Category Archives: Financial markets

If You Don’t See Any Risk, Ask Who Will “Buy the Dip” in a Freefall? by Charles Hugh Smith

When a market is breaking down and every second counts, liquidity disappears and sometimes doesn’t reappear for days. From Charles Hugh Smith at oftwominds.com:

Nobody thinks a euphoric rally could ever go bidless, but as Greenspan belatedly admitted, liquidity is not guaranteed.

The current market melt-up is taken as nearly risk-free because the Fed has our back, i.e. the Federal Reserve will intervene long before any market decline does any damage.

It’s assumed the Fed or its proxies, i.e. the Plunge Protection Team, will be the buyer in any freefall sell-off: no matter how many punters are selling, the PPT will keep buying with its presumably unlimited billions.

If this looks risk-free, ask who else will be “buying the dip” in a freefall? Former Fed Chair Alan Greenspan answered this question in his post-2008 crash essay Never Saw It Coming: Why the Financial Crisis Took Economists By Surprise (Dec. 2013 Foreign Affairs):

“They (financial firms) failed to recognize that market liquidity is largely a function of the degree of investors’ risk aversion, the most dominant animal spirit that drives financial markets. But when fear-induced market retrenchment set in, that liquidity disappeared overnight, as buyers pulled back. In fact, in many markets, at the height of the crisis of 2008, bids virtually disappeared.”

For the uninitiated, bids are the price offered to buyers of stocks and ETFs and the ask is the price offered to sellers. When bids virtually disappear, this means buyers have vanished: everyone willing to buy on the way down (known as catching the falling knife) has already bought and been crushed with losses, and so there’s nobody left (and no trading bots, either) to buy.

When buyers vanish, the market goes bidless, meaning when you enter your “sell” order at a specific price (limit order), there’s nobody willing to buy your shares at the current price. The shares remains yours all the way down.

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The $2.3 Quadrillion Global Timebomb, by Egon von Greyerz

It’s a question of when, not if, the timebomb explodes. From Egon von Greyerz at goldswitzerland.com:

Credit Suisse is hours from collapse and the consequences could be a systemic failure of the financial system.

Disappointingly, my dream last night stopped there. So unfortunately I didn’t experience what actually happened.

As I warned in last week’s article on Archegos and Credit Suisse, investment banks have created a timebomb with the $1.5 quadrillion derivatives monster.

A few years ago, the BIS (Bank of International Settlement) in Basel reduced the $1.5 quadrillion to $600 trillion with a pen stroke. But the real gross figure was still $1.5q at the time. According to my sources, the real figure today is probably over $2 quadrillion.

A major part of the outstanding derivatives are OTC (over the counter) and hidden in off balance sheet special purpose vehicles.

LEVERAGED ASSETS JUST GO UP IN SMOKE

The $30 billion in Archegos derivatives that went up in smoke over a weekend is just the tip of the iceberg. The hedge fund Archegos lost everything and the normal uber-leveraged players Goldman Sachs, Morgan Stanley, Credit Suisse, Nomura etc lost at least $30 billion.

These investment banks are making casino bets that they can’t afford to lose. What their boards and top management don’t realise or understand is that the traders, supported by easily manipulated risk managers, are betting the bank on a daily basis.

Most of these ludicrously high bets are in the derivatives market. The management doesn’t understand how they work or what the risks are and the account managers and traders can bet billions on a daily basis with no skin in the game but massive potential upside if nothing goes wrong.

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From the Notebook: The Digital Yuan, Proof of Guns, and the Expiration of Money, by Tom Luongo

Central bank digital currencies aren’t going to fix the mess central banks have made of their non-digital currencies. From Tom Luongo at tomluongo.me:

One of the things that converted me to the Austrian way of thinking about the economy was the concept of money with an expiration date.  Early articles at Lewrockwell.com and Mises.org covering hyperinflations of various forms and kinds horrified me when banknotes and government scrip reached the point of forcing people to spend money versus having it lose its ‘legal tender’ status.

Money that ‘expired’ like points on your credit card was simply a horrifying idea.

Martin Armstrong makes the point all the time that the main reason why the U.S. dollar is the world’s reserve currency is because it is the only modern government-issued currency that hasn’t been defaulted on in over two hundred years.

In fact, it was the consolidation of the Colonial government debt held over from the Revolutionary War which ultimately doomed the government under the Articles of Confederation giving rise to the current U.S. constitution and its monopoly power to issue dollars.

That power gave the Constitution its power as an international player, telling the world the new government honored its debts. The inability of the ECB today to control the debt issuance of the euro-zone states is that currency zone’s fatal flaw and why any move towards consolidation of that power is the goal of all EU fiscal and EU monetary policy.

Absent that the EU is doomed to the same fate as the Articles of Confederation.

Fast forward to today with the world awaiting the birth of the first Central Bank Digital Currency (CBDC), the Digital Yuan from China, and we see the concept of expiration being embedded directly into what looks like the next monetary system planned for us.

We’ve come full circle, folks.

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2021: The year of the Black Swans? by Tuomas Malinen

All sorts of things could wrong this year, and probably will. From Tuomas Malinen at gnseconomics.com:

A “Black Swan” is best defined as an unforecastable, low-probability, high-impact event. They may include more prosaic natural disasters, like earthquakes, but are more generally understood to be unforeseeable economic, financial and political calamities.

While Black Swan events are, by this definition, unforecastable, the trends building up to them can often be observed, and that process has been our aim since the inception of GnS Economics in 2012. For example, it’s nowadays often possible to observe the buildup of pressure in volcanos. This does not guarantee an eruption, naturally, but it provides an indication that such an event could occur.

The same principle applies to political, economic and financial events.

One of the most worrying trends contributing to the development of potential Black Swans has been the increasing fragility of the global economy, which we have been warning about since 2017. Recently, the fragility of the global economy has been aggravated by lockdowns and the ill-advised “support policies” of governments and central banks worldwide.

This has only accelerated the zombification of the global corporate sectors, while creating an intrinsic asset bubble, which keeps on expanding—and now an inflation shock lurks on the horizon. All these increase the likelihood of an economic “eruption”. However, political shocks may also be approaching.

The failure of contemporary politics to understand and correctly address this complex set of economic policy issues is one of the main reasons we are in this mess.

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Nancy Pelosi’s Husband Buys Microsoft Ahead of Big Govt Contract, by Mike “Mish” Shedlock

This is legal! From Mike “Mish” Shedlock at thestreet.com:

Nancy Pelosi’s husband made an excellent Microsoft stock market trade. Let’s check out the details.
Purchase of Stock Via Call Options

Barron’s reports Nancy Pelosi’s Husband Bought Roblox, Microsoft Stock

Speaker Nancy Pelosi’s husband just disclosed he bought Roblox stock the day it went public, and acquired Microsoft stock through options.

The Barron’s article is behind a paywall. Fox News also reports the same thing: Pelosi’s Husband Bought $10M in Microsoft Shares Through Options.

House Speaker Nancy Pelosi’s husband purchased millions of dollars worth of Microsoft (MSFT) and Roblox (RBLX) shares last month, new financial disclosures form reveal.

Paul Pelosi exercised call options and paid $1.95 million to buy 15,000 shares of Microsoft at a strike price of $130 on March 19, according to an April 9th filing with the House clerk. That same day, Pelosi, who owns and operates a California venture capital investment and consulting firm, paid $1.4 million for 10,000 shares valued at $140 apiece.

Since Pelosi made the purchase, Microsoft share prices have climbed from about $230 to roughly $255 – an increase of close to 11% – after the company secured a lucrative government contract worth nearly $22 billion to supply U.S. Army combat troops with augmented reality headsets. The deal was announced on March 31.

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The “Helicopter Parent” Fed and the Fatal Crash of Risk, by Charles Hugh Smith

Neither people nor markets learn or grow when they’re always bailed out of their mistakes. From Charles Hugh Smith at oftwominds.com:

All the risks generated by gambling with trillions of borrowed and leveraged dollars didn’t actually vanish; they were transferred by the Fed to the entire system.

The Federal Reserve is the nation’s Helicopter Parent, saving everyone from the consequences of their actions. We all know what happens when over-protective Helicopter Parents save their precious offspring from any opportunity to learn from mistakes and failures: they cripple their child’s ability to assess risk and learn from failure, guaranteeing fragility and catastrophically blind-to-risk decisions later in life.

Helicopter Parents generate a perfection of moral hazard, defined as there is no incentive to hedge risk because one is protected from its consequences. Moral hazard perversely increases the incentives to take on more risk because Mommy and Daddy (the Fed) will always save me / bail me out.

For example, when Mommy and Daddy make their reckless teen’s DUI charge go away, the teen’s already potent sense of godlike liberation from real-world consequences floats even higher. So next time the teen gets into his car drunk and takes his friends on a high-speed spin down Mulholland Drive, he loses control and kills everyone in the car–not just himself but those who trusted his warped sense of risk.

The Fed is the ultimate Helicopter Parent, protecting all the power players in our economy and society from the consequences of their risky actions. By crushing interest rates to near-zero, the Fed has perversely incentivized increasingly risky expansion of credit, and given the green light to there’s no limit, spend as much as you want government borrowing.

The Fed’s implicit promise to never let the stock market drop for more than a few days–the Fed Put–has incentivized every punter from billionaires to corporations to unemployed people with stimmy checks to max out their credit (or margin accounts) to increase their bets in the market casino.

The Fed has implicitly informed the bigger players that they can bet as big as they want because the Fed will always bail them out, transferring private losses to the public via Fed bailouts, lines of credit, backstops, etc.

The Fed has also signaled it will change the rules as needed to save its Players from loss. Mark-to-Market reveals the insolvency of the Players? Well, we’ll just get rid of that. All fixed! (heh)

Once the path of moral hazard has been taken, a fatal feedback loop takes hold: as reckless punters take on more risk to boost their gains, the fragility and brittleness of their positions increases geometrically. This soon endangers not just their own bets but the entire financial system, as it’s not just one punter who responds to the Fed’s Helicopter Parenting promise of no consequences for taking on more risk–every punter gets the green light to take on more risk because the Fed has our back.

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Eurozone inflation is high when it comes to the prices of daily purchases, by Daniel Lacalle

One way to keep inflation down is to take out the things that people actually buy out of the price indexes. From Daniel Lacalle at dlacalle.com:

For more than ten years, ECB monetary policy has been ultra-expansionary, whether there was crisis, a recovery, economic growth or stabilization. The worst excuse of all that was used to justify endless quantitative easing has been the often-repeated mantra that “there is no inflation.”

Defenders of aggressive monetary policy have always used the same arguments really.

First, they say there is no inflation – as if an average 2% increase in prices during a crisis whereby many salaries fell up to 20% does not constitute “inflation”.

After, they say it is temporary, so to justify maintaining aggressive easing policies.

Next up, the “inflationistas”  seek to blame businesses or some kind of external enemy for the rise in prices, whereby they ask governments to impose price controls.

Important to understand here is that money creation is never neutral. It disproportionately benefits the first recipients of newly created money – governments -, and negatively affects real wages and savings of those that are not able to buy financial assets: the poorest.

There clearly is massive inflation when it comes to financial asset prices. Negative-yielding sovereign bonds of nations with weak solvency ratios amount to massive inflation. Continuous price increases of both quoted and private assets amount to high inflation, and all of this is caused by monetary policy.

Furthermore, anyone can understand that the official headline consumer price index (CPI) is masking the increase in the price of goods and services that we really purchase on a daily basis, relative to the ones we only purchase occasionally, or for leisure. Any European citizen understands that tourism and technology may become cheaper, as a result of competition and innovation, but that the things we purchase every day have increased more in price than reflected by the headline CPI.

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Scarcity Cred, by Scott Galloway

Scarcity can be a value, which is one explanation for the people scratching their heads about the popularity of cryptocurrencies. From Scott Galloway at profgalloway.com:

Any firm that approaches $1T in value has tapped into a basic human instinct. Consuming, signalling, loving, and praying have been the fuel of Amazon, Apple, Facebook, and Google’s ascents, respectively. That the crypto asset class universe has reached $2T reveals, I believe, that it taps into two attributes we instinctively pursue: trust and scarcity.

Trust

Our superpower as a species is cooperation, which requires trust. It’s the reason banks, traffic lights, and anesthesiologists exist. Even before crypto, creative minds have been drawn to finance, as trust creates opportunities for leverage and securitization. In 1997, seeking more control over his songwriting catalog, David Bowie raised $55 million with Bowie Bonds. The bonds paid 7.9 percent interest over a 10 year-long term — a scant premium to a U.S. 10 Year Treasury Note at 6.4 percent. What made Bowie Bonds unique was the collateral, or source of trust: future royalties on Bowie’s music, which the bondholder felt people would continue to value. Moody’s rated the bonds A3 and Bowie used the proceeds to buy out his former manager, shoring up the bonds and securing long-term control of his music.

Though innovative in its collateralization, the Bowie Bond was on its face a vanilla financial instrument, no different in form than a bond issued by GM or P&G. In order to connect his art and potential investors, Bowie had to rely on the (expensive) apparatus of traditional gatekeepers in finance and entertainment to imbue his bonds with the essential attributes of trust and scarcity. The royalty stream (trust) was mediated by lawyers and accountants in big publishing houses, and the legitimacy of each individual bond (scarcity) was dependent on the financial powers of Wall Street.

What if Sir David Bowie (note: he declined knighthood in 2003, but it’s my blog) fell to earth in 2021? What might Bowie have done … with crypto?

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“You’d Have To Shut Down The Internet” To Ban Bitcoin, Says SEC’s Hester Peirce, by Tyler Durden

Will governments ban Bitcoin and other private cryptocurrencies? Tread carefully, it’s not clear what the outcome will be. From Tyler Durden at zerohedge.com:

Any government efforts to ban Bitcoin would be “foolish,” said Hester Peirce (aka “Crypto Mom”), a very Bitcoin-friendly commissioner at the U.S. Securities and Exchange Commission (SEC), during a MarketWatch virtual conference earlier this week, according to Cryptoslate reporter Liam Frost.

“I think we were past that point very early on because you’d have to shut down the Internet,” Peirce said, adding, “I don’t see how you could ban it. You could certainly make the effort. It would be very hard to stop people from [trading Bitcoin]. So I think it would be a foolish thing for the government to try to do that.”

Not only that, but the government would immediately wipe out $2 trillion in net wealth – the market cap of the crypto sector – an event that would have profoundly deleveraging consequences, and since much of that wealth is now backed by debt, for example all those debt-funded purchases of bitcoin by Microstrategy, such a move by the government would immediately destabilize the all important debt market.

The statement came on the heels of Ray Dalio, a billionaire investor and founder of Bridgewater Associates, arguing that there’s “a good probability” that governments around the world would ban Bitcoin and other cryptocurrencies.

Dalio told Yahoo Finance:

“Every country treasures its monopoly on controlling the supply and demand. They don’t want other monies to be operating or competing, because things can get out of control. They outlawed gold, that’s why also outlawing Bitcoin is a good probability.”

However, according to Peirce, the main issue for authorities—at least when it comes to cryptocurrencies—is to find an approach to regulation that would be productive and non-restrictive at the same time. She noted:

“We’ve seen other countries take, I would say, a more productive approach. We really need to turn that around. And I’m optimistic, with a new chairman coming in with a deep knowledge of these markets, that is something we could do together—build a good regulatory framework.”

At the same time, Peirce also pointed out that she doesn’t know when—or if—a Bitcoin exchange-traded fund (ETF) will finally be approved in the U.S. Recently, we’ve seen a new wave of major investment companies, such as Fidelity Investments, SkyBridge Capital, and VanEck, filing their applications for Bitcoin ETFs with the SEC.

The regulator, however, never approved a single filing of this kind so far, which as discussed earlier, may be a good thing for not only bitcoin but the entire nascent DeFi ecosystem where hundreds of billions in very real money is now intertwined.

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Into the Swarm #1: Archegos in the Coal Mine, by Romain Bocher

Investors herd, driving prices up and then scattering, taking their liquidity with them, when the market heads the other way. From Romain Bocher at theswarmblog.com:

Down the Market Hole

 

While the S&P 500 keeps rallying and hitting new records, the spectacular collapse of Archegos family office brought a sharp reminder of the consequences of excessive leverage in the financial system.

As always, Warren Buffet had already warned us: “Having a large amount of leverage is like driving a car with a dagger on the steering wheel pointed at your heart. If you do that, you will be a better driver. There will be fewer accidents but when they happen, they will be fatal.”

I do not know what the worst part of that story is. Whether it is the fact that Bill Hwang had criminal record. Or that Archegos used the same collateral to enter contracts with up to seven banks boosting leverage as high as 500%. Or if it is Nomura’s reaction, saying basically that whatever happens central banks will rescue banks if needed. Nothing seems to matter anymore for a system accustomed to perpetual bailouts since the LTCM failure.

But beyond those ethical considerations, the Archegos collapse has taught a few interesting things about US capital markets.

The first lesson for investors is the fact that years of lose monetary policy have laid the ground for moral hazard and very risky bets, as evidenced by the  record of margin debt. And the higher the leverage ratio, the bigger the vulnerability to unexpected moves.

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