Saturday, November 8, 2014

Weekly Commentary, August 31, 2012: Risk #3

August 30 – Bloomberg (Mark Deen): “Yale University professor Stephen Roach said Federal Reserve Chairman Ben S. Bernanke shouldn’t be given a third term because of his role in managing the U.S. economy before the financial crisis. ‘I think Bernanke tried his best post-crisis, but he’s part of the problem pre-crisis,’ Roach said… ‘He and Alan Greenspan condoned asset bubbles at a time the economy needed more discipline.’ …For Roach, Bernanke’s work to calm markets following the financial crisis doesn’t mean his part in inflating asset bubbles in previous years should be overlooked. ‘To reward him for post-crisis, very valiant efforts of public service completely overlooks the role he played in getting the U.S. asset markets and an asset-dependent economy into this mess in the first place…”

Chairman Bernanke titled his 2012 Jackson Hole presentation “Monetary Policy since the Onset of the Crisis.” His review begins with the Fed’s initial response to the unfolding mortgage crisis in August 2007. The paper then details five years of policy measures, with section headings “Balance Sheet Tools,” “Communication Tools,” “Economic Prospects,” and “Making Policy with Nontraditional Tools: A Cost-Benefit Framework.” Dr. Bernanke concludes with coded dovish messages, including “grave concern” that “high levels of unemployment will wreak structural damage” – after earlier signaling support for the Draghi Plan (“recent policy proposals in Europe have been quite constructive in my view, and I urge our European colleagues to press ahead…”).

As noted above by the astute Stephen Roach, Dr. Bernanke played an instrumental intellectual role in crafting policy with Chairman Greenspan that fatefully nurtured the mortgage finance Bubble. In arguably history’s greatest monetary policy misadventure, the Greenspan/Bernanke Fed purposely ignored the unfolding Bubble, choosing instead to commit the Federal Reserve to aggressive post-Bubble “mopping up” strategies. Five years into the crisis, the extent of required “mopping up” remains an unfolding saga that will be analyzed and debated for decades to come. To be sure, the Federal Reserve’s framework for monetary policy cost-benefit analysis during the post-technology Bubble reflationary period (2002-2007) was an abject failure. Most of us strive to learn from our big mistakes.

Chairman Bernanke, not surprisingly, made it clear in Jackson Hole that he is prepared to move further into the uncharted waters of “non-traditional” monetary tools. His review came out on the side of benefits outweighing “manageable” costs, although perhaps to placate the hawks he cautioned, “The hurdle for using nontraditional policies should be higher than for traditional policies. At the same time, the costs of nontraditional policies, when considered carefully, appear manageable, implying that we should not rule out the further use of such policies if economic conditions warrant.”

Before delving into his cost-benefit framework, it is worth mentioning that the word “Bubble” is nowhere to be found in Bernanke’s paper. I strongly argue that the issue of whether the Fed is once again accommodating a Credit (“government finance”) Bubble is today’s prevailing – potentially catastrophic - policy risk. The possible role that non-traditional policy tools might be playing in nurturing Bubble dynamics should be the focal point of any cost-benefit analysis related to the Fed’s experimental policymaking endeavor. Regrettably, it’s completely disregarded - hear no evil, speak no evil, and see no evil.

Dr. Bernanke highlights four potential costs of large-scale asset purchases (LSAP): 1) Impairment to the functioning of securities markets (“Fed dominance” “degrading liquidity and discovery”). 2) Substantial Fed balance sheet expansion could reduce public confidence (i.e. exit strategy and inflation expectation issues). 3) Risks to financial stability (i.e. “could induce imprudent reach for yield by some investors”). 4) “The possibility that the Federal Reserve could incur financial losses should interest rates rise to an unexpected extent.”

I take exception with those calling Bernanke’s presentation “balanced.” He again misjudges and woefully understates risk. My analytical focus is directed at Risk #3, with the view that the Bernanke Fed is again disregarding myriad risks to financial stability associated with marketplace interventions and manipulations. Indeed, it would appear that risks to financial stability are escalating in concert with the escalation in the course of global monetary management. Dr. Bernanke’s “imprudent reach for yield by some” contrasts with my fear of the greatest financial Bubble in the history of mankind.

From Bernanke’s paper: “Of course, one objective of both traditional and nontraditional policy during recoveries is to promote a return to productive risk-taking; as always, the goal is to strike the appropriate balance. Moreover, a stronger recovery is itself clearly helpful for financial stability. In assessing this risk, it is important to note that the Federal Reserve, both on its own and in collaboration with other members of the Financial Stability Oversight Council, has substantially expanded its monitoring of the financial system and modified its supervisory approach to take a more systemic perspective. We have seen little evidence thus far of unsafe buildups of risk or leverage, but we will continue both our careful oversight and the implementation of financial regulatory reforms aimed at reducing systemic risk.”

I will first note that the Greenspan Federal Reserve was caught completely off-guard by the market excesses that their policies had nurtured back during the (then) aggressive 1992/93 reflation period. It's worth noting that the hedge fund community has expanded about 20-fold since, to a record $2.1 TN. Global derivatives markets have mushroomed to hundreds of Trillions. Importantly, derivatives markets as well as the global “leveraged speculating community” have continued to grow post-2008 crisis – only further bolstered by aggressive policy regimes. The failure of JPMorgan’s “whale” derivatives trades to garner the attention of regulators (prior to disclosure) does not inspire confidence that the Federal Reserve can satisfactorily gauge the amount of leverage or other risks that have accumulated in the amorphous world of global securities and derivatives markets.

That non-traditional monetary policy tools today work similarly to how traditional measures functioned historically is one of the great policy myths of this period. There remains this notion, furthered again by chairman Bernanke, that some quantity of quantitative easing (additional debt purchases/liquidity creation/Fed balance sheet growth) today would equate to, say, a 25 bps point cut in the Fed funds rate 25 years ago. Yet the entire monetary policy transfer mechanism has been radically altered, foremost by the transformation of system Credit expansion from primarily bank loan-driven to one dominated by marketable debt and myriad risk intermediation channels.

Traditionally, central bank stimulus would entail adding reserves into the banking system to effectively reduce the cost of funds, thereby incentivizing additional bank lending. Today, Federal Reserve monetary stimulus is transmitted primarily through incentivizing risk-taking and leveraging in the securities, derivatives and other risk asset markets. We now have about 20 years experience in support of the thesis that there exists a dangerously powerful interplay between activist central banking, marketable debt and financial speculation. Yet the Fed somehow seems to ensure that its analysis avoids addressing the associated risks of an ever-increasing Federal Reserve role in the pricing and trading dynamics of an ever-expanding quantity of securities, derivatives and market speculation.

The media continue with this focus on the timing of the Fed’s QE3 announcement. This now seems archaic. Global central bankers, whether Draghi at the ECB, or the Bernanke Fed, the Bank of England, the Swiss National Bank (SNB), or others, now actively pursue the power of “open-ended” monetary and market support/intervention. No quantification necessary. This escalation to unconstrained monetary stimulus was the motivation for last week’s “Do Whatever it Takes!” Drs. Draghi and Bernanke have done nothing less than to signal to the marketplace that they at any point and to any extent deemed necessary will be there to backstop the markets. Worries – albeit those associated with so-called “exit strategies” or inflation risks – have been completely overshadowed by a resolute determination to avert another global crisis. It may have been subtle; it’s no doubt radical. The Draghi and Bernanke “puts” have been significantly bolstered and manifestly communicated. Sophisticated global speculators operate knowing central bankers are unequivocally determined to quell so-called “tail” risk of illiquid and faltering securities markets.

I know most would today consider this whole line of analysis wacko lunatic fringe stuff. I am, as well, confident that in, say, five or so years’ time analysts will look back at this period and state it was obvious that Fed policy had been fueling a Bubble in Treasury and other securities markets. We’ve seen it all before. Yet with markets rallying strongly over the past month and with heady 2012 gains only mounting, the bullish spirit has triumphed. Talk has turned to a new secular bull market, along with visions of the “American Decade” (and century!). If only Washington would get to work on the fiscal issue, sound economic fundamentals would be free from worry – or so the thinking goes.

I’m the first to admit that it’s easy to dismiss the view that, only a month or so ago, rapidly escalating European debt tumult was at the brink of unleashing the forces of global financial and economic crisis. The path from illiquid Spanish and Italian debt markets and a crisis of confidence in the euro to a more globalized panic was not so difficult to discern: illiquid markets, de-risking/de-leveraging dynamics, capital flight, systemic banking stability issues, derivative and counterparty concerns, hedge fund problems and a resulting abrupt tightening of global financial conditions. Draghi surely believed he had no alternative than to go radical – and now Bernanke and others are as well ready to do whatever it takes.

Let’s return to Risk #3. Global markets have rallied strongly. Those bearishly positioned have been mauled. Risk hedges have been unwound. The speculator community has positioned bullishly around the globe to profit from the latest policy-induced bout of “risk on.” Those betting on the power of the policymaker market backstop have been rewarded and emboldened. What if it doesn’t work? What if policymakers have prodded everyone to one side of the boat - and then it tips? Is policymaking bolstering stability or, rather, exacerbating instability? It is now generally accepted that additional monetary stimulus would have little economic impact. Yet moving toward aggressive “open-ended” market interventions is, understandably, having a major impact on marketplace dynamics. Is financial stability again being unwittingly subverted?

Monetary policy will not resolve deep structural financial and economic issues in Europe – nor in the U.S., Japan, China or elsewhere around the world, for that matter. History informs us that it will likely make things worse. With focus on Jackson Hole, it was easy Friday to miss the widening hole in the Spanish bond market. Spain’s 10-year yields jumped 27 bps to 6.81%, with yields up 45 bps for the week. Spain Credit default swap (CDS) prices jumped 21 bps this week (eight-session rise of 62bps) to an almost one-month high 518 bps. Italian CDS ended the week 12 higher to 467 bps. Curiously, precious metals gained this week while most industrial metals declined. Is this evidence of market players willing to bet on policy-induced currency devaluation, while less convinced that impending monetary stimulus will have much real economic impact?

Draghi clearly has his plan – and his wingman at the Federal Reserve. There may be no turning back. At the same time, the European financial, economic and political issues may very well prove insurmountable. Yet why would the speculator community spend much time fretting the next round of “risk off,” not with global central bankers waiting anxiously with bazookas fully loaded. In the end, I suspect policymakers will regret inciting this particular, potentially unwieldy, phase of “risk on” market speculation and financial mania.

For the Week:

The S&P500 slipped 0.3% (up 11.9% y-t-d), and the Dow declined 0.5% (up 7.2%). The S&P 400 Mid-Caps added 0.1% (up 10.5%), and the small cap Russell 2000 rose 0.4% (up 9.6%). The Morgan Stanley Cyclicals fell 1.2% (up 7.8%), and the Transports sank 2.2% (down 0.2%). The Morgan Stanley Consumer index added 0.2% (up 7.5%), while the Utilities fell 1.0% (down 0.8%). The Banks were little changed (up 19.8%), while the Broker/Dealers increased 0.4% (down 2.5%). The Nasdaq100 slipped 0.2% (up 21.7%), and the Morgan Stanley High Tech index declined 1.0% (up 14.8%). The Semiconductors fell 0.7% (up 8.7%). The InteractiveWeek Internet index declined 1.1% (up 10.1%). The Biotechs dipped 0.4% (up 34.2%). With bullion up $46, the HUI gold index added 0.6% (down 8.1%).

One Treasury bill rates ended the week at 8 bps and three-month closed at 7 bps. Two-year government yields were down 5 bps to 0.22%. Five-year T-note yields ended the week down 12 bps to 0.59%. Ten-year yields fell 14 bps to 1.55%. Long bond yields sank 13 bps to 2.67%. Benchmark Fannie MBS yields sank 17 bps to 2.27%. The spread between benchmark MBS and 10-year Treasury yields narrowed 3 to 72 bps. The implied yield on December 2013 eurodollar futures fell 6.5 bps to 0.41%. The two-year dollar swap spread was little changed at 18 bps, and the 10-year dollar swap spread was little changed at 11 bps. Corporate bond spreads ended mixed. An index of investment grade bond risk increased one to 101 bps. An index of junk bond risk declined 3 to 543 bps.

Debt issuance slowed to a trickle. I saw no domestic investment grade debt or junk issued this week.

Junk bond funds saw inflows rise to $1.17bn (from Lipper).

I saw no convertible debt issued.

International dollar bond issuers included China Oilfield $1.0bn, Trancent Holdings $600 million and Manitoba $600 million.

Spain's 10-year yields jumped 45 bps to 6.81% (up 177bps y-t-d). Italian 10-yr yields rose 14 bps to 5.82% (down 121bps). German bund yields declined 2 bps to 1.33% (down 49bps), while French yields jumped 11 bps to 2.15% (down 99bps). The French to German 10-year bond spread widened 13 bps to 82 bps. Ten-year Portuguese yields declined 3 bps to 8.98% (down 379bps). The new Greek 10-year note yield dropped 46 bps to 22.74%. U.K. 10-year gilt yields fell 6 bps to 1.46% (down 51bps). Irish yields were up 4 bps to 5.77% (down 249bps).

The German DAX equities index was unchanged (up 18.2% y-t-d). Spain's IBEX 35 equities index gained another 1.5% (down 13.4%), and Italy's FTSE MIB rose 1.5% (up 0.1%). Japanese 10-year "JGB" yields declined one basis point to 0.79% (down 20bps). Japan's Nikkei sank 2.5% (up 4.6%). Emerging markets were weak. Brazil's Bovespa equities index fell 2.3% (up 0.5%), and Mexico's Bolsa dropped 2.0% (up 6.3%). South Korea's Kospi index slipped 0.8% (up 4.4%). India’s Sensex equities index fell 2.3% (up 12.5%). China’s Shanghai Exchange dropped 2.1% to a three-year low (down 6.9%).

Freddie Mac 30-year fixed mortgage rates fell 7 bps to 3.59% (down 63bps y-o-y). Fifteen-year fixed rates slipped 3 bps to 2.86% (down 53bps). One-year ARMs were down 3 bps to 2.63% (down 26bps). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed rates down 6 bps to 4.21% (down 68bps).

Federal Reserve Credit declined $7.0bn to $2.804 TN. Fed Credit was down $32bn from a year ago, or 1.1%. Elsewhere, Fed Foreign Holdings of Treasury, Agency Debt this past week (ended 8/29) rose another $4.5bn to a record $3.568 TN. "Custody holdings" were up $147bn y-t-d and $81bn year-over-year, or 2.3%.

Global central bank "international reserve assets" (excluding gold) - as tallied by Bloomberg – were up $422bn y-o-y, or 4.2% to a record $10.575 TN. Over two years, reserves were $2.015 TN higher, for 24% growth.

M2 (narrow) "money" supply dropped $25.7bn to $10.044 TN. "Narrow money" has expanded 6.5% annualized year-to-date and was up 5.7% from a year ago. For the week, Currency increased $2.1bn. Demand and Checkable Deposits fell $23.4bn, while Savings Deposits increased $1.1bn. Small Denominated Deposits declined $2.6bn. Retail Money Funds fell $3.0bn.

Total Money Fund assets slipped $3bn to $2.571 TN. Money Fund assets were down $124bn y-t-d and $71bn over the past year, or 2.7%.

Total Commercial Paper outstanding increased $6.8bn to $1.032 TN. CP was up $73bn y-t-d, while having declined $66bn from a year ago, or down 6.0%.

Currency Watch:

The U.S. dollar index declined 0.5% to 81.208 (up 1.3% y-t-d). For the week on the upside, the Canadian dollar increased 0.6%, the Norwegian krone 0.6%, the euro 0.5%, the Swiss franc 0.5%, the Danish krone 0.5%, the British pound 0.4%, the Japanese yen 0.4%, the Singapore dollar 0.3%, and the Taiwanese dollar 0.1%. On the downside, the New Zealand dollar declined 1.0%, the Australian dollar 0.8%, the Swedish krona 0.3%, the Brazilian real 0.2%, and the Mexican peso 0.1%.

Commodities Watch:

August 30 – Wall Street Journal (Sameer C. Mohindru): “A Taiwan importers' association bought soybeans Tuesday, in what might seem a routine tender. But it wasn't. Instead of buying one cargo of around 60,000 metric tons, as usual, the… Taiwan's Breakfast Soybean Procurement Association bought three, including one not due for shipping until next July. It was the second time in less than a week that a Taiwanese buyer had taken above-average or far-forward amounts. With prices already in uncharted territory and an even tighter market in the future seeming all but inevitable, soybean importers elsewhere having been locking in supplies, too. Prices for wheat and corn are also soaring... But the time bomb ticking under the global soybean trade is potentially more explosive. Corn and wheat can be substituted for one another for many uses—but soymeal substitutes are limited, and even costlier.”

The CRB index increased 1.2% this week (up 1.4% y-t-d). The Goldman Sachs Commodities Index gained 0.7% (up 4.7%). Spot Gold rose 1.3% to $1,692 (up 8.2%). Silver gained 2.4% to $31.44 (up 12.6%). October Crude rose 32 cents to $96.47 (down 2%). October Gasoline jumped 2.1% (up 12%), and October Natural Gas gained 2.4% (down 6%). December Copper declined 0.9% (up 1%). September Wheat added 0.3% (up 33%), while September Corn was little changed (up 24%).

Global Credit Watch:

August 31 – Dow Jones: “German Chancellor Angela Merkel has asked Italian Prime Minister Mario Monti to delay any bailout request for Italy, El Mundo reported… She will ask the same of Spanish Prime Minister Mariano Rajoy when they meet in Madrid next Thursday, the paper added. The reason behind Ms. Merkel's requests is to calm down tensions with the German Bundesbank head Jens Weidmann, who has been vehemently opposing any action from the European Central Bank to buy Spanish or Italian bonds.”

August 31 – Bloomberg (Jeff Black and Jana Randow): “The euro area’s 17 national central bank governors will have about 24 hours to digest European Central Bank President Mario Draghi’s bond-buying proposal before they start debating it, three officials said. The ECB’s Executive Board will send a list of options for the bond-buying program to the governors on Sept. 4, a day before the Governing Council convenes in Frankfurt… The meeting concludes on Sept. 6, after which Draghi holds his regular press conference. No single policy option has emerged as preeminent, the officials said… The lack of a clear preference, the complexity of the issue and the shortage of time increase the risk that Draghi won’t present a detailed plan next week, according to economists at Commerzbank AG and JPMorgan Chase & Co. The ECB may choose to hold back some details of the plan until the German Constitutional Court rules on the legality of Europe’s permanent bailout fund on Sept. 12, two of the officials said.”

August 29 – Financial Times (Miles Johnson, Ralph Atkins and Claire Jones): “Catalonia will request an emergency €5bn credit line from Spain’s central government as the region struggles to refinance its debts, underscoring anxieties about the eurozone debt crisis a week before the European Central Bank is expected to unveil details of its revamped bond-buying programme. The government of Catalonia, which has debts of €42bn and manages an economy as large as Portugal’s, on Tuesday said it would request the aid from Spain’s regional bailout fund. The region has been locked out of capital markets and will become the second of Spain’s 17 autonomous regions to formally request aid from a €18bn government rescue fund. Francesco Homs, spokesman for the regional government, said it would not accept additional political conditions over budgetary measures already agreed with Madrid ‘because the money is Catalan money’ – a stance that risks fostering further tension with Spain’s central government after Catalonia boycotted a meeting to set regional budgets in late July.”

August 31 – Bloomberg (Angeline Benoit): “Catalonia’s credit rating was cut to junk by Standard & Poor’s after Spain’s most indebted region said it needs to tap a national rescue fund, even as the central government said its budget deficit swelled to 48.5 billion euros ($61bn) in the year through July. The cash-strapped national government in Madrid also moved today to inject capital into the Bankia group ‘immediately’ after the nationalized lender posted a 4.45 billion-euro first- half loss.”

August 30 – Bloomberg (Angeline Benoit): “The Spanish region of Murcia became the third to say it will need emergency loans, and Valencia signaled it needs funds to cover current and past overspending, adding fiscal pressure on Prime Minister Mariano Rajoy. A day after Catalonia said it needed 5 billion euros ($6.3bn) from an 18 billion-euro bailout fund announced by Rajoy last month, an official in southeastern Murcia yesterday put its needs at 700 million euros. In Valencia… 3.5 billion euros would cover only current needs… The country’s regions risk overwhelming a plan to tackle the euro area’s third-biggest budget deficit. They were responsible last year for most of Spain’s overspending, which remained nearly unchanged from 2010 at 8.9% of gross domestic product… Together with Murcia, Valencia and Catalonia, Spain’s two most indebted regions, aim to use more than half of Rajoy’s last bailout fund, created to enable regions to face bond redemptions and finance their deficits in the second half. ‘Everything depends on Andalusia now,’ said Juan Rubio- Ramirez, an economist at Duke University in Durham, North Carolina. ‘If Andalusia asks for aid, it could be a similar amount to Catalonia and that means the fund may not be enough.’ Rubio-Ramirez co-authored a report this month forecasting the regions may run deficits as high as 4% of GDP this year, compared with 3.3 percent last year and a target of 1.5% for 2012.”

August 27 – Bloomberg (Angeline Benoit): “Spanish Prime Minister Mariano Rajoy’s austerity drive will intensify this week as a sales-tax increase tightens the squeeze on consumers whose spending is already plummeting. The move to raise the value-added tax on Sept. 1 will follow a flurry of data showing pressure building on household finances in the euro area’s fourth-biggest economy, home to a third of its unemployed. A report today showed mortgages fell 25.2% from a year ago in June after a 30.5% drop in May. Meanwhile, the Health Ministry… said spending on prescription drugs fell 23.9% from a year ago in July… after the government last month increased the share patients pay for pharmaceuticals.”

August 29 – Reuters (Carlos Ruano and Jesús Aguado): “Nationalised lender Bankia is expected to post first-half losses of more than 4 billion euros (3bn pounds) on Friday, highlighting the need for capital from a European rescue of Spanish banks that is unlikely to arrive before the end of September. Bankia was taken over by the government in May when it asked for 19 billion eurosof state aid after anticipating the steep losses from real estate investments which soured after the property market crashed four years ago.”

August 31 – Bloomberg (James G. Neuger): “Countering arguments made by the German economics establishment since before the introduction of the euro, European Central Bank President Mario Draghi said it’s in Germany’s interest to consent to extraordinary steps to preserve the currency shared by 17 nations. Draghi used the… German weekly Die Zeit to plead for a more expansive role for the central bank and to say that the crisis-struck currency can be stabilized without sacrificing each country’s independence to a unified European political system. In tactical terms, Draghi sought to neutralize protests made by Germany’s top central banker, Jens Weidmann…”

August 27 – Bloomberg (Fred Pals): “Dutch caretaker Prime Minister Mark Rutte, seeking a return to power after Sept. 12 elections, said he would block a third aid package for Greece and defended austerity as the only way out of Europe’s debt crisis. ‘We’ve helped twice and now it’s up to the Greeks to show that they want to stay within the euro,’ Liberal leader Rutte, 45, said… ‘The Netherlands has been severely hit by the debt crisis and the solution is to lower taxes, get government finances in order and make room for investment.’”

August 30 – Bloomberg: “Chinese Premier Wen Jiabao told visiting German Chancellor Angela Merkel that Spain, Italy and Greece must take ‘comprehensive measures’ to prevent a worsening of the euro region’s sovereign-debt crisis. ‘The main worries are two-fold: First is whether Greece will leave the euro zone,’ Wen said… ‘The second is whether Italy and Spain will take comprehensive rescue measures. Resolving these two problems rests with whether Greece, Spain, Italy and other countries have the determination for reform.’”

Global Bubble Watch:

August 31 – Bloomberg (Sarika Gangar): “Sales of corporate bonds globally surged to the most on record for August as issuers rushed to lock in record-low borrowing costs. Siemens AG, Europe’s largest engineering company, and JPMorgan Chase & Co. led borrowers selling $237.6 billion of debt this month, exceeding the $235.3 billion raised in August 2010… Yields fell to an unprecedented low of 3.72% on Aug. 28…”

August 29 – Financial Times (Kandy Wong): “China’s top banks are stepping up their lending activities in the US as large US companies diversify their funding sources and seek to penetrate more deeply into the world’s second-largest economy. Chinese banks’ share of US syndicated lending has risen to 6.1% of the total market so far in 2012, up from 5.1% last year, according to data from Dealogic. So far this year, the total value of syndicated loans from Chinese banks into the US has reached $51bn.”

Germany Watch:

August 28 – MarketNews International: “The European Central Bank will be overextended and no longer able to fulfill its price stability mandate if it engages in more sovereign bond buys, former ECB Executive Board member Juergen Stark wrote in an editorial for German daily Handelsblatt… Stark, who resigned from the ECB in 2011, in large part because of the original SMP bond-buying program, said restarting such a program would lead to inflation dangers down the road and further erode the ECB's political independence. Stark accused the ECB Governing Council members from southern peripheral Eurozone countries of trying to use the ECB to achieve national interests. He said bond buys were ‘hardly’ relevant for monetary policy and instead amounted to ‘de facto’ state financing. ‘The role, which the ECB appears prepared to take on, will over-extend the central bank and further erode its independence from politics. And in the end, the central bank will no longer be able to perform its core task, guaranteeing price stability,’ Stark wrote.”

European Economy Watch:

August 31 – Bloomberg (Jim Brunsden and Rebecca Christie): “The European Central Bank would have the sole power to grant banking licenses under proposals to give it supervisory powers and build a euro-area banking union, a European Union official said. The ECB would have a monopoly on granting all bank licenses within the 17-nation euro area under the plan, due to be unveiled on Sept. 12, the official said, speaking on condition of anonymity… the ECB would also gain discretion over which banks to supervise directly and when it will delegate day-to-day oversight responsibilities, the official said. National regulators will retain control over when and how to close a bank under the proposals. At the same time, the central bank would be able to make recommendations and have a voice in the process.”

August 28 – Bloomberg (Angeline Benoit): “Spain’s recession worsened in the second quarter as the government’s austerity push to reduce the euro area’s third-biggest budget deficit and a slump in consumer spending offset growth in exports. Gross domestic product fell 0.4 percent from the previous quarter, when it declined 0.3%... ‘We fear that things are likely to get worse before they get better,’ said Martin van Vliet, an economist at ING Bank in Amsterdam… ‘With much more fiscal austerity in the pipeline and unemployment at astronomic highs, the risks are clearly tilted toward a more protracted recession.”

August 30 – Bloomberg (Angeline Benoit): “Spanish inflation accelerated more than economists forecast in August as the government stepped up efforts to plug the euro region’s third-largest budget deficit amid a worsening recession. Consumer prices… rose 2.7% from a year earlier after an annual gain of 2.2% in July…”

August 29 – Bloomberg (Stefan Riecher): “German inflation accelerated more than economists forecast in August on higher energy costs. The inflation rate, calculated using a harmonized European Union method, rose to 2.2% from 1.9% in July…”

August 31 – Bloomberg (Chiara Vasarri and Tommaso Ebhardt): “Giovanni Cimmino filled up his Fiat Multipla in Croatia before returning to Italy after his summer holiday, avoiding Europe’s highest gasoline prices. ‘You need a smart strategy to save on gas,’ said Cimmino, 37, who manages a metals trading company near Milan. With pump prices at a record in Italy, ‘I tend to use more public transportation and avoid driving when it’s not necessary.’ Unleaded fuel has climbed to more than 2 euros ($2.50) a liter, about $9.50 a gallon, in some areas of Italy…”

August 28 – Bloomberg (Jana Randow): “Lending to households and companies in the 17-nation euro area increased for the first time in three months in July after European leaders committed to new measures to solve the debt crisis. Loans to the private sector rose 0.1% from a year earlier after dropping an annual 0.2% in June… Lending increased 0.3% from June, the first gain since January.”

China Watch:

August 31 - South China Morning Post (Teddy Ng): “Premier Wen Jiabao voiced his fears about the European debt crisis yesterday after a meeting with visiting German Chancellor Dr Angela Merkel. ‘The European debt crisis has continued to worsen, giving rise to serious concerns in the international community. Frankly speaking, I am also worried,’ Wen said. ‘The main worries are two-fold. First is whether Greece will leave the euro zone, and the second is whether Italy and Spain will ask for comprehensive rescue measures.’ He called on Greece, Spain and Italy to embrace budget cuts and other reforms to restore confidence in the fragile euro zone.”

August 28 – Bloomberg: “China’s corporate bonds are set for their first monthly loss this year as more than half of issuers reported profit growth slowed. Company debt in the world’s second-biggest economy has lost 0.8% in August, paring gains for the year to 3.6% compared with 6.4% in 2011… Issuance has increased 53% in 2012 from the year earlier, weighing on demand… Among listed issuers, 55% said profit fell from a year earlier and 9% reported losses, according to China International Capital Corp…. ‘The whole economy is slowing, which is obviously leading to a decline in company profits,’ and putting pressure on bond returns, said Fan Wei, a fixed-income analyst at Hongyuan Securities Co…. Premier Wen Jiabao has encouraged companies to sell debt to replace state-owned bank loans. Corporate bonds accounted for a record amount of total financing in the economy in July… Issuance of the securities has jumped to 2.3 trillion yuan this year from 1.5 trillion yuan for the same period last year…”

August 27 – Bloomberg: “Chinese industrial companies’ profits fell in July by the most this year, a government report showed today, adding to evidence the nation’s economic slowdown is deepening. Income dropped 5.4% last month from a year earlier to 366.8 billion yuan ($57.7bn), the fourth straight decline… That compares with a 1.7% slide in June and a 5.3% drop in May.”

August 29 – Bloomberg: “Health-care spending in China will almost triple to $1 trillion annually by 2020 driven by an aging population and government efforts to broaden insurance coverage, according to a McKinsey & Co. report… China will spend more on drugs, medical devices and hospital treatments as it lifts spending to 7% of gross domestic product, from 5.5%, or $350 billion, in 2010, McKinsey said. This will make it the biggest market globally by 2020 after the U.S., which in 2009 spent $2.5 trillion, or 17.6% of its GDP, on health care…”

Japan Watch:

August 31 – Bloomberg (Andy Sharp and Toru Fujioka): “Japan’s consumer prices slid at a faster pace in July and industrial production unexpectedly slumped, raising the danger that the world’s third-largest economy has slipped back into a contraction. The benchmark price gauge, which excludes fresh food, fell 0.3% in July from a year before, putting the central bank’s 1% inflation goal further from reach… Industrial output fell 1.2%. A private measure of manufacturing for August was the lowest since the aftermath of the record March 2011 earthquake.”

U.S. Bubble Economy Watch:

August 28 – Reuters (Carlos Ruano and Jesús Aguado): “America’s 50 state governments owe $4.19 trillion, including outstanding bonds, unfunded pension commitments and budget gaps, according to a new report. At $617.6 billion, California had by far the biggest total debt, more than twice the total of No. 2, New York, with $300.1 billion owed, according to State Budget Solutions, a research and non-partisan advocacy group.”

August 27 – Bloomberg (Shobhana Chandra and Sandrine Rastello): “The worst U.S. drought in at least 50 years may restrain consumer confidence and spending as it pushes Americans’ grocery bills higher later this year. Food prices will increase an average 4% annual rate in the nine months ending June 2013, up from 1.5% currently, said Michael Feroli, chief U.S. economist at JPMorgan… That may trim real disposable incomes by 0.3 percentage point from the fourth quarter of 2012 through the first half of next year and reduce spending by a similar amount, he estimates. The projected food-price increase will squeeze budgets of households already contending with a 13% gain in gasoline prices since early July and unemployment that is stuck above 8% three years into the economic recovery… ‘Energy is hitting us now, food is going to hit us later,” Feroli said. ‘It will be a headwind for consumers. It’s going to damp people’s perceptions of the economy.’”

August 29 – Wall Street Journal (John D. McKinnon and Scott Thurm): “More big U.S. companies are reincorporating abroad despite a 2004 federal law that sought to curb the practice. One big reason: Taxes. Companies cite various reasons for moving, including expanding their operations and their geographic reach. But tax bills remain a primary concern. A few cite worries that U.S. taxes will rise in the future, especially if Washington revamps the tax code next year to shrink the federal budget deficit."

Central Bank Watch:

August 31 - Wall Street Journal (Jon Hilsenrath): "Fed Chairman Ben Bernanke wasn't expecting he would have to make another speech like the one he will deliver here Friday. A few months ago the Federal Reserve seemed to be on cruise control as the economy healed. Many officials at the central bank hoped they were done with launching complicated programs to spur a sluggish economy. But Mr. Bernanke and his colleagues, once again disappointed by slow growth and small employment gains this year, are formulating another new dose of monetary stimulus to be considered at their next policy meeting... Mr. Bernanke has argued that when the Fed buys long-term Treasury securities or mortgage bonds, it pushes down long-term interest rates and pushes up prices of assets such as stocks. Fed officials also believe the purchases help weaken the dollar."

August 31 – Bloomberg (Joshua Zumbrun and Jeff Kearns): “Federal Reserve Chairman Ben S. Bernanke, lamenting the suffering caused by unemployment of more than 8% and defending his unprecedented actions, made the case for further monetary easing. ‘The costs of nontraditional policies, when considered carefully, appear manageable, implying that we should not rule out the further use of such policies if economic conditions warrant,’ Bernanke said… Bernanke, speaking two weeks before the next meeting of the Federal Open Market Committee, emphasized that a new round of bond purchases is an option. Stocks and Treasuries climbed and the dollar weakened to a more than three-month low as investors speculated steps to boost the economy may come as soon as next month. ‘The door is wide open to the Fed contemplating additional action,” said Josh Feinman, a former Fed senior economist who helps oversee $219 billion at Deutsche Bank AG’s asset management unit in New York. ‘It reaffirms other messages sent by the Fed that additional action is still very much on the table. By the end of the year we’ll probably get both rate guidance extension and more asset purchases.’”

Muni Watch:

August 29 – Bloomberg (Michelle Kaske): “Illinois, which has the worst-funded pension system among U.S. states, had the rating on its general-obligation debt cut one level to A by Standard & Poor’s and may face more downgrades. The change followed state lawmakers’ failure to agree to reduce retirement costs during a special session Aug. 17. The outlook for the fifth-most populous state’s debt, which now has S&P’s sixth-highest grade, is negative. California, with an A- ranking, one level below Illinois, remains S&P’s lowest-rated state.”