What Will Cause The Collapse?

Bear markets only end when price reaches a gut wrenching low. When speculators have been beaten down so much that mere mention of their favorite stock or commodity induces nausea and they do not want to touch it in their life time, ever. By that token the bear markets in the US stock markets will reach its nadir when S&P will be near 400, Dow near 3000. At these levels, 2008 will sure look like a trailer. At that level, there will be no safe haven except cash. That will be the ultimate collapse that the mega bears are hoping for.

Will that happen? If that were to happen, when will that happen? The global economy seems to be lurching from one crisis to another and still S&P has not breached 1000 yet. What we are seeing, is that a normal correction in a bull market or beginning of a bear market ? 

The Western civilization has modeled itself on the Keynesian theory where higher government spending has created an illusion of growth. In reality, there has been no wage growth in the USA in the last 20 years. The macro story is same in the USA or Greece or Japan. Only difference is, some countries can print their own money, some cannot. But printing money does not give the solution to the problem of solvency. If you do not believe, ask Robert Mugabe of Zimbabwe. With 200% debt to GDP ratio, Japan is trying for the last 20 years to bring in prosperity. And yet, the Nikkei is down from 38000 to 9000. 

The ZRIP and easy money policy that are being followed by the Fed or JCB indicates that the Central Bankers of the world are worried about deflation, not inflation. With the Balance Sheet contraction upon us, all the central banks are trying to inject as much liquidity in the financial system as possible. Their only hope of survival is to re-float the financial markets. 

What QE1 and QE2 did was just that. It helped re-inflate the collapsed bubble. There were no growth then, there is no growth now. So why then the markets are not collapsing, given that there is no QE3, there are sovereign default threats and GDP is barely moving. What is holding up the support level? 

The answer can possibly be found in the last G20 meeting. With the world economies so inter connected, it is a kind of MAD world. (Mutual Assured Destruction). Therefore, China wants to keep the markets going in the USA and in Europe so that it can keep its millions of rural poor employed and keep a lid on social unrest. US of A provide dollar swap lines to virtually dead European banks because not keeping them alive will de-stabilize the world economy big time. SNB pegs its currency to sick Euro so as to keep the Swiss Franc low. Every country is doing what it can to keep the music going.

Under such a situation, the world economy will lurch from one crisis to another, only to be propped up by more money. Volatility will be high. Even safe havens like gold swing between 2% to 7% in one market session. But TPTB (The Powers That Be) will not let the bottom fall off. The world markets are pushing on a string.

Only thing that can destroy this equilibrium is going to be something which is beyond the control of the CB and TPTB. A true black swan event. I do not think that the coming black swan event will be financial. Even if Greece defaults, it will not cause the system collapse. It has now been almost two years and the default has been priced in. The only black swan event I can imagine is going to be Geo-Political. For e.g. Israel Iran conflict. 

When the markets know that the governments are watching their back, they keep gambling. And they are doing exactly the same thing. Today, the US markets went up by 2% on no good news. Nothing fundamentally changed from last week. It is as if, yes they can. Right now, it is money moving from the pocket of one hedge fund and bank to another. Ordinary investors are not a part of it. The gamblers will continue to do so till such an external shock crashes the system. What will force that is anybody’s guess. Till that time, keep the good times rolling.

I will be travelling for the next two weeks and the posts will be somewhat irregular. But if I come across something interesting, I will do my best to bring it to your attention.

Hope Is Eternal and Futures Are Up

The futures are up in the morning and possibly we will see a gap-up opening. But I do not think we should jump back in the markets yet. Most likely this rally will be short lived. It is more of a dead cat bounce after a big sell off week. The EU has not yet come up with any definitive solutions and we can expect the volatility to continue well in October. I think SPX will have trouble going past 1150.

Corrections in Gold and Silver continue.  Silver can reach around $22 level or below. I am not sure about Gold and hence staying away from it for now. The funny thing is, historically, gold has performed better in a deflationary environment. If anyone cares to remember that gold was in a 20 year bear market when the stock markets were going up and inflation was much higher than it is today. So if we see a yearend rally from end of October, we might see a sharp selloff of gold.

For now, it is better to be in cash and wait for a good low in October before any buying opportunity comes up.

P.S; The markets opened gap up but now some are in red and some are struggling to keep the opening gain. In the mean time, I hear Cramer in CNBC that he is buying gold. Hmmmm. If the snake oil salesman is now pushing gold, may be it is time to seriously short gold.
This one is from Kitco at 10.45 AM on 26th Sept. 2011;

Did gold really go down 62.90?

Yes. The stronger US Dollar was responsible for 3.50 of that drop.

Gold price Change due to Strengthening of USD

-3.50

Gold price Change due to Predominant Sellers

-59.40

Gold Price: Total Change

-62.90

Correction in Gold & Silver And Coming Year End Rally.

In my last post I wrote; “I am not sure if the corrections are over or we shall see renewed weakness again. …….. The weakness in the market may continue till October.”  That was after the markets rallied for a week and people were hoping for a trade-able bottom and there were talks of new Bull Run.  However Euro did not live up to the hype and came down couple of hundred pips.  I said that the big money is leaving Europe and they want to keep that flight low key and orderly and the correction in precious metal may have just started.

Right on cue, price of gold came down by over 5% in the week. Everyone is speculating why the price of gold and silver came down. The easy answer that is being talked about is that CME hiked the margin. But that is not the complete answer. Yes, margin hike deter additional position taking and sometimes forces the weak speculators to liquidate. But the more compelling reason was the position liquidation and margin call by the Mutual Funds and Hedge Funds. I think most funds were caught by surprise by the violent plunge in the stock market.  So when the sell orders came in, they held on to their loss positions and liquidated the position in precious metal which was in profit. Moreover, there were widespread disappointments with the Fed action.  Again, in the last post I said that the rally was “in anticipation of Santa Clause coming early on September 21st. There may be some disappointments and we might see some selling the news.”

I would like to show two charts. First the gold chart.

If gold falls below $1550 by next week, the next support is around $ 1050 / $ 1100. But even that kind of correction would keep gold on a long term bull run. Whether that will happen or not, is anybody’s guess. But the chances of the continued correction are high.

The 2^nd chart is of Silver. 

Silver has already broken the trend line big time and the next support is around $ 25. I think even that support will be broken. By the same token, gold may also suffer. My favourite chartist Chris Kimble has this Eiffel Tower chart for gold. So make your own conclusion.

Coming back to the stock markets, I expect the weakness to continue in October, till the Europeans show some guts and political will to throw more good money after the bad. The Obama administration is pushing Germany hard and want a trillion euro rescue fund. The problem is that Madam Markel is losing the political capital and the German population is becoming sick of supporting Greece.  But the cost of not supporting Euro is very high and Germany may just want to buy more time. That Greece will default is given. The European banks, particularly the French Banks are going to suffer the most. The most important question is, is Greece going to be the only sovereign default? The Euro Zone may be able to handle Greek default but if Ireland and Portugal and Spain are added to the equation, then it is a different ball game.

I do not expect the markets to fall much below from here onward. My short term downside target is around 1125 in SPX.  If that is broken, the next support level is around 1050 in SPX. A close below that would mean big trouble. However I do not expect the bottom to fall off yet and most likely we would see a bounce of the lows.

The central bankers and the world governments are missing the woods for the trees. For them everything is a liquidity problem when in fact the problem facing the world is solvency problem. The only way they are trying to solve the crisis is by pumping in more money in the banking system. But it s a giant black hole sucking the life out of the world economy. The balance sheet contraction is on us, however much the central bankers and governments may try. Remember the QE2? After $ 600 billion, the US stock markets are now below the level of QE2. The desperate fight is on to save the system and for a while PTB (Powers That Be) will succeed. I am expecting a yearend rally to start from end of October which may well take the stock markets to a new high in 2012 before the game is over.

For now, let us see how low gold goes.

Corrections In Gold?

Markets are playing exactly according to the script. Stocks rallied for 4^th day straight on the news of European fix. I have been writing for a while that CBs( Central Bankers of the world) have learned their lesson from the 2008 crisis and they would prevent such a crisis from developing again. So we see that the ECB, BOE, SNB, BOJ, BOC and of course the FED has come together to provide liquidity to the market.  Once again, I have been writing that the only thing the CBs know is how to pump in money in the system and although such an action will only delay the inevitable balance sheet contraction, it will provide some much needed time for the speculators and too big to fail banks to make some more money.

The CBs have set up US Dollar swap lines for the “Zombie European Banks” who survive on leverage and are actually dead men walking. That has resulted in the short squeeze in the world stock markets.  This should lead to further decline in US Dollar and a rally in Equities.

However, I am not sure if the corrections are over or we shall see renewed weakness again. It seems that the “Big Banks” are buying all that their clients are selling. Again, this is in anticipation of Santa Clause coming early on September 21^st. There may be some disappointments and we might see some selling the news. The weakness in the market may continue till October. But the bottom-line is, the mega bears are going to be disappointed that world has not ended as predicted and Zero hedge will go ballistic with different conspiracy theories. For the next three months, we will see these dooms day soothsayers go rabid with froth in the mouth. They may still be vindicated at a later date sometime in 2012, but for entirely different reasons. More on that later.  

The new trade now is “Buy Euro and Sell Gold”.  In fact, the corrections in precious metal may have just started.  Let me show you the chart from Chris Kimble.

Both the precious metals have broken multiple support lines and from technical perspective, it may be time to short them with a tight stop.

From fundamental perspective, once again, the big money is leaving Europe but they want that flight to be low key and orderly. So on the superficial level, there will be show of strength of Euro and with the help of the CBs, sell gold.  Precious metals should be considered as insurance to inflation and break down of fiat currency. I do not see US Dollar going out of fashion any time soon. In fact, with the balance sheet contraction looming over the global economy, brake-up of Euro zone and a possible Geo-political clash in Middle East, the flight to safety will be towards US Dollar.

It is going to be an interesting time.

European Union. Win of Hope Over Commonsense

In continuation of the analysis of the crisis in Europe, here is a beautiful and well researched article from "Startfor". Startfor provides the best Geo-political analysis ever and is an invaluable tool for understanding the global macro economics. It cuts through the noise and presents the clear picture. Read on;


Before 1492, Europe was a backwater of small nationalities struggling over a relatively small piece of cold, rainy land. But one technological change made Europe the center of the international system: deep-water navigation.

The ability to engage in long-range shipping safely allowed businesses on the Continent’s various navigable rivers to interact easily with each other, magnifying the rivers’ capital-generation capacity. Deep-water navigation also allowed many of the European nations to conquer vast extra-European empires. And the close proximity of those nations combined with ever more wealth allowed for technological innovation and advancement at a pace theretofore unheard of anywhere on the planet. As a whole, Europe became very rich, became engaged in very far-flung empire-building that redefined the human condition and became very good at making war. In short order, Europe went from being a cultural and economic backwater to being the engine of the world.

At home, Europe’s growing economic development was exceeded only by the growing ferocity of its conflicts. Abroad, Europe had achieved the ability to apply military force to achieve economic aims — and vice versa. The brutal exploitation of wealth from some places (South America in particular) and the thorough subjugation and imposed trading systems in others (East and South Asia in particular) created the foundation of the modern order. Such alternations of traditional systems increased the wealth of Europe dramatically.
But “engine” does not mean “united,” and Europe’s wealth was not spread evenly. Whichever country was benefitting had a decided advantage in that it had greater resources to devote to military power and could incentivize other countries to ally with it. The result ought to have been that the leading global empire would unite Europe under its flag. It never happened, although it was attempted repeatedly. Europe remained divided and at war with itself at the same time it was dominating and reshaping the world.

……………..The tensions underlying Europe were bought to a head by German unification in 1871 and the need to accommodate Germany in the European system, of which Germany was both an integral and indigestible part. The result was two catastrophic general wars in Europe that began in 1914 and ended in 1945 with the occupation of Europe by the United States and the Soviet Union and the collapse of the European imperial system. Its economy shattered and its public plunged into a crisis of morale and a lack of confidence in the elites, Europe had neither the interest in nor appetite for empire.
Europe was exhausted not only by war but also by the internal psychosis of two of its major components. Hitler’s Germany and Stalin’s Soviet Union might well have externally behaved according to predictable laws of geopolitics. Internally, these two countries went mad, slaughtering both their own citizens and citizens of countries they occupied for reasons that were barely comprehensible, let alone rationally explicable. From my point of view, the pressure and slaughter inflicted by two world wars on both countries created a collective mental breakdown.

………………Paradoxically, it was the United States that gave the first shape to Europe’s future, beginning with Western Europe. World War II’s outcome brought the United States and Soviet Union to the center of Germany, dividing it. A new war was possible, and the reality and risks of the Cold War were obvious. The United States needed a united Western Europe to contain the Soviets. It created NATO to integrate Europe and the United States politically and militarily. This created the principle of transnational organizations integrating Europe. The United States also encouraged economic cooperation both within Europe and between North America and Europe — in stark contrast to the mercantilist imperiums of recent history — giving rise to the European Union’s precursors. Over the decades of the Cold War, the Europeans committed themselves to a transnational project to create a united Europe of some sort in a way not fully defined.

………………..The European Union was designed not simply to be a useful economic tool but also to be a means of European redemption. The focus on economics was essential. It did not want to be a military alliance, since such alliances were the foundation of Europe’s tragedy. By focusing on economic matters while allowing military affairs to be linked to NATO and the United States, and by not creating a meaningful joint-European force, the Europeans avoided the part of their history that terrified them while pursuing the part that enticed them: economic prosperity. The idea was that free trade regulated by a central bureaucracy would suppress nationalism and create prosperity without abolishing national identity. The common currency — the euro — is the ultimate expression of this hope. The Europeans hoped that the existence of some Pan-European structure could grant wealth without surrendering the core of what it means to be French or Dutch or Italian.

Yet even during the post-World War II era of security and prosperity, some Europeans recoiled from the idea of a transfer of sovereignty. The consensus that many in the long line of supporters of European unification believed existed simply didn’t. And today’s euro crisis is the first serious crisis that Europe has faced in the years since, with nationalism beginning to re-emerge in full force.

In the end, Germans are Germans and Greeks are Greeks. Germany and Greece are different countries in different places with different value systems and interests. The idea of sacrificing for each other is a dubious concept. The idea of sacrificing for the European Union is a meaningless concept. The European Union has no moral claim on Europe beyond promising prosperity and offering a path to avoid conflict. These are not insignificant goals, but when the prosperity stops, a large part of the justification evaporates and the aversion to conflict (at least political discord) begins to dissolve.

Germany and Greece each have explanations for why the other is responsible for what has happened. For the Germans, it was the irresponsibility of the Greek government in buying political power with money it didn’t have to the point of falsifying economic data to obtain eurozone membership. For the Greeks, the problem is the hijacking of Europe by the Germans. Germany controls the eurozone’s monetary policy and has built a regulatory system that provides unfair privileges, so the Greeks believe, for Germany’s exports, economic structure and financial system. Each nation believes the other is taking advantage of the situation.

Read more: The Crisis of Europe and European Nationalism | STRATFOR 
Republished with permission of STRATFOR.

Sell Everything? Not Yet.

Following the crisis in Euro zone, one would be tempted to sell everything. But we should have sold and got out of equity in April itself. Now it is little late in the season because, we might be reaching a bottom soon, or at least by October. In the mean time enjoy the following clip;

To Be or Not To Be.

The markets are betting that Greece will default anytime now. The one year Greek bond yield is at 91%!

 If anyone is expecting a different outcome, then s/he is living in denial.  The debt to GDP ratio is well over 140% now and Greece is well behind all projections of deficit reduction. What else would you expect? Even in the best of times, the tax collection system in Greece was a joke. Now, with austerity, the GDP has gone down further and the tax collection along with it.

There is a general air of acceptance of the inevitable about the Greek default and with that, the non-PIIGS countries are trying to shore up their banks and insurance companies, which will have severe haircut, from 50% to 90% on their sovereign bond holdings and contagion effect. So now Germany is putting money in its financial institutions instead of putting in more money in the black hole that is Greece.

Last week, UBS published a research report on how solving the Euro problem will be expensive but not solving it will be even more expensive. For whatever it is worth, such a report should be taken with a large pinch of salt because if the Euro goes, UBS also goes under. Their conclusion, save Euro whatever the cost otherwise there will be war. It seems Paulson has found his match in Europe.

The European Union has only two choices:
1. Either save the Euro at the cost of the Sovereigns
2. Or, Save the Sovereigns and destroy the Euro in its present form.
But sometimes things do not go as planned and so it might be that both the Euro and the Sovereigns are destroyed.

Let us analyze the options.

The Euro at its current form can be saved only if Germany and other rich North European countries continue to provide unlimited funding and guarantees for the debts of the PIIGS countries. The public opinion and the political maneuver room is becoming narrower for this option.  They cannot force Greece out of the union. Only way possible is for Greece to leave voluntarily.  But Greece will not leave voluntarily because going forward; nobody will touch their new "Drachma". Apart from showing their ruins to the tourists, Greece does not have much to sell to earn money.  They import 70% of their energy, so energy cost will be prohibitive. Food will be so expensive that it will cause street riots. Banking will be dead. Business will suffer and unemployment will be sky high.  So Greece will continue to drain the Euro and suck Germany dry.

But how long before Germany says enough? If Germany is to leave Euro, its new "Mark" will be expensive like Swiss Franc. That will surely hurt the export driven economy of Germany. In addition, they will lose market access to the rest of the Europe. German banks that have lent money to other European countries, will be massive losers and will need Government bailouts.

In the first scenario, ECB will have to print money like the FED to continue to buy bonds of the PIIGS countries and that is not acceptable to Germany. In the second scenario, there will be huge disruption of trade and commerce and a depression is sure to follow.

In fact a depression is sure to follow in either way. The G7 countries are trying to solve the problem by injecting more liquidity. That serves to prop up the sick banks and financial institutions at the cost of the ordinary voters. And sooner or later, voters will respond with their boot. In worst case, with blood on the road. How far the political class will go to save the oligarchy is the moot question.

From John Hussman of Hussman Fund: “The global economy is at a crossroad that demands a decision - whom will our leaders defend? One choice is to defend bondholders - existing owners of mismanaged banks, unserviceable peripheral European debt, and lenders who misallocated capital by reaching for yield and fees by making mortgage loans to anyone with a pulse. Defending bondholders will require forced austerity in government spending of already depressed economies, continued monetary distortions, and the use of public funds to recapitalize poor stewards of capital. It will do nothing for job creation, foreclosure reduction, or economic recovery.
The alternative is to defend the public by focusing on the reduction of unserviceable debt burdens by restructuring mortgages and peripheral sovereign debt, recognizing that most financial institutions have more than enough shareholder capital and debt to their own bondholders to absorb losses without hurting customers or counterparties - but also recognizing that properly restructuring debt will wipe out many existing holders of mismanaged financials and will require a transfer of ownership and recapitalization by better stewards. That alternative also requires fiscal policy that couples the willingness to accept larger deficits in the near term with significant changes in the trajectory of long-term spending.”
More from Mr. Hussman: ” Presently, the global economy is in a low-level Nash equilibrium where consumers are reluctant to spend because corporations are reluctant to hire; while corporations are reluctant to hire because consumers are reluctant to spend. Unfortunately, simply offering consumers some tax relief, or trying to create hiring incentives in a vacuum, will not change this equilibrium because it does not address the underlying problem. Consumers are reluctant to spend because they continue to be overburdened by debt, with a significant proportion of mortgages underwater, fiscal policy that leans toward austerity, and monetary policy that distorts financial markets in a way that encourages further misallocation of capital while at the same time starving savers of any interest earnings at all.
We cannot simply shift to a high-level equilibrium (consumers spend because employers hire, employers hire because consumers spend) until the balance sheet problem is addressed. This requires debt restructuring and mortgage restructuring (see Recession Warning and the Proper Policy Response ). While there are certainly strategies (such as property appreciation rights) that can coordinate restructuring without public subsidies, large-scale restructuring will not be painless, and may result in market turbulence and self-serving cries from the financial sector about "global financial meltdown." But keep in mind that the global equity markets can lose $4-8 trillion of market value during a normal bear market. To believe that bondholders simply cannot be allowed to sustain losses is an absurdity. Debt restructuring is the best remaining option to treat a spreading cancer. Other choices are fatal.”
You can read the entire article here: http://hussmanfunds.com/wmc/wmc110905.htm

The smart money of Europe know that the situation is dire and money is leaving the shores of Europe like never before. In fact the Banks in the USA are now charging interest to accept short term deposit. That is why yield of 10 year US Notes are falling to ridiculous level. What do they know that we are missing?

Even if the USA  can manage to muddle through, events in Europe will surely push US and global economy in recession or worst still, in depression.  In short term, we can expect the weakness in the US markets to continue till October.  May be a tradable bottom will be available around Sept. 21st when the FED is expected to come out with QE3. As I continue to say, the world governments are better prepared than they were in 2008, but even then their hands are tied behind their back with the massive debt level.  There will be one last push up before the melt down. I do not believe that we shall see the S&P 500 below 1000 in 2011 but the fair value of SPX is around  400 to 600. That will be reached during the coming balance sheet contraction. May be it is time to listen to Napier again.

Keynesian Capitalism

The USA is the bastion of free market or so we are told. The animal spirit of capitalism encourages innovation and improves standard of living of ordinary people. or so we are told. So we cheer when the profits of the big companies go up and S&P 500 goes higher. ( Forget the small business, they do not have money to spare for lobbying to Congress). Will it be surprising then to note that in this era of super growth of corporate profits, the share of wages in GDP is the lowest?

Unfortunately the chart shows that most of the profit growth has come at the expense of wages. But wait, if there is no wage growth, how come people are buying stuff? Sale of ipods and ipads are going through the roof even when food stamp usage is at record number. Where the money is coming from? Well, apart from not paying the mortgage, most of the money is coming from Government transfer payments:

In fact, 22% of every dollar of the US personal consumption is coming from Uncle Sam. So in effect, The government transfer payments are keeping the corporate profits healthy. Capitalism for the mass indeed.

Have you ever wondered, why the Government and the Fed are so keen to keep the asset values ( read stock markets) high? May be the following chart will help in understanding.

 Do we still need more narratives?

Up or Down?

Although in the above picture the manure is near the fan, in reality it will not be till April of 2012 when the S**T hits the fan. Can you tell three good reasons why the markets went down for three days? Was it fear of recession? Was it fear of Euro splitting up? Was it Italy defaulting? if so, then how come the markets went up today? Last I checked, none of these problems have been solved. All the gyration of the stock markets are just the rigged game of the big speculators. It is a market for speculators not for investors.
The weakness in the market will continue at least till Sept. 21 when the Fed's two day meeting will possibly bring in QE3 in some form or other. Till then let us watch this clip of George Carlin. These are profound words indeed.

The Fed's Twisted Plan

Adapted from Stock World Weekly: Count Down To Zero

While world markets sell off, and President Obama and Congress wrangle over some form of job-creating legislation, the Federal Reserve is busy with its own problems as it attempts to deal with stubbornly high and persistent unemployment. Expectations for additional quantitative easing (QE) are running very high, but there is the possibility that the Fed may undertake a different kind of QE program, designed to provide stimulus without actually putting more money into the system. One widely discussed possibility would be to replay the famous 1961 “Operation Twist” action, where the Fed used open market operations to shorten the maturity of public debt in the open market. (History of Federal Open Market Committee actions) By buying longer-term bonds, the Fed will cause price of those bonds to go up, and this will drive the longer-term yields down.  Selling shorter-term bonds (to fund the purchase of the longer-term bonds) will put pressure on the price of the shorter term bonds, while driving short term yields up. 

According to Bloomberg, “the Fed may decide at its Sept. 20-21 meeting to replace short-term Treasury securities in its $1.65 trillion portfolio with long-term bonds in a bid to lower rates on everything from mortgages to car loans... The Fed’s influence on the economy will probably be muted as sagging consumer confidence, depressed home values and 6 million workers unemployed for six months or more weigh on demand.” 

Theoretically, driving down longer-term interest rates should help boost the housing market and consumer spending. However, this is another top down approach, and many doubt it would significantly effect the economy. As John Silvia, chief economist at Wells Fargo, noted, “The problem is that rates have been low for three years now and that isn’t spurring people to buy. Companies won’t hire unless demand is there. The Fed can lower the cost of credit, but it can’t force companies to create jobs.” (Next Stimulus May Do Little to Help Jobless) 

Rob Hosking summarized the situation:

"Dr Bernanke 'has no real policy options left that he did not use already last year and that with hindsight had no discernable economic impact,' Mr Walters [JP Morgan Australia and New Zealand economist] says. The stimulus did have a financial – as opposed to an economic – impact and one of those was to drive up the value of other currencies, the New Zealand dollar being one of them. Instead, there is a growing expectation the Fed will perform an updated version of Operation Twist,  a move first performed in the early 1960s and named after a dance craze of the time.

Under that move, which ran between 1961-65, the Fed bought up long-term US Treasury bonds and sold short term bills, in a bid to flatten the yield curve, and thus help the housing market, but to do so in “sterilised” way that did not expand the money supply.

The move was widely regarded to have failed at the time, although recent academic work suggests it was more effective than was realised. (Financial markets: QE3 or Operation Twist?)

But Operation Twist is not a money printing campaign. Describing details about how Operation Twist will work, Emily Flitter suggests it would take some "fancy footwork" and the New York Fed would probably have to hold two auctions in a single day. The Fed would sell shorter-dated securities in a first auction, and then hold another auction to buy bonds with longer maturities. These auctions would both settle the following day. 

While it would lower rates at the back end of the yield curve, Operation Twist could also nudge front-end rates higher, possibly to the benefit of money market funds scrambling for ultra-safe securities with a yield above zero.

"The way we looked at it, it looks like they could sell something like $265 billion -- everything they hold through June 30, 2013 -- and that could be absorbed with very modest rate movement," said Thomas Simons, money market economist at Jefferies & Co in New York. 

"It might push rates a few basis points higher" in shorter-dated Treasuries, he added.

Goldman's Hatzius said such an operation would ultimately remove so much longer-dated debt from the market, its effect would be almost as big as the Fed's last major easing program. (Market expects Operation Twist in September)

Cullen Roche, at Pragmatic Capitalism, is concerned that more QE, even in the form of a twist, if open-ended, will cause more inflation. He concluded, 

"open ended purchases are dangerous in this environment as it could fuel further surges in commodity prices leading to even higher cost push inflation as we saw during QE2. Misunderstanding leads to disequilibrium leads to increased economic turmoil (sound familiar?).  This does not help the broader economy and in fact only further pressures the private sector.  Pinning long-term rates will “work” in that it will suppress long rates, but I am doubtful that the Fed will do this and I am even more skeptical that it will have a substantive impact on the broader economy.  Instead, my fear is that QE^n of this sort will merely induce further cost push inflation which will actually hurt the broader economy by offsetting any positive impact.  The refinancing effect via lower long-term rates will certainly ease debt burdens on some households, but I am not optimistic that it will offset the potential risk of surging commodity prices (the refinancing effect is very focused while the commodity effect is broad across the entire economic spectrum)." (OPERATION TWIST – QE3 STYLE)

According to Bill Gross and Mohamed A. El-Erian at PIMCO, more stimulus from the Fed might have an adverse effect on the economy by driving up commodity prices.

“The balance between the benefits and cost and risks has changed in an adverse manner,” El-Erian said. “At the end of the day we will not be solving anything. We’ll just be undermining the economy and a critical institution for the well being for America.”

Governments should be focusing on creating growth rather than reducing debt, Gross said. “To do it right now is almost suicidal,” he said. (Gross Says Operation Twist Likely From Fed: Tom Keene)

Stock World Weekly editor Ilene asked Lee Adler of the Wall Street Examiner: “What makes "Operation Twist" a QE that will presumably help the economy?”

Lee responded (see also If Fed Twists, It Won’t Be Like It Did Last Summer): 

“My understanding of the Twist is that the Fed would sell its shorter term Treasuries back to the Primary Dealers and buy an equal amount of longer term Treasuries from them. I guess the theory is that by pushing longer term rates even lower than they are now, this will magically transform the US economy into a growth dynamo. They apparently haven’t noticed that long term rates have been collapsing and that this has been accompanied by a weakening economy. They also haven’t noticed that Japan has tried variations of this theme for 15-16 years. Lots of good it did Japan.

“You are correct (in questioning how this will help the economy.) This is in no way a QE if the Fed simply holds its balance sheet flat. It would still be a net negative for the markets without actual SOMA [System Open Market Account] expansion. It’s a mean, stupid, and futile gesture (with apologies to Animal House) for an economy locked in a liquidity trap, and it could be a net negative for the banking system if it were successful in reducing long term yields (which I doubt it would be).” (Excerpt from Lee's Wall Street Examiner Professional Edition Treasury update.) 

Whether the Fed begins another round of quantitative easing (QE3) or deploys another form of intervention (such as 'Operation Twist V2.0') the likely reality is that the Fed has no genuinely viable options remaining to help it achieve its dual mandate of maximum employment and stable prices, as established by the Federal Reserve Act. Instead, the Fed has been reduced to promoting politically expedient "solutions" in the face of a moribund global economy suffering from persistent and intractable unemployment.

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Labour Day Blood Bath In World Stock Markets

Wish everyone a good labour day holiday.  While the North American markets are closed, the markets in Asia and Europe are open and having a bloodbath so to say.  At this point of writing, DAX and STOXX are down almost 5%.  It is the same story being repeated. The flare up is now coming from Italy and the political situation in Germany, where Madam Markel is losing her grip on the power.  I have been writing that European union will eventually break up and there will be a Northern Euro and a Southern Euro. It is not going to happen in September 2011 but the chances are higher in 2012. When that happens, the economic tsunami will be severe. It is now widely accepted that Greece will default and to a certain extent, the markets have priced that in.  But even then, some of the banks in Europe will definitely go bust and that coupled with sovereign default of Ireland, Portugal and Spain will unleash a fresh round of Global recession.

Unlike 2008, this time, the central bankers and governments are aware of this problem but their hands are tied to the massive debt and there is very little room for effective maneuver. Only thing they know and can do, is to print money like hell, but apart from skyrocketing commodity prices and hyperinflation, money printing will not solve this problem. Till the printing press starts to roll and it may be as soon as October, the real threat is stagflation or deflation.

Housing constitutes over 40% of the CPI in the USA. While the low and declining housing price is dragging down the CPI, it is masking or hiding the higher cost of food and other daily necessities for the poor and middle class. The uses of food stamps are rising to an unprecedented level and there is no real income growth or job growth in the US economy. Happy Labour day indeed.  At best the US economy will muddle through without external shock from Europe, but Europe will definitely collapse sooner rather than later and that will push the USA in deep recession as well.

According to the WSJ, the Federal Housing Finance Agency is set to file suits against more than a dozen big banks, accusing them of misrepresenting the quality of mortgage securities they assembled and sold at the height of the housing bubble. The suits, which are expected to be filed in the coming days in federal court, are aimed at Bank of America, JPMorgan Chase, Goldman Sachs and Deutsche Bank, among others, according to three individuals briefed on the matter.

According to Phil Davis of Philstockworld: “Asian shares were already following US financials downhill on overblown fears of the FHFA lawsuit.(I say overblown because the first bank sued, ING, already settled for .20 on the Dollar so banks are reacting as if they already lost $30Bn when it’s much more likely this will all get washed away for $6Bn, or about 2 day’s worth of profits (4%).  We’ve already seen the banking community write down over $1Tn in losses and survive to screw us over another day – do we really think this little wrist-slap will end them or is this just another example of retail suckers being stampeded out of the sector that is likely to benefit most from QE3? 

I somewhat agree with Phil that US Banks will survive these lawsuits and they will use free money from government to pay the government. That way, the current administration can say that they have taken action against the banks, punished corrupts etc etc without actually doing anything and that will satisfy the sheeple on the main st. After that the government will socialize the underwater mortgages in the books of the banks and the oligarchy in the USA will live happily ever after with the political class. Talk of vote bank economics!

This much they can control and manipulate. But the events in Europe or a geo-political flare up in the form of Israel-Iran conflict is beyond the control of the market manipulators.  Tomorrow when the markets open in the North America, we will see them plunge. I expect that the lows of August will be revisited or broken. But the end of the world is not coming yet. This is just the scare tactics to force the retail investors to sell out before the QE3. The bottom will fall off in 2012, when the debt deleveraging process will start in earnest.

It is going to be an interesting time for sure. When the recession hits will full force, many businesses will close down but many will survive as well. The survival of a business in bad times is not just a matter of luck. It is also a matter of great planning and anticipation. It will also bring in new opportunities. Those who can see it coming will come out stronger than ever. 

 Charles Dickens wrote “A Tale of Two Cities” in 1859.  Even after 150 years later, his writings still holds true as if it is written for today ;” It was the best of times, it was the worst of times, it was the age of wisdom, it was the age of foolishness, it was the epoch of belief, it was the epoch of incredulity, it was the season of Light, it was the season of Darkness, it was the spring of hope, it was the winter of despair, we had everything before us, we had nothing before us, we were all going direct to heaven, we were all going direct the other way - in short, the period was so far like the present period, that some of its noisiest authorities insisted on its being received, for good or for evil, in the superlative degree of comparison only.  “

You can also read it here:

http://bbfinance.org/1/post/2011/09/labour-day-blood-bath-in-world-stock-markets.html