My Weekly Commentary: Out of Thin Air

In its basic form, Credit is someone’s promise to pay “money” at some point in the future. Credit instruments are an “IOU.” Importantly, new Credit/“IOUs” create additional purchasing power. Especially late in prolonged Credit booms, financial instruments and claims come to account for enormous amounts of system “wealth.” Crises are the process of rectifying the divergence that develops between financial wealth and actual underlying economic wealth. This process invariably unmasks the systematic wealth redistribution that gathered momentum throughout the boom cycle.

Borrowing language from Murray Rothbard, money (and Credit) can be created “Out of Thin Air.” Such Credit expansion is referred to as “Credit inflation.” And, importantly, the resulting inflation in purchasing power can exert various price and other inflationary effects. It’s a popular misconception that consumer price inflation is the prevailing and more dangerous type of inflation. Never has this been as apparent as right now.

Traditionally, banks and governments were the culprits responsible for Credit expansions that on occasion turned into runaway booms and devastating busts. There are excellent historical accounts and analyses of centuries of Credit Bubbles. Even so – and even post-2008 - central bankers remain more determined than ever to disregard Credit theory, history and analysis.

The current global Credit Bubble is unlike anything in history (and the analysis incredibly challenging). I’ve tried to explain its origin was the Federal Reserve’s response to the early-nineties banking crisis. The Greenspan Fed spurred non-bank Credit growth that evolved into a historic Credit expansion. The upshot was a Bubble in Credit instruments intermediated through Fannie Mae, Freddie Mac and the Federal Home Loan Bank System. Closely related was a corresponding general boom in securitizations and derivatives, along with myriad Credit instruments involved in securities finance/leveraging (“repos,” Fed funds, financial CP, special purpose vehicles, etc.). Over the years, I referred to this powerful new financial apparatus as “market-based Credit” and “Wall Street finance.”

Updating Minsky’s analysis, I coined the term “Financial Arbitrage Capitalism” to describe the period of the nineties through 2008. The extraordinary post-mortgage finance Bubble reflation compelled another analytical “update.” We are now well into our seventh year of “Global Government Finance Quasi-Capitalism.” There should be little mystery surrounding so-called “secular stagnation,” as well as rising social stress and geopolitical friction.

The creation of “money” and Credit (“Out of Thin Air”) throughout the market-based Credit apparatus evolved into history’s most powerful Credit mechanism. It also proved fatefully contagious. Unprecedented access to cheap mortgage (along with auto, Credit card, student loan, etc.) borrowings was granted to millions of individuals with deficient Credit histories. Similar dynamics created unimaginably easy Credit Availability for business borrowers. For sovereigns, the boom in market-based finance doomed the likes of Argentina, Iceland and Greece (to name only a few). Predictably, the resulting busts have been progressively more spectacular.

“Market-based” Credit has always been somewhat of a misnomer. Sure, the nineties saw Trillions of new Credit instruments trade freely in the marketplace at impressive valuations (i.e. narrow spreads to Treasuries). Yet the entire marketplace was constructed upon the explicit and implied guarantees from the Treasury and Federal Reserve. The resulting “moneyness” of this Credit apparatus ensured excesses neared catastrophic extremes.

The consensus view holds that today’s financial backdrop is benign. Policymakers have learned from previous mistakes. There is nothing comparable to the excesses of subprime and Lehman Brothers.

The reality is that governments globally have now overtly commandeered so-called “market-based finance.” Securities markets are openly manipulated. Trillions of securities have been monetized. Prices and risk perceptions throughout global securities and derivatives markets have been perverted like never before. The upshot has been a globalized Bubble of unprecedented scope. Looking back, the 2008/09 crisis was a case of major market distortions coming home to roost. Today’s global market distortions greatly overshadow those of 2008.

Backed by concerted government manipulation and intervention, global “money” and Credit have become fungible. Tens of Trillions of electronic debits and Credits spur the free-flow of “money” in and about global markets. Never have such enormous quantities of global securities and financial instruments been perceived as safe or low-risk (“money-like”).

There are a few critical aspects to the backdrop worth keeping in mind. For all intents and purposes, it’s become one enormous global Bubble – the U.S., China, EM, Europe and Japan. Unfettered fungible “money” and Credit - “Out of Thin Air” - have provided both the fuel and the glue. Especially after BOJ and ECB QE/currency devaluations – and the resulting flow of speculative finance to “king dollar” securities markets – tightly interrelated global Bubbles essentially converged into one. With China’s renminbi tied to the U.S. dollar, the two super financial and economic Bubbles have for awhile now been closely interlinked. And as cracks have surfaced in China - surely exacerbated by global competitive currency devaluations - Chinese and American Bubbles have become only further melded.

Throughout history, booms have been a source of major increases in perceived wealth and power. Yet Credit inflations and Bubbles are at their roots about wealth redistribution and destruction. Given sufficient time and opportunity, the creation of “money” and Credit “Out of Thin Air” will have profoundly adverse consequences and ramifications. And, indeed, this runaway global Credit inflation’s deleterious effects are these days on display.

I’ll borrow a Larry Lindsey quote from last week’s CBB: “Because the government will not voluntarily let itself go out of business. It will use all of its powers - I’m not talking about just our government but any government - will use all of its powers in order to fund itself…”

So much of the world’s wealth now hinges upon the global Credit Bubble. It’s a given that governments around the world will use all their powers to fund themselves. Will they also use all their powers to protect their nation’s wealth – real as well as perceived wealth that has inflated so profoundly during this boom? When government officials in today’s increasingly hostile world focus on “security” matters, do they place financial security in equal footing with military security? And this gets to the heart of a critical facet of the globalized adoption of market-based finance: inflated securities market prices have become fundamental to a nation’s wealth, national interests, political and social stability, and national security. In an increasingly polarized and spiteful world, who is now willing to take away the punchbowl?

At this point, global central bankers remain united in their cause. Military leaders are not. On the one hand, central banks around the world face similar pressures and remain motivated to work in concert to sustain both domestic Bubbles and the greater global Credit Bubble. Government and military officials, though, are increasingly focused on a spectrum of pressing security issues – military, cyber, economic and financial. With the global pie no longer expanding, policies have turned inward looking and insecure. Integration and cooperation are giving way to antagonism and aggression. We saw it again this week.

And this framework helps explain what can appear a confounding paradox: In an increasingly troubling and uncertain world, global securities markets seemingly couldn’t be more upbeat. At this point, markets remain fixated on central bankers. And the more antagonistic the geopolitical backdrop, the more confident market players have become that timid central bankers will fall in line. There’s too much to lose. Thursday WSJ headline: “Fed’s Williams Says Never Use Rates to Prick Bubbles.” Only use rates to inflate Bubbles.

My deep concerns for the global Credit Bubble are coming to fruition. The Chinese Bubble got completely away from officials. They recognized their predicament too late and too reluctantly. Meanwhile, a complex geopolitical backdrop has unfolded. No longer is reining in Credit Bubble excess viewed as a priority. Chinese domestic fragilities were much greater than previously appreciated – and there’s today no tolerance for risking a bust. Meanwhile, opting out of the inflating global Bubble would not be in China’s interest. With the U.S., Japan and Europe desperately inflating a securities market Bubble, Chinese officials may have decided the risks of being the lone Bubble Popper were too great.

I believe future historians will look back at Russia’s invasion of Ukraine as a major geopolitical and financial inflection point. Putin’s speeches laid it out rather clearly: Russia can only be pushed around for so long. There is a line that can’t be crossed – and the U.S. and the “West” crossed that line. Putin slammed the U.S. for blatantly violating Russia’s vital national interests in neighboring Ukraine.

A year ago economic sanctions were going to discipline an “isolated” Russia. In a world of integrated markets and economies, changes in behavior could be dictated without resorting to tanks and bombers. Moreover, in this dispute between Russia and the West, China was viewed as neutral at worst. Putin’s rants against U.S. domination of global finance, trade and security arrangements could be dismissed as a lunatic’s senseless tirade.

The U.S. is now involved in an increasingly tense standoff with the Chinese in the South China Sea. Presidents Putin and Xi have become fast friends. And I just don’t see aggressive behavior from Russian and Chinese governments as coincidental. They will both err on the side of belligerence.

Last year’s Ukrainian crisis corresponded with serious cracks throughout the emerging markets, not to mention a collapse in crude (that Russia claims was orchestrated as punishment) and commodities. It quickly became an inopportune juncture for the Chinese to rein in their Credit Bubble. Instead, opportunity beckoned to begin building a formidable non-U.S. alliance and competing (non-dollar) global financial structure. This would require ongoing Chinese economic expansion and a stable currency. The Chinese must have viewed the benefits of a new global structure as exceeding the risks associated with accommodating additional Bubble excess. Moreover, imposing sanctions on Russia awakened the Chinese to the risks of something similar befalling their economy.

Global market Bubbles have benefited from the Chinese backtracking from Bubble containment. In the short-term, this lessened the risk of a Chinese financial accident. Similarly, having the Chinese focused on their currency attaining international reserve status has also reduced near-term risk of a disorderly currency devaluation. This has as well been pro-global Bubble.

Meanwhile, intermediate- and long-term risks are rapidly escalating. Regrettably, China has prolonged its “Terminal Phase” of excess, with dire consequences. Extending the life of the global Bubble comes with similar risks. At the same time, the building of a non-U.S. alliance and competing global financial infrastructure unfolds in earnest. Clearly, the Chinese military is preparing for a world that is changing in profound ways. The U.S. military has begun to adjust as well.

Global markets remain unsettled. The Chinese stock market Bubble has all appearances of an accident in the making. A Greek accident could be only days away. European periphery debt markets appear more fragile. EM seems more vulnerable. Currency markets are highly unstable. The dollar, bunds and Treasuries caught decent safe haven bids this week.

The age old problem with creating “money” is that once commenced in earnest it’s extremely difficult to curb. There comes a point where the soundness of the underlying Credit structure begins to be questioned. Such questioning is well overdue. Do central bankers have any idea of their role in fomenting geopolitical turmoil? Just print “money” Out of Thin Air.



For the Week:

The S&P500 declined 0.9% (up 2.4% y-t-d), and the Dow fell 1.2% (up 1.1%). The Utilities slipped 0.3% (down 7.1%). The Banks lost 0.8% (up 1.7%), and the Broker/Dealers dipped 0.4% (up 4.6%). The Transports dropped another 2.2% (down 9.2%). The S&P 400 Midcaps declined 1.1% (up 5.0%), and the small cap Russell 2000 fell 0.5% (up 3.5%). The Nasdaq100 declined 0.4% (up 6.4%), and the Morgan Stanley High Tech index fell 0.6% (up 3.3%). The Semiconductors surged 3.5% (up 8.5%). The Biotechs were little changed (up 20.8%). With bullion down $13, the HUI gold index dropped 2.6% (up 1.7%).

Three-month Treasury bill rates ended the week at zero. Two-year government yields were unchanged at 0.61% (down 6bps y-t-d). Five-year T-note yields fell seven bps to 1.49% (down 16bps). Ten-year Treasury yields dropped nine bps to 2.12% (down 5bps). Long bond yields declined 10 bps to 2.88% (up 13bps).

Greek 10-year yields declined 16 bps to 10.86% (up 112bps y-t-d). Ten-year Portuguese yields rose 13 bps to a four-month high 2.53% (down 9bps). Italian 10-yr yields slipped a basis point to 1.84% (down 5bps). Spain's 10-year yields rose six bps to a six-month high 1.83% (up 22bps). German bund yields fell 11 bps to 0.49% (down 5bps). French yields dropped 10 bps to 0.79% (down 4bps). The French to German 10-year bond spread widened one to 30 bps. U.K. 10-year gilt yields sank 12 bps to 1.81% (up 6bps).

Japan's Nikkei equities index gained 1.5% (up 17.8% y-t-d). Japanese 10-year "JGB" yields slipped three bps to 0.38% (up 6bps y-t-d). The German DAX equities index was hit for 3.4% (up 16.4%). Spain's IBEX 35 equities index sank 2.9% (up 9.1%). Italy's FTSE MIB index fell 1.2% (up 23.6%). Emerging equities were under pressure. Brazil's Bovespa index was hit 3.0% (up 5.5%). Mexico's Bolsa slipped 0.4% (up 3.6%). South Korea's Kospi index fell 1.5% (up 10.4%). India’s Sensex equities index declined 0.5% (up 1.2%). China’s bubbling (and volatile!) Shanghai Exchange declined 1.0% (up 42.6%). Turkey's Borsa Istanbul National 100 index was slammed for 3.4% (down 3.3%). Russia's MICEX equities index sank 3.4% (up 15.2%).

Junk funds saw outflows of $111 million (from Lipper).

Freddie Mac 30-year fixed mortgage rates increased three bps to a 2015 high 3.87% (unchanged y-t-d). Fifteen-year rates gained six bps to 3.11% (down 4bps). One-year ARM rates dipped a basis point to 2.50% (up 10bps). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed rates down three bps to 4.00% (down 28bps).

Federal Reserve Credit last week declined $5.0bn to $4.438 TN. Over the past year, Fed Credit inflated $154bn, or 3.6%. Fed Credit inflated $1.627 TN, or 58%, over the past 133 weeks. Elsewhere, Fed holdings for foreign owners of Treasury, Agency Debt increased $2.1bn last week to $3.327 TN. "Custody holdings" were up $33.6bn y-t-d.

M2 (narrow) "money" supply jumped $27.0bn to a record $11.940 TN. "Narrow money" expanded $650bn, or 5.8%, over the past year. For the week, Currency increased $1.6bn. Total Checkable Deposits fell $10.8bn, while Savings Deposits jumped $39.7bn. Small Time Deposits slipped $2.5bn. Retail Money Funds declined $1.1bn.

Money market fund assets gained $4.6bn to $2.614 TN. Money Funds were down $119bn year-to-date, while gaining $27bn y-o-y.

Total Commercial Paper dropped another $18.9bn to $9bn. CP declined $83bn over the past year, or 8.1%.

Currency Watch:

May 29 – Wall Street Journal (Lingling Wei): “China’s central bank has made the yuan Asia’s best-performing currency in the past year, rising in value against major currencies, in an effort to stem capital outflows and raise the Chinese currency’s appeal globally. Now, at least one prominent government adviser is publicly making a case for devaluing the yuan to help bolster the country’s flagging growth. In an analysis released early this week, Zhang Ming, a senior economist at the government think tank Chinese Academy of Social Sciences, said the yuan’s strength has ‘seriously deviated’ from China’s economic fundamentals. ‘A devaluation by a proper amount,’ he argued, would help revive China’s exports and growth. Mr. Zhang’s comments come as the Chinese leadership is struggling to reach its already-lowered growth target, set at 7% this year. A range of economic ills – from weak exports to an anemic property market and a heavy debt load – are weighing on the world’s second-largest economy.”

The U.S. dollar index advanced 0.8% to 96.89 (up 7.3% y-t-d). For the week on the downside, the New Zealand dollar declined 2.8%, the Brazilian real 2.7%, the Australian dollar 2.3%, the South African rand 2.2%, the Japanese yen 2.1%, the Norwegian krone 1.6%, the Swedish krona 1.5%, the Canadian dollar 1.4%, the British pound 1.3%, the Mexican peso 0.7% and the euro 0.2%.

Commodities Watch:

The Goldman Sachs Commodities Index slipped 0.6% (up 5.0% y-t-d). Spot Gold dropped 1.1% to $1,191 (up 0.5%). July Silver lost 2.1% to $16.70 (up 7%). June Crude increased 58 cents to $60.30 (up 13%). June Gasoline gained 0.9% (up 42%), while June Natural Gas sank 8.7% (down 9%). July Copper fell 3.0% (down 4%). July Wheat lost 3.0% (down 4%). July Corn sank 7.4% (down 19%).

Fixed Income Bubble Watch:

May 28 – CNBC (Lawrence Delevingne): “Billionaire investor Paul Singer says he has spotted the next big thing to bet against: bonds. ‘Today, six and a half years after the collapse of Lehman, there is a Bigger Short cooking. That Bigger Short is long-term claims on paper money, i.e., bonds,’ Singer wrote in a letter to investors of his hedge fund firm Elliott Management… ‘Bigger Short’ is a play on ‘The Big Short,’ the book by Michael Lewis describing how a tiny group of investors made huge sums of money for their contrarian bets against mortgage-backed securities... ‘Central bankers have chosen, and doubled down on, a palliative (super-easy money and QE), which is unprecedented and extreme, and whose ultimate effects are unknowable,’ Singer wrote… ‘Asset prices are skyrocketing because of massive public-sector purchases. The tinkering and experimentation that characterizes each round of novel central bank policy leads to more and more complicated unwanted consequences and convolutions…Central bankers are, in our view, getting 'pretzeled' by all this flailing, yet they deliver it with aplomb and serene self-confidence. Are they really taming volatility with their bond-buying, or just jamming it into a coiled spring?’”

May 29 – Reuters (Anjuli Davies): “Dealmaking in the United States has made its strongest start to a year since Reuters records began in 1980, climbing 52% year on year to $746.9 billion in the Jan. 1 to May 28 period… Global M&A activity is up 35% from the same period in 2014, with $1.7 trillion of deals having been struck.”

U.S. Bubble Watch:

May 27 – Bloomberg (Jeanna Smialek): “Five years after the recession ended, many Americans still teeter on the financial brink, barely prepared to handle an emergency expense and aging toward retirements they haven’t saved for, a Federal Reserve report shows. About 47% of 5,896 respondents in the Fed’s 2014 household survey, taken last October and November, wouldn’t be able to cover an emergency $400 expense without selling something or borrowing money. While that marks an improvement from 52% last year, the report states that it shows many Americans to be ‘ill-prepared for a financial disruption.’ The survey paints an image of fragile households, seemingly at odds with climbing consumer confidence and a healing economy.”

May 26 – Wall Street Journal (Vipal Monga, David Benoit and Theo Francis): “U.S. businesses, feeling heat from activist investors, are slashing long-term spending and returning billions of dollars to shareholders, a fundamental shift in the way they are deploying capital. Data show a broad array of companies have been plowing more cash into dividends and stock buybacks, while spending less on investments such as new factories and research and development… An analysis conducted for The Wall Street Journal by S&P Capital IQ shows that companies in the S&P 500 index sharply increased their spending on dividends and buybacks to a median 36% of operating cash flow in 2013, from 18% in 2003. Over that same decade, those companies cut spending on plants and equipment to 29% of operating cash flow, from 33% in 2003.”

May 27 – Wall Street Journal (Peter Rudegeair and Ryan Tracy): “U.S. banks are lending to businesses at such a rapid clip that those loans are on pace to overtake residential mortgages for the first time since the 1980s.Commercial and industrial loans rose 8.5% in the first quarter from the year-ago period and accounted for about 21% of outstanding loan balances at U.S. banks, the highest level in 13 years, according to Federal Deposit Insurance Corp. data… If they continue increasing at this pace over the next year, business loans would overtake residential mortgages at banks for the first time since 1988… The shift shows that manufacturers, retailers and other big companies have ramped up borrowing in recent months to get ahead of an expected rise in interest rates.”

May 27 – New York Times (Mary Williams Walsh): “Facing a shortfall of more than $50 billion in his state’s pensions, and with no simple solution at hand, Gov. Tom Wolf of Pennsylvania is proposing to issue $3 billion in bonds, despite the role that such bonds have already played in the fiscal woes of other places. And he is not alone. Several states and municipalities are considering similar action as they struggle with ballooning pension costs. Interest in so-called pension obligation bonds is expected to intensify in the wake of a recent Illinois Supreme Court decision that rejected the state’s attempt to overhaul its severely depleted pension system. The court ruled unanimously that Illinois could not legally cut its public workers’ retirement benefits to lower costs, forcing lawmakers to scramble for the billions of dollars it will take to keep the system intact.”

May 25 – New York Times (Monica Davey and Mary Williams Walsh): “Illinois is facing one of the worst fiscal crises of any state in recent decades, largely because it has mismanaged its pension system. The shortfalls could potentially mean sharply higher taxes and cuts in spending. And even though the state’s highest court just this month threw out a landmark plan to cut worker and retiree benefits, some lawmakers say they may have to find another way to make those reductions as well. Illinois’s problems resonate well beyond its borders. Pennsylvania, New Jersey and Kentucky are among the states confronting similar problems, and to them, Illinois is a model of what can go wrong — with political intransigence, mounting costs and a complicated legal terrain… The state faces a range of problems. Illinois has one of the worst-funded pension systems in the nation. Chicago also has a pension crisis, leading Moody’s… to downgrade its credit rating to junk status… And the state faces an expected budget deficit of $6 billion, which it needs to address quickly.”

May 26 – Bloomberg (John Gittelsohn): “One of the biggest homes in U.S. history is rising on a Los Angeles hilltop, and the developer hopes to sell it for a record $500 million. Nile Niami, a film producer and speculative residential developer, is pouring concrete in L.A.’s Bel Air neighborhood for a compound with a 74,000-square-foot (6,900-square-meter) main residence and three smaller homes… The project… will exceed 100,000 square feet, including a 5,000-square-foot master bedroom, a 30-car garage and a ‘Monaco-style casino,’ Niami said. ‘The house will have almost every amenity available in the world,’ he wrote in an e-mail. ‘The asking price will be $500 million.’”

May 27 – Bloomberg (Prashant Gopal and Heather Perlberg): “Merion Homes bought two dozen rambler-style houses in Northern Virginia’s Pimmit Hills community for about $450,000 each, just to knock them down. Now it’s selling customized residences three times larger at prices topping $1 million. ‘The original homes don’t fit today’s market,’ said Ryan Bensten, 35, a principal of Merion Homes… ‘They don’t have enough bedrooms -- they’re too small.’ Home teardowns are becoming common in U.S. suburbs such as Pimmit Hills…”

Federal Reserve Watch:

May 28 – Dow Jones (Pedro Nicolaci da Costa): “The Federal Reserve should refrain from using interest-rate policy to address risks to financial stability ‘even as a last resort,’ San Francisco Fed President John Williams said… That is because the effects of monetary policy on financial markets and excess risk taking are highly uncertain and potentially detrimental to the central bank's main objectives of stable inflation and maximum employment. ‘I am convinced that monetary policy should not be used to address risks to financial stability given the very real and sizable costs, not to mention that the potential benefits are anything but certain,’ Mr. Williams said… His remarks come amid debate over whether central banks should consider raising interest rates to prick apparent financial asset bubbles while they are forming, to forestall the damage to the financial system that could occur if they burst on their own.”

May 26 – Wall Street Journal (Pedro Nicolaci da Costa): “The Federal Reserve and other financial regulators have yet to adequately deal with the problem of banks that are viewed as too big to fail—and many of their interventions only heighten the perception, Richmond Fed President Jeffrey Lacker said… ‘Perceived guarantees thus encourage fragility, which induces interventions, which encourages further fragility,’ Mr. Lacker said in prepared remarks… ‘The ultimate result of this cycle is taxpayer-funded subsidies to financial firms that are widely viewed as deeply unfair.’ Mr. Lacker a frequent critic of the Fed’s interventions during the financial crisis… said new regulations stopped short of ensuring regulators will resist the urge to bail out very large Wall Street firms that run into trouble, Mr. Lacker said… ‘Regulation alone is not likely to be enough to counteract the moral hazard afflicting such a large — and growing — share of the financial sector’s liabilities… Creditors must not expect government support in the event of financial distress. Policymakers must actually allow financial firms to fail without government support.’”

Global Bubble Watch:

May 29 – Reuters (Caroline Copley): “Europe's rescue fund is seeking to revise its investment guidelines to allow it to buy lower-rated debt as it grapples with record low interest rates, according to documents from the so-called ESM and German finance ministry… At the end of March, more than half of the ESM's paid-in capital of 80 billion euros ($87.6 billion) was invested in assets with negative yields… To avoid incurring losses, the ESM wants to change its investment guidelines so that it can invest in riskier assets that generate higher returns. The ESM was set up in 2012 to provide financial aid to euro zone member states in difficulty… The trend underscores the limitations - at least so far - on so-called quantitative easing or money printing to buy government bonds. ‘Lots of the ECB's money is going into mortgages," said Carsten Brzeski, an economist with ING. "Construction is booming in Germany. The rest is being hoarded or spent on bonds and shares.’”

Central Bank Watch:

May 28 – Reuters (Love Liman and Johan Carlstrom): “Some of the biggest banks in Scandinavia are warning that Sweden’s Riksbank risks hurting bond market liquidity with its quantitative easing program. Any efforts to expand asset purchases would deplete Sweden’s already limited sovereign debt supply, according to SEB AB and Danske Bank A/S. ‘We see wider bid-ask spreads, lower liquidity, lower volumes and lower liquidity in the inter-bank system, which makes it more difficult for market makers to manage their risk,’ Jussi Hiljanen, head of fixed-income strategy at SEB…said… ‘I’m worried that liquidity in the Swedish bond market will be very low for the rest of the year.’”

Europe Watch:

May 27 – Reuters (Ben Hirschler): “Cash-strapped Greece has racked up mounting debts with international drugmakers and now owes the industry more than 1.1 billion euros ($1.2bn), a leading industry official said… The rising unpaid bill reflects the growing struggle by the nearly bankrupt country to muster cash, and creates a dilemma for companies under moral pressure not to cut off supplies of life-saving medicines. Richard Bergstrom, director general of the European Federation of Pharmaceutical Industries and Associations, told Reuters his members had not been paid by Greece since December 2014.”

May 29 – Reuters (John O'Donnell and Jonathan Gould): “Lending throughout the euro zone failed to grow in April after a promising uptick a month earlier, a slip that tempers hopes for a rapid turnaround in borrowing to boost the economy. European Central Bank data showed… that overall lending growth to households and firms was unchanged in the month, despite the recent launch of a massive money-printing programme to bolster the 19 countries in the euro bloc.”

May 29 – CNBC (Julia Chatterley): “While Greece has been hitting the headlines recently, Matteo Renzi has quietly had a tough few months. The Italian prime minister has had to tackle difficulties both abroad and at home – including a slow economic recovery. All this presents a difficult backdrop for Renzi as he faces 22 million voters with elections in 7 regions and over 1,000 municipalities this weekend. On the domestic front, we've seen protests over education reform and a court ruling that pension cuts were unconstitutional, a decision that will require 13 billion euros ($14.2bn) in repayments. On top of that, there are accusations of political corruption and organised crime links within Renzi's Democratic Party (PD).”

May 27 – UK Telegraph (Mehreen Khan): “Tensions over the future course of eurozone integration have been laid bare as Spain has proposed a radical expansion of the European Central Bank's powers over member states. Ahead of a June summit of European leaders, Madrid has urged its fellow member states to expand the role of the ECB in order to curb dangerous ‘macroeconomic imbalances’ building up in the currency union. In list of highly ambitious proposals, Spain also called for the single currency to adopt a common budget for use in emergency rescues, and issue debt in the form of eurobonds… Both measures are likely to meet the resistance in Germany, Europe's largest creditor, as a further pooling of funds that would effectively subsidise southern debtor states.”

China Bubble Watch:

May 25 – Reuters (Li Zheng, Li He and Pete Sweeney): “China's top banking regulator warned of rising credit risk from real estate, local government debt and unconventional forms of finance, sources with direct knowledge told Reuters, highlighting Beijing's struggles to prevent risky debt from engulfing a stuttering economy. The sources cited a speech given by Shang Fulin, chairman of the China Banking Regulatory Commission (CBRC)… The amount of non-performing loans in the first quarter has already reached 56% of the total amount last year, Shang said… Unconventional forms of credit… were also on the rise, he said… Shang said credit risk had risen among commercial banks in China in the first quarter, with the total number of bad loans at 982.5 billion yuan (102.3 billion pounds), up 139.9 billion yuan from the same period last year, bringing the bad loan ratio to 1.39%. He said over 30% of loans to local governments used land or proceeds from land sales as collateral, which will cause increased repayment pressure as proceeds from land sales decline… Sliding land prices will also cause the value of the loan collateral to decrease, Shang added.”

May 26 – CNN (Sophia Yan): “Wealthy Chinese are getting even richer really fast. A new billionaire was created almost every week in China in the first quarter of 2015, according to a report by UBS and PricewaterhouseCoopers. Wealth creation is booming for the Chinese… and it's all happened in the last 15 years, said Francis Liu, a managing director at UBS Wealth Management. They're primarily pulling in the big bucks from real estate, technology, healthcare and other consumer industries, he said. In 2014, there were about 200 billionaires in China, versus 570 in the U.S., according to UBS.”

May 27 – Bloomberg: “Brokerages across China are tightening rules for lending to stock investors to try to limit the risks from any market bust. Changjiang Securities Co. joined larger rivals GF Securities Co. and Haitong Securities Co. in increasing its margin requirement… ‘We will definitely see more brokerages follow suit, stock prices have risen too fast and risks are accumulating,’ said Tang Yayun, a Shanghai-based analyst at Northeast Securities Co. ‘Brokerages are taking measures to protect themselves as there’s been concern that a bubble is forming in the stock market.’”

May 27 – Reuters (Peter Thal Larsen): “The main fuel for China’s stock market boom is running low. Borrowed money helped the Shanghai and Shenzhen stock exchanges double in value in six months. Despite frantic fundraising by brokerage houses, however, demand for leverage may be nearing its limits… The balance of outstanding margin loans has almost doubled since the end of last year to reach 1.9 trillion yuan ($300bn), according to Fitch. Breakneck growth in this lucrative but capital-intensive business has sent securities firms scrambling to raise new funds. Hence outfits such as GF Securities… have issued equity worth more than $10 billion this year. At Huatai Securities, the Nanjing-based broker currently completing a $4.5 billion Hong Kong fundraising, margin-related lending and trading accounted for 28% of revenue in the first quarter, up from just 8% in 2012.”

May 27 – CNBC (Mia Tahara-Stubbs): “Kaisa Group Holdings Ltd., the first Chinese developer to default on offshore debt, had its restructuring thrown into doubt after rival Sunac China Holdings Ltd. abandoned a proposed acquisition. Kaisa bonds slumped the most in five weeks in early trade after Sunac announced Thursday that it dropped the offer that could have helped the troubled developer restructure its $10.5 billion of debt, including $2.5 billion of offshore bonds.”

May 25 – Bloomberg (David Yong): “China will likely prop up bondholders in any onshore defaults until August to ensure a smooth clean up of its local debt mess, according to Oversea-Chinese Banking Corp. Events this year have defied Chinese rhetoric on embracing market-based reforms, after authorities passed up chances to make investors stomach losses from two local defaults, the bank wrote… This week sees a potential third missed payment after beverages bottle maker Zhuhai Zhongfu Enterprise Co. said it can only partly pay principal due May 28. Forcing investor losses may sour market sentiment and hinder the successful completion of state efforts to clear a debt pile issued by provincial cities, according to OCBC. Banks must swap out 1 trillion yuan ($161bn) of high-cost local government bonds issued by 36 Chinese cities for municipal debt with lower coupons by the end of August, it said.”

EM Bubble Watch:

May 25 – Bloomberg (Nathan Crooks and Andrew Rosati): “Venezuela’s largest bill of 100 bolivars is now worth less than a U.S. quarter to money-changers after a plunge in the currency’s black-market value. The bolivar fell 25% on the black market last week to 423 per dollar before strengthening to 413 today… That’s 66 times the primary official rate of 6.3 bolivars per dollar, and means the 100-bolivar bill fetches about 24 U.S. cents from illegal street dealers.”

May 27 – Bloomberg (Piotr Zalewski): “If you give me the powers I'm asking for, I can boost gross domestic product from $11,000 per capita today to $25,000 in eight years. That is the ambitious vow Turkish President Recep Tayyip Erdogan has made to voters in an attempt to turn the nation's June 7 parliamentary elections into a referendum on his political goals. If his Justice and Development Party (AKP) wins the fiercely contested vote by a wide enough margin, Erdogan has announced, he will transform Turkey into a presidential system, effectively consolidating his role as a one-man executive. An increasingly populist debate over the country's economy — an issue that has helped Erdogan and the AKP win every election since 2002 — will help determine whether he gets what he wants.”

May 26 – Reuters (Nick Tattersall and Orhan Coskun): “Turkey's general election looks likely to push Tayyip Erdogan's dream of an all-powerful presidency further from his reach, and usher in a period of turbulence as its most divisive modern leader jockeys to maintain his dominance. Barred by the constitution from party politics as head of state, Erdogan has nonetheless campaigned across Turkey before the June 7 parliamentary vote in a sign of how much he has riding on the outcome. ‘You will not take me away from these stages, you will not silence me,’ he told a rally… explaining why the presidency should get greater powers. Constitutionally, most authority has lain with the Turkish prime minister, an office Erdogan held from 2003 to 2014. But since becoming head of state last year, he has pushed hard for an executive presidency akin to the United States or France. However, the AK Party which he founded looks unlikely to win two thirds of the seats in parliament, the majority needed to change the constitution without putting the plan to a referendum.”

Brazil Watch:

May 29 – Bloomberg (Filipe Pacheco and Paula Sambo): “The real extended its monthly decline as Brazil braced for its worst recession in 25 years after the government reported that Latin America’s largest economy contracted in the first quarter. Attempts by President Dilma Rousseff’s administration to reassure investors by raising taxes and reducing expenditures are expected to limit the nation’s gross domestic product in the second quarter. The central bank’s increase in interest rates to their highest level since 2009 to curb above-target inflation adds to the drag on output.”

Geopolitical Watch:

May 29 – UK Telegraph (Xing Zhigang): “A Chinese guard of honour joined the Victory Day parade in Moscow’s Red Square for the first time on May 9, as 18 Russian veterans who fought against the Japanese in Northeast China during the Second World War were presented with medals. The events highlighted the friendship between China and Russia, forged with lives and blood during the war, and Russian President Vladimir Putin was officially invited to attend a parade in China on Sept 3 to celebrate the Chinese victory over the Japanese aggression. President Xi Jinping took advantage of the Chinese presence at the Moscow commemorations for the 70th anniversary of the end of the Great Patriotic War… to lay the foundations for China’s own celebrations. The near-complete absence of Western leaders at the ceremony, underlining the tensions between Russia and the West over the Ukraine crisis, also gave prominence to the presence of President Xi…”

May 26 – New York Times (Andrew Jacobs): “China intends to project naval power in the open ocean in coming years, and not just defend the country’s coastal waters, according to a strategy paper… The paper, the first policy document issued by the Chinese military in two years, comes at a time of growing Chinese assertiveness in the South China Sea. China’s efforts to enforce its disputed claims to vast stretches of the sea by building up artificial islands and structures on reefs and outcroppings have drawn the Philippines and its ally the United States into a test of wills in the region… The policy document… lays out China’s military ambitions, a central element of what its leaders call a ‘national rejuvenation,’ as Beijing moves to counter what it sees as American efforts to contain its rise. It extends beyond naval policy to emphasize the continued modernization of the Chinese military in general, and it describes cyberwarfare as a ‘grave security threat’ that requires the development of a cybermilitary force.”

May 26 – Reuters (Megha Rajagopalan): “China outlined a strategy to boost its naval reach on Tuesday and held a groundbreaking ceremony for two lighthouses in disputed waters, developments likely to escalate tensions in a region already jittery about Beijing's maritime ambitions. In a policy document issued by the State Council, the Communist-ruled country's cabinet, China vowed to increase its ‘open seas protection’, switching from air defense to both offence and defense, and criticized neighbors who take ‘provocative actions’ on its reefs and islands.”

May 27 – Financial Times (Charles Clover): “China has mooted the possibility of controlling the airspace over the disputed South China Sea, as it ratchets up rhetoric in response to a US overflight of an island claimed by China earlier this month. A senior foreign ministry official spoke on Wednesday about the possibility of implementing an Air Defence Identification Zone over the sea, a move that would be widely regarded as an effort to stamp its sovereignty over a series of islands it claims. An ADIZ requires all aircraft flying through it to identify themselves to the controlling government. ‘China has the right to establish ADIZs,’ said Ouyang Yujing, director of boundaries and oceanic affairs for the foreign ministry… Whether or not China will establish a South China Sea ADIZ will depend on factors such as whether China’s air safety is under threat, and the seriousness of the threat,’ he said.”

May 27 – Washington Post (Craig Whitlock): “Defense Secretary Ashton Carter bluntly warned China Wednesday to stop its buildup of man-made islands in the South China Sea and vowed that the U.S. military would continue to patrol international waters and airspace in the region. Carter’s comments… further escalated a simmering rhetorical conflict between Washington and Beijing over access to the South China Sea and other Asian waters. ‘There should be no mistake: the United States will fly, sail, and operate wherever international law allows, as we do all around the world,’ Carter said at the U.S. military’s joint base at Pearl Harbor.”

May 27 – AFP (Dan De Luce): “Russia's provocative rhetoric and its dramatic expansion of flights by nuclear bombers are deeply troubling and dangerous, NATO Secretary General Jens Stoltenberg said… Russia's plans to deploy nuclear-capable missiles in Kaliningrad -- near Poland's border -- and its threat to move nuclear forces in Crimea would ‘fundamentally change the balance of security in Europe,’ Stoltenberg warned… In blunt language, the NATO chief delivered a scathing critique of Russia's behavior over the past year… and vowed the transatlantic alliance would redouble its commitment to ‘collective defense.’ ‘Russia's recent use of nuclear rhetoric, exercises and operations are deeply troubling,’ he told an audience…”

May 27 – CNN (Chris Frates): “The IRS believes that a major cyber breach that allowed criminals to steal the tax returns of more than 100,000 people originated in Russia, two sources briefed on the data theft tell CNN. On Tuesday, the Internal Revenue Service announced that organized crime syndicates used personal data obtained elsewhere to access tax information, which they then used to file $50 million in fraudulent tax refunds.”

May 25 – Reuters (Matt Siegel): “Japan will join a major U.S.-Australian military exercise for the first time in a sign of growing security links between the three countries as tensions fester over China's island building in the South China Sea. While only 40 Japanese officers and soldiers will take part in drills involving 30,000 U.S. and Australian troops in early July, experts said the move showed how Washington wanted to foster cooperation among its security allies in Asia… ‘I think the U.S. is trying to get its allies to do more,’ said Euan Graham, director of the International Security Program at the Lowy Institute in Sydney.”

May 24 – Financial Times (Simeon Kerr): “Lines of green Saudi flags hang proudly along Riyadh’s wide highways while screens around the capital broadcast footage on a loop of warplanes flying into combat and massive explosions. Local companies have taken out giant billboards pledging allegiance to the ‘decisive and determined’ King Salman bin Abdulaziz al-Saud, while ordinary Saudis have taken to social media to show their support for the new king and the county’s military campaign in Yemen. An unprecedented jingoism — hidden for decades — has swept through Saudi Arabia since King Salman ascended to the throne in January and the launch in March of the aerial campaign against Shia Houthi rebels. Although the air strikes have raised international concern and heightened tensions with Iran, its rival for regional dominance, they have been cheered in Saudi by an increasingly nationalist and sectarian sentiment. ‘We are strong again under them,’ says Ahmed, a middle-aged Saudi national…”

Russia and Ukraine Watch:

May 27 – Reuters (Maria Tsvetkova): “Russia's army is massing troops and hundreds of pieces of weaponry including mobile rocket launchers, tanks and artillery at a makeshift base near the border with Ukraine, a Reuters reporter saw this week. Many of the vehicles have number plates and identifying marks removed while many of the servicemen had taken insignia off their fatigues. As such, they match the appearance of some of the forces spotted in eastern Ukraine, which Kiev and its Western allies allege are covert Russian detachments. The scene at the base on the Kuzminsky firing range, around 50 km (30 miles) from the border, offers some of the clearest evidence to date of what appeared to be a concerted Russian military build-up in the area. Earlier this month, NATO military commander General Philip Breedlove said he believed the separatists were taking advantage of a ceasefire that came into force in February to re-arm and prepare for a new offensive.”

May 27 – Financial Times (Elaine Moore): “Ukraine’s decision last week to grant its government the power to stop foreign debt payments marks a distinct shift in tone for the wartorn and recession-battered country. As negotiations between Kiev and its creditors stall and full-blown bankruptcy nears, the rhetoric of government communiques is shifting from conciliation to accusation. Spot the difference in sentiment. In March a presentation to investors noted that ‘a collaborative process is paramount . . . Ukraine is committed to undertake consultations with its creditors’. By May the government declared it ‘has the right . . . not to return loans borrowed by [a] kleptocratic regime’. In sovereign debt circles the tack Ukraine appears to be taking is known as the odious debt argument, which rejects the notion that governments are liable for the debts of their predecessor.”

Japan Watch:

May 27 – Bloomberg: “Tokyo stocks are at fifteen-year highs and the yen at eight-year lows, but Bank of Japan Governor Haruhiko Kuroda told CNBC he doesn't think a bubble is brewing nor is he worried about where the yen is headed. ‘We don't think there is any asset bubble or stock market bubble, but we will continue to monitor carefully,’ BOJ governor Haruhiko Kuroda told CNBC… As for the Japanese currency, the ‘yen might appreciate. But I think the exchange rate, including the yen, should move in line with economic fundamentals,’ he said.”

May 27 – Bloomberg (Dave McCombs and Jason Clenfield): “Japan’s companies, long known for stinginess with shareholders, doled out record amounts of cash to investors in the last year. It’s just the start of the payouts. Dividends and buybacks soared 76% to 12.8 trillion yen ($104bn) in the 12 months ended in March, according to Nomura Holdings… This newfound affection for shareholders is born out of necessity, not sudden generosity.”

My Weekly Commentary: Out of Thin Air

In its basic form, Credit is someone’s promise to pay “money” at some point in the future. Credit instruments are an “IOU.” Importantly, new Credit/“IOUs” create additional purchasing power. Especially late in prolonged Credit booms, financial instruments and claims come to account for enormous amounts of system “wealth.” Crises are the process of rectifying the divergence that develops between financial wealth and actual underlying economic wealth. This process invariably unmasks the systematic wealth redistribution that gathered momentum throughout the boom cycle.

Borrowing language from Murray Rothbard, money (and Credit) can be created “Out of Thin Air.” Such Credit expansion is referred to as “Credit inflation.” And, importantly, the resulting inflation in purchasing power can exert various price and other inflationary effects. It’s a popular misconception that consumer price inflation is the prevailing and more dangerous type of inflation. Never has this been as apparent as right now.

Traditionally, banks and governments were the culprits responsible for Credit expansions that on occasion turned into runaway booms and devastating busts. There are excellent historical accounts and analyses of centuries of Credit Bubbles. Even so – and even post-2008 - central bankers remain more determined than ever to disregard Credit theory, history and analysis.

The current global Credit Bubble is unlike anything in history (and the analysis incredibly challenging). I’ve tried to explain its origin was the Federal Reserve’s response to the early-nineties banking crisis. The Greenspan Fed spurred non-bank Credit growth that evolved into a historic Credit expansion. The upshot was a Bubble in Credit instruments intermediated through Fannie Mae, Freddie Mac and the Federal Home Loan Bank System. Closely related was a corresponding general boom in securitizations and derivatives, along with myriad Credit instruments involved in securities finance/leveraging (“repos,” Fed funds, financial CP, special purpose vehicles, etc.). Over the years, I referred to this powerful new financial apparatus as “market-based Credit” and “Wall Street finance.”

Updating Minsky’s analysis, I coined the term “Financial Arbitrage Capitalism” to describe the period of the nineties through 2008. The extraordinary post-mortgage finance Bubble reflation compelled another analytical “update.” We are now well into our seventh year of “Global Government Finance Quasi-Capitalism.” There should be little mystery surrounding so-called “secular stagnation,” as well as rising social stress and geopolitical friction.

The creation of “money” and Credit (“Out of Thin Air”) throughout the market-based Credit apparatus evolved into history’s most powerful Credit mechanism. It also proved fatefully contagious. Unprecedented access to cheap mortgage (along with auto, Credit card, student loan, etc.) borrowings was granted to millions of individuals with deficient Credit histories. Similar dynamics created unimaginably easy Credit Availability for business borrowers. For sovereigns, the boom in market-based finance doomed the likes of Argentina, Iceland and Greece (to name only a few). Predictably, the resulting busts have been progressively more spectacular.

“Market-based” Credit has always been somewhat of a misnomer. Sure, the nineties saw Trillions of new Credit instruments trade freely in the marketplace at impressive valuations (i.e. narrow spreads to Treasuries). Yet the entire marketplace was constructed upon the explicit and implied guarantees from the Treasury and Federal Reserve. The resulting “moneyness” of this Credit apparatus ensured excesses neared catastrophic extremes.

The consensus view holds that today’s financial backdrop is benign. Policymakers have learned from previous mistakes. There is nothing comparable to the excesses of subprime and Lehman Brothers.

The reality is that governments globally have now overtly commandeered so-called “market-based finance.” Securities markets are openly manipulated. Trillions of securities have been monetized. Prices and risk perceptions throughout global securities and derivatives markets have been perverted like never before. The upshot has been a globalized Bubble of unprecedented scope. Looking back, the 2008/09 crisis was a case of major market distortions coming home to roost. Today’s global market distortions greatly overshadow those of 2008.

Backed by concerted government manipulation and intervention, global “money” and Credit have become fungible. Tens of Trillions of electronic debits and Credits spur the free-flow of “money” in and about global markets. Never have such enormous quantities of global securities and financial instruments been perceived as safe or low-risk (“money-like”).

There are a few critical aspects to the backdrop worth keeping in mind. For all intents and purposes, it’s become one enormous global Bubble – the U.S., China, EM, Europe and Japan. Unfettered fungible “money” and Credit - “Out of Thin Air” - have provided both the fuel and the glue. Especially after BOJ and ECB QE/currency devaluations – and the resulting flow of speculative finance to “king dollar” securities markets – tightly interrelated global Bubbles essentially converged into one. With China’s renminbi tied to the U.S. dollar, the two super financial and economic Bubbles have for awhile now been closely interlinked. And as cracks have surfaced in China - surely exacerbated by global competitive currency devaluations - Chinese and American Bubbles have become only further melded.

Throughout history, booms have been a source of major increases in perceived wealth and power. Yet Credit inflations and Bubbles are at their roots about wealth redistribution and destruction. Given sufficient time and opportunity, the creation of “money” and Credit “Out of Thin Air” will have profoundly adverse consequences and ramifications. And, indeed, this runaway global Credit inflation’s deleterious effects are these days on display.

I’ll borrow a Larry Lindsey quote from last week’s CBB: “Because the government will not voluntarily let itself go out of business. It will use all of its powers - I’m not talking about just our government but any government - will use all of its powers in order to fund itself…”

So much of the world’s wealth now hinges upon the global Credit Bubble. It’s a given that governments around the world will use all their powers to fund themselves. Will they also use all their powers to protect their nation’s wealth – real as well as perceived wealth that has inflated so profoundly during this boom? When government officials in today’s increasingly hostile world focus on “security” matters, do they place financial security in equal footing with military security? And this gets to the heart of a critical facet of the globalized adoption of market-based finance: inflated securities market prices have become fundamental to a nation’s wealth, national interests, political and social stability, and national security. In an increasingly polarized and spiteful world, who is now willing to take away the punchbowl?

At this point, global central bankers remain united in their cause. Military leaders are not. On the one hand, central banks around the world face similar pressures and remain motivated to work in concert to sustain both domestic Bubbles and the greater global Credit Bubble. Government and military officials, though, are increasingly focused on a spectrum of pressing security issues – military, cyber, economic and financial. With the global pie no longer expanding, policies have turned inward looking and insecure. Integration and cooperation are giving way to antagonism and aggression. We saw it again this week.

And this framework helps explain what can appear a confounding paradox: In an increasingly troubling and uncertain world, global securities markets seemingly couldn’t be more upbeat. At this point, markets remain fixated on central bankers. And the more antagonistic the geopolitical backdrop, the more confident market players have become that timid central bankers will fall in line. There’s too much to lose. Thursday WSJ headline: “Fed’s Williams Says Never Use Rates to Prick Bubbles.” Only use rates to inflate Bubbles.

My deep concerns for the global Credit Bubble are coming to fruition. The Chinese Bubble got completely away from officials. They recognized their predicament too late and too reluctantly. Meanwhile, a complex geopolitical backdrop has unfolded. No longer is reining in Credit Bubble excess viewed as a priority. Chinese domestic fragilities were much greater than previously appreciated – and there’s today no tolerance for risking a bust. Meanwhile, opting out of the inflating global Bubble would not be in China’s interest. With the U.S., Japan and Europe desperately inflating a securities market Bubble, Chinese officials may have decided the risks of being the lone Bubble Popper were too great.

I believe future historians will look back at Russia’s invasion of Ukraine as a major geopolitical and financial inflection point. Putin’s speeches laid it out rather clearly: Russia can only be pushed around for so long. There is a line that can’t be crossed – and the U.S. and the “West” crossed that line. Putin slammed the U.S. for blatantly violating Russia’s vital national interests in neighboring Ukraine.

A year ago economic sanctions were going to discipline an “isolated” Russia. In a world of integrated markets and economies, changes in behavior could be dictated without resorting to tanks and bombers. Moreover, in this dispute between Russia and the West, China was viewed as neutral at worst. Putin’s rants against U.S. domination of global finance, trade and security arrangements could be dismissed as a lunatic’s senseless tirade.

The U.S. is now involved in an increasingly tense standoff with the Chinese in the South China Sea. Presidents Putin and Xi have become fast friends. And I just don’t see aggressive behavior from Russian and Chinese governments as coincidental. They will both err on the side of belligerence.

Last year’s Ukrainian crisis corresponded with serious cracks throughout the emerging markets, not to mention a collapse in crude (that Russia claims was orchestrated as punishment) and commodities. It quickly became an inopportune juncture for the Chinese to rein in their Credit Bubble. Instead, opportunity beckoned to begin building a formidable non-U.S. alliance and competing (non-dollar) global financial structure. This would require ongoing Chinese economic expansion and a stable currency. The Chinese must have viewed the benefits of a new global structure as exceeding the risks associated with accommodating additional Bubble excess. Moreover, imposing sanctions on Russia awakened the Chinese to the risks of something similar befalling their economy.

Global market Bubbles have benefited from the Chinese backtracking from Bubble containment. In the short-term, this lessened the risk of a Chinese financial accident. Similarly, having the Chinese focused on their currency attaining international reserve status has also reduced near-term risk of a disorderly currency devaluation. This has as well been pro-global Bubble.

Meanwhile, intermediate- and long-term risks are rapidly escalating. Regrettably, China has prolonged its “Terminal Phase” of excess, with dire consequences. Extending the life of the global Bubble comes with similar risks. At the same time, the building of a non-U.S. alliance and competing global financial infrastructure unfolds in earnest. Clearly, the Chinese military is preparing for a world that is changing in profound ways. The U.S. military has begun to adjust as well.

Global markets remain unsettled. The Chinese stock market Bubble has all appearances of an accident in the making. A Greek accident could be only days away. European periphery debt markets appear more fragile. EM seems more vulnerable. Currency markets are highly unstable. The dollar, bunds and Treasuries caught decent safe haven bids this week.

The age old problem with creating “money” is that once commenced in earnest it’s extremely difficult to curb. There comes a point where the soundness of the underlying Credit structure begins to be questioned. Such questioning is well overdue. Do central bankers have any idea of their role in fomenting geopolitical turmoil? Just print “money” Out of Thin Air.



For the Week:

The S&P500 declined 0.9% (up 2.4% y-t-d), and the Dow fell 1.2% (up 1.1%). The Utilities slipped 0.3% (down 7.1%). The Banks lost 0.8% (up 1.7%), and the Broker/Dealers dipped 0.4% (up 4.6%). The Transports dropped another 2.2% (down 9.2%). The S&P 400 Midcaps declined 1.1% (up 5.0%), and the small cap Russell 2000 fell 0.5% (up 3.5%). The Nasdaq100 declined 0.4% (up 6.4%), and the Morgan Stanley High Tech index fell 0.6% (up 3.3%). The Semiconductors surged 3.5% (up 8.5%). The Biotechs were little changed (up 20.8%). With bullion down $13, the HUI gold index dropped 2.6% (up 1.7%).

Three-month Treasury bill rates ended the week at zero. Two-year government yields were unchanged at 0.61% (down 6bps y-t-d). Five-year T-note yields fell seven bps to 1.49% (down 16bps). Ten-year Treasury yields dropped nine bps to 2.12% (down 5bps). Long bond yields declined 10 bps to 2.88% (up 13bps).

Greek 10-year yields declined 16 bps to 10.86% (up 112bps y-t-d). Ten-year Portuguese yields rose 13 bps to a four-month high 2.53% (down 9bps). Italian 10-yr yields slipped a basis point to 1.84% (down 5bps). Spain's 10-year yields rose six bps to a six-month high 1.83% (up 22bps). German bund yields fell 11 bps to 0.49% (down 5bps). French yields dropped 10 bps to 0.79% (down 4bps). The French to German 10-year bond spread widened one to 30 bps. U.K. 10-year gilt yields sank 12 bps to 1.81% (up 6bps).

Japan's Nikkei equities index gained 1.5% (up 17.8% y-t-d). Japanese 10-year "JGB" yields slipped three bps to 0.38% (up 6bps y-t-d). The German DAX equities index was hit for 3.4% (up 16.4%). Spain's IBEX 35 equities index sank 2.9% (up 9.1%). Italy's FTSE MIB index fell 1.2% (up 23.6%). Emerging equities were under pressure. Brazil's Bovespa index was hit 3.0% (up 5.5%). Mexico's Bolsa slipped 0.4% (up 3.6%). South Korea's Kospi index fell 1.5% (up 10.4%). India’s Sensex equities index declined 0.5% (up 1.2%). China’s bubbling (and volatile!) Shanghai Exchange declined 1.0% (up 42.6%). Turkey's Borsa Istanbul National 100 index was slammed for 3.4% (down 3.3%). Russia's MICEX equities index sank 3.4% (up 15.2%).

Junk funds saw outflows of $111 million (from Lipper).

Freddie Mac 30-year fixed mortgage rates increased three bps to a 2015 high 3.87% (unchanged y-t-d). Fifteen-year rates gained six bps to 3.11% (down 4bps). One-year ARM rates dipped a basis point to 2.50% (up 10bps). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed rates down three bps to 4.00% (down 28bps).

Federal Reserve Credit last week declined $5.0bn to $4.438 TN. Over the past year, Fed Credit inflated $154bn, or 3.6%. Fed Credit inflated $1.627 TN, or 58%, over the past 133 weeks. Elsewhere, Fed holdings for foreign owners of Treasury, Agency Debt increased $2.1bn last week to $3.327 TN. "Custody holdings" were up $33.6bn y-t-d.

M2 (narrow) "money" supply jumped $27.0bn to a record $11.940 TN. "Narrow money" expanded $650bn, or 5.8%, over the past year. For the week, Currency increased $1.6bn. Total Checkable Deposits fell $10.8bn, while Savings Deposits jumped $39.7bn. Small Time Deposits slipped $2.5bn. Retail Money Funds declined $1.1bn.

Money market fund assets gained $4.6bn to $2.614 TN. Money Funds were down $119bn year-to-date, while gaining $27bn y-o-y.

Total Commercial Paper dropped another $18.9bn to $9bn. CP declined $83bn over the past year, or 8.1%.

Currency Watch:

May 29 – Wall Street Journal (Lingling Wei): “China’s central bank has made the yuan Asia’s best-performing currency in the past year, rising in value against major currencies, in an effort to stem capital outflows and raise the Chinese currency’s appeal globally. Now, at least one prominent government adviser is publicly making a case for devaluing the yuan to help bolster the country’s flagging growth. In an analysis released early this week, Zhang Ming, a senior economist at the government think tank Chinese Academy of Social Sciences, said the yuan’s strength has ‘seriously deviated’ from China’s economic fundamentals. ‘A devaluation by a proper amount,’ he argued, would help revive China’s exports and growth. Mr. Zhang’s comments come as the Chinese leadership is struggling to reach its already-lowered growth target, set at 7% this year. A range of economic ills – from weak exports to an anemic property market and a heavy debt load – are weighing on the world’s second-largest economy.”

The U.S. dollar index advanced 0.8% to 96.89 (up 7.3% y-t-d). For the week on the downside, the New Zealand dollar declined 2.8%, the Brazilian real 2.7%, the Australian dollar 2.3%, the South African rand 2.2%, the Japanese yen 2.1%, the Norwegian krone 1.6%, the Swedish krona 1.5%, the Canadian dollar 1.4%, the British pound 1.3%, the Mexican peso 0.7% and the euro 0.2%.

Commodities Watch:

The Goldman Sachs Commodities Index slipped 0.6% (up 5.0% y-t-d). Spot Gold dropped 1.1% to $1,191 (up 0.5%). July Silver lost 2.1% to $16.70 (up 7%). June Crude increased 58 cents to $60.30 (up 13%). June Gasoline gained 0.9% (up 42%), while June Natural Gas sank 8.7% (down 9%). July Copper fell 3.0% (down 4%). July Wheat lost 3.0% (down 4%). July Corn sank 7.4% (down 19%).

Fixed Income Bubble Watch:

May 28 – CNBC (Lawrence Delevingne): “Billionaire investor Paul Singer says he has spotted the next big thing to bet against: bonds. ‘Today, six and a half years after the collapse of Lehman, there is a Bigger Short cooking. That Bigger Short is long-term claims on paper money, i.e., bonds,’ Singer wrote in a letter to investors of his hedge fund firm Elliott Management… ‘Bigger Short’ is a play on ‘The Big Short,’ the book by Michael Lewis describing how a tiny group of investors made huge sums of money for their contrarian bets against mortgage-backed securities... ‘Central bankers have chosen, and doubled down on, a palliative (super-easy money and QE), which is unprecedented and extreme, and whose ultimate effects are unknowable,’ Singer wrote… ‘Asset prices are skyrocketing because of massive public-sector purchases. The tinkering and experimentation that characterizes each round of novel central bank policy leads to more and more complicated unwanted consequences and convolutions…Central bankers are, in our view, getting 'pretzeled' by all this flailing, yet they deliver it with aplomb and serene self-confidence. Are they really taming volatility with their bond-buying, or just jamming it into a coiled spring?’”

May 29 – Reuters (Anjuli Davies): “Dealmaking in the United States has made its strongest start to a year since Reuters records began in 1980, climbing 52% year on year to $746.9 billion in the Jan. 1 to May 28 period… Global M&A activity is up 35% from the same period in 2014, with $1.7 trillion of deals having been struck.”

U.S. Bubble Watch:

May 27 – Bloomberg (Jeanna Smialek): “Five years after the recession ended, many Americans still teeter on the financial brink, barely prepared to handle an emergency expense and aging toward retirements they haven’t saved for, a Federal Reserve report shows. About 47% of 5,896 respondents in the Fed’s 2014 household survey, taken last October and November, wouldn’t be able to cover an emergency $400 expense without selling something or borrowing money. While that marks an improvement from 52% last year, the report states that it shows many Americans to be ‘ill-prepared for a financial disruption.’ The survey paints an image of fragile households, seemingly at odds with climbing consumer confidence and a healing economy.”

May 26 – Wall Street Journal (Vipal Monga, David Benoit and Theo Francis): “U.S. businesses, feeling heat from activist investors, are slashing long-term spending and returning billions of dollars to shareholders, a fundamental shift in the way they are deploying capital. Data show a broad array of companies have been plowing more cash into dividends and stock buybacks, while spending less on investments such as new factories and research and development… An analysis conducted for The Wall Street Journal by S&P Capital IQ shows that companies in the S&P 500 index sharply increased their spending on dividends and buybacks to a median 36% of operating cash flow in 2013, from 18% in 2003. Over that same decade, those companies cut spending on plants and equipment to 29% of operating cash flow, from 33% in 2003.”

May 27 – Wall Street Journal (Peter Rudegeair and Ryan Tracy): “U.S. banks are lending to businesses at such a rapid clip that those loans are on pace to overtake residential mortgages for the first time since the 1980s.Commercial and industrial loans rose 8.5% in the first quarter from the year-ago period and accounted for about 21% of outstanding loan balances at U.S. banks, the highest level in 13 years, according to Federal Deposit Insurance Corp. data… If they continue increasing at this pace over the next year, business loans would overtake residential mortgages at banks for the first time since 1988… The shift shows that manufacturers, retailers and other big companies have ramped up borrowing in recent months to get ahead of an expected rise in interest rates.”

May 27 – New York Times (Mary Williams Walsh): “Facing a shortfall of more than $50 billion in his state’s pensions, and with no simple solution at hand, Gov. Tom Wolf of Pennsylvania is proposing to issue $3 billion in bonds, despite the role that such bonds have already played in the fiscal woes of other places. And he is not alone. Several states and municipalities are considering similar action as they struggle with ballooning pension costs. Interest in so-called pension obligation bonds is expected to intensify in the wake of a recent Illinois Supreme Court decision that rejected the state’s attempt to overhaul its severely depleted pension system. The court ruled unanimously that Illinois could not legally cut its public workers’ retirement benefits to lower costs, forcing lawmakers to scramble for the billions of dollars it will take to keep the system intact.”

May 25 – New York Times (Monica Davey and Mary Williams Walsh): “Illinois is facing one of the worst fiscal crises of any state in recent decades, largely because it has mismanaged its pension system. The shortfalls could potentially mean sharply higher taxes and cuts in spending. And even though the state’s highest court just this month threw out a landmark plan to cut worker and retiree benefits, some lawmakers say they may have to find another way to make those reductions as well. Illinois’s problems resonate well beyond its borders. Pennsylvania, New Jersey and Kentucky are among the states confronting similar problems, and to them, Illinois is a model of what can go wrong — with political intransigence, mounting costs and a complicated legal terrain… The state faces a range of problems. Illinois has one of the worst-funded pension systems in the nation. Chicago also has a pension crisis, leading Moody’s… to downgrade its credit rating to junk status… And the state faces an expected budget deficit of $6 billion, which it needs to address quickly.”

May 26 – Bloomberg (John Gittelsohn): “One of the biggest homes in U.S. history is rising on a Los Angeles hilltop, and the developer hopes to sell it for a record $500 million. Nile Niami, a film producer and speculative residential developer, is pouring concrete in L.A.’s Bel Air neighborhood for a compound with a 74,000-square-foot (6,900-square-meter) main residence and three smaller homes… The project… will exceed 100,000 square feet, including a 5,000-square-foot master bedroom, a 30-car garage and a ‘Monaco-style casino,’ Niami said. ‘The house will have almost every amenity available in the world,’ he wrote in an e-mail. ‘The asking price will be $500 million.’”

May 27 – Bloomberg (Prashant Gopal and Heather Perlberg): “Merion Homes bought two dozen rambler-style houses in Northern Virginia’s Pimmit Hills community for about $450,000 each, just to knock them down. Now it’s selling customized residences three times larger at prices topping $1 million. ‘The original homes don’t fit today’s market,’ said Ryan Bensten, 35, a principal of Merion Homes… ‘They don’t have enough bedrooms -- they’re too small.’ Home teardowns are becoming common in U.S. suburbs such as Pimmit Hills…”

Federal Reserve Watch:

May 28 – Dow Jones (Pedro Nicolaci da Costa): “The Federal Reserve should refrain from using interest-rate policy to address risks to financial stability ‘even as a last resort,’ San Francisco Fed President John Williams said… That is because the effects of monetary policy on financial markets and excess risk taking are highly uncertain and potentially detrimental to the central bank's main objectives of stable inflation and maximum employment. ‘I am convinced that monetary policy should not be used to address risks to financial stability given the very real and sizable costs, not to mention that the potential benefits are anything but certain,’ Mr. Williams said… His remarks come amid debate over whether central banks should consider raising interest rates to prick apparent financial asset bubbles while they are forming, to forestall the damage to the financial system that could occur if they burst on their own.”

May 26 – Wall Street Journal (Pedro Nicolaci da Costa): “The Federal Reserve and other financial regulators have yet to adequately deal with the problem of banks that are viewed as too big to fail—and many of their interventions only heighten the perception, Richmond Fed President Jeffrey Lacker said… ‘Perceived guarantees thus encourage fragility, which induces interventions, which encourages further fragility,’ Mr. Lacker said in prepared remarks… ‘The ultimate result of this cycle is taxpayer-funded subsidies to financial firms that are widely viewed as deeply unfair.’ Mr. Lacker a frequent critic of the Fed’s interventions during the financial crisis… said new regulations stopped short of ensuring regulators will resist the urge to bail out very large Wall Street firms that run into trouble, Mr. Lacker said… ‘Regulation alone is not likely to be enough to counteract the moral hazard afflicting such a large — and growing — share of the financial sector’s liabilities… Creditors must not expect government support in the event of financial distress. Policymakers must actually allow financial firms to fail without government support.’”

Global Bubble Watch:

May 29 – Reuters (Caroline Copley): “Europe's rescue fund is seeking to revise its investment guidelines to allow it to buy lower-rated debt as it grapples with record low interest rates, according to documents from the so-called ESM and German finance ministry… At the end of March, more than half of the ESM's paid-in capital of 80 billion euros ($87.6 billion) was invested in assets with negative yields… To avoid incurring losses, the ESM wants to change its investment guidelines so that it can invest in riskier assets that generate higher returns. The ESM was set up in 2012 to provide financial aid to euro zone member states in difficulty… The trend underscores the limitations - at least so far - on so-called quantitative easing or money printing to buy government bonds. ‘Lots of the ECB's money is going into mortgages," said Carsten Brzeski, an economist with ING. "Construction is booming in Germany. The rest is being hoarded or spent on bonds and shares.’”

Central Bank Watch:

May 28 – Reuters (Love Liman and Johan Carlstrom): “Some of the biggest banks in Scandinavia are warning that Sweden’s Riksbank risks hurting bond market liquidity with its quantitative easing program. Any efforts to expand asset purchases would deplete Sweden’s already limited sovereign debt supply, according to SEB AB and Danske Bank A/S. ‘We see wider bid-ask spreads, lower liquidity, lower volumes and lower liquidity in the inter-bank system, which makes it more difficult for market makers to manage their risk,’ Jussi Hiljanen, head of fixed-income strategy at SEB…said… ‘I’m worried that liquidity in the Swedish bond market will be very low for the rest of the year.’”

Europe Watch:

May 27 – Reuters (Ben Hirschler): “Cash-strapped Greece has racked up mounting debts with international drugmakers and now owes the industry more than 1.1 billion euros ($1.2bn), a leading industry official said… The rising unpaid bill reflects the growing struggle by the nearly bankrupt country to muster cash, and creates a dilemma for companies under moral pressure not to cut off supplies of life-saving medicines. Richard Bergstrom, director general of the European Federation of Pharmaceutical Industries and Associations, told Reuters his members had not been paid by Greece since December 2014.”

May 29 – Reuters (John O'Donnell and Jonathan Gould): “Lending throughout the euro zone failed to grow in April after a promising uptick a month earlier, a slip that tempers hopes for a rapid turnaround in borrowing to boost the economy. European Central Bank data showed… that overall lending growth to households and firms was unchanged in the month, despite the recent launch of a massive money-printing programme to bolster the 19 countries in the euro bloc.”

May 29 – CNBC (Julia Chatterley): “While Greece has been hitting the headlines recently, Matteo Renzi has quietly had a tough few months. The Italian prime minister has had to tackle difficulties both abroad and at home – including a slow economic recovery. All this presents a difficult backdrop for Renzi as he faces 22 million voters with elections in 7 regions and over 1,000 municipalities this weekend. On the domestic front, we've seen protests over education reform and a court ruling that pension cuts were unconstitutional, a decision that will require 13 billion euros ($14.2bn) in repayments. On top of that, there are accusations of political corruption and organised crime links within Renzi's Democratic Party (PD).”

May 27 – UK Telegraph (Mehreen Khan): “Tensions over the future course of eurozone integration have been laid bare as Spain has proposed a radical expansion of the European Central Bank's powers over member states. Ahead of a June summit of European leaders, Madrid has urged its fellow member states to expand the role of the ECB in order to curb dangerous ‘macroeconomic imbalances’ building up in the currency union. In list of highly ambitious proposals, Spain also called for the single currency to adopt a common budget for use in emergency rescues, and issue debt in the form of eurobonds… Both measures are likely to meet the resistance in Germany, Europe's largest creditor, as a further pooling of funds that would effectively subsidise southern debtor states.”

China Bubble Watch:

May 25 – Reuters (Li Zheng, Li He and Pete Sweeney): “China's top banking regulator warned of rising credit risk from real estate, local government debt and unconventional forms of finance, sources with direct knowledge told Reuters, highlighting Beijing's struggles to prevent risky debt from engulfing a stuttering economy. The sources cited a speech given by Shang Fulin, chairman of the China Banking Regulatory Commission (CBRC)… The amount of non-performing loans in the first quarter has already reached 56% of the total amount last year, Shang said… Unconventional forms of credit… were also on the rise, he said… Shang said credit risk had risen among commercial banks in China in the first quarter, with the total number of bad loans at 982.5 billion yuan (102.3 billion pounds), up 139.9 billion yuan from the same period last year, bringing the bad loan ratio to 1.39%. He said over 30% of loans to local governments used land or proceeds from land sales as collateral, which will cause increased repayment pressure as proceeds from land sales decline… Sliding land prices will also cause the value of the loan collateral to decrease, Shang added.”

May 26 – CNN (Sophia Yan): “Wealthy Chinese are getting even richer really fast. A new billionaire was created almost every week in China in the first quarter of 2015, according to a report by UBS and PricewaterhouseCoopers. Wealth creation is booming for the Chinese… and it's all happened in the last 15 years, said Francis Liu, a managing director at UBS Wealth Management. They're primarily pulling in the big bucks from real estate, technology, healthcare and other consumer industries, he said. In 2014, there were about 200 billionaires in China, versus 570 in the U.S., according to UBS.”

May 27 – Bloomberg: “Brokerages across China are tightening rules for lending to stock investors to try to limit the risks from any market bust. Changjiang Securities Co. joined larger rivals GF Securities Co. and Haitong Securities Co. in increasing its margin requirement… ‘We will definitely see more brokerages follow suit, stock prices have risen too fast and risks are accumulating,’ said Tang Yayun, a Shanghai-based analyst at Northeast Securities Co. ‘Brokerages are taking measures to protect themselves as there’s been concern that a bubble is forming in the stock market.’”

May 27 – Reuters (Peter Thal Larsen): “The main fuel for China’s stock market boom is running low. Borrowed money helped the Shanghai and Shenzhen stock exchanges double in value in six months. Despite frantic fundraising by brokerage houses, however, demand for leverage may be nearing its limits… The balance of outstanding margin loans has almost doubled since the end of last year to reach 1.9 trillion yuan ($300bn), according to Fitch. Breakneck growth in this lucrative but capital-intensive business has sent securities firms scrambling to raise new funds. Hence outfits such as GF Securities… have issued equity worth more than $10 billion this year. At Huatai Securities, the Nanjing-based broker currently completing a $4.5 billion Hong Kong fundraising, margin-related lending and trading accounted for 28% of revenue in the first quarter, up from just 8% in 2012.”

May 27 – CNBC (Mia Tahara-Stubbs): “Kaisa Group Holdings Ltd., the first Chinese developer to default on offshore debt, had its restructuring thrown into doubt after rival Sunac China Holdings Ltd. abandoned a proposed acquisition. Kaisa bonds slumped the most in five weeks in early trade after Sunac announced Thursday that it dropped the offer that could have helped the troubled developer restructure its $10.5 billion of debt, including $2.5 billion of offshore bonds.”

May 25 – Bloomberg (David Yong): “China will likely prop up bondholders in any onshore defaults until August to ensure a smooth clean up of its local debt mess, according to Oversea-Chinese Banking Corp. Events this year have defied Chinese rhetoric on embracing market-based reforms, after authorities passed up chances to make investors stomach losses from two local defaults, the bank wrote… This week sees a potential third missed payment after beverages bottle maker Zhuhai Zhongfu Enterprise Co. said it can only partly pay principal due May 28. Forcing investor losses may sour market sentiment and hinder the successful completion of state efforts to clear a debt pile issued by provincial cities, according to OCBC. Banks must swap out 1 trillion yuan ($161bn) of high-cost local government bonds issued by 36 Chinese cities for municipal debt with lower coupons by the end of August, it said.”

EM Bubble Watch:

May 25 – Bloomberg (Nathan Crooks and Andrew Rosati): “Venezuela’s largest bill of 100 bolivars is now worth less than a U.S. quarter to money-changers after a plunge in the currency’s black-market value. The bolivar fell 25% on the black market last week to 423 per dollar before strengthening to 413 today… That’s 66 times the primary official rate of 6.3 bolivars per dollar, and means the 100-bolivar bill fetches about 24 U.S. cents from illegal street dealers.”

May 27 – Bloomberg (Piotr Zalewski): “If you give me the powers I'm asking for, I can boost gross domestic product from $11,000 per capita today to $25,000 in eight years. That is the ambitious vow Turkish President Recep Tayyip Erdogan has made to voters in an attempt to turn the nation's June 7 parliamentary elections into a referendum on his political goals. If his Justice and Development Party (AKP) wins the fiercely contested vote by a wide enough margin, Erdogan has announced, he will transform Turkey into a presidential system, effectively consolidating his role as a one-man executive. An increasingly populist debate over the country's economy — an issue that has helped Erdogan and the AKP win every election since 2002 — will help determine whether he gets what he wants.”

May 26 – Reuters (Nick Tattersall and Orhan Coskun): “Turkey's general election looks likely to push Tayyip Erdogan's dream of an all-powerful presidency further from his reach, and usher in a period of turbulence as its most divisive modern leader jockeys to maintain his dominance. Barred by the constitution from party politics as head of state, Erdogan has nonetheless campaigned across Turkey before the June 7 parliamentary vote in a sign of how much he has riding on the outcome. ‘You will not take me away from these stages, you will not silence me,’ he told a rally… explaining why the presidency should get greater powers. Constitutionally, most authority has lain with the Turkish prime minister, an office Erdogan held from 2003 to 2014. But since becoming head of state last year, he has pushed hard for an executive presidency akin to the United States or France. However, the AK Party which he founded looks unlikely to win two thirds of the seats in parliament, the majority needed to change the constitution without putting the plan to a referendum.”

Brazil Watch:

May 29 – Bloomberg (Filipe Pacheco and Paula Sambo): “The real extended its monthly decline as Brazil braced for its worst recession in 25 years after the government reported that Latin America’s largest economy contracted in the first quarter. Attempts by President Dilma Rousseff’s administration to reassure investors by raising taxes and reducing expenditures are expected to limit the nation’s gross domestic product in the second quarter. The central bank’s increase in interest rates to their highest level since 2009 to curb above-target inflation adds to the drag on output.”

Geopolitical Watch:

May 29 – UK Telegraph (Xing Zhigang): “A Chinese guard of honour joined the Victory Day parade in Moscow’s Red Square for the first time on May 9, as 18 Russian veterans who fought against the Japanese in Northeast China during the Second World War were presented with medals. The events highlighted the friendship between China and Russia, forged with lives and blood during the war, and Russian President Vladimir Putin was officially invited to attend a parade in China on Sept 3 to celebrate the Chinese victory over the Japanese aggression. President Xi Jinping took advantage of the Chinese presence at the Moscow commemorations for the 70th anniversary of the end of the Great Patriotic War… to lay the foundations for China’s own celebrations. The near-complete absence of Western leaders at the ceremony, underlining the tensions between Russia and the West over the Ukraine crisis, also gave prominence to the presence of President Xi…”

May 26 – New York Times (Andrew Jacobs): “China intends to project naval power in the open ocean in coming years, and not just defend the country’s coastal waters, according to a strategy paper… The paper, the first policy document issued by the Chinese military in two years, comes at a time of growing Chinese assertiveness in the South China Sea. China’s efforts to enforce its disputed claims to vast stretches of the sea by building up artificial islands and structures on reefs and outcroppings have drawn the Philippines and its ally the United States into a test of wills in the region… The policy document… lays out China’s military ambitions, a central element of what its leaders call a ‘national rejuvenation,’ as Beijing moves to counter what it sees as American efforts to contain its rise. It extends beyond naval policy to emphasize the continued modernization of the Chinese military in general, and it describes cyberwarfare as a ‘grave security threat’ that requires the development of a cybermilitary force.”

May 26 – Reuters (Megha Rajagopalan): “China outlined a strategy to boost its naval reach on Tuesday and held a groundbreaking ceremony for two lighthouses in disputed waters, developments likely to escalate tensions in a region already jittery about Beijing's maritime ambitions. In a policy document issued by the State Council, the Communist-ruled country's cabinet, China vowed to increase its ‘open seas protection’, switching from air defense to both offence and defense, and criticized neighbors who take ‘provocative actions’ on its reefs and islands.”

May 27 – Financial Times (Charles Clover): “China has mooted the possibility of controlling the airspace over the disputed South China Sea, as it ratchets up rhetoric in response to a US overflight of an island claimed by China earlier this month. A senior foreign ministry official spoke on Wednesday about the possibility of implementing an Air Defence Identification Zone over the sea, a move that would be widely regarded as an effort to stamp its sovereignty over a series of islands it claims. An ADIZ requires all aircraft flying through it to identify themselves to the controlling government. ‘China has the right to establish ADIZs,’ said Ouyang Yujing, director of boundaries and oceanic affairs for the foreign ministry… Whether or not China will establish a South China Sea ADIZ will depend on factors such as whether China’s air safety is under threat, and the seriousness of the threat,’ he said.”

May 27 – Washington Post (Craig Whitlock): “Defense Secretary Ashton Carter bluntly warned China Wednesday to stop its buildup of man-made islands in the South China Sea and vowed that the U.S. military would continue to patrol international waters and airspace in the region. Carter’s comments… further escalated a simmering rhetorical conflict between Washington and Beijing over access to the South China Sea and other Asian waters. ‘There should be no mistake: the United States will fly, sail, and operate wherever international law allows, as we do all around the world,’ Carter said at the U.S. military’s joint base at Pearl Harbor.”

May 27 – AFP (Dan De Luce): “Russia's provocative rhetoric and its dramatic expansion of flights by nuclear bombers are deeply troubling and dangerous, NATO Secretary General Jens Stoltenberg said… Russia's plans to deploy nuclear-capable missiles in Kaliningrad -- near Poland's border -- and its threat to move nuclear forces in Crimea would ‘fundamentally change the balance of security in Europe,’ Stoltenberg warned… In blunt language, the NATO chief delivered a scathing critique of Russia's behavior over the past year… and vowed the transatlantic alliance would redouble its commitment to ‘collective defense.’ ‘Russia's recent use of nuclear rhetoric, exercises and operations are deeply troubling,’ he told an audience…”

May 27 – CNN (Chris Frates): “The IRS believes that a major cyber breach that allowed criminals to steal the tax returns of more than 100,000 people originated in Russia, two sources briefed on the data theft tell CNN. On Tuesday, the Internal Revenue Service announced that organized crime syndicates used personal data obtained elsewhere to access tax information, which they then used to file $50 million in fraudulent tax refunds.”

May 25 – Reuters (Matt Siegel): “Japan will join a major U.S.-Australian military exercise for the first time in a sign of growing security links between the three countries as tensions fester over China's island building in the South China Sea. While only 40 Japanese officers and soldiers will take part in drills involving 30,000 U.S. and Australian troops in early July, experts said the move showed how Washington wanted to foster cooperation among its security allies in Asia… ‘I think the U.S. is trying to get its allies to do more,’ said Euan Graham, director of the International Security Program at the Lowy Institute in Sydney.”

May 24 – Financial Times (Simeon Kerr): “Lines of green Saudi flags hang proudly along Riyadh’s wide highways while screens around the capital broadcast footage on a loop of warplanes flying into combat and massive explosions. Local companies have taken out giant billboards pledging allegiance to the ‘decisive and determined’ King Salman bin Abdulaziz al-Saud, while ordinary Saudis have taken to social media to show their support for the new king and the county’s military campaign in Yemen. An unprecedented jingoism — hidden for decades — has swept through Saudi Arabia since King Salman ascended to the throne in January and the launch in March of the aerial campaign against Shia Houthi rebels. Although the air strikes have raised international concern and heightened tensions with Iran, its rival for regional dominance, they have been cheered in Saudi by an increasingly nationalist and sectarian sentiment. ‘We are strong again under them,’ says Ahmed, a middle-aged Saudi national…”

Russia and Ukraine Watch:

May 27 – Reuters (Maria Tsvetkova): “Russia's army is massing troops and hundreds of pieces of weaponry including mobile rocket launchers, tanks and artillery at a makeshift base near the border with Ukraine, a Reuters reporter saw this week. Many of the vehicles have number plates and identifying marks removed while many of the servicemen had taken insignia off their fatigues. As such, they match the appearance of some of the forces spotted in eastern Ukraine, which Kiev and its Western allies allege are covert Russian detachments. The scene at the base on the Kuzminsky firing range, around 50 km (30 miles) from the border, offers some of the clearest evidence to date of what appeared to be a concerted Russian military build-up in the area. Earlier this month, NATO military commander General Philip Breedlove said he believed the separatists were taking advantage of a ceasefire that came into force in February to re-arm and prepare for a new offensive.”

May 27 – Financial Times (Elaine Moore): “Ukraine’s decision last week to grant its government the power to stop foreign debt payments marks a distinct shift in tone for the wartorn and recession-battered country. As negotiations between Kiev and its creditors stall and full-blown bankruptcy nears, the rhetoric of government communiques is shifting from conciliation to accusation. Spot the difference in sentiment. In March a presentation to investors noted that ‘a collaborative process is paramount . . . Ukraine is committed to undertake consultations with its creditors’. By May the government declared it ‘has the right . . . not to return loans borrowed by [a] kleptocratic regime’. In sovereign debt circles the tack Ukraine appears to be taking is known as the odious debt argument, which rejects the notion that governments are liable for the debts of their predecessor.”

Japan Watch:

May 27 – Bloomberg: “Tokyo stocks are at fifteen-year highs and the yen at eight-year lows, but Bank of Japan Governor Haruhiko Kuroda told CNBC he doesn't think a bubble is brewing nor is he worried about where the yen is headed. ‘We don't think there is any asset bubble or stock market bubble, but we will continue to monitor carefully,’ BOJ governor Haruhiko Kuroda told CNBC… As for the Japanese currency, the ‘yen might appreciate. But I think the exchange rate, including the yen, should move in line with economic fundamentals,’ he said.”

May 27 – Bloomberg (Dave McCombs and Jason Clenfield): “Japan’s companies, long known for stinginess with shareholders, doled out record amounts of cash to investors in the last year. It’s just the start of the payouts. Dividends and buybacks soared 76% to 12.8 trillion yen ($104bn) in the 12 months ended in March, according to Nomura Holdings… This newfound affection for shareholders is born out of necessity, not sudden generosity.”