The Age of the Shadow Bank Run

I RECENTLY asked a group of colleagues — and myself — to identify the single most important development to emerge from America’s financial crisis. Most of us had a common answer: The age of the bank run has returned.

Since the end of World War II, economists have generally thought that runs on banks were dead, at least as a phenomenon in advanced nations. In the United States, for example, bank deposits are insured by the Federal Deposit Insurance Corporation, and, as a last resort, the Federal Reserve can back deposits by printing money.

The new complication is that bank deposits are no longer the dominant form of modern short-term finance. The modern bank run means a rush to withdraw from money market funds, the disappearance of reliable collateral for overnight loans between banks or the sudden pulling of short-term credit to a troubled financial institution. But these new versions are in some ways still similar to the old: both reflect the desire to pull money out of an endeavor — and to be the first out the door. And both can set off a crash.

These newer forms occur in the so-called shadow banking system, involving short-term financial credit not guaranteed by the deposit insurance umbrella. According to the Federal Reserve Bank of New York, shadow banking accounts for about $15 trillion in assets — more than the traditional banking system. But as recently as 1990, the shadow-banking total was much lower, at less than $4 trillion. The core problem is that the growth of short-term credit has been outracing our ability to protect it, and since 2008 most investors have realized that these shadow-banking transactions are not risk-free.

On top of this problem is the market for derivatives. The quantity of open derivatives amounts to trillions, and these positions are another source of short-term credit risk. So a need for sudden payouts could also prompt a run on a financial institution.

It now seems that the 21st century will resemble the 19th and early 20th centuries, with periodic panics and runs on financial institutions, perhaps followed by deflationary collapses. In the euro zone, these problems have plagued banks and entire countries, like Greece and Portugal. The “country as bank” is a new and not entirely reassuring catch phrase, and it shows that the problem goes beyond the private sector.

If a central bank is deft enough, it can avoid deflation by using loans and monetary policy to guarantee the liabilities of run-prone institutions. That worked reasonably well in 2008, but in the long term such a policy sets up the system for even more danger, by subsidizing bank risk-taking and precarious financial structures.

Another problem is that ending those central bank guarantees isn’t always easy. The European Central Bank has stemmed a financial collapse for now, but only by lending large amounts to banks at 1 percent for a three-year window. And yet the euro zone has entered a recession, so it’s unclear when troubled European banks can return to private capital markets. The central bank may end up taking over much of the allocation of capital.

The arrangement also assumes that economic growth will pick up fairly quickly in the euro zone — hardly a certainty. And there is little market discipline to force European banks to clean up their balance sheets or to exercise caution for the future. So the system remains extremely vulnerable.

Another feature of this new order is that more and more financial transactions will be collateralized with the safest securities possible: United States Treasuries. Demand for them will remain high, and low borrowing costs will ease our fiscal problems. Still, the resulting low rates of return serve as a tax on safe savings, encourage a risky quest for yield and redistribute resources to government borrowing and spending. It isn’t healthy for the private sector when investors are so obsessed with holding wealth in the form of safe governmental guarantees.

THIS entire package of problems seems to be part of “the new normal” — it’s not going away anytime soon.

Some economists, like Ricardo J. Caballero of the Massachusetts Institute of Technology , have called for extending governmental guarantees well beyond traditional bank deposits. That would check the problem, but at what cost? In a larger financial crisis based on insolvency, our government would face intolerable financial burdens, as happened in Ireland when its government guaranteed bank debts.

A broader government guarantee would also spread the moral-hazard problem to an even larger class of financial transactions, raising the odds that the guarantee will someday have to be paid out. In any case, bailouts for creditors are already politically unpopular, and are unlikely to be expanded.

In short, no promising financial path is before us. It’s good that the American economy seems to be recovering, and this may shove some problems into the future. But banking and finance remain a mess at their core. Welcome to the 21st century.


NY Times

Japanese Bond Bubble Is Ready To Burst, Anticipates 40% Yen Devaluation

It is a fact that when it comes to the oddly resilient Japanese hyperlevered economic model, the bodies of those screaming for the end of the JGB bubble litter the sides of central planning's tungsten brick road. Yet in the aftermath of last month's stunning surge in the country's trade deficit, this, and much more may soon be finally ending. Because as Caixin's Andy Xie writes "The day of reckoning for the yen is not distant. Japanese companies are struggling with profitability. It only gets worse from here. 

When a major company goes bankrupt, this may change the prevailing psychology. A weak yen consensus will emerge then." As for the bubble pop, it will be a sudden pop, not the 30 year deflationary whimper Mrs. Watanabe has gotten so used to: "Yen devaluation is likely to unfold quickly. A financial bubble doesn't burst slowly. When it occurs, it just pops. The odds are that yen devaluation will occur over days. Only a large and sudden devaluation can keep the JGB yield low. Otherwise, the devaluation expectation will trigger a sharp rise in the JGB yield. The resulting worries over the government's solvency could lead to a collapse of the JGB market." It gets worse: "Of course, the government will collapse with the JGB market." And once Japan falls, the rest of the world follows, says Xie, which is why he is now actively encouraging China, and all other Japanese trade partners of the world's rapidly declining 3rd largest economy to take precautions for when this day comes... soon. Oh, and this: " If the bond yield rises to 2 percent, theinterest expense would surpass the total expected tax revenue of 42.3 trillion yen."

Why has Japan been able to sustain its deflationary collapse for over 3 decades? Simply - an ever rising currency.

A strong yen, deflation and rising government debt form a short-term equilibrium that lasts as long as the market believes it is sustainable. The yen has seen a relentless upward trend since it depegged from the dollar in 1971, up to 83.4 from 360 again to the dollar. When wages and asset prices rise, a strong currency can be justified. When wages and asset prices fall, a strong currency is suicide. Japan's nominal GDP peaked in 1997 and its nominal wages did too. Its property prices have declined every year since. The Nikkei rose in only four out of the last fifteen years and is still close to a three-decade low.

Japanese policymakers, businesses, academics, currency traders and the average Mrs. Watanabe all believe in a strong yen. This belief is wrong but self-fulfilling. It has lasted so long because the Japanese government adopts policies to offset the destabilizing effects of deflation due to a strong yen. Hence, Japan's national debt has marched upwards along with the value of yen. It is expected to top yen 1,000 trillion in 2012, 215 percent of GDP, 7.8 million yen (or roughly US$ 94,000) per person, and about half of net household wealth per capita.

The sustainability of Japan's deflationary path depends on the market's confidence in Japan's debt market. As Japanese institutions and households hold almost all of the government's debts, their faith in the government's creditworthiness is the mojo for Japan's seemingly harmless deflationary spiral.

There's that. And also that it is nothing but a ponzi. In Xie's words.

The justification for the low JGB yield is deflation. The real interest rate (the nominal rate plus deflation) is comparable to that in other countries. This rationale requires deflation to persist. But, deflation shrinks the nominal GDP or tax base. How could the government pay back its escalating debt by taxing a shrinking economy? It can only sustain its debt by borrowing more. This fits the definition of a particular type of Ponzi scheme.

Deflation is ok, if in addition to collapsing GDP, it is paralleled by declining wages.

The JGB bubble explains the seeming lack of pain in Japanese society. A strong yen and deflation haven't led to an employment crisis because the government deficit is pumping up aggregate demand. As long as wages decline in line with prices, one doesn't feel the pain. Japan's household debt is only half of GDP, about half of the level in the United States. Deflation doesn't cause much balance sheet trouble.

Unfortunately this is unsustainable by definition, as the divergence is a finite series at which point it become self-destructive. And yet the strong Yen is the glue that ties the rickety house of cards together... for now.

Despite the fact Japan has had a bad economy for so long, the yen has remained strong. It reinforces the Japanese psyche on the issue. The strong yen has become a cult.

The international financial market believes in a weak yen from time to time. In 1998, the short-selling by foreigners briefly caused the yen to touch 140 against the U.S. dollar. But, as the Japanese hold all of the yen, if they believe in the yen, foreign short-sellers get punished eventually. Over time, yen bears are all weeded out of the market. The remaining yen traders are all believers in a strong yen.

So far so good: any cult can exist in its own bubble if left to its own devices. However, as much as it is trying to avoid it, Japan's secular role in international society is changing, and very soon the habitual self-delusion of its citizens, politicians, and FX traders will do nothing to offset the advent of reality.

While the Japanese can always take care of business within, they cannot control the outside world. The country's Achilles heel is losing trade competitiveness due to the destructive impact of deflation on business confidence and the strong currency itself. When a trade deficit emerges, it signals the beginning of the end.

Japan has lost competitiveness in a swath of industries that it used to dominate. Its automobile industry is losing out to Germany, South Korea and the United States. Japan's automobile industry used to be competitive in cost and far superior in quality to its global competitors. But the world has changed. The yen has dropped below 110 from as high as 160 against the euro. The South Korean won was about ten against the yen and is now 13. Cost-cutting cannot offset such a big change in exchange rates. The U.S. auto industry cut its labor costs and debt burden through the government bailout. It is now more competitive than Japan's.

The automobile industry is the pillar of Japan's economy. Its decline leaves Japan's economy nowhere to turn. Indeed, if the auto industry leaves Japan, it will become a poor country.

Japan's electronics industry, still significant to its economy, is losing out big time to its Asian competitors. Nothing hot in electronics is made in Japan now. U.S. companies like Apple leverage China's manufacturing sector to turn out hot products. South Korea is embracing the vertically integrated model and churning out competitive products like Japan used to.

Nothing symbolizes Japan's decline like its electronics industry. It was the envy of the world and had all the ingredients to take the industry into the mobile internet era. Instead, it embraced insulation and made products just for the Japanese market. Now it is almost irrelevant to the outside world.

Japan isn't just facing macro troubles. Its micro competitiveness is rotting away. It is just bizarre to see that the whole world believes in a strong yen when Japan is failing on such a grand scale.

This is especially true in the aftermath of the Fukushima disaster, when one of the primary drivers of economic growth - energy creation, has collapsed, and as of Today Tepco has shut down its last reactor. Thus an energy crisis imminent. It will also accelerate the transition of Japan from a trade surplus to deficit econoy. In this case the trend is certainly not Japan's friend.

Japan's trade balance may swing into surplus from time to time, but the negative trend is irreversible. Japan will face rising trade deficits. That makes foreigners' views important because Japan would need foreign money to fund its deficit. When foreigners change their views, which they surely will, the yen will crash.

There is only one controlled way out for Japan: take the pain now, or let a veritable epic econoic collapse sweep everything that Japanese society stands for. Recent overtures by the BOJ show it understands what has to be done. It is, alas, not doing it fast enough.

Japan has only one way out – a massive devaluation. If the stable national debt is 120 percent of GDP, the yen needs to be devalued by 40 percent because devaluation is ultimately equal to the nominal GDP increase. The devaluation is likely to sustain 2 percent to 3 percent of nominal GDP growth for Japan beyond the repricing induced increase, which is necessary to restore Japan's tax revenue. Deflation has caused Japan's tax revenue to decline as a share of GDP. It can be only reversed through restoring nominal GDP. A devaluation of 40 percent can restore Japan's competitiveness against Germany and South Korea, which will lay the foundation for Japan's industrial recovery.

The Bank of Japan is trying to weaken the yen through expanding its balance sheet. It has an asset purchase program of 65 trillion yen and a lending program of 5.5 trillion yen. The two are equivalent to 15 percent of GDP, comparable to what the Fed or European Central Bank have done. The effectiveness is limited so far. Because Japanese businesses, households and investors believe in a strong yen, the printed yen largely stays in the country and just slows down money velocity. The U.S. dollar has risen 10 percent against the yen from last year's bottom. This is probably due to the financial market upgrading its view of the U.S. economy rather than the BoJ's action.

To Andy Xie, the day of reckoning has never been nearer. And to those who have grown disenchanted with the Kyle Bass view of an epic JGB bubble pop, it may be time to refresh your lost cost hedge. Because a devaluation, to be truly effective, will not be visible from a mile away: it will be sudden, and very, very shocking, unless the government opts for the worse of to evils - a bond market collapse.

Yen devaluation is likely to unfold quickly. A financial bubble doesn't burst slowly. When it occurs, it just pops. The odds are that yen devaluation will occur over days.Only a large and sudden devaluation can keep the JGB yield low. Otherwise, the devaluation expectation will trigger a sharp rise in the JGB yield. The resulting worries over the government's solvency could lead to a collapse of the JGB market. Of course, the government will collapse with the JGB market.

The day of reckoning for the yen is not distant. Japanese companies are struggling with profitability. It only gets worse from here.When a major company goes bankrupt, this may change the prevailing psychology. A weak yen consensus will emerge then.

Finally, no matter how it's spun, the outcome, whether a 40% JPY deval, or a JGB bubble pop, will have devastating consequences on both the regional, and global economy.

A yen collapse will impact China and South Korea most, just like in 1998. It will trigger substantial weakness in their industries. If a banking system succumbs, the shock can bring down an entire economy, as South Korea's experience in 1998 demonstrates.

Both China and South Korea have weak banking systems. South Korea's banking system is one of the most leveraged in the world due to high level of household loans. In 1998, a similar shock sank its banking system that was overleveraged with industrial loans. Now it is overleveraged with household loans. A shock could sink it again.

Overinvestment and a property bubble make China's banking system very vulnerable to such a shock. Unless China substantially increases the capital in its banking system, a big yen devaluation could cause China's banking system to sink. China suffers from overinvestment and a property bubble, as Southeast Asia and South Korea did in 1997. In terms of the magnitude of leverage, China's situation is much worse. Hence, a yen devaluation could wreak havoc to China's economy.

Perhaps there is a reason why the global market (not US stock futures of course - those only care what comes out of the Chairman's mouth) is so very concerned with what is happening in China right now: perhaps the Chinese hard landing (which will come, no doubt about it) is not so much an underlying cause of the Chinese malady but a symptom of the Japanese deflationary unwind, which like a tsunami will drag first the Koreas, then China, then Southeast Asia, and finally the world underwater. And this time no amount of trivial Greece-like headline posturing ad headlines will have any impact whatsoever.

Yet following all that, we fully expect nothing to change, because the entire world is now hypnotically rushing toward the cliff, very likely bringing Dow 36,000 with it, if only for one instant, because with nothing getting fixed, the moment of global euphoria will be truly transitory. It will be then followed by an all out deflationary collapse... or much more likely since in this day and age printing a trillion, quadrillion or quintillion, is only a CTRL+P keystroke away, hyperinflationary.

And just to show the sensitivity of the world's most indebted nation to interest rates, here again is Andy:

Even though the yield on 10-year Japanese Government Bonds (JGB) is only 1 percent, the interest expense is expected to top 22.3 trillion yen in the fiscal year that begins next month. This is one-quarter of the general account budget. If the bond yield rises to 2 percent, the interest expense would surpass the total expected tax revenue of 42.3 trillion yen.

Yup: a mere "surge" in interest rates to a whopping 2.00% will destroy the Japanese economy.

Good luck.

Legal Irregularities Chuck Missler

A Harbinger of Things to Come

1937 Stock Market Action: A Model for Today?

In March 1937, the Benny Goodman dance craze was in full force. The mood was upbeat.

 

That same psychology was also at work in a rising market. Most investors did not anticipate the serious tumble stock prices were about to take.

 

But tumble they did.

 

Here's what Robert Prechter wrote in the August 2011 Elliott Wave Theorist:

 

I’ve...been using 1937 as a model...the market made its true high in 1999-2000, just like the market made its true high in 1929, after which it had a terrific drop and then a partial recovery into March 1937. And the market has been doing something analogous during the past 12 years.

Here's a look at the 1937-1938 downtrend:

 

 

 

 

As you can see on the chart, prices rebounded after the first leg down, reclaiming 83 percent of the decline. In other words, just when it seemed the worst was over, the bottom really fell out.

 

In March 2012, stock prices are within a stone's throw of the 2007 all-time high. The rally has gone on so long that even some of the most entrenched bears have embraced stocks.

 

Moreover, the total assets in the Rydex money market funds have been at a new low. As you know, investors decrease their cash holdings when they believe the stock market is heading up.

 

The only fear in the market has been the fear of missing out on gains.

 

Even so, are we heading for a more literal understanding of "market fear," when investors can't find the exit fast enough?

 

Here's what we do know:

 

• even during the recent rally, the market has lacked strong momentum
• critical technical divergences indicate a fractured market
• the market's Elliott wave pattern has become increasingly clear, including the near-term 

Elliott Wave

Locator RFID Chips Keep Track Of Students In Brazil

Twenty thousand students in 25 of Vitoria da Conquista’s 213 public schools started using T-shirts with chips earlier this week, secretary Coriolano Moraes said by telephone.

By 2013, all of the city’s 43,000 public school students, aged 4 to 14, will be using the chip-embedded T-shirts, he added.

“I believe we may be setting a trend because we have received many requests from all over Brazil for information on how our system works,” he said.

Radio frequency chips in “intelligent uniforms” let a computer know when children enter school and it sends a text message to their cell phones. Parents are also alerted if kids don’t show up 20 minutes after classes begin with the following message: “Your child has still not arrived at school.”

“We noticed that many parents would bring their children to school but would not see if they actually entered the building because they always left in a hurry to get to work on time,” Moraes said in a telephone interview. “They would always be surprised when told of the number times their children skipped class.

After a student skips classes three times parents will be asked to explain the absences. If they fail to do so, the school may notify authorities, Moares said. The city government invested $670,000 to design, test and make the microchipped T-shirts, he said.

The chips, similar to those used to track pets in many countries, are placed underneath each school’s coat-of-arms or on one of the sleeves below a phrase that says: “Education does not transform the world. Education changes people and people transform the world.”

The T-shirts, can be washed and ironed without damaging the chips, Moraes said adding that the chips have a “security system that makes tampering virtually impossible.”

Moraes said that Vitoria da Conquista is the first city in Brazil “and maybe in the world” to use this system.

“I believe we may be setting a trend because we have received many requests from all over Brazil for information on how our system works,” he said.


Yahoo News

Hippies head for Noah’s Ark: Queue here for rescue aboard alien spaceship

A mountain looming over a French commune with a population of just 200 is being touted as a modern Noah's Ark when doomsday arrives – supposedly less than nine months from now.

A rapidly increasing stream of New Age believers – or esoterics, as locals call them – have descended in their camper van-loads on the usually picturesque and tranquil Pyrenean village of Bugarach. They believe that when apocalypse strikes on 21 December this year, the aliens waiting in their spacecraft inside Pic de Bugarach will save all the humans near by and beam them off to the next age.

As the cataclysmic date – which, according to eschatological beliefs and predicted astrological alignments, concludes a 5,125-year cycle in the Mesoamerican Long Count calendar – nears, the goings-on around the peak have become more bizarre and ritualistic.

For decades, there has been a belief that Pic de Bugarach, which, at 1,230 metres, is the highest in the Corbières mountain range, possesses an eery power. Often called the "upside-down mountain" – geologists think that it exploded after its formation and the top landed the wrong way up – it is thought to have inspired Jules Verne's Journey to the Centre of the Earth and Steven Spielberg's Close Encounters of the Third Kind. Since the 1960s, it has attracted New Agers, who insist that it emits special magnetic waves.

Further, rumours persist that the country's late president François Mitterrand was transported by helicopter on to the peak, while the Nazis, and, later, Israel's Mossad, performed mysterious digs there. Now the nearby village is awash with New Agers, who have boosted the local economy, though their naked group climbs up to the peak have raised concerns as well as eyebrows. Among other oddities, some hikers have been spotted scaling the mountain carrying a ball with a golden ring, strung together by a single thread.

A grizzled man wearing a white linen smock, who calls himself Jean, set up a yurt in the forest a couple of years ago to prepare for the earth's demise. "The apocalypse we believe in is the end of a certain world and the beginning of another," he offers. "A new spiritual world. The year 2012 is the end of a cycle of suffering. Bugarach is one of the major chakras of the earth, a place devoted to welcoming the energies of tomorrow."

Upwards of 100,000 people are thought to be planning a trip to the mountain, 30 miles west of Perpignan, in time for 21 December, and opportunistic entrepreneurs are shamelessly cashing in on the phenomenon. While American travel agents have been offering special, one-way deals to witness the end of the world, a neighbouring village, Saint-Paul de Fenouillet, has produced a wine to celebrate the occasion.

Jean-Pierre Delord, the perplexed mayor of Bugarach, has flagged up the situation to the French authorities, requesting they scramble the army to the tiny village for fear of a mass suicide. It has also caught the attention of France's sect watchdog, Miviludes.

A genial sexagenarian, Mr Delord says: "We've seen a huge rise in visitors. Already this year more than 20,000 people have climbed right to the top, and last year we had 10,000 hikers, which was a significant rise on the previous 12 months. They think Pic de Bugarach is 'un garage à ovnis' [an alien garage]. The villagers are exasperated: the exaggerated importance of something which they see as completely removed from reality is bewildering. After 21 December, this will surely return to normal."

Masking his fears of what might happen on 21 December, Mr Delord jokes that he will throw a party and supply vin chaud and cheese. "I'm sure we'll have a little fete to celebrate that we're still alive," he smiles. "I suppose it's up to each of us to find our own way."


The Independent