By the Rivers of Babylon

Age of Wisdom, Age of Foolishness (36)

Written by Adam Whitehead, KeySignals.com

“A River No Longer Runs Through It.”

Age of Wisdom, Age of Foolishness (31) “The Longest Day”^[i] explained how the real Weapons of Mass Destruction in Syria and Iraq are the Tigris and Euphrates Rivers. Turkey was observed to be holding back the flow of both these rivers, with potential disastrous consequences for its neighbours downstream. This evolving disaster of biblical proportions, in the Cradle of Civilization, has all the markings of a UN Resolution; which mandates military intervention to avoid genocide and an environmental disaster.

“Grounds for a UN Resolution.”

Britain’s Royal United Services Institute recently began to signal that this is the direction in which the international community is moving^[ii]. The institute opined that military victory is associated with control of the region’s water resources. Clearly at some stage, in the very near future, the UN must become involved; to resolve an issue which if left to the militias will result desertification and famine.

“Common Ground.”
Beyond the Pale

Age of Wisdom, Age of Foolishness (18) “Beyond the Pale” suggested that Israel was the common denominator of the crisis in Ukraine; and what was predicted to unfold in the Middle East. Age of Wisdom, Age of Foolishness (24) “The Short Good Friday”^[iii] opined that

“Israel on its present economic and political course is headed for a major conflict”.

Since then, the Middle East has unfolded spectacularly. The common denominator has shown itself to be the Yisrael Beiteinu faction, of the now defunct coalition with Likud, which once upheld President Netanyahu^[iv]. Yisrael Beiteinu is a cohort which represents the diaspora from Russia. It is this cohort which is causing the economic stress within Israel, that is creating the tension with its immediate regional neighbours over scarce resources.

This cohort is also the source of the reverse diaspora, which is increasingly militant in Ukraine. Its leader Avigdor Lieberman has now withdrawn his support for Prime Minister Netanyahu, because the latter has not been vigorous enough with Hamas in Gaza. The mobilization of 20,000 troops^[v] suggests that Netanyahu is vigorous, even if not vigorous enough for his former coalition ally.

A second Intifada is now in process^[vi], even though Netanyahu has been criticised for a soft response to Hamas’ provocation. This Intifada has the added complication of the threat from ISIS on Israel’s border with Jordan. There is also the no-less important detail that Iran is currently engaged in Syria and Iraq, whilst also supplying ordnance to Hamas in Gaza.

“Everybody now expects the Spanish Inquisition.”
The Longest Day

Age of Wisdom, Age of Foolishness (31) “The Longest Day”^[vii] suggested that there would be an “Inquisition” for the PIIGS; in which their religious belief in the dogma of fiscal austerity would be tested by fire and water. Age of Wisdom, Age of Foolishness (35) “Red Lines/Green Lights” prefaced the upcoming friction between Italy and Germany, in relation to Matteo Renzi’s U-Turn on austerity in favour of looser EU fiscal policy.

The “Inquisition” began with Jens Weidmann’s call for Italy to adhere to its fiscal commitments, which was met with “friction” from Prime Minister Renzi for Germany allegedly “undermining” both the efforts of his country and other European nations to create growth^[viii]. France joined the melee; in what at first appeared to be a swipe at America in retaliation for the record BNP fine.  Deutsche Bank and Commerzbank are allegedly also going to be punished for trading with America’s enemies^[ix].

Closer inspection, showed that France is actually trying to promote the “United States of Europe”.  Finance Minister Michele Sapin called for more international payments to be cleared in Euros^[x].  Global markets will never accept Euro parity with the US Dollar, unless there is a single government in Europe and a single fiscal system. Sapin was therefore using the BNP crisis as a catalyst to promote the “Federal United States of Europe”. French industrialists were simultaneously calling upon President Hollande to press ahead with structural economic reforms, to make France more competitive^[xi]. They used the example of Spain’s reforms and the corresponding rebound in its economy, which has got greater momentum than that of France.

“Gotterdammerung.”

Age of Wisdom, Age of Foolishness (35) “Red Lines/Green Lights” observed the “Three Teutonic Tenors” singing the European ode to joy of tighter fiscal criteria, in order to hold back Matteo Renzi’s push for debt mutualisation masquerading as Federalism.

“Die Valkyrie.”

When Sabine Lautenschlaeger brought the curtain down, with a Hawkish solo^[xii] in her first public performance at the ECB, it was beginning to look as though Europe was heading for a Wagnerian ending. Lautenschlaeger only sees the need for QE, under extreme circumstances in which the threat of deflation is imminent. Needless to say, she sees no deflation at present. She obviously has sung at the Paris Opera yet!!!

“Die Meistersinger von Ifo Institute.”

This year’s Beyreuth economic festival now features dissonance from a German singer however. Hans-Werner Sinn, the head of the German Ifo Institute, advocates writing off some Peripheral debts via negotiation and mutual consent^[xiii]. Age of Wisdom, Age of Foolishness (35) “Red Lines/Green Lights” opined that it is going to be amusing to watch how Germany enforces fiscal discipline without derailing the whole European Project. Seemingly, this will be a carrot and stick approach, involving the carrot of forgiveness as the reward for accepting the stick of tighter fiscal criteria.

“Man with a carrot earring.”

Dutch Finance Minister Dijsselbloem dangled an even bigger carrot, with acknowledgement by the EU that nations who are making attempts to restructure their economies should be given more time and space to bring their deficits down^[xiv]. The tune of European consensus politics, which David Cameron finds so unpleasant, is starting to play loud and clear. It is audible as the sound of a giant can being kicked further down the road. Hans-Werner Sinn however understands that this is no panacea and is suggesting scrapping the can altogether.

Bulls Make Money, Bears Make Money and ‘PIIGS’ Get Slaughtered”

The article “Bulls Make Money, Bears Make Money and ‘PIIGS’ Get Slaughtered”^[xv], of December last year, prefaced how the PIIGS intended to game the EU 2015 Budget negotiations by creating primary surpluses which will give them bargaining power.

As we observed in Age of Wisdom, Age of Foolishness (35) “Red Lines/Green Lights” not all PIIGS are the same; and in fact Italy is a dog. The EU is now in the process of resolving these budget issues.

“Woof, Woof!”

Portugal suddenly revealed that its banking sector is still insolvent, as Banco Espirito Santo’s parent holding company defaulted on loan payments^[xvi]. It is clear to see that Portuguese bank balance sheets are clean, because the toxic stuff has been hidden within the holding company capital structure. One wonders which other European banks have availed themselves of this accounting scam; and what the ECB stress tests in mid-October will reveal. Greece rejected a further bailout^[xvii], because it thinks (or rather pretends) that it doesn’t need it, by nature of its primary surplus. In truth it needs another bailout and a debt write-off also. Spain is keeping quiet, because it has its own internal crises with its monarchy and separatist Catalan region.

“Bow, Wow, Wow!”

Italy is trying to bluster its way to debt mutualisation with Germany, under the guise of promoting Federalism. It cannot however bluster its way through its latest Industrial Production numbers^[xviii], which showed a contraction. Italian companies are sitting tight, cutting costs and raising prices. Their government is doing the same. Both have been paid to do so, by ECB monetary policy and EU austerity legislation. They may literally get paid to do nothing by the ECB, if interest rates go negative.

France is hopping on any bandwagon it can get a ride on, in order to get a looser fiscal regime at the EU level.

“A Howler!”
Economists Are Running Out Of Ways To Describe How Bad It Is In France

The latest French Industrial Production data^[xix] showed a “surprise” contraction and falling inflation. Why this is a “surprise” is the biggest surprise of all. French companies like their Peripheral competitors have simply cut back production, raised prices and subsisted on ECB liquidity. The French government has done the same in the name of austerity. The PIIGS (plus France) are about to feel the “Teutonic Stick”, having been shown the “Teutonic Carrot” by Sinn and Dijsselbloem.

“Zelig Conflicted.”

We have criticised Mario Draghi for being like Zelig; and saying “whatever it takes” to whoever his audience may be, in order satisfy all of them. This communication strategy has ultimately become so conflicted that it can no longer continue. Mario Draghi’s low interest rates and “do whatever it takes” rhetoric have encouraged the PIIGS to hold out for more fiscal concessions. Speculators who believed in Draghi’s rhetoric have driven the PIIGS’ interest rates to levels that have convinced them that they can hold out for more.

It is now time to see what kind of bargain is driven with the EU. Clearly the Germans would like to weaken the negotiating position of the PIIGS, without derailing the whole European Project. Yield spreads need to widen enough to cause the PIIGS to capitulate, without causing the European Project to unravel. There is always the risk that the speculators will drive yield spreads to break-up levels. The Far Right parties, who have been successful in the recent European Parliament elections, can also act as what Lenin termed as “useful idiots” in order to widen spreads and to threaten the Project. Ultimately, when things look their darkest, it will be time for a compromise and some strong actions from Draghi to get the European markets moving onwards and upwards together again. In the meantime, it is going to be ugly.  We are entering the scenario which was described in Age of Wisdom, Age of Foolishness (35) “Red Lines/Green Lights” as:

‘Weaker growth conditions will be met with easier monetary policy – “Buy the Dip!” (and Buy Gold also, as was observed in Age of Wisdom, Age of Foolishness (33) “Good Fellas”).’

Draghi is becoming impatient with the lack of progress on both fiscal and banking union. His largesse was supposed to facilitate the process. Instead it has been used by national governments to preserve the status quo and manoeuvre for looser fiscal oversight from the EU. Draghi has helped to create this monster; in the same way that he has created the Stagflation monster in European companies; which do nothing except cut costs, cut debts, buy shares (their own or competitors’) and raise product prices.

Far from being objective and above reproach, the ECB is complicit in this unfolding nightmare. The ECB is now trying to exonerate itself and speed up the resolution of this crisis, by demanding that the Eurozone banks realise losses and raise capital. This will come as a great shock to the banks (and their shareholders), since they were hoping that they could use the ECB’s largesse to raise asset prices to levels at which they did not need writing down or capital provisions. The collapse in yield spreads had convinced them that they would get away with it.

Unfortunately however, the ECB has just called time and given them until mid-October’s stress tests to clean up their balance sheets and raise equity capital^[xx]. They will now be selling assets and new shares into a weakened market, which risks undermining all the ECB’s hard work inflating asset prices since last summer.

Draghi’s frustration caused him to stray into the verboten wasteland of European politics. He advocates what he euphemistically calls “higher powers”, to enforce structural change within the Peripheral countries^[xxi], so that his pro-growth monetary policy can have the desired effect rather than being gamed by the PIIGS. So far the PIIGS have used his largesse to tread water and create primary fiscal surpluses with which to negotiate with the EU.  Draghi’s “higher powers” are clearly Federalist.

The perverse behaviour of European equities continued. Having been dragged along by the American short-squeeze into the Fourth of July weekend, they collapsed the following Monday. With all the shorts squeezed, the buying power disappeared and speculators began to look for fundamental reasons to explain the fall in prices. The emerging European consensus was ignored as attention was focused back on the “Three Teutonic Tenors” and the brawl involving Italy, France, Germany and America.

When violence escalated in Gaza and Ukraine, the panic buttons were finally hit. The markets then got the American squeeze from the release of the FOMC Minutes, after which they collapsed when the news from Portugal and the Industrial Output data crossed the tape the following day.  American markets then squeezed after the European slide, as the invisible hands started to discount the easing of monetary policy after the Taper ends. American traders may also be starting to look to something unorthodox from Yellen, at Jackson Hole later this summer. The NASDAQ therefore continued to defy gravity….. and the Dow Industrials.

“What immortal hand or eye. Could frame this fearful symmetry?”

A chorus of doomsayers is also becoming more audible in America. Falling American productivity and output, is suggesting to some observers that there is not actually as much slack in the economy as Yellen says that there is. This resonates strongly with our observation of Stagflation. If this is the case, she has very limited room for further easing, without sparking problematic inflation.

Allegedly her predicament is similar to that of Arthur Burns^[xxii]. The choice of Burns is interesting, because he was the Fed Chairman who monetised the deficits, for the American military spending, which ultimately saw the country forced to close the Gold Window. As the “Warmongers” make the case for more robust foreign policy, the trap that Burns fell into is there for Yellen also. Gold Bulls with long memories may have noticed this.

“All That Glisters, is Glistening Again.”

It was certainly observed by us in Age of Wisdom, Age of Foolishness (33) “Good Fellas”. If and when Yellen lands the Helicopter at Jackson Hole this summer, she will need a growing fiscal deficit to permanently monetise. Thus far the partisans in Congress cannot agree upon civilian spending, however military spending is something that they can all agree upon.

Going forward, readers are advised to closely follow the relationship of the European Federalist Project versus Yellen’s Arthur Burns moment. A combination of European Federalism and Arthur Burns moment would signal a secular strategic problem for the US Dollar. Europeans paying for expensive oil and gas, as a consequence of wars in the Middle East, with Euros that they print would level the playing field; between them and the American superpower which lost its monopoly on settling world trade flows.

Since the US Dollar and the Euro are virtually at parity, in terms of the exchange rate, the only true way for this dynamic to manifest itself is via the Gold Price. The Gold Price will signal the relative rate of US Dollar debasement versus the Euro; and also the outright level of debasement of all fiat currencies that follow the American lead. The Gold Market has already forgotten that Japan is way ahead of both America and the ECB; and is only just waking up to the fact that America is following the Japanese example. The Taper is actually yesterday’s news already. What should now be discounted is the Fed’s reaction to the consequences of the Taper.

“Yella, Yella!”

The new old lady, at the “Old Lady”, signalled that Britain will be following the same exit strategy from QE (which is in fact no exit at all) as the Fed. Nemat Shafik opined that the Bank’s balance sheet will remain extended for some time after QE officially ends. This suggests that Britain is also about to land the Helicopter; and provide a permanent increase in the money supply. Such a permanent increase requires collateral to permanently monetise, hence the Bank will hang onto its Gilts and do the needful.

“It is the best of times, it will be the worst of times in 2060.”
Policy Challenges for the Next 50 Years

The OECD released its own biblical tales of Genesis and Armageddon last week, entitled “Policy Challenges for the Next Fifty Years”^[xxiii]. This report should have been entitled “A Tale of Two Cities” because, in addition to predicting the best and worst of times, it reads like an age of wisdom and foolishness guide. Allegedly global growth will slow to approximately two-thirds of its current rate, inequality will increase exponentially and climate change will make the Apocalypse (which never happens) worse. The developed nations have already had the best of times; and now face the worst of times. The developing nations are just about having the best of times now; and will get to the worst of times in 2060.

On the bright side, the world will be four times richer, more productive, more globalised and more highly educated…… assuming that revolution born of inequality and global warming doesn’t prematurely end civilization as we know it! The OECD prescribes increased globalization; and regulation by an enlightened global elite as the solution. This must be what the new buzzword macroprudential is all about. Conveniently, this elite happen to own most of the assets which are threatened by the global anarchy and global warming; so clearly enlightened self-interest seems to be driving the solution. No corrective mechanism is suggested for the inequality or even the climate problem; all that is prescribed is a system to manage this unstable equilibrium.

Conveniently also, this report assumes a benign co-existence between the developed nation has-beens and developing wannabes; which maintains their relative status, until the world ends in 2060. Presumably the developed nation elite, own the Emerging Market assets and also regulate them; in addition to governing the asset poor masses in both locations. This is presumed, because it is not made clear but only inferred in the OECD report.

Events in the Middle East and the “Pivot” to the troubled seas around China, suggest that this peaceful coexistence is a fantasy. One can “live the dream” but one cannot “live the fantasy”, especially when human beings and human nature are involved. This document is therefore, a mendacious diversion from reality, to sugar coat what is going to be a very violent and cruel half century. The characteristic violence and cruelty can currently be evinced in the Middle East and Ukraine.

“First came the monolith from nowhere.”
The Short Good Friday

The OECD report is a more user friendly version of the “Georgia Guidestones”; which appeared, like the monolith in 2001 Space Odyssey, at a time of change similar to the one we are at now back on Jimmy Carter’s watch.  In Age of Wisdom, Age of Foolishness (24) “The Short Good Friday”^[xxiv] we suggested that:

“The Mark Twain Playbook, based on rhyming rather than repeating history, suggests that some monolithic declaration of intentions and capabilities in the New Republic and the Holy Land will soon materialize like an angel to herald the end of Obama.”

Maybe the OECD has just created the afore-mentioned monolithic declaration of intentions and capabilities, in pdf format rather than in granite!!!

References

1. The Longest Day
2. Water supply key to outcome of conflicts in Iraq and Syria, experts warn
3. The Short Good Friday
4. Liberman and Yisrael Beiteinu sever partnership with Netanyahu’s Likud
5. Israel Mobilizes 20,000 Troops for Possible Gaza Invasion
6. Israel Strikes Gaza by Air and Sea to Halt Rocket Attacks
7. The Longest Day
8. Italy Accuses Germany of Undermining Its Economic Efforts
9. US regulators begin settlement talks with Commerzbank, Deutsche Bank -source
10. France Says Boosting Use of Euro Is Issue of ‘Global Balance’
11. Hollande Told by Executives to Act as France Lags Behind Peers
12. QE Should Only Be Emergency Tool, ECB Board Member Says
13. Ifo’s Sinn Urges Debt Cut to End Southern Europe’s Crisis
14. EU Ministers Offer Nations Chance to Earn Leeway on Budgets
15. “Bulls Make Money, Bears Make Money and ‘PIIGS’ Get Slaughtered”
16. Espirito Santo Creditors Doubt Containment on Missed Payment
17. Greece Resists Troika on Third Bailout as Draghi Protests Delays
18. Italy’s industrial output unexpectedly fell in May
19. Economists Are Running Out Of Ways To Describe How Bad It Is In France
20. ECB Summons Bankers for Catch-Up as Stress Test Looms
21. Draghi Says Europe Needs Higher Powers as Leaders Quarrel
22. Yellen’s Economy Echoes Burns’s More Than Greenspan’s
23. Policy Challenges for the Next 50 Years
24. The Short Good Friday