SP 500 September Futures

The index is coiled into a tight spot, and is likely for a sharp move, but perhaps not until the GDP number is released on Friday.

Morgan Stanley: Government Defaults Inevitable

In addition to "It's different this time" and "Self sufficiency is an out-moded concept" one of the deadliest assumptions is "That can never happen here."

Morgan Stanley says what we have all known for some time. There will be government defaults of various types on debts which have become unmanageable.

As we see in a UK Telegraph story today, a report claims the Tories are placing the greatest pain in managing their budget gaps on the backs of the less well to do, presumably protecting their more well to do constituency. No surprise to anyone if it is true. And yet this may not be enough unless the economy recovers and the great mass of the public can regain some reasonable level of organic economic activity.

In the States, the uber wealthy will be spending large sums to lobby against new taxes, and even removing tax cuts that were known to be untenable, and based on false economic assumptions, at the time they were passed under Bush. Instead they will point to more broadly public and regressive taxes such as VATs, and seek to curtail public programs like Medicare and Social Security, while leaving their own subsidies and welfare, such as those in the financial sector and corporate and dividend tax breaks, sacrosanct.

In the US the broad mass of consumer have been the economy's golden goose, and after decades of median wage stagnation, neo-liberal economic policies, and overseas military expansions and expeditions, that goose looks cooked.

But at the end of the day this soft class warfare, despite its vicious hypocrisy and pettiness, is all intramurals, as the real defaults and debt reconciliation will most likely be in the form of artificially low bond rates accompanied by devaluations in the Western fiat currencies. I have been trying to figure out a way that a selective default could be accomplished, but have not quite muddled through that yet.

The limit of the Fed's and Treasury's ability to monetize the debt, which is a form of default through a true monetary inflation, is the value of the dollar and the bond. People who have never lived through it will begin to finally understand this in the days to come.

Bloomberg
Morgan Stanley Says Government Defaults Inevitable
By Matthew Brown
Aug 25, 2010 11:44 AM ET

Investors will face defaults on government bonds given the burden of aging populations and the difficulty of securing more tax revenue, according to Morgan Stanley.

“Governments will impose a loss on some of their stakeholders,” Arnaud Mares, an executive director at Morgan Stanley in London, wrote in a research report today. “The question is not whether they will renege on their promises, but rather upon which of their promises they will renege, and what form this default will take.” The sovereign-debt crisis is global “and it is not over,” the report said.

Borrowing costs for so-called peripheral euro-region nations such as Greece and Ireland surged today, resuming their ascent on concern that governments won’t be able to narrow their budget deficits. Standard & Poor’s downgraded Ireland’s credit rating yesterday on concern about the rising costs to support nationalized banks.

Mares said debt as a percentage of gross domestic product is a false indicator of an economy’s health given it doesn’t reflect governments’ available revenue and is “backward- looking.” While the U.S. government’s debt is 53 percent of GDP, one of the lowest ratios among developed nations, its debt as a percentage of revenue is 358 percent, one of the highest, the report said. Conversely, Italy has one of the highest debt- to-GDP ratios, at 116 percent, yet has a debt-to-revenue ratio of 188, Mares said.

Double Dip

“Outright sovereign default in large advanced economies remains an extremely unlikely outcome, in our view,” the report said. “But current yields and break-even inflation rates provide very little protection against the credible threat of financial oppression in any form it might take.”

Mares once worked at the U.K.’s Debt Management Office and is a former senior vice-president at credit-rating company Moody’s Investors Service.

“Note that a double-dip recession would not invalidate this conclusion,” Mares’ report said. “It would cause yet further damage to the governments’ power to tax, pushing them further in negative equity and therefore increasing the risks that debt holders suffer a larger loss eventually.”

Investors’ concern that the U.S. may fall back into recession has grown in recent weeks as U.S. economic data missed economists’ estimates. A Citigroup Inc. index of U.S. economic data surprises fell to minus 59 last week, the least since January 2009...

“The conflict that opposes bondholders to other government stakeholders is more intense than ever, and their interests are no longer sufficiently well-aligned with those of influential political constituencies,” such as elderly voters and their claims on pensions and health insurance, Mares wrote.

Net Asset Values of Certain Precious Metal Trusts and Funds

Ben Davies: Market Trend Ready for Silver Up Days of Two, Three, Four Dollars

Ben Davies - Hinde Capital audio interview on King World News- August 25th

Also his recent paper Silver Velocity - The Coming Bullet

- Market is coiling and trend ready. A substantial break to the upside in the price of silver is coming.

- China and other emerging countries will be driving the price of gold and silver higher.

- Would not be surprised to see a lot of gold and silver Pandas around in the world in the next few years.

- We will look back and view this summer as 'the defining moment' for gold and silver

- There just isn't enough silver to go around, and the price is being held down by a couple of the large bullion banks.

- We have seen silver above ground inventories move from 10 to 6 Billion ounces and that is now only 500 million ounces.

- We are now short 150 to 200 million ounces a year to satisfy demand.

- The short side of the market will be pressured going forward.

- The price explosion has not happened yet but we are near the zenith point where paper will no longer control the silver price.

- The seasonals provide a fantastic backdrop for an explosive silver rally after option expiry it could be game on for September.

- We are entering a world of 'beggar thy neighbor' currency devaluations

- We are brewing to a substantial upside break in gold price of 400-500 dollars.

- The unwind of the silver shorts is going to lead to updays in silver of two, three, four dollars.

Gold Daily Chart With Cup and Handle: 50 Day Moving Average

Gold Daily Chart

The cup and handle formation remains active, and the trend channels appear to be working as gold climbs the wall of worry in the 'handle.'



Gold Daily Chart with 50 DMA

Gold did a quit but precise hit on the 50 Day Moving Average today and then rebounded with a vicious rally higher. This speaks of the strength of the physical market underlying the paper market, and the role that gold played today as a store of wealth in a period of perceived risk.

SP 500 and NDX Futures

SP 500



NDX

Gold and Silver Go Vertical Intraday

Gold and silver spot prices went straight up in a 'flight to quality' on the news from Goldman Sachs that the Fed will have to engage in substantial quantative easing. This analysis received a boost by a much worse than expected existing home sales number, with 3.83 million units sold versus 4.72 million expected.

So the squid threw a rock in the pond ahead of Thursday's precious metals option expiration on the Comex, and caught many traders offsides in what was expected to be the usual 'skin the specs' easy money trade. As the metals market rig starts crumbling look for more players to break ranks and start taking chunks out of the bullion bank elephants for themselves.

Gold Chart Intraday



Silver Chart Intraday

US Money Supply Figures: Dude, Where's My (Monetary) Deflation?

As a review or refresher please read: Money Supply A Primer if you need to remind yourself what these money supply figures represent.

Considering the high unemployment and sluggish GDP the fall off in year over year growth in the money supply figures is to be expected, especially after the bubbliciously high growth rates (11% and 16% respectively) just prior to the financial crisis. That is why one should look at both the nominal and the percent year over year charts.

There is certainly price deflation from slack aggregate demand fueled by stagnant wages and high unemployment, and it may get worse as the Fed and the government coddle their unreformed pet Banks, leaving the real economy and most Americans to twist in the wind. But there is no true monetary deflation yet, the kind which is supposed to stiffen the back of the dollar and all that.

There is also sufficient room for concern about the US dollar and its sustainability as the world's reserve currency. This would be familiar to most economists as Triffin's Dilemma. As the world shifts from the Bretton Woods II compromise to a less dollar specific regime the adjustment could be quite traumatic, especially to the financialization industry. Here is another description of the same phenomenon called the Seigniorage Curse. It is why I have called the US dollar and its associated bonds The Last Bubble.

"The Seigniorage Curse appears to hollow out the economy by the following manner: First, the premium charged to holders of dollars becomes a new source of accrued, aggregate revenue. This extra capital flowing into the economy is initially seen as a global honoring of our economy’s strength, and innovation. But when innovation falters and less value is created, seigniorage is maintained–and thus the unhealthy dynamic begins. From this point forward, whether the US economy either leads in innovation, or lags in innovation, the Dollar advantage grows regardless. It then becomes clear that manufacturing Dollars, rather than manufacturing goods, is a better value proposition. Once that dynamic is in place, then a long cycle of financialization ensues, in which innovation and talent moves from design and manufacturing to the financial sector. The financial sector then becomes rapacious, as it scours what’s left of the economy to monetize. Whereas manufacturing and innovation were once monetized, the financial sector begins to monetize itself...

Every inheritance starts out as a gift. Just as oil-cursed nations remain ever vulnerable to swings in the price of oil, the United States is now vulnerable to its own number one export–the value of the US Dollar and by extension the value of US Treasury Bonds."

True Money Supply is included for all you Austrian Economists, and it has enjoyed a bumper expansion under Bernanke's chairmanship. This is the money that is ready and able to be used as a medium of exchange, what the Austrians consider 'real money.' I am quite sure that Messrs Ludwig and Murray would be aghast at Bernanke's banking practices.

I include Eurodollars chart at the bottom. This is the 'missing component' from the M3 series. Several commentators seek to estimate M3 by obtaining the other M3 components from existing sources and then estimating eurdollars based on correlations and trending. See M3 Hysteria and a Look at M2, MZM, GDP and PPI.

The Eurodollar is a particularly interesting money measure to me be because of the two enormous dollar short squeezes which we have seen in Europe as customers demanded dollars based on dollar assets deposited in dodgy CDOs. It was on a parabolic trajectory BEFORE the squeezes, and one can only wonder where they are now.

I am still comfortable with my forecast for a severe stagflation, considering both a protracted monetary deflation and hyperinflation as less probable 'on the tail' events that almost certainly would reflect fiscal and monetary policy errors. What also concerns me is the failure to reform and address the grossly imbalanced economy. I am less confident today however, that Bernanke and the Congress will not make these errors because of the blind greed of the oligarchy and their influence over the country.

M2



M2 Year over Year Growth



MZM



MZM Year over Year Growth



True Money Supply (aka Rothbard Money Supply)

"The True Money Supply (TMS) was formulated by Murray Rothbard and represents the amount of money in the economy that is available for immediate use in exchange. It has been referred to in the past as the Austrian Money Supply, the Rothbard Money Supply and the True Money Supply. The benefits of TMS over conventional measures calculated by the Federal Reserve are that it counts only immediately available money for exchange and does not double count. MMMF shares are excluded from TMS precisely because they represent equity shares in a portfolio of highly liquid, short-term investments which must be sold in exchange for money before such shares can be redeemed. For a detailed description and explanation of the TMS aggregate, see Salerno (1987) and Shostak (2000). The TMS consists of the following: Currency Component of M1, Total Checkable Deposits, Savings Deposits, U.S. Government Demand Deposits and Note Balances, Demand Deposits Due to Foreign Commercial Banks, and Demand Deposits Due to Foreign Official Institutions."

Eurodollars

I think a case could be made that the US is exporting its monetary inflation overseas, particularly to Asia. At some point these eurodollars may come home to roost, and the arrival could be quite memorable. I try to recreate some sense of Eurodollar growth from the BIS reports, especially when verifying these eurodollar short squeezes, but the lags of over a quarter in reporting are quite tiresome.

SP 500 September Futures; Gold Daily and Weekly Charts: Silver Weekly Chart

SP 500 Futures
@ 11 PM EDT

Existing home sales tomorrow at 4.6 Million consensus. Refis are progressing so quickly the NY Fed is growing concerned about its shrinking MBS portfolios that it took over from the banks. As refis are done the mortgages leave the pool.

US GDP second estimate for Q2 on Thursday 27 August. Consensus is for 1.4% versus the first estimate of 2.4% and a chain deflator of 1.8%. If the deflator deviates lower from this figure then it might to 'enhance' a bad GDP figure. Watch inventories as well.



Gold Daily Chart

It is options expiration this week (26 August) at the Comex for the precious metals.



Gold Weekly Chart



Silver Weekly Chart

CFR: China Poised to Shock the Oil Market And Its Possible Consequences for Hyperinflation

I found this paper published by the Council on Foreign Relations to be a plausible argument in favor of the exhaustion of cheap oil, also known as Peak Oil. This growth in Chinese oil consumption into the 'knee of the curve' given its growing per capital income could very well cause an oil shock as the title of the paper suggests. As you may recall it was an oil shock that triggered the stagflation of the 1970's, a black swan event if there ever was one.

The weakness in its logic is assuming that things which happen in one country will necessarily happen in others, based on relatively simple vectors like per capita income. Examples of possible differences are the national infrastructure in roads, deployment of population relative to travel needs and the availability and pricing of public relative to private transportation. Since these are often significantly affected by policy decisions it is sometimes difficult to forecast them accurately.

Notice that China is under running the trends of the comparison countries at current levels. Why would we assume they would start tracking more closely to model once a certain threshold is surpassed? And then there are the growth assumptions for China, which could be optimistic. Extending aggressive trends is sometimes a dangerous forecasting method. It would also have been interesting to see where India fits on this chart.

Most of these factors modulate the timing of the outcome, but not necessarily the outcome itself. So the trend to cheap oil exhaustion remains persuasive; but as we all know, anything can happen, and sometimes it does.

As competition for oil increases it could have interesting effects on currency valuations, inter currency rates, and international relationships.

It was a bit of a coincidence that I had just reread How Hyperinflation Will Happen by Gonzalo Lira. It is a compelling read.

He had asked me to provide some feedback and any possible weakness in his argument, which I did in a comment at his site and in a few email responses.

Here is my edited comment from his site:

Although the scenario of a 'run on Treasuries' is possible as a path to hyperinflation, I do not think it is probable unless there is a significant 'trigger event' to precipitate it. The magnitude of the 'trigger event' required could lessen with time if the US financial situation continues to deteriorate.

Why do I say this? Because the TBTF banks have no incentive to join in the selling if the Fed stands to defend a price in the market. For JPM and Citi it is likely to be suicide to do so. Even the mighty Goldman is unlikely to buck the system, as it were. The NY Fed not only knows where the bodies are buried, it has helped to bury quite a few of them itself.

It took a 'Soros' for example to call the Bank of England out in their support for the pound in that famous incident. I see no such party of sufficient size and inclination now to take on the US Treasury and NY Fed in the debt markets.

I do think a trigger event or incident is possible. I believe it would involve an exogenous party of size, for example China, and an announcement regarding Treasury reserves.

I also think the Treasury run could be triggered by a precipitous decline in the value of the dollar. Note this implies the Treasury run would start on the shortest end of the curve, Fed notes of zero duration. Then the longer end would follow.

Very nice description of such an event, and chilling to say the least. But I think we are some distance from this without a substantial 'trigger event.'

And then I picked up this CFR essay which describes something which might fit the criterion of a 'trigger event.' After all, it was the oil embargo which precipitated the stagflation of 1970's. An oil shock could shake an already weakened US dollar as the trade deficit opened into a yawning chasm.

But I do remain convinced that hyperinflation is unlikely simply because the TBTF banks 'have the Fed's back' which is why they were allowed to continue to remain in business, with substantial subsidies, and grow even larger. All it takes to create a money machine is the Federal Reserve of New York and one or two captive Primary Dealer banks. The dodgy backroom deals are probably more abundant than we realize or suspect even now. And I do not even wish to thing of the loathsome creatures that would enjoy taking advantage of a crisis of this magnitude to further promote their oligarchy and a New World Order.

As a reminder, black swan events like market crashes and runs on banks tend to be on the edges of probability. But they can happen, and are more likely to happen at certain times. Therefore it is potentially fatal to assume that things will always remain the same, and that the big trend changes will never occur.

Council on Foreign Relations
China Will Force the World Off Oil
By Paul Swartz
August 23, 2010

As a country’s per capita income increases, its per capita oil consumption increases. Consumption growth tends to be modest up until $15,000 income per head, but then accelerates rapidly. China is quickly approaching this point. South Korea, which consumes 3% of world oil output, is too small to disrupt oil markets.

China is too big not to disrupt them. Were China’s per capita oil consumption to be brought up to South Korea’s, its share of global consumption would increase from today’s 10% to over 70%. In order to cap China’s share at 22%, which is the U.S. share today, global oil output would have to increase by a massive 13% per annum over ten years – well beyond the 1% growth averaged since 1975.

This rate of growth is inconceivable, even if vastly more expensive sources of supply, such as the Canadian oil sands, were developed at breakneck speed. If China’s recent economic growth pace continues, it will surpass South Korea’s current per capita GDP shortly after 2020 – meaning that the world may be forced onto alternative energy sources much sooner than it realizes.

Blankfein to Paulson: OK Now What?

Thanks to Janet Tavakoli for a great takeoff on Milligan's classic laugh.

It’s September 2008. Goldman and AIG are trading in the markets, and Goldman notices that AIG seems to be having very severe liquidity problems. AIG needs to renew repo agreements after investing the trades’ cash in plunging mortgage collateral bought from investment banks, and asks around for various other sources of funding.

Recognizing an emergency, Blankfein whips out his cell phone and calls Hank Paulson. He gasps to the Treasury Secretary and former Goldman CEO: "AIG, one of my biggest trading partners is going under! This will cause a market meltdown! What should we do?"

Paulson, in a calm comforting voice says: "Take a deep breath and pull yourself together. I can help. First, let's make sure AIG is really going under."

There is a long pause, during which Blankfein checks the status of his credit default protection and other hedges against an AIG failure, yanks AIG’s credit lines, and presses AIG with calls for collateral on credit default swap agreements on plummeting CDOs.

Blankfein’s voice finally comes back on the line. He says: "OK, now what?"

Spike Milligan's Original

Two hunters are out in the woods when one of them collapses. He doesn't seem to be breathing and his eyes are glazed. The other guy whips out his phone and calls the emergency services. He gasps, "My friend is dead! What can I do?".

The operator says "Calm down. I can help. First, let's make sure he's dead."

There is a silence, then a shot is heard.

Back on the phone, the guy says "OK, now what?"

Ex-Fed Governor Mishkin in 'Pay for Say' Controversy Over Icelandic Economy

The Icelandic Chamber of Commerce commissioned ex-Fed Governor Mishkin to write a glowing report on their economy, even while the country was being destroyed from within by a rogue banking system, a financial oligarchy, and a corrupt regulatory regime.

What is surprising is that there was no disclosure of the payment of $124,000 and that Mishkin was unable to cite any substantial effort he made to investigate the economy when forming his analysis.

Alan Greenspan handled his own apparent faux pas in mismanaging the Federal Reserve and actively opposing the regulatory efforts that might have stemmed the orgy of financial fraud which occurred on his watch much more skillfully, so that the Fed was able to gain even more power from the recent 'financial reform' crafted by an industry complaisant Congress.

In a recent NY Times piece Making It Up, Paul Krugman takes economic fluffery to task, and rightfully so. In this day of think tanks and special interest foundations, there are often experts willing to engage in 'pay for say.' Experts are not exempt from the powerful contamination and capture by special interests, particularly the financial industry, that has affected regulators and politicians

In the formulation of public policy the learned opinions of economists must be weighed carefully, and the supporting data examined. And of course any conflicts of interest disclosed. Academic economists are no different than anyone else, because as it appears, their interests are not always purely academic.

As in so many instances of scandal and corruption, the best disinfectant is the light of day in the form of transparency, disclosure, and public accountability and review.

"Every thing secret degenerates, even the administration of justice; nothing is safe that does not show it can bear discussion and publicity." Lord Acton

W. E. Pollock: ZIRP the Wrong Tool For the Job

Gold Daily Chart

Gold had a spectacular run the last two weeks, with only occasional pullbacks such as we had today.

Let's see if gold can hold together into its option expiration next week on the 26th.



Option Expiration Schedule at the Comex

SP 500 and NDX September Futures Daily Charts;

Very quiet expiration for August stock options today.

Q2 GDP second estimate next Friday the 27th.


SP 500

The SP was under pressure all day, but there was a bump up in the afternoon to bring them back to the pivot point around 1070.



NDX

The NDX broke cleanly down out of the rising wedge, so there may be more work on the downside. Potential bear flag that we will have to watch.




Heard on the Street

05/24/10 Goldman adds CME to its conviction buy list. Closing price $323.01
08/12/10 Goldman removes CME from the list. Closing price $249.39

What are the chances they were not on the other side of that?

Gold Daily Chart

Gold has been like a juggernaut the past week.

Let's see if it can take out 1240 without getting too overbought.

As a reminder next week is September options expiration for gold and silver.



Gold Daily Chart



Gold Daily Chart - closer look

SP 500 September Futures @ Noon

Stocks fell from overnight highs on higher than expected unemployment claims this morning, and a much worse than expected Philly Fed. But as one financial wiseguy said on Bloomberg, who cares about manufacturing? Probably does not care about jobs either.

A test of the pivot point support is underway. I would expect it to hold and perhaps recover after the Europeans have gone home to their folks and blokes, but if it gives way, which would be a clear break of the lower bound of that 'pivot channel' then its a new game, as they say.

Unenlightened Self-Interest: Deficit Hawk Down On Tax Cuts and Financial Reform

"Economics is haunted by more fallacies than any other study known to man." Henry Hazlitt

The argument that 'tax cuts for the wealthiest few stimulates growth' aka the trickle down theory needs to be buried alongside the 'efficient markets hypothesis' and the other principle beliefs of voodoo economics that have brought the US from the world's greatest nation to third world status in a generation.

It was the irresponsible tax cuts enacted by Bush II while increasing military spending on two wars, one highly discretionary, along with the increasing financialization of the economy through deregulation, fraud, 'one way globalization,' and crony capitalism that have undermined the foundation of the American economy.

The banks must be restrained, the financial system reformed, and balance restored to the real economy before there can be any sustained recovery.


h/t The Economist's View for the cartoon

The following charts are from the ContraryInvestor but all annotations and comments are mine.

Think about what this chart below is saying. Will a return to the status quo through Fed intervention 'work?' Is austerity directed at the middle class the answer, as in the suffering endured by the many in the Great Depression?



What would happen if the economy 'recovered' with the same fundamentals in place? Fundamentals such as an overly large financial sector, increasing wealth disparity, and a stagnant median wage?

Can 'the many' continue to borrow to maintain a constant standard of living? Can a democracy be maintained in conditions that start to resemble a third world country? How long before a 'strong man' rises to take control of the political situation on behalf of the national society of workers? And how long after that would it be before the industrialists and oligarchs lose control of this strong man, as they always seem to do?

Can the US afford to maintain 800 overseas military bases while the domestic tax base continues to erode through a parasitical transferal of wealth from the many to the few based on leverage, speculation, monopoly, asset bubbles and fraud?

Closer View of the Rise of Neoliberal Economics and the Ponzi Economy



US Federal Debt Only as a Percent of GDP Since 1792



What the US needs right now, more than ever, is a coherent industrial policy and a national strategy focused on the median wage, a serious reform movement, a reduction in its military spending, and a set of encompassing social principles with a longer term vision for the country as its goal.

Americans may not trust government as a recent tenet of dogmatic faith, but in doing so they are entrusting their futures to other people's governments, and soulless multinational entities who are in fact using globalization and the 'free markets' to aggressively advance their own ends and benefits, which are probably antithetical to yours.

Bringing a dogmatic neo-liberal bias for "free markets" (ironically promoted by political neo-conservatives) into a game where every other major country is executing a well thought out industrial policy based on increasing net exports is like bringing a knife to a gun fight, and then stabbing yourself in the back as an opening move.

Gold Daily Chart

SP 500 and NDX September Futures Daily Charts

Stocks were pushed higher for much of the day.

The GM IPO was announced and stocks faded into the close losing even more ground after the 4 PM cash trade cutoff. As you know the futures trade until 4:15 PM.

It is too soon to attribute anything to this one way or the other, except for another failure at the test of overhead resistance, but no breakdown below key support and the key Pivot.

SP 500



NDX