PM Daily Market Commentary - 1/14/2015

davefairtex
By davefairtex on Thu, Jan 15, 2015 - 2:34am

Gold dropped -1.80 to 1229.10 on heavy volume; silver dropped -0.25 to 16.84 on moderately heavy volume.  Gold rallied strongly immediately prior to the NY open hitting a new cycle high of 1244.60, but the rally failed, and gold sold off into the close with gold printing another doji/inverted hammer.  1240 resistance is proving a tough nut for gold to crack; it seems to be able to rally through that level, but not close above it.  Two failed rallies on relatively high volume makes me a bit nervous in the near term for gold.

Silver was substantially weaker than gold, selling off hard in Asia.  At one point it was down more than -0.50.  Silver recovered somewhat during the NY session, but it ended down substantially on the day.

The buck fell today, dropping -0.18 to 92.28.  At one point the dollar was down a lot more substantially (it hit 91.80 a few hours before the NY open) - and it was at that same time that gold had its strong intraday rally through 1240.  However, the dollar did not stay down, and as the dollar recovered, gold fell.  It seems that if the dollar ever does correct, we will probably get that close above 1240.

Mining shares continued lower today, with GDX dropping -1.17% on moderately heavy volume, and GDXJ dropped -2.12% also on moderately heavy volume.  As yesterday, the mining shares opened up and then sold off for most of the day.  There was a rally into the close, however, which hints at buyers starting to show up for the miners.

SPX had another volatile day; a poor December Retail Sales report released at 0830 caused the market to drop, and oil testing $46 caused it to fall further, breaking briefly below the most recent low set on January 5.  But then in the afternoon, oil started to rally, and that seemed to pull the equity market higher.  At the close, SPX was down -11.76 to 2011.27 - a big improvement over the 1988.44 low it made at 1330 EST.  On the day, SPX printed a bullish hammer candle, which is a reversal bar, requiring confirmation tomorrow.  The equity market still looks weak, but we might get an oil-related bounce here.  VIX climbed +0.92 to 21.48.

Long bond ETF TLT rallied +0.76% making another new cycle high.  Since January 2014, TLT is up almost 33%.  20 year bond yields hit a new low of 2.20%.  Bonds are clearly benefitting from (and perhaps signaling) equity market weakness.  JNK was down -0.23%.

The overall commodity index ($CRB) rallied strongly today, up +1.63%.  The MACD technical trend indicator is showing a possible reversal in the commodity index trend, which is ridiculously oversold and theoretically should be more than ready for a bounce.  Perhaps this is the start of said bounce.

Oil confirmed its low from yesterday, with WTIC rallying strongly and closing up a big +2.51 [+5.44%] to 48.62.  Oil did this in the face of a terrible Petroleum Status Report (at 1030 EST) and a flood of news stories about how Wall Street is now expecting oil in the 30s and how US production will continue to increase in 2015 even with a falling rig count (my opinion: production likely peaked in November/December 2014).  With sentiment this bad, and the news flow this horrid, and the market this oversold, its probably time for a rally.  Remember, the market acts to disappoint as many people as possible.  I'm not sure we move immediately back to $70 oil, but I do think we have a chance at a bounce here.  Whether that bounce survives the Greek elections is another matter.

Copper too may have put in a low - it had a massive 7% trading range on the day, bottoming out at 2.42, although that looks a bit less certain.

Compared to the rest of the commodities, gold is performing quite well, having strongly outperformed the commodity index since December 2014.  A good thing too, or else we'd probably be seeing gold around the $1000 level at this moment.

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24 Comments

davefairtex's picture
davefairtex
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Swiss End Peg to Euro - USD/CHF down 12%!!

http://www.bloomberg.com/news/2015-01-15/snb-unexpectedly-gives-up-cap-on-franc-lowers-deposit-rate.html

Swiss unexpectedly ended the peg to the Euro this morning at 0430 EST, immediately triggering a colossal move in the Swiss Franc vs other currencies.  The USD/CHF cross dropped 12% in minutes.  This is a huge move, quite positive if you own Swiss Francs.   In the first 15 after the annoucement, the EUR/CHF cross was off an unbelieveable 30% - from 120 down to 85.  It finally settled down "only" 14%.

EUR/USD is now off -1.03% - at one point early on, it hit 115.76 and is now 116.67. 

The impact on the derivative markets, I can't even imagine.  Massive and unexpected changes like this will cause all sorts of trouble if your friendly TBTF bank has written a bunch of puts, never expecting the market to move this dramatically.  Odds are, some bank trader somewhere, just saw their derivative P&L turn a very ugly sea of red, and we won't find out who it might be for a while.

Gold bounced around, but finally ended up blowing through 1240 to a new high of 1253...for now the market is saying this is a gold-positive event.  Silver is following along.

To me, this is a massive vote of NO CONFIDENCE in the Euro by the Swiss, who are voting with their wallets.  Keeping that EUR/CHF peg intact meant they'd end up with a huge pile of (possibly worthless) Euros if the zone were to break up - which they clearly didn't want to do anymore.  So they bailed out.

HughK - looks like you didn't have to go too far afield to find a good currency.  :-)  Sometimes things just work out all on their own...

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Time2help
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Paging Mr. Draghi...

Swiss sucker punch global markets

Looks like somebody's central bank doesn't have a mandate for price stability.

Jim H's picture
Jim H
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Things are accelerating...

http://www.zerohedge.com/news/2015-01-15/end-cb-power-snb-folds

Thomas Jordan, the head of the SNB has repeated said that the Franc peg would last forever, and that he would be willing to intervene in "Unlimited Amounts" in support of the peg. Jordan has folded on his promise like a cheap suit in the rain. When push came to shove, Jordan failed to deliver.

This is why we own Gold.. you are not going to be told ahead of time when the final reset is about to happen.  In fact, you will be told that it will not happen. 

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bwh1214
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The statement on the chart is

The statement on the chart is just plain false.  It could read "everything from Switzerland just got 12.5% more expensive", but the most correct statement would be "Swiss exports just got 12.% more expensive for the rest of the world, and Swiss imports just got 12.5% cheaper for the Swiss people".  This should be a good thing but in our interconnected debt saddled economy the answer isn't so clear.

 

One think I know is the statement "Everything in Switzerland just got more expensive by 12.5%" was made by someone that is reading the chart upside down. Normally when we are talking about "everything getting more expensive in a country" we are talking about a weakening currency, such as when the Yen or Ruble fell recently.

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sand_puppy
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Monopoly Game Played in a Burning Room

My good friend is a Warren Buffet "value investor" who is doing quite well for himself analyzing companies and buying and selling stock.  A smart guy.  (Of course most are doing well in a Fed-fueled broadly rising  market.)  

He believes my looking outwardly at the global financial and political situation is a quite goofy and that money in gold is "wasted."   He encourages me to find some really good stocks and start building my fortune.

The analogy here is that he is playing on a game board which is located in a room that has caught on fire.  

All the rules of the game are suspect.

 

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davefairtex
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charts & false statements

I encourage you to post a chart with a non-false statement on it.  Show us how it's really done.  :-)

 

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bwh1214
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Clarification

davefairtex

Sorry, my statement was not an attack on you, your analysis  was correct, just on the chart comment.  I actually assumed you pulled the chart with comment from another source, and whoever put the comment on there was incorrect.  I just want to ensure there isn't any confusion about the events of the morning.  If you do have control over the comment on the chart you may want to tweak it a little as outlined in my first post.  Changing the 'in' to 'from' would be the simplest correction. Again sorry if it appeared as if I was going after you, I wasn't, I'm just detail oriented. 

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davefairtex
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being told ahead of time

I totally agree, nobody will tell us when the final reset (at least for this generation) will happen, or what form it will take.

We will get a sense of pressure building, however.  Take the current case of the CHF/EUR peg.  The Euro has been falling now since its high of 160 back in 2008, with things accelerating in recent months and more recently after the breakdown from 120.  This release of the peg didn't come out of a clear blue sky.  It came after a relentless recent pressure against the Euro, with two major events (Dragi's money printing on 22 Jan) and Greek Elections (25 Jan) in the offing that could well lead to catastrophic failure of the currency.

Check out the gold chart in euros: up +4.74% just today, a huge move.  Silver isn't really following (its only up +0.92%) so this is just a classic safe haven move.

 

 

 

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davefairtex
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chart comments

No, I get to fall on my sword for all the bad chart comments I post.  They're all 100% mine!

From the perspective of me possibly visiting Switzerland, everything there felt like it would be 12.5% more expensive.  And so that's what I wanted to convey.

Clearly, what I actually wrote didn't accurately communicate this sentiment of mine...

 

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bwh1214
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Understood

davefairtex

Well that does make sense and I actually thought about the fact that for tourists, using credit cards, in fact everything would be 12+% more expensive, but also considered that a much smaller number of people than the people living in Switzerland with savings and paychecks in Swiss francs.

I have to learn to check myself a bit more on this site.  I often reply on other financial sites but need to remember that this site has like minded readers and I should not be so combative. 

I hope you get a chance to travel to Europe but you may want to try a different destination.  I would love to do the same, but have 2 under 2 so that's not in the cards.  We loved Barcelona a few years ago. 

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Things are accelerating

The following remarks by Jim H and Dave are gold nuggets from where I sit, and thanks!
"I totally agree, nobody will tell us when the final reset (at least for this generation) will happen, or what form it will take.  In fact, you will be told that it will not happen.  …  We will get a sense of pressure building, however. "
   The trick for us, if it happens in our life times, is to get a set of "indicators of building pressure" that we can use as our "tea leaves".   Also, hopefully, some well-followed press people will get wind of mysterious plane trips and meetings involving central-bank staffs and key political people; because the next emerging Black Swan is going to involve several countries, and given the inter-connectedness of currency trading centres, they are going to have to collaborate.

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davefairtex
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currencies are tricky

bwh-

I've often found that currencies are a bit tricky to understand and/or explain.  Its like fish trying to think about water - citizens of a nation swim in a sea of their own currency every day so most people don't have an gut-level intuition about what currency movements mean.  "So what if the dollar climbs or drops - my paycheck hasn't changed, so why should I care?"

And largely, they really aren't affected, since their liabilities are (usually) denominated in the currency in which they are paid.

Its only expats, travelers, people with debts denominated in other currencies, or companies with earnings abroad who really get the currency game, simply because they have to.

The same thing is true for gold.  "Gold priced in Euros is climbing."  But as a US citizen, why should I care?  After all, if I sell gold, I'm going to get dollars, not Euros.

And at its most basic level, gold is just another currency - one that is mined every year, rather than printed.  So understanding gold's moves is as much a currency discussion as it is anything else.

So I struggle with how to make it all understandable - how to explain currencies to those who only ever have to deal with the USD.  How a rising dollar can mask a gold rally.  Why holding gold (as your own personal "unprintable reserve currency") would be useful if and when the USD ever has a currency problem.  Which it probably will, once Europe sorts out the Eurozone thing.

Here's a thought.  The SNB released the EUR/CHF peg today resulting in a huge one-day move.

The Eurozone overall is one massive collection of currency pegs, each building up stresses internally - right now, money really wants to flow out of Spain to Germany, but it can't since this pseudo-peg (called the Euro) won't allow it.  So stresses build up, until at some point they will inevitably pop - Spain resets its Euro/Peseta peg (by leaving the Eurozone), the currency has a massive one-time adjustment, debts are defaulted on as appropriate, and then the pressure is relieved and it all settles down.

 

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Arthur2014
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Eurozone
davefairtex wrote:

The Eurozone overall is one massive collection of currency pegs, each building up stresses internally - right now, money really wants to flow out of Spain to Germany, but it can't since this pseudo-peg (called the Euro) won't allow it.  So stresses build up, until at some point they will inevitably pop - Spain resets its Euro/Peseta peg (by leaving the Eurozone), the currency has a massive one-time adjustment, debts are defaulted on as appropriate, and then the pressure is relieved and it all settles down.

Dear davefairtex,

Why / under which conditions should the Euro re-appreciate in value relative to the US dollar?

Do you expect that the Eurozone will shrink so that only its central European and northern European member states with stronger economies stay / remain in it?

Which members must leave the Eurozone so that the Euro will re-appreciate? Greece, Portugal, Spain, Italy? All together? Further?

 

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davefairtex
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euro re-appreciation

So there are two problems in the Euro.  The biggest one is debt; bad private debts that have been pretended away resulting in a banking system built on lies, as well as a very heavy sovereign debt that will result in a ongoing burden on society until it gets sorted out.  To add to that, banks own a whole lot of sovereign debt, so even one or two sovereign defaults will likely wipe out the capital of Europe's banking system.

But once all the bail-ins are done, and the bad private debt is written down, and the banks are made sound, and the sovereigns are no longer groaning under 100% debt/GDP, money really will rush back in.  Everything will be trading at a big discount.

And the contrast with America will be striking.  Our problems won't have been resolved, theirs will have, and so Europe will look a lot more attractive.

The second is the linking of currencies without the sharing of debt.  All states in the US are responsible for the national debt, but there is no "national debt" in the Eurozone, there is only individual state debt.  Having a currency union without a debt union doesn't work - at least, it will never result in a true "reserve currency."  Can you imagine China having to buy the debt of each of the 50 US states in order to have dollar reserves?

So if they were to enter into a debt union, that would be distinctly Euro-positive as well.

But my question is, over the long haul, can Spain and Italy remain in a debt union with Germany?  The cultures and policies are just too different.  A married couple, one of whom loves to spend, and the other loves to save, will have ongoing difficulties.

One suggestion is that debt below 60% of GDP is shared, and any debt over 60% is not shared.  That might work.  But then there are the issues of non-elected bureaucrats in Brussels dictating policy for the whole zone, as well as meddling in the internal politics of each country when things get tough: can you imagine Ben Bernanke pulling on the levers of power in order to get the governor of Texas replaced with an unelected "technocrat"?

I think we may end up with a very narrow Euro at the end of the day: perhaps countries content to follow Germany's lead on things will remain in a rump Northern Euro.  I'm not sure a Southern Euro led by France will end up being all that interesting, but who can say for sure?

I can see one approach working.  Country leaves the zone, resets its currency, defaults on its debt, and then rejoins with a new (and much lower) currency peg.

But then, once again, we have a currency peg.  And we've learned just recently that currency pegs don't work well over the long term.

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Interesting post Dave...

First off let me say that I would like to follow through on your suggestion that I question Ellis on some of his ideas regarding Gold... I have been too busy to post much. 

Your posts this morning are interesting to me as they maybe shed light on why we see Gold differently.. and I think it's because we see fiat currency so differently.  Your posts above would tend to suggest to the reader that you think the fiat currency regimes in place now could withstand multiple traumas, which would by necessity play out over reasonably long period of time (at few years?) at which point we would still have a reasonably well functioning set of sovereign currencies, much as we do today, only with some different relative valuations.  In other words, you seem to, based on your words, expect the fiat regime to keep on truck'in.. no major hyperinflations.. no major collapses.  I can't imagine the future proceeding in this way. 

Let me take a few points and parse them;

But once all the bail-ins are done, and the bad private debt is written down, and the banks are made sound, and the sovereigns are no longer groaning under 100% debt/GDP, money really will rush back in.  Everything will be trading at a big discount.

And the contrast with America will be striking.  Our problems won't have been resolved, theirs will have, and so Europe will look a lot more attractive.

I don't know where to begin..  first off, are you really suggesting that all the problems of Europe can be solved by bail in's alone, or are you assuming (as we all are) that they will begin some form of unsterilized QE in order to clean up the bank balance sheets, as soon as next week?  The problem with QE is that it does NOT reduce a nation's sovereign debt.. it simply allows it to be shifted from bank balance sheets to the roach motel of the central bank balance sheet.  The sovereigns are still in debt though.  So, I am assuming that is where the bail-in's come in to your scenario... to pay down the sovereign debt loads.   

Now I would not argue with you that bail-ins are in our future.. at least for some of us in countries overburdened with sovereign debt.  What I would argue with is the idea you are proposing above, and that you expounded upon later in the comment;

I can see one approach working.  Country leaves the zone, resets its currency, defaults on its debt, and then rejoins with a new (and much lower) currency peg.

So, you are suggesting that a country might pull an Iceland.. and then REJOIN the Euro?  Why on earth would a country go through the pain of regaining it's monetary sovereignty, along with the resultant pain of getting all local (paper) wealth and paper promises haircut, only to give it up again?  

My view is this;  Once there are bail-in's in any majory Western-style economy, confidence in banks around the world will be lost.  People are in general dumb sheeple.. I get that.. and you really have to hit them over the head with what's going on before they get it and lose confidence.  But, If say Italy were to have bail-in's.. that's when the Kevin Bacon moment happens, and my wife hears from the relatives in Italy that they have lost their money in the bank.  And that will happen a million times over until everybody is only one step removed from somebody that has felt the pain of this.  Cyprus was a warning sign to the awake.  Italy, or Portugal, would bring about an awakening.  Give me an Italy or Portugal bail-in, and I will show you money velocity rising all over the Western world as confidence is finally lost.   

You are projecting some kind of linear outcome.. some kind of return to a comfortable status quo with fiat currencies after these bad things happen;

Spain resets its Euro/Peseta peg (by leaving the Eurozone), the currency has a massive one-time adjustment, debts are defaulted on as appropriate, and then the pressure is relieved and it all settles down.

You have to be kidding me. 

         

   

     

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davefairtex
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debt defaults

JimH-

You are projecting some kind of linear outcome.. some kind of return to a comfortable status quo with fiat currencies after these bad things happen;

The odd thing is, we're treating debt default - sovereign debt default + private debt default - as tlhough it were literally the end of the world.  It just isn't.  Major european powers did this not so long ago.  Even England defaulted on her debts in the 1930s, right alongside most of the major powers in Europe.  The world did not end.

The world does end for bank shareholders, and for the bank managers, but that's not the same thing - although they'd sure like us to believe that if they lose their jobs, our world will literally come to an end.  That way we'll do anything it takes, pay any price, to make sure they survive in their positions.  So far, its worked.

The only thing I'm projecting in my story line is what has already happened repeatedly throughout history.  Overindebted countries default, a flurry of bank collapses occur, lots of people lose money, and life goes on.  It really does.  Bail-ins are another form of bank collapse, just in a different form.  Snatching money from large depositors probably just works once.  After that, its the bondholders you go after and you hope that's enough.  But I worry less about the form the collapse will take.

Again, I'm just looking back at actual historical defaults and how they went down.

Argentina had one - lots of bad things happened, but once they sorted it all out, money rushed back into the country to pick up all the bargains lying around.  I'm just projecting the same thing for Spain.  If they did default, and their banking system got cleaned out and all that overhang from the bad debt was acknowledged and written down, all that money sloshing around the system really would come rushing back in to pick up all the tasty bits at a discount.  Its the current high level of uncertainty that kills investment.  Everyone knows the system is rotten, so nobody wants to put their money at risk.  Take away rotten and stuff really does just get better.

Again, I'm not some psychic genius, or some crazy wishful-thinking storyteller.  I just read history.

As for why people might rejoin the Euro after leaving it - it might be a situation that the Eurozone itself proposes.  "We're going to have a trial separation - you go off and get your shit together, and once you do, you can come back and rejoin the club if you like."  Notice I did say "might".  I don't know any more than you do.  I'm just trying to think through the options.  Polls in Greece show that people actually like the Euro, they like being part of the Eurozone.  If there was a way to just "take a break", they might well go for it.

Can a country default within the zone?  Perhaps that's another option too.

Brussels might actually start getting creative if their backs are pushed to the wall, and especially if "There is no Plan B" ends up looking foolish because Plan A is just a dead end.

Jim, gold standards and fiat money are both the same. They are both run by men, and they depend entirely on whether those men are good stewards of the system.  Get a gold standard, and put Nixon in charge, and you end up with rampant inflation and fiat money.  Put the gang from the Bundesbank in charge of a fiat money system, and the outcome is clearly better than Nixon's gold standard.

After thinking about this for a long time, I believe it boils down to people and mind-sets, not about selecting the perfect fool-proof system ("gold really will fix everything") that will somehow make up for the limitations of mankind.

There is no "incorruptible instrumentality" we can hope to impose on the world.  Fiat money isn't the problem.  People are the problem.

Look at the US.  We started out with a pretty nifty Constitution, and now we have Patriot Acts, Executive Orders, a national surveillence system - we are basically a stone's throw away from a police state.

Every system is only as good as the stewards that run it.

Last point.  I believe gold is awesome as a personal sort of "reserve currency", a personal hedge against sovereign shenanigans.  Its just not the remedy to fix all our systemic monetary ills.

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When will a critical mass of the Sheeple wake up?

    The educational value of this thread is simply outstanding (I say that from reading a lot of related stuff elsewhere).  Peak Prosperity management should move treads like  this  (or copies of same) into a place  not tied to changing commentaries on market developments, so that people can stay focused on these fundamentals.  Anyway, thanks to you all.
     Will the "rescue resources" available from the bail-in process be sufficient to keep one of the big banks solvent if it gets into real trouble?  Do you guys have an opinion on this question?  Looking at the social-psychological forces, it does seem arguable that only one bail-in of a money-center bank will enough to let loose the fundamental Confidence shaker we are all worried about, especially now that one Leader has widely broadcast that their solemn policy proclamations may not be trustworthy.  
     Here's something else that could cause a lot more people to think about the system, if it is correct.  Is it correct that the process that is driving currency values up and down is the same trading process that we use in the stock market, except that the assets are units of currencies rather than shares of stocks? This would mean,  for example, that when a currency appreciates enormously it is simply a result of layers of selling offers being taken off the table, so that bidders have to reach up way up the rungs of the ladder of potential offers to find a willing seller.  
     The media and experts will then wax on and on about how X currency "appreciated dramatically", when what they should get their heads around are the systemic implications of the endless confrontation between profit-seeking currency buyers and sellers that creates such an appreciation.  This becomes even more distressing when you realize that the profits they seek are *trading*  profits denominated in fiat money, which, at the end of the day, is nothing more than a quantity of bytes on somebody's computer.  (And keep in mind that it is fragile institutional forces which say these bytes belong to party X and not to party Y.)  In the mean time, your pension fund and retirement savings may be impacted!
     If this is a decent characterization of the process, just think of the implications for the system when certain of the players can continue in the game after taking a big loss by just going into their back rooms and printing some more "money".  If all this is right, do we not have a case of Monopoly on steroids?
     Add to all that the fact that much as we may bewail the indebtedness of various parties in the game, banking system profitability *requires* endless debt expansion until the system has to be rebooted, and the process starts all over again. 

     We may be decades away from our own rebooting moment, however.  It all depends on how soon some key party shouts "fire in the theatre!"  One wonders if the designers of the policy to bail-in on Little Peoples' bank accounts have thought about the psychological forces that a big bail-in might let loose.

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davefairtex
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bail-ins, rescues, resources

theo-

The reason I'm here is because people are so much more reasonable and thoughtful (and respectful) than in many, many other places on the net.  I give credit to the proprietors, who take pains to make the effort to walk the fine line between censorship and fair enforcement of civility standards.

Will the "rescue resources" available from the bail-in process be sufficient to keep one of the big banks solvent if it gets into real trouble?

That is the real question.  I sorted through the details of this a few years back when things were chaotic as part of the whole Cyprus thing, but haven't kept up to date on current policy...but after some research, I came up with some numbers which might be interesting.

My guess is, it depends.  Bail-ins as currently envisioned won't be enough, if we have real systemic problems, most especially if there is some kind of big derivative accident.  But for the more garden variety failures, it should be fine.

Here's the resolution procedure, which boils down to "remove liabilities, and then add assets until fixed:"

  1. assess size of total liabities on the balance sheet
  2. seize "own funds" (cash, reserves, etc)
  3. wipe out shareholders
  4. convert "bail-in eligible" liabilities to new equity, in order: junior unsecured, other liabilities greater than 1 year, senior unsecured, uninsured depositors, up to (a minimum of) 8% of total liabilities.
  5. recapitalize using capital (money) contributed by the resolution fund [*not yet established] of up to 5% of total liabilities.
  6. recapitalize further using capital from national funds (i.e. taxpayers) as necessary.

Liabilities not subject to bail-in:

  1. insured depositors
  2. salary and pension accruals for employees
  3. senior secured debt

See document here: https://www.bbvaresearch.com/wp-content/uploads/2014/12/20141203_Regulation-Watch_MREL-Vdef.pdf

Also mentioned as optionally being excluded from bail-in eligibility are corporate transaction accounts - there does seem to be some wiggle room as to what is eligible and what is not.

I got the sense that bankers work like crazy to protect their senior bondholders from losses; Great Aunt Sadie gets thrown under the bus long before senior secured debt.

Effectively, bail-ins are a part of the total resolution puzzle, which seems well structured to deal with moderate-sized problems.  According to the stuff I read, the 8% of total liabilities number was deemed reasonable protection (especially if you include the 8% "own funds") from problems they've seen before.  And banks are going to be required to submit the list of their bail-in eligible buffers (called MRELs) as part of the regulatory structure - not yet implemented, but on the way.

For what its worth, my sense is, if there is a major derivative accident at an important bank, or if there is a rash of sovereign failures, then bail-ins will only provide the down payment, especially for the national banks who have loaded up on their national sovereign debt.

As an example, Spanish domestic banks own 33.6% of the total outstanding Spanish government debt - 16.4% of their total loan book.  If those were defaulted upon 100%, the 8% bail-in would not be enough to recapitalize them, although "own cash" + bail-in liabilities might match losses, and then a recapitalization effort could happen from public funds that were used to effectively nationalize the bank - which presumably would be recaptured years later after the bank was re-floated as per GM here in the US.  A 50% sovereign default might be ok though.

A real-world example: Irish bank bailout cost between 40-70 billion euros (final costs depend largely on how much the Irish government finally gets for the properties in the "Bad Bank"), against a total loan book of 688 billion euros at the peak.  The Irish experience was pretty extreme, but overall system losses were "only" around 10% of liabilities.

So that 8% number isn't all that horribly low.

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kelvinator
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Posts: 213
Great Discussion

with good points all around.

It seems to me that both your points of view are important, Dave and Jim H - Dave's that the world won't end if there are large sovereign defaults, but will follow historically tried and true patterns for jump starting commerce once again by dumping a chunk of the heavy burden of unpayable paper claims on real wealth, and Jim's that there's a good chance that such a default/reset really isn't going to solve the problems we're seeing build year after year.   It's an unpredictable spectrum that real events will fall into.  It seems that, one way or another, there's a very high likelihood that a macro structure of polticians, bankers, financiers and bureaucrats making laws, rules, policy pronouncements will keep on keepin' on, restructuring deals, printing money, going to court, whatever is necessary to preserve a life-like simulation of sorting out the morass of legacy claims on current and future values.   As is already true now, this will likely be a process of manufacturing continuity, and maintaining enough confidence that there is some civilization, rule of law, fairness, etc., that as high a level of commerce can be maintained as possible.   The question will be, as it was in the existential depths of the Depression, how high a level of commerce can be re-jump started after a "discontinuity", when will it kick in, and will the restructuring be in depth enough to be sufficient to permit the restart to be sustainable over a long period of time?

It seems likely that, as Gail Tverberg and Chris discussed in the recent podcast, the problem may end up being one of limited mass purchasing power (limited demand that has the clout to offer equivalent value of assets owned or valued work to pay for something wanted) versus the limited amount of real stuff available.  A week or two ago, I tried to explain to a traditional financial advisor that his advice to just buy and hold a traditional mix of stocks and bonds might not work well in the end because the ultimate buying power of those assets might not pay for the retirement housing, nursing care and food that everyone thinks they have "safely saved" based on current cash and asset values.   He really didn't get it at all, but thinks you just turn a crank, follow tradition and we're all good.

In principal, to my mind, there's no real difference between Bernie Madoff's investors wanting to withdraw all the non-existent dollars plus supposed returns they earned out of Bernie's fund in 2008 and global investors gradually wanting to "withdraw" their happy retirement out of massively over-leveraged claims on future resources and services.   The main difference, as we've seen since 2008, is that Bernie's ponzi scheme was a much easier problem to solve (as is, in some respects, the purely financial aspect of the building global crisis). Just make a few policy decrees, debt jubilees, print money, say this debt is good and can be recovered, that's bad and is gone - tools Bernie didn't have.  It's the fact that we can't print resources and services to cover the promises of a high quality of life for the masses that's likely to be a much more real and pernicious problem.

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Jim H
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Imagining monetary neutron bombs.....

Thank you for the detailed exposition on your thoughts Dave.  You say many things that are true, but you still manage to weave an overall narrative that goes in a direction that I feel is highly unlikely.  What direction?  In your narrative, the money lives on... banks may go down, bank debt. may go down, sovereign debt may be defaulted upon, but the money itself remains viable.  Thus my neutron bomb reference;  I don't see any way that we get through this without much of the money dying too.  Maybe, possibly if there is a near complete repudiation of Keynesian economics soon (is the SNB decision the leading edge of this?) the currencies as we know them could live on... but some countries and currencies (Japan and the Yen) are already well beyond the point of no return.  Mises describes this point of no return very concisely in his famous quote - it is this catastrophe of the currency system that I speak of;

  “THERE IS NO MEANS OF AVOIDING THE FINAL COLLAPSE OF A BOOM BROUGHT ABOUT BY CREDIT EXPANSION. THE ALTERNATIVE IS ONLY WHETHER THE CRISIS SHOULD COME SOONER AS THE RESULT OF A VOLUNTARY ABANDONMENT OF FURTHER CREDIT EXPANSION OR LATER AS A FINAL AND TOTAL CATASTROPHE OF THE CURRENCY SYSTEM INVOLVED.”

Ludwig von Mises – Austrian Economist (1881- 1973) 

So Dave, does much of the world go full boat non-Keynsesian, or do many of the currencies die?  That is the question as I see it.

I would suggest that my view is very different from Dave's in large part due to our divergent views on manipulation of the Gold market.  If you believe, like trader Dan, Martin Armstrong, and Davefairtex that the current Gold price is not heavily manipulated, i.e. does reflect to a reasonable degree the balance between supply vs. demand, then you would maybe come to the conclusion that there is not enough tension in the system building up to lead to the kind of monetary destruction that I imagine.  Things can't be too bad, because Gold is well off it's highs of a few years ago.  It's been in a, "bear" market, right? 

I view the SNB unpegging of last week as very instructive as it relates to my tension model.  Manipulation creates tension and most market participants seem oblivious to the potential destructive forces that can be unleashed.  The SNB peg was a much more overt form a manipulation than the Gold price rigging...in other words, everybody knew it was rigged.  But for the Market, having central bankers say it would stay rigged was enough.  Silly Market.  Look at the amount of destruction that has resulted from this isolated tension release;

http://www.zerohedge.com/news/2015-01-17/everest-macro-hedge-fund-blows-...

http://www.zerohedge.com/news/2015-01-16/knight-20-jefferies-rescues-fxc...

http://www.zerohedge.com/news/2015-01-16/its-not-just-retail-head-europe...

While I have never advocated a return to the Gold Standard in my writings here... I am certainly an advocate of allowing Gold to trade freely.. i.e. the idea that the price of Gold represents the balance between real, bonified sellers of physical Gold, and buyers of same.  I am an advocate of allowing Gold to both reflect, and to some extent, relieve tensions in the currency markets.. tension between currencies, and tension that reflects loss of confidence in currencies.  Those tensions exist, but they are veiled today due to the Gold price rigging.  One benefit of the Gold standard was that, while the machinations were, as Dave suggests, less than perfect and subject to distortions... at least there was a mechanism available to relieve tensions;  formal devaluation of currencies relative to Gold such as that which occurred after the Gold confiscation of 1933.  

Today, in the era of unbacked floating currencies with none pegged to Gold, AND a manipulated Gold price, you have NO means to relieve tensions.  I suggest that extraordinary tensions are building below the surface... and that what happened with the SNB unpegging is just a tiny version of the destruction that will happen when the Gold market rigging finally breaks.  This destruction will include the currencies themselves.

Dave gave examples of cases where systems have made it through debt defaults of various sorts.. but I would hazard a guess that these are rare compared to historical cases of fiat currencies that have died.  Again, we are weighing the possible outcomes here... I say that it's much more plausible that the currencies themselves die.  Dave says that the debt can die but the currencies will not (monetary neutron bomb).  Hopefully we can hash this out more in future posts.   

For those who would like to do their own due diligence regarding my contention that currency collapses are common in history... here is a reference;

    http://www.rapidtrends.com/history-of-fiat-and-paper-money-failures/

       

  

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KugsCheese
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Fractal Compression

The FED and associated CB's have created a kind of Fractal Compression, FC, that hides the real danger.  This is how natural systems work even if temporarily distorted (e.g. big build of ice, the FED distorting money etc), the so-called calm before the storm.  It has been proven FC has a ratio of ~ 50:1.  So once the balloon inflates to reveal the reality of counter-party risk it is too late to correct.  I am with JimH.

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davefairtex
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currency collapses are common

JimH-

I totally agree, pretty much anyone would call what happened in Germany back in the 20s a currency collapse.  Same thing in the 1930s.  The entire pegged monetary system collapsed too.   And yet - that pesky fiat money still exists, doesn't it?

Why then would we assume that even a widespread currency problem of the kind that happened in the 1930s result in the complete rejection of fiat money?

Fiat money has been with us for a very long time, in one form or another.  I'm going with the odds here.  It will continue to be with us for a very long time to come.  That's not good or bad, it just is.

Now then, a gold-backed currency (that you have never advocated here) is nothing more than a currency peg, and we just had a great demonstration that pegs don't work so well in the real world, which is a very dynamic environment.  Its a good thing you don't advocate such a thing.  :-)

The problem often lies at the level where politicians decide to peg the currency (either to gold, or to another currency).  If its too high, or too low, the peg can't hold.  Also, if underlying circumstances change, the peg  no longer reflects reality, and so peg gets attacked by the market.

Now then, I'm not exactly sure what you mean when you say "currencies die."  Or rather, I'm not sure what the implications of a "currency death" really are.  Every now and then a currency blows up or goes through a big devaluation, but it does not therefore follow that the inhabitants of that country forevermore reject fiat money.

Take Zimbabwe, where there was horrid hyperinflation; did the citizens there reject fiat money?  Or did they simply swap fiat Zim dollars for fiat US dollars?  (Hint: you know the answer already).   I also point to Cambodia, where the ATM machines spit out crisp $100 US bills.  (I know this because I was actually quite surprised when I arrived in Phnom Penh, looked to get some local currency, and ended up with $200 in very familiar-looking C-notes!).  They reject Cambodian fiat currecy, but embrace the US fiat currency.

Clearly in both those cases, acceptance of currency is all about confidence.  As soon as confidence is lost, something will need to be done to re-establish confidence in the currency.  But in the upcoming crisis, not every central bank will take actions that result in their currency blowing up.  As a result, fiat money will still exist in those places where confidence remains in the currency.  I could easily see the CHF remain fiat, or the New Deutchmark, since the people in both countries have faith in their central banks to preserve value.  (Its just the exporters and the currency gamblers that are whining about the SNB's decision, not the people themselves; they've all benefitted from the breaking of the EUR/CHF peg)

And in countries (like Spain) with a debt problem who also have an internal peg to the Euro, I could easily see a course they could take that would involve a one-shot devaluation followed by a banking system cleanup (using printed money) and debt default that would result in a massive, overnight deleveraging that would definitely cause a huge impact, but would not snap confidence in the currency.

And even in places where confidence is lost, it can be restored relatively easily.  The Rentenmark in Germany, for instance, restored confidence in currency after the Weimar hyperinflation.

Your contention that we have a completely controlled gold price rests entirely on the fact that it entered a downcycle for a time, and you just don't think gold should have cycles.  For you, gold should always rise in price - that seems to fly in the face of how markets work.  All markets have cycles to them, including currencies, and since gold is a currency like any other, gold doesn't get a pass here.

I think gold is already trading freely, and it will act and is acting in just the way you predict - as a currency that people can go to when their own currency starts to have issues.  During the upcoming devaluations which seem inescapable, gold should provide a nice "personal reserve currency"/safe haven for savers.

But that doesn't mean people everywhere will reject fiat.

theordore's picture
theordore
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Posts: 48
Effectriveness of bank bail-ins

    Coming back to this thread after several days I realize that I forgot to thank you  davefairtex for the effort made and the excellent value you delivered with your views on the issue of the adequacy of bail-ins to secure the solvency of a major bank should it get into real trouble.  Your views have been helpful to me in developing strategy concerning my portfolio management challenges. Apologies!
     I have a questions in reaction to the extension of this great discussion since your post that I just cited.   Isn’t the reset already underway in the sequence of international QEs we are now seeing? 

davefairtex's picture
davefairtex
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Posts: 5456
reset underway?

theo-

have a questions in reaction to the extension of this great discussion since your post that I just cited.   Isn’t the reset already underway in the sequence of international QEs we are now seeing?

My sense is no.  QE is an attempt to keep things going without addressing the debt issues at all.  Euro-bank solvency isn't addressed by QE, and neither is sovereign solvency.  (Bank profit does increase since bank-held assets increase in value via QE - but bank loan quality issues are not addressed by QE).  The patient got a QE-pain-killer rather than an actual debt cure.

I think the big currency moves we see right now are partly side effects of fears surrounding Eurozone insolvency issues that remain unaddressed, and partly comparative yields (negative yields on German bonds vs positive yields in US treasury bonds).

My concept of a reset awaits actual attempts to solve the debt overhang.  So far, that hasn't happened.

I don't think the periphery will continue suffering too much longer under its current debt situation.  Something will snap, and Greece looks to be the first test case of this.  Going forward, either mainstream political parties in peripheral Europe will attempt to stay the course and be replaced by the fringe parties at the ballot box, or the mainstream parties will decide to try and remain in power and pre-empt the fringe by taking action on the debt themselves.

It will be interesting to see who does what.  Once it is seen by the peripheral politicans that following the orders of the creditors ends up being political suicide, rebellion against Brussels will go mainstream.  At that point, the wheels really will fall off, and that's when we'll get our reset, one way or the other.

This quote is relevant here: "Men and nations behave wisely...when they have exhausted all other resources."

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