THINGS THAT MAKE YOU GOHmmm.....A walk around the fringes of finance

05 August 2012 1

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"Living on a time we have to borrowThe expectations getting higher and higherBut I don’t wanna wait no more and I don't wanna stay here

Stop the world I want to get offAnd find myself a better rideStop the world I want to get offPayed in full and now goodbyeStop the world I want to get offAnd find myself a better ride”– GORKY PARK, STOP THE WORLD (I WANNA GET OFF)

"I am an obsessive rewriter, doing one draft and then another and another, usually five. In a way, I have nothing to say, but a great deal to add”– GORE VIDAL

“I miss the sane

days when only

crazy people bought g

old”

– Dave Collum

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The 174-room Algonquin Ho-tel is situated at 59 West 44th street in Manhat-

tan. It was opened in 1902 and is des-ignated as a New York City Historic

Landmark. Originally conceived as an apartment hotel in the grand

New York style of the era, the owner, Frank Case, failed

to sell enough long leases and decided to turn it into a regular hotel which he intended to name ‘the Puritan’.

thankfully, after dis-covering the first inhab-

itants of West 44th street were in actual fact the Al-

gonquin tribe (admittedly this was before street signs), Case

decided to rename the hotel the Algonquin. History would cast this

decision in a very favourable light.

there are many idiosyncrasies that sep-arate the Algonquin from the rest of the hotel world, amongst which is the tradition that has been in place since the 1930s whereby a ‘hotel cat’ has been given free reign throughout the property; a practice that originated the day Case took in a stray:

(Wikipedia): Hotel lore says actor John Bar-rymore suggested the cat needed a theatri-cal name, so he was called Hamlet. Decades later, whenever the hotel has a male he car-ries on the name; females are named Matil-da. The current Algonquin cat, a Matilda, is a Ragdoll that was named 2006 cat of the year at the Westchester (New York) Cat Show. Vis-itors can spot Matilda on her personal chaise longue in the lobby; she can also be found in her favorite places: behind the computer on the front desk, or lounging on a baggage cart. The doormen feed her and the gen-eral manager’s executive assistant answers Matilda’s e-mail. During 2011, Matilda was temporarily confined to upper floor or to the limits of a leash tethered to the check-in

desk, due to a directive from the city Depart-ment of Health. As of late 2011, Matilda has been confined to the non-food areas of the lobby by an electronic pet fence.

But more than a decade before the original Ham-let took residence at the Algonquin, another tra-dition was begun when Dorothy Parker, Robert Benchley and Robert E. sherwood—Vanity Fair writers all—began meeting for lunch daily in the Rose Room. this gathering quickly expanded to include many literary figures, actors and jour-nalists of the day (this was a time when a daily luncheon was an integral part of the routine—somewhat akin to the City of London until the late 1990s). Amongst the glitterati that attend-ed these gatherings regularly were george s. Kaufman, F. scott Fitzgerald and Ernest Heming-way. It was this august body that founded the New Yorker Magazine (a publication which is, in-cidentally, given free of charge to all hotel guests to this day).

Legend tells of one such lunch at which Heming-way was present along with several writers of the day during which a discussion on the skill of concise story-writing evolved to the point that a wager was made.

Hemingway bet $10 of his own against each $10 stake of his companions that he could write a six-word-long short story. six words that would contain a beginning, a middle and an end. the wager was duly accepted by all and one of the more junior members dispatched to fetch drinks for the bon vivants gathered at the Round table.

Hemingway took a napkin and scribbled six words upon it which he then presented to the group. It read simply:

“For sale: Baby shoes. Never worn.”

Wager won. Brilliantly.

I was reminded of this tale a few days ago as I listened to the words of Mario Draghi and the immense amount of speculation surrounding his incendiary words last week at a nondescript event in London. Draghi was making unpre-pared remarks—which is always dangerous in

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a position such as his—and yet markets, bereft of optimism, ripped the words from his lips and clutched them feverishly to their collective bo-som in the hope that this, finally, was the water-shed Europe had been waiting for.

this week saw statements released by both the Federal Reserve Open Market Committee and the ECB and, as is the norm when these pro-nouncements are made, every word is scruti-nized for the tiniest clue as to future action.

One can’t help but wish for Hemingway-like brevity from these clowns, but such a flight of fancy is akin to great Britain’s chances of top-ping the medals table at the London 2012 Olym-pics; a beautiful dream, but one that will never, ever, EVER come true.

Before we get to the nitty gritty (such as it was) of this week’s events, however, a little expansion on my thoughts in the last things that Make You go Hmmm..... about Draghi’s comments in Lon-don late last week.

The innocuously-titled Global Investment Conference in London on June 26th hardly seemed likely to generate headlines around the globe until ECB governor, Mario Draghi stepped to the podium to give a speech for which there was no pre-prepared tran-script—indicating decisively that these remarks were very much ‘off-the-cuff’ and definitely NOt approved ECB policy.

Draghi began by compar-ing the Euro, rather curi-ously, to a bumble bee:

(ECB): The euro is like a bumblebee. This is a mystery of nature because it shouldn’t fly but instead it does. So the euro was a bumblebee that flew very well for several years. And now – and I think people ask “how

come?” – probably there was something in the atmosphere, in the air, that made the bumblebee fly. Now something must have changed in the air, and we know what after the financial crisis. The bumblebee would have to graduate to a real bee. And that’s what it’s doing.

Fair enough, Mario. Personally, I would have opted perhaps for a duck-billed platypus or even Frankenstein’s monster, but, at the risk of mixing my metaphors, we’ll run with the bee.

the next part of Draghi’s speech was where the fun began:

(ECB): The first message I would like to send, is that the euro is much, much stronger, the euro area is much, much stronger than peo-ple acknowledge today. Not only if you look over the last 10 years but also if you look at it now, you see that as far as inflation, employ-ment, productivity, the euro area has done either like or better than US or Japan.

Classic Central Bank jawboning there; Ben would be proud. Mario was telling the world something it can plainly see is absolutely not true in such certain terms as to make those paying attention think for a brief second that maybe, just maybe, they are mistaken.

Mario, the euro is NOt strong. Really. It isn’t.

Euro vs USD

SOURCE: BLOOMBERG

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As for the Eurozone, that may well be stronger than people acknowledge (though recent data would suggest that perhaps it isn’t as strong as YOu acknowledge), but the same problem re-mains: however strong the Eurozone is right now, it is forever basically one poor decision by either its leaders, the ECB or a combination of the two away from total implosion and, I am afraid to have to tell you, Mario, you guys have hardly given us cause to think that perhaps you’ll all sail through this without making one.

But back to the speech.

Leaving aside inflation which, as we all know is amongst the most easily-manipulated of govern-ment statistics, it’s hard to make a case for the Eurozone’s employment picture being anything other than dire, quite frankly as the chart be-low demonstrates. the chart shows unemploy-ment rates in the Eurozone, greece, spain, Italy and France since 1991. Yes, Picking greece and spain was easy, which is why I included France and Italy, but the key line is the purple line; total Eurozone unemployment. Helpfully, five days af-ter Draghi’s bullish assessment of the unemploy-ment situation in Europe, Eurostat were kind enough to publish the latest numbers:

(Eurostat): The euro area (EA17) seasonally-adjusted unemployment rate was 11.2% in June 2012, stable compared with May. It was

10.0% in June 2011. The EU271 unemploy-ment rate was 10.4% in June 2012, also sta-ble compared with May. It was 9.5% in June

2011.

Eurostat estimates that 25.112 million men and women in the EU27, of whom 17.801 million were in the euro area, were un-

employed in June 2012. Compared with May 2012, the number of persons unemployed in-creased by 127 000 in the EU27 and by 123 000 in the euro area. Compared with June 2011, unemployment rose by 2.165 million in the EU27 and by 2.024 million in the euro area...

Compared with a year ago, the unem-ployment rate fell in seven Member States, increased in nineteen and re-mained stable in Sweden.

the New York times weighed in:

(NY Times): Unemployment in the countries that use the euro re-mained at a record high in June, official fig-ures showed Tuesday, underlining the de-bilitating effect of Europe’s continuing debt crisis on its economy.

With the European econo-my paying the price for an acute lack of business confi-dence, hopes are high that the president of the Euro-pean Central Bank, Mario Draghi, will follow through on his pledge, made in Lon-don last week, to do “what-ever it takes” to preserve the euro.

“We and the rest of Europe are approaching the end of the tunnel,” Mr. Monti said.

“... We and the rest of Europe are approaching the end of the tunnel” - Mario Monti”

SOURCE: BLOOMBERG

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Draghi then moved swiftly onwards in his com-parison of the Eurozone to those two other deadbeats, Japan and the usA to talk about debt and deficits:

(ECB): Then the comparison becomes even more dramatic when we come to deficit and debt. The euro area has much lower deficit, much lower debt than these two countries. And also not less important, it has a balanced current account, no deficits, but it also has a degree of social cohesion that you wouldn’t find either in the other two countries.

Ok Mario, I’ll score you a point for a favourable comparison against Japan—the most debt-rid-den nation in history—and the usA—owners of the world’s reserve currency and inveterate money-printers, but did you really just talk about the degree of social cohesion that is present in Europe that you won’t find in Japan?

(UK Daily Telegraph, November 2011): The [Japanese] government has launched a na-tionwide “Warm Biz” campaign, calling on the public to resist the temptation to turn the heating up as temper-atures fall.

The indications are that this winter may be a particularly cold one in Japan, with the sea-son’s first snowfall in the northern prefecture of Hokkaido recorded on October 2, some 20 days earlier than usual and the earliest since 1898.

The Environment Ministry is encouraging people to limit their use of air conditioners and heaters by setting room temperatures at offices and in homes no higher than 20 de-grees Centigrade (68F).

Officials are also suggesting that people wear more layers of clothing and eat food that will be both filling and warming, such as meals containing root vegetables.

The campaign comes on the heels of the gov-ernment’s “Cool Biz” effort, which was insti-tuted in the summer of 2005 and encouraged

office workers to replace their stiff suits and ties with loose shirts and more casual outfits.

(Associated Press): Spanish police fired rub-ber bullets and charged protestors in central Madrid early Friday at the end of a huge demonstration against economic crisis mea-sures.

The protest was one of over 80 demonstra-tions called by unions across the county against civil servant pay cuts and tax hikes which drew tens of thousands of people, in-cluding police and firefighters wearing their helmets.

“Hands up, this is a robbery!” protesters bel-lowed as they marched through the streets of the Spanish capital.

At the end of the peaceful protest dozens of protestors lingered at the Puerta del Sol, a large square in the heart of Madrid where the demonstration wound up late on Thurs-

day.

Some threw bottles at police and set up barriers made up of plastic bins and cardboard boxes in the middle of side streets leading to the square and

set them on fire, sending plumes of thick smoke into the air.

Riot police then charged some of the protes-tors, striking them with batons when they tried to reach the heavily-guarded parlia-ment building.

social cohesion, you say? OK. Moving on...

Draghi then explained how much things had improved during the preceding six months and how much better the entire world is today. No, he really did, look:

(ECB): ...the second message I would like to send today, is that progress has been ex-traordinary in the last six months. If you com-pare today the euro area member states with six months ago, you will see that the world is entirely different today, and for the better.

“... the second message I would like to send today, is that prog-ress has been extraordinary in the last six months”

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I...how...what are...that must be some good stuff you’re...aren’t they... oh what’s the point?

On we go.

the next few minutes went something like this:

Blah blah blah...progress...blah, blah, blah...structural reform...blah, blah, blah...complex process...blah, blah, blah...the last summit was a real success.

then Mario dropped the hammer on the mar-kets with the words that caused the violent up-ward moves in the Euro and peripheral debt as well as equity markets in the days that followed. this is what he said, verbatim:

(ECB): When people talk about the fragility of the euro and the increasing fragility of the euro, and perhaps the crisis of the euro, very often non-euro area member states or lead-ers, underestimate the amount of political capital that is being invested in the euro.

And so we view this, and I do not think we are unbiased observers, we think the euro is irre-versible. And it’s not an empty word now, be-cause I preceded saying exactly what actions have been made, are being made to make it irreversible.

But there is another message I want to tell you.

Within our mandate, the ECB is ready to do whatever it takes to preserve the euro. And believe me, it will be enough.

“Believe me, it will be enough”

Boom!

By making this speech, (you can read the full, official transcript HERE if you are so inclined) Draghi backed himself into the tightest of cor-ners ahead of the ECB meeting which would fol-low a week later so let’s think for a second about the implications of what he said.

What is ‘enough’?

Well, in order to provide a long-term solution to the problems facing the Eurozone, ‘enough’

is basically trillions of freshly-printed Euro notes and a fiscal union to provide common backing for individual debts.

that’s it. Nothing else will do at this stage.

so Draghi, essentially, promised the world the debt union European leaders have thus far man-aged to avoid putting in place due largely to the objections of Frau Merkel and the Bundesbank (represented latterly by Jens Weidmann after such proposals led to the resignation of its for-mer head, Axel Weber).

It struck me as odd at the time that, if such an agreement HAD been put in place, it would be announced to the world at a small investment conference in London and not at a triumphant press conference accompanied by a million flashbulbs and the tawdry sight of Hol-lande and Monti climbing over each other to be given the lion’s share of the credit for ‘saving’ Europe. Was Frau Merkel really likely to allow Draghi to tell the german electorate that they’d better get their checkbooks out? Hardly.

CLICK TO ENLARGE SOURCE: THE BASIS POINT

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We’ll get to last thursday’s eagerly-antic-ipated ECB announcement from Draghi shortly, but before that, the FOMC minutes were re-leased on Wednesday and, once again, the night before their dissemination, hopes were high af-ter Fed mouthpiece-in-chief, Jon Hilsenrath coin-cidentally popped-up in the Wall street Journal:

(WSJ): The Fed could unveil a new program for buying mortgage or government securi-ties to bring down long-term interest rates, or take other actions to spur growth, or sim-ply promise to do more later if necessary. Of-ficials might wait until September, when they will formally update their economic fore-casts, before deciding anything significant.

When reached for a comment on Hilsenrath’s article and the FOMC’s strategy, the cast of the Broadway musical, ‘West side story’ had this to say:

the bottom line? Minor language changes (see side-by-side comparison, previous page) a whole lot of poring over every nuanced detail but, ul-timately, no action. Just hints of further action. Maybe.

I’m no Hemingway (as if you needed telling) and six words is a stretch, so hopefully you’ll allow me eight when attempting to shorten the FOMC minutes:

“Help needed urgently. One bullet left. Mustn’t waste”

Which brings us nicely on to thursday, and the most eagerly-awaited ECB press conference since...well, the last one.

Hopes were high going in that this time—surely this time—Draghi was going to back up his promises from the previous week and do ‘enough’.

(Economist): At the press conference fol-lowing the council’s meeting attention then turned to what Mr Draghi had to say. Once again there was some disappointment—stockmarkets fell—with the fact that he did not follow through his remarks in London with concrete action. Instead he sketched out a plan under which the bank would play its part along with the euro area’s rescue funds together with undertakings by govern-ments—most likely Spain and Italy—to carry out reforms and get their public finances back into shape.

Under the plan, beleaguered governments in southern Europe would request help from either the European Financial Stability Facil-ity (EFSF), the temporary rescue fund, or the European Stability Mechanism (ESM), the permanent but not yet operational fund. That help would be granted only if the gov-ernments complied with conditions. It would take the form of the fund buying their debt when they borrow (primary issuance), some-thing the ECB cannot do because monetary financing of deficits is banned. The ECB, for its part, would buy government bonds in the secondary market, restarting its Securities Markets Programme (SMP) which has been inactive since early March after making pur-chases worth over €200 billion ($245 billion) from May 2010 when it was established.

Could be! Who knows?

There’s something due any day; I will know right away,

Soon as it shows. It may come cannonballing down through the

sky, Gleam in its eye, Bright as a rose!

Who knows? It’s only just out of reach,

Down the block, on a beach, Under a tree.

I got a feeling there’s a miracle due, Gonna come true,

Coming to me!

Could it be? Yes, it could. Something’s coming, something good,

If I can wait! Something’s coming, I don’t know what it is,

But it is Gonna be great!

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Mr Draghi also indicated that he was ready to deal with one of the main worries markets have had about the ECB buying bonds again: that it could backfire because bondholders would fear subordination. This fear arose after the central bank insisted that it should not participate in the swingeing restructur-ing of Greek government debt in March. He said today that if the ECB were to carry out market purchases under the plan “the con-cerns of private investors about seniority will be addressed”.

the lack of concrete action by Draghi seemed to catch markets by surprise and, as the chart below demonstrates, spanish 10-year bonds in-stantaneously gave back most of the gains they had made in the aftermath of his “believe me” speech, but whether through masterful manipu-lation of the press or the use of the Jedi Mind trick, the analysis that followed over the next 24 hours hinted that Draghi may just have the ker-nel of a plan that may just be workable and may just save the euro. Possibly.

Ambrose Evans-Pritchard of the uK Daily tele-graph was amongst the first to accentuate the positive in a blog post titled ‘Draghi Delivers’:

(UK Daily Telegraph): Wow, the ECB really is preparing to hit the nuclear button.

Mario Draghi has activated the ECB’s mon-etary policy, risk, and market committees to draw up drastic plans.

This will include open-market operations – ie bond purchases – that may be “unlimited” and may be “unsterilized” (ie QE net stimu-lus).

The missile is being loaded. The launch trig-ger is being cocked (if you cock such things).

Markets have tanked because they don’t get instant gratification, but I rather suspect that they have missed the point.

All this can only happen when the EFSF/ESM bail-out funds are activated by governments, because only they have the power to force supplicant states to sign a Memorandum and give up fiscal sovereignty.

That is the famous “conditionality” demand-ed by the Teutonic bloc and on which the whole package hinges.

Over to you, Mariano Rajoy. Now you must fall on your political sword, sacrifice your ca-reer for the EMU cause, and request a formal rescue for Spain to set this whole process in motion.

Suerte, Caballero.

the reason for Ambrose’s somewhat unchar-acteristic burst of enthusiasm? this piece of Draghi’s statement:

(ECB): As implementation takes time and fi-nancial markets often only adjust once suc-

cess becomes clearly visible, governments must stand ready to activate the EFSF/ESM in the bond market when exceptional financial market circumstances and risks to financial stability exist – with strict and effective conditionality in line with the es-tablished guidelines. The adherence of governments to their commitments and the fulfilment by the EFSF/ESM of their role are necessary conditions [for some action on the ECB side]. The Governing Council, within its mandate to maintain price sta-bility over the medium term and in obser-vance of its independence in determining monetary policy, may undertake outright

“Believe Me”

Spain 10-Yr Yield

“I Got Nuthin’ For Ya”

SOURCE: BLOOMBERG

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open market operations of a size adequate to reach its objective. In this context, the concerns of private investors about seniority will be addressed. Furthermore, the Govern-ing Council may consider undertaking further non-standard monetary policy measures ac-cording to what is required to repair mon-etary policy transmission. Over the coming weeks, we will design the appropriate mo-dalities for such policy measures”.

When asked to comment on Draghi’s statement, the cast of the Broadway musical Chicago had this to say:

Now I have a huge amount of respect for Am-brose and I value his opinions highly, but I have to say this smacks of yet more ‘promises’ de-signed to buy time.

the stakes are sO high now that, based on ex-perience to date, there is a very real chance that the Eurocrats misjudge this situation one last,

fatal time and presume they will be given all the time they need to put the fix in. Can they do it, finally, after all this time?

the Economist, looking at what might go wrong, remains skeptical:

(Economist): But will the plan really work? There are a number of potential pitfalls. First, the German constitutional court is currently considering whether the ESM is consistent with the German constitution. That judg-ment will not be passed until September 12th, so even if it is favourable there could be a delay until then, since the EFSF has already committed much of its firepower (including most recently funds to support Spain’s bank-ing bail-out).

Second, a small creditor county in northern Europe may throw a spanner in the works. Finland’s government in particular is wary of using the rescue funds to purchase bonds and is now calling for real guarantees such as public property if they are used in the pri-mary market. That could be a bitter pill for a government in southern Europe to swallow: not the least of the difficulties in making the plan fly is the reluctance of proud Spain to request help beyond the aid it has already se-cured for its banks.

And third, Mr Draghi has to reckon with opposition from the German Bundesbank, which forms part of the Eurosystem along with the other national central banks and the ECB. The “Buba” has from the outset been neuralgic about bond-buying, which it re-gards as blurring the lines of fiscal and mon-etary policy. Jens Weidmann, its president, may have only one vote on the 23-strong ECB governing council, but in remarks pointedly published on the Bundesbank’s website this week, he said that “we are the largest and most important central bank in the Eurosys-tem and we have a greater say than many other central banks in the Eurosystem”.

Backing up words with more words is always a problem, particularly when there are so

Give ‘em the old razzle dazzleRazzle Dazzle ‘em

Give ‘em an act with lots of flash in itAnd the reaction will be passionate

Give ‘em the old hocus pocusBead and feather ‘em

How can they see with sequins in their eyes?

Give ‘em the old flim flam flummoxFool and fracture ‘em

Give ‘em the old double whammyDaze and dizzy ‘em

Back since the days of old MethuselahEveryone loves the big bambooz-a-ler

Give ‘em the old three ring circusStun and stagger ‘em

When you’re in trouble, go into your dance

Give ‘em the old Razzle DazzleRazzle dazzle ‘em

Show ‘em the first rate sorceror you areLong as you keep ‘em way off balanceHow can they spot you’ve got no talent

Razzle Dazzle ‘emAnd they’ll make you a star!

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many moving parts, as in the euro area. In an ominous sign, Spanish 10-year bond yields climbed back above 7%. Now they know what Mario really meant, the markets may remain unconvinced until his plan actually takes off.

It boils down to this:

Draghi has potentially opened the door to pro-viding bailout funds to spain and, po-

tentially Italy, on the proviso that they formerly request a bailout and submit themselves to being put in ‘a program’. this is what the excite-ment is all about.

However, you’ll have to colour me skeptical because, as the last several years have proven beyond all rea-

sonable doubt, getting anything agreed and then implemented

in Europe is a task that sisyphus himself would likely call ‘somewhat tricky’. In fact, the cast of the Broadway musical ‘Man of La Mancha’ de-scribed it thus this week during a break from re-hearsals:

Remember late-2010? When spain wasn’t a problem, but merely a potential problem? I do:

(FT, November 17, 2010): For some of the world’s biggest hedge funds, typically re-garded as the savviest traders in the market, there is now one big question facing the eu-rozone: what is going to happen to Spain?

While Europe’s politicians are grappling with the crisis unravelling in Ireland, hedge fund managers are already turning their attention to the issue of how – and if – a peripheral crisis in Ireland could leap via Portugal and Spain to become a systemic crisis for the eu-rozone as a whole.

“The Irish problem will be contained,” says Guillaume Fonkenell, chief investment of-ficer at Pharo, one of Europe’s biggest and most successful macro funds, which special-ises in trading on macroeconomic events and trends. “For us contagion is the issue . . . If the market loses confidence in Spain, then all bets are off. Spain is too big to bail.”...

Back then, the general opinion was that if the contagion spread to spain the game was over because there wasn’t enough money with which to bail out an economy the size of the Kingdom of spain. I’m not sure exactly what happened—maybe I wasn’t paying attention—but suddenly, almost two years on and in an environment where even the rich nations of Europe are see-ing an undeniable slide towards recession, there is no talk about spain being ‘too-big-to-bail’ any-more.

Did somebody repeal the laws of mathematics? Presumably, if the contagion reaches Italy that would be OK too now, I guess.

As it first hit the headlines as a potential prob-lem, spain made a presentation to potential in-vestors that highlighted how strong the country actually was despite the conjecture amongst market participants. the presentation is highly educational and can be found in full HERE, but as a taster, here’s one particular slide that caught my eye:

To dream ... the impossible dream ...To fight ... the unbeatable foe ...

To bear ... with unbearable sorrow ...To run ... where the brave dare not go ...

To right ... the unrightable wrong ...To love ... pure and chaste from afar ...

To try ... when your arms are too weary ...To reach ... the unreachable star ...

This is my quest, to follow that star ... No matter how hopeless, no matter how far ...

To fight for the right, without question or pause ...

To be willing to march into Hell, for a Heavenly cause ...

And I know if I’ll only be true, to this glorious quest,

That my heart will lie will lie peaceful and calm,

when I’m laid to my rest ... And the world will be better for this:

That one man, scorned and covered with scars, Still strove, with his last ounce of courage,

To reach ... the unreachable star ...

11.THINGS THAT MAKE YOU GO Hmmm...

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Oh, to hell with it... here’s another:

some opportunity.

Anyway, late on saturday night, my friends at Zerohedge published a lengthy piece that refer-ences Citi’s Jürgen Michaels and, in essence, it lays out precisely where things stand in Europe. I include a longer excerpt and a link to the ar-ticle in its entirety on Page 20 but for now, here is part of the introduction:

(ZeroHedge): The reality is that, just like all other central bankers, Draghi did what he does best: use big words and threats of ac-tion in hope it will buy him a few extra days of time. The reality is also that, just like when the LTRO was announced, the market did get it right initially, when peripheral bonds

plunged, and got it wrong over the subsequent 3 months when bond pric-es rose, only to collapse to new lows (and in the case of Spain - record high yields as of two weeks ago). Back then, the ECB merely bought a few months time with its transitory intervention. This time it has at best bought a few days with the lack of any actual ac-tion. And yet, Draghi did leave a way out, for at least another brief respite (where unless Europe expands the available bailout machinery yet again, the respite will have an even briefer half life than that from the LTROs). The way out is simple, and in order to avoid any confusion, we will use an al-legory from the movie Batman: Spain and Italy can be saved. But first they must be destroyed.

Why? Because the market may or may note have gotten the desired knee jerk response right - higher - eventu-ally, but what it got absolutely wrong is the fact that in the new normal, at-tempts to front-run politicians, whose motivations are entirely different from those of the market, are always and without fail self-defeating. In oth-er words, by sending the Spanish and Italian curve short-ends soaring (and

yields tumbling), the market just made the only catalyst that would validate the kind of response to Draghi’s comment that we wit-nessed in a few short trading hours, mean-ingless.

so there you have it. In a ten-day period, the heads of two of the world’s big central banks have succeeded in doing nothing but some-how buying themselves just a little more time in which to do it. You have to give them props for that.

the FOMC now runs the risk of being seen to be taking sides in the November Presidential elec-tion if it acts in september—whether justified or not, while the ECB Mario Draghi has backed

SOURCE: KINGDOM OF SPAIN

SOURCE: KINGDOM OF SPAIN

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itself himself into a corner, the like of which it he will do extremely well to escape.

In fact, pretty much the only thing Draghi has go-ing for him at the moment is the apparent dog-like ease with which the market is seemingly dis-tracted from contemplating Europe’s imminent doom by his promises of action at some future

date. that cannot last forever.

I suspect strongly that the Fed is waiting until the last possible mo-ment to unleash QE3 because they realise that it is the only bullet they have left in their gun and I suspect that Draghi is doing what-ever he thinks he can to try and get Europe’s leaders on the same page, but, as he him-self said in London last week,

“...very often non-euro area member states or leaders, underesti-

mate the amount of political capital that is being invested in the euro”

I have a nasty feeling that the extent of political capital at stake as Europe teeters on the brink of implosion is something he, himself is underesti-mating severely.

Yes, he managed to lower the short-end of the curve in spain and Italy with his jawboning, but that is not where the problem necessarily lies if this ongoing nightmare is to cease to haunt the world. these countries need access to afford-able medium-to-long term debt markets if they are to buy themselves time and that, it would seem, is only going to happen if the ECB step in all guns blazing.

Well, Mario? You told us you would do ‘whatev-er it takes’. You told us to believe you. You told us ‘it’ would be ‘enough’.

Whatever ‘it’ is, the talking has to stop. It’s time you made us believers.

*******

OK, so this week, after that lengthy in-troduction, here is a quick list of what you can expect to find in the pages of things that Make You go Hmmm.....:

• John Mauldin

• greece

• Bo Xilai’s wife

• BoJ stimulus

• the demise of san Bernadino

• Facebook tax problems

• An audit of the Fed’s gold

• the imminent destruction of spain & Italy

• Anarchy within the troika

• Jim Puplava

• the Knight Capital fiasco

• Mike Krieger

• A (broken) promise from Barack Obama

• James turk

• A Eurozone recession

• Mario

• gold & silver charts

• Household wealth

• Photos from the Olympics

Until next time...

13.THINGS THAT MAKE YOU GO Hmmm...

05 August 2012 13

Contents 05 August 2012

Japan Foreign-Bond Debate May Boost BOJ stimulus Odds

Burst Balloons: the Frightening Lessons Of the Bo Xilai Affair

san Bernardino, California, Files Chapter 9 Bankruptcy

ECB Disappoints Investors With No Euro Action

California says tax Revenue ‘At Risk’ From Facebook Drop

What’s In Your Vault? uncle sam Audits Its stash Of gold At the New York Fed

Why the ‘Long, Painful Correction’ Is Nowhere Near Over

In Order to Be saved, spain And Italy Must First Be Destroyed

For greece, ECB = End Close, Beware

greece: Anarchy Inside the troika

Charts that Make You go Hmmm.....

Words that Make You go Hmmm.....

And Finally.....

The Gonnie, Gonnie Banks

# Bank Assets ($m) Deposits ($m) Cost ($m)

40 Waukegan Savings Bank, Waukegan, IL 88.9 77.5 19.8

Total Cost to FDIC Deposit Insurance Fund 19.8

14.THINGS THAT MAKE YOU GO Hmmm...

05 August 2012 14

An emerging debate over authorizing the Bank of Japan to buy foreign-currency bonds may spur the central bank to take alternative stimulus action next week, as board members seek to forestall an option they have opposed.

seiji Maehara, the policy chief of Japan’s ruling party, yesterday said it was “desirable” for the government and BOJ to reach a deal allowing purchases of foreign securities. A former BOJ deputy governor has advocated a 50 trillion yen ($640 billion) initiative to combat the yen’s gains through foreign- debt buying.

governor Masaaki shirakawa is among BOJ of-ficials who have opposed the idea, which would challenge the bank to identify appropriate for-eign assets and manage the domestic liquidity that would result. the BOJ has instead focused asset purchases on Japanese government bonds and a limited amount of other items, including real-estate investment trusts and exchange- trad-ed funds. the BOJ next meets Aug. 8-9.

“Political calls on the BOJ to help curb the yen’s strength are gaining momentum,” said Chotaro Morita, a fixed- income strategist at Barclays Plc in tokyo. “should politicians’ calls for such foreign debt-buying intensify, the BOJ may be forced to seek some other monetary stimulus step as an alternative.”

With interest rates near zero, the asset-purchase program is the bank’s main policy tool for fight-ing deflation and stimulating the economy. shi-rakawa hasn’t clearly stated his view on the ef-fectiveness of buying foreign bonds as part of this program. such a policy would be aimed at easing yen appreciation and currency interven-tion is the jurisdiction of the finance minister, shirakawa said at a news conference on May 23.

“Leaving aside whether this policy is right or wrong, it can be done even now by using the for-eign reserves special accounts,” shirakawa said at the press conference. “Whether its right or

not to implement this policy is for the govern-ment to decide.”

takehiro sato, a former economist at Morgan stanley who joined the BOJ board last month, said July 24 that buying foreign bonds is one op-tion for the central bank. takahide Kiuchi, a fel-low newcomer to the board, said the same day that the bank may need to consider “new forms of monetary easing.”

O O O BLOOMBERG / LINK

Thugs and bandits. Any day now, the world will hear the guilty verdict handed down by a Chinese court on gu Kailai, the wife of Bo Xi-lai, a disgraced Chinese politician. China’s rulers hope this will draw a line under an embarrass-ing, lurid murder trial. they may get away with it. But the episode gives the lie to many of the

myths they foster: that, despite being unelected, they are “meritocrats”, in their jobs because they are good at them; that they are, if not entirely honest, then at least cor-rupt within forgivable bounds; and that the way

a new generation of leaders is chosen every ten years is orderly and consensual. the Bo Xilai case has lifted a curtain on a world of thuggery, ban-ditry and vicious, personalised power struggles, reminiscent in some ways of the ten-year night-mare from which the country spent a generation trying to awaken: the Cultural Revolution.

Ms gu and an employee are accused of poi-soning Neil Heywood, a British businessman, last November. the case will be presented as a kind of freak incident that has been dealt with: the crime solved, the perpetrators punished, and the political repercussions contained, with the dashing of Mr Bo’s ambition to reach the pinnacle of power in China, the nine-member standing committee of the Communist Party’s Politburo. the party can get on with its autumn Congress, which will name the people who will run the country for the next decade.

“... Should politicians’ calls for such foreign debt-buying in-tensify, the BOJ may be forced to seek some other monetary stimulus step as an alternative.”

15.THINGS THAT MAKE YOU GO Hmmm...

05 August 2012 15

thanks to the internet and microblogs, however, Chinese citizens now know things about the Bo family that make the party look, well, not quite the vanguard of the proletariat. Mr Bo was a Politburo member until April, and until the pre-vious month was party secretary in the city of Chongqing and its province-sized hinterland. tales have spread of the Bo family’s millions—or billions—in assets salted away overseas, of their son’s education in elite British and American in-stitutions, of his mother’s access to the private jet of a tycoon buddy.

Of all her antics, however, it is the balloon that really bugs Banyan. In 1999, having seen a nice one from the window of her penthouse in Bour-nemouth, on Britain’s south coast, she report-edly decided to buy pas-senger-carrying helium balloons to grace Dalian, the north-eastern Chinese city her husband was running at the time. No role model is more salu-brious than Bournemouth, of course. But Ms gu apparently wanted the balloon-winch supplier to pad his price to cover her son’s school fees. Do high-flyers such as Ms gu really have to sweat the small stuff like that?

China’s leaders are highly sensitive to the no-tion that the Bo-gus are not freaks, but actually typical of the ruling class. Bloomberg, a news agency, has suffered sanctions for reporting on the wealth amassed by relations of Xi Jinping, China’s next leader. Mr Xi, like Mr Bo, is a revo-lutionary aristocrat, the son of a civil-war hero. some “princelings” feel themselves born to rule.

the transition this autumn will be the fourth the party has been through since the revolution in 1949. Only one, the most recent, in 2002, has been smooth. Mao Zedong’s passing in 1976 led to the arrest of his widow and her “gang of Four”. In 1989 the looming succession to Deng Xiaoping was fought out in part on the streets, before power passed to a generation of largely soviet-trained technocrats.

Perhaps because Deng had endorsed them long

in advance, the first Cultural Revolution genera-tion that took over in 2002 did so without open dissension. Fear of the chaos of that earlier de-cade (1966-76) demanded no less. But the Cul-tural Revolution must also have warped the per-ceptions of those, like Mr Bo, who took part. He is alleged to have joined “struggle” sessions against his own father, before spending five years in jail and labour camps. He learned that politics is as ruthless as war. In power, he broke with tradition by campaigning more or less openly for his own promotion, using a crackdown on the mafia and, bizarrely, Maoist revivalism, as populist tools. He might have succeeded had he not fallen out with

his former chief of police, Wang Lijun, who is now also in Chinese custody af-ter fleeing to an American consulate. that made the murder allegations public, dooming the effort to por-

tray Heywood’s death as an accident.

If the party looks corrupt and divided, the le-gal system, its pliant tool, is weak. the gu Kailai trial will take place in Hefei in Anhui province, although, as Donald Clarke, an American schol-ar, notes on his blog, there is nothing in China’s criminal-procedure law to suggest that a court outside Chongqing should have jurisdiction. Presumably, however, Chongqing judges are untrustworthy. unusually, the announcement of the trial (which, calling the evidence “irrefut-able”, anticipated the verdict) also attributed a motive to Ms gu: that Heywood was threaten-ing her son. that may allow Ms gu to avoid the death penalty. the courts are bit-players in a party-scripted drama.

O O O ECONOMIST / LINK

San Bernardino, California, filed for municipal bankruptcy after disclosing a $46 million shortfall in the city’s budget, the third California city to seek court protection from creditors since June 28.

California cities from the Mexican border to san Francisco Bay are confronting rising pension

“... China’s leaders are highly sensitive to the notion that the Bo-Gus are not freaks, but actu-ally typical of the ruling class”

16.THINGS THAT MAKE YOU GO Hmmm...

05 August 2012 16

costs as they contend with growing unemploy-ment and declining property- and sales-tax rev-enue. the costs stem from decisions made when stock markets were soaring and retirement funds were running surpluses.

san Bernardino officials sped up the timing of the bankruptcy filing because they were concerned that some creditors may take legal action against the city, Mayor Patrick J. Morris said yesterday in a phone interview. un-der Chapter 9, all court cases and other legal ac-tions against the city will be halted until the bank-ruptcy case is over.

the city was forced to seek court protection so abruptly because of actions by plaintiffs in three cases involving the san Bernardino Police Department, prompting the city to submit an “emergency filing,” according to an e-mailed statement from the san Bernardino city attor-ney’s office.

san Bernardino, a city of 209,000 about 60 miles (97 kilometers) east of Los Angeles, listed assets and debt of more than $1 billion in a filing yes-terday with the u.s. Bankruptcy Court in River-side, California.

“All of our vital service bills will continue to be paid,” Mayor Morris said. “We are going to keep our city services running.”

Pension liabilities in the California cities of Fair-field, Inglewood, Pomona, san Bernardino, stockton and Vallejo rose 6 percent to $4.3 bil-lion for the year ending June 30, 2010, from $4.1 billion in 2009, according to the most recent data available from the California Public Employees’ Retirement system.

In the northern California municipality of Fair-field, near the Napa Valley winegrowing region, 18 percent of the general- fund budget goes to-ward pension costs, up from 14 percent in fiscal 2008, said David White, the deputy city manager.

Fairfield, Inglewood, Pomona and other Califor-nia municipalities including Compton are on a list of cities “on the precipice” compiled by Matt Fabian, a managing director for Concord, Massa-chusetts-based Municipal Market Advisors, who cited news reports in identifying them in a July 23 research note.

san Bernardino has reduced its workforce by 20 percent in the past four years and negotiated la-

bor cuts valued at about $10 million annually, ac-cording to a June 26 bud-get analysis posted on its website.

One of the main prob-lems is the high cost of the city’s union contracts, particularly for police and fire service, City Council-

man Fred shorett said in a phone interview.

under the city charter, which is like a constitu-tion for municipal governments, city officials must use a specific formula for determining wag-es and other benefits paid to its police and fire employees, shorett said. that formula requires the city to set compensation by comparing em-ployee pay in san Bernardino, which has one of the highest home foreclosure rates in California, with cities in the state that are about the same size and have more money to spend, shorett said.

“We are set up for failure,” he said.O O O BLOOMBERG / LINK

Investors may not have liked what European Central Bank head Mario Draghi had to say on thursday, but it was the clearest indi-cation yet that a plan is finally taking shape to reduce borrowing costs for spain and Italy. ger-many remains wary, though, and commentators say the outcome could be disastrous.

the markets were disappointed. European Cen-tral Bank head Mario Draghi’s press conference on thursday sent stock indexes around the

“... Pension liabilities in the Cali-fornia cities of Fairfield, Ingle-wood, Pomona, San Bernardino, Stockton and Vallejo rose 6% to $4.3 billion for the year ending June 30, 2010, from $4.1 billion in 2009”

CLICK TO ENLARGE

17.THINGS THAT MAKE YOU GO Hmmm...

05 August 2012 17

world plummet-ing, as investors had been hoping the bank would immediately re-sume buying up sovereign bonds from crisis-strick-en euro-zone countries. Even worse, spain’s borrowing costs on 10-year bonds rocketed above the critical 7 percent mark -- a product of Draghi’s press-c o n f e r e n c e pledge that the ECB would only

step in if a country applies for a euro-zone bail-out.

Many politicians in germany, however, were ec-static. Leaders from most of the country’s major parties welcomed Draghi’s inaction, including lawmakers from parties in Chancellor Angela Merkel’s governing coalition.

“I completely agree with ECB President Mario Draghi that decisive consolidation and reform policies at the national level should be the ab-solute top priority and are indispensable,” said Economy Minister Phillip Rösler. the leader of Merkel’s junior coalition partner, the Free Dem-ocratic Party (FDP), Rösler is also deputy chan-cellor. He added that monetary policy cannot replace national efforts and “does not offer a lasting solution to the crisis.”

senior FDP member Rainer Brüderle, who was economy minister prior to Rösler, added that “the ECB should concentrate on its core compe-tency. Fundamentally, it is not the duty of a cen-tral bank to participate in state financing.”

Opposition leaders likewise welcomed Draghi’s reticence and took the opportunity to criticize Merkel’s crisis management strategy. “Instead of

fighting for Europe, she is taking what she thinks is the easier path and is driving the ECB into an-other round of buying up sovereign bonds,” said Frank-Walter steinmeier, floor leader in Berlin for the social Democrats. “It has become clear that such purchases do not offer a lasting solu-tion to the crisis.”

germany has long been wary of ECB bond pur-chases and opposition has only grown since the Frankfurt-based central bank largely ceased buy-ing sovereign bonds last year. Jens Weidmann, head of germany’s central bank, the Bundes-bank, has been particularly vociferous in his crit-icism of bond purchases, saying they rewarded debt-ridden countries without demanding re-forms in return. Draghi even mentioned Weid-mann’s opposition to the program in his thurs-day press conference.

still, the widespread resistance in germany to ECB action, and to many other euro-crisis pro-posals that could increase german taxpayer li-ability, has painted Merkel into a corner. With the opposition in Berlin showing a decreased willingness to rubber stamp her euro-crisis mea-sures and a growing rebellion within the ranks of her own government, her ability to respond to the worsening crisis may become increasingly limited.

O O O DER SPIEGEL / LINK

Facebook Inc.’s declining price may cost California “hundreds of millions of dol-lars” in revenue expected from taxes on capital gains, the state’s fiscal analyst said.

the owner of the world’s largest online social network, touched $19.82 today, the lowest price since the Menlo Park, California-based company first offered shares to the public at $38 on May 17.

the most populous u.s. state’s $91.3 billion bud-get, signed by governor Jerry Brown in June, counted on $1.9 billion in income-tax revenue from company insiders such as Chief Executive Officer Mark Zuckerberg exercising options or sell shares, assuming an average price of $35.

CLICK TO ENLARGE SOURCE: DER SPIEGEL

18.THINGS THAT MAKE YOU GO Hmmm...

05 August 2012 18

Facebook, which touched $45 May 18, has aver-aged $29.49 on the Nasdaq stock market.

“Facebook share prices have fallen far below lev-els assumed in the state’s revenue projections,” the nonpartisan Legislative Analyst’s Office said yesterday in a report. If “the lower share prices persist through November and December, hun-dreds of millions of dollars of income-tax rev-enue assumed in the state budget plan are at risk.”

Ashley Zandy, a Facebook spokeswoman, said the company didn’t have a comment. Executives and investors were expected to sell 157.4 million shares in the initial public offering, according to a regulatory filing.

Facebook, which hasn’t closed above the $38 IPO price since May 18, its first day of trading, last week said second-quarter sales growth was 32 percent from the same period a year ear-lier, down from 45 per-cent in the previous three months. the company still needs to prove to inves-tors that it can profit from the growing number of users who access the site on mobile devices, said tom Forte, an analyst at telsey Advisory group in New York.

Zynga Inc., an online-game developer based in san Francisco, went public in December and has declined from a $15.91 high on March 2 to as low as $2.68 today, a record.

A Zynga investor sued the company and the IPO underwriters this week, claiming sharehold-ers were misled about its financial health. the company reported lower-than-expected second-quarter earnings July 25, and fell 37 percent the next day.

state finance officials typically update revenue estimates when presenting the governor’s pro-posed budget in January. New information on Facebook probably will be used in that update,

according to the Legislative Analyst’s Office.

California, the world’s ninth-biggest economy, took in $7.2 billion from income taxes in April.

O O O BUSINESSWEEK / LINK

For decades, the u.s. government has stashed gold five stories beneath Manhattan in a vault under the Federal Reserve’s fortress near Wall street.

Or has it?

some conspiracy theorists suspect that the bil-lions of dollars’ worth of bullion might have been looted in a dramatic heist, a la the movie “Die Hard: With a Vengeance.” Others claim that the gold has been used in a shadowy government transaction, or swapped with gold-painted bars. It’s even caught the attention of politicians like

Rep. Ron Paul and mem-bers of germany’s Parlia-ment.

Now all of us may finally get some answers.

the federal government has quietly been complet-ing an audit of u.s. gold stored at the New York Fed. the effort included drilling small holes in the bars to test their purity.

the treasury Department has refused to disclose what the audit has revealed so far, saying the re-sults will be announced by year’s end. But as one former top Fed official said recently, the testing may finally prove that “goldfinger didn’t sneak in at night” and take the gold.

“the calls for audits are saying, ‘We don’t trust the government for the last 200 years,’” said ted truman, a former assistant treasury secre-tary and Fed official. He called perennial ques-tions about the country’s reserves “the gold bug equivalent of the birther movement.”

the treasury’s auditing operation, including drill-ing, is a first for the New York Fed. the depart-

“... The Treasury Department has refused to disclose what the audit has revealed so far, saying the results will be announced by year’s end. But as one former top Fed official said recently, the testing may finally prove that “Goldfinger didn’t sneak in at night” and take the gold”

19.THINGS THAT MAKE YOU GO Hmmm...

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ment’s inspector general previously audited and tested only gold it keeps under heavy guard at Ft. Knox, West Point and the u.s. Mint in Denver. these three locations hold 95% of the country’s bullion.

In New York, about $21 billion in u.s. gold is locked inside the Fed’s vault. It’s stored alongside bullion from three dozen other countries and or-ganizations such as the International Monetary Fund. All told, about 23% of the world’s official gold reserves are stored in the central bank’s vaults.

the audit, which began in January, took place 80 feet below the Fed’s limestone and sand-stone Italian Renaissance building in Manhat-tan’s financial district. Visitors to the vault make their way through a steel and concrete entrance where a 90-ton door ro-tates open.

Inside, a massive scale is ringed by 122 blue cages that hold about 530,000 gold bars — 34,021 of which belong to uncle sam. the auditing team counted the u.s. stash, selecting more than 350 bars from which to extract samples for assaying.

the process involved about half a dozen employ-ees of the Mint, the treasury inspector general’s office and the New York Fed. It was monitored by employees of the government Accountability Office, Congress’ investigative arm.

the bars were first weighed on a small electronic scale, then transferred to a table mounted with a long, thin drill used to burrow into the gold, said a person familiar with the operation who was not authorized to speak publicly.

Workers were careful to collect any stray gold bits, the source said. Based on the market price of about $1,600 per troy ounce, the treasury re-moved more than $110,000 worth of gold sam-ples.

A Mint spokesman said about 1 to 1.5 grams of each sample is destroyed in the assaying pro-

cess, with the remaining granules returned to the government.

the New York Fed refused to comment.O O O CHICAGO TRIBUNE / LINK

Where were you when the global finan-cial crisis began five years ago this month? I re-member the start of the credit crunch in August 2007 as if it were yesterday, ironically because I nearly missed it altogether.

When we headed off to our friends’ log cabin for our summer holiday in the New England woods all was well.

When we emerged a couple of weeks later all hell had broken loose and the journey to today’s income-hungry world had begun. the events of

which we were blissfully unaware as we enjoyed our thoreau at Walden Pond moment added up to the first full-blown panic of a crisis that had been quietly brewing for the six months since HsBC

blamed us sub-prime loans (whatever they were!) for its first ever profits warning.

two months later, mortgage lender New Century Financial filed for bankruptcy, then in June, Bear stearns bailed out one of its hedge funds, let another go under and halted redemptions at a third. By July, home foreclosures were running at almost twice the level of a year earlier.

In early August, shortly after we lost radio con-tact with the outside world, BNP Paribas stopped investors redeeming cash from some of its funds, saying that the turmoil in the sub-prime market meant it was unable to value them.

the next day central banks pumped billions of pounds into the banking system to head off a feared credit seizure. European shares suffered their biggest one-day fall in more than four years and the Federal Reserve’s new chairman, Ben Bernanke, swung into action, cutting the primary discount rate at which the Fed lends money to

“... With the benefit of hind-sight, it is clear that the world we left behind as we headed into the woods disappeared during those two happy weeks”

20.THINGS THAT MAKE YOU GO Hmmm...

05 August 2012 20

America’s banks. the plunge to the zero-bound world shown in the chart had begun.

With the benefit of hindsight, it is clear that the world we left behind as we headed into the woods disappeared during those two happy weeks.

Flicking through press reports of a debt-fuelled takeover bid for sainsbury’s or the preposter-ous battle between RBs and Barclays for control of ABN Amro is like looking at photos of young people larking about in the summer of 1914. Did they really have no idea what was coming?

some did, but not many. Five years ago, the Daily Reckoning website said this: “Never before in the history of the world have so many people be-lieved so many things that couldn’t be true. Now they owe more money to more people than ever before. And it could take a long, painful correc-tion ... or worse ... to straighten things out.” How prescient was that?

But it was not the conventional wisdom five years ago. this from the International Monetary Fund was closer to what most of us convinced ourselves was the case: “these events are likely to have some negative impact on growth not only in the united states but also in a number of other countries, so wherever forecasts were a month ago they should be cut a little bit.” go on then, just a trim.

the day the Fed cut interest rates for the first time, August 17, 2007, the London market rose by more than 3pc. german 10-year bund yields edged back up to 4.3pc that day. gold “hit a peak” of $663.50!

If someone had said five years ago that those silly American home loans would, within half a decade, have torn the eurozone asunder, left the us on the brink of a fiscal abyss and driven the Chinese economic locomotive into the buffers, very few would have taken them too seriously.

O O O UK DAILY TELEGRAPH / LINK

In order to activate the ECB’s new fa-cility, Spain and Italy have to ask the EFSF for assistance, and the Eurogroup (backed by the German parliament) has to approve the request....Mr. Draghi was very explicit in respect to the conditions for ECB assistance for governments in bond markets, but Span-ish PM Mariano Rajoy and Italian PM Mario Monti ignored that part of the ECB state-ment.

While Mr. Monti, as before, left open wheth-er Italy would requeEFSF/ESM assistance, Mr.

Rajoy, also in line with pre-vious statements, declined tostate that Spain would ask for such assistance.

To us, this is another ex-ample of the Spanish gov-ernment’s poor communi-cation, and highlights the

need to restore credibility by getting external monitoring (at least from the EU Commis-sion and the ECB, probably with technical assistance from the IMF). Given the strong resistance of the Spanish government to ask-ing the EFSF/ESM to activate the primary market purchase facility — although a Mem-orandum of Understanding regarding the required conditionality is already available with the existing bank support programme — and with no planned issuance in coming weeks, we do not expect that Spain will ask for assistance in August.

Forced by a further increase in its funding costs, we expect the Spanish government to make a U-turn and to ask for assistance dur-ing September.

And what is true for spain, is true for its far big-ger, and just as financially distressed cousin, Italy.

therein lies the rub: by pushing the funding costs on the short-end far cheaper, both Rajoy and Monti are now certain to not even consider ask-ing for a bailout - after all the market just validat-ed their failed policies (or so they think)! to the career politician and unappointed technocrat, instead of having to ask for aid, the market’s re-

“... by pushing the funding costs on the short-end far cheaper, both Rajoy and Monti are now certain to not even con-sider asking for a bailout”

21.THINGS THAT MAKE YOU GO Hmmm...

05 August 2012 21

sponse is one which precludes said aid request... until, at least such time as the market realizes it was once again manipulated by politicians.

What happens then is the same rinse-repeat cycle we have grown to hate and loathe so well: the spanish and Italian curves go bidless, in the process inverting once again, followed by the same summit/ECB announcement response with promises that both spain and Italy will demand a bailout, sending bonds soaring, and making a bailout demand unnecessary.

Of course, this Catch 22 of confounding cause and event can continue seemingly indefinitely, although in reality it can’t. Because fundamen-tally what the bond market does is keep sover-eigns “honest” - just as schauble said a week ago, spanish yields at 7% are not the end of the world - instead what they are is a signal to the country to get its spending in control in order to reduce its deficit, and fundamentally get its house in order - yes, that means getting govern-ment spending to a sustainable level and firing hundreds of thousands of workers, as well as probably raising taxes even more. It also means pain all around, but the pain is inevitable and will only be worse the longer reality is denied.

thus all the ECB does, with every incremental at-tempt to manipulate the bond curve, is delay the day when the inevitable hard choices and diffi-

cult decisions have to be made. In the process, the deficit gets bigger and bigger, even as the country can still continue to fund itself at seem-ingly sustainable rates (very soon both Italy and spain will be forced to keep rolling its debt every several months as anything beyond Bills will be trading at ridiculous rates, while the short-end will be anchored by fears of more brutal Draghi rhetoric). All this comes to a head eventually when the spread between reality and central bank ivory towers becomes so wide not even the most stockholm syndrome-addled bond “vigi-lantes” can continue to ignore it any longer.

O O O ZEROHEDGE / LINK

The European Central Bank’s deci-sion on Friday to stop accepting greek govern-ment bonds as collateral was not the first such move made by Frankfurt but there was some-thing distinctly ominous about the timing and implications of its choice.

“the ECB will assess their potential eligibility fol-lowing the conclusion of the currently ongoing review, by the European Commission in liaison with the ECB and the IMF, of the progress made by greece under the second adjustment pro-gram,» the central bank said.

the ECB has twice before this year refused greek banks the ability to use government bonds to draw much-needed liquidity. the first was after the bond restructuring, or PsI, and the other was before the start of the bank recapitalization pro-cess. In both cases, greek banks were excluded and had to rely on Emergency Liquidity Assis-tance (ELA) to gain access to funds. they have reportedly drawn more than 60 billion euros this way.

ELA means that the banks are able to borrow from the Bank of greece, rather than the ECB, by putting up collateral that is theoretically more risky than bonds, such as small business loans or mortgages. While ELA is a useful stopgap mea-sure, it is no more than that.

First of all, it is not sustainable. ELA funding re-quires a spread of about 200 basis points above

CLICK TO ENLARGE SOURCE: CITI/ZEROHEDGE

22.THINGS THAT MAKE YOU GO Hmmm...

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the ECB’s marginal lending facility rate, which is currently at 1.5 percent. this means that cash-strapped greek banks borrow at about 3.5 per-cent, more than double what lenders in other eurozone countries are paying.

ELA also spells trouble for the Bank of greece because it bears the risk of the loans rather than the ECB. If greek banks are borrowing via the ELA, the ECB and the Eurosystem is less exposed to a default. In the time that greek lenders drew 62 billion euros from ELA, they have borrowed 74 billion from the ECB, according to Reuters. If there is an underlying intention from Frankfurt to hedge its bets, it doesn’t seem to have done badly.

Finally, ELA leaves greece’s financial sector at the mercy of the ECB board. the Bank of greece needs Frankfurt’s approval to accept assets from local lenders. A two-thirds majority deci-sion by the ECB’s governing council could deny greece’s central lender the right to fund local banks through ELA. ECB politics means that it could only take one or two important members — such as the head of germany’s central bank, Jens Weidmann, to swing the decision and stop the liquidity program.

However, the technicalities of the ELA are the least of greece’s worries at the moment. It is the implications of the ECB’s decision that should have the alarm bells ringing in Athens.

While Frankfurt’s two pre-vious refusals to accept greek bonds this year were linked to specific events and served as a brief parenthesis in the liquidity process, by linking its latest decision to the troika report on greece, the ECB has opened a bracket without knowing when or if it will be closed.

the troika’s assessment of the greek program is not due until the end of August and will not be discussed at a European level until september. this is a worryingly long time for greek banks,

which have been losing deposits steadily over the last three years, to be left in this liquidity limbo, cut-off from ECB credit. there must be se-rious doubts about whether the greek financial system can survive such a test at this challenging time.

O O O EKATHIMERINI / LINK

The European Central Bank has snatched greek survival from the jaws of sov-ereign bankruptcy. It’s done this by securing in-terim financing in the form of additional emer-gency loans from the Bank of greece, Die Welt reported today (saturday).

It’s emerged that the ECB’s governing Council agreed at its meeting on thursday to increase the upper limit for the amount of greek short-term loans the Bank of greece can accept in ex-change for emergency loans, Die Welt asserted.

Well zipperteedoo-dah what a wonderful day, but how will this meld with the euronotes that greece is still printing (while the ECB quietly burns them on receipt) and the hard-to-ignore reality that technically, without a constant sup-ply of Frankfurtergeld, the Bog would be insol-vent itself? Nobody cares any more, for this is now the Bunker-whacky world of eurozone fi-nance: short terms are safer than emergencies,

toilet paper can bail out whole nations, and Ber-lin is the guarantor of last resort….except when the Bundesbank in Frankfurt suggests otherwise.

thus, a decision made in private will have ap-

proximately a hundred times the effect of Mario Draghi publicly vowing to do Whatever it takes – up to but not defining ‘whatever’.

O O O THE SLOG / LINK

“... ELA funding requires a spread of about 200 basis points above the ECB’s margin-al lending facility rate, which is currently at 1.5 percent”

23.CHARTS THAT MAKE YOU GO Hmmm...

05 August 2012 23

It’s been a while since we checked in with Jesse for a look at gold and silver charts so let’s put that right.

Bases are building that suggest we COuLD see some power-ful upside action but, as always with the precious metals, we are one piece of Officialspeak away from an air-pocket.

Personally, I tend to try and look a lot farther into the future where these particular assets are concerned. I find the skies a lot clearer there...

SOURCE: JESSE’S CAFE AMERICAIN

SOURCE: JESSE’S CAFE AMERICAIN

CLICK TO ENLARGE

CLICK TO ENLARGE

24.CHARTS THAT MAKE YOU GO Hmmm...

05 August 2012 24

CLICK TO ENLARGE SOURCE: DOUG SHORT

As the Eurozone recession (which started months ago) worsens, the area’s manufacturing activity, as measured by the PMI index, is contracting at a pace not seen since 2009.

A great deal of this decline however is now driven by germany (rather than the periphery), whose manufac-turing PMI is showing a rapid deterioration. It is some-what surprising, given that we had signs of economic improvements in germany as recently as May. But the german “decoupling” hopes did not materialize, as the economy is pulled down by the rest of the Eurozone com-bined with the slowdown in China, one of the nation’s largest export markets.

O O O SOBERLOOK / LINK

Any Questions?

SOURCE: MARKIT

25.CHARTS THAT MAKE YOU GO Hmmm...

05 August 2012 25

In April 2007, while forecasters predicted at least two more years of increases, the first “Be-yond the Horizon” article stated:

“Earnings have increased at double-digit growth rates for five consecutive years – although many agree that earnings growth may be slowing, it’s beyond almost everyone’s foreseeable horizon that earnings might actually experience a decline.”

By the end of 2007, earnings per share (EPs) for the s&P 500 declined versus 2006.

By the end of 2008, after an 80%+ decline in reported earnings, it was beyond almost everyone’s horizon that reported net earnings would recover to more than $90 per share over the subsequent several years ... yet this year’s forecast is now $93 and next year is expected to top $103 per share.

since the fundamental principles of the business cycle cause history to repeat itself, a decline in EPs should not be beyond your horizon!

Currently, profit margins are cyclically high, near historical highs, and already at unsustainable levels, with projected further increases over the next two years. Beware.

O O O JOHN MAULDIN / LINK

26.

05 August 2012 26

WORDS THAT MAKE YOU GO Hmmm...

“We can not and will not sustain deficits like these without end. Contrary to the prevailing wisdom in Washington these past few years, we can not simply spend as we please and defer the consequences to the next budget, the next administration or the next generation. We are paying

the price for these deficits right now. In 2008 alone we paid $250 billion in interest on our debt, that is more than three times what we spent on education that year, more than seven times what we spent on VA health-care. So if we confront this crisis without also confronting the deficits that helped cause it, we risk sinking into another crisis down the road as our interest payments rise, our obligations come due, confidence in our economy erodes and our children and grandchildren are unable to pur-sue their dreams because they are saddled with our debts. That’s why today I am pledging to cut the deficit we inherited by half by the end of my first term in office. this will not be easy - it will require us to make dif-ficult decisions and face challenges we have long neglected but I refuse to leave our children with a debt they can not repay. And that means taking responsibility right now in this administration, for getting our spending under control.”

O O O VIA ZEROHEDGE / LINK

James Turk on gold & silver, the dollar, Fed policy and the problems facing monetary authorities as they keep interest rates artificially low in an attempt to subvert centuries of mon-etary precedent.

Fascinating.

Below are two friends of mine who both have a lot of insight to offer. Always.

this week Jim Puplava (left) talks to Eric Hunsader of Nanex about High-Frequen-cy trading and the Knight Capital fiasco this past week and it’s a must-listen for anyone involved in markets.

On the right is Mike Krieger who returns to New York this week from the wilds of Colorado to talk to Lauren Lyster of Capi-tal Account about Friday’s jobs number and the truth behind the slew of statis-tics that belie the real condition of the us economy as well as Louis Bacon’s decision to return $2bln of investors’ capital.

CLICK TO WATCH

CLICK TO WATCH

CLICK TO LISTEN

CLICK TO LISTEN

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and finally…

05 August 2012 27

Hmmm…

Regular readers will be familiar with my passion for photography and the Olympics always provides plenty of amazing images but this collection from the uK Daily telegraph is both interesting and different as it takes a look at the games from a variety of unusual angles...

CLICK TO VIEW

© THINGS THAT MAKE YOU GO HMMM..... 2012

28.THINGS THAT MAKE YOU GO Hmmm...

05 August 2012 28

As a result of my role at Vulpes Investment Management, it falls upon me to disclose that, from time-to-time, the views I express and/or the commentary I write in the pages of Things That Make You Go Hmmm..... may reflect the positioning of one or all of the Vulpes funds - though I will not be making any specific recommenda-tions in this publication.

Grantwww.vulpesinvest.com

Grant Williams

Grant Williams is a portfolio and strategy advisor to Vulpes Investment Management in Singapore - a hedge fund running over $250million of largely partners’ capital across multiple strategies.

The high level of capital committed by the Vulpes partners ensures the strongest possi-ble alignment between us and our investors.

In Q4 2012 we will be launching the Vulpes Agricultural Land Investment Company (VALIC), a globally-diversified agricultural land vehicle which will provide truly diver-sified exposure to the agricultural sector through a global portfolio of physical farm-land assets.

Grant has 26 years of experience in finance on the Asian, Australian, European and US markets and has held senior positions at several international investment houses.

Grant has been writing ‘Things That Make You Go Hmmm.....’ since 2009.

For more information on Vulpes please visit www.vulpesinvest.com

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California Investment Conference 2012 Presentation: ‘simplicity’: Part I : Part II