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Jim Cook



Every once in a while I switch the TV channel from Fox to CNBC to see what the liberals are saying.  After listening awhile I get a deep sense of hopelessness and foreboding for our country.  The most important thing for the left is giving money to people.  They are happy to see the growth of food stamps, disability payments, housing subsidies, free healthcare and all the other welfare benefits.  They utterly fail to see the damage it is doing to the recipients.  Whole cities that once flourished have deteriorated into rotting eyesores populated with shambling hulks of chemically dependent drones.  These people are no longer employable.  They have become incompetent and helpless and the liberals can’t see that it’s their doing.

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The Best of Jim Cook Archive

Best of Doug Noland
July 6, 2011
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Greek contagion fears now cast quite a pall.  There were indications of ongoing de-risking and de-leveraging.  The energy and commodities sectors suffered another tough week, and the leveraged players certainly can’t feel better about the world.   And it is an important part of the thesis that a debt crisis-induced tightening of financial conditions will particularly weigh on those economies suffering structural short-comings.  Italy fits the bill. 

At 119%, Italian debt as a percentage of GDP is second only to Greece (143%) in the Eurozone (according to Bloomberg data).  In the best of market times, this debt appears sound; in the worst, its non-productive and a huge problem.  Fortunately, a highly accommodative global marketplace has to this point made Italy’s heavy debt-load manageable.  At about 5%, Italy’s annual deficit has looked favorable relative to many countries in and outside the region.  And with Italian banks having limited exposure to periphery debt, the market had believed the sector was largely immune to the crisis.

Yet Italy today hangs very much in the balance.  Contagion fears are pushing up Italy’s market yields, risking a problematic jump in future debt service costs (and deficits).  And as was demonstrated in Greece, when market sentiment changes and things turn sour…  The Italian system now confronts market, political, economic and social uncertainties these days associated with additional austerity measures.  Voting with their feet, the marketplace this week scampered away from the Italian financial sector.  A tightening of lending by the markets and the banking sector comes at an inopportune time for the moribund Italian economy.  GDP expanded only 1.3% in 2010, this following 2009’s 5.2% contraction and 2008’s 1.3% drop.

Not dissimilar to the United States of America, Italy’s debt mountain ($2.3TN) is sustainable only with decent and persistent economic growth.  When global market confidence is running high, liquidity abundant and risk-taking in vogue, envisaging an optimistic scenario comes easily for the marketplace.  But when the clouds darken, things turn dismal in a hurry.  And when folks become nervous about a debt-laden and structurally-challenged economy, they will quickly take a keen interest in capital ratios and the general soundness of that economy’s banking system.  Economic and debt structures suddenly move to the front burner.  That’s where we are with Italy, and others, these days, as contagion effects gain important momentum by the week. 

The VIX index (the market’s estimate of the near-term future volatility of the S&P500) actually declined this week.  It is interesting to note that at 21.10, the VIX closed today slightly above its one-year average (20.19).  The VIX spiked above 37 last July and briefly traded above 30 this past March.  It is remarkable that contagion effects, having so hastily arrived at Italy's door, are not provoking a dramatic market response in the equity options marketplace.   Clearly, the markets have bought into “global too big to fail.”  Apparently, the more troubling Greek contagion risks become, the greater the markets’ faith that global policymakers will find the necessary resolve to come together and ensure things don’t spiral out of control. 

I would be remiss not mentioning the notably strong performance by Asian markets this week, a region still holding the potential to underpin (exceedingly unbalanced) global growth.  And, curiously, today from the Financial Times:  “Chinese premier Wen Jiabao has declared victory over domestic inflation [in an op-ed piece in today’s FT], saying that the government has successfully reined in price pressures.  ‘China has made capping price rises the priority of macro-economic regulation and introduced a host of targeted policies. These have worked…We are confident price rises will be firmly under control this year.’”  

Well, OK.  And it would be consistent with my thesis that the unfolding “Greek” crisis tempts the Chinese and others to back away from their rather timid tightening measures, giving an extended lease on life to their dangerous Credit Bubbles (while further feeding global imbalances).  I ponder where the euro would trade today without the market perception that the Chinese are there to provide a backstop bid for European debt and the currency.    

I have no doubt that global policymakers will act in ways to try to stabilize the system; I’m just increasingly concerned with unintended consequences.  A few examples:  European policymakers have, for the most part, reached a consensus view that any Greek debt restructuring must avoid triggering defaults within the expansive CDS marketplace.  In the process, such maneuverings come with the high cost of damaging the integrity of this market and, perhaps, derivatives markets more generally.  Why purchase insurance if politicians and political pressure can come to bear on the fulfillment of future contractual obligations?  Elsewhere, politicians can release oil reserves and at least temporarily reduce energy prices for the benefit of consumers and economies.  Yet, in an age of highly speculative markets, such moves exacerbate market turbulence, risk aversion and de-leveraging.  And as Chairman Bernanke claims that the Fed retains considerable firepower to support the recovery, the marketplace is left to ponder what the devil he has in mind.