Notes From Underground: For What It’s Worth

“There’s something happening here

But what it is ain’t exactly clear

There’s a man with a gun over there

Telling me I got to beware

I think it’s time we stop

Children,what’s that sound?
Everybody look ,what’s going down? [Buffalo Springfield]
Readers know I enjoy using old rock lyrics to make a point and this Buffalo Springfield song from 1967 is a beautiful way to put the markets in perspective. For what it’s worth, Notes From Underground is all about a global macro perspective. So while the TV pundits are filling the airwaves with noise, it is time to examine what is going down. Last week I tried to articulate why the current EMERGING MARKET CRISIS is not a repeat of 1997-98 and the blog generated some great discourse. Nothing has changed as far as that analysis is concerned, although as KM of Hanover pointed out, what is the percentage of debt that is denominated in the domestic currencies of the recent highlighted countries? I will get to that, or if anybody wants to post those numbers or write a guest piece, please take a step forward.
Reuters ran a story today, “European Banks Have $3 Trillion of Exposure to Emerging Markets.” The article notes that European banks have “… more than four times U.S. lenders and putting them at greater risk if financial market turmoil in countries such as Turkey, Brazil, India and South Africa intensifies. The risk is most acute for six European banks–BBVA, ERSTE BANK, HSBC, SANTANDER, STANDARD CHARTERED and UNICREDIT.”
This just adds to the woes of the coming asset quality review, or stress test. I wonder if the sovereign debt of the emerging countries is deemed a riskless asset on the risk-weighting scale. The article goes further and says, “… about 12 percent of their assets in emerging markets, and about a quarter of their earnings come from the region as often the businesses there are ‘unusually profitable.'” If the world is in the beginnings of a new financial crisis –for what it’s worth–Europe will be a far greater problem as the high level of unemployment and large pool of non-performing loans will lead to a massive round of deleveraging, thus necessitating a massive liquidity response.
Last Friday, India’s central bank governor Raghuram Rajan castigated the FED and other developed markets’ central banks for their nonchalant attitude in the current crisis of the emerging markets. Mr. Rajan  is an economist for which I have high regard as much of his research prior to the subprime crisis was prescient. The new governor of the Bank of India has a deep knowledge of the global macro system and his voice carries great in policy and academic circles. While some policy makers pretend that the EM problems were domestically created, Governor Rajan maintains that the emerging markets responded to the G-20 call by providing fiscal and monetary stimulus. Mr. Rajan maintains, “Industrial countries have to play a part in restoring cooperation, and they can’t at this point wash their hands and say, we’ll do what we need to and you do the adjustment.” The financially stressed EMs, for what it’s worth, will not accept a German-style lecture about the need for rebalancing and austerity in order to correct any imbalances.
The emerging markets are going to need some type of liquidity infusion or at least backstop so as to help stabilize the market, but where it will come from ain’t exactly clear. Oh, wait. IMF Managing Director Christine Lagarde is suggesting some type of global wealth tax to help support the global financial system. A January 2 piece by Ambrose Evans-Pritchard, “IMF Paper of ‘Saving Tax’ and Mass Write-Offs As West Debt Hits 200-Year High,” is a response to an IMF paper written by Reinhart and Rogoff. “The paper says the western debt burden is now so big that rich states will need some tonic of debt haircuts, higher inflation and financial repression …” This paper has taken on added importance in the light of the problems of the emerging markets. The IMF has stepped up to bail out the European peripheries and thus the European sovereigns, as well as the domestic banks of Greece and Ireland. Governor Rajan is playing a deft hand by accusing the developed world of complacency and Christine Lagarde is playing the fool for a very competent central banker.
AGAIN, IT IS TIME FOR THE IMF TO ISSUE GOLD-BACKED BONDS SO AS TO MONETIZE ITS LARGEST ASSET. The IMF has 90.5 million ounces of gold on its balance sheet carried at a value of $4.8 billion, but with a market value 30 times greater. IMF BONDS with a yield and backed by a fifth of an ounce of GOLD would raise a huge amount of money to help support the emerging markets in any systemic crisis that develops. It amuses me that such staunch Keynesians are terrified of utilizing what they deem to be a barbarous relic.
***IN the midst of all this uncertainty, the Bank of England and the ECB hold their meetings on Thursday and announce any change in interest rate policy. The BOE‘s Governor Carney will keep rates steady and will not want to add more volatility to a tenuous global financial system. The ECB will announce 45 minutes later and although President Draghi would probably like to cut rates, he will keep trying to hold the European situation steady with jawboning until the German Constitutional Court renders a verdict on the legality of previous ECB actions in regard to German law. It was interesting that during the last two days Draghi has repeated his view on sterilization of ECB bond purchases. The ECB would stop draining money from the European banking system after it bought bonds if the Bundesbank gave its approval.
Overnight rates in Europe have been above the official ECB rate because of temporary draining actions. It is amazing that Mario Draghi is so openly seeking Bundesbank approval. Things are tight in Europe but Mario Draghi will keep on hold as long as the world’s focus is elsewhere. NO CHANGE and rates will stay at 0.25% … “For What It’s Worth.”

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13 Responses to “Notes From Underground: For What It’s Worth”

  1. Nate Says:


    Awesome Post! Thank you for sharing your knowledge. It is a very complex situation that I wish I understood better. When a bank has 12% of its assets pulling in 25% of its earnings, it is no wonder the QE has made its way into EM. I wonder how much they have leveraged, off-balance sheet, and/or in derivatives? Instead of asking how do we profit from this uncertainty, maybe we should ask how do we protect ourselves (Gold, Real Estate, cash)? I wish I knew…

    Ms. Lagarde is calling for more collaboration from CBs in a recent WSJ article:

    Interestingly, I think the CBs will give the APPEARANCE of collaborating publicly, while finding ways to protect themselves privately. After all, isn’t that why the ESF was created back in 1934?

    What would gold-backed IMF bonds do to the price of physical gold?

    How would the IMF prove it has the GOLD? There have been many questions as to whether the NY Fed has the German gold and there are certainly rehypothecation questions that would need to be addressed. If the US Treasury offered gold backed bonds I wouldn’t touch them until it was proven to have the physical to hold as collateral. I do love the concept though!

  2. asherz Says:

    An interesting cocktail. 12% of a bank’s assets in EM markets that are in crisis, operating in a fractional banking system, that is interconnected with banks worldwide, and the dominoes are lined up. The Central Banks have the fire engines in place. China Credit Trust passed a recent test. Will there be enough water pressure to contain the brush fires that threaten to go out of control? Stay tuned.

  3. Alex Says:

    Yes, what would Gold backed IMF bonds do the metal’s price? I would think higher, but the more I’m in this game, the less I probably know…(2 + 2 = 5 for a good example)

  4. Richard H Papp Says:

    “Everybody look what’s going down?” Is it time to dust off a Dow Theory Test of the averages? That is, let them find support, rally and the retest. React accordingly!!!!!!!!!!!!!

  5. Rich (@skylanetk) Says:

    It would be better if the private capital system made loans to the EMs. But at this time that is wishful thinking, big banks will continue to go to the government and central banks to socialize their losses.

  6. Shocked to Find Gambling Says:

    Agree some type of EM bailout is coming…..the central bankers are afraid the EM crisis will spill over into developed economies. Gold-backed bonds as funding, maybe……….but this is just another form of unsustainable QE. As Nate points out, they’re still looking for the German gold at the NY FED, so I wonder if the IMF gold isn’t encumbered in some way. “Blue Horseshoe loves gold-backed bonds”.

  7. yra Says:

    Shocked–you are a very funny man.Gold-backed bonds won’t happen because it would monetize gold and the world’s arbiter of all things Keynesian just cannot admit to that possibility—to stay in theme–we will always have Bitcoin—because it was interesting that the Bernank saw a role for Bitcoin but yet admitted to not understanding gold

  8. Shocked to Find Gambling Says:

    Yra, I thought you were arguing for gold-backed bonds………agree it probably won’t happen The central bankers hate gold and they would see gold-backed bonds as an admission of failure.

    Just read on the newswires that they found the German gold at the NY FED…….it was behind the Bitcoin machine in the executive lunch room.

  9. Chicken Says:

    True, if they deem gold a barbarous relic then why do they bother holding onto it?

  10. yra Says:

    Shocked–I am arguing for gold backed bonds–feel it is long overdue as a way to increase liquidity ,put to work a dormant asset and ultimately hold the authorities accountable.The Chinese seem to be doing it in a modified form by the extensive use of commodities for collateral

  11. Shocked to Find Gambling Says:

    Yra, now I understand. Of course if they back the bonds with gold,
    they are transferring ownership of their only asset that does not have counterparty risk. As we saw in 2008-2009, counterparty risk can bankrupt you. If it were my decision, I would hold onto the gold as insurance.

  12. Chicken Says:

    Well, maybe Germany will agree to providing financial assistance for EM’s?

  13. Chicken Says:

    “Hold the authorities accountable”
    Therein lies the show stopper.

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