Why forex traders tend to lose money...

CURRENCY ANALYSIS (History Lesson)

Majors report EUR/JPY

In the trend of Euro/Yen, since the introduction of Euro in January 1999, we can notice, as a whole, 4 different macro-phases:

Phase I (Jan 1999 – Oct 2000): falling down.

After being exchanged in the 132.50-135.50 area, just after the start of transactions in January 1999, the cross EurYen fell to a historical low at 88.97 on October 26th, 2000.

Phase II (Nov 2000 – Jul 2008): strong euro rally.

Since November 2000, there is the developing of a long phase dominated by a strong Euro, with the yen systematically sold and used as a funding currency, in order to finance investments in asset classes denominated in other currencies. This carry-trade activity brought to a “currency bubble”, which kept inflating till the burst of the real estate-financial bubble in Summer 2007. The cross reached a historical high at 169.95 in July 2008 (+91% vs. the year 2000-bottom).

Phase III (Aug 2008 – July 2012): euro’s collapse

With the burst of the real estate-financial bubble, since Summer 2007 and with an acceleration after Lehman Brothers’ bankruptcy in September 2008, a progressive strong disinvestment out of the major world Bourses brought to heavy buying of Japanese yens in order to square-up the enormous carry trade positions accumulated in the years before. That brought to a collapse of the cross euro/yen, fuelled by a double drive: the fall of the euro vs. the US dollar together with the fall of the US dollar vs the Yen. The cross collapsed to a low at 94.12 on July 24th (-44.6% from the historical high).

http://www.fxtradermagazine.com/images/UsdJpy.PNG

Phase IV (July 2012- today): strong euro’s recovery, and consolidation.

Since the end of July 2012, a really strong rally was favored by the first cheering-up signals in the euro-zone – that contributed to a renewed risk-on attitude in the financial markets – together with the aggressive monetary easing that has been implemented by the Abe administration since the end of 2012. The cross reaches a peak at 145.70 on December 27th 2013 (+55% since the July 2012 lows), overcoming by far the previous peaks of September 2009 at 139.25.

Since the beginning of 2014 there has been a downward movement – along with the corrections in Nikkei225 -, with a fall to a low at 136.23 on February 4th. The cross has then recovered towards 143.00/80 in March-April, to decline again towards 137.70-138 area in the last weeks. In order to validate the recovery signals post-July 2012 an eventual correction movement must remain above the key support area 128.25-129 (intermediate support 135-136). The current trend is weak/sideways, with the cross moving between 136.20 and 143.00/80. A first positive signal would be triggered by a break above 143.00/80 (premature) but the prevailing uptrend would resume only above 145.65-146.00 (not vey likely).

As long as the cross stays below 140 the present correction could continue towards the February’s lows around 136.20. A break below that support would provide a weakness signals also for the coming weeks, targeting firstly 134.00/50 and afterwards the strong support in area 130-131, with possible extensions (not very likely right now) towards the key support area 128.25-129.

Maurizio Milano

DAVOS, Switzerland The secret Swiss bank account is no longer what is used to be.

For years the accounts were the basis of plots both real and imagined in which people hid cash to avoid the taxman or the police if the gains were from crime.

But prior to a midnight New Year's Eve deadline, many of the Swiss banks agreed to divulge to the U.S. government which Americans have accounts here to avoid prosecution on charges of helping them evade taxes.

As many as 40 of Switzerland's approximately 300 banks are reported to have said publicly that they would voluntarily hand over closely guarded client information to the Department of Justice in return for prosecutorial immunity.

After decades of facilitating, even if not explicitly engineering, the shielding of undeclared assets from foreign tax authorities, a Swiss banking industry built on a legacy of absolute secrecy on behalf of customers may start singing like a canary.

"What's really clear is that this (Justice) program is at the limit of what is tolerable for banks in Switzerland," says Sindy Schmiegel, of the Swiss Bankers Association, in Basel.

"Participation is very costly, and banks that join the plan may still face huge fines," she says. "It's important to remember that banking secrecy in Switzerland was not introduced for tax reasons."

Any adult can open a bank account in Switzerland no matter their citizenship. The banks would normally refuse entreaties from foreign governments looking to see if citizens hiding cash were among the account-holders identified by numbers.

That prompted accusations that the Swiss were aiding and abetting crime. But the Swiss Bankers Association insists that anonymity does not absolve account-holders from their obligation to respect what the Swiss Bankers Association refers to as "the legal provisions of the home country with regard to cross-border business."

As for the secrecy aspect of the accounts, it's true that under Swiss law banks are not permitted to disclose financial information to third parties. But the banks are required to be aware of the identity of account-holders. And there are numerous provisions under Swiss civil and criminal law that permit banking secrecy to be lifted.

Clive Church, a professor of Swiss politics at the University of Kent in Britain, says that the tradition for financial discretion in Switzerland can be traced back fairly precisely to 1934, when it was forged into law as a consequence of French and German agitation.

"You often hear that it was introduced to preserve Jewish money from the Nazis," says Church. "That probably happened at first, but it actually came about because the Third Republic and Weimar governments were extremely worried about large leakages of money to Switzerland because both of them were, for all sorts of reasons, politically unstable."

In response, Church says that Switzerland with its stable society and well-developed banking sector decided to make it a criminal offense to breach a stringent financial confidentiality law. The Swiss then ended up adopting the concept of concealment as a cornerstone of the nation's cultural identity.

"But that's changing now. The industry has realized that you can't just sell yourself on the basis of secrecy. You have to have other services, as well," says Church.

The crack in secrecy laws began in earnest following the first financial crisis when in 2009 the Swiss withdrew objections to a widely accepted Organization for Economic Co-operation and Development tax reporting convention.

The convention resulted in Swiss banks being permitted to supply some information to foreign tax authorities but only for specific and substantiated reasons. In other words, if there is a solid basis to suspect foul play, the banks would review requests for information on a possible account-holder on a case-by-case basis.

In 2009, UBS, Switzerland's largest bank, agreed to pay a $780 million fine related to allegations of concealing identities and assets from the IRS.

Whether the loss of inviolate secrecy will hurt Swiss banking, which accounts for 10% of Swiss gross national product, remains to be seen.

The Wall Street Journal reported in December that many Swiss banks are pressuring U.S. account-holders to make sure they are not hiding anything so as not to affect their amnesty deal with the U.S. Justice Department. In some instances banks have frozen accounts unless the customer can prove what's inside has been declared to the IRS.

"Some people believed that if they closed or moved an account, they wouldn't be found, but that's not the case," William Sharp of law firm Sharp Partners told theJournal. "Now IRS detection of an account is simply a matter of when."

In a recent report by EY, a financial services firm, around two-thirds of Swiss banks surveyed were said to be experiencing "major misgivings" over the attempt to end the tax dispute. A majority expected any future settlements to have a negative effect on its banking industry.

The Swiss, meanwhile, are pushing back and have launched a probe into a former UBS banker for revealing information in violation of Swiss law about U.S. clients, according to the Office of the Attorney General of Switzerland, which confirmed the case to USA TODAY.

This week marks the start of the World Economic Forum at the Swiss mountain resort of Davos, where more than a few of the world's richest people in attendance may have a Swiss account or two. The forum has scheduled a discussion about how, with traditional banking secrecy gone, Switzerland can reinvent itself.

"Swiss bankers accept that they are living in a new reality," says Bruno Patusi, head of wealth and asset management at EY, based in Zurich.

"But we will only see a change in certain areas. Confidentiality is still extremely important. It is true that we are seeing assets flow out (of Switzerland), but that's partly because the next generation is more interested in spending than saving."

Meanwhile, the Swiss bank account so long associated in the public imagination as a place to deposit large amounts of money with little expectation of discovery may be on its way out. The bank account used so often by master criminals, spies and sheiks in film and international thriller novels may live on only in fiction.

The comedian Woody Allen once joked: "If only God would give me some clear sign! Like making a large deposit in my name in a Swiss bank." He may want to look elsewhere for a message from above.

Kim Hjelmgaard,

USA TODAY

7:03 a.m. EST January 22, 2014

These Yellen-Proof ETFs Hedge Against Rising Rates
byEric Balchunas

The products have been outperforming unhedged bond peers recently

As the Federal Reserve prepares to raise interest rates, exchange-traded funds designed to protect bond portfolios from the fallout are likely to see big inflows.

Investors have pulled $7 billion from fixed-income ETFs as of March 12. This is a huge reversal from the $20 billion that flowed in during January and February. A positive jobs report and signs of an improving economy have investors thinking the Fed may raise rates as early as June. That would have ripple effects across the bond market as newly issued bonds become more attractive than existing bonds suddenly sporting below-market interest rates.

That's just the environment where a fairly new kind of ETF, which hedges against interest rates, should perform well. In the past six weeks, as rates have crept up, these ETFs have outperformed their plain-vanilla peers. While their assets have about tripled in the past year, to $443 million from $154 million, the products still relatively small and unknown. If and when rates rise, though, the ETFs could be the next big thing.

These products, like their currency-hedged cousins, serve up something investors want (bond exposure) while eliminating something they don’t (interest-rate risk). The ETFs effectively give retail investors access to an institutional-level product. In the past two years, 10 of them have been launched by issuers such as BlackRock Inc., ProShares, WisdomTree Investments Inc., Deutsche Bank and Van Eck Global. The areas of the bond market they cover range from investment grade to high yield to emerging market debt.

What makes these funds different from regular fixed-income ETFs? They sell Treasury futures that parallel the maturities of the bonds in their portfolios. By betting against Treasury futures, the ETF gets a lift when the prices of those bonds fall, which is what happens when interest rates rise. That's how the risk of rising rates gets mitigated.

One example is the ProShares Investment Grade-Interest Rate Hedged ETF (IGHG), which owns 209 investment grade corporate bonds.

The fund yields 3.5 percent and the bonds it holds mature, on average, in 14 years. This is pretty consistent with most investment-grade corporate bond ETFs.

Without the hedge, IGHG would suffer if rates rise. With the hedge in place, the ETF neutralizes the negative effect of rising rates on its current portfolio. It charges investors 0.30 percent of assets, very low for a product that's not a plain-vanilla offering. It has $112 million in assets.

There are two important things investors should understand when using interest-rate hedged ETFs. First, the ETF is on the hook to pay the coupon of the Treasury futures that they borrow to go short. Right now, that costs about 2.5 percent per year. Second, investors still have the credit risk that comes with owning bonds. And if rates were to go down—an unlikely scenario at this point—and there were also concerns about bond defaults, these ETFs would be slammed.

FXCM Makes Clients Responsible for Trading Losses Over $50,000
Friday, March 20, 2015, By Lucy Meakin

Risk Intelligence » News Feed » News » »

(Bloomberg) -- FXCM Inc., the largest U.S. currency brokerage for retail clients, said it will start making traders liable for losses of more than $50,000.

The company will waive negative account balances below that amount, it said in a statement Friday. The policy will apply even during exceptional market movements and will be introduced in the “near future,” FXCM said.

The announcement comes as repercussions from the Swiss National Bank’s unexpected removal of its currency floor on Jan. 15 continue to shake the foreign-exchange industry. The franc surged against more than 150 global peers when that happened, prompting some dealers to temporarily stop providing price quotes and sapping market liquidity.

Banks including Citigroup Inc. and Deutsche Bank AG were said to have suffered losses, while London-based broker Alpari (UK) Ltd. entered insolvency. FXCM lost more than $200 million and was saved from violating capital requirements by a $300 million bailout from Leucadia National Corp., owner of investment bank Jefferies Group LLC.

Federal Court Orders Royal Bank of Canada to Pay $35 Million Penalty for Illegal Wash Sales, Fictitious Sales, and Noncompetitive Transactions
December 18, 2014

Canadian Bank Traded Single Stock Futures and Narrow-Based Stock Index Futures on OneChicago Futures Exchange
Washington, DC – The U.S. Commodity Futures Trading Commission (CFTC) today announced that on December18, 2014, Judge Alvin K. Hellerstein of the U.S. District Court for the Southern District of New York entered a Consent Order for Permanent Injunction and Civil Monetary Penalty against Royal Bank of Canada(RBC) for engaging in more than 1,000 illegal wash sales, fictitious sales, and noncompetitive transactions over a three-year period. The Order enjoins RBC from committing future violations of the wash sale, fictitious sale, and noncompetitive transaction prohibitions of the Commodity Exchange Act and the CFTC’s Regulations, and requires RBC to pay a civil monetary penalty of $35 million.
CFTC Director of Enforcement Aitan Goelman stated: “Illegal wash trades may seem innocuous. They are not. They provide misleading signals to the market and are thus prohibited, whether their purpose is to lessen a foreign tax bill or another reason. This matter clearly demonstrates that the CFTC will vigorously enforce this prohibition to protect the integrity of our markets.”

The court’s Order arises from a Complaint filed by the CFTC on October 17, 2012, that charged RBC with engaging in illegal wash sales, fictitious sales, and noncompetitive transactions involving stock futures contracts, among other illegal conduct (see CFTC Press Release 6223-12, April 2, 2012). In its Order, the court found that between June 1, 2007 and May 31, 2010, RBC knowingly executed 1,026 illegal wash sales and fictitious sales of narrow-based stock index futures (NBI) and single stock futures (SSF) contracts.

RBC conducted the transactions as block trades through its branches and internal trading accounts trading opposite two of RBC’s off-shore subsidiaries, and executed the trades on the OneChicago, LLC futures exchange in Chicago, Illinois. The court also found that RBC’s NBI and SSF transactions were noncompetitive transactions prohibited by CFTC Regulations.

According to the Order, senior RBC personnel designed the trading strategy, which was motivated in part by tax benefits it generated for the RBC corporate group. The Order states that, as designed, RBC and its subsidiaries entered into the NBI and SSF trades so that RBC entities would be both buyer and seller in the transactions, initiated with the express or implied understanding that they would later unwind the positions opposite each other through offset or delivery, and that the trades were equal and offsetting in all material respects: They involved the trading of the same quantity of the same futures contracts at the same price and time, and therefore achieved a wash result for RBC. Further, the Order states that the employees who oversaw RBC’s NBI and SSF trading knew that the trades negated the market risk inherent in normal futures transactions because the profits and losses that accrued to the RBC entities participating in the trades were ultimately consolidated in the RBC corporate group’s overall profits and losses, where they netted to zero, and were therefore economic and futures market nullities for the bank.

Finally, the Order finds that RBC’s trades were noncompetitive because RBC failed to timely report part of each trade to the OneChicago futures exchange, in violation of the exchange’s written rules. Because the trades did not comply with the written rules of the exchange, they violated a CFTC Regulation requiring futures transactions to be executed openly and competitively on designated contract markets in accordance with the exchange’s written rules.

CFTC Division of Enforcement staff members responsible for this action are David Slovick, Lindsey Evans, Susan Gradman, Amanda Harding, Joseph Patrick, Scott Williamson, Rosemary Hollinger, and Richard Wagner. The Division of Enforcement also recognizes the contributions of CFTC Division of Market Oversight staff.

Media Contact
Dennis Holden
202-418-5088

Moneycorp Dealer Team, Moneycorp
20th March 2015

USD

The dollar did not have a lot of fun. It fared better than the pound, but so did every other major currency. It had two main problems to contend with: a rebound from a multi-year high against the euro and an unexpectedly soft-pedal approach to higher interest rates on the part of the Federal Reserve.

After rising steadily against the euro for the last 12 months the dollar hit a wall last week and investors are unsure what will happen next. That uncertainty has worked against the dollar and has been compounded by the US Federal Reserve. As expected, on Wednesday the Fed scrapped its pledge to be "patient" in returning interest rates to normal. However, the chairperson poured cold water on any notion that this could mean an increase might be imminent.

In the end the dollar lost one cent to the euro. It strengthened by a cent against the pound.


CAD

For the first half of the week the Loonie tracked its US cousin quite closely. There had been a bit of a wobble last Friday when Canadian unemployment unexpectedly popped up from 6.6% to 6.8% but that was offset by a smaller-than-expected loss of jobs and an increase in the participation rate.

The British pound, meanwhile, was slipping lower. It was mainly a matter of sentiment but the UK employment data were unhelpful when unemployment failed to tick lower and wage growth slowed. Wednesday's Budget also highlighted the political risk that is increasing as the general election approaches.

On Wednesday the Loonie jumped higher against the US dollar when the Federal Reserve appeared to push back the timing of its first interest rate increase. Consequently, the Loonie strengthened by a quarter of a US cent on the week and it went up by two cents against sterling.


EURO

The euro had a good week. It strengthened by one US and one Australian cent and by two cents against sterling. Its recovery had much less to do with what was going on in Euroland than with what was happening elsewhere and, importantly, what had already happened.

There were three factors working in the euro's favour, none of them of its own making: a rebound from long-term lows against the US dollar and the pound, increased political risk for sterling, as evidenced by a blatantly election-focused Budget, and an apparent postponement of higher US interest rates by the Federal Reserve.

It still remains to be seen whether the euro's gains are symptomatic of a trend reversal or are simply another bump on its route south. However, it is no longer possible to claim with any confidence that it is bound to fall further.


AUD

By and large it was a good week for the commodity-oriented currencies but the Aussie was unable to squeeze maximum advantage from investors sentiment: although it strengthened by a cent and a half against sterling it was only able to hold steady against the US dollar. It went down by a cent against the NZ dollar, coming close to the long-term low it scored earlier this month.

The minutes of the Reserve Bank of Australia's monetary policy meeting, published on Tuesday, did not do any obvious damage at the time but seem to have weighed on the currency. They confirmed that "further easing [lower interest rates] over the period ahead may be appropriate". It was probably that knowledge that made the Aussie unable to make the most of the US Federal Reserve's announcement on Wednesday when it told investors not hold their breath in anticipation of higher US rates.


NZD


By and large it was a good week for the commodity-oriented currencies and the Kiwi made the most of its opportunity. It strengthened by five eighths of a US cent and by three and a half cents against sterling. The NZ dollar picked up a cent against the Aussie, coming close to the long-term high it scored earlier this month.

The only NZ economic data of any consequence were for gross domestic product in the fourth quarter of 2014. They showed the economy expanding by 0.8%, a better result than expected.

On Wednesday the US Federal Reserve gave a global boost to all "risky" investments, including shares and the commodity dollars, when it said investors should not hold their breath in anticipation of higher US interest rates. They had been expecting a move perhaps as soon as April; now it looks like September at the very earliest.

Expert Says: “Look who’s going bankrupt next in America”
New currency law—part of H.R. bill 2847—now in effect. Could make situation worse
03.20.2015 BY MIKE PALMER, STANSBERRY RESEARCH

No one believed Porter Stansberry six years ago.

As head of one of America’s largest independent financial research firms, Mr. Stansberry’s work back in 2008 led him to a bold, but worrisome, conclusion:
That the world’s largest mortgage bankers–Fannie Mae and Freddie Mac, which at the time were responsible for nearly 50% of all the mortgages in America–would soon go bankrupt.

RELATED: Multi-millionaire shares his blueprint for surviving the coming currency collapse.

In fact, in June of 2008, while their stock prices were still trading at well over $20 per share, Stansberry published a report to his customers titled: “Fannie Mae and Freddie Mac Are Going to Zero.”

Inside Stansberry explained:

“For those of you who don’t work in the financial industry, it might be hard for you to immediately grasp what’s so dangerous about the extreme amount of leverage employed by Fannie Mae and Freddie Mac. Let me explain exactly what Fannie and Freddie do and why they’re in so much jeopardy…”
We all know what happened next.

Both agencies went bust—and if not for a bailout from the Federal Government, both would have declared bankruptcy.

Barron’s—America’s second biggest financial newspaper—even wrote a story about Mr. Stansberry’s accurate prediction short, and called it “remarkably prescient.”

Over the years, Mr. Stansberry has made a name for himself by accurately predicting the biggest and most important collapses in America.
A few of the others he’s accurately identified well in advance include: General Motors, General Growth Property (America’s biggest mall owner), D.R. Horton (a homebuilder), and Gannett newspapers, to name just a few.

Stansberry also predicted the recent collapse of oil and natural gas prices as early as 2010, when he wrote a report titled: “Peak Oil is a Flat Lie.”
Well, now Mr. Stansberry has issued another fascinating warning, about a new and looming bankruptcy.

RECOMMENDED: Next white house scandal? Looming financial scandal could send stocks tumbling

As Mr. Stansberry writes:

“No one believed me years ago when I said the world’s largest mortgage bankers would soon go bankrupt.

And no one believed me when I said GM would fall apart… or that the same would happen to General Growth Properties.

But that’s exactly what happened.”

And, he says, that brings us today…

Stansberry says the next big bankruptcy in America will be even bigger than those he’s identified in the past. In fact, he says this looming bankruptcy will threaten your way of life, whether you own any investments related to it or not.

This collapse, says Stansberry, will change everything about our normal way of life: where you vacation… where you send your kids or grandkids to school… how and where you shop… the way you protect your family and home.

How to Use Fundamental Research in Day Trading
by Adam Halpern

Day traders do very little fundamental research.

Sure, they know 'demand' for ethanol affects corn prices, but they really want to know what the price will do right now relative to where the price was a few minutes ago. How a proposed farm bill might affect ethanol prices in six years doesnt figure into day trade.
Knowing a little bit about the fundamentals those basic facts that affect the supply and demand for a security in all markets can help the day trader respond better to news events. It can also give you a better feel for when swing trading (holding a position for several days) will generate a better profit than closing out every night. But knowing a lot can drag a day trader down.

Fundamental analysis can actually hurt you in day trading, because you may start making decisions for the wrong reasons. If you know too much about the fundamentals, you may start considering long-term outlooks instead of short-term activity.

For example, many people buy Standard & Poors (S&P) 500 Index mutual funds for their retirement accounts because they believe that in the long run, the market will go up. That does not mean that people should trade E-mini S&P futures or an S&P exchange-traded fund today, because a lot of zigzagging can happen between now and the arrival of the long-run price appreciation.

Fundamental research falls into two main categories: top-down and bottom-up. Top-down starts with broad economic considerations and then looks at how those will affect a specific security. Bottom-up looks at specific securities and then determines whether those are good buys or sells right now.

If you love the very idea of fundamental research, then day trading is probably not for you. Day trading requires quick responses to price changes, not a careful understanding of accounting methods and business trends. A little fundamental analysis can be helpful in day trading, but a lot can slow your trading assertions and progress.

Leaves in a Swimming Pool

My life is pretty awesome. Indescribably great, at times. It wasn’t always this way. (If you want to read about when it was not so great, go here.)

There’s an old saying: My problems are like leaves in a swimming pool. It means that it makes no sense to be angry or upset about the fact that you have leaves in your swimming pool, because… you have a swimming pool! Your life is so great that you have a swimming pool, and you’re upset that you have leaves in it? A little perspective is needed.

So whenever I find myself tied up in knots about this or that problem, I like to think that things could be (and have been) much, much worse.

Are Americans Too Negative?

Sometimes I think we have a problem with perspective. A lot of people in this country like to focus on the negatives—stagnant incomes in lower deciles, for example. But someone with an income in the 20th percentile in the US (about $20K) would be one of the richest people in the world—by a lot.

Sure, many people don’t have jobs, but many people do—and companies can’t hire workers fast enough.

Here’s my favorite chart:
http://d21uq3hx4esec9.cloudfront.net...26_10thMan.gif

It’s funny—my article “I Heart Capitalism” from about a month ago stirred up all kinds of controversy. (For more controversial topics, check out these short interviews, each only a couple minutes long, that I did on volatility, interest rates, and my highest-conviction trade: shorting Canada.)

If you recall, I talked about how prices of certain goods were collapsing in real terms. People criticized the article, pointing out how the prices of some things, like higher education and health care, are skyrocketing. It brought out all the pessimists.

May I remind people that higher education and health care are two of the most heavily subsidized sectors in America?

In health care and higher education, the free market isn’t allowed to function properly. It’s no wonder prices are so high! The market works just fine when you leave it alone; prices will go down over time.

One of the things I forget as a “Wall Street guy” or a “finance guy” is that people take problems like joblessness, underemployment, and stagnant incomes very seriously, because there is a human cost to them. “Poverty porn” has become a whole new genre of journalism or at least one that hadn’t been popular since the 1930s. We’re bombarded with information on a daily basis about how hard people have it.

So it’s easy to sit back in my air-conditioned office and manipulate my spreadsheets and talk about how, no, actually, our standard of living is much higher than it was 15 years ago, even though it may not seem like it. People don’t like those arguments. They seem insensitive. And maybe I am insensitive, since I haven’t been a working stiff since my Coast Guard days.

But it has gotten to the point where if you are an optimist, you are persona non grata. Don’t tell my friends, but I use Facebook as sort of a social laboratory. I post provocative things and see how people respond. I was posting on Facebook recently about how we are close to curing cancer (it’s actually true—read for yourself), and people were cynical about it! How can you be cynical about curing cancer, saving millions of lives?

There was a piece on Vox recently, with 26 charts showing how the world is getting unimaginably better. The charts showed that poverty and hunger were decreasing, and that our access to leisure time and cheaper food, and our life expectancy were all getting better. I posted that on Facebook. It got a handful of likes. People were trying to figure out what my angle was.

I think human beings naturally have a pessimism bias, but I think it’s gotten out of control.

The problem with pessimism is that it affects people’s politics. If we think that the world sucks and always needs fixing, then we are going to elect really angry, indignant people who are going to try to fix something that may not be broken.

Happiness Is Hard to Find

Parts of the financial markets are overheating. Silicon Valley is stupid. Credit is too tight. If you look hard enough, you can probably find a bubble somewhere.
I remember 1999 like it was yesterday. People were happy. They were deliriously happy. Life could not have been better.

We were at the tippy-top of eight years of uninterrupted economic expansion (really 17 years—the 1991 recession had been quite mild), there were no wars, the Dow hit 10,000, the Nasdaq hit 5,000, everyone was day trading, people were listening to Britney Spears… madness.

It was the closest thing to complete social euphoria I have ever seen.

The stock market has been going up for six years now, and is up 200%. And people aremiserable. Just miserable human beings.

Stock market tops are not usually made when people are miserable. I suppose there is a first time for everything. But it seems unlikely.

Sincerely,

The Leaves in a Swimming Pool Guy
http://images.mauldineconomics.com/b...ed-dillian.png
Jared Dillian
Editor, The 10th Man

Crude


Crude prices rose by 6 percent overnight after Saudi Arabia and allies launched air strikes on Yemen, which also pushed equities lower in Europe, the Mid East and Asia. Currencies such as the AUD, CAD and NOK – so called “commodity currencies” – were big winners as WTI crude touched $52 per barrel, up $4 during the session. The latest military operations in the troubled region are targeting Iran-backed rebels surrounding the Yemen city of Aden. The Gulf of Aden is key to oil shipments to Europe.

Although the US dollar is normally a flight to safety in these “risk off” scenarios, the greenback had dropped another 0.8% since Wednesday’s strikes began. As commodities rise, the dollar is on retreat and other safe haven currencies such as the yen and Swiss franc take up the mantle. The USD/JPY rate crashed to its lowest level since February 24, gaining nearly 1% against the dollar. Economic data was limited out of Asia as equities paced world markets following Wednesday’s sharp drop from US bourses, which lost about 1.50%.

The euro continues to move higher, taking advantage of the weakened dollar amid last week’s FOMC meeting, softening US data and the rise in commodities. Stop-losses were triggered as the rate touched a four week high of $1.1052, aided by better than expected GFK consumer confidence. The New York Times is reporting today that Tuesday’s tragic Germanwings plane crash in the French Alps may not have been mechanical error, but to this point, those reports are unsubstantiated and the markets are not reacting. The euro did lose a bit of ground to its British counterpart after February retails sales in the UK beat expectations, rising 0.7%. The pound did its best at a $1.50 run but failed miserably and is trading lower as the North American session opens. French fourth quarter GDP was confirmed at 0.2%.

In the US, equity futures are getting crushed in pre-market trading, taking the most recent sell-off into its fourth consecutive day. FOMC member Lockhart speaks at 9am EST following another strong round of weekly jobless claims. For the week ending, March 20th, only 282K Americans filed new unemployment claims. American economic data closes out the week with the final confirmation of Q4 GDP growth, expected to be coming in at 5.0%. Turning to Canada, the Loonie is trading much higher this morning, aided by the rise in oil on the Saudi airstrikes. On Thursday, Bank of Chairman Stephen Poloz will be making a speech in London, titled Central Bank Credibility and Policy Normalization. It is expected that Mr. Poloz will do his best to convince markets that Canada’ policy is fine, currently on hold and waiting for more data on the impact of oil’s fierce price drop since late last year.

Best of Luck!

Stephen Casey
Senior Foreign Exchange Trader and Market Analyst

Living in a Free-Lunch World
By John Mauldin | Mar 28, 2015


Everyone is a prisoner of his own experiences. No one can eliminate prejudices just recognize them.
Edward R. Murrow, US broadcast journalist & newscaster (1908 1965), television broadcast, December 31, 1955

High debt levels, whether in the public or private sector, have historically placed a drag on growth and raised the risk of financial crises that spark deep economic recessions.

The McKinsey Institute, Debt and (not much) Deleveraging

The world has been on a debt binge, increasing total global debt more in the last seven years following the financial crisis than in the remarkable global boom of the previous seven years (2000-2007)! This explosion of debt has occurred in all 22 advanced economies, often increasing the debt level by more than 50% of GDP. Consumer debt has increased in all but four countries: the US, the UK, Spain, and Ireland (what these four have in common: housing bubbles). Alarmingly, Chinas debt has quadrupled since 2007. The recent report from the McKinsey Institute, cited above, says that six countries have reached levels of unsustainable debt that will require nonconventional methods to reduce it (methods otherwise known as defaulting, monetization; whatever you want to call those measures, they amount to real pain for the debtors, who are in many cases those least able to bear that pain). Its not just Greece anymore. Quoting from the report:

Seven years after the bursting of a global credit bubble resulted in the worst financial crisis since the Great Depression, debt continues to grow. In fact, rather than reducing indebtedness, or deleveraging, all major economies today have higher levels of borrowing relative to GDP than they did in 2007. Global debt in these years has grown by $57 trillion, raising the ratio of debt to GDP by 17 percentage points (see chart below). That poses new risks to financial stability and may undermine global economic growth.

http://d21uq3hx4esec9.cloudfront.net.../150328-01.jpg

This report was underscored by a rather alarming, academically oriented paper from the Bank for International Settlements (BIS), Global dollar credit: links to US monetary policy and leverage. Long story short, emerging markets have borrowed $9 trillion in dollar-denominated debt, up from $2 trillion a mere 14 years ago. Ambrose Evans-Pritchard did an excellent and thoroughly readable review of the paper a few weeks ago for the Telegraph, summing up its import:
Sitting on the desks of central bank governors and regulators across the world is a scholarly report that spells out the vertiginous scale of global debt in US dollars, and gently hints at the horrors in store as the US Federal Reserve turns off the liquidity spigot.
It shows how the Fed's zero rates and quantitative easing flooded the emerging world with dollar liquidity in the boom years, overwhelming all defences. This abundance enticed Asian and Latin American companies to borrow like never before in dollars at real rates near 1pc storing up a reckoning for the day when the US monetary cycle should turn, as it is now doing with a vengeance.
Ambroses parting takeaway?
[T]he message from a string of Fed governors over recent days is that rate rises cannot be put off much longer, the Atlanta Fed's own Dennis Lockhart among them. All meetings from June onwards should be on the table, he said. [This is from a regional president whose own research suggests GDP growth in the first quarter of 1%! JM]
The most recent Fed minutes cited worries that the flood of capital coming into the US on the back of the stronger dollar is holding down long-term borrowing rates in the US and effectively loosening monetary policy. This makes Fed tightening even more urgent, in their view, implying a higher path for coming rate rises.
Nobody should count on a Fed reprieve this time. The world must take its punishment.

Ouch! Please sir, may I have another? Punishment indeed. Ask the Greeks. Or the Spanish. Or perhaps there is punishment coming soon to a country near you!

I began a series on debt a few weeks ago, and we return to that topic today. I believe the fundamental imbalances we are seeing in the world (highlighted in the two papers mentioned above) are the result of the massive increases in global debt and misunderstandings about the use and consequences of debt. Too much of thewrong kind of debt is going to be the central cause of the next investment crisis. As I highlighted in my February 24 letter, the right type of debt can be beneficial. However, as the McKinsey Report emphasizes,
High debt levels, whether in the public or private sector, have historically placed a drag on growth and raised the risk of financial crises that spark deep economic recessions.
Read that again. This isnt the Mises Institute. This is #$%%*# McKinsey. As establishment as it gets. And they are clearly echoed by the BIS, the central bankers central bank. Unless this time is different, they are saying, the high levels of debt are the reason for slowed growth in the developed world, a point we have highlighted for years in our research. There is a point at which too much debt simply sucks the life out of an economy.

Nobody Understands Debt

A useful starting point for todays letter is Paul Krugmans lament that Nobody understands debt. But to borrow a phrase from Bill Clinton, it really depends on what your definition of debt is.

Paul Krugman has actually written two New York Times columns entitled Nobody Understands Debt. The first, and more nuanced, one was published on January 1, 2012; and the second one appeared last month (on February 9). It is a constant theme for him. If you want a short take on what at an uber-Keynesian believes on debt, these columns are a good place to start. (Paul [may I call him Paul?] is as good a representative of the neo-Keynesian species Homo neo-keynesianis as there is, an interesting subset of the human genus.) In our musings on debt, we are going to look at these two essays in the effort to understand the differences b etween those who want more government spending and increases in debt and those who favor what is now disparagingly referred to as austerity.

I choose Krugman not because of any need to disparage him (he does write some rather good essays) but because he writes remarkably clearly for an economist, he has an extensive body of public work to choose from, and he says many things about debt that I think everyone can agree with. The differences between his positions and mine can, however, be pronounced; and I have spent some time trying to discern why reasonably intelligent people can have such significant disagreements. My goal here is to be respectful and gentlemanly while trying to expose the foundations (there is a pun here, soon to be revealed) of our disagreement.

To do this, we are now going to step out of the economic realm and move a little farther afield. Some readers may wonder at the journey I am am about to take you on, but this diversion will be helpful in explaining Pauls and my different approaches to debt. Well return to our central theme by and by. Stick with me.

Foundational Presuppositions

One of the things I learned in my religious studies (yes, I did attend and graduate from seminary as penance for what must have been multiple heinous sins in my past lives) is that disagreements are often driven not by the logic path of an individuals thoughts but instead by their core presuppositions. Presuppositions are often more akin to tenets of faith and insight than they are to actual, provable observations or facts. They are things assumed to be true beforehand, ideas taken for granted. Sometimes our presuppositions are rooted in prejudice, but more often than not they just arise from normal human behavior. Often, presuppositions are formed because of beliefs stemming from other areas of our lives or imposed by society. Your basic presuppositions, what everyone knows to be true, can lead to absurd conclusions. If you believe, as people did in Galileos day believed, that the Bible teaches the earth is fl at and that the Bible is the authoritative source for understanding physical geography along with everything else, then it is logical to believe you can sail off the end of the Earth.

We are, as the great journalist Edward R. Murrow said, prisoners of our own experiences.

Presuppositions (we all have them) are at the heart of all sorts of irrational behavior that we are learning about from the growing understanding of behavioral economics. Not only can we demonstrate that humans are irrational, we are predictably irrational. That irrationality was actually bred into us when we were a young species, dodging lions and chasing antelopes on the African savanna. But what were useful survival traits two million years ago can now be problematic in modern society. Our presuppositions can lead us to errors in investing and cause all sorts of societal problems. Bluntly put, presuppositions can come seemingly out of nowhere and bite you on the ass.

Presumably, if two people start with the same presuppositions, then logic and reasoning should allow them to come to agreement about their conclusions. (Yes, I know, its not quite that simple, but I dont want to write a book on presuppositionalism here. Van Til did that, and it is unreadable. So work with me.)
Long-time readers know that I also send out a weekly letter called Outside the Box. It features the work of other writers I find interesting. I often send out material that I dont necessarily agree with but that makes us think. If you cant read something you disagree with and know why you logically disagree, then maybe you need to examine your own presuppositions and possibly arrive at different conclusions.

I think the difference that Mr. Krugman and I have on debt basically comes down to our presuppositions. I suspect they impact other aspects of our lives similarly. Like me, Mr. Krugman grew up on science fiction and still keeps up. He credits reading science fiction as a youth with his ultimate choice of economics as a career. In a very real sense, so do I. But I was more influenced by Lazarus Long (a recurring character in the books of Robert Heinlein) than Hari Selden (the genius who saves the galaxy in Isaac Asimovs brilliant Foundation series.) The former is distrustful of government, while the latter assumes that humanity is better off with a few brilliant people running the show, if behind the scenes. (I say people, but after following the exploits of Hari Selden for a few decades, we learn that the real masters are technocratic robots.)

While I agree with Krugman that the Foundation trilogy may be the finest science fiction books ever written (and still highly recommend them to anyone wanting to jump into science fiction), they are a poor manual for the organization of government.

Two years ago Krugman wrote this about Asimovs trilogy: My Book the one that has stayed with me for four-and-a-half decades is Isaac Asimov's Foundation Trilogy,written when Asimov was barely out of his teens himself. I didn't grow up wanting to be a square-jawed individualist or join a heroic quest; I grew up wanting to be Hari Seldon, using my understanding of the mathematics of human behaviour to save civilisation. (This is an excellent review, by the way, and I encourage those who are interested to read it.)

Am I cooking up a simplistic analogy? Perhaps not, since our presuppositions actually show up in our views on economics. It is Hayek versus Keynes (though admittedly you get better writing and plot lines when you read Asimov and Heinlein than you do when you peruse our economic giants). Asimov, as my friend (and Science Fiction Hall of Fame writer) David Brin wrote,

was quite liberal and progressive. His Robots universe, however, kept toying with notions of technocracy a concept of his youth in which the best and brightest over-rule the hot-tempered and irrational masses. [H]is fiction cycled around an ambivalence about humans ability to govern themselves with foresight and wisdom.

Heinlein, on the other hand, would be called a libertarian in todays world. He was committed to absolute freedom and individual responsibility mixed in with patriotism, mixed in with some personal eccentricity.

(David Brin is one of the worlds true experts on Heinlein and Asimov and knew them both well. He told me in a recent conversation that they each recognized the weaknesses in the philosophies that underpinned their created worlds, if those worlds are taken to their logical conclusion. Ironically, in their novels, both authors end up espousing a sort of neofeudalism. Asimov, however, became very uncomfortable later in life with the technocratic, omnipresent government that dominated the Foundation Trilogy.)

The fundamental difference in Asimovs and Heinleins views, and in the views of Keynes and Hayek, is the power of individuals and markets versus the power and influence of government. So lets take a look at some of Mr. Krugmans views on debt; and then you can see whether you agree with his assumptions and in general with Keynes and much of academic economics today, or with Hayek. This topic may take a few weeks to cover fully, but its important. Your assumptions about how the world works will translate into investment decisions. Ideas have consequences, and nothing is more fundamental to the way you interface with the world of macroeconomics today than your views on debt.

Debt Is Money We Owe to Ourselves Sort of
High debt levels, whether in the public or private sector, have historically placed a drag on growth and raised the risk of financial crises that spark deep economic recessions.

The McKinsey Institute, Debt and (not much) deleveraging
I rather suspect that Paul Krugman would take issue with the statement above, given his column of February 6, 2015, entitled Debt Is Money We Owe To Ourselves. Lets look at his first couple of paragraphs:

http://d21uq3hx4esec9.cloudfront.net.../150328-02.jpg

Antonio Fatas, commenting on recent work on deleveraging or the lack thereof, emphasizes one of my favorite points: no, debt does not mean that were stealing from future generations. Globally, and for the most part even within countries, a rise in debt isnt an indication that were living beyond our means, because as Fatas puts it, one persons debt is another persons asset; or as I equivalently put it, debt is money we owe to ourselves an obviously true statement that, I have discovered, has the power to induce blinding rage in many people.

Think about the history shown in the chart above. Britain did not emerge impoverished from the Napoleonic Wars; the government ended up with a lot of debt, but the counterpart of this debt was that the British propertied classes owned a lot of consols.

Consols are a type of British government bond that are perpetual in nature, in that they are interest-only bonds. They were first issued in 1751 and eventually financed the Napoleonic wars. There are multiple other instances where governments amassed large amounts of debt to finance wars and were able to pay the debt down over time. Think the US after the Civil War and World War II. Proponents of such massive government debt issuance will point out that growth was not constrained in 19th century Britain or after the Civil War or World War II in the US.

Krugman contends that the problems with public debt are also mainly about possible instability rather than borrowing from our children. He completely dismisses this latter idea as nonsensical rhetoric (his words).

So, do historically high levels of debt drag down growth, as McKinsey and the Bank of International Settlements assert, or do they not? In general, I think they do, but I would agree that sometimes it depends on the type of debt and the situation. Certainly you can find examples where nations took on huge debts and there was still adequate growth in the wake of doing so. But in the overwhelming preponderance of cases, when governments and/or the private sector have taken on too much debt, there has not only been a drag on growth, there have also been devastating financial crises and deep recessions or depressions.

As I tried to make clear in the last letter, not all debt is bad. There are times when debt can be actually quite productive, whether it is personal or governmental debt. But the issue hinges on the difference between good debt and bad debt and on who owes debt to whom.
Very simply, bad debt is debt, whether private or public, that cannot be repaid from current cash flows. All debt is good until the moment it is defaulted upon (both legally and realistically).

Further, it is intuitively obvious that if a country or company is using current cash flows to repay debt that was incurred for nonproductive purposes, that limits its ability to use that cash for other purposes. Assuming the other purposes are important to further growth, then growth is constrained, and options are reduced.

If taxes must be increased to pay off the debt, that limits the cash available to finance further private-sector growth, which is far and away the largest source of growth for the economy. Only if you contend that government spending per se and in general is an engine of growth can you argue that it makes no difference whether spending is public or private.

While certain types of government spending are conducive to growth (think infrastructure development, education, scientific research, and law enforcement as examples), only a small portion of US federal government spending falls into those categories; so the preponderance of federal spending does not enhance productivity. I think the bulk of academic research supports that conclusion. That is not to say that some government expenditures for nonproductive uses are not proper or necessary, but thats a different argument for a different day. (A social safety net comes to mind.)

You cant contend that there is not a cost, in terms of private-sector productivity, incurred by taxes. That is not saying that a particular tax expenditure may not be worth the cost. Some government expenses are vital to public well-being and to a stable, properly functioning economy. Just be clear that there is always a cost. The negative slope of the curve when growth is plotted against taxation rates is quite clear. At some point, high overall taxes and high debt become a drag on growth (in terms of GDP, not effects on individuals, although you can make that argument). Think Europe. And Japan.

Most periods of high government debt that were not a drag on growth followed wars, when previously massive defense spending was radically decreased and the resulting extra income was then used to reduce the debt. Further, wars are the epitome of nonproductive spending, even when they are necessary for survival. A cessation of hostilities and the returning of soldiers to productive activities will in and of itself increase productivity and GDP, and that growth in turn increases the ability of an economy to pay back debt! That scenario is significantly different from a period where government debt, incurred to fund current consumption, is allowed to increase beyond the ability of cash flows to pay off the debt.

Greece is now in the latter situation. Rogoff and Reinhart detail over 260 other such episodes in history, where countries incurred insupportable debt and were forced to default in one manner or another. Default can take several different forms: deferral, restructuring of the terms to the detriment of the creditor, outright refusal or the inability to pay, etc. Monetization is a form of default that we will deal with shortly. From the point of view of the creditor, if you have to change the terms in such a way that you get less than you originally bargained for, even if that is the best outcome under the current circumstances, you will now have less money than you expected to have. You can call it what you like, give it all sorts of pretty names, but it means that a debtor did not live up to the terms originally agreed upon.

Mrs. Watanabes Bonds

It is time to take up the question of whether government debt is just money we owe to ourselves. Lets take a real-world example of a nation that has incurred a very large debt that it increasingly struggles to make payments on and yet essentially owes the money to itself. I refer to Japan.

Japan has amassed a debt that is roughly 250% of GDP, far higher than that of any other country. The government has been able to grow such an outsized debt precisely because its citizens have, either directly or indirectly through their pension funds, been willing to purchase that debt. It is estimated that up to 95% of Japanese bonds are owned by the Japanese themselves (directly or through institutions). The rest is primarily in the steady hands of other central banks and a few funds with position mandates.

There is no country anywhere that can truly be said to owe more to themselves than Japan does. To sort out whether debt that we owe to ourselves is truly not a problem, lets drop in at the home of the proverbial Mrs. Watanabe, who, it just so happens, is being paid a courtesy visit by Prime Minister Shinzo Abe and Bank of Japan Governor Haruhiko Kuroda. Lets listen in:

Kuroda [bowing]: Mrs. Watanabe, we are here today because we have a national crisis. Previous Japanese governments have run up a rather large debt, and we find ourselves in the unfortunate position of not being able to repay that debt unless we monetize it. But since we owe that money to ourselves, and since you are us, we thought we might ask if you, along with all your neighbors and friends, would be willing to forgo payment so that we can reduce the national debt. We realize this will make things more difficult for you in your remaining years, but it really is for the good of the nation.

Abe: Can we count on your support? And of course we would like you to vote for us in the next election.
Mrs. Watanabe: Honorable Prime Minister, my husband and I have worked very hard all our lives. We have done exactly as good Japanese citizens should do. We saved our money, invested in government bonds, and now were depending on them for our retirement. We need those bonds to be paid in full in order to have enough to buy our rice and miso soup and sake. In fact, listening to what you say, I think I need a cup of sake to calm me down. Pardon me for a moment.

[Mrs. Watanabe serves sake to her esteemed guests, takes a stiff gulp herself, then stands and draws a deep breath, bows, and looks the Prime Minister in the eye.] Let me be very clear. I fully expect to be able to cash in my bonds when I need the money. Further, I expect my pension to be paid in full in exactly the manner I was promised. If your administration cannot fulfill those promises without endangering my life, then I and my many friends will make sure that you are not allowed to continue in public office. Good day, gentlemen.

Now I know that is not the way the conversation would actually go. Mrs. Watanabe is a very polite Japanese lady who would never speak so directly to her Prime Minister. Nevertheless, I suspect my version of the conversation has captured the gist of what she was actually thinking.

And of course Abe-sama and Kuroda-sama know better than to ever have that conversation, because that is essentially the reaction they would expect to get from their citizens. In fact, a survey conducted a few years ago confirmed that less than 13% of Japanese citizens would be willing to sacrifice for the good of the nation when it came to their government bonds. So much for Japanese solidarity.

So Abe has had to choose between Disaster A and Disaster B. Rather than suffer a deflationary collapse, Disaster A, he has chosen Disaster B, the monetization of his debt. Which is precisely what Professors Krugman and Bernanke have suggested that Japan should do, although under the guise of quantitative easing, with the aim of creating inflation. So now Japan is experimenting with the most monumental quantitative easing ever undertaken by any developed country in the history of the world.

So hows that quantitative easing thingy working out for Japan? Inflation should be going through the roof by now, right? Well, not so much.
Japan's annual core consumer inflation ground to a halt in February, the first time it has stopped rising in nearly two years, keeping the central bank under pressure to expand monetary stimulus later this year. Other data published on Friday didn't offer much solace with household spending slumping [2.9% y-o-y, for 11 straight months of decline] even as job markets improved, underscoring the challenges premier Shinzo Abe faces in steering the economy toward a solid recovery.

While the Bank of Japan has stressed it will look through the effect of slumping oil prices, the soft data will keep it under pressure to expand stimulus to jump-start inflation toward its 2 percent target. (Reuters, March 27)

Aside from not being able to generate inflation, the Japanese economy is doing as well as can be expected and better than it has in most of the past 25 years. But the Japanese government desperately needs 2% inflation and 2% real growth in order to be able to deal with its debt, if it is not to be forced into outright monetization.

So the economy is doing kind of all right, and Japanese quantitative easing has been a roaring success, right? Perhaps from the perspective of the Japanese elite, its politicians, and of course its economists, but not, perhaps, from the perspective of Mrs. Watanabe.

She has seen the purchasing power of her currency drop by 33% in the past few years. That massive hit on her spending power affects her directly when she goes to buy imported goods, and it affects her indirectly through the high cost of all the energy Japan must import. When your buying power is reduced in retirement and Japan has a rapidly aging population I dont think you can call that a roaring success.

The truth is, the Japanese government is passing on the pain of 25 years of running up too much debt to Japanese savers and retirees. I think the value of the yen is likely to drop another 50% (at least) before Japan can allow the market to set interest rates. They are going to print more money than any of us can possibly imagine. (I have documented on numerous occasions why Japan cannot allow interest rates to rise. Higher rates would be an utter disaster for the country.)

Quantitative easing seems like a Free Lunch World to many politicians and even to many economists, who should know better. But it is not a free lunch for Mrs. Watanabe. It is her lunch, scarfed from her table. And it will not be a free lunch thats served in Europe as Mario Draghi eases and European savers watch the yield of their bonds and the value of their currency erode.

There Aint No Such Thing as a Free Lunch

There aint no such thing as a free lunch (TANSTAAFL). Quantitative easing comes with a price. The question is, who will pay it? The unprecedented financial repression that we are seeing in the world has been foisting the cost of bailing out bankers and stock market investors onto the aching, sagging backs of savers and retirees. Some might consider that an acceptable outcome, given that the global financial system has recovered, after a fashion, from the Great Recession.

But Paul Krugman and his neo-Keynesian colleagues, including most central bankers, seem to think theyre living in a free-lunch world. They are either not aware or do not care who is picking up the check.

No matter how debt is reconciled, whether through the normal means of it being paid back or through some type of default, workout, or monetization, someone ends up paying. Oftentimes, there is simply no choice but to resort to some type of debt reconciliation. You cant squeeze blood from a turnip, especially a Greek turnip. (Another pithy economic lesson I learned from my dad.)

Which leads us to a topic we will take up in a future letter if not next week: how much debt is too much, and how do we avoid getting to that point? Stay tuned.

(Trivia: The maxim There aint no such thing as a free lunch dates back to the 1930s. The phrase and its acronym are central to Robert Heinlein's 1966 science fiction novelThe Moon Is a Harsh Mistress, which helped to popularize it. The free-market economist Milton Friedman also used the phrase as the title of a 1975 book, and it shows up in economics literature to describe opportunity cost.)

Home Gearing Up for SIC

Surprisingly, other than a few personal day trips here and there, I am home for the next month until I leave for San Diego for my Strategic Investment Conference. You really should consider coming, as this is the single best macroeconomic conference in the country. I say that without reservation. Find me a conference lineup that it is better at any price. If I listed just the people we have lined up to moderate the question-and-answer sessions, they would constitute a fabulous conference in their own right. I am simply thrilled by the massive intellectual firepower that is going to be in the room. Plus, we just finalized Peter Diamandis to speak Thursday night. My friends and Hall of Fame science fiction writers David Brin and Vernor Vinge, two of the best futurists on the planet, will be there to ask Peter questions and to push back, and they will all min gle with you before dinner. You really dont want to miss it. The conference is April 29 through May 2. There are just a few places left.

Its time to hit the send button. I am truly interested in your comments, positive or negative, on this letter in particular, as I hope to develop it into a longer piece on debt. I always read the comments you post beneath the letter on our website. Have a great week!
Your admittedly eccentric analyst,
http://images.mauldineconomics.com/n.../signature.png
John Mauldin

The Corn & Ethanol Report

03/27/2015

By Daniel Flynn

Market Analyst at The PRICE Futures Group

Corn Overbought?
Good Morning!

The gains in the grains momentum has slowed down for now. Export Sales were not as attractive as they were last week. Also iffy global economic data is contributing to the negative sentiment. In the overnight electronic session the May Corn is currently trading at 389 33/4 which is 1 ½ of a cent lower. The trading range has been 393 ½ to 389 ¾ so far. Weather will be a factor as we get closer to planting season. And can we expect China to continually be an aggressive buyer.

On the Ethanol front the May contract is trading a little easier in the overnight electronic session. We are currently trading at 1.496 this morning which is .003 of a cent lower. The trading range has been 1.510 to 1.496. The market is being influence by lower Grain and Energy prices.

On the Crude Oil front we seem to be backing off the fear factor for now with the Saudi's unilateral attacks on terrorist in Yemen. Another sign of U.S. foreign policy that has our allies going it alone. In the overnight electronic session the May contract is currently trading at 5071 which is 72 points lower. The trading range has been 5138 to 5005 so far and we may see a short covering rally going into the weekend.

On the Natural Gas front the May contract is currently trading at 2.668 which is .020 cents lower. The trading range has been 2.697 to 2.651 so far. I do expect a shoulder season rally in this long-term bullish market.

Have a Great Trading Day!

Thanks,
Daniel Flynn

Fibonacci expansion: A better way to time price targets
By Toni Hansen

Identifying turning points in the market can be a daunting task. If you are already in a position, it’s easy to let your emotions take over and throw your larger goal out the window in favor of smaller, more immediate returns. Often, this is the wrong approach and you will stand on the sidelines as prices continue to rise or fall in accordance with your initial bias as you mentally slap yourself for your lack of discipline.

When your instincts are telling you that the odds are in your favor, why is it so difficult to just stay the course? For most, the reason boils down to confidence. While the seeds of confidence are often sown in instinct, it is reason that nurtures your ability to trust those instincts.

The greatest key to building confidence and hanging onto winning positions longer is to have a solid target and exit strategy in place before initiating a trade. The majority of traders try to improve their odds of correctly identifying these targets through the use of indicators. Most indicators, however, are only as good as the trader using them and correct applications and interpretations can take years to master.

A disconcerting fact for those studying market indicators is that there are relatively few that can assist in all aspects of trade management. One exception is a form of market analysis that we know today simply by the name of the author who is credited for introducing the system’s underlying numerical sequence to the West: Fibonacci.

Sweet sequence

Fibonacci indicators that have become popular in technical analysis today are based upon ratios that are derived from the numbers that make up the “Fibonacci sequence.” This sequence is the result of adding each new number to the one that precedes it, beginning with 0 and 1. For example: 0+1=1, 1+1=2, 1+2=3, 2+3=5, 3+5=8, etc.

After the first several numbers, an interesting symmetry begins to develop. For example, from 13 onward, every time you divide a number by the one to the right of it, the result is 0.618. When you divide a number by the one two places to the right, the result is 0.382. These numbers are converted by market analysts into 61.8% and 38.2% respectively.

The significance of the Fibonacci numbers and resulting ratios is a topic that has been debated widely over the years. While scholars argue the veracity of many claims that Fibonacci is part of the underlying fabric of natural design, in the financial markets it is the skeptics that often take a back seat. Support and resistance levels based on Fibonacci numbers and ratios hold remarkably well when applied to chart analysis. This is true especially for forex and futures markets and in individual, high-volatility securities.

There are numerous applications for Fibonacci ratios in technical analysis. Among the most popular are Fibonacci retracement levels, price and time extensions and Fibonacci fans. While these tools transcend markets, they also transcend time frames and are viable for traders and investors alike.

Simple application

A trading minimalist can appreciate the simplicity of relying on pure price action to decide how to place and manage a trade. Many popular indicators simply create clutter and confusion, eroding confidence as opposed to bolstering it as the market landscape shifts and trends change. Fibonacci, on the other hand, is rather exceptional. It works well in both a trending market and in periods of congestion.

Although learning a new system of market analysis might seem daunting, and the plethora of Fibonacci applications can make some traders shy away, many Fibonacci techniques are surprising simple to use and are relatively foolproof. Perfection is not necessary.

A Fibonacci expansion is a type of extension tool that relies on three price points instead of the typical two you will find when using Fibonacci retracements. The first two anchor points in a three-point expansion are based on a primary trend move, otherwise known as an “impulse wave,” in a futures, currency or security.

In an uptrend, the first anchor point is the low of the uptrend. This is shown as “A” in the accompanying charts. After selecting the Fibonacci expansion tool in your charting platform, click on this first low to begin the expansion. Next, click on the high of the impulse wave. This is shown as “B” in the accompanying charts. The third point, marked “C,” anchors the expansion move itself.

Consider a trade in the E-mini Dow futures as an example. This trade uses Fibonacci expansions to demonstrate how to identify a target that developed overnight. The indicated circle in the first chart in “Expanding opportunity” (below) shows an early buy trigger that was missed, while the circle in the second chart shows an entry zone caught later that morning after the Fibonacci expansion was re-applied.

http://futuresmag.com/sites/default/..._Expanding.jpg
Many traders struggle with drawing Fibonacci levels properly, but even levels that are not drawn ideally will yield strong support and resistance points. Indeed, if you pick a number of random highs and lows in a security on which you base Fibonacci levels, many of the resulting horizontal lines cluster together at certain price zones. These clusters are what traders use to distinguish major from minor support and resistance.

Fibonacci expansion works well for establishing price targets. When a trader can place a target level on a chart visually, holding for that target point is much easier than simply waiting for an upside move of indeterminate size. By seeing the Fibonacci-based targets hit consistently over time, it makes it even easier to hold positions into those target levels instead of jumping ship too early.

Price points

Fibonacci combines well with other strategies, such as technical price pattern analysis. Typical price patterns in which the Fibonacci expansion tool is particularly useful are continuation strategies such as bull flags, triangles, ABCD patterns, etc. When the momentum of a price move breaking out of these periods of congestion is comparable to the impulse wave heading into them, Fibonacci expansion is most useful. These patterns can create a great deal of choppiness, however, before a breakout occurs. This can lead traders to question whether or not their anchor points are placed properly.

In the E-mini Dow trade, we look at two different price points that were used for the third anchor in the Fibonacci expansion. In the first chart in “Expanding opportunity,” you will find the most commonly used third anchor: The low of the trading channel. The 100% expansion of this move meant that the primary target would have been 15,249. Instead, the breakout move took the YM into the 138.2% expansion zone of 15,294.

There are several reasons for this larger price move on this particular breakout. First, the Dow congestion held within the middle of the original impulse wave of buying. This created stronger resistance at the prior highs, which you will note corresponded to the 61.8% Fibonacci expansion level in the first chart. Second, once those highs broke, the pace of the buying was much stronger than the original impulse wave. When this is the case, it is more common for the breakout move to aim for higher expansion levels than 100%.
Alternately, if the breakout move had been slower than the original impulse wave, it may have been necessary to adjust for a lower Fibonacci target, such as the 61.8% level that paused the original breakout.
The second chart includes an alternate Fibonacci expansion based upon using the last low in the tightest portion of the congestion as the third anchor point. While the absolute low is the most common third anchor, often a 100% expansion target based upon this last pivot low tends to hold most often when the pace of a breakout move is similar to the pace or momentum of the impulse move. This meant that 15,270 would be the most common target going into a position such as this one.

Notice, however, that a number of the Fibonacci resistance levels that result from using the last low within the congestion itself as the third anchor point are almost identical to those in the first chart. The only difference is the percentage label attached to each level. The 38.2%, 76.4% and 123.6% Fibonacci expansions in the second chart are each within a few ticks of the 61.8%, 100% and 138.2% Fibonacci expansion levels in the first chart. Either method would have yielded comparable price points as targets. While the increased momentum on the breakout allowed the Dow futures to push past the typical 100% expansion target, using the Fibonacci expansion tool demonstrated that we were working with the next target zone, removing some guesswork from the trade.

While Fibonacci expansion is an excellent tool to help traders visualize target points on continuation strategies, other popular Fibonacci tools, such as retracements and fans, offer traders a similar edge. The particular tool varies depending upon the type of strategy being traded and whether or not you are timing an entry or exit. Regardless, if you want to improve your trading and build consistency in your models, Fibonacci expansion is a solid tool to have.

May you choose the path of least resistance.

Chaos in Yemen Could Undermine Dollar
By Lior Alkalay March 29, 2015


Yemen, a country south of Saudi Arabia, and with an economic output roughly the equivalent to that of say, San Antonio, Texas, is sinking deeper into chaos. Though in the grand scheme of things in the Middle East, that chaos stems from a relatively small country, it is likely to have widespread ripples that could affect market sentiment, in general, and specifically, in the FX market.

One might ask how on earth Yemen, a small country that is primarily desert and which is categorized as among the world’s poorest, could affect trends in the Dollar, the Euro and other currencies?

Yes, it’s Oil Again

The answer, as you might have guessed, and the only way that trouble in a small Middle Eastern country could have repercussions on global markets, is through Oil. Despite the fact that Yemen produces less Oil than Denmark and its direct effect on Oil supply is marginal, its location is critical. Yemen is situated on the banks of the Gulf of Aden, the 4th largest passage for Oil in the world and a key passage for seaborne Oil and gas from the Middle East. Analysts point out that with the country deteriorating into chaos, the risk of Oil tankers being hijacked by pirates grows much higher and thus heightens Oil supply risks.

Now, while this might be a plausible risk scenario, it is not the real reason why Yemen’s chaos is an issue in the global markets. The real reason is the potential geopolitical threat that chaos, which is currently contained within Yemen, could continue to heat up and then “boil” or spill over. That spillover could result in a military showdown between Saudi Arabia and Iran, the Middle East’s two largest oil producers. The Iranian government is actively assisting the rebels against the Yemen president, Abed Rabbo Mansour Hadi, who is an ally of the Saudis. And Saudi forces are actively engaged against the rebels in an effort to protect their own (Saudi) interests. Thus this potential for a spillover could, in reality, eventually devolve into a major conflict between Saudi Arabia and Iran which could jeopardize Oil supplies and thus impact Oil prices.

Back to the FX Market

So, back to the question, how can this mess impact sentiment in the FX arena? Quite simply, if this Middle East hotspot spills over, Oil prices could bounce higher and thus encourage investors to move into risk-on mode. “Risk-on” sentiment tends to favor currencies oriented closely with commodities, such as the Norwegian Krone and the Aussie, Kiwi, and Canadian Dollars, while at the same time being rather negative for the US Dollar. In other words, if things do de-escalate towards a risk of real war, Oil could surge further and possibly generate a shift towards commodities and away from the US Dollar, thus being a potential catalyst for a Dollar correction.

Why the Dollar is Vulnerable?

The Fed had just laid out its plans to raise rates when all of a sudden the data suggested it wasn’t necessarily warranted and so a dovish Fed prevails. With the biggest hurdle to rising interest rates being low inflation, one might presume that higher Oil prices would raise inflation expectations and thus increase the chances for an interest rate hike. However, under the current circumstances, that presumption would be wrong.

For Oil prices to generate inflationary pressures they need to rise constantly and create a buildup of expectations for higher prices. Currently, Oil fundamentals remain weak since the market is oversupplied and given that there is still excess capacity in the Oil market the chances are that any surge in Oil prices would be temporary and would likely even out over the long term. Even if Oil does eventually stabilize above $60 a barrel, the chances are it won’t be on a constant upward trend because for that to happen, supply has to really turn tight. This is why the mere risk of war between Saudi Arabia and Iran could push Oil to settle higher but it would not necessarily initiate a long-term bullish trend.

Hence, any impact would be more of a short-term nature than a long term one, and inflation expectations won’t likely be affected. Investors would prefer to move into short term speculative bets, buying into riskier currencies while curbing bets on the Dollar, which could mean that the Dollar is expected to slide lower if Oil prices surge on the back of Yemen’s chaos. In the broader scheme of things, of course, this could be just another “excuse” for Dollar bulls to diverge away from the Dollar after a very lucrative year. But whatever their reasons or rationale, until investors get the long awaited Dollar correction they will become increasingly uneasy with their Dollar holdings.

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How I Disproved Efficient Market Theory
by Being a DJ


Yes, DJing is a hobby of mine. I’ve been doing it for about seven years, picking it up late in life. Call it midlife crisis number one.
I have had a pretty fun DJ career, all things considered. I’ve played in a couple of really famous clubs, and I’ve done all kinds of private parties—parties where people have gone nuts. I post my mixesonline for people to enjoy. I’ve spent way more money than I’ve earned (especially on music—I pay for all my tracks). But it’s been worth it.

Most people here are probably dimly aware of the electronic-music phenomenon that’s been happening worldwide, but they might not know or understand what DJing is all about. A DJ plays recorded music live. That’s it. He chooses the order of the songs. In the old days, this was done via vinyl records, and there was a great deal of skill involved in adjusting the speed of the records to match the beats. Nowadays, you can get a computer to do that for you if you want, though the annoying purists will hate you for it.

None of this sounds hard, right? Why do people consider it an art form? Well, first of all, the DJ is a curator of music. This is more difficult than it sounds. It’s not like pop music, where the same ten songs play on the radio on a loop. If you’re into underground music like me, you’re digging deep to find great tracks that nobody has ever heard before. In the old days, this would entail spending hours at the record store. Now you can do it online. But it’s still a lot of work.

Is the curator an artist? Yes and no. Think of the museum curator—he decides what paintings to hang and what order to hang them in. A DJ does the same thing. It’s an art form that is not fully appreciated. Back when I lived in New York and went to clubs, there was a progressive house DJ named Zack Roth who used to warm up for all the big trance acts that came to town. I was obsessed with being a warm-up DJ. The warm-up DJ goes on first, around 10 p.m., and plays dark, deep stuff, gradually bringing up the energy (and the tempo) until he’s whipped the crowd into a frenzy just as the main event comes on. Zack Roth was the master.

All this is done by playing songs in a particular order. Amazing!

Why does this work? Well, it works because you have memory. You may not notice the transition from one song to the next, but you will notice the increase in tempo, the rise in energy. Over the course of a few hours, you will have noticed that you started at 1 and ended up at 10.

If you had no memory—if you had the memory of a goldfish and you couldn’t even remember the last song played—DJing wouldn’t work. You could play the songs in whatever order; it wouldn’t matter. The only song that would matter would be the one you were currently playing.

Path Does Matter

There is a concept in finance known as path dependency. Like, the price of a security goes from A to B over time. Does it matter what path it took to get there?
In the derivatives markets, this question is of crucial importance. There are some exotic options, like lookback options, whose price actually depends on the path the asset takes. But with plain-vanilla puts and calls, path doesn’t matter—all that matters in the pricing of the option is where the asset is currently.
It seems obvious that path would be super important, though. Think of it this way: right now the S&P 500 is at about 2,000. You know what path it took to get there. It went down to 666 in the financial crisis and has basically gone up for six years straight, until today. People are pretty bullish, right? The market has been going up every single year, for six years.

But what if the market had gone down to 666, then up to 4,000, then crashed to 2,000? This is a stupid example, but not really. Would people feel the same with the SPX at 2,000 if it had taken this path, crashing 50%, rather than the previous one, where the market went straight up?

Of course not. If the market had arrived at 2,000 by going down 50%, nobody would be bullish at all.

Path really matters. Here’s another example.

The Gas Tax and Path Dependency

Gas prices were really high over the last several years. Even if you’re not a financial expert, you can probably tell me the approximate path of gasoline prices over the last 20, 30 years. Because you remember.

So gas prices were high for years, running up to $4 a gallon and more—until they suddenly crashed, dropping by over 50%.

Did you see what happened next?

Politicians started calling for an increase in gas taxes. Why? Because people were usedto high gas prices and could easily absorb an extra 10 cents on the gallon.

What’s interesting is, if gasoline had been $2 all along—or, say, it had been at $1 for 10 years and then had gone up to $2—there is no way politicians would have been calling for gas tax hikes. People would be furious. So gas prices are path dependent!

Well… so is everything else.

EMH Is Dead

The Efficient Market Hypothesis is the idea that all information (including the path of previous stock prices) is reflected in current stock prices.
Even in the age of the Internet, this is not true.

There was a 60 Minutes episode on curing cancer last Sunday. The biotech guys have known about this for years. The information is publicly available, but unsurprisingly, most people don’t make the effort to learn about that stuff. It takes time for information to travel, sometimes a long time.

Most options are priced with similar assumptions. They’re modeled on something calledgeometric Brownian motion, which describes the behavior of a particle suspended in gas. The particle has no memory. It is path independent. But unlike the particle, the market has memory. People have memory. And as we demonstrated, it is path dependent. So its behavior will not be a true random walk.

People are slowly learning what the quant guys have known for years: the market is not random, and you can profit from that. There would be no commodity trading advisors (CTAs) if the market were random. But the guys who have disproved market efficiency are making too much money to bother filling out a Nobel Prize application.

This is the problem technical analysis claims to solve. The technical guys are half right. The market is path dependent, yes, and they have constructed a set of rules to describe this behavior. Problem is, sometimes the rules work… sometimes they don’t. Technical analysis is most helpful as a guide rather than gospel.
This is a roundabout way of saying that the efficient-market people who tell you that you can’t beat the market so you shouldn’t try—well, those people suck. Don’t hang around with those people. Deep down, I have always felt that you should try. Anything worth doing is worth doing well.
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Jared Dillian
Editor, The 10th Man
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Dollar slides as commodities recover
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Iran nuclear talks continue into weekend
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GBP lower as construction PMI misses mark

After a brief respite around the month and quarter end, the US dollar is poised to close another week lower. Global investors are selling the greenback once again this Thursday, one day ahead of the US March non-farm payrolls report and the long Easter holiday weekend. On Wednesday, more doubt was cast over sustainable US growth for 2015 as ADP reported fewer new private sector jobs for March than had been expected, and a slew of economic indices missed expectations. Fed Chairman Janet Yellen will be speaking this morning, making the welcoming remarks at a conference in Washington, D.C. Economic data was broadly limited overnight as most European markets will be closed on Friday.

The only data release of note across the pond came in the form of UK construction PMI. Although this latest read missed the mark, coming in at 57.8 versus 59.5 expected, the pound is still trading higher against the dollar as Tuesday’s sell-off is confirmed to be short lived. Currently, all eyes in Europe and around the world are centered on the Iran-Nuclear negotiations happening in Switzerland. While all sides remain optimistic about a deal, the talks are now two days past due as world leaders try to come to some kind of compromise. The Wall Street Journal is reporting this morning that Greece continues to make little headway on their ongoing negotiations. The troubled nation continues to try to end its standoff with international creditors, facing the prospect of another month starved for cash. Most of Europe and the UK will be off tomorrow and Monday so trading should grind to a reluctant halt.

In Asia, it was commodities the paced the markets as iron ore prices dropped below the $50 mark. The Australian dollar has lost nearly 1% in value over the last 24 hours despite a slightly smaller trade deficit as both exports and imports showed a slight bump in February. The Reserve Bank of Australia is expected to announce another rate cut next Tuesday, the first trading day after markets close down under for the Easter holiday. In Japan, the yen continues to be pinned to the 120 mark for now, but should the Iran talks finish without a deal, it could spark a furious yen rally as a flight to safe haven assets is expected. As those talks continue, the risk lies in a sharp drop for USDJPY, perhaps to test lows around 118. Japanese stocks ended 1.50% higher, ending a three day sell-off around their fiscal year end.

Turning to the US, the dollar is finding some brief support following the release of weekly jobless claims. Only 268k Americans filed for new unemployment claims, down 20k from last week. While economic data in the US has waned over the last few weeks, the jobs market continues to be the shining light, possibly carrying the Fed to raise rates at the end of the summer. Tomorrow, the US will release a slew of economic data, and being the only market to be reporting data, it could make for an interesting close to the week. March non-farm payrolls are expected to be in the range of +295k as the world’s largest economy continues to expand in possibly the most important sector. The Canadian dollar continues to rise on Thursday, recovering nicely from the quarter end decline. As oil prices have stabilized, the Loonie is trading over 1% higher after the USDCAD rate got up toward the $1.2800 level on Tuesday. Canada will be closed on Friday for the Easter long weekend.

Good luck!

Stephen Casey
Senior Foreign Exchange Trader and Market Analyst

Small vs. Large Hedge Funds: Does Size Matter?
APRIL 1, 2015 By Hedge Fund Alliance

If there is one point that we can agree on, no study of hedge fund size relative to hedge fund performance has been conducted that is capable of defending its conclusions effectively against all-comers. The nature of the industry, in terms of its diverse strategies, varying degrees of management competency and numberless external market forces, precludes the possibility of bullet-proof conclusions.

There Are Things We Know and Things We Dont Know

We know that no consensus definition exists for small and large. As a result, no valid conclusions can be drawn by comparing studies with differing definitions. For example, if study A caps small hedge funds at $500 million and study B caps them at $100 million; significant overlap exists between small and large funds rendering any consolidation of data questionable.

Similarly, study C may confine comparisons to a finite universe of strategies, while study D adopts a macro view that encompasses hedge funds which ply an infinite variety of strategies. In both examples, attempts at comparing the conclusions are, by definition, flawed.

Taking the argument a step further, imagine that studies being compared were conducted in different years. Comparing a study concluded in 2009 to a study concluded in 2012 would necessarily yield disparate results due to the incongruity of market forces.

We know that we cannot predict how political climate will exert its influence on the direction of regulation and legislation and these forces will necessarily impact the performance of hedge funds regardless of size. Small hedge funds may be able to adapt more readily than large funds or, conversely, large funds may have superior resources allowing them to adapt in a manner that eludes smaller hedge funds. A recent example of one such change is lifting the general solicitation ban. Future changes may include redefining the parameters which constitute a qualified investor.

We do not know what innovative financial products are on the horizon and we certainly dont know if they will be more or less suited to the small, medium or large hedge fund. We dont know at this point what defines a small, medium or large hedge fund.

There Are also Unknown Unknowns

The significant factors affecting hedge fund performance may be unknown unknowns! How are potential investors supposed to govern themselves in this environment? While there is no clear-cut answer, the conclusions reached in existing studies trend in favour of the extremes. That is small hedge funds on one end and large hedge funds on the other, with those in the middle being the poorest performers.

Beyond the Question of Size

Factors other than size are key drivers in rates of return. Investors must look beyond size when choosing a hedge fund. Important factors include:

1. The proven track record of the hedge fund manager
2. The funds investment strategy
3. Management and performance fees

The means of choosing a hedge fund has not been distilled into anything resembling a scientific formula. Potential investors will continue to rely on their own good judgement, due diligence and gut instinct for the foreseeable future.

May you choose the path of least resistance.

Quant Perspectives: A Quant’s View of Negative Interest Rates
Thursday, April 02, 2015, By Joe Pimbley


The world has negative interest rates. How did that happen?! What does it mean for quantitative modeling?


In rough numbers, nearly € 2 trillion of the € 6 trillion of outstanding Eurozone sovereign debt currently has negative yield. That’s not just amazing – it’s stunning! Negative yields for German Bunds go all the way out to seven years in tenor. Though we focus on Eurozone countries here, let’s also note that the central banks of Switzerland, Sweden and Denmark impose negative deposit rates.

Readers of this column are financial professionals, but let’s ask and discuss simple-sounding questions:

What is the Meaning of Negative Interest Rates?

With negative yields, the lender ultimately receives a lower amount in future interest and principal payments than it pays originally for the bond. For example, the borrower may pay a periodic coupon, but the total undiscounted value of all coupons and principal payments is less than the current bond price.

As of, say, just five years ago, virtually all financial experts would have proclaimed sustained negative interest rates to be practically impossible.

First, there have never been sustained negative rates through history. (Japan has lived through miniscule but positive rates since the 1990s, and short-term rates in the Swiss franc fell below zero briefly in 1979.) History, though, is merely an observation, rather than an argument or proof.

Second, it seemed that lenders would always be free not to lend to a borrower with negative yield. In principle, an individual, a bank or a business could hold physical cash in the form of bank notes. The reality, though, is that it’s not feasible to hold large sums – millions and billions of euros – in bank notes.

Institutions with significant cash must hold this cash in electronic form, and are therefore hostage to negative rates on deposits. With negative “cash rates,”
lenders have incentive to buy Eurozone sovereign bonds with negative yields when such yields are greater than the cash rates.

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Joe Pimbley

Why are Eurozone Interest Rates Negative?

The answer is the European Central Bank (ECB).

First, the “deposit rate” at the ECB is negative 0.20% per annum. Excluding physical bank notes in the vaults, Eurozone banks hold their cash with the ECB. Thus, this negative cash rate incentivizes banks to make loans or buy other assets rather than hold cash.


Second, the ECB announced its quantitative easing (QE) program in January 2015, and began this program’s planned purchase of Eurozone sovereign debt this month. As a large buyer of such debt with the announced intention to pay prices at negative yields, the ECB is a deliberate enabler of below-zero interest rates.

Yet a third contributor is the precarious financial strength of most Eurozone banks. Through requirements of Basel III, the national central banks and the ECB, banks must both reduce the risk of their assets relative to their equity and improve their liquidity positions. This regulatory regime encourages banks to buy sovereign debt through favorable (and arguably over-optimistic) risk and liquidity assessments.

Combining the negative ECB deposit rate with evolving regulations, it is rational for Eurozone banks to buy highly rated sovereign debt with low, zero or negative yield, as long as the yield exceeds the deposit rate.

Are Negative Interest Rates a Tax on Cash?

Yes! Certainly the ECB deposit rate is not negative due to any fee or operational cost of holding bank reserves. For a sovereign entity that sells debt at a price higher than its repayment obligation, the excess amount goes to funding government operations – just like a tax. The ECB’s deliberate intent, both for its deposit rate and for the negative sovereign yields, is to penalize holding cash and near-cash instruments.

While these circumstances drive banks to the “near-cash” sovereign debt purchases (as we noted above), non-bank corporate entities generally have more flexibility. The ECB may hope that corporates will increase capital expenditures and/or hire more people to increase production. However, the necessary demand may be absent.

The more likely consequence is that companies will dissipate the cash to shareholders through dividends and stock repurchases. The loss of cash in this manner harms the creditworthiness of these firms.

How Does a Quant Model Negative Interest Rates?

In the time-honored sense of what we call a “quantitative model” or a “stochastic process,” there is no possibility of modeling negative interest rates. The dominant core principles of interest rate modeling of the past decades have been that (1) interest rates don’t go negative; (2) there must be consistency with current bond prices; and (3) there must be parametric consistency with historical data.

Clearly, the first principle is gone (possibly forever), and there is no intuitive and convincing lower bound to replace zero. Moreover, all historical data now strikes us as irrelevant to the current paradigm. So there is no history to guide an appropriate contemporary model approach.

One might argue that, though we must discard log-normal models since they incorporate zero yield as a strict lower bound, the quant analyst may keep the familiar normal distribution “random walk.” This random walk, also known as Brownian motion, can simply wander around in negative yield territory.

However, while we can espouse the equations, draw the diagrams, and create the computer code, it would be wrong.

In the original Brownian motion of the nineteenth century, Robert Brown observed the motion of pollen grains under a microscope. Ultimately, the source of the motion was numerous random, small, invisible collisions from lesser objects. The statistical aggregate of these “numerous collisions” created the observed motions.

In the financial world analogy, the “numerous collisions” are individual trades in the marketplace. The analogy fails when there is simply a dominant force – the ECB – setting the prices through its deliberate actions.

Can Foreign Exchange Rates Go Negative?

The question seems absurd! How can an FX rate be negative? To be specific, how could the EUR-USD exchange rate – expressed as $ / € - go negative? It might conceivably fall arbitrarily close to zero, but how could it go negative?

We raise the question only to make the point that one cannot dismiss it by saying “that’s never happened,” or “nobody would choose to exchange a dollar for a negative number of euros (i.e., a euro liability).”

Though it’s a stretch, imagine that owning euros in this future scenario entails an obligation such as a negative interest rate or another tax or payment obligation that could somehow exceed the long euro position itself. When offered the euros, then, a person or institution might also demand U.S. dollars in order to take the euro position (and its implied liability). That’s a negative FX rate!

Will Eurozone Sovereigns Issue Bonds with Negative Coupons?

One of our friends wondered recently if Germany, for example, might issue five-year debt at par with a negative coupon. Given that the secondary five-year Bund yield is negative, the simple math requires a negative coupon for new debt.

Think of the consequences! The bondholder would need to send in more money (the negative coupon) on every payment date. It’s an operational nightmare!

Of course, there are simpler alternatives. Germany would likely choose to issue its debt with a zero or positive coupon, and then expect a sale price in excess of par to give the target (negative) yield. Or it could sell debt with a negative coupon at par, but then simply net the negative coupon payment when due against the bond principal.

These are strange solutions that convince us, again, that negative interest rates are counter-intuitive!

Pre-election nerves
7th April 2015, by Moneycorp

US jobs and dollar fall short

An ad hoc poll on a social network website asked people at home which English word they found hardest to pronounce. It turned out to be Worcestershire. That is presumably because people at home don't realise they are pronouncing nucular incorrectly. Nonfarmpayrolls is another tricky one, at least for the dollar.

After months - nay, years - of exceeding investors' expectations the monthly change in US nonfarm payrolls fell woefully flat on Friday. Just 126k jobs were added in March, only about half the number predicted by analysts. Downward revisions to the two previous months exacerbated the situation by leaving the overall tally 188k short. The US dollar lost a cent on the news.

Although it has recovered some of the lost ground overnight the dollar was still the weakest-performing currency over the long weekend. It is down by two thirds of a cent against sterling and has lost a cent and a half to the top performer, the euro.

RBA surprises again

People at home who were expecting the Reserve Bank of Australia to lower its benchmark interest rate this morning were taken aback when it didn't. It was the second time in two months that the RBA had failed to deliver an expected cut and the Aussie jumped two cents.

Whilst the RBA said again in its statement that "further easing of policy may be appropriate over the period ahead", investors looking for a cut today had little option but to buy the Australian dollar when it didn't materialise. The RBA's comment that "further depreciation seems likely" for its currency did not carry much weight with investors and the Aussie was the strongest performer overnight.

On the day sterling is, on average, unchanged against the other dozen most actively-traded currencies. Compared with Thursday morning's levels it is down by an average of -0.5% though, and it has fallen by -2% from a month ago. Thursday evening's multi-party political "debate" did not help the pound's case. A bit like in a seven-sided tennis match there could be no objective winner; the exercise simply drew attention to the uncertainty of the election's outcome.

PMI round two

Today brings the second round of purchasing managers' index readings, this time for the services sector. The UK figure should be among the best but might not be enough to take sterling higher.

Before the weekend the UK construction sector PMI came in a disappointing two points lower at 57.8 and today's services sector number is pencilled in to be roughly unchanged at 57.0. The equivalent US readings came in at 56.5 and 59.2 yesterday with the seasonally-adjusted Canadian figure at 47.9 and the Australian one just scraping into the growth zone at 50.2.

Can planets Affect Your Portfolio?

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Kenneth Rapoza

CONTRIBUTOR

For some investors, astrologers who study the natal charts of companies and entire countries are as good a stock forecaster as technical and fundamental analysis. Will the stars align for the U.S. economy in 2012?

Investments are a bet on the future. Could that future be foretold through complex readings of our solar system? And if it can, what do the stars say about the economy in 2012?

J.P. Morgan once famously said that millionaires don’t need astrologers, but billionaires do. Are we in charge of the economic matters on earth, or are invisible forces “out there” shaping the economic and social outcomes of individual nations?

J.P. Morgan thought there was more to the market than timing, and he used astrologers to help guide him in that timing in his businesses and investments. He’s not alone.

Raymond Merriman has been at this for more than 30 years. His Michigan based company, MMA Cycles has over 7,000 subscribers, many of them from well-known investment banks and broker-dealers. They’re portfolio managers, certified financial planners and heads of trading firms primarily from New York, Chicago, Tokyo to Zurich. Some know a thing or two about astrology. Others are looking for a little extra-terrestrial advice.

“They come for my analysis on various markets based on planetary cycles, pattern recognition and geocosmic market turning points,” he said. “Most of them all understand the market, but they don’t have this kind of edge on market timing.”
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Analysts like Merriman use complex planetary charts to decipher where an economy, or investment, is heading. It’s approach, like fundamental or technical analysis, can be either top down — a big picture look at the whole economy — or bottom up — which examines an individual company.

To do that kind of research, analysts need the company or country’s birth date in order to see where the planets were traveling through the solar system, and through which constellations, at the time. The people who do this kind of work call themselves astrological economists or financial astrologers. The work they do is not comparable to the garden variety horoscope.
“Astrological economics is not fortune cookie baloney,” sa
id Robert Gover, author of the book Time & Money: The Economy and the Planets. “We go back deep into history to see where the planets were in the sky at the time of certain events. Years ago you had to come up with star charts and calculate their radiuses by using complex math. Now we have computer programs that can chart that out for us. What you see over time is that there is alot of movement up there in the solar system, and that movement can affect individual lives as much as it can effect nations.”

In January 2009, Grace Morris told subscribers to her Astro Economics Stock Market Newsletter that the S&P 500 index would bottom out around Mar. 9, 2009. It reached an intraday low of 666 points on March 6. Morris wrote in the first part of 2010 that the market would bottom around July 13 and start moving up by Nov. 2010. She was right. The U.S. stock market was one of the best performing in early 2011, and despite a lackluster year, the S&P 500 actually settled higher. It performed better than European stock markets, and better than all of the stock markets in Brazil, Russia, India and China.


People are wary of 2012. It’s a supernatural year, not only because of the popular mythology surrounding the Mayan calendar and the I-Ching. It is also an election year, so political fighting inWashington is expected to keep the U.S. in gridlock.

“This is a crossroads year,” Morris said. “It’s not the end of the world for the U.S. economy and the planets tell us that it’s going to be good first half for U.S. stocks.”



The stars, however, are not aligning for Europe. The euro was born on Jan. 1, 1999 at midnight in Frankfurt, Germany. Saturn is moving into the constellation Libra and that will be challenging for the euro’s Sun, Mars, Saturn and Venus position. It’s not easy for a layman to understand. From an economic standpoint, the planetary reading for the euro means the period from Sept 2103 through 2014 will be as bad or worse as the eurozone is now, according to Morris’s reading of the stars.

“If the euro survives 2014, it will come out stronger than ever,” she said.

As 2012 progresses, the planets are in constant flux. Pluto is slowly moving through the constellation Capricorn, which is exactly where Pluto was during the years leading up to the Revolutionary War. Prior to that, the last time Pluto was in Capricorn, the Spanish came to the Americas. For the native tribes, it was an alien invasion. Pluto entered Capricorn most recently in 2008. It’s arrival in that constellation happens roughly four times every 248 years as it orbits the sun, and its affects last anywhere from 12 to 26 years.

This one lasts until 2024.

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Although there is some debate within the astrological economist community as to when the U.S. was actually born, the July 4, 1776 in Philadelphia, PA chart is the one most often used.

Yet, Pluto in Capricorn could also be a good thing, said Gover. “We broke away from the British then and became the superpower we are today. One thing is certain, great change is coming. Uranus is flying through Aires on the opposite side of the U.S. natal chart position of where Saturn was on July 4, 1776. Pluto is in Capricorn moving opposite U.S. natal position of the Sun, which is in Cancer. All of this makes a pattern like an X in a box. Most astrologers call this the grand cross and it is the most difficult pattern,” Gover said.

Financial astrologers have their own language. Knowing where the planets are in the night sky, and what that means, is as close to planetary insider information as one can get. The movement of the stars through the solar system, according to Merriman, suggests a period of great social and political unrest in the U.S..

“The U.S. natal chart told us that this period would begin with a financial crisis, and it did, and that crisis would last between 2008 to 2015, maybe as long as 2020. The period we are in now is a lot like the star charts of 1963 to 1969 and 1929 to 1934, and even more so 1873 to 1878. It indicates that the very structure of government, the role of presidency, is vulnerable to demands for change,” he said.

There are some things the planets cannot predict. Human behavior is constantly changing. There are lots of variables at play. The U.S. presidency four years ago was indeed ripe for change. An Illinois Senator named Barack Obama ran on that promise. At the 2008 United Astrology Conference (UAC) with 2000 people attending, a panel of 8 astrologers all agreed he would win the 2008 election. Another election panel is scheduled for the May 2012 UAC in New Orleans. Meanwhile, the country is still hoping for change.

Last year, Pluto and Uranus were in a hard angle to Venus and Jupiter, two important planets in the U.S. natal chart. This position is often referred to as a bankruptcy position. The U.S. credit rating was downgraded on Aug. 5, 2011. The planets are still in those positions on the chart. Looking at the economy through a telescope suggests that the problems are not over. Only now, they are shifting to political leaders as Pluto and Uranus, known for turmoil, move to form a hard angle against the U.S. Sun, the presidential birth chart, and Saturn, the government’s birth chart.

“With Saturn moving into Scorpio later this year as Pluto stays in Capricorn, it will be a time of reckoning and not only for the U.S., but for Japan and also Europe,” warned Merriman. “Pluto represents debt and Capricorn and Saturn represent accountability. You experience the consequences of your actions in regards to debt when the planets are in that position. The best case scenario is a sobering one where all sides agree it will be a five to 8 year process to fix these major economies. The worst case scenario is that spending continues to exceed revenue, and the credit worthiness of any of these nations is downgraded yet again. Europe and the U.S. are both vulnerable to this potential reality, and it is coming soon, before 2014.”

This month, Morgan Stanley’s head of European equity strategy, Graham Secker,warned that the recent rise in the U.S. stock market won’t last. The planets might agree. For people like Merriman, Gover and Morris, the truth is definitely “out there”.