbers of people who have ‘lost’ their house through foreclosure have actually realized a profit because they carried out refinancings earlier that gave them cash in excess of their cost. In these cases, the evicted homeowner was the winner, and the victim was the lender.

~ Warren Buffett, Berkshire Hathaway

The evidence that I’ve seen and that we’ve done within the Fed suggests that monetary policy did not play an important role in raising house prices during the upswing.

~ Ben Bernanke, Chair of FOMC

We economists…have reason to be proud of our analyses over the past five years. We understood where we were heading, because we knew where we had been.

~ Brad DeLong, economist at UC Berkeley

Quantitative easing isn’t being imposed on an unwitting populace by financiers and rentiers; it’s being undertaken, to the extent that it is, over howls of protest from the financial industry.

~ Paul Krugman, Princeton University and Nobel Laureate

The demonization of Wall Street and bankers is very much a function of the press and of Washington, and not much more broadly held.

~ John Thain, former CEO of Merrill Lynch

Wage and price controls distort markets…prices are prices…We’re not going to monetize US debt.

~ Ben Bernanke, FOMC

Thank the people of AIG for having the courage to do what they did.

~ Robert Benmosche, CEO of AIG

To claim that it’s effectively a gift you have to claim that the prices the Fed is paying are artificially high, or equivalently that interest rates are being pushed artificially low. And you do in fact see assertions to that effect all the time. But if you think about it for even a minute, that claim is truly bizarre.

~ Paul Krugman, Princeton

There is a German word, backpfeifengesicht, that reputedly translates to “a face badly in need of a fist.” It seems appropriate for some of these characters, which would generate some serious schadenfreude. For these gentlemen, however, I’ll let pop culture respond:

What you have just said is one of the most insanely idiotic things I have ever heard. At no point in your rambling, incoherent response were you even close to anything that could be considered a rational thought. Everyone in this room is now dumber for having listened to it. I award you no points, and may God have mercy on your soul.

~ The Principal in Billy Madison

Personal Debt

I spent all my money on women and wine, and the rest I wasted.

~ George Best, Irish soccer player

Debt permeates all levels of the global economy. In the U.S., debt is growing much faster than the GDP (Figure 12). A montage of over 50 charts showing all facets of debt is well worth a peek.¹⁶⁴ Authorities are convinced that more spending and more debt will be our salvation. Daniel Bell, a Marxist from the turn of the 20th century, took the other side of this bet, suggesting that the consumer would eventually consume themselves. Apparently, I’m a Marxist. In this section I would like to briefly discuss personal debt. (Special aspects of student and mortgage debt are cordoned off into their own sections.)

Figure 12. Accrued debt with annotations showing dollars of debt required per dollar of GDP (source link lost).

The so-called resilient consumer is getting squeezed from every direction. The income of the average family has dropped from $53,000 to $47,000 in only 5 years.¹⁶⁵ Deleveraging is evidenced by a dropping debt-to-income ratio in Figure 12, yet two thirds stem from defaulted mortgages.¹⁶⁶ The national savings rate has once dropped to zero from historical norms of 10%. Credit card debt is said to be the leading cause of suicide among adult males.¹⁶⁷ Trimtabs reports a 40% drop in net median family worth since 2007.¹⁶⁸

Should the average family of four earning $47,000 happen to rashly buy everybody iPhones, they just committed 4-5% of their gross income to phone service. I’m not sure even families earning $150,000 should spend that much on phone service. Television and children’s activities used to be largely free; now we pay. Internet, as amazing as it may be, is a necessary expense. Don’t think so? See how your kids do in school without it. Figure 13 shows the ratio of personal consumption versus compensation. That rise stems from a combination of decreased savings and increased debt.

Figure 13. Personal consumption versus compensation.¹⁶⁹

In 2010 I discussed an insidious and overlooked contribution to inflation—accelerated depreciation. It is still overlooked by the mainstream so I am going to take one more abbreviated whack at it. For example, in 2009 I broke a 40-year-old blender. The Boskin Commission¹⁴ would argue that its replacement is even cheaper than the price tag would indicate because it has more buttons. Government statisticians actually “hedonically” adjust the price down for improved quality. Alas, that really cheap blender died after only two years of dedicated service. Chintzy goods at affordable prices have trapped consumers in a vicious replacement cycle. If Boskin et al. had looked at the per year cost of the blender, they would have corrected for depreciation with a 20-fold price multiplier before comparing the relative prices of old and new. The net domestic product—the gross domestic product with depreciation included—is an antiquated concept that needs resurrection.¹⁷⁰ Meanwhile, the consumers are choking on their vomit trying to keep up with depreciation.

Mortgage Debt

There is not a menace in the world today like that of growing public indebtedness and mounting public expenditures.

~ Warren G. Harding, former President of the United States

Harding was considered to be one of the least competent presidents. Could have fooled me. Mortgage debt presents its own unique issues. We are slowly winding down the mortgage bubble that burst in 2007 through a combination of defaults and debt restructurings. To say, however, that a modest uptick in housing activity means that the problem is solved is ridiculous (Figure 14). Is housing recovering? Not really. Maybe sentiment has begun to change but only with the unprecedented force of a central bank behind it.

Figure 14. Home building employment (red) compared with home builder sentiment (blue).

There are still an estimated 11 million homeowners underwater on their mortgages, including more than a million people who have just bought in the past two years.¹⁷¹ Ill-advised efforts to bail them out—foreclosures clear the market—seem to have faltered. Special Inspector General of the TARP Neil Barofsky discovered Geithner never intended to aid homeowners, only to delay foreclosures for a year or two so that they could occur orderly. Writedowns are taxable income,¹⁷² which prevents homeowners from accepting them. Distressed real estate purchased by speculators appears to decrease the housing glut. Unfortunately, this shadow inventory still exists if the speculators intend to flip the houses for a quick capital gain. The market won’t clear until demographics and income growth clear it, both of which are going backwards.

There seems to be some resolution of the catastrophe caused by the Mortgage Electronic Registration System (MERS) in which the ownership of millions of houses are being thrown into legal purgatory by foreclosure. Bank of America supposedly offered to take a deed in lieu of foreclosure, presumably to get the deed legally.¹⁷³ Legally dubious foreclosures are clearing through the legal expedient of turning a blind eye. Efforts in California to use eminent domain to clear out problematic underwater mortgages are so egregious that I have deferred them to the section on Civil Liberties and the Constitution.

Student Debt

Bart: don’t make fun of grad students. They just made a terrible life choice.

~ Marge Simpson

You’re f*cked.

~ Robert Reich, former Secretary of Labor, to Class of 2012

Student loans have soared from $200 billion in 2000 to over $1 trillion today (Figure 15),¹⁷⁴ surpassing credit card debt. Some say there is a student loan bubble, but the Bush-era legislation ensuring that student debt cannot be discharged even in bankruptcy suggests there is no bursting mechanism. Nevertheless, something will give, because loan delinquencies are going parabolic.¹⁷⁵ The paradoxical effect of the full-recourse loans is that banks are happy to provide almost unlimited funding to a slice of society rich in ill-conceived ideas. This debt is also localized in the most financially vulnerable demographic slice during a severe economic downturn. It ain’t just the kids. An estimated $38 billion in student loans are owed by seniors 60 and older, probably stemming from desperate efforts to retool their careers as well as co-signed loans for children and grandchildren.¹⁷⁶

As if the debt burden was not enough, potential employers are checking credit reports. High student debt can render you unemployable.¹⁷⁷ Seems unfair. The average medical school graduate has $161,000 in student loans.¹⁷⁸ The ultimate irony is that those young doctors on the cusp of achieving the American Dream cannot afford a starter house. Ben Bernanke’s son is said to be $400,000 in the hole.¹⁷⁹ Bernanke is indeed the father of a gigantic credit bubble. Financial independence for twenty-somethings—a rite of passage only a few years back—has become increasingly out of reach.

Figure 15. Comparison of student loan growth and other consumer debt growth.¹⁸⁰

An entire generation has been set up for debt servitude. We are eating our young. The source of the problem is a complex and nuanced confluence of factors. The chronically profligate boomers, stressed by inflationary pressures and dazed by the equity and real estate downturn, are in no position to help their kids pay for college. The cost of a four-year college education has also soared, while earnings after college have stagnated (Figure 16).¹⁸¹ The number of 26-year-olds living with their parents has jumped almost 46 percent since 2007.¹⁸²

Figure 16. Plot comparing college costs and earnings in early adulthood.¹⁸³

What is causing the rapidly escalating college costs? As a professor of 33 years, I can offer a few thoughts and opinions.

            (1) College tuition—the cost of running a small city—may be the single best measure of inflation. The tuition growth squares well with the inflation numbers posted by John Williams of Shadowstats.com.

            (2) Rapidly growing federal and state mandates to universities escalate bureaucratic costs. You know all those extra positions you see in secondary schools that didn’t exist when we were kids? Universities have them too.

            (3) Universities are much more complex, interconnected organizations than they were 30-40 years ago.

            (4) The quest to attract the best possible students and faculty has produced something akin to an arms race among the schools, forcing up the costs of chasing the competition.

            (5) Universities are financial enterprises that can approach $1 billion annual operating costs and are managed largely by academics often lacking the requisite training. The Dean of Arts and Sciences at Cornell is a physicist—a smart guy by any measure. What prepared him to run a $100+ million enterprise?

            (6) Guaranteed payers—banks offering unlimited student loans in this instance—are always inflationary.

I have an aversion to debt jubilees, but I suspect we are heading for a federally sponsored bailout of borrowers and those who traffic in student loans. How do we prevent a repeat of this debt problem? First, a warning: Don’t buy into the increasingly common claims that college is a waste of money. Such blanket statements are counterfactual. One rich dude bribed 100 kids not to go to college.¹⁸⁴ Some will be fine but others are going to get hit by the cluster truck. There are, however, many circumstances in which a kid should not go to college.

Students must be good consumers. It’s not just a degree; it’s an education. This means choosing paths wisely and working hard. Not all majors or institutions are created equal; enough said. Debt is a bad idea if it is not self-extinguishing—paid off with the net gain in proceeds from the education. If the kids lack direction or need a break, parents need to let them take time off. You read that right— it's the parents, not the kids, who oppose the change. Save your money until it will be used wisely. For their part, schools need to focus on strengths and, in many cases, specialize. Paul Smith's College, a small college in the Adirondack Mountains, is a great example. They educated my older son. His profound success after an inauspicious secondary education stems from the school’s focus—only four, highly pragmatic, majors. What a great model!

How do we fund college educations going forward? I understand the origin of full-recourse loans but find non-dischargeable debt to be anathema to the American system. We’ve got to curb predatory lending; full recourse loans with interest rates and penalties akin to subprime debt is loan sharking. The libertarian in me says caveat emptor, yet this is a vulnerable demographic lacking fully developed frontal cortexes. The best idea may involve creditors purchasing a percentage of the students’ earnings after graduation for a fixed period (10% for ten years, by example). It’s a form of venture capitalism. I would gladly invest in a tranche of loans to MIT students promising a slice of their earnings—at the right price, of course. For those schools in which the bet is a bad one—the loans are too big, attrition is TOO high, or incomes after graduation are on average too low—the resulting market-determined high interest rates would force change or the institution would fail.

The idea of “no child left behind” would take a beating, but I don’t buy the notion that we need more college-educated adults. We need better-educated adults. Whether this means education in a four-year college or a trade school is highly student dependent. Father Guido Sarducci’s “Five Minute University” has an appeal.¹⁸⁵ Another very entertaining parody makes a case for Princeton.¹⁸⁶ I would also say beware of law schools. They can be great opportunities but can also be exceedingly expensive holding tanks for college graduates still lacking direction.¹⁸⁷

By the way, would somebody—anybody—start teaching courses in personal finance at the high school and collegiate levels? That void is what got us into this mess in the first place.

Municipal and State Debt

This is not a boating accident.

~ Richard Dreyfus in Jaws

The balance sheets of municipalities and states are a total mess. Forbes recently noted 11 states flagged for dangerous finances.¹⁸⁸ It’s not just the sand states that are in trouble. Syracuse, NY is considering a debt restructuring due to excessive expenditures and pension promises.¹⁹⁴ Reuters reported that outstanding bonds, unfunded pension commitments, and budget gaps exceed $4 trillion for the 50 states.¹⁹⁵ That’s approximately $40,000 per taxpayer in the country. Illinois is now $150 billion in the hole, yet the voters defeated legislation designed to stem rising pension costs.¹⁸⁹

California’s estimated annual deficit rose from $9 billion to a considerably larger $15 billion in a matter of months. California alone owes over $600 billion, with New York coming in a distant second at $300.1 billion.¹⁹⁰ These are self-inflicted wounds. Orange County paid lifeguards annualized salaries of $200K.¹⁹¹ Hermosa Beach meter maids racked up an astonishing $300K annual salaries.¹⁹² Stockton, San Bernardino, and Mammoth Lakes all filed for bankruptcy protection this summer.¹⁹³ San Bernardino City officials sped up the filing to preempt legal action by creditors. Under Chapter 9, all court cases and other legal actions are halted until the bankruptcy case is over.

Rock star banking analyst Meredith Whitney predicted serious financial stresses for municipalities, yet she made the fateful mistake of predicting what and when.¹⁹⁶ The Mayans taught us that you never predict both. At year end, the criticisms have been mounting. With that said, Moody’s is looking to downgrade some California municipal bonds. Buffett picked up a pile of municipal bonds at deep discount during the crisis, presumably using inside knowledge of the Fed backstop that he helped design, only to dump a bunch of these bonds this year.¹⁹⁷ The muni bond story is just getting started.

Corporate Debt

In aggregate, US balance sheets are in very poor shape.

~ Andrew Smithers, CEO of Smithers and Co.

You may have heard recently that…U.S. companies…are sitting on growing piles of cash they are ready to invest in the economy. There's just one problem: It's a crock.

~ Brett Arends, MarketWatch

Andrew Smithers and Brett Arends are the only two guys I know who claim that corporate balance sheets are not in good shape.^198,199 Everybody else raves about the robust corporate balance sheets while focusing on only one side. Corporations are flush with cash and chock full of debt (Figure 17).²⁰⁰ They are hoarding cash, presumably in anticipation of more credit constraints. The DOW 30 has a net debt (debt minus cash) of $500 billion despite fortress balance sheets by a minority including Microsoft, Cisco, and, if you believe them, JPM. Only 7 of the DOW 30 have net positive cash positions. Pensions of large-cap companies are also significantly underfunded (vide infra). It is estimated that major corporations globally will be refinancing $45 trillion of debt over the next couple of years.²⁰¹ None of this suggests strong balance sheets, only generous credit lines.

Figure 17. Non-financial US corporate debt market (billions of dollars) (source: SIFMA).

Sovereign Debt

There are two ways to conquer and enslave a nation. One is by the sword…the other is by debt.

~ John Adams, former President of the United States

There’s always the Federal Government to bail us out, right? Maybe, but we’re in serious trouble. The U.S. debt doubled in only four years (19% annualized). A recent Treasury report indicates that in less than a year we added $2.1 trillion to the national debt. Although it is tempting to point fingers, a screw-up of this magnitude requires a bipartisan effort. The Federal debt and deficit inspired Egan-Jones to downgrade U.S. debt,²⁰² which then inspired the SEC to investigate them (Egan-Jones, that is).²⁰³ The spendthrifts declare that we had a financial malaise to deal with. I wonder if history will look favorably on a Keynesian experiment in which we injected $1 million of government stimulus for each newly created job.²⁰⁴

It is estimated that we are collecting only 60 cents of every dollar spent by the Federal government. This is not the beginning of the end of some debt frenzy. It is the end of the end. Who is buying all this debt? Funny you should ask. The Fed is buying 60-80% of it. How do we afford it? Oddly enough, the Fed controls the interest rate on federal debt. Uncle Sam has an unbelievably cushy line of credit thanks to Fed largesse. The whole Fiscal Cliff debate illustrates that austerity is too inconvenient to deal with right now. We can worry about tightening the belt later. But this secular bond bull market is very long in the tooth. At some point rates will rise just like night follows day. Each 1% rise in rates on $16 trillion dollar debt adds an additional $160 billion to our interest rate payments.

What if we just really suck it up? Seriously. What if we go to the extreme by dropping all discretionary spending? No more military, highways, education, parks, etc. and pay only the interest on the debt and other payments mandated by statute. We still fall short of a balanced budget.²⁰⁵

For those confused about the Clinton-era balanced budget, it was a hoax—we had gobs of off-balance-sheet expenses putting us in the red. The reported deficit is the innocuous part. If one looks at unfunded liabilities—promises made to the populace for which we haven’t a clue where the money will come from even after projected tax revenues are included—we are in huge trouble. Years ago, Kotlikoff, Burns, and Smetters estimated $44 trillion of unfunded liabilities. Kotlikoff is now estimating over $200 trillion—40 Krugmans! (1 Krugman = $5 trillion)²⁰⁶ That comes to an IOU of $2 million dollars per viable taxpayer. So let’s not trivialize this issue by suggesting that this will hurt our grandchildren. As far as I am concerned, they are on their own. This is gonna crush you and me.

Pension Crisis

Demography is like a glacier: It doesn't move fast, but it is very predictable...it's inexorable.

~ Neil Howe, author of The Fourth Turning

We have a massive, multi-dimensional pension problem. Let’s begin with a look at the personal pension plans most commonly associated with 401K plans and related IRAs. Optimistic retirement planners at Fidelity recommend socking away 8x annual income by retirement.²⁰⁷ That’s not enough. More conservative estimates reach as high as 20x or even 25x your annual salary in savings.²⁰⁸ Further problems stem from the bond market, which approximates 40% of all retirement portfolios.²⁰⁹ In the downturn, huge gains in principal mitigated the pain of the equity losses. The best-case scenario going forward is that rates stay low forever, resulting in miniscule cash flows and no loss in principal. The more likely scenario is that interest rates rise and prices drop causing significant losses in principal. There is no slack left. Reaching for yield buying sketchy forms of fixed income is likely to be a road to ruin. Bold assumptions of 7-8% annual returns on pension portfolios will require double digit equity gains. Buffett and anybody else actually paying attention, however, will tell you that dropping rates, not low rates, helps equities.²¹⁰ Only the legalize-marijuana crowd on CNBC believes rising rates will not hurt equity returns.

Let us look at what is nearly a best-case scenario, a family in the top 5th percentile—the 5 percenter. This family is defined as earning $154,000 and a net worth of $1.2 million,²¹¹ which, by coincidence, is about an 8-fold ratio of savings to annual earnings. A couple at the demographic heart of this 5 percenter also is likely to be a late stage boomer on the doorstep of retirement. Way to go, Fidelity! Using assumptions based on standard portfolio theory and grounded in legally mandated IRA withdrawal rates, the 5 percenter should withdraw only 4% to ensure the money lasts—$48,000 per year. This is a problem. I’ve got to imagine that a 5 percenter is going to find a 50th percentile cash flow in retirement austere. The average boomer with a net worth of $180,000 spinning off only $7,000 per year is within an error bar of living on Social Security. 40% of the boomers literally will have only Social Security.

What about all those folks with defined benefit plans? First, defined benefit plans are becoming anachronistic, having been abandoned years ago by companies unwilling to shoulder the risk. Nonetheless, 341 of the 500 large caps in the S&P have retained some semblance of a defined benefit plan.²¹² It is also estimated, however, that the pension plans in 97% of these companies are underfunded.²¹³ A paper by William R. White out of the Dallas Fed estimated that the 1,500 leading companies in the U.S. have a 30% pension deficit of $689 billion.¹⁶² Despite the Pension Protection Act passed in 2006 aimed at protecting workers against companies using pension pools as cookie jars to boost earnings, the crisis in 2007 and affiliated lobbying campaigns convinced law makers that such protections were too inconvenient.

The municipal and state pension problems are acute. The Illinois State Pension Fund is currently 40% underfunded; there is no obvious way out of their hole short of a Federal bailout. Some states are topping off their pension plans by borrowing money from…wait for it…their state pension plans! Read that last sentence again.²¹⁴ Fully funding the state pensions would cost >$30,000 per taxpayer.

There is no guarantee that the defined benefits plans will survive. Chapter 11 corporate debt restructurings and Chapter 7 liquidations will continue to chip away at this liability. The Chapter 7 liquidation of Hostess and ensuing Twinkie riots—at least I rioted—leaves some wondering what kind of union-management stalemate could drive a company into bankruptcy. The 2,500 workers lost it all. Chapter 9 bankruptcies for restructuring municipal debts and negating pension commitments, unheard of only several years ago, are likely to become well known.

Unimaginable ink has been spilled discussing and analyzing the coming Social Security crisis. It’s an off-balance-sheet Ponzi scheme. Social Security also will be increasingly important as the other support mechanisms fail. With cooked inflation numbers and affiliated inadequate inflation adjusted payouts, it’s easy to imagine seniors getting stiffed.

Roth IRA: A Bad Idea

Cost of living now outweighs benefits.

~ Headline from The Onion

Before leaving the world of pensions I’m gonna pick a fight with Roth IRAs. When the Roth IRA was first announced I had a unique—as in only-guy-on-the-planet unique—visceral response. The original IRA was very farsighted: Savers were allowed to compound wealth unfettered by taxes while the government deferred tax revenues to future generations. By contrast, the Roth IRA pulled tax revenues forward, leaving future generations to take a hike. Imagine the truly awesome demographic problems we would have if the Roth had been introduced in the 60s and the entire baby boom generation became entirely tax exempt. Was this an oversight? I don’t think so. The introduction of the Roth and the substantial revenues from regular-to-Roth rollovers coincided with the Clinton administration’s efforts to balance the on-balance-sheet Federal budget for the first time in decades.

That is my minor gripe. To set up my really big gripe we must first dispel a widely held misconception and a common oversight.

(1) In a regular IRA, the money is taxed at the end, whereas in a Roth IRA taxes are levied up front. If the two are taxed at the same rate—this is a critical provision—the outcome is identical. They are not just similar, it’s an identity. Break out your calculator if you must. There is no differential advantage offered by compounding in the Roth over the regular IRA. Simply put:

Any advantage of the Roth IRA relative to a regular IRA necessarily stems from a lower tax rate while working than in retirement. Period/full stop.

(2) The tax rates of the Roth and regular IRAs are fundamentally different:

Roth IRA: Front-end loaded taxes paid at the marginal tax rate (highest tax bracket).

Regular IRA: Back-end loaded taxes paid at the effective tax rate (integrated over all tax brackets).

The distinction of marginal versus effective tax rate is critical and seems to be lacking from most analyses. One can calculate marginal and effective rates for any income online.²¹⁵ Let’s return to the top-5-percentile family—the 5 percenter. If they had used a regular IRA, they would be paying a 7% effective tax rate incurred on their $48,000 per year withdrawal in retirement. They paid an approximate 32% marginal tax rate—the tax rate at the top bracket—to shelter a few thousand per year in a Roth IRA. The numbers simply do not work.

It is worse than that. Let us consider the lucky soul family—the extraordinarily rare couple—who actually accrued 25 annual salaries in their retirement account. For this family a 4% annual withdrawal will be equal to an annual salary while working, placing them in the same tax bracket (ignoring unknowable tax law changes). Even so, they paid 32% marginal tax on the Roth to avoid a 22% effective tax rate incurred by the regular IRA. The numbers still don’t work. I do not understand why the Roth is being sold so enthusiastically to the public.

Now ponder all those folks who rolled over a lump sum from a regular to a Roth IRA. They not only paid the marginal tax rate on the rollover but caused the marginal rate to spike to a higher level! It’s hard to imagine that will prove to be a smart move. Congress is considering moving all pension funds to what is effectively Roth IRA rules as part of their Fiscal Cliff negotiations.²¹⁶ You young guys are about to get hosed.

Europe

The ECB is going to buy bonds of bankrupt banks just so the banks can buy more bonds from bankrupt governments. Meanwhile, just to prop this up the ESM will borrow money from bankrupt governments to buy the very bonds of those bankrupt governments.

~ Kyle Bass, CEO of Hayman Capital

Watching Europe is like reading Waiting for Godot—it is unintelligible. This is unfortunate because these folks may determine my fate. The problems begin with the PIIGS—Portugal, Italy, Ireland, Greece, and Spain—suffering from insolvency. We were assured that the Maastricht Treaty and Haagen Dazs Accord that spawned the Euro explicitly forbade deficits and bailouts.²¹⁷ Well that was then and this is now. Christine Lagarde, head of the IMF, held a press conference literally flashing a big, black purse suggesting that it needs some serious money, and—Shazam!—a €700 billion bailout was in place before the weekend was over. Soon there were trillion-euro bailouts with fuzzy names such as Long-Term Refinancing Operation (LTRO), European Stabilization Mechanism (ESM), European Financial Stability Facility (EFSM), and Monetary Injection Liquidity Fund (MILF). Spiking interest rates of the PIIGS were driven down to levels that look like AAA-rated debt of Pfizer and General Electric. The European Commission (EC), International Monetary Fund (IMF), and European Central Bank (ECB)—the so-called Troika—are the enforcers. The banks get what the banks want.

A Greek exit—shortened to Grexit by Willem Buiter—would have created a fiscal crisis as well as an acronym crisis—PIIS. We endured an insane discussion about whether or not Greece should suffer austerity.²¹⁸ Versus what? Rich, prosperous, and productive? The only legitimate employment was hawking gyros to rioters. A photograph of the Greek Ministry of Finance showing total chaos went viral, becoming a metaphor for the nation.²¹⁹ Nobody got the memo: Austerity is not a choice; it’s a result. Any banker who lends to Greece will be the author of his own (and our) misfortunes. Iran stopped shipping oil to Greece. Just when Greece appeared to be plumbing the bottom, they suffered a locust attack—a real one.²²⁰ Greece is the smallest pawn on the chessboard and with little bargaining power. They were asked to sign a bailout agreement with deep-seated sovereignty issues, yet the document was written in a different language with an incomplete translation.²²¹ However, the Greek default could cost the banks trillions, and the Greeks know this.²²²

The bailouts are coming from Germany because everyone else is on the receiving end. Yet, with an economy 20% the size of the U.S. economy, the Germans are trying to prop up a gaggle of countries that are collectively bigger than the U.S. economy. Europe has $30 trillion unfunded pension liabilities. It’s not going to work. Discussions of why the Americans should bail out Europe—even more than the hundreds of billions of QE II that ended up in European banks—led to a classic Santelli-Liesman love-fest on CNBC.²²³ The banks get what the banks want.

Soon Spain began to slip into the abyss,²²⁴ something I had been waiting for since 2009. [3] Shockingly, Mariano Rajoy, Prime Minister of Spain, declared, “We support a rescue mechanism, the bigger the better."²²⁵ It was all part of a shakedown of the EU, and it seemed to work. Money began flowing into Spanish banks. (Bankia actually got a bailout before the bailouts officially began because they couldn’t wait.)²²⁶ Spain put a €2500 cap on cash transactions,²²⁷ which is emblematic of an end game. Meanwhile, Spain is bidding for the 2020 Olympics. They will be sponsored by Lowenbrau.²²⁸

Then came the Italians. Bill Gross noted that "Italian banks are now issuing state guaranteed paper to obtain funds from the European Central Bank (ECB) and then reinvesting the proceeds into Italian bonds, which is QE by any definition and near Ponzi by another." The oldest bank in the world, Banca Monte dei Paschi di Siena founded in 1472, got bailed out. I wonder how many times that has happened in the last 540 years.²²⁹ The wheels of justice in Italy were moving forward; they convicted scientists for failing to predict an earthquake.²³⁰ The guys who cause earthquakes are still on the lam.

What happened to the assurances of the Maastricht Treaty that no sovereigns would be bailed out? It seems simple enough to me. Politically disconnected sovereign states are strongly shackled together by a common currency and borderless multinational banks. Why would the politicians in the sovereign states agree to self-destructive austerity deals rather than giving them the Icelandic Salute—a default and the finger? That’s easy, too; the banks own the politicians, probably via Cayman Island subsidiaries. (In the olden days, it would have been the Swiss, but their money-laundering ways are at risk.²³¹) One of the many subplots is a mountain of credit default swaps that would break the banks if they were triggered.²³² No problem: The banks refuse to declare the credit event. The banks get what the banks want.

The LTRO is particularly insidious because it subordinates existing debt, inducing a bad case of transurphobia (fear of haircuts). The more LTRO money, the less capital remains backing the existing debt.²³³ Which legal body gets to make this decision? That’s what the Troika is for—democracy not included. These guys are undermining the debt markets in fundamental ways.

The 2012 Nobel Peace Prize was awarded to the European Union,²³⁴ rumored to be for “keeping their shit together” and for “displaying an unprecedented willingness to not start another world war.” The great part about this wave of absurd Nobel Peace Prizes is that, in theory, I could get one—a dollar and a dream.

A World Economic Forum (WEF) report says we must double global debt by 2020 (to $210 trillion) to keep the global economy growing.²³⁵ If that’s the price, shrinkage is sounding pretty rational. The killer phrase was that “most of the growth will come from the government segment.” That ain’t economic growth.

Let us not forget the troubles in the UK. Goldman announced that they were installing one of their boys (Mark Carney) as head of the Bank of England, prompting David Stockman to ask, “Is there any monetary post in the world not run by Goldman Sachs?”²³⁶ UK family debts are up by almost 50% in a year. That is serious slippage. The Bank of England cranked $140 billion into the system in one day—equivalent to 177% of the annual global gold production.²³⁷

The Brits et al. are eating a lot of "toast sandwiches," otherwise known as the "austerity sandwich"—two slices of bread wrapping a piece of toast (butter/salt optional).²³⁸ Irish taxpayers withheld property taxes in protest to the Troika. This smacks of a “peasant rebellion” claiming taxation without representation. With this history ringing in his ears, Sir Mervyn King, Governor of the Bank of England, noted, “I have deep sympathy with those who are totally unconnected with the origins of the financial crisis who suddenly find that the returns on their savings have reached negligible levels. These are consequences of the painful adjustment prompted by the financial crisis and the need to rebalance our economy.”²³⁹ We feel your pain too, Sir Mervyn. Can I offer you a toast sandwich?

The whole mess has been summarized and bulleted by countless bloggers. A few are worth reading.^240,241,242 Credit Swiss noted that “Portugal cannot rescue Greece, Spain cannot rescue Portugal, Italy cannot rescue Spain, France cannot rescue Italy, but Germany can rescue France.”²⁴³ Of course, in February Baghdad Ben Bernanke noted that "the ECB is well capitalized."

Asia

Asia is, by comparison, a relatively serene place. There was a seemingly ominous event when the Bank of Japan was said to be selling its bonds (JGBs) for the first time in years.²⁴⁴ This smelled like the beginning of a large deleveraging. Recent reports suggest that they are back to monetizing debt in a big way.²⁴⁵ Some bears such as Greg Weldon, Simon Johnson, and Kyle Bass view Japan as ground zero for financial carnage.^246,247,248 Japan has spent 20 years losing 80% on the Nikkei—the so-called “lost decade” to those who can’t count—and now the carnage begins in earnest? Losing all of their nuclear reactors also seems ominous; I am guessing they were not using them as backup sources.²⁴⁹ Demographically, their population will continue to age for decades. This is not a pretty picture.

There are others who think China will be the source of fireworks. On the bearish side, you have Jim Chanos placing some serious shorts in position.²⁵⁰ You must take this as a serious omen. The average bloke does not understand the thoroughness of analyses by guys like Chanos and Einhorn. (Chanos, for example, was way ahead of all of Hewlett Packard’s auditors in detecting an $8 billion screwup in their purchase of Autonomy.²⁵¹) Besides a bloated real estate market and terrible bank balance sheets, China is said to have a huge buildup of finished goods—channel stuffing—which will cause trouble at some point.²⁵² This is consistent with often-cited suggestions that the authorities are terrified of unemployment and accompanying social unrest. On the other side, Stephen Roach and Jim Rogers, both highly respected market watchers, are rather enthusiastic about China. Years ago Rogers predicted strife in China would come to a head, and that would be the time to buy. I am quite confident, however, that I have no prayer of understanding China either now or in retrospect.

The Baltic Dry Index²⁵³ is a widely followed indicator of global economic activity (Figure 18). As you can see, the global economy is looking a little green around the gills.²⁵⁴

Figure 18. Baltic Dry Index as an indicator of global economic well being.²⁵⁴

I leave this section with an aside that is too curious to ignore. We were told this year that Japan had unwisely dumped $138 billion into Lehman before the company’s collapse and were promptly reimbursed by the Fed.²⁵⁵ Makes you wonder about those two Japanese businessmen caught crossing the Italian border with $134 billion of Treasury bonds.²⁵⁶ The Treasury denounced them as fake, but the Italians thought they were real. Who could launder them? (Silly question: HSBC would gladly do so for a cut.)

Government Corruption

Geithner heard this information and looked the other way. Geithner and other regulators should be held accountable, they should be fired across the board. If they knew about an ongoing fraud, and they didn't do anything about it, they don't deserve to have their jobs. I hope we see people in handcuffs.

~ Neil Barofsky, Special Inspector General of TARP

What we’re showing here is that cronyism is now permeating our justice system.

~ Peter Schweizer, author of Throw Them All Out

2012 witnessed plenty of government corruption. It is my thesis that corruption within government is getting worse for three reasons: (1) government is a larger percentage of our peacetime GDP than in any other time in history, (2) thanks to the Supreme Court, unlimited funds flooding into election cycles drown out all other interests, and (3) profound financialization of the economy—movement of money for the sake of money—due to unprecedented Fed interventions and deficit Federal spending aggregates criminal elements and elicits criminal behavior. To put it simply, the crime syndicates all had IPOs. Almost without fail the punishments for white-collar crime—really substantial graft—are a small percentage of the booty obtained from the crime. Failures to investigate and prosecute men of wealth and power are emblematic of a kakistocracy—government by the most unprincipled.

Attorney General Eric Holder was up to his ears in dirt. Holder’s law firm defended Corzine against prosecution by Holder’s Department of Justice.²⁵⁷ The law firm won that battle. This was the same Eric Holder who was charged with contempt of Congress for not forking up information about the “Fast and Furious” Mexican arms deals.²⁵⁸ This was the putative sting in which Federal agents sold arms to Mexicans to track the arms but somehow forgot to include tracking devices. Congress also appears to have forgotten to follow up on the contempt charge. I asked Peter Dale Scott, a UC Berkeley octogenarian and multi-decade scholar on the politics of drug cartels, if he knew what the real story was behind Fast and Furious. He assured me that “there is something very wrong with the picture and the official explanation for it.” Oddly, the investigation into the arms deals was terminated by...you guessed it, the Obama Department of Justice.²⁵⁹ That would be Eric Holder.

The authorities continue to cauterize the wounds from the mortgage fiasco by out-of-court settlements with banks, allowing no admission of guilt, no criminal prosecutions, and cash settlements representing small fractions of the profits. (I get in more trouble for leaving the seat up.) We thought the authorities finally levied a severe fine on the banks and brokerages with a sizeable $25 billion settlement for fraudulent foreclosures, only to find that most of the money—all but a few billion dollars—came from the bailout money and even their own write-downs of losses on defaulted mortgages.²⁶⁰ Dean Baker notes that Obama gave bankers immunity from prosecution, and in return, bankers agree to accept government money to cut mortgage principle.²⁶¹ Everything but the reduction in mortgage principal came to pass.

Although this is not easily prosecuted corruption, the racketeering (RICO) laws seem appropriate. To clarify, I am recommending RICO laws be used on the government officials who participated. Even the document that represented the attorneys generals’ settlements with the banks was shown to be fraudulent.²⁶² The New York Times reported that money intended for homeowners in the fraud settlement, as little as it was, got diverted by the states into general operating funds.²⁶³

Walmart got caught bribing Mexican politicians to foster their business interests South of the Border.²⁶⁴ Somebody bribed the Mexicans? Shocking indeed. This does not happen in the U.S. because we have registered lobbyists. Those same lobbyists will ensure that Walmart’s transition to redemption is seamless.

The SEC, to evade a Freedom of Information Act (FOIA) suit, expunged data pertaining to Citigroup as part of their catch-and-release program.²⁶⁵ Citigroup is protected by the Rubin mafia. This is politics Geithner Style. It will be interesting to see where the starting lineup for Team Obama ends up after they finish their first term. The FOIA by Bloomberg showed how the revolving door totally commandeered the Dodd-Frank act to make sure it was banking-friendly.²⁶⁶ The average salary boost on passing through the government-Wall Street revolving door is estimated at 1400%.²⁶⁷ I’m sure that top dogs like Geithner will do considerably better. Don’t let the revolving door hit you guys in the butts.

Another proud moment for the Obama administration’s push for alternative funding energy: Electric car battery maker Ener1, which received more than $100 million in government handouts, has filed for bankruptcy protection.²⁶⁸ I’m beginning to suspect cronyism here! Peter Schweizer’s book Throw Them All Out (vide infra) documented in repulsive detail the shovel-ready cronyism that occurred during the financial crisis.

There were old-school politics going on when Mississippi Governor Haley Barbour left office. On his way out the door he pardoned a number of seedy characters, including eight men convicted of killing their wives or girlfriends.²⁶⁹ The Mississippi Supreme Court upheld the decision. In Mississippi, the Rule of Law is a bad joke, and True Blood is a documentary. We have, however, not plumbed the level of the Thai politicians. A Thai senator shot his secretary with a machine gun in a restaurant and got a $625 fine for it.²⁷⁰ Very Cheney-esque.

If you want some fun, find the Clinton pardons. The original list I saw had over 1,100 and was easily located. The list was laced with drug busts and bank frauds. I can only find partial lists now. Even so, the number who were in prison for drugs or some form of bank fraud is striking.²⁷¹ This would partially explain how Clinton left office burdened by onerous legal fees and now has an estimated net worth of $80 million.²⁷² That’s a lot of honoraria for rubber chicken dinners. Tony Blair also seems to have laundered serious money into shell companies.²⁷³

State Supreme Court judges run for office in 38 states. Jeffrey Toobin warns us that the lobbyists discovered them in the mid-90s and are diverting some of their resources.²⁷⁴ In 1990 candidates for state supreme courts only raised around $3 million…in the races to the high courts, candidates now raise more than $50 million.

The government sold $5 billion worth of AIG stock acquired during the bailouts. AIG bought $2 billion of it, presumably using money from government bailouts. AIG was shockingly profitable owing to $17 billion of tax credits (gifts by the taxpayer).²⁷⁵

Harvard had a publicly embarrassing cheating scandal in which over a hundred kids in one course were accused of plagiarizing. What course would warrant such bad behavior? Introduction to Congress.²⁷⁶ I’m sure the kids will do better in their Introduction to Ethics in their MBA programs.

Recall the must-see Miami Vice episode entitled, “Prodigal Son?”²⁷⁷ Tubbs and Crocket trace the drug money straight to a wrinkly old banker who explains that the drug money ensures payment of South American bank debt. I remember at the it time that made sense, and it seems haunting now. It is rumored that Mr. Burns in the Simpsons was modeled after the Miami Vice banker.

Civil Liberties and the Constitution

There is very grave danger that an announced need for increased security will be seized upon by those anxious to expand its meaning.

~ John F. Kennedy, former President of the United States

There may be a number of people who cannot be prosecuted for past crimes, in some cases because evidence may be tainted, but who nonetheless may pose a threat to the security of the United States.

~ Barack Obama, President of the United States

One of my favorite bloggers, Charles Hugh Smith, cogently summarized instances in which incarceration was used to protect democracy and civil liberties.²⁷⁸ How ironic. Doug Casey provided a haunting account of creeping fascism in Germany in the ‘30s and how it occurs incrementally.²⁷⁹ It is an easy case to make that we are in a battle to preserve civil liberties simply because every year is a battle to preserve civil liberties. Civil liberties are forfeited one at a time. The battle lines are being drawn. You should fight every fight, no matter how big or small.

There is an ongoing battle for ultimate control of the Internet. Legislation includes the Stop Online Piracy Act (SOPA), the Protect IP Act (PIPA), and the Anti-Counterfeiting Trade Agreement (ACTA).^280,281 Superficially they are designed to achieve the named goals. The notion is that pirating sites can be blocked if they are interfering with trade. Their reach, however, is far greater. An accusation alone is sufficient to block a web site prior to any clear evidence of guilt.²⁸² Authorities could shut down search engines Yahoo, Google, or Bing suspected of enabling these hooligans. SOPA got shelved after there was, ironically, a massive Internet-derived protest. The digital world has taken our lives by storm. The Internet is as profoundly democratic as Gutenberg’s printing press. Keep it wide-open at all costs. Efforts to control information flow will keep appearing like the proverbial camel nose under the tent. And here comes the next one on cue in 3…2…1…enter the Trans-Pacific Partnership (TPP)!²⁸³

The implications of armed drones are staggering. We are not the only country with drones; they are proliferating around the globe. We managed to survive thermonuclear risk for half a century, and yet we find ourselves racing toward a Skynet-like drone war of staggering magnitude. The skies will be littered with drones like aerial minefields. It is terrorism to those on the receiving end, causing blowback to be almost a certainty. Congress passed a law opening U.S. skies to unmanned drones.²⁸⁴ Companies are lining up to launch them—an estimated 30,000 drones within a few years²⁸⁵—forming a nouveau industrial-military complex. As a guy who finds automated speed-monitoring devices irritating and automated ticketing profoundly disturbing, the drones make me crazy. Even if unarmed, is this not Constitutionally prohibited unlawful search? What event will elicit armed variants to protect us from the bad guys? And if all that isn’t spooky enough, the drones are being engineered for autonomous (human-free) response.²⁸⁶

Digital monitoring of “crimes against traffic” frees up police for more hands-on police work. Petty arrests now justify strip searches. The Economist describes increasing predilections toward stop-and-frisk policies within the cities.²⁸⁷ Legal scholar Jonathan Turley estimates that over 700,000 unwarranted stop-and-frisk searches occur each year in NYC alone.²⁸⁸

Jonathan Turley also notes that the Administration claims the right to assassinate a U.S. citizen either here or abroad, and it would seem that we did such a thing.²⁸⁹ Of course, the target deserved it because he undermined America! The FBI has described extremists as those who “may refuse to pay taxes, defy government environmental regulations, and believe the United States went bankrupt by going off the gold standard."²⁹⁰ Y’all should be careful because you never know what is flying 50,000 feet right above your heads. Obama is the only Nobel Peace Prize winner with a kill list. God save the poor soul spotted by drones entering Manhattan with a Big Gulp. Mayor Bloomberg’s war on Big Soda could turn violent.

Sergey Aleynikov was arrested in 2009 for the most egregious of crimes—stealing software from Goldman Sachs. The Goldman Stasi are good at their jobs, getting him into custody within hours. In 2010, he was convicted and sentenced to 8 years in jail for this profitless crime despite the probation office’s recommendation of 2 years.²⁹¹ The system seemed to correct itself when the United States Court of Appeals threw the case out in 2012, ruling the source code was not a "stolen good.”²⁹² It was a pyrrhic victory for Aleynikov. They arrested him again using a different jurisdiction to avoid double jeopardy.

Joshua Dressler, a criminal law professor at Ohio State University said that “it was highly unlikely that the separate Federal and state prosecutions in the Aleynikov case would violate the Constitution.” I think they just did. At least now Sergey doesn’t have to start his car in fear.

The National Defense Authorization Act (NDAA) was enacted to protect us against terrorists.²⁹⁴ Of course it was. It provided government authority to incarcerate an American citizen indefinitely without access to legal defense or the courts. Protestors challenging the unlawful incarceration were (you got it) arrested.²⁹⁵ In September, a Federal judge ruled it was not even in the same zip code as the Constitution and put a permanent injunction to protect us.²⁹⁶ Here’s the really troubling part: It had been passed by a large majority in Congress and a 91:9 vote in the Senate, and signed by President Obama. When the outcry began in earnest, Obama assured us that his administration would never act recklessly. I beg to differ: Signing the bill was reckless. I’ll take it a step further: Signing the bill was treason. Read your job description, Mr. President. Watch for that part about upholding the Constitution. And by the way, Team Obama is fighting the injunction.²⁹⁷

There is little doubt that municipalities in the sand states would do almost anything to dig themselves out of the mortgage crisis. The brain trust in San Bernardino, with the legal help of one of my colleagues (Professor Robert Hockett) got the idea to use eminent domain to commandeer underwater mortgages—mortgages that exceed the value of the house.²⁹⁸ The idea is to pay “fair value” (red flag!), bundle them up (red flag!), and sell them to private investors (red flags!). There would be no shortage of cronies willing to buy up these bundles. The subplot might be that this is a veiled attempt to clean up the MERS boondoggle that is causing foreclosures to throw the title of houses into a legal vortex. As preposterous as this sounds, it’s probably Constitutional given the eminent domain case in Connecticut that some believe drove Sandra Day O’Conner to retire from the court.²⁹⁹ It may, however, be illegal in California.³⁰⁰

The Citizens United suit gave Super PACS their unlimited political power by allowing them to spend unlimited money on political campaigns provided they follow a few guidelines.³⁰¹ Journalist and civil servant Jim Hightower referred to the majority justices as "five traitors to the democratic ideal.” It is indeed odd that support for freedom of speech may have profoundly oppressed free speech. A banking Super PAC overtly promoted by American Banker is blood curdling in its goal to defeat any candidate that is not friendly to banks.³⁰² A suit to ban excessive donations in Montana got nuked.³⁰³ According to the Supreme Court, money is speech. As a corollary, if you don’t have money, you will lack a voice.

Corporate civil rights seem to be in the news. An Occupy Wall Street (OWS) protestor carried a sign, "We will know corporations are people when Texas executes one." It seems clear that corporate civil liberties without civil responsibilities is a problem. It is not true, however, that this was a recent or rapid change. Organizations began to accrue Constitutional protections beginning with a case of Dartmouth College versus the State of New Hampshire in 1819. Ted Nace’s Gangs of America tracks through the Supreme Court decisions that incrementally granted civil liberties to corporations. Despite the hyperbolic title, it is a balanced, scholarly analysis.

Why are civil liberties eroding? One notion is that tension between the central planners and free market crowd led to a societal compromise in the 1930s. Capitalism was allowed to flourish, but with safeguards to keep communistic ideals in check. With the fall of the Berlin Wall and the Soviet Block, the proletariat (in the U.S., that is) had no alternative system to keep powerful individuals mindful of their needs. Glass Steagall fell in the late 90s, the banking cartels grew, and wealth disparity—financial apartheid—emerged.

Limits of Government

A sinking economy requires stimulus from two agents, the Federal Reserve and the government.

~ Rich Yamarone, Director of Argus Research

During the time of the Soviet Union the role of the state in economy was made absolute, which eventually led to the total non-competitiveness of the economy…I am sure no one would want history to repeat itself.

~ Vladimir Putin, communist

We have witnessed a seemingly endless battle for the Grand Compromise between those supporting central planning versus market forces. 18th century economist Edmund Burke warned of the role of intellectuals trafficking in snark and trumpeted the Law of Unintended Consequences. Burke also recognized the wealth disparity in 18th-century France and accurately predicted the murderous end result. 19th-century economist Alexi de Tocqueville described the genius of America as not the equality of outcome but rather equality in the eyes of the law. 20th-century economist Joseph Schumpeter also viewed intellectuals with disdain and capitalism not as flawed but fragile. Friedrich Hayek, famous for his opposition to John Maynard Keynes, supported the notion of social safety nets, just not so many and not so invasive. I think Hayek’s stroke of insight was recognizing significant analogies with Darwinian evolution to understand that complex systems arise and persist more by trial and error than by explicit human engineering. Hayek’s Fatal Conceit describes the folly of intellectuals thinking they are smart enough to mess with free markets, hoping to obtain only intended consequences. My reading of Keynes is that he was a profound interventionist—a knob twirler—and was also a radical socialist.

The Yamarone quote illustrates that we have degenerated to a society in which even the big money guys—supposedly the bright bulbs—think that government will solve our problems. While watching a Yale panel discussion on the economy, I was struck by the explicit endorsement of government solutions by the panelists.³⁰⁴ Apparently, we are all Keynesians now. I could buy into a variant of the Keynesian model in which government acts as a financially interested party, buying goods and services when they are cheap and pulling back when they are expensive. It would naturally be counter-cyclical. Unfortunately, there is no chance it will ever work that way. Paraphrasing my dad who was paraphrasing Milton Friedman, government does everything inefficiently, so don’t ask them to do more than you must. It’s not about the morality of what government does; it’s about the low quality and horrendous inefficiency.

Hernando De Soto warns that the U.S. is forfeiting a critical feature that distinguishes it from Third World countries—well-defined property rights. The MERS catastrophe that threw the title of millions of properties into question was an 80-car pile-up on a foggy freeway that will be corrected by legal fiat. By contrast, mutation of the banking system into a cartel, while by no means unprecedented, is a serious problem. Now that this gargantuan organism has control, there is no means to wrestle it back. When you can purchase a politician for $100,000, how can we expect real change? The Citizens United case that opened the political process to unlimited capital is profound because attempts to unring that bell are opposed by unlimited capital. The power of the banking trusts has gone beyond the failsafe point. The Fed—the One Ring that controls them all—is the key. It will be a long trek to the Crack of Doom.

Challenges to our civil liberties, overreach of eminent domain, domestic drone surveillance, and attempts by elected officials to knowingly subvert Constitutional rights all attest to the insidious Orwellian creep of government into our lives. It is not obvious to me that we can negotiate our way out of this one. Some problems do not have solutions if you define a solution as a fix with tolerable pain. I suspect that resolution will occur, but it will be something historic. We are in a barrel speeding down the Niagara River toward the Falls. This is not an episode of Batman or McGyver: all palatable solutions have passed. We will experience the Falls up front and personal. Those in power will claim they did their best when, in fact, they were the root cause. Bernanke, one of the reputed world’s experts on the Great Depression, never mentions loose monetary policy in the 1920s as the cause. It is a lie by omission; a profound one at that.

I close with a simple directive: Watch Ron Paul’s farewell speech to Congress.³⁰⁵ You owe it to yourself. He’s the one that got away. To paraphrase Marlon Brando, “He coulda been a contender.” If you’ve had enough of darkness, try this John Cleese seminar on creativity³⁰⁶—it’s brilliant—or this photo montage of history’s most epic photos.³⁰⁷ Soon I will be off like a prom dress, but first I wish to share the books that I read this year, and the all-important acknowledgements.

Books

Every year I summarize books that I read. I am a slow reader so I try to chose them carefully. I’ve overdosed on crisis books for over a decade (beginning with crisisforeshadowing books) but succumbed to the temptation a few more times. I also slipped back into pop psychology mode.

The Clash of Economic Ideas: The Great Policy Debates and Experiments of the Last Hundred Years by Lawrence H. White

White describes the debates that took place throughout the 20th century, pitting the free market advocates against the central planners. Although White shows his colors as a free marketeer, he does a beautiful job of letting the reader ponder the debate rather than force-feeding the conclusion. The book might not be wonky enough for the pros, but I found it to be very scholarly—a great book for a wide swath of macroeconomic enthusiasts. This is the stuff economists-in-training seem to miss in modern curricula. I took the plunge prompted by an Econtalk interview of the author.³⁰⁸

Broken Markets: How High Frequency Trading and Predatory Practices on Wall Street are Destroying Investor Confidence and Your Portfolio by Sal L. Arnuk and Joseph C. Saluzzi

I don’t really know Sal Arnuk but am a big fan of Joe Saluzzi, occasionally swapping barbs about the horrendous price discovery process in modern markets. Joe and Sal describe in detail how high frequency traders are eroding the foundations of the markets—not just equity markets—through their relentless game of high-frequency Whac-A-Mole. Although Sal’s and Joe’s knowledge of the markets and passion for change is uncontestable, their frustration at times overwhelms the prose. I recommend the book, but some enthusiasm for trading may be required to nudge this book into the five-star group.

Bull by the Horns: Fighting to Save Main Street from Wall Street and Wall Street from Itself by Sheila Bair

I wasn’t going to touch this book if it were not for a personal endorsement from Chris Whalen. Bair, Chair of the FDIC (Federal Deposit Insurance Corporation), describes the incredible turf wars and petty battles below the surface of the bailouts. I previously had sensed Sheila was one of the good guys; the book reinforced it. She describes Bernanke as generally well-meaning, Geithner as a relentlessly pro-Citigroup promoter and Rubin pawn (to the point of racketeering), and a host of others who clearly need severe beatings. It is an antidote to the highly lopsided Sorkin treatise, Too Big to Fail. Here is a Bair interview.³⁰⁹

Bailout: An Inside Account of How Washington Abandoned Main Street While Rescuing Wall Street by Neil Barofsky

Neil entered the crisis plotline as the young, feisty special investigator general to oversee the TARP bailout (SIG-TARP). From his presentation, he was green and naïve, unready for the thugs he would be dealing with. By example, he figured out relatively late in the game that the gaping holes in the bailouts used by the banks to siphon trillions from the Fed were left there by design, not by mistake. The big loser is Geithner, who comes across yet again as a despicable human being. I was disappointed not to get more insight into Elizabeth Warren’s role as Chair of the TARP oversight committee. Barofsky has done many interviews; an Econtalk variant is particularly thorough.³¹⁰

Reckless Endangerment: How Outsized Ambition, Greed, and Corruption Led to Economic Armageddon by Gretchen Morgenson and Joshua Rosner

This is an excellent and detailed analysis of the financial crisis, deeply probing the mortgage industry’s role (more than simply explaining the basics found in all of the crisis books.) Some may find this old news that they would like to put behind them. My only caveat is that one should read this book or Nocera and McLean’s All the Devils Are Here, but not both.

The Battle of Bretton Woods: John Maynard Keynes, Harry Dexter White, and the Making of a New World Order by Benn Steil

Benn is a fellow at the Council on Foreign Relations (CFR) with what I would call an Austrian economic slant. The book will be released in March. In it, Steil describes a fascinating battle between Harry Dexter White and John Maynard Keynes before, at, and after the 1944 Bretton Woods Conference in which the future world currency regime was hammered out. We get deeply insider views of the events in a prose and presentation that I found gripping. Keynes’s role as a diplomat, unknown to many, may have been his most important single contribution. Heads up: Steve Hanke of the Cato Institute and Johns Hopkins University also has a book on the Bretton Woods Conference coming.

Throw Them All Out: How Politicians and Their Friends Get Rich Off Insider Stock Tips, Land Deals, and Cronyism That Would Send the Rest of us to Prison by Peter Schweizer

Many may know Schweizer from a 60 Minutes episode that revealed broadly based, scandalous insider trading by Congress that is legal for them. This is the book upon which the 60 Minutes episode was based. Schweizer tells horror story after horror story of graft that would get normal citizens sent to prison. What is appalling is how often they sell the taxpayer out by billions of dollars so that they can make a few hundred thousand dollars. Obama comes out looking particularly bad as the author describes how shovel-ready projects were really about massive kickbacks for campaign donors. It was not, however, a partisan hatchet job.

Thinking About Capitalism by Jerry Z. Muller and Modern Economic Issues by Robert Whaples

These two trimester-length audio books from The Teaching Company focus on basic principles of economics from a decidedly descriptive slant (as mandated by audio).³¹¹ It’s easy listening stuff that is appropriate for those trying to become comfortable with foundational principles. I liked them because they provide these principles in particularly clear and cogent prose. Never pay retail; they go on sale at 80% discount many times during the year.

The Clash of Generations: Saving Ourselves, Our Kids, and Our Economy by Laurence J. Kotlikoff and Scott Burns

This is a follow up to Kotlikoff’s The Coming Generational Storm describing the impending problems from off-balance sheet obligations. The authors, in conjunction with Kent Smetters, did the seminal studies on unfunded liabilities—promises that are unfunded even when projected tax revenues are subtracted. The authors now estimate them at over $200 trillion. I found the The Coming Generational Storm more appropriate for my needs. The clash of generations is part warning and part investment book for those who are not familiar with this issue. I think the authors manifest ‘doomsayer’s fatigue’—the need to be optimistic after years of seeing a dismal future. I am, nonetheless, a huge Kotlikoff fan.

Thinking, Fast and Slow by Daniel Kahnemann

Kahnemann is probably the most prominent contributor to behavioral economics, garnering him the Nobel Memorial Prize in Economics. He works with Nassim Taleb and appears to be Taleb’s mentor. Thinking Fast and Slow presents the constant battle between the instinctive thoughts and more decidedly cognitive reasoning, explaining how we make decisions and how they can go astray. It is more thoughtful than Gladwell’s Blink, sometimes demanding deeper thought.

How We Decide by Jonah Lehrer

Lehrer’s book came recommended via an Econtalk interview.³¹² It is yet another Blink-genre book looking into how humans make decisions. I love these books but this treatise is presented at a much lower level than Kahnemann’s and is remarkably similar to a book entitled Sway by Ori and Rom Brafman. Consumers of pop psychology should probably check out Ed Yong’s interview on Econtalk discussing the underlying flaws in this type of social science.³¹³

The Wisdom of Crowds by James Surowiecki

Surowiecki discusses how collections of people with limited individual insights, if acting truly independently, display collective "wisdom" and how that wisdom is lost when they start acting in a correlated fashion. There are many cute snippets describing the results that, at times, become a little too loosely connected. Aficionados of this genre will find it both fun but partially redundant to other works (Taleb; Kahnemann; Gladwell).

My Stroke of Insight: A Brain Scientist's Personal Journey by Jill Bolte Taylor

Jill, a Harvard neurophysiologist, wakes up one morning and finds herself having a stroke in the highly rational left brain. Her deductive reasoning goes on- and off-line, throttling her back and forth between euphoria and panic. The story describes the stroke and the long recovery in hysterically funny prose from an especially insightful perspective of a neurophysiologist. I found the audio book to be an excellent medium.

Steve Jobs by Walter Isaacson

In case you’ve been living under a rock, this fully sanctioned biography that was in no way edited by Steve or his family is simply the best biography I’ve ever read. You get a bird’s-eye view of the computer revolution from soup to nuts through the detailed stories and words of all of the key players. Steve was a unique personality with a unique ability to translate unimaginable compulsive behavior into profound success rather than total failure. My conclusion: Sell any shares of Apple Computer because it ain’t the same company without Steve.

Secrets: A Memoir of Vietnam and the Pentagon Papers by Daniel Ellsberg

Ellsberg describes the events leading up to, during, and following the release of the Pentagon Papers, the media-driven exposé of nefarious activities by a string of administrations. It is not really about the content of the papers. Presidents who lie to the American populace seem rather pedestrian in this era. It was interesting but only in the four-star category.

Human Prehistory and the First Civilizations by Professor Brian M. Fagan

I have listened to dozens of trimester-length courses provided by The Teaching Company as audio books.³¹⁴ With only one exception, they have been great. In this course, Fagan does a great job of following the lineage from the origins of humans starting about 8 million years ago through to the ancient (pre-historic) civilizations across all continents. It’s both informative and very easy listening. Reminder: Never pay retail for these books: they go on 80% sale routinely, bringing the price down to about $70.

Bonhoeffer: Pastor, Martyr, Prophet, Spy by Eric Metaxas

Bonhoeffer was a cleric and a spy in Nazi Germany who eventually gets executed for his role in a conspiracy to kill Hitler. (That is not a plot spoiler; the author tells you he died right up front.) The biography describes the church-state battle, which was very new to me. In my opinion, however, there was way too much church and not enough state. Despite over 500 bonkers reviews at Amazon I found it to be boring.

Acknowledgements

OK. This ain’t a book; it’s just a friggin’ blog. I’ve got to take this opportunity, however, to thank some folks who have generously shared their time and insights so as to make thinking about capitalism a special experience. You guys have made a difference. Chris Martenson brings gravitas to the debate on resource depletion and, in conjunction with Adam Taggart, graciously publishes my Reviews and invited me for my favorite interview.³¹⁵ Rick Sherlund of Goldman Sachs/Nomura and friend of 40 years inadvertently and unknowingly triggered a discontinuity in my perception of markets with the most innocuous of statements. Bloomberg reporters are especially accessible. I have exchanged hundreds of emails with Mark Gilbert, head of Bloomberg’s London Office, Caroline Baum, and many other colleagues. Dave Lewis, a former Louis Bacon protégé and scholar of a higher order I call a friend although we meet up only sporadically. I have had dozens of exchanges with an eclectic mix of characters ranging from Elizabeth Warren on the left and Lew Rockwell on the way right. Within that enormous chasm includes multiple and meaningful exchanges with Stephen Roach (Morgan Stanley), James Howard Kunstler, Art Cutten (Jesse’s Café Americain), Byron King (Agora), John Rubino, Bill Fleckenstein, Benn Steil (CFR), Gerard Minack (Morgan Stanley), Doug Noland (Federated Investors), Richard Daughty, Jack Crooks, Grant Williams, and Jim Rickards. I thank Richard Uhlig, former CEO of Morgan Stanley’s banking subsidiary, for giving a two-hour guest lecture on mortgage-backed securities in my honors chemistry class. (The kids loved it!) Meetings and conversations with economists Larry Kotlikoff and Steve Hanke are enormously appreciated. I have especially cherished numerous exchanges with David Einhorn, a truly unique individual and intellect, culminating in a meeting with David and subsequent breakfast with his parents. (Mom is quite the bear.) I was profoundly honored when David Weidner included me in a WSJ article on the flash crash and Demetri Kofinas and Lauren Lyster invited me to do an amazing interview on Capital Account.⁷ These experiences are special and wholly orthogonal to my exposure in chemistry. Lastly, Bruce Ganem rekindled my interest in markets, politics, and economics. Our colleagues will never forgive you.

David B. Collum

Betty R. Miller Professor of Chemistry and Chemical Biology

Cornell University

dbc6@cornell.edu

@DavidBCollum

Links

The superscripted links are found here.

Full pdf version of this epic review here.

Dear All, 

As Bollinger question why their sales have dropped off a 'cliff' (excuse the pun), since London's LIBOR traders find themselves looking for a career change, the rest of the investment community continue to act with the confusion and irrationality that fuel the modern markets.  S&P 2000, 3000 or even 10 000 - seemingly anything has become possible as the powers that be finally commit to full debt monetisation to preserve the worlds over-leveraged, under-funded and wounded economy.   

"When dealing with people, remember you are not dealing with creatures of logic, but creatures of emotion"

Dale Carnegie

Despite all the doom and gloom, here at Tick By Tick, we are here to provide an air of rationality and guidance to help keep your feet on the ground . As a result, we feel obliged to provide you, the loyal reader, with a seasonal present of our own.  (Drumroll please).  I would like to present Tick By Tick's 13 Economic Tales to Take You Into 2013

 1.       Being long the US markets (SPX, NDAQ, DJIA and Russ 2K) vs. the PIIGS (PSI 20, MIB, ASE, ISEQ and IBEX) YTD would have only resulted in 14bps of outperformance (1206 bps vs. 1192 bps)

2.        When comparing Jan-Jun of 2011 vs. 2012 in terms of Futures trading volume, total volume has fallen 10.2%.  More interestingly, PM volume was up 32.8% vs. Equity Indices at -14.4% despite both essentially delivering no gains over the period

3.       Between 2007 and 2010, the US birth rate fell 8% to 63.2 births per  1000 women – this includes a 23% drop in the Mexican birth rate over the same period.  These new figures have seen the US fertility rate drop below population stagnation rate of 2.1 to 1.9 children

4.       Despite 10s of thousands of individuals reading the Gartman Letter on a daily basis, should you have invested in his Horizons ETF since its inception, you would be lagging the SPX by 50%

5.       The largest two Global brokerages (MS and GS) were 253 and 170 SPX points away from the current level of 1420 in their 2012 predictions.  Following their advice would have cost you 17.8% and 11.9% respectively

6.       If being married was a requirement of voting in the US Presidential election, Mitt Romney would have won 56-42.  Instead, due to the American demographic, Obama retained power due to the proportionately high unmarried population voting 62-35 in his favour.

7.       If the economies of the US and Chile were compiled into audited accounts, every fundamental investor would pick Chilean debt as comparatively better purchase.  Despite this, the 10yr yield spread is 372bps and US Treasury allocations are near historic highs

8.       Whilst John Paulson, founder of Paulson & Co, basked in the fame of making +600% during the last financial crisis. A relatively unknown individual named Andrew Lahde, founder of Lahde Capital Management, generated returns in excess of 1000% before closing his fund and using his 5 minutes of fame to remind the world of the idiocy that surrounds the global Hemp market

9.       Despite running a trade surplus, having a full funded pension liability and complete energy independence, investors prefer to hold the US dollar, which offers none of the above, over the Norwegian Krone that offers all of these characteristics

10.   On December 6^th Apple lost $35bn in market capitalisation, that is 5.5x the total market capitalisation of Research in Motion who previously controlled 44.5% of the Smartphone market in 2008

11.   On May 4^th 2012, Michael Pachter from Wedbush was the first bullish analyst on FB providing a $44 price target following the IPO.  Six months later on 6^th November, FB traded at $22, exactly half of his target

12.   Those who believe that a cashless society is inevitable have been labelled conspiracy theorists, yet Mastercard, Visa and AMEX are up 120%, 150% and 33% over the last 2 years.

..     ...and finally

        13.  In the UK, houses with the number 13 are, on average, 2% cheaper than the identical houses either side of them 

Before we leave you to question the logic in the facts set out before you, as the founder of Tick By Tick, I would like issue a small apology to my loyal reader-base who have found Tick By Tick market comments absent from their inboxes for the last 6 months.  Big changes - that will be explained in my future insights -  are coming that will ensure this is a Black Swan event rather than the norm.

Thank you for the continued support and a Happy New Year to you all.

Best Regards

George Adcock 

Founder

www.tickbytick.co.uk

 #0000ff;"> 

Twitter: @TickByTick_Team

*All figures correct at time of writing

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