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Ukraine Accuses Russia Of Invasion, Considers State Of Emergency After Masked Gunmen Occupy Two Crimean Airports | Zero Hedge

Ukraine Accuses Russia Of Invasion, Considers State Of Emergency After Masked Gunmen Occupy Two Crimean Airports | Zero Hedge.

The bizarre events in the Crimea continued overnight, after unidentified masked men but dressed like those who took over the parliament in Simferopol yesterday, took over two airports by blockading one near the Russian naval base in Sevastopol and another in the capital of Simferopol. This prompted the Ukraine’s interior minister Arsen Avakov, to accuse Moscow’s military of blockading the airports, and in a Facebook post, he called the seizure of the Belbek international airport in the Black Sea port of Sevastopol a “military invasion and occupation.” He added: “It is a breach of all international agreements and norms.” As NBC reports, the Interfax news agency quoted Russian military sources as saying the incident at Belbek airport was intended to stop “fighters” flying in. However, Interfax later quoted a Russian official as saying that no units had approached the airport or blockaded it. In a nutshell, Russia continues to push with escalation ever further, and is testing just how far it can and will go without Ukraine responding.

2-3 dozen militiamen at Simferopol #Crimea airport quickly piled into a truck – with no plates – and are leaving. pic.twitter.com/wgcIjvE8jV

— Alexander Marquardt (@MarquardtA) February 28, 2014

Kyivpost has a more detailed account:

Two Crimean airports were taken over by Russian military troops, Interior Minister Arsen Avakov said on Facebook this morning. He said the situation in the autonomous republic has now escalated to “a military intervention” and called on the National Security Council to take urgent steps towards its regulation.

 

“My assessment of what’s going on is that it’s a military intervention and occupation in violation of all international agreements and norms,” he said in his statement. “This is a direct provocation of bloodshed on the territory of a sovereign state.”

 

Avakov said that Sevastopol’s military airport Bilbek at night was blocked off by the military units of the Russian navy, which is based in Sevastopol. He said the airport is surrounded by camouflaged military troops with no identification and carrying guns. He said they do not hide their Russian affiliation.

 

Inside the airport there is a group of Ukrainian soldiers and border guards, and Ukrainian police troops have surrounded the outer perimeter of the airport. “There have been no armed clashes so far,” he said.

 

The navy base is Sevastopol is key for the Russian army. Under agreements signed between two countries in 2010, the Russian military can continue to use Sevastopol until 2042, with an option of extending the lease to 2047.

 

Some 70 kilometers away from the coast, in Crimean capital Simferopol, another airport was taken over by a group of about 100 plain-clothed men, who went inside the airport and onto the runway.

 

“The interior troops and police pushed these people first into the airport building, and then out of the territory. No weapons were used,” Avakov said.

 

He said that after the armed men left, a new group of camouflaged men arrived around 1:30 in the morning. They carried automatic weapons and had no markings. Avakov said they entered the building and stayed int he restaurant.

 

“They are not hiding their affiliation with the army of the Russian Federation,” Avakov said. “Told by the Ukrainian Interior Ministry workers that they are military men and have no right to be there, they answer curtly that they have no instructions to negotiate with you.”

 

Avakov said that so far there have been no clashes, but tension is growing as Ukrainian police troops continue to arrive. “The law enforcement organs cannot oppose the army,” Avakov concluded.

In the meantine, Ukraine is starting to realize that it may have bitten more than it can chew, and as Interfax reported:

  • UKRAINE WEIGHS STATE OF EMERGENCY IN CRIMEA: INTERFAX
  • RUSSIA BLACK SEA FLEET, HELICOPTERS BREAK UKRAINE ACCORDS: IFX

And the immediate re-escalation:

  • RUSSIAN BLACK SEA FLEET SETS UP BALACLAVA BLOCKADE: INTERFAX

Visually:

Coastguard and frigate at entrance to Balaclava bay pic.twitter.com/Yvb69jPtHM

— Christian Fraser (@ForeignCorresp) February 28, 2014

Yet none of this compares to today’s main event when a t 5pm local time, in the Rostov-on-Don Technical University, deposed Ukraine president Yanukovich who is currently in Russia, is expected to hold a press conference. Missing since the beginning of the week, the ousted ukrainian president had fled the country to Russia in the latest days, either by car through the Donetsk region, either escorted by military planes, according to different reports.

We doubt anything he says will difuse the situation.

US And Israel Quietly Provide Military Support And Parts To Iran, Which In Turn Is Arming Syria | Zero Hedge

US And Israel Quietly Provide Military Support And Parts To Iran, Which In Turn Is Arming Syria | Zero Hedge.

Before the Ukraine, there was Syria. Before Syria, there was Iran. For over 30 years, Iran was the perpetual strawman of every attempt to escalate hostilities in the middle east. One only needs to recall that the original “red line” was not Obama’s but that of Israel’s PM Netanyahu referring to Iran’s nuclear program (which most likely was under the control of Stuxnet, and thus the NSA, more than it was Iran’s to begin with).

What is surprising in recent months, is how quickly in the aftermath of the Syrian failed escalation script from last summer, Iran quickly dropped off the axis of America’s worst enemies, and from the biggest bogeyman, has rapidly become a nation with which the US is eager to resume diplomatic and trade relations. Sure, Israel pretended to be angry about Iran’s ascent in the ranks of US foreign allies-to-be, and issued a few angry press releases, but that’s all it was – posturing, fit only for the front page of tabloids. It is what was happening behind the scenes that is noteworthy.

And what is happening behind the scenes is the same thing that happens every time the US (or Israel, or any other western nations) finds a surprising new ally: said ally proceeds to purchase military equipment from the US (or other western nations), using loans from the US (or other western nation banks).

Enter bizarre twist #1 – US companies selling military parts to none other than the formerly country non grata (at least until mid-2013): Iran. Reuters reports:

U.S. aerospace companies are seeking permission to sell airliner parts to Iran for the first time in three decades, in a key test of the temporary relief on sanctions given under talks to curtail Iran’s nuclear activities.

 

At least two leading manufacturers, Boeing and engine maker General Electric, have applied for export licenses in a six-month window agreed by Iran and six world powers in November, industry officials and other sources familiar with the matter said.

 

If approved, the sales would be the first acknowledged dealings between U.S. aerospace companies and Iran since the 1979 U.S. hostage crisis led to sanctions that were later broadened during the dispute over Iran’s nuclear activities.

 

A source familiar with the matter said that Boeing, the world’s biggest manufacturer of passenger jets, had also filed a request for permission to export parts to Iran.

 

Boeing declined to comment, referring questions to the U.S. State Department, which in turn referred queries to the U.S. Treasury. A spokeswoman for the Treasury Department, which enforces international sanctions, declined to comment on specific license requests or applications.

Enter bizarre twist # 2 – “GE is doing it for the kids.”

A GE spokesman said his company had been asking since 2004 for permission to provide parts and maintenance for engines for safety reasons, without profiting from the scheme. GE, the world’s largest maker of jet engines by sales, refiled its request after the sanctions relief came into force, he added.

 

“We don’t want to make a penny on it. It’s entirely for flight safety,” Rick Kennedy said, adding that GE would donate any proceeds to charity.

But of course, because when one thinks suing the US to get tax refunds corporate generosity (if not bailouts), one thinks GE.

Enter bizarre twist # 3 – it is not only the US that is seeking to promptly capitalize on this “temporary” elimination of Iran sanctions. It is Iran’s perpetual nemesis, Israel, that is not only planning to supply weapons to Iran, but is already doing so. However, unlike the US which at least has clumsily stumbled upon a detente whose only purpose is logically to get Iran to buy Made in America weapons, with Israel the hypocrisy takes on a whole new meaning. Quote the Telegraph:

Benjamin Netanyahu, the Israeli prime minister, called for increased pressure on Iran to force it to abandon a programme that Israel regards as a front for building an atomic bomb and a threat to its existence.

 

Visiting the Golan Heights on Tuesday, he accused Iran of “arming those who are carrying out the slaughter” in neighbouring Syria.  “I would like to tell the world, today, as the talks between the major powers and Iran are being resumed, that Iran has changed neither its aggressive policy nor its brutal character. Iran is continuing to support the Assad regime, which is slaughtering its own people,” Mr Netanyahu said.

And this is where it gets embarrassing for Bibi: it was Israel that was arming Iran.

[A] court in Athens has told The Telegraph that parts appearing on an American list of forbidden military-grade materials had been shipped from Israel on two occasions, apparently destined for Iran.

 

The seized items comprised spare parts for military aircraft: a constant speed drive designed for the F-4 Phantom jet, and a voltage output sensor used in the F-14 Tomcat. The parts were confiscated by Greece’s financial crimes squad and were being sent to the US for investigation, court officials said.

 

 

Israeli arms dealers twice tried to send spare parts for fighter planes to Iran, The Telegraph has established, flouting an international arms embargo and openly contradicting the bitter enmity between the Jewish state and the Islamic regime.

 

The illegal shipments are now being investigated by the US Homeland Security Department after they were intercepted by authorities in Greece.

 

The shipments – one in Dec 2012 and the other last April – were sent by courier from the Israeli town of Binyamina-Givat Ada, near Haifa, via a company in Greece, the newspaper reported. The firm was later established to be a ghost company. Its contact number was said to belong to a British national in the Greek city of Thessaloniki, who could not be traced.

Was Mossad involved? But of course.

A blogger, Richard Silverstein pointed the finger at two possible culprits who he said were well-known arms dealers living in Binyamina-Givat Ada. The pair had come to the attention of Israeli and US authorities on suspicion of violating the arms embargo on Iran in the past, Silverstein wrote, but had never been charged or prosecuted. “There can be no doubt that they are colluding with Israeli intelligence,” he added.

For those who are not convinced, “The defence and foreign ministries in Israel declined to comment on the seizures, which were first revealed by Kathimerini, a Greek newspaper. 

Finally, tying it all together, is another report from Reuters. in which we learn that “as Syria’s war nears the start of its fourth year, Iran has stepped up support on the ground for President Bashar al-Assad, providing elite teams to gather intelligence and train troops, sources with knowledge of military movements say.

This further backing from Tehran, along with deliveries of munitions and equipment from Moscow, is helping to keep Assad in power at a time when neither his own forces nor opposition fighters have a decisive edge on the battlefield.

Assad’s forces have failed to capitalize fully on advances they made last summer with the help of Iran, his major backer in the region, and the Hezbollah fighters that Tehran backs and which have provided important battlefield support for Assad.

 

But the Syrian leader has drawn comfort from the withdrawal of the threat of U.S. bombing raids following a deal under which he has agreed to give up his chemical weapons.

 

Shi’te Iran has already spent billions of dollars propping up Assad in what has turned into a sectarian proxy war with Sunni Arab states. And while the presence of Iranian military personnel in Syria is not new, military experts believe Tehran has in recent months sent in more specialists to enable Assad to outlast his enemies at home and abroad.

 

Assad’s forces have failed to capitalize fully on advances they made last summer with the help of Iran, his major backer in the region, and the Hezbollah fighters that Tehran backs and which have provided important battlefield support for Assad.

 

But the Syrian leader has drawn comfort from the withdrawal of the threat of U.S. bombing raids following a deal under which he has agreed to give up his chemical weapons.

 

Shi’te Iran has already spent billions of dollars propping up Assad in what has turned into a sectarian proxy war with Sunni Arab states. And while the presence of Iranian military personnel in Syria is not new, military experts believe Tehran has in recent months sent in more specialists to enable Assad to outlast his enemies at home and abroad.

To summarize: in an act of complete disregard for the official diplomatic song and dance, both Israel and the US are now providing military support to Iran, which in turn is providing military support to Syria, which is also getting military support from Russia. And now, just to make things more interesting, the same labyrinth of “military support” is about to be unleashed in the Ukraine, whose western half is just as likely getting arms and military equipment (not to mention funding)from the West under the table, while Russia, whose main Black Sea port is in the Ukraine’s Crimean peninsula, is arming the Eastern part of the Ukraine.

What can possibly go wrong?

“The Pig In The Python Is About To Be Expelled”: A Walk Thru Of China’s Hard Landing, And The Upcoming Global Harder Reset | Zero Hedge

“The Pig In The Python Is About To Be Expelled”: A Walk Thru Of China’s Hard Landing, And The Upcoming Global Harder Reset | Zero Hedge.

By now everyone knows that the Chinese credit bubble has hit unprecedented proportions. If they don’t, we remind them with the following chart of total bank “assets” (read debt) added since the collapse of Lehman: China literally puts the US to shame, where in addition to everything, the only actual source of incremental credit growth over the same time period has been the Fed as banks have used reserves as margin for risk purchases instead of lending.

 

Everyone should also know that like a metastatic cancer, the amount of non-performing, bad loans within the Chinese financial system is growing at an exponential pace.

 

Finally, what everyone learned over the past month, is that as the two massive, and unresolvable forces, come to a head, the first cracks in the facade are starting to appear as first one then another shadow-banking Trust product failed and had to be bailed out in the last minute.

However, as we showed last week, and then again last night, the default party in China is only just beginning as Trust failures in the coming months are set to accelerate at a breakneck pace.

 

The $64K question is will the various forms of government be able to intercept and bail these out in time, as they have been doing so far despite their hollow promises of cracking down on moral hazard: after all, everyone certainly knows what happened when Lehman was allowed to meet its destiny without a bailout – to say that the CNY10 trillion Chinese shadow banking industry will not have far more dire consequences if allowed to fall without government support is simply idiotic.

But what could be the catalyst for this outcome which inevitably would unleash the long-overdue Chinese hard landing, and with it, a new global depression?

Ironically, the culprit may be none other than the Fed with the recently instituted taper, and the gradual, at first, then quite rapid unwind of the global carry trade.

Bank of America explains:

QE and the Emerging Markets carry trade

 

The QE channel has worked through Emerging Markets and China is a key vehicle. By lowering the US government bond yields to a bare minimum, and zero –ish at the short end, a search for yield globally ensued. Emerging market banks and corporates have gone on an international leverage binge, yet another carry trade, the third in 20 years. The first one was driven by European banks, financing East Asian capex – that ended in 1997. The second one was global banks and equity-FDI supporting mainly capex in the BRICs. That ended in 2008. This time, it is increasingly non-equity: commercial banks and more importantly, the bond market – often undercounted in the BoP and external debt statistics that conventional analysis looks at.

 

Chart 9 shows the rise of EM external loans and bond issuance (both by residence and nationality). Since, end-3Q2008 to end-3Q2013, external borrowing from banks and bonds has risen USD1.9tn. Bank loans have risen by USD855bn and bond issuance in foreign currencies by nationality is up USD1,042bn. In the prior five-year period (i.e. end-3Q2003 – end-3Q2008), forex bond issuance rose only USD432bn. Clearly, the importance of external bond issuance is rising. See Table 5 for details.

 

In China, since, end-3Q2008 to end-3Q2013, outstanding external borrowing from banks and bonds has gone from USD207bn to USD849n – a net rise of USD655bn. Outstanding bank loans are up from USD161bn to USD609bn – a net rise of USD464bn. Bond issuance in foreign currencies by nationality is up from USD46bn to USD240bn – a net rise of USD191bn. In the prior five-year period (ie, end-3Q2003 – end-3Q2008), forex bond issuance rose only USD28bn in China. Clearly, the importance of external bond issuance is rising in China.

 

 

There is more to this story.

 

As mentioned earlier, for externally-issued bonds, USD1,042bn has been raised by the nationality of the EM borrower since end-3Q 2008, but USD724bn by residence of the borrower – a gap of USD318bn, or 44%. This undercount is USD165bn in China, USD100bn in Brazil, USD62bn in Russia, and USD37bn in India. The carry trade this time around was helped substantially by access to the bond market, especially from overseas affiliates of EM banks and corporations.

 

There are a lot of moving parts in the balance of payments that finally affect the change in international reserves at any EM central bank – eg, the current account, portfolio equity investment and direct equity investment, and debt flows – both from the bond market and lending from banks. We focus on the link between these debt flows and the international reserves in China. As Table 5 below shows, China’s external debt – from bond issuance and forex borrowing from banks – rose USD655bn during 3Q08-3013.

 

 

We posit that this large rise was in part driven by the carry trade offered up by QE – China banks and corporates issued substantial forex-denominated bonds, and borrowed straight loans from international banks. We recognize the caveat that correlation does not imply causation. The USD655bn rise in China debt issuance is highly correlated to the Fed’s balance sheet since late-2008. As Chart 11 shows, the rise in China debt issuance of USD 655bn has (along with FDI and the C/A surplus), boosted international reserves by USD1,773bn since late-2008. Also, as Chart 11 shows, the USD1,773bn rise in China international reserves mirrors the rise of USD2,585bn in the EM monetary base. Lastly, the rise of China’s monetary base of USD2,585bn correlates well with the USD10.9tr rise in China’s broad money expansion.

 

 

 

As the Fed tapers, and the size of its balance sheet stabilizes/contracts, we should expect this sequence to reverse. Confidence is a fragile membrane. Not only does the Fed’s balance sheet matter as a source of funds, but we believe so does the attractiveness of the recipient of the carry trade – and the trust in its collateral. As Gary Gorton puts it…

 

The output of banks is money, in the form of short-term debt which is used to store value or used as a transaction medium. Such money is backed by a portfolio of bank loans in the case of demand deposits, or by collateral in the form of a specific bond in the case of repo. The backing is designed to make the bank debt as close to riskless as possible — in fact, so close to riskless than nobody wants to really do any due diligence on the money, just transact with it. But the private sector cannot produce riskless debt and so it can happen that the backing collateral is questioned. This typically happens at the peak of the business cycle. If its value is questioned, it loses its “moneyness” so no one wants it, and cash is preferred. But as we know, if everyone wants their cash at the same moment, their demands cannot be satisfied. In this sense, the financial system is insolvent. (interview with the FT) 

 

What makes sense for an individual carry trade – borrow low, invest at higher rates – falls prey to the fallacy of composition, when too many engage in the same carry trade. And eventually question the underlying collateral, now huge, and potentially suspect. China is a case in point. If our colleagues David Cui and Bin Gao are right, the trust sector in Chinacould create rollover risks that reverse a gluttonous carry trade within China, but partly financed overseas. In China’s case, this trade was between low global interest rates, low Chinese deposit rates, expectations of perpetual RMB appreciation on the one hand, and higher investment returns promised by Trusts on the other. A part of the debt funds raised overseas, we suspect were put to work in this Trust carry trade. The HK-based banks are big participants in intermediating the China carry trade – as Chart 12 shows, their net lending to China went from 18% of HK GDP in 2007 to 148% in late-2013.

 

There are always fancy names given to carry trades – financial liberalization of capital accounts, the Bangkok International Banking Facility, currency internationalization, etc. We remain skeptics of these buzzwords.

 

 

 

The potential consequences of Trust defaults and a China carry trade unwind

 

1. If the EM carry trade diminishes as a consequence of a changed Fed policy and/or less attractive risk-adjusted returns in EMs as collateral quality is questioned, the sources of China’s forex reserve accumulation will need to change. Perhaps to bigger current account surpluses, more equity FDI and portfolio investment through privatization and more open equity markets. If that does not happen, expanding the Chinese monetary base might require PBOC to increase net lending to the financial system and/or monetize fiscal deficits (this last part has not worked so well in EMs).

 

2. Potential asset deflation is a risk, as the carry trades diminish/unwind. Property prices are at risk – the collateral value for China’s financial systems. This is not a dire projection – it simply seeks to isolate the US QE as a key driver of China’s monetary policy and asset inflation, and highlights the magnitudes involved, and the transmission mechanism. Investors should not imbue stock-price movements and property price inflation in China with too much local flavor – this is mainly a US QE-driven story, in our view.

 

3. Currently, China’s real effective exchange rate is one of the strongest in the world. Concerns about China’s Trust sector, and its underlying collateral value, sees some of this carry trade unwound, the RMB could be under pressure.

 

 

4. Given HK’s role in the China carry trade, HK property prices and its banking system should be watched carefully for signs of stress.

 

5. UK, US, and Japan banking systems have been active lenders to China since QE. They should be on watch if the Trust rollover risk materializes and creates a growth shock in China. See Chart 15.

 

 

 

6. Safe haven bids for DM government bonds, overseas property and precious metals might emerge from China.

 

Could the party go on? Yes, if for some reason a significant deterioration in the US labor market, or a deflationary shock from China, or any other surprise that could lead to a cessation of the US tapering could prolong this carry trade. This is not the house base case. We believe it is better to start preparing for a post-QE world. As one of our smartest clients told us: “the main theme in the past five years was QE. If that is coming to an end, investments and themes that worked in the past five years must therefore be questioned.” We agree.

* * *

Yes, Bank of America said all of the above – every brutally honest last word of it.

The question, however, in addition to “why”, is whether the Fed also agrees with BofA’s stunningly frank, and quite disturbing conclusion, perhaps finally realizing that aside from the US, the biggest house of cards that would topple once the “flow”-free emperor is exposed in his nudity, is that of the world’s largest “growth” (and credit) dynamo of the past two decades – China.Because, as noted above, if Lehman’s collapse was bad, a deflationary collapse brought on by Chinese hard landing coupled with a full unwind of the global carry trade, would be disastrous and send the world into a depression the likes of which have never before been seen.

Finally, for those who want the blow by blow, here is BofA’s tentative take of what the preliminary steps of the next global great depression will look like:

If we do experience a sizable default, the knee-jerk market reaction will be cash hoarding since it will strike as a big surprise. Thus, we expect the repo rate to rise first, while the long term government bond would get bid due to risk aversion flows.

 

However, what follows will be quite uncertain, aside from PBoC injecting liquidity and easing monetary policy to help short term rate come down. It has been proven again and again the Chinese government will get involved and be proactive. The bond market reaction will be different depending on the government solution.

Alas, at that point, not even the world’s largest bazooka will be enough.

At this point one should conclude that reality – through massive, unprecedented liquidity injections – has been deferred long enough. It is time to let the markets finally return to some semblance ofuncentrally-planned normalcy: there is a reason why nature abhors a vacuum. Even if it means the eruption of the very painful grand reset, washing away decades of capital misallocation, lies and ill-gotten wealth, so very overdue.

Welcome To Phase Three Of The Global Financial Crisis | Zero Hedge

Welcome To Phase Three Of The Global Financial Crisis | Zero Hedge.

It’s deliciously ironic that emerging market (EM) problems have flared so soon after the meeting of the rich and powerful in Davos. According to the central bankers at Davos, the financial crisis is behind us and brighter days lay ahead. According to these bankers, the EM issues which have since arisen are confined to a handful of developing countries and they won’t impact the West.

If only were that so. What the eruptions of the past week really show is that the system based on easy money created by these bankers remains deeply flawed and these flaws have been exposed by moves to tighten liquidity in the U.S. and China. The system broke down in 2008, and again in Europe in 2011 and now in EM in 2013-2014.

The market reaction to the latest events has been abrupt and violent, particularly in the currency world. In my experience, markets generally cope well when there is one crisis. If the current issue was isolated to Turkey, markets outside of this country would probably shrug their shoulders and move on. But when there are multiple spot fires like the last week, markets don’t cope as well.

What are investors supposed to do now? Well, going into this year, Asia Confidential suggested (herehere and here) being cautious on stocks given increasing deflationary risks from U.S. tapering and a China slowdown. And to go long government bonds in developed markets (the U.S) given these risks and junior gold miners due to the extraordinarily cheap valuations on offer. These recommendations have performed well year-to-date and should continue to out-perform for the remainder of 2014.

Simple explanations for the crisis

Much ink has been spilled (or keyboards worn, in this day and age) trying to make sense of the past week’s event. China’s economic slowdown has copped much of the blame. As has QE tapering. And idiosyncratic issues in Turkey and Argentina have received their fair share of attention.

There have also been more sophisticated explanations such as this one from Kit Juckes at Societe Generale:

“There has been a shift in the balance of growth as Chinese demand for raw material wanes, and as higher wages and strong currencies make many EM economies less competitive. Meanwhile, the Fed policy cycle IS turning, and 4 years of capital being pushed out in a quest for less derisory yields, are ending. This isn’t a repeat of the 1990s Asian crises, because domestic conditions are completely different but it is a turn in the global market cycle. We need to transition from a world where investment is pushed out of the US/Europe/Japan to one where it is pulled in by attractive prospects. When that happens, flows will be differentiated much more from one country (EM or otherwise) to another. But for now, we’re just waiting for global capital flows to calm down.”

Now I have a large issue with the purported attractive prospects of the US, Europe and Japan, but let’s put that aside. The bigger issue is that the explanation here appears to be addressing the symptoms of the crisis (global capital flows) rather than the disease (excess credit and an unstable global economic system).

A more nuanced view

Let me elaborate on this. In a previous post, I echoed the thoughts of India’s new central bank chief in suggesting that there were four main causes for the 2008 financial crisis:

  • Rising inequality and the push for housing credit in the U.S.. Growing income inequality in America, exacerbated by technology replacing low-wage jobs and an inadequate education system which failed to re-skill people, led to politicians allowing easier credit conditions to boost asset prices and make people feel wealthier. That resulted in the subprime and housing crisis.
  • Export-led growth and dependency of several countries including China, Japan and Germany. The debt-fueled consumption in the U.S. would have been inflationary were it not for these countries not meeting the consumption needs of Americans. In other words, they aided and abetted the consumption binge in the U.S.
  • A clash of cultures between developed and developing countries. This relates back to 1997 when the Asian crisis force countries in the region to go from being net importers to substantial net exporters, thereby creating the conditions for a global glut in goods.
  • U.S central bank policy pandering to political considerations by focusing on jobs and inflation at any cost. The bank acted in accordance with the wishes of politicians by keeping interest rates too low for too long. They did this to maintain high employment, one of the bank’s two central mandates.

It’s important to note that none of these issues has been resolved. In fact, many of them have worsened. And any hint of adjustments to one or more of these problems results in further crises (like Europe in 2011 and in EM mid-last year and today).

This isn’t to excuse the governance issues in the likes of Argentina and Turkey. But it is to suggest that they are merely symptoms of a deeper malaise.

Deflation is winning battle over inflation

If these adjustments were to happen in full, it would result in plunging global asset prices as excessive debt loads are unwound. De-leveraging, in economic terms. This deflationary action is anathema to the world’s central bankers as deflation is enemy number one. Hence, they’ll do “whatever it takes” to produce inflation. And if that means flushing currencies down the urinal, so be it. The battle between inflation and deflation is ongoing, though the latter has the upper hand right now.

The weapons of choice for central bankers to fight off deflation are QE and zero interest rates. Central bankers tell us that these policies are necessary for economies to heal. I’d suggest this is baloney and they’re exacerbating the aforementioned problems.

To see why, it’s important to understand that interest rates are the central price signal off which all assets are priced. If central banks keep rates artificially low, it distorts these asset prices. And if you keep rates low for long enough, it distorts prices to such an extent that it’s impossible to know what the real value of certain assets are.

Another issue is that by keeping rates low, businesses which should go bankrupt stay alive. That’s why government bail-outs of almost any private company are a bad idea. Keeping zombies businesses alive means economies become less competitive over time. Witness Japan since 1990.

These are but a few of the unintended consequences of the current policies.

The endgame

There are three possible endgames to the current situation:

  1. There’s a global deflationary shock where all asset prices fall and fall hard. A la 2008. In this instance, central banks would go in all guns blazing with more money printing on an even grander scale. This would risk inflation if not hyperinflation as faith in currencies is diminished, if not lost.
  2. You have a gradual global recovery and inflation stays tame enough for a smooth exit from current policies.
  3. There’s a recovery but central banks are slow to raise rates and inflation gallops, which forces tightening and a subsequent economic slowdown.

My bet remains on the first scenario given intensifying deflationary forces from a China economic slowdown and Japan currency debasement (which aids exporters in being more price competitive).

If I’m right, there may be deflation followed by extreme inflation (or one quickly followed by the other). That makes investing a tough game. Under both of those scenarios, stocks and bonds would under-perform in a big way (my current call to own developed market government bonds is a 6-12 month one, not long-term). That’s why cash (which would out-perform in deflation), gold (which would prosper under extreme inflation) and select property and other tangible assets such as agriculture (which may out-perform under extreme inflation on a relative rather than absolute basis) should be part of any diverse investment portfolio.

This post was originally published at Asia Confidential
http://asiaconf.com/2014/01/29/phase-three-financial-crisis/

Geithner Warned S&P Chairman US Would Retaliate For Downgrade | Zero Hedge

Geithner Warned S&P Chairman US Would Retaliate For Downgrade | Zero Hedge.

Who can forget Tim Geithner’s historic interview from April 2011, in which he said:

Peter Barnes “Is there a risk that the United States could lose its AAA credit rating? Yes or no?”

Geithner’s response: “No risk of that.”

“No risk?” Barnes asked.

No risk,” Geithner said.

Considering that the US was downgraded by S&P just 4 months later, one person who certainly will never forget his idiotic preannouncement, is the former Treasury secretary, Tim Geithner. And being the sore loser that everyone suspected he was (although one hopes his recent well-paid move to Warburg Pincus will help soothe his sensitivity) it will come as no surprise that Geithner told the Chairman of embattled rating agency Standard & Poor’s, that its downgrade of the US from AAA to AA+ “would be met by a response.

From Bloomberg:

S&P filed a declaration of McGraw yesterday in federal court in Santa Ana, California, as part of a request to force the U.S. to hand over potential evidence the company says will support its claim that the government filed a fraud lawsuit against it last year in retaliation for its downgrade of the U.S. debt two years earlier.

In his court statement, McGraw said Geithner called him on Aug. 8, 2011, after S&P was the only credit ratings company to downgrade the U.S. debt. Geithner, McGraw said, told him that S&P would be held accountable for the downgrade. Government officials have said the downgrade was based on an error by S&P.

“S&P’s conduct would be looked at very carefully,” Geithner told McGraw according to the filing. “Such behavior would not occur, he said, without a response from the government.”

The Justice Department last year accused S&P of lying about its ratings being free of conflicts of interest and may seek as much as $5 billion in civil penalties. The government alleged in its Feb. 4, 2013, complaint that S&P knowingly downplayed the risk on securities before the credit crisis to win business from investment banks seeking the highest possible ratings to help sell the instruments.

None of this somces as a surprise, and it has been well-known for a long time that the only reason the US Department of Injustice targeted only S&P and not Moody’s or Fitch for their crisis era ratings of mortgages is precisely due to Geithner’s vendetta with S&P. Of course, this kind of selective punishment simply means that nobody else will dare to touch the US rating ever again, or speak badly against the sovereign in a public medium for fears of retaliation.

Naturally, while this means that the credibility of the rating agencies is now non-existent even among the head in the sand groupthink, what is worse is observing the US’ slide into the kind of totalitarian, 1st Amendment quashing tactics that worked out so well for all previous fascist regimes.

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