Check the share portfolio for CARBON

In January this blog suggested that carbon companies were a SELL.  It became one of our best recorded posts.   Much of that commentary was based on the excellent research conducted by the Carbon Tracker Initiative.  That website is listed at the bottom of this page.


Now the Rolling Stone magazine has given their work much greater coverage with a fantastic article by Bill McKibben; himself one of the renowned authors in this field.  It is five pages but provides an excellent summary of where we have been and are headed.  I exhort you to read it.  Most of the following comes from his article. 

And he starts of with the fact there are only a few numbers anybody needs to know when considering carbon dioxide (CO₂₎ in the atmosphere.  The first is that the temperature around the world has increased 0.8 degrees Celsius.  Which I have written about previously.

The international community has agreed that beyond 2 degrees Celsius is catastrophic for the weather and humans.  So we are nearly half way there already. 

But some reports calculate that even if we stopped increasing CO₂ now, the temperature would likely still rise another 0.8 degrees, as previously released carbon continues to overheat the atmosphere. That means we're already three-quarters of the way to the 2 degree limit target.

The second number that it is important to know is that to reach that 2 degrees,  by mid century humans can only release another 565 gigatons of carbon dioxide into the atmosphere. 

The third important number is that in 2011, the International Energy Agency said that CO₂ emissions rose to 31.6 gigatons. So by the end of this year, that means that we have only 16 years remaining before we must stop emitting ANY CO_2. 

Not just reducing, but stopping.  Cars, power plants, fires, planes, etc.

Now here is the next important number (and a return to our investing theme) the number of CO₂ contained in confirmed coal / fuel / gas fields is 2,795 gigatons.  That is, 5 times higher than what we can burn. 

That is, this is the known reserves in the ground and excludes any future discoveries from exploration. 

Now we can put some further analysis around those numbers.  The first point to make is that for children entering primary school this year, when they graduate, they will face a very frightening world (as McKibben points out).  That is how soon it is.

The second is in our investment portfolios.  At some stage in the next 16 years, we are going to realise – through more catastrophic weather events – that owning shares in the companies that produce this fuel is not a good idea.  

And that is because those 2,795 gigtons is actually on the companies’ balance sheets, and is built into the share price as an asset, and we simply cannot burn it all and survive.  The Carbon Tracker Initiative lists all those companies and you can look it up if you like.  Al Gore puts the number at US$7 trillion of value in carbon related companies, of which one fifth is US$1.4 trillion -  an overvaluation of US$5.6 trillion.

So can we then derive that those company balance sheets are possibly 5 times over-valued? I guess it is a toss-up really.  Kids or carbon.  Australian legislation on what has become known as the "carbon tax" is not the first to introduce it, but it became effective this month.  And as McKibben points out, it is the only way to stop these behemouth companies in their tracks and save this planet. Oh, but sell the shares first huh!

This is what you get!!

I recall the first time I went to the USA.  On business.  I stayed at the Ritz in New York.  And every time I walked out the door, a few paces, I would be accosted all the way down the street by people trying to sell me drugs, consorts, and pan handlers.  The touts were rampant.  And frightening. It would have been fall 1987.  It seemed to me at that time that the city’s crime rate, which was very high, could never be turned around.  Tourists were turning away in droves. 

And of course it was.  Turned around.  I visited the city a hundred times over the next several decades, and observed its transformation.  The touts disappeared; new buildings were erected; the parks cleaned up; and it once again felt safe to walk down the street.  Into the parks, the churches, just walk and walk.  Or run on occasion. On one occasion, there was a street person with all his worldly goods beside him, and as I passed, his mobile phone rang.  And he answered it.  How bad could it be?

Yet still my current view of the USA, is a country at war with itself.  We have all read of the 46 million on food stamps.  The shockingly difficult unemployment figures.  And recently I read that new job creation has a ratio of 1 in ten being a permanent job, and the rest temps or contract.  The average wage is $25,000, and the wealth of the average middle class American has declined by 41 % in the last five years (versus an increase in the top quartile, and mainly because their wealth is held in their home which have declined in value).

Yet as I have written here, one of the few industries with huge growth over the last four years is guns:  “98% increase in Ruger quarterly firearm sales since 3Q08 from $117m to $232m”. 

Another blog dealt with the crash and grab of the legislature as it throws up and sometimes passes the most extraordinary legislation. 

But I am going to again bang on about the out of control law(less?) enforcement being used to target its citizens by the USA.  I just don’t get why more people are not commenting on this in the international press.   The country is simply heaving with cities or suburbs in lockdown with an occupation style mentality, and people all armed. Syria, huh!!

Hotel rooms and TV;  watched a documentary the other night about the city of Philadelphia, in north eastern USA.  It reputedly (at the time of the show) had the highest murder / gun crime rate in the USA.  The show, Louis Theraux:  Law and Disorder in Philadelphia.

The cops were all doing their best in Philli.  The put-upon African Americans who were being constantly harassed by them, also got a little heated about what they believed was racial profiling.  And I have to admit, on several occasions, that’s what it looked like to me.  But African Americans represent 43.4% of the population there, and whites 41%.  So I am not sure that claim can be substantiated.

But a young articulate African American speaking to camera summed up one incident between the police and a group of his friends this way: “This is what you get in America right now”.  Couldn’t have put it better myself.

Peak Oil v Peak Carbon v Giant Carbonised Insects

More on how the rug rats of today are going to live as adults, dodging the gnashing jaws of carbonised giant insects:  is it just me or is the oil peak being pushed out further and further?

Over the last few months, and despite limited interest in the industry (other than to shut it down), there seem to be a plethora of new oil deposits found / exploited.  Big ones.  Some media refer to them as giant fields.  If this observation is correct, then Peak Oil is a thing of the past and we are definitely all going to be gobbled. 

As an aside, with so many giant carbonised insects – such as the meter long centipede referred to in an earlier blog – we will also have a new source of food /protein to feed the masses tipped to hit 10 billion in my [old already] lifetime. 

But back to the new oil sources.  Some months ago I read about BP (and others) making a large find off the northern coast of the UK.  Or was it the end of last year?

Anyway another has been announced only last month.  UPI reports “British energy company Premier Oil announced that it made an oil discovery in the Catcher area of the country's territorial waters of the North Sea.”

And remember a few months ago the announcement of the large oil deposit find off the coast of Ireland;  poor ol’ Ireland that has lost its wealth, its income, and a whole generation to austerity??  Exploration company Providence Resources announced the find off the coast of Cork.  The find was referred to as “major”.  The article went on to say ”The coastal Basins surrounding Ireland have long been known to harbour valuable natural resources. It’s estimated that they could produce 10 billion barrels of oil and an unquantifiable amount of gas. In the past, exploration has been held back by a lack of technology and low oil prices.”

As probably more of a political statement, Kurdistan has started shipping oil to Turkey.  Whilst in east Africa, “Tullow Oil, a London-based explorer with the most licences in Africa, said it planned to accelerate drilling in Kenya after making the East African (Kenya) state’s first discovery earlier this year.  Tullow forecast Kenya has the potential to exceed Uganda, where with Total and CNOOC it plans to invest more than $10bn to unlock an estimated 2,5-billion barrels of oil. $4 per barrel.”

But wait, there’s more.

The Norwegian oil firm DNO International said it is ramping up oil production in Iraq as it confirmed an oil discovery in the country's resource-rich Tawke field and has resumed drilling operations in Yemen. DNO, which explores and produces oil and gas in Iraq and Yemen and plans to expand activities in North Africa and the Middle East

And more.

“Online PR News – 05-July-2012 –PierMax Energy Exploration is pleased to announce that, it has made a significant oil discovery in current onshore Kurdistan oil exploration project.”

And so it goes on and on.

And to crown my paranoia about never reaching Peak Oil (which has been forecast to be occurring around now) and thus never reigning in the carbon problem, I read George Monbiot recent article False Summit (meaning oil summit or ‘peak’).  The great eco campaigner. 

His first sentence is “We were wrong about peak oil: there’s enough in the ground to deep-fry the planet.”  And ends with “But right now I’m not sure how I can look my children in the eyes.”

In between those two emotionally charged sentences, is a great article, and as usual well researched.  Citing various article, he asserts that the recent sustained high price of oil has triggered to new oil resource boom.  That indeed, it is not so much how much oil, but at what price. With US$2.6 trillion spent over this three year period in exploration etc (end 2012).  Some of it extracted using fracking, the environmentally fraught polluter.

Yeah gads!!

So back on the research car and this was found.  Published in 2006, so it overlooks the recent massive investment in oil production and discoveries;  by the way, all of which are found and delivered from very difficult methods / places (fracking, deep sea). These five key points are believed at that time to be irrefutable and the basis of Peak Oil. 

1. The biggest oilfields in the world were discovered more than half a century ago, either side of the Second World War.

2. The peak of oil discovery was as long ago as 1965.

3. There were a few more big discovery years in the 1970s, but there have been none since then.

4. The last year in which we discovered more oil than we consumed was a quarter of a century ago.

5. Since then there has been an overall decline.

So anything written since then to confirm this thesis?  Well in May this year, there is a long post on oil and the industry on scepticblog.org by a reasonably senior academic geologist.  It is extremely lengthy, however sufficiently erudite and simplistic (for this oil idiot) for it to be recommended to all.  These are just a few extracts of interest: 

Academic geologists are nearly 50% women now, and they are distributed across all age classes. Oil geologists, by contrast, are nearly all old white guys in their 60s or older, with a lot of young men (and a few women) just recently hired in the business. The entire generation that would now be in their 40s and 50s is missing because of the attrition during the oil busts of the late 80s-90s. [I just thought this was interesting].

As the Time magazine article pointed out, now they’re spending most of their time and money on increasingly risky and expensive operations like fracking, pumping water in old fields to push out the last drops of oil, or mining oil sands with all their environmental costs. The biggest push is in offshore oil platforms—and the 2010 Gulf oil disaster (along with previous oil disasters on platforms around the world) shows just how risky it is to drill so far offshore.

So what about the world discovery rate? That answer has been known for a long time. World discovery rate peaked in 1965, and has been steeply declining ever since, even though more and more exploration is conducted in the farthest reaches of the globe in the past 47 years. The “peak oil” effect has probably already occurred, and we are likely on the slow downward decline in discoveries of cheap, easy-to-pump oil.

……in recent years most of the estimates place the total volume of ultimately recoverable oil in the range of 1.8 to 2.6 trillion barrels, with most estimates around 2.0 trillion barrels.

The booming economies of China and India, along with some other developing nations, are greatly exceeding any increased production due to new discoveries. The numbers are truly staggering. From only 50,000 barrels/day in 1980, world consumption is now almost 100,000 barrels/day. As oil executive Peter Tertzakian pointed out in his book title, we’re nearing the once-unimaginable consumption rate of a thousand barrels a second! Even as the U.S. finds more oil in unconventional places, we cannot keep our domestic prices down because demand outside the U.S. is driving the world price upwards.

So by my calc that is ~55,000 years of oil supply at today's consumption levels if we use the 2 trillion estimate with current consumption at 100k barrels per day.  At that level we are toast!! Something doesn't seem to be adding up here.  Then we look at the next argument, of 1,000 per second.  That equals about 86 million barrels per day; being 60,000 per minute;  3.6 million barrels per hour; etc.   So I think he meant 1,000,000 not 100,000.  Which brings the ~55,000 back to ~55 years of supply at today's consumption level.  Phew!!

There is also the fact that the peak of discovery of major oil fields occurred 47 years ago, and there have been no giant oil fields found in a long time, and most of the world’s older oil fields are nearing their ends.

An acre of corn consumes 80 gallons of oil in the form of pesticides, fertilizers, and fuel for the tractors.  Without [oil], our food supply would collapse, and the world would be looking at a global famine. The end of cheap oil will force everyone to re-examine agricultural practices, since you can’t make most pesticides or fertilizers out of coal. 

And thus cannot replace lost oil with biofuel. 

So rug rats.  There are your choices:  eaten by giant carbonised insects or die of starvation.  Blame the old white guys in the oil industry. 

However, I believe that we can confirm that peak oil has definately come and gone.  So that is hopeful.  Right?

You're Officially Fired

As anyone will tell you, hosting a blog requires frequent posts.  And here is the confession:  it is five weeks since I last posted.  I am sorry.  And especially to the many great people who have been reading this blog regularly from all over the world.  Truly gobsmacking that people do (read the blog).  Thanks.

Since the last post though, absolutely nothing has happened to change the very real major catastrophes around the world about which I have written relentlessly:  Climate and those idiots running the economies into a global depression. 

The recent global intercessional meeting s in Bonn (the Bonn Climate talks following on from Durban last year) ended with a complete and utter failure.  This is how it is reported in the USA site:

"Parties in Bonn eventually broke the deadlock and agreed on an agenda that will guide the Durban Platform negotiations through 2015………. It is now very clear that we have a difficult four years ahead of us of negotiating the Durban Platform, an agreement that will bind all nations to curtail greenhouse gas emissions after 2020.  Scientists warned us again in Bonn that the door to avoiding a maximum 2 degrees Celsius global average temperature rise is about to close."

The emphasis is mine. 

But there was a minor advance at the G20 meeting in Mexico, where:

"Mexico, host of the G20 talks this year, passed a law ratifying their COP15 pledges (namely a 30% pollution reduction below business as usual by 2020 and a 50% reduction by 2050)."

Well goody, but that is of course too late.  The carbon emission peak must be well before 2020.  And most countries haven’t even started. 

One event that did happen during my “break” from blogging, was I watched a documentary called  “How to Grow a Planet”.  Fantastic.  In one section it explored the great Oxidation Event, from which much of life was derived.  This occurred about 2.5 – 3 billion years ago.

To cut a long story short, I have always wondered what would happen to mankind when the oxygen / atmosphere is so carbonised that our bodies cannot work properly.  I mean, I don’t really care, I’ll be dead. 

During the show, it illustrated that when there was substantially less oxygen in the air mix (where we are heading!) at the time lived giant insects relative to our size today.  Centipedes a meter long;  dragon flies with four meter wing spans;  giant ants.  You get the picture. 

And it soon became apparent that the end of mankind may not be from a lack of oxygen, but being eaten alive by giant insects.  There are more of them right?  Anyway good luck with that all you little rug rats. 

And which countries will be safer on a relative basis?  Those where the population have already eaten most of the insects (Asia) or killed most of the birdlife (Italy, say) or the fish (just about everywhere).  Those countries working hard to save biodiversity are in trouble.  So which side are you on?

Pennies and Dimes and the 99%

It was this time last year that I fell out of love with London.  I was staying in a three story walk-up flat, in Kensington.  Close to shops, tube, and some great pubs.  And walking distance to the Chelsea Flower Show and Q&A amongst other museums.  From my bower window I could sit in the afternoon spring sun and watch the pedestrians far below, hithering and thithering.

Kensington was dirty, and the people grasping.  The young women wore stiletto heals that were reminiscent of the foot binding days of the Chinese.  All the shops had sales, although I am not a shopper, it was noticeable that along the strip the retailers were doing it tough.  Clear signals of a weak economy. 

The fact that it rained most of the week could have also contributed to my gloom.  In one day alone we had boiling heat, torrential and flooding thunderstorm, hail, and a wind storm.  

Across the street from my flat, and a floor lower was a gorgeous apartment.  Decorated and furnished in the old English style it was immaculate, with real old world charm.  The curtains were always open as though the owner was inviting people to glance in and admire.  

The owner himself was of old world charm style, an English gentleman.  Maybe ex military, because he stood tall and ramrod straight despite his clearly many years, and groomed to within an inch.  

As I sat in the evening, it was the only time I saw him, despite having a clear view the entire length of his apartment.  At that time, he would sit beside the window and read the paper, on occasion leaning into the window as the light faded, holding up the paper.  

Maybe I am slow, but it took a few days to realise that he was using daylight to read by rather than turn on an overhead light.  And further, that I at no time when glancing out the window saw lights – either overhead or from a flickering TV – in the evening.  In the kitchen, I only ever saw tin cans on the bench, despite the inviting décor.  It took me a little time to understand that all over London some, like this elderly gentleman living in a million pound apartment, and others less fortunate, were not turning on the lights nor cooking, because they couldn’t afford it from their income.  I wasn’t just the poorer demographic.  The seemingly wealthy were suffering also.  

And maybe like this gentleman, they lived a proud existence, and told nobody for the shame.

I have written about inflation and ivory towers, in which I suggested that the governments would soon (and again) be adjusting how they measure inflation to grab back money on say, pensions.  Inflation is a number on which the whole world spins, whether measuring real investment returns, pensions adjustments, or planning for future expenditure.  

And that the western economies are experiencing stagflation, whereby the cost of essentials – food, water, energy, healthcare – are rising faster than the income on which we rely to meet these essentials.  And I don’t see how it is going to be any better for decades.  (I took my own advice and bought a farm.)

Then a month ago there was this extraordinary article, as if to prove me completely correct.  So that I am sure you have the benefit of reading it (and the following comments) here is the link in full.

http://www.bloomberg.com/news/2012-04-25/chained-cpi-switch-is-a-slam-dunk-even-in-election-year.html

I learnt various things from this article.  First, that Bloomberg now had its own editors publishing editorials.  When did that happen?  Second, that they also posted comments about an editorial.  Again, since when?  Third that Bloomberg is still getting its facts wrong.  Evan when written by the “editors” themselves, whose primary role is, after all, to edit the facts.  

Here is the opening line:  “Sadly, Congress and the White House seem incapable of agreeing on substantive measures to tackle the $10.4 trillion mountain of U.S. debt.”

Now the interesting thing about that line, is that the US debt is in fact US$15 trillion, because I looked it up on Bloomberg.  

The article then goes on (the “slam dunk” in the heading is a tip to its quality) to say that the government should switch to a Chained Inflation measure rather than the standard measure used today.  

Chained inflation is a measure, that reputedly tracks changes in consumer purchasing behaviour.  The example they use is that when the price of a granny smith apple rises, the consumer switches to the lower cost red delicious apple.  

Now, for sure you are getting the drift.  As inflation on food essentials (as an example) keeps rising, people will continuously switch to lower and lower cost products.  Cat food comes to mind, as it did to the many commentators who overwhelmingly mocked this article.  Dog bones anybody?  What inflation?

The “editors” suggested that this would save the government US$300 billion over ten years.  No suggestion how this was going to pay down the debt.  And at 0.2% it isn’t even enough to pay the interest on the debt. 

And you guessed it, the savings came from:  social security and cost of living adjustments;  pensions; and probably food stamp recipients.  The 99%. 

And again this turns to a continuing theme in this blog – penny and diming the 99% whilst the 1% carry on.  As pointed out in prior blogs, taxing the OTC derivative market, US$700 trillion and counting, just 0.1%, would raise US$700 billion.  And if the duration of the OTC market is 3 months, that would be US$2.8 trillion per year, or enough to pay off the USA debt in total plus a huge surplus using Bloomberg’s 10 year measure.  

Of course the USA is not the home to all the global derivatives, but probably a lot of them.  There would be quite a material amount in other financial centres such as London.  

And you guessed it, the Telegraph reports that that government is about to pennie and dime its citizens by adjusting how the RPI is measured.  That's the retail price index.

It reports “A reduction in RPI would save the Government up to £3bn a year on the interest payments it makes on index-linked gilts, but would also slash income for pensioners and those whose pay packages are linked to the measure.”

Like the pension for that charming elderly gentleman living in Kensington.  Or should I say, surviving, just! 

All wrong on JP Morgan

In our Pennies and Dimes blog in April, we identified that JP Morgan had US$70 trillion of derivative exposure at the end of 2011, of a total market of ~US$707 trillion.  So it had 10% of the market. 

We argued that if governments wacked these OTC derivatives onto an exchange and then taxed the market at 0.1% turnover then it would generate US$700 billion in tax revenue and is easily the slam dunk for the global debt problems (see tomorrow’s blog).  Taking it further, if the average life of each derivative was 4 months (qtr – but the total global portfolio of derivatives may well be a bit longer) then total tax revenue would be four times US$700 billion per annum = US$2.8 trillion.  Enough to bail out Italy I believe, and certainly enough to pay off some of USA government debts. 

Continuing this theme, we then blogged on the massive US$1.5 trillion in excess reserves held with the Fed by the US banks.  We raised the question “Why hoard expensive capital, with the toll on profits given there is little place to invest it with much return, unless you are (i) scared out of your wits about another mighty downturn and massive liquidity crunch or (ii) there is a lot of short term risk (OTC derivatives?) they may have but we do not know, against which they are holding this capital (and not required by prudential standards).”

And followed on with the distrust on counter parties being a rationale for this excess capital – and as it turned out for good reason.

Then of course we learnt of the rating agencies demands that (To Big To Fail) banks must hold much greater capital relative to that required for “prudential” guidelines to ensure that they have their derivative exposure covered in the event of loss.  Or indeed any margin call on their leveraged books.  Remember you and I bailed them out last time so this is a good thing.  Again, this is all about counter party risk and who gets shafted if one makes a blunder.  So we were correct on both fronts with respect to the excess capital: derivative cover and counter party risk. 

And as an aside, making the prudential guidelines for capital meaningless as clearly the market is dictating the terms of capital guidelines.

So, thennnnn………JPMorgan blows up US$2 billion.  As I said this story theme just keeps giving.  And of course it is now reported to be close to US$3 billion (in Bloomies) as the market vampires sink their teeth into the unwinding artery and suck.  Heh heh heh!!

There are several points here, again that I have not seen written about.  But first, if I had picked up this theme in April – and I am not in the market these days – then the market knew about JPM at least as early as April, and this has since been reported as correct.  

The second thing is that JPM was reputedly trying to hedge long tail risk in its book – or total portfolio.  And people have been jumping up and down about this being a hedging exercise rather than a portfolio (b/s) risk management exercise (and hence the Volker Rule in the USA must be passed).  Frankly I disagree with all of it.  There is nothing wrong with hedging your whole portfolio.  Fund managers do it by asset allocating (if they are long only) and insurance companies do it by laying off risk, either in tranches of value or tranches of time.  Perfectly acceptable.

But what possibly was happening at JPM which is unforgiveable was that it was only participating in a meme – an imitation of what is a very trendy risk management tool in investment banks at the moment: hedging out your long tail risk.  So, sadly, they were actually just doing it for trendy reasons rather than for strategic risk management.  Or maybe I am wrong and should give them more credit (no pun intended) for independent thinking.

The problem with all this is that long tail risk is meant to be covered by / with (i) today’s profits stored in reserves until the risk expires (ii) the pricing mechanism when the lending business (which in aggregate makes up the whole portfolio) is actually written, or struck.  That is, the margin above the risk free rate which is composed of credit risk, liquidity risk, etc.

So, to want to hedge your long tail risk, you should be reserving profits today AND pricing your risk (especially on long term business) correctly.  

So one of these two things at JPM must have changed if we are to give them credit for making sound rationale for hedging their long tail risk (and not just imitating the meme).   Either they are reserving insufficient capital for long tail risk, or they have miss – priced their book when the business was written.

OR we are completely wrong in all of this and they were just prop trading.  A big no no. 

But back to giving them some credit.  The (now) US$3 billion they have lost is just 0.004% of their reported derivatives exposure.  (Which leads my blood pressure to rise:  what if they had lost more?)  I mean, really, it is hardly risk taking is it?  That is, if you measure it against their total derivative exposure of US$70 trillion. And as a loss to book is concerned, it is still only 12 basis points or 0.12%.  Loose change.

Where the first problem comes in:  why do you need US$70 trillion of derivatives to protect a ~US$2.5 trillion book?  That is 28 times.  And if it is intended to be a hedge of their book rather than a punt, then it should in theory always be net neutral so it is highly unlikely – even black swan events – to be losing money.  (But you could argue that a .004% loss on US$70 trillion is virtually net neutral).

So why is everybody jumping up and down.  Frankly, I do not believe they have thought it through.  Just doing back of the envelope numbers; capital on the US$2.5 billion book would be US$250 billion assuming 10%.   So they have lost a little over 1% of capital. 

Which leads to the second: what if they lose 1% of their derivative book?  That would be US$700 billion, or nearly three times capital reserves.  So in theory, JPM would need to increase their capital base 3X to maintain an AAA counter party rating, if a 1% margin call was the criteria. 

When you are 10% of the total market – you are at multiplies of greater risk for it to move against you - whether punting or hedging.  This is the position JPM finds itself, and frankly should have been smart enough to price this illiquidity when hedging its book.  And there are other practical issues, such as the market turning for other unrelated reasons when you are in the process of placing your “net neutral” position.  I mean, their loss is so small on a relative basis, this is probably what happened, together with the market dominance risk above.

No, I think everybody is looking in the wrong direction.  Banks and other risk takers are meant to take and manage / mitigate their risk to optimise profits.  

The real problem is the scale of the derivative market.  JPM exposure (and every other bank) should have a limit on it (think of the concentration in AIG in 2008).  THAT would make them think how to use it more judiciously.  I mean US$70 trillion for US$2.5 trillion?  That’s the problem.  

Oh dear!!

Politicususa published a list of thirty pieces of Republican legislation introduced to government [s] in the Obama term that they considered the Republicans War On America.  Their view was that Republicans are using these legislation to destroy America.  We republished their headings, but also gave access to the very very detailed and impressive research they had done to support their thesis.

One piece of legalisation in this honourable list was called “The War on Human Foetuses in Food” , which they poohed poohed as representing how mad the Republicans are.

Wrong guys.  The Republicans had every conceivable reason to suggest, and probably pass this legislation if this report in the Daily Mail can be believed.

In South Korea, customs intercepted cargo that included more than 17,000 capsules containing powder made from dried aborted Chinese babies.  

Frankly, I have nothing more to say on that.

However, the number of wars will now have to be 29.  

Right Not to Trust (the Fed)

So we have been writing about the massive excessive reserves of the USA banks held with the Fed Reserve.  At an official rate of 0.25% (in the "prudential market" lets call it) versus more than 3% in the capital market.   The opportunity cost seemed large, let alone the US$18 trillion lost lending.  Hmmmm!!!


Excess reserves of course, is capital reserves in excess of reserves required under prudential guidelines.

We concluded that this US$1.5 trillion hoard of excess reserves was as a consequence of a loss of trust between bank counter parties and / or (ii) there is a lot of short term risk (OTCderivatives?) they [banks] may have but we do not know, against which they are holding this capital (and not required by prudential standards).

And via zerohedge we have the answer…..and it turns out we were correct.   The banks do not trust each other and the banks require substantial extra capital in the event of the credit downgrade.   A credit downgrade would trigger derivative margin calls, and those margin calls would need to be capitalised.  

For example, Morgan Stanley has just filed its 10-Q with the SEC, and shows that it requires another US$10 billion.  About another third of its current capital base.   So that in the event that it is downgraded three levels by a rating agency, it has sufficient capital to cover its margin calls.  

Let's also recall that the derivative market is reputedly US$700 trillion.  And further that Morgan Stanley, our example, is one of those Too Big Too Fail designated banks, that in the event of a failure are backed by the government.  So we know in advance that it will be bailed out.

So why call it "excess capital" Fed?  It is not excess.  It is in fact the level of capital required to maintain its  credit rating.  You could call it the amount that the banks require so that you (Fed) do not have to spend my money bailing them out.  If their shareholders are earning the revenue on these derivatives, they should carry the cost of offloading the risk as well.  [In a previous blog we also referred to reading a Federal Reserve piece on the excess reserves that frankly was a crock of.   Serious shortcomings there.]

It should be required capital to have the capacity to cover your derivative margin calls.  Looks to me like the rating agencies are doing the Fed’s job for them.  For a change, I should add.

Global trade like a drunken sailor

A couple of weeks ago there were several articles about how the Baltic Dry Index (BDI) was out of favour.    Or to be more precise, that it had lost its relevance.  Too much shipping supply and not enough global demand had compounded within the index to push it to the lowest level in recorded history.  One article in the Telegraph (I think) suggested that the ships are worth more as scrap than for the primary purpose. 

For those who are unfamiliar with this index, Seekingalpha.com describes it as:

The BDI is a shipping and trade index created by the London-based Baltic Exchange that measures changes in the cost to transport raw materials such as metals, grains and fossil fuels by sea. The Baltic Exchange directly contacts shipping brokers to assess price levels for a given route, product to transport and time to delivery (speed). For shipping companies, a higher BDI is better than a lower one as it means that they will get to charge more for their services.

I was going to write about it back then, that the articles were simply wrong.  The index is doing no more than it should, showing exactly where the global economy is functioning.  There is oversupply in many parts of the economic world:  labour, money, cars, trucks, houses etc etc, and shipping.  And whatever index you follow, when that happens indexes go down when the bubbles burst.

But the blog didn’t get written, and now if you search for news on the web for the Baltic Dry Index, there is an enormous number of news articles.  Why?  Because the index is, like a drunken sailor, lifting itself off the floor.  Up more than 60% in the past few months. 

And seekingalpha.com explains in its article why the various shipping companies are good investments right now.  And the arguments are strong – with Price/Book discounts of 80% or more.  Assuming that they do not go bankrupt before, any minor improvement in global economy will reap substantial rewards with small movements in the share price.  And many an international investor has made their money buying ships cheap and selling them into a growing market.  The Greek shipping magnates come to mind. 

But you know what?  This just doesn’t look like a resuming global boom to me.  It looks like a drunken sailor.  But there is one thing for certain, the index is not broken.  It is telling you that the global economy continues to be severely tough. 

USA Civil War

In this blog we wrote about what appeared to be the civil war in many countries and includng the USA.  And those views haven't changed.

To celebrate the 1st May Labour Day, Politicususa published an astounding piece.    Called......

The Dirty Thirty – Occupy May Day Edition

By: Hrafnkell Haraldsson

"On March 14, 2011 we (they)  first published a list of thirty pieces of Republican legislation “that Republicans are using to destroy America” and called it “The Dirty Thirty.”

And here they are:

The War on Women's Reproductive Rights

The War on Human Foetuses in Food

The War on the Girl Scouts

The War on Divorce

The War on Church and State

The War on Special Supplemental Nutritional Program for Women, Infants and Children (WIC)

The War on National Public Radio (NPR)

The War on Desegregation

The War on High-Speed Rail

The War on Marriage Equality and the Anti-Gay Agenda

The War on Net Neutrality

The War on Obama: Birthers and Anti-Obama Legislation

The War on Unions and Collective Bargaining/War on Middle Class

The War on Immigration

The War on Child Labor Laws

The War on Islam/Islamophobia

The War on the Federal Government (Tentherism)

The War on Gun Control

The War on Consumers

The War on Democracy

The War on Jobs

The War on Science, the Environment and Health

The War on Hungry Children and Families

The War on Education/Historical Revisionism

The War on Anti-Bullying Laws

Doomsday Legislation

The War on Freedom of Expression

You’ve pushed us white folks too far!

The War on Privacy

The War on the “New World Order”? Really?

Following each heading is a comprehensive list of all the new Republican legislation brought (nearly typed “bought” which would be equally appropriate) to various government chambers all over the USA in the past 2 years.  The writer concludes that the USA is at war with itself.  

You can’t know a country until you read its policies in detail.  It is a very long read.  But well worth it.  Here is the link in full.

http://www.politicususa.com/the-dirty-thirty-occupy-may-day-edition.html

Yep!!

Biflation Triflation Miflation

Banging on about the current world experience of stagflation in this blog, (amongst other in the inflation tag line) it appears only rarely in the mainstream press, and even the blogosphere.   

Whatever it is that we are experiencing, framing the landscape is critical for setting investment strategies for investors and companies, and fiscal and monetary policies.  

Consider the current investment landscape.  If you are twenty years old, you need to know where to put your money for risk returns.  If you are fifty, you need to know where to put your money for capital preservation.  Indeed, in some issues written in this blog, sovereign diversity is one of the key issues whether through migration to growing countries (such as Mexico) for employment if you are young, or placing some of your savings elsewhere if you are older.  

To confuse analysis of what is written, there are arguments raging about, inflation, chained inflation, headline and core inflation, CPI and RPI, and of course my favourite, stagflation.  And all mean something different. 

Inflation, chained inflation, headline and core inflation, CPI and RPI are all manipulated by the government for budget boosting reasons.  So ignore them – other than a vicarious interest into what the majority of the investors are doing.  

Stagflation means (Wiki) the inflation rate (if it wasn't manipulated) is high and the economic growth rate slows and unemployment remains steadily high.  And that has been my position for some time.  But I have added deflating assets and also wage growth sub (true) inflation on the essentials.

And it is inflation in the essentials that is critical as written about here.  Food, water, shelter, health and education services, and important – energy costs.  

However there are some other inflation derivatives.  Biflation for example.  According to Wiki, first coined in 2002 by Dr F Osbourne Brown, it means there is a rise in the prices of commodity / earnings based assets (inflation) and simultaneous fall in the price of debt based assets (deflation).  Further:

“With biflation on the other hand, the economy is tempered by increasing unemployment and decreasing purchasing power. As a result, a greater amount of money is directed toward buying essential items and directed away from buying non-essential items. Debt-based assets (mega-houses, high-end automobiles and other typically debt based assets) become less essential and increasingly fall into lower demand. As a result, the prices for them fall due to the decreased volume of money chasing them. The decreasing costs to purchase these non-essential assets is the price-deflationary arm of biflation.”

Okay, got that.  And it does seem as though some of these criteria for biflation is being experienced today as well.  But not exactly spot on.  For example, mega houses and the assets of the uber rich (very high end brands) are doing very well.  It is the assets of the middle classes and poorer demographics that are deflating in the OECD countries.  So there is another element missing in biflation.

So I have invented a new term, which encompasses both stagflation, and biflation, with the chasm of the polarisation of wealth, and called it “triflation”.  Representing both aforementioned inflation derivatives but includes the effect on the economies from trickle down policies that is polarising wealth.  

Which as I have written elsewhere, ultimately gives rise to trickle up austerity, and then the next phase is “miflation”.  Another invented term to encompass what is being experienced today for the 99%. 

That is when the masses, impoverished through trickle down policies that give rise to stagflation and biflation, that in turn leads to trickle up austerity, eventually migrate to another country (again Mexico comes to mind) for food and essential services security.  

You read it here first.