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Sound or Unsound?

Add meltdown in Iraq to the long list of geopolitical risks.

As follow-up to last week's quarterly "flow of funds" analysis, I'll take a brief look at the Rest of World ("ROW") category. ROW now holds an incredible $22.971 TN of U.S. Financial Assets. To put this number into some perspective, ROW holdings began the nineties at $1.874 TN. Ballooning U.S. Credit and attendant unprecedented Current Account Deficits saw ROW holdings surge $4.335 TN, or 230% during the nineties. During the past 22 years, ROW holdings of U.S. Financial Assets have inflated $21 TN, or over 1,000%. Essentially, the U.S. has unrelentingly flooded the world with dollar balances. This helps explain a lot.

The consequences of the massive inflation/devaluation of the world's reserve currency have for a long time been readily apparent. For starters, our huge trade deficits with Japan and U.S. pressure for the Japanese to stimulate domestic demand played a prevailing role in Japan's fateful late-eighties Bubble. The Greenspan Fed's early-nineties stimulus measures then supported the inflation of myriad foreign Bubbles, certainly including Mexico 1992-1994. The Mexican bailout then ensured catastrophic "Terminal Phase" Bubble excess throughout the Asian Tiger "Miracle" Economies in 1996. An unstable global financial "system" nurtured serial major Bubbles, including Russia, Argentina, Iceland, Brazil, etc. throughout the nineties.

After ending the '90s at $6.209 TN, ROW holdings of U.S. Financial Assets doubled (again) in just over six years. The mortgage finance Bubble period (2002-2007) saw ROW holdings surge $8.7 TN, or 116%, to $16.2 TN. It's my view that the historic dollar devaluation during this period played a major role in precarious Bubble excess throughout the Eurozone (especially at the periphery). The crisis year 2008 saw U.S., European and global financial chaos. During that year, ROW holdings dropped an unprecedented $813bn to $15.386 TN.

In the 21 quarters since the end of 2008, ROW holdings have jumped $7.585 TN, or 49%. The world was once again literally flooded with dollars. The global government finance Bubble thesis posits that these dollar balances inundated the emerging markets, fueling unprecedented Credit growth, financial Bubbles and economic malinvestment. China, in particular, succumbed to Bubble Dynamics on an historic scale.

I have what should be a rather basic question: Is global finance sound or unsound? Is contemporary "money" and Credit sound? The issue of sound money and Credit has occupied a lot of thinking and written pages over centuries. Today, everyone seemingly couldn't care less. Anyone that argues against conventional thinking on the subject is considered a wacko.

Back in 1999 everyone was crazy bullish and there was the outward appearance of a New Age miracle economy. I didn't buy into the exuberance for one simple reason: It was obvious to me that the underlying finance fueling the boom was unsound. In late-2007, with stocks at record highs and the economy and markets trumpeted for their impressive resiliency, I was convinced a major crisis was imminent. Why? Because there was absolutely no doubt that the underlying "money" and Credit was alarmingly unsound.

So, here we are in mid-2014. The financial mania is back, bigger and bolder than ever. U.S. and global markets are again lauded for resilience in the face of myriad issues. Here at home, it's Miracle Economy 2.0. Meanwhile, the underlying finance driving the boom is the most unsound and dangerous ever. It's as clear to me today as it was in 1999 and 2007.

It's curious that the issue of unsound money and Credit is not today central to the economic debate. After all, history is unequivocal. Unsound "money" ensures financial, economic and social instability. It guarantees problematic price instability, deep structural economic impairment and income and wealth inequalities. Especially after the 2008 crisis, one would think the sound money debate would be front and center. Yet somehow the doctrine of inflationism completely dominates economic curriculums, thinking, policy and discourse. The specious doctrine that deflation is the overarching risk goes unchallenged.

Simplistically, the consensus view holds that the financial system and economy are best served by inflation (CPI) rising steadily at a rate of two to three percent annually. A little inflation is thought to grease the wheels. A steadily rising price level is believed to ensure that the economy can consistently grow out of potential debt problems. This fallacy is highly pertinent and should be addressed.

In a closed economy with generally stable finance and economic output, one might make a believable case for the benefits of steady annual 2-3% inflation. But especially during the past 25 years, we've seen major developments that wreak havoc on simple models and premises. "Globalization" ensures the closed system model is invalid. There have been as well myriad profound changes in the nature of economic output. The technology revolution, the proliferation of services throughout the economy and the rapid growth in healthcare are just the most obvious areas that have profoundly altered the nature of economic output - along with the ability of contemporary economies to readily boost the supply of things (that absorb purchasing power). Moreover, the past 25 years have been a period of extreme financial innovation.

I have argued that it is a myth that contemporary central bankers control CPI (for starters, they don't control Credit/purchasing power or output). Indeed, if they strive for 2-3% annual inflation they will ensure acute financial and economic instability. In the U.S., 2-3% inflation equates with flooding the world with dollar balances and devaluing the world's reserve currency. Moreover, modest consumer price inflation these days equates with a massive inflation of Federal Reserve "money" - liquidity that has profoundly altered risk perceptions, asset prices and market behavior throughout the system. As we've seen with 18 months of QE3, 2% consumer inflation can equate to 30% stock market inflation and double-digit price gains in national home price indices. Two percent CPI has equated with an unprecedented flow of finance into higher-yielding securities, instruments and products, in the process fueling a massive mispricing of corporate debt. Modest inflation ("stable prices") has equated with virulent monetary disorder across the globe.

China international reserve assets have surged $700bn over the QE3 period to a record $3.948 TN. It is worth noting that Chinese reserves began 2002 (start of mortgage finance Bubble) at about $200bn. In many ways, the Chinese Bubble is the mirror image of the U.S. Credit Bubble. China is today also at the epicenter of unsound global "money" and Credit. It is my view that if not for the massive inflation of U.S. Credit (dollar devaluation), it would have been impossible for the Chinese Credit system to have operated without any constraint for so long. Unfettered cheap Chinese finance has allowed massive overinvestment throughout scores of industries (not to mention apartment units!). The world now faces the consequences: "disinflationary" pressures on many things as well as the specter of major unfolding Chinese financial issues.

June 13 - Wall Street Journal (Daniel Inman, Fiona Law and Enda Curran): "The commodity-backed loans at the center of a probe into an alleged financial scam at a Chinese port are part of a ramp-up in offshore borrowing by Chinese companies that Beijing is looking to tamp down. As Chinese authorities tightened credit at home in the past year, local firms instead looked abroad for financing. Asian-Pacific banks alone had $1.2 trillion in loan exposure to China at the end of 2013, up two-and-a-half times from 2010, according to Fitch... A chunk of the borrowing has been by Chinese firms taking out short-term overseas loans backed by commodities, part of an effort to lock in gains by borrowing offshore at lower rates, and investing the money at higher rates on the mainland. This lending has complicated Chinese policy makers' attempts to slow rapid credit growth in the nation's so-called shadow banking sector... Foreign banks have stepped up commodity-backed lending to China in recent years, a profitable business that now is looking increasingly shaky."

I cannot blame all the world's problems on unsound U.S., Chinese and global finance. The frightening unfolding Shia vs. Sunni debacle in Iraq and the Middle East obviously predates Western central banking, the dollar reserve system and unconstrained finance. Yet I look around the world and see initial consequences of the world's greatest episode of unsound finance and financial mania. Asia is a tinderbox, and I fear that Chinese leadership will be tempted to lash out as their Bubble deflates. I look at Russia and the ongoing "Ukraine" crisis and I see deep Russian animosity towards their view of U.S. dominated global finance and economic arrangements. It seems obvious to me that Russia, China and others will increasingly see it in their best interest to change the "world order."

I am an analysts and not a pessimist. I actually have an optimistic nature. Without it I would not be able to do what I do - including chronicling the world's greatest Credit Bubble on a weekly basis for about 15 years.

But I look around the world today and am more worried about the future than ever before - Iraq, the Middle East, China and Asia, the emerging markets, Europe, Ukraine and Russia. The "social mood" is sour at home and abroad. Animosity. Anti-Americanism. Anti-Capitalism. Fragmentation. Conflict.

Compounding the problem, I see wildly distorted global central bank-induced Truman Show securities markets. I see a mirage of prosperity fueled by surging values of all kinds of financial (and real) assets. And I see endless electronic debit and Credit entries - contemporary finance - that is supposed to equate with unprecedented global wealth. Yet there's a massive gulf between perceived and real wealth. I see incredible bullishness and denial in the face of deep structural issues for both U.S. finance and our economy. I see the mirage of U.S. prosperity dependent more than ever before on highly accommodating central bankers and unending bull markets. I just don't buy the view of the U.S. as an oasis of prosperity impervious to global degradation.

On an almost globalized basis, there is this very troubling divergence between highly speculative and inflated securities markets - and a really uncertain future. I've argued that central bankers can't make things better - that their monetary inflation only makes things worse. It seems obvious that a most protracted period of unsound "money" has created one hell of a mess. As for geopolitical risk, Ukraine and Russia remain issues. Asia is an accident waiting to happen. And, now, instability in the Middle East risks a blowup that could wreak havoc on global energy markets - not to mention a horrific human tragedy.


For the Week:

The S&P500 declined 0.7% (up 4.8% y-t-d), and the Dow fell 0.9% (up 1.2%). The Utilities dropped 1.5% (up 10.0%). The Banks slipped 0.2% (up 2.1%), and the Broker/Dealers fell 0.5% (down 2.3%). The Morgan Stanley Cyclicals were down 1.3% (up 6.0%), and the Transports were hit for 2.0% (up 8.7%). The S&P 400 Midcaps lost 0.6% (up 4.5%), and the small cap Russell 2000 slipped 0.2% (down 0.1%). The Nasdaq100 declined 0.5% (up 5.1%), and the Morgan Stanley High Tech index was unchanged (up 4.9%). The Semiconductors jumped 1.7% (up 17.3%). The Biotechs rose 1.7% (up 16.2%). With bullion up $23.60, the HUI gold index surged 6.4% (up 12.2%).

One-month Treasury bill rates ended the week at two bps and three-month rates closed at three bps. Two-year government yields jumped five bps to 0.45% (up 7bps y-t-d). Five-year T-note yields rose five bps to 1.69% (down 5bps). Ten-year Treasury yields increased two bps to 2.60% (down 43bps). Long bond yields declined two bps to 3.41% (down 56bps). Benchmark Fannie MBS yields added a basis point to 3.26% (down 35bps). The spread between benchmark MBS and 10-year Treasury yields widened one to 66 bps. The implied yield on December 2015 eurodollar futures jumped seven bps to 1.015%. The two-year dollar swap spread increased one to 15 bps, while the 10-year swap spread declined two to 10 bps. Corporate bond spreads widened (for a change). An index of investment grade bond risk increased three to 60 bps. An index of junk bond risk jumped 10 to 307 bps. An index of emerging market (EM) debt risk rose seven to 262 bps.

Debt issuance was huge. Investment-grade issuers included John Deere $2.0bn, Johnson Controls $1.7bn, Bank of America $1.5bn, Ford Motor Credit $1.3bn, Citigroup $1.25bn, Home Depot $1.0bn, Magna International $750 million, New York Life $700 million, Sempra Energy $500 million, Penske Truck Leasing $500 million, Vornado Realty LP $450 million, First Republic Bank $400 million, Mid-America Apartments LP $400 million, Odebrecht Oil & Finance $400 million, Oglethorpe Power $250 million, TTX $250 million, Airgas $300 million, Arizona Public Service $250 million, WinTrust Financial $140 million and Indianapolis P&L $130 million.

Junk funds saw inflows of $277 million (from Lipper). Junk issuers included Rio Oil Finance $2.0bn, Davita Healthcare $1.75bn, Istar Financial $1.32bn, Tenet Healthcare $1.1bn, Gates Global $1.0bn, Sanchez Energy $850 million, Envision Healthcare $750 million, JBS $750 million, Men's Wearhouse $600 million, Gibson Energy $550 million, COTT Beverages $525 million, Avanti Communications $520 million, Chesapeake Oil $500 million, Ferrellgas LP $475 million, Chassix $375 million, Hillman Group $330 million and Compass Minerals International $250 million.

Convertible debt issuers this week included Colony Financial $380 million, J2 Global Communications $350 million, Verint Systems $350 million and Ariad Pharmaceuticals $200 million.

International dollar debt issuers included European Investment Bank $3.0bn, Banco do Brasil $2.5bn, Australia & New Zealand Bank $2.25bn, Uruguay $2.0bn, Actavis $3.7bn, Svensak Handelsbanken $1.4bn, European Bank of Reconstruction & Development $1.27bn, Barclays $1.2bn, PTT Exploration & Production $1.0bn, Emirates Telecom $1.0bn, Export Development Canada $1.0bn, Oversea-Chinese Banking $1.0bn, Turk Telekomunikasyon $1.0bn, Swedish Export Credit $1.0bn, Marfrig $850 million, Royal Bank of Canada $400 million, GS Caltex $400 million and Virgolina de Oliveira $135 million.

Ten-year Portuguese yields fell another 13 bps to a near-record low 3.38% (down 275bps y-t-d). Italian 10-yr yields added a basis point to 2.77% (down 135bps). Spain's 10-year yields increased two bps to 2.66% (down 150bps). German bund yields increased one basis point to 1.36% (down 57bps). French yields rose three bps to 1.73% (down 83bps). The French to German 10-year bond spread widened two to 37 bps. Greek 10-year yields increased two bps to 5.80% (down 262bps). U.K. 10-year gilt yields jumped nine bps to 2.75% (down 27bps).

Japan's Nikkei equities index was little changed (down 7.3% y-t-d). Japanese 10-year "JGB" yields were unchanged at 0.60% (down 14bps). The German DAX equities index declined 0.7% (up 3.8%). Spain's IBEX 35 equities index gained 0.5% (up 12.1%). Italy's FTSE MIB index fell 0.6% (up 16.9%). Emerging equities were mixed. Brazil's Bovespa index jumped 3.2% (up 6.4%). Mexico's Bolsa declined 0.7% (down 0.6%). South Korea's Kospi index dipped 0.2% (down 1.0%). India's Sensex equities index slipped 0.7% (up 19.2%). China's Shanghai Exchange jumped 2.0% (down 2.1%). Turkey's Borsa Istanbul National 100 index fell 1.7% (up 16.5%). Russia's MICEX equities index gained 1.1% (down 0.2%).

Freddie Mac 30-year fixed mortgage rates gained six bps to 4.20% (up 22bps y-o-y). Fifteen-year fixed rates jumped eight bps to 3.31% (up 21bps). One-year ARM rates were unchanged at 2.40% (down 18bps). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed rates up one basis point to 4.61% (up 26bps).

Federal Reserve Credit last week expanded $8.8bn to a record $4.294 TN. During the past year, Fed Credit expanded $930bn, or 27.6%. Fed Credit inflated $1.483 TN, or 53%, over the past 83 weeks. Elsewhere, Fed Foreign Holdings of Treasury, Agency Debt increased $12.5bn to $3.308 TN. "Custody holdings" were down $46bn year-to-date, with a one-year decline of $6bn.

Global central bank "international reserve assets" (excluding gold) - as tallied by Bloomberg - were up $801bn y-o-y, or 7.2%, to $11.9 TN. Over two years, reserves were $1.523 TN higher for 15% growth.

M2 (narrow) "money" supply expanded $10.9bn to a record $11.322 TN. "Narrow money" expanded $742bn, or 7.5%, over the past year. For the week, Currency increased $1.6bn. Total Checkable Deposits surged $57.5bn, while Savings Deposits sank $47.4bn. Small Time Deposits were down $0.9bn. Retail Money Funds were about unchanged.

Money market fund assets increased $2.6bn to $2.582 TN. Money Fund assets were down $136bn y-t-d and dropped $29bn from a year ago, or 1.1%.

Total Commercial Paper gained $7.6bn to $1.046 TN. CP was up $0.7bn year-to-date, while increasing $12bn over the past year, or 1.2%.

Currency Watch:

June 6 - Bloomberg (Kyoungwha Kim): "The yuan's biggest decline among Asian currencies this year is giving Chinese exporters an advantage as a rebound in shipments comes at the expense of companies in South Korea, according to Morgan Stanley. ...China's exports are forecast to increase 6.6% in May, based on a Bloomberg News survey, while shipments from South Korea fell 0.9% last month in the first contraction since January. The yuan has weakened 5.9% against the won and 3.2% versus the dollar in 2014. The nation's compete in overseas markets in products such as semiconductors, steel and mobile handsets."

The U.S. dollar index added 0.2% to 80.58 (up 0.7% y-t-d). For the week on the upside, the New Zealand dollar increased 1.9%, Brazilian real 1.0%, the British pound 1.0%, the Canadian dollar 0.7%, the Japanese yen 0.4%, the South Korean won 0.3%, the Taiwanese dollar 0.1% and the Singapore dollar 0.1%. For the week on the downside, the South African rand declined 0.8%, the Norwegian krone 0.8%, the euro 0.8%, the Swiss franc 0.7%, the Danish krone 0.7%, the Mexican peso 0.7% and the Swedish krona 0.2%.

Commodities Watch:

June 13 - Bloomberg (Jasmine Ng): "Iron ore fell to the lowest since 2012 on concern that a probe into commodity financing at China's Qingdao port may hurt demand for the raw material amid a global seaborne glut... Prices lost 3.8% this week and retreated in eight of the past nine weeks. Chinese and foreign banks are examining loans linked to metals at Qingdao amid concern that risks are more widespread in the country, where traders use commodities from copper to iron ore and rubber to get funding."

The CRB index rose 1.5% this week (up 10.6% y-t-d). The Goldman Sachs Commodities Index jumped 2.1% (up 4.5%). Spot Gold gained 1.9% to $1,277 (up 5.9%). September Silver rallied 3.5% to $19.66 (up 1.5%). July Crude surged $4.25 to a nine-month high $106.91 (up 9%). July Gasoline surged 4.0% (up 10%), and July Natural Gas added 0.6% (up 12%). July Copper declined 0.7% (down 11%). July Wheat sank 5.2% (down 3%). July Corn dropped 2.6% (up 6%).

U.S. Fixed Income Bubble Watch:

June 13 - Bloomberg (Sarah Mulholland): "In response to rising default rates on subprime U.S. auto loans, bond investors are deciding the best thing to do is pile into securities backed by the debt. In the market where auto loans to people with spotty credit are bundled into bonds, the difference in yield between the lowest-rated securities and the safest has narrowed to the least since August 2007... Demand for the bonds is translating into cheap funding for lenders, allowing them to make even more loans though payments more than 60 days late are on the increase. Investors are turning to riskier debt to boost returns as stimulus measures from central banks around the world suppress interest rates.

Federal Reserve Watch:

June 11 - Bloomberg (Craig Torres and Matthew Boesler): "Federal Reserve officials, concerned that selling bonds from their $4.3 trillion portfolio could crush the U.S. recovery, are preparing to keep their balance sheet close to record levels for years. Central bankers are stepping back from a three-year-old strategy for an exit from the unprecedented easing they deployed to battle the worst recession since the Great Depression. Minutes of their last meeting in April made no mention of asset sales. Officials worry that such sales would spark an abrupt increase in long-term interest rates, making it more expensive for consumers to buy goods on credit and companies to invest, according to James Bullard, president of the Federal Reserve Bank of St. Louis. That 'is a widespread view in parts of the Fed, I think, and in financial markets,' Bullard said... While he disagrees with that perspective, it 'won the day.'"

U.S. Bubble Watch:

June 11 - Bloomberg (Jeffrey McCracken): "The $1 trillion M&A quarter, not seen since before the global financial crisis, is back. Global deal volume this quarter is $992 billion... That number puts this three-month period on pace to be the biggest for M&A since the third quarter of 2007 -- the best year ever for deals -- before Lehman Brothers Holdings Inc.'s 2008 bankruptcy gave Wall Street a near-death experience... There were three $1 trillion-plus quarters in 2007 -- a year in which total M&A hit $4.8 trillion. Since then, the quarterly average has been about $650 billion, for annual volume of around $2.6 trillion. According to data compiled by Bloomberg going back 12 years, the $1 trillion in quarterly value was only breached six times, all in 2006 and 2007."

June 9 - Bloomberg (Richard Clough): "Cash hoarding is so last year. As U.S. companies cut deals at a faster clip, spending is back in vogue. ...Corporate cash in the most recent quarterly filings fell about $90 billion, the largest drop in at least four years... More than half of that decline came as Verizon Communications Inc. in February completed its $130 billion purchase of Vodafone Group Plc's minority stake, reducing Verizon's cash by $51 billion. The data confirms anecdotal signs of increased spending in early 2014 by companies such as Apple Inc., which boosted a share buyback program by $30 billion..."Central Bank Watch:

June 10 - Reuters: "The package of monetary policy measures agreed by the European Central bank last week are an indication of how little room it has to cut rates in order to deal with the inflation outlook, Governing Council member Jens Weidmann said. The ECB cut interest rates to record lows..., launched a series of measures to pump money into the sluggish euro zone economy and pledged to do more if needed to fight off the risk of Japan-like deflation. 'The interest rate cuts were a response to the unsatisfactory inflation outlook,' Weidmann was quoted as saying..., adding that the central bank was entering 'new ground' with such measures. 'That we took unconventional measures is both down to the fact that we have almost used up the room to cut rates, and that we wanted to ensure that our expansive monetary policy also came through to the real economy,' he said. He also said the measures were a 'wake-up call' for governments that needed to continue with reforms."

June 13 - Wall Street Journal (Brian Blackstone): "Bundesbank President Jens Weidmann warned Thursday against using central bank money to purchase government bonds, suggesting the European Central Bank would face stiff opposition from its most powerful member bank if it decided to engage in such a policy that has been used aggressively by central banks in the U.S., Japan and U.K. Mr. Weidmann's comments... came one week after he signed on to a dramatic array of stimulus measures, including interest rate cuts to record lows, agreed to unanimously by the ECB... 'While sovereign bond purchases are a widely used monetary policy tool, they are not without risks,' Mr. Weidmann said. 'Asset purchases may act like a sweet poison for the governments. The rude awakening may come when the purchases are reduced or stopped altogether,' he said."

June 10 - CNBC (Matt Clinch): "The policy actions announced by the European Central Bank last week received major criticism on Tuesday, with the head of influential German think tank ZEW detailing his concerns about surging asset prices which he says are creating dangerous bubbles. Clemens Fuest, from the Mannheim-based organization best known for its widely-watched economic sentiment index - told German business daily Handelsblatt that the euro zone region could be at a 'turning point.' 'I've got a bad feeling about this...I am concerned by the danger that the ECB is producing new bubbles with its policy of cheap money,' he told the newspaper. 'We have all the ingredients of a bubble: The prices of real estate and stock markets continue to rise, and on the bond markets, yields are falling despite high risks.'"

Geopolitical Watch:

June 13 - Telegraph (Ruth Sherlock): "Three army deserters tell the Telegraph how Mosul, the second biggest city in Iraq, was given to terrorists by senior Iraqi army officials. Military deserters have painted a devastating picture of the inability of the Iraqi army to stand and fight, telling The Telegraph how entire divisions surrendered Mosul, Iraq's second city, without firing a single shot. Speaking from the Kurdish city of Erbil, the defectors accused their officers of cowardice and betrayal, saying generals in Mosul 'handed over' the city over to Sunni insurgents, with whom they shared sectarian and historical ties. With Sunni insurgents now threatening the capital Baghdad the eyewitness accounts from the deserters' reveal how sectarian enmity has, in the space of mere weeks, destroyed the Iraqi national army, which the US government spent billions of dollars to build."

June 11 - Bloomberg: "China is hoarding crude at the fastest pace in at least a decade, shielding itself from supply disruptions and helping keep prices above $100 a barrel. The country imported a record volume in April as it emulates steps taken by the U.S. in the 1970s to create a strategic petroleum reserve... Chinese President Xi Jinping is building stockpiles as his nation clashes with Vietnam over resources in the South China Sea and faces potential risks to oil sales from Russia, Africa and the Middle East because of sanctions and violence. The purchases are helping drive oil prices higher... 'This panicked stockpiling is one of the ways that geopolitical tensions can actually tighten physical oil markets,' Seth Kleinman... at Citigroup, said... 'This buying spree is partly driven by the infrastructure needs of China's ongoing refinery expansion, but also reflects the rise in geopolitical tensions.'"

June 11 - Bloomberg (Joel Guinto): "Sand, cement, wood and steel are the latest tools in China's territorial arsenal as it seeks to literally reshape the South China Sea. Chinese ships carrying construction materials regularly ply the waters near the disputed Spratly Islands, carrying out work that will see new islands rise from the sea... 'They are creating artificial islands that never existed since the creation of the world, like the ones in Dubai,' said Eugenio Bito-onon, 58, mayor of a sparsely populated stretch of the Spratlys called Kalayaan... 'The construction is massive and nonstop. That would lead to total control of the South China Sea,' Bito-onon said... Artificial islands could help China anchor its claims and potentially develop bases to control waters that contain some of the world's busiest shipping lanes. China, which says the area falls within its 1940s-era 'nine-dash line' map... 'China's end game is to have de facto -- if not de jure -- control over adjacent waters, the Western Pacific,' said Richard Javad Heydarian, a political science lecturer at the Ateneo de Manila University."

June 9 - Bloomberg: "China said Vietnam sent divers to disrupt its drilling operations as the two countries accused each other of escalating tensions in disputed waters of the South China Sea. Vietnam continues to send ships to the region near an oil rig placed by China off Vietnam's coast, China's foreign ministry said... Chinese ships have now been rammed more than 1,400 times..."

June 9 - Bloomberg: "China's quarantine agency suspended issuing permits to import a U.S.-produced animal-feed ingredient made from corn... Effective June 6, U.S. shipments of dried distillers' grains, known as DDGS, can no longer enter the country, because the government deems them a high risk of containing MIR 162, a genetically modified strain... While U.S. corn shipments into the country plunged amid restrictions on the MIR 162 variety, imports of DDGS continued to rise because some port officials had been lenient, said Sylvia Shi, an analyst at Shanghai JC Intelligence Co. 'It looks like the government is determined to stop any form of corn imports from the U.S.,' said Shi..."

Ukraine & Russia Watch:

June 9 - Financial Times (Sam Jones): "The running theme of Nato's criticism of Russia is that when it comes to Ukraine, the Kremlin has slipped back into a cold war mentality. But while Russia's strategic thinking might recall the ruthless geopolitics of the past century, its tactics for military analysts have been a model of warfare in the 21st, employing everything from small groups of unidentifiable specialist personnel to cyber warfare. In more than a dozen interviews, planners, security officials and members of the intelligence community have spoken of Moscow with universal, if grudging, praise. Tactically, they say, Russia has waged a dexterous and comprehensive campaign, and has been one step ahead at every turn. The Kremlin's operations on the ground have been 'masterly', said one."

June 12 - Reuters (Natalia Zinets and Timothy Heritage): "Ukraine accused Russia... of allowing separatist rebels to bring three tanks and other military vehicles across the border into the east of the country to fight the Ukrainian army. Evidence that Russia is sending in weapons or assisting the rebels militarily would implicate Moscow in the uprising against Kiev's pro-Western leaders, making a mockery of its denials that it has played a role in weeks of fighting. Interior Minister Arseny Avakov stopped short of directly accusing Russia of sending the tanks but made clear he held President Vladimir Putin responsible for failing to carry out a promise to tighten controls at the border."

China Bubble Watch:

June 10 - Bloomberg: "Commodities financing transactions in China are projected by Goldman Sachs Group Inc. to continue unwinding amid a probe into metals inventories in the biggest consumer of raw materials. Claims that single batches of copper and aluminum at Qingdao Port were pledged as collateral for multiple loans risks undermining a broader practice in which traders use everything from iron ore to rubber to get funding. The investigation is already weighing down copper prices and may curb foreign exchange inflows to China... Standard Chartered Plc said last week it was reviewing financing to some companies in China and Standard Bank Group started looking at 'potential irregularities' with metals at Qingdao. Citigroup Inc. said it would work closely with authorities and warehousing companies to resolve any problems for clients. 'The developments in Qingdao are likely to continue the significant scaling back of FX inflows from foreign banks into China via commodity financing business,' analysts at... Goldman said... 'As foreign banks reduce their exposure to Chinese commodity financing deals, the profitability of these could be reduced meaningfully.'"

June 10 - Wall Street Journal (Enda Curran and Isabella Steger): "One of China's most important financial companies moved to secure metals at a warehouse while concerns about fraud in commodities markets spread to a second Chinese port. State-owned Citic Resources... said... it has applied to courts in the port city of Qingdao to secure metal assets it owns in warehouses, as concerns mount over the use of commodities for financing in China. Citic Resources' parent is Citic Group, one of the country's biggest state-owned enterprises. The operator of Qingdao port, on China's eastern coast, confirmed on Monday that Chinese authorities were conducting a probe into allegations of fraud. Separately, Western banks worry that the potential fraud has flared up at a second Chinese port, Penglai, also located in Shandong province, according to people familiar with the matter."

June 7 - Bloomberg: "China's President Xi Jinping says fiscal reform will be a 'heavy, difficult' task and shouldn't be carried out for the sake of expediency, the official Xinhua News Agency reported... A long-term systematic reconstruction of fiscal mechanisms is required rather than changes to overcome temporary difficulties, and such reform will require extensive coordination among different interests, Xi says: Xinhua Objectives of fiscal reform include ensuring a clear division of power and reform of the taxation system, Xi says: Xinhua."

June 11 - Bloomberg: "Xu Gao, Chief Economist at Everbright Securities Co. says [China's] increased spending 'in line with the series of policies to stabilize growth that have been rolled out recently.' May fiscal spending rose 24.6% to 1.28t yuan: according to a statement on the Ministry of Finance website. Jan.-May fiscal spending rose 12.9% to 5.26t yuan."

June 10 - Bloomberg: "The ranks of China's first-home buyers have shrunk amid a market slowdown, according to a report from the Survey and Research Center for China Household Finance. About 20% of buyers are purchasing homes for the first time this year..., compared with 48% in 2012, said Gan Li, director of the center... Such buyers accounted for 90% in 2000, said Gan... 'The era of Chinese real estate industry being driven by first-time homebuyer demand is over,' Gan said... 'The market is going to be driven by investment and improvement in demand that is sensitive to price.'"

June 13 - Bloomberg: "China's home buyers are being offered no-money-down purchases in an echo of the subprime lending that triggered a U.S. economic meltdown and the global financial crisis. Deals skirting government requirements for minimum 30% down payments have emerged this year from Guangzhou and Shenzhen in the south to Beijing in the north as real-estate sales slump... Government warnings to consumers indicate that officials will strive to limit such arrangements, a sign of stress in a property market with a glut of homes. 'The risk is severe for developers and third parties because there is no commitment from home buyers,' said Ding Shuang, senior China economist at Citigroup Inc in Hong Kong. 'Zero down payment has appeared in the U.S. before. It basically enabled unqualified people to buy houses,' said Ding, who used to work for the International Monetary Fund."

June 13 - Reuters (Clare Jim): "Chinese property developers may be forced to embrace steeper price cuts, broader promotions or a change in strategy in the third quarter as they scramble to meet 2014 sales targets after many achieved less than 30% of their forecasts in the first five months... Some developers are opting to adjust their strategies by introducing more basic housing where demand is solid compared to luxury apartments and by turning to commercial projects. 'We are seeing more developers changing to renting their properties from selling because the market is very slow. By renting they can at least get some revenue,' said Raymond Wei, the Shanghai-based general manager for the commercial sector for realtor Centaline Property Agency Ltd... In the first five months, at least 13 Hong Kong-listed Chinese developers said they recorded a drop in sales compared to a year earlier, with declines ranging from single digits to more than 50%."

June 10 - Bloomberg (Tan Hwee Ann): "The Chinese government said that some people in Hong Kong are 'confused' over the limits of the city's autonomy, as it seeks again to shape the debate over universal suffrage. The city must understand that its autonomy comes from the Chinese government and 'is not an inherent power,' the State Council said in a policy paper today. The system of 'One Country, Two Systems,' introduced by former leader Deng Xiaoping, must maintain China's interests, it said. The debate over how to elect Hong Kong's next leader in 2017 has divided the city, with some pro-democracy groups threatening protests in the business district from as early as July if the public can't nominate candidates. Chinese leaders have repeatedly said candidates must be vetted by a committee, according to existing laws. 'Some are even confused or lopsided in their understanding of 'One Country, Two Systems,' and the Basic Law,' the State Council said... 'Many wrong views that are currently rife in Hong Kong concerning its economy, society and development of its political structure are attributable to this.'"

June 10 - Reuters: "China warned Hong Kong... that there were limits to its freedom and it should adhere strictly to the law ahead of a planned pro-democracy protest that could end up shutting down part of the financial hub's business district. As the most liberal city on Chinese soil, the former British colony has grappled with Beijing since its return to Chinese rule in 1997 to preserve its freedoms and capitalist way of life under a 'one-country, two-systems' formula. Over the past year, however, a push by democracy activists to hold protests, as part of a campaign for the right to choose candidates for a poll in 2017 to elect Hong Kong's next leader, has stoked friction and unnerved Beijing leaders fearful of an opposition democrat taking the city's highest office. China's State Council... reiterated in a 'white paper' ...that the city, despite its wide-ranging autonomy, comes under the control of China and has limits to its freedom. 'The high degree of autonomy of Hong Kong is not full autonomy, nor a decentralized power. It is the power to run local affairs as authorized by the central leadership,' the cabinet said... 'There is no such thing called 'residual power'. ...China has agreed to let Hong Kong elect its next leader in 2017 in what will be the most far-reaching version of democracy on Chinese soil. Specific arrangements, however, have yet to be decided including, crucially, whether public nominations of candidates, including opposition democrats, will be allowed. Senior Chinese officials have already all but ruled out public nominations, saying it is not allowed for in the law and that a small committee of about 1,200 largely pro-Beijing loyalists should choose who gets on the ballot."

Global Bubble Watch:

June 13 - Wall Street Journal (Gregory Zuckerman, Rob Copeland and Juliet Chung): "Some of the biggest investors on Wall Street are losing money with wrong-way bets in markets around the globe, a surprising black eye amid a rise in stock and bond prices. Hedge-fund managers including Paul Tudor Jones, Louis Bacon and Alan Howard are among those who have misread broad economic and financial trends. Some have lost money as Japanese stocks fell, while others have been upended by the surprising resilience of U.S. bonds... The flagship fund at $15 billion Moore Capital Management LP, led by star investor Mr. Bacon, was down 5% this year through the end of May... Mr. Jones's flagship fund at $13 billion Tudor Investment Corp. is down 4.4% this year..."

June 11 - Bloomberg (Sandrine Rastello): "The World Bank cut its global growth forecast amid weaker outlooks for the U.S., Russia and China, while calling on emerging markets to strengthen their economies before the Federal Reserve raises interest rates. The Washington-based lender predicts the world economy will expand 2.8% this year, compared with a January projection of 3.2%. The U.S. forecast was reduced to 2.1% from 2.8% while outlooks for Brazil, Russia, India and China were also lowered."

June 9 - CNBC (Robert Frank): "The world added 2.6 million millionaire households last year, showing that the rich are getting richer -- and far more numerous... The total number of millionaire households in the world rose 19% last year, to 16.3 million households, according to Boston Consulting Group's Global Wealth report. Millionaire households represent 1.1% of all households globally. The U.S. added the most millionaire households and has the highest total, with a gain of 1.1 million households last year. That brings the total to 7.135 million. China's millionaire population grew to 2.4 million last year from 1.5 million in 2012. But Japan's millionaire population fell by 300,000 to 1.2 million last year, driven mainly by the falling value of the yen versus the dollar."

June 9 - Bloomberg (Giles Broom and Margaret Collins): "Rich Chinese helped make Asia the fastest-growing region for affluent families as the increase in global wealth accelerated last year, according to a study by Boston Consulting Group. Private wealth in the Asia-Pacific region excluding Japan jumped 31% to $37 trillion in 2013, supporting a 15% advance to $152 trillion globally. That outpaced 8.7% growth in 2012... 'Wealth managers globally had another outstanding year of growth in 2013,' BCG said. 'The Asia-Pacific region accounted for the strongest growth.' China leapfrogged Germany and Japan in the past five years to trail only the U.S. in a ranking of countries by private financial wealth. China's $22 trillion is expected to increase more than 80% to $40 trillion by 2018, while the U.S. may grow to $54 trillion from $46 trillion over the same period, BCG said. Globally, stock-market gains averaged 21% in 2013, providing the primary driver of growth in private wealth..."

June 10 - Bloomberg (Andrea Wong and Ye Xie): "Mario Draghi is becoming one of currency traders' only friends. With the $5.3 trillion-a-day foreign-exchange market poised to deliver its worst first-half returns on record, the carry trade is about the only way traders are making money by exploiting differences in global borrowing costs as volatility tumbles. That strategy became more profitable after the European Central Bank president cut interest rates on June 5. 'The ECB has signaled risk is on again,' Eric Busay... money manager at the California Public Employees' Retirement System, the largest U.S. public pension fund with $294 billion in assets, said... 'People are concerned when to exit the trade and they understand the rush to exit could be crowded. But at the same time, you have to be in it to win it.'"

EM Bubble Watch:

June 9 - Bloomberg (Katia Porzecanski and Ben Bain): "Mexico's deepening economic malaise is making central bank Governor Agustin Carstens less predictable than ever. Carstens cut the key interest rate by a half-percentage point to a record low 3% on June 6, surprising all economists surveyed... The unprecedented move comes two weeks after the central bank lowered its 2014 growth forecast for Latin America's second-biggest economy as consumer demand plunges amid a stalled expansion..."

June 9 - Bloomberg (Matthew Malinowski): "Brazil economists cut both 2014 and 2015 growth estimates for the second week in a row on signs that a period of waning economic activity has extended beyond the first quarter. Brazil's economy will expand 1.44% this year and 1.80% in 2015... Both estimates are the lowest since the central bank started publishing the data."

Europe Watch:

June 10 - Bloomberg (Robert Hutton and Patrick Donahue): "German Chancellor Angela Merkel warned that threats are not the way to win arguments in the European Union as Prime Minister David Cameron suggested that failing to get his way may increase the chances of a U.K. exit. After an overnight meeting hosted by Swedish Prime Minister Fredrik Reinfeldt at his country residence in Harpsund, Merkel and Cameron were still at loggerheads over the candidacy of Jean-Claude Juncker to head the European Commission. Merkel urged her fellow leaders to proceed in 'the European spirit.' 'You know, threats are not part and parcel of that spirit, that's not part of the way in which we usually proceed,' Merkel... told reporters..."

June 7 - Wall Street Journal (Amnton Troianovski): "For the German media, the European Central Bank's rate cut announcement was part monetary policy, part horror movie. Conservative daily Welt Kompakt ran a photo from the Alfred Hitchcock film 'Psycho' across its front page... with the caption: 'Europe's central bankers are causing nightmares among many savers.' Meanwhile, the highbrow Frankfurter Allgemeine Zeitung declared it a 'historic watershed' that offered little hope for 'German savers clinging to their savings plans and life insurance.' The left-wing Tageszeitung suggested it was time for readers to take some risks with their money -- such as buying stocks or playing Blackjack. And the tabloid Bild, Germany's largest-circulation paper, asked at the top of page one: 'How bad will old-age poverty get?' Germany, where saving money is seen as a fundamental virtue and borrowing can seem like moral weakness, reacted in disbelief the day after ECB President Mario Draghi said a key interest rate would be lowered below zero. Years of criticism in Germany that the central bank's policies were inflating a new bubble while hurting mom-and-pop Germans with savings accounts, reached new heights... The emerging consensus around Mr. Draghi's decision was that international bankers won and German savers lost."


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