Douglas Noland's Contributions

November 16 – Wall Street Journal (Damian Paletta and Carol E. Lee): “White House officials are in advanced internal discussions about a plan to replace the sweeping spending cuts set to begin in January with a smaller, separate package of targeted spending cuts and tax increases… They would cut spending by roughly $100 billion next year, and then for eight additional years…

In the face of human hardship, the big debate seems to be whether Sandy will be a positive or negative for GDP. Will rebuilding provide a needed boost to the U.S. economy? Is it good for stock prices?

Let’s return this week to the broader global Macro Credit Thesis. First of all, we live in a highly over-indebted world that becomes only more so each year. Moreover, the global system is today in an exceptionally high-risk phase of rapid non-productive debt growth in concert with historic financial and economic imbalances.

A 100% increase in Federal debt and 200% growth in the Federal Reserve’s balance sheet are surely not indicative of system de-leveraging. Such extraordinary Credit developments do, however, have profound effects throughout the markets and real economy.

“I used to think if there was reincarnation, I wanted to come back as the President or the Pope or a .400 baseball hitter. But now I want to come back as the bond market. You can intimidate everyone.” James Carville, Clinton campaign strategist, 1993

Our government literally injects trillions into the economy – Credit that inflates incomes and sustains consumption and elevates asset prices. The downside of this economic miracle is that, at the end of the day, there’s little left to show for the whole exercise except for an ever-expanding mountain of suspect financial claims.

I believe it was the History Channel, but it may have been Discovery. It was one of those restless nights where sleep wasn’t coming easy – a couple years back, as I recall. The subject of the program was an intellectual framework for better understanding the escalation of aerial attacks against civilians during World War II.

Truth be told, Fannie, Freddie, and the American taxpayer and economy will remain highly exposed to mortgage Credit risks for many years to come. While GSE mortgage holdings (and balance sheets) have been somewhat reduced, exposure to mortgages they’ve insured remains at near-record levels.

The “go ahead, make my day,” Draghi “will do everything to save the euro” rally saw Spanish and Italian stocks jump 10.6% and 9.5%, respectively, in six sessions. The S&P500 rose 2.0%, with the Goldman Sachs “Most Short” index surging 7.4% (in six sessions).

Things get wackier by the week. My proposition has been that once a Credit crisis comes to afflict the “core” (gravitating from the “periphery”) the deleterious consequences tend to be irreversible. As such, with Spain now engulfed in full-fledged financial, economic, political and social crisis, the overall European debt crisis has turned interminable.

In commemoration of M2 surpassing $10.0 TN for the first time – not to mention the unfolding confrontation between ECB President Draghi and Germany’s Bundesbank - this week’s CBB will focus on Monetary Analysis.

It was, to say the least, another interesting week. JP Morgan restated its first quarter earnings, as the company’s “London Whale” synthetic derivative loss jumped to $5.8bn. Another city in California can’t pay its bills and readies for bankruptcy.

The structure of today’s marketplace (especially with respect to the proliferation of hedging and derivative trading strategies) is conducive to short squeezes. This is compounded by the policy environment backdrop whereby market players (sophisticated and otherwise) fully recognize that policymakers are determined to backstop the markets.

Global systemic stress has been gaining critical momentum, and markets this week were heartened that global policymakers were in the process of mustering meaningful responses.

Swiss two-year yields ended the week at negative 48 bps. Two-year yields were also negative in Denmark (-21 bps) and traded slightly negative for much of Friday’s trading session in Germany. Ten-year German bund yields closed the week at a record low 1.17%.

For more than a year now, I have posited the thesis that unstable global finance is highly vulnerable to a problematic bout of de-risking and de-leveraging. The unfolding European debt crisis was viewed as the likely catalyst.

It’s a different era of course, but the scope of global policy interventions over the past two decades (and especially since 2008) makes 1920’s policy measures look rather microscopic in comparison. It has been an important aspect of my thesis that aggressive fiscal and monetary stimulus has become increasingly ineffective, destabilizing and dangerous.