Friday, May 24, 2013 - Where the Puck Will Be

Where the Puck Will Be

by Sinclair Noe

DOW + 8 = 15,303
SPX – 0.91 = 1649
NAS – 0.27 = 3459
10 YR YLD - .01 = 2.01%
OIL - .38 = 93.87
GOLD – 5.20 = 1387.30
SILV - .24 = 22.39

The S&P 500 is now down for 3 consecutive days and the major stock indices posted their first negative week in more than a month. For the week, the Dow slipped 0.3 percent, while the S&P 500 and the Nasdaq each lost 1.1 percent.

The Federal Reserve left many people mildly dazed and slightly confused this week, what with Bernanke speaking before the Joint Economic Committee and the release of the FOMC minutes. It used to be easier to figure out the Fed; it was a fairly straightforward cost/benefit analysis of inflation versus employment and inflation was usually at the top of the list. Then all of the sudden financial instability suddenly became the main concern. So, people were rethinking monetary policy; probably thinking too much.

I don't think the Fed is ready to step away from its easy money policies, but they are likely to change the composition. Maybe a little less mortgage-backed securities purchases and a little more Zero Interest Rates; maybe they'll look toward some other areas altogether. How about jumping into the Muni-bond market? Or something else that might be a bit more direct? Maybe the Fed could make some direct injections of capital for infrastructure.

America has dropped in the World Economic Forum's global rankings of economic competitiveness for each of the past four years, falling from first in the world to seventh, in part because of its sagging infrastructure. Its global ranking in terms of "quality of overall infrastructure" has dropped from ninth to 25th in the world.

The American Society of Civil Engineers estimates that we are spending $157 billion less per year on infrastructure than we need to. And instead of ramping up that spending, we are slashing it. Infrastructure spending as a percentage of GDP has tumbled to its lowest level in at least 20 years. In March 2009 the country spent $325 billion on public construction; that amount has dropped to $258 billion.

It's still not entirely clear what caused I-5 bridge over the Skagit River in Washington to collapse Thursday night. Nor is it clear, despite media reports, how strong the bridge was before it broke. What is clear is that, had the state needed to repair it, getting federal money to do so would be an uphill climb. By the way,there are reportedly 750 bridges in Washington state that are in worse condition than the one that collapsed last night. The ASCE estimates there are more than 150,00 structurally deficient or functionally obsolete bridges in the country.

And bridges are probably not even the worst aspect of American infrastructure: The ASCE report card gives U.S. bridges a "C+" grade. Our aviation system, dams, levees, drinking water, waste water disposal, hazardous waste disposal, roads, mass transit, schools and energy systems all received "D" grades. The ASCE estimates that under-spending on infrastructure will cut $3.1 trillion from our gross domestic product by 2020.

Meanwhile, the bond market followed the advice of Wayne Gretzky; skate to where the puck will be, not where it is. In this case, it means that expectations for QE are just as important as actual QE. So if the Fed signals QE will continue at a slower pace than investors expected, it will ultimately buy less than expected and yields should go up. But what we really learned is that Fed policy is not set in stone. This isn’t that surprising; the Fed always reserves the freedom to respond to the data and hates feeling boxed in by market expectations. Yet trying to get the market to believe the path isn’t predetermined is probably futile. After all, the Fed will slow QE according to its view of how the economy progresses; or maybe they'll ramp it up again if the economy heads south.

And after all, we don't know which way it will go, because, after all, there is financial instability. And when I think financial instability, I think of the usual suspects – the banksters. As long as they're running the show, what could go right?

Wall Street Lobbyists are still plying their trade, rolling back finance reform, again. During a week where attention was focused on IRS scandals and AP scandals and whatever the scandal du jour, the banksters found bipartisan support for a series of deregulatory bills dealing with derivatives trading and the Commodities Futures Trading Commission and watering down the already soggy Dodd-Frank legislation.

The latest move involves wiping out a little clause that would have prevented bailouts for bankers playing with derivative swaps, specifically federally insured banks would have a safety net so long as the swaps gambling was done as a bona fide hedge, or in “certain structured finance swap activities” which means basically any trade they happen to make. Which basically means the bank lobbyists have now removed the threat of not getting a bailout if or when they screw up again.

And then they managed to push through the “Swaps Jurisdiction Certainty Act”, which basically says that they can move their derivatives trading operations offshore and not have to comply with US requirements on trading swaps. And then the lobbyists managed to wipe out requirements to provide some sort of transparency to prices and quotes on swaps, which means the derivatives markets will continue to operate with all the transparency of a black box.

What could go wrong? I'm sure we'll find out in the richness of time. And yes, the legislation working its way through Capitol Hill is bipartisan. The Republicans and Democrats can't agree on much but they can agree to sell out to the banksters. High minded political ideology tends to vaporize in the presence of campaign donations.

According to the New York Times, one bill that through the House Financial Services Committee, allowing more of the very kind of derivatives trading (bets on bets) that got the Street into trouble, was drafted by Citigroup -- whose recommended language was copied nearly word for word in 70 lines of the 85-line bill. The lawmakers who this month supported the bills championed by Wall Street received twice as much in contributions from financial institutions compared with those who opposed them.

And so far, not one single banker has been prosecuted for the actions that lead up to the country's financial meltdown. Remember the Occupy movement, those protesters who were ticked at all the damage done by Wall Street? Well, they haven't disappeared, but quite a few were arrested. Since September of 2011, approximately 7,736 Occupy protesters in 122 cities nationwide have been arrested. Earlier in the week a few hundred members of Occupy Our Homes, an organization supporting homeowners facing foreclosure, protested outside the Justice Department. Seventeen former homeowners were arrested.

Meanwhile, New York Attorney General Eric Schneiderman says there is more evidence that Bank of America Corp, Wells Fargo and other banks violated the terms of a settlement designed to end mortgage servicing abuses.

Schneiderman plans to sue Bank of America and Wells Fargo for failing to live up to their obligations under the deal, and now he says other states had found similar problems. The $25 billion settlement was brokered last year between five banks and 49 state attorneys general. The other banks are JPMorgan Chase, Citigroup, and Ally Financial. The banks agreed to provide relief to homeowners and comply with a set of servicing standards to atone for foreclosure misconduct.

In a letter to the monitor for the settlement Schneiderman says: "Several other states have identified similar recurring deficiencies by the participating servicers." In his letter, Schneiderman did not identify which other states had provided evidence of banks failing to abide by the settlement. Nor did he identify the banks with recurring deficiencies.

In Thursday's letter, Schneiderman said there had been "inordinate delays" in reviewing loan modification applications at Wells Fargo, so applicants had to resubmit documents. He cited evidence of piecemeal requests for additional documents in one modification application at Bank of America, and said more than three months passed without a request for more information or a decision on another application.

So, you're listening to this and probably thinking that the banksters are a little bit lousy but how does it really affect you. And besides, you're probably already planning you're Memorial Day barbeque. Turns out that Goldman Sachs is also thinking about the food on your plate. Last year, Goldman made an estimated $400 million from speculating on food. The World Bank estimated in 2010 that 44 million people were pushed into poverty because of high food prices, and that speculation is one of the main causes.

In 1996, speculators held 12% of the positions on the Chicago wheat market, with most of the market being made up of the legitimate users of food – from farmers to producers. But the legitimate hedging element of commodity markets has virtually disappeared in the intervening years. By 2011, pure speculators made up a staggering 61% of the market. Of course, Goldman Sachs isn't the only player, but it is certainly the largest.

For several years, it was hotly debated whether speculation in food commodities drives up prices. But the evidence now firmly says it does, and that there's little correlation between rising prices and actual supply and demand. There are now well over 100 studies which agree (pdf), from sources as varied and valuable as Harvard University, the Food and Agricultural Organisation and the United Nations; and it appears that food prices have less to do with supply and demand than speculation. The knock-on effect of increased speculation has meant price spikes are now more and more common. In November 2012, the World Bank declared a new era of food price volatility.

Thursday, May 23, 2013 - Premature Punch Bowl Withdrawal

Premature Punch Bowl Withdrawal

by Sinclair Noe

DOW – 12 = 15,294
SPX – 4 = 1650
NAS – 3 = 3459
10 YR YLD un = 2.02%
OIL + .01 = 94.29
GOLD + 21.80 = 1392.50
SILV + .36 = 22.73

Yesterday, Fed Chairman Bernanke delivered testimony before the Joint Economic Council and then the minutes from the most recent FOMC meeting were released. The Fed policymakers seem concerned about bubbles. Stock markets have been hanging out near record highs, the S&P is up about 15% year to date. Look back to earlier this year. The boring stocks led us higher. Your mega-cap, super-safe, dividend-paying names were the stocks to own. These stodgy companies sprinted higher for weeks. Safe became the new speculative.

Next, the rally broadened. First, it was short squeezes. Then, the rally focused on the more cyclical names. Energy stocks have found a second wind. Small-caps were. Technology names began pushing the market higher. Bloomberg reports that the most indebted US companies are rallying more than any time in almost four years compared with the rest of the market.

The bulls argue that stocks will keep going up,even if the Fed takes away the QE punchbowl; the argument is that there are record corporate profits. But then we have to ask why there are record corporate profits. The answer is the Fed's accommodative monetary policy. The Fed is effectively subsidizing earnings by providing cheap credit for the federal government. Government spending replaces paychecks as a source of income for consumers to consume. Corporations cut wages and operate lean and mean, and they report record profits. The top line, revenue, has been weak but it hasn't collapsed because the government has been providing just enough to keep the economy moving. The government provides income to citizens and they are still consuming.

Beyond that, corporations benefit from extremely low interest rates, which allows companies to refinance debt and pocket the difference. Or, in the case of Apple, they can borrow at extremely low rates, pass out the cash as dividends, and it's still cheaper than repatriating profits from offshore and paying the taxes. The debt to equity ratio for S&P 500 companies is now 57% above historical averages.

The Fed's accommodative monetary policy has allowed income to be detached from employment. Corporate America has been slowly and surely eroding its own customer base and the government has been picking up the slack with social safety nets. At the end of the day, a safety net is a stopgap measure, not a permanent solution. Without more jobs, without real income, the equity markets will eventually revert to lower valuations.

And so yesterday, Chairman Bernanke continued to beg for fiscal policy, or at least fiscal policy that doesn't embrace austerity. Bernanke has to be worried about the imbalances and he is aware the lesson the Great Depression taught many is that the principal symptom of internal economic imbalance was unemployment; a big enough problem to create a grand market failure. The equilibrium that economies find routinely is one where aggregate demand and output are not enough to ensure that the available labor force is working; that's why the Fed has a mandate of maximum employment, not just a target of 6.5% unemployment. The idea is to ensure internal balance by having the government increase spending, thereby boosting demand, which in turn, increases output, which means more jobs. It's a virtuous cycle. Except it isn't working quite like planned.

Apple is parking money offshore; same with GE, Starbucks, Google, and almost all of the big multinationals. Somewhere along the way, the idea of an economy that maximizes aggregate utility has given way to maximizing profits for a small minority who possess capital. And the idea of the government safety net being utilized to provide capital to increase consumer spending and crank up the virtuous cycle, well that is running into a brick wall in the form of austerity.

The pace, depth and breadth of the stock market rally is certainly not justified by economic fundamentals alone. Investors continue to buy because they are in a desperate search for returns in a low-return world and feel that cheap money will keep them 'whole' if they invest in risky assets, such as stocks.

Yesterday, Bernanke was asked a question that suggested the Fed's super loose, accommodative monetary policy might be creating asset bubbles, which might end very badly. Bernanke responded that “there's no risk free strategy right now.” And that risk is not restricted to the stock market. His all-consuming concern right now must be to avoid the kind of bond market carnage that was created in 1994 when the Fed raised rates unexpectedly, and I suspect that the debate within the FOMC is becoming much more heated with regard to how to achieve some scaling back of asset purchases without causing a similar bond market rout.

Bernanke started yesterday's testimony with prepared remarks by pronouncing: "a premature tightening of monetary policy could lead interest rates to rise temporarily, but would also carry a substantial risk of slowing or ending the economic recovery and causing inflation to fall further." It seemed a clear signal that the Fed would continue QE to infinity and beyond.

Then, in the Q&A session, he commented that the Fed could cut the pace of asset purchases "in the next few meetings." It seemed a complete about face.

So, we're back to watching the Fed's targets for inflation and unemployment. There are good economic arguments for inflation to become extremely sticky to the downside at these low levels; just over 1 percent. We'll keep an eye on the next few jobs reports, where good news could be bad news. Also, keep a look at global unemployment numbers. In 14 out of the 35 advanced economies covered by the IMF’s World Economic Outlook dated April 2013, the unemployment rate in 2012 was at its highest since 2007. In terms of jobs, in many countries the crisis is intensifying, not retreating.

The problem is not just that the incidence of unemployment is uneven across the advanced countries. It is also that it is extremely uneven across age groups, or more importantly, generations. The generation that has entered the labor force over the last five years is the hardest hit. These numbers are important because they represent systemic failure in labor, and the Fed can't operate in a vacuum with its monetary policy. It would be strange to see the Fed tightening, while the ECB is loosening. If you want to create problematic global imbalances, all it will take is a gear-shift by the US Federal Reserve and the inevitable dollar surge that follows. Remember that it was the Volcker Fed that set off Latin America's defaults in the early 1980s. It was the mighty dollar that set off Mexico's Tequila crisis, and then the East Asian tiger economies, chain-reaction in the 1990s.

Foreigners have pumped more than $8 trillion dollars into the emerging markets of the BRICS. European banks have lent another $4.4 trillion to the BRICS. If the Fed tightens, the dollar soars, the BRICS freeze, the defaults follow.

I'm not sure what the possible exit plan is for the Fed, maybe for now, it's nothing more than jawboning, trying to gauge the possible responses. So, there is widespread, deep-seated cynicism about the ability of democratic governments, once engaged in stimulus, to change course in the future. Ending stimulus has never been a problem; in fact, the historical record shows that it almost always ends too soon. What needs to happen before we start talking about ending stimulus is a good strong look at fiscal policy; the kind of policy that allows corporations to shovel profits offshore, and erode their long-term customer base in pursuit of short-term profits.

Global corporations have no allegiance to any country; their only objective is to make as much money as possible — and play off one country against another to keep their taxes down and subsidies up, thereby shifting more of the tax burden to ordinary people whose wages are already shrinking because companies are playing workers off against each other.

The total corporate contribution to federal revenue, including employers' share of payroll taxes, has dwindled from 32 percent in 1950 to about 17 percent today. Employer contributions to payroll taxes make the unfairness of the tax code slightly less unfair, but the trend is still clear and dramatic: Corporations are paying a lot less than they used to.

So, Tim Cook of Apple went before the Senate this week and explained the problem, and the problem isn't Apple; it's our tax laws. Apple is only doing what the laws allow. Apple and the other big companies are trying to lower their tax bill, and you would probably do the same thing if you were as big as Apple, and had a fiduciary duty to your shareholders. The problem is the laws allow them to keep billions offshore, which does nothing to create jobs in this country, which does nothing to repair infrastructure, which does nothing to create aggregate demand, which does nothing to crank up the virtuous cycle; which instead puts us on a downward spiral. When you hear outrage about the IRS scandal, don't get distracted; the real scandal shouldn't be whether some low-level IRS employees were taking shortcuts; the real scandal; the multi-trillion dollar scandal was on full display this week.

Wednesday, May 22, 2013 - Throwing Ben From the Chopper

Throwing Ben From the Chopper

by Sinclair Noe

DOW – 80 = 15,307
SPX – 13 = 1655
NAS – 38 = 3463
10 YR YLD +.08 = 2.03%
OIL – 1.53 = 94.65
GOLD – 6.30 = 1370.70
SILV - .16 = 22.37

Federal Reserve Chairman Ben Bernanke went to Capitol Hill this morning and that was followed by the release of the Federal Open Market Committee, or FOMC, minutes from their May 1^st meeting and that was followed with a big swing lower for stocks on very heavy volume and a big swing lower for bonds and everything was just rocking and rolling.

Bernanke was appearing before the Joint Economic Committee this morning; the gavel fell; Bernanke delivered some prepared remarks: "A premature tightening of monetary policy could lead interest rates to rise temporarily but would also carry a substantial risk of slowing or ending the economic recovery and causing inflation to fall further."

So, that sounded like no tapering off of QE anytime soon. Stocks and bonds inched a little higher. Bernanke went on to say that fiscal policy continues to be a drag on the economy. Right, we've heard it before.

Then, Bernanke stressed that slowing asset purchases would not be the automatic beginning of the exit. The flow of purchases could be ramped up depending on the data. Now, the markets were trying to figure out which direction he's going.

Asked when the Fed will slow down asset purchases, Bernanke says it could come in "next few meetings”, but he won't give a date. Then he says financial stability is biggest risk of asset purchase program, but a weak economy comes with its own stability concerns. Then he says the Fed does not have to sell any agency mortgage-backed securities when the central bank exits its easy policy stance. The markets start to tank.

Is the Federal Reserve doing too much to stimulate the economy, or not enough? Many of the questions directed at Bernanke this morning were about the risks of the Fed doing too much and whether their monetary policy was hurting savers and creating asset bubbles. An equally valid question is whether the Fed is pushing hard enough, given that the economy is growing more slowly than the Fed wants it to and the jobs market remains stagnant and inflation is running well below its target.

Helicopter Ben, the student of the Great Depression willing to throw cash out of a helicopter; that Fed Chairman was nowhere to be found; replaced by a Chairman willing to stand pat despite failing to achieve the Fed’s own self-imposed targets.

Bernanke isn’t ruling out stronger action. In his testimony he said that depending on incoming data, “we could either raise or lower our pace of purchases.” But raising purchases is clearly not Plan A. As the outlook for the labor market “improves in a real and sustainable way, the committee will reduce the flow of purchases,” the chairman said, without specifying a time.

Bernanke says for the record that the Fed could do more if necessary, but he is behaving as if he believes monetary policy is at or near its limit. He testified: “Monetary policy does not have the capacity to fully offset an economic headwind of this magnitude.”

That doesn't really sound like Helicopter Ben. Has he lost his swagger? Hang on. He's saying the Fed is willing to hold on to all the Mortgage Backed Securities they've been buying, maybe just stick them in the vault and wait; that is not an acknowledgment of failure in monetary policy, but it is looking like an acknowledgment of asset bubbles.

And then we got the FOMC minutes.

The FOMC minutes showed they were still waiting for more progress before they would slow Quantitative Easing, but they were thinking about an exit plan; they discussed the old plan form 2011, debated whether it was still valid or needed updating, talked about the possibility of slowing asset purchases as early as June, that didn't fly, and then the punchline– assett bubbles.

The FOMC minutes say, in writing: "a few participants expressed concern that conditions in certain U.S. financial markets were becoming too buoyant.... One participant cautioned that the emergence of financial imbalances could prove difficult for regulators to identify and address, and that it would be appropriate to adjust monetary policy to help guard against risks to financial stability."

The big question is whether the Fed will actually have a mutiny and throw Bernanke from the helicopter and abandon super-easy monetary policy? So, let's dig a little deeper into the minutes: “Regarding the composition of purchases... ,in light of the substantial improvement in the housing market and to avoid further credit allocation across sectors of the economy, the Committee should start to shift any asset purchases away from MBS and toward Treasury securities.”

Where do we go from here? The Fed holds on to its existing asset purchases; they won't shy away from ZIRP, the Zero Interest Rate Policy; they are getting closer to using some new tools, and it's probably more than just a shift from MBS to Treasuries. What tools? We didn't really get a clue today, but we did get some acknowledgment that they recognized the limitations of the tools they've been using. So, we should be looking for new tools, or look for Bernanke to be tossed from the helicopter – it could go either way.

The latest poll of Morgan Stanley's top clients from across the world says it all. Not a single investor at the bank's Florence forum thought the world economy would rebound with any strength later this year.

Just a quarter expect a return to trend growth. Some 57pc think there will be no escape from the "twilight" conditions afflicting the western world, and 20pc expect an full-blown global recession. That is a remarkably bearish set of views. Yet the same investors are overwhelmingly bullish on stocks and property.

This schizophrenic exuberance seems entirely based on the assumption that QE and central bank largesse will keep the game going, flooding asset markets with liquidity. Indeed, 80pc think the ECB will cut rates again, and half think it will have to swallow its pride and join the QE club in the end.

Eighty percent think equities will gallop on upwards over the next year. Complacency is rife. It became very clear, and many investors were quite explicit about this, that markets are lulled by the lure of liquidity resulting from negative real interest rates and global QE. When the music stops, in terms of liquidity, things will be complicated. But as long as the music is playing, you’ve got to get up and dance. We’re still dancing.

Yesterday, shareholders at JPMorgan Chase decided to keep Jamie Dimon as chairman and CEO. The shareholders trying to take away Dimon's chairmanship weren't trying to take the job of running JPMorgan away from him. They just wanted to give the board's oversight function to somebody else -- they didn't want Dimon being his own boss. But even this minor tweak to Dimon's job function would have been such an outrageous affront to Dimon's royal personage that he might have taken his indispensable skills away from the bank forever, causing the stock price to collapse, or so the bank told shareholders, at least in private. Jim Cramer said it publicly: "If you voted for Dimon to lose chairmanship, you voted for a lower stock."

The Office of the Comptroller of the Currency cut it's rating of the bank's management and says it need simporvement, but shareholders weren't buying it. Last weekend I heard one analyst explain that concerns about out of control trading, and the trading losses of the London Whale, and allegations of money laundering, institution wide regulatory violations, and auditors that are on the verge of throwing up their arms; for a complete list of violations, there is a report entitled “JPM – Out of Control” , which basically describes a criminal enterprise. Any way, the analyst over the weekend was saying that shareholders should forget about all that because Dimon delivers record profits, and that's all that really matters. Rather than humbling Dimon, JPMorgan shareholders have declared, loudly, that Dimon alone should hold their fate in his hands. They had better hope it doesn't go to his head.

Hurricane Sandy was the deadliest and most destructive hurricane since Katrina. It caused 285 total fatalities and was the second-costliest hurricane in United States history.

During the immediate aftermath of this act of Nature, Senators Inhofe and Coburn from the state of Oklahoma, were among many who decided to use the disaster as a political platform. They voted against a full FEMA / Army Corp of Engineer reconstruction, and repeatedly delayed votes to fund any for of rescue. The Republican Governor of New Jersey went postal against the GOP House members as well as these two Oklahoma Senators. Eventually, federal aid for Hurricane Sandy was passed. A big chunk of the Sandy emergency package replenished FEMA, which had been underfunded by the usual suspects. The Sandy relief package replenished its coffers. The votes in favor of Sandy Aid ironically funded FEMA, and it is helping with the rescue and clean up efforts in Oklahoma. Now Coburn is insisting that any federal aid to deal with the tornado in his home state must be offset by budget cuts, but he says that “as the ranking member of Senate committee that oversees FEMA, I can assure Oklahomans that any and all available aid will be delivered without delay.”

Tuesday, May 21, 2013 - Apple Gimmicks

Apple Gimmicks

by Sinclair Noe

DOW + 52 = 15,387
SPX + 2 = 1669
NAS + 5 = 3502
10 YR YLD - .02 = 1.94%
OIL - .98 = 95.95
GOLD – 18.10 = 1377.00
SILV - .49 = 22.53

It's Tuesday. The markets moved higher. It's almost inevitable. The Dow Industrials have closed higher every Tuesday this year, with the exception of January 8^th; 19 consecutive Tuesdays. No, I don't know why.

Well, today, part of the reason could be traced to the Federal Reserve. A couple of Fed heads were talking up easy money. New York Fed President William Dudley said he cannot be sure whether policymakers will next reduce or increase the amount of purchases, due to the "uncertain" economic outlook. The QE taper may end up being a QE expansion. Dudley worries about investor over-reaction to a "normalization" of policy and suggests the FOMC may need to update what it needs to see to move in that direction. Earlier, James Bullard, president of the Federal Reserve Bank of St. Louis, urged the European Central Bank to consider employing a US style quantitative easing program to counter slowing inflation and recession in the euro zone.

Tomorrow, Fed Chairman Ben Bernanke will speak before a congressional panel, the Joint Economic Committee. The minutes of the Fed's latest policy-setting meeting will be released on Wednesday afternoon. When the Fed showers liquidity, the money flows to the markets, but I can't give a good reason for the Tuesday winning streak.

There is a certain symmetry in life: fire and ice, winter and summer, darkness and light, yin and yang. And this brings us to the IRS scandal; last week we learned about the demand treatment afforded some groups by the IRS, this week we learn about the generous nature of the taxman. It's not so much that the taxman is benevolent; we all no better; but some entities demand preferential treatment; powerful, giant corporations are holding governments and citizens up for ransom; taking tax breaks and subsidies from countries in the name of competitiveness; sheltering profits in off-shore tax havens.

Google, Amazon, Starbucks, GE, Apple, and pretty much every other major corporation and the big Wall Street banks siphon off profits via off-shore entities that are sometimes no more than a mailbox on a tropical island, and they don't pay taxes like the rest of us, because if they did it would destroy their ability to be competitive.

And today, Tim Cook, the CEO of Apple, ran down the aisles of Congress and hurled his hammer at the totalitarian overlords, metaphorically speaking. Actually, Cook appeared before the Senate Permanent Subcommittee on Investigations. Congressional investigators found that some of Apple’s subsidiaries had no employees and were largely run by top officials from the company’s headquarters in California. By officially locating them in places like Ireland, Apple was able to, in effect, make them stateless — exempt from taxes, record-keeping laws and the need for the subsidiaries to even file tax returns anywhere in the world.

Apple Operations International, which has no employees but reported $30 billion in income over the four years, has not filed an income tax return in any country for the last five years, the subcommittee investigation found.

A second company, Apple Sales International, holds the economic rights to Apple's intellectual property in Europe, Asia and Africa. The subsidiary had $74 billion in sales income from 2009-2012 but paid less than 1% in taxes to Ireland.

The only taxes paid were on the interest earned by the cash pile and small sums in local markets. Senate investigators allege a total of $70bn has been sheltered this way in four years.

The tactic, which is legal, is possible through complex cost-sharing agreements that transfer the economic rights to the valuable intellectual property behind the iPhone, the iPad, and other products to subsidiaries outside the US.

Tim Cook told the senators: “We pay all the taxes we owe, every single dollar.” And that appears to be the case; Apple does pay a considerable amount of taxes in the US . Cook added: “We don't depend on tax gimmicks.” And that appears to be a slightly more dubious claim. Cook said he "personally doesn't understand the difference between a tax presence and a tax residence".

In a dramatic display of how threats from multinational corporations are driving down taxes across the world, Cook warned Congress that he would refuse to repatriate a total of $100 billion stashed offshore unless it acted to slash the 35% US rate. Cook said the tax rate for repatriated money should be set "in single digits" to persuade companies to bring it back. Standard tax for US profits should be, he said, in the "mid 20s". 

 Everyone "knows" that the corporate income tax is a mess. Ask any company. They pay too much in corporate income tax, face rates higher than in any other OECD country, and are just following the law when they use tax havens to keep profits eternally deferred from taxation and to perform general sleight-of-hand. There is a big difference between the headline rate of 35%, which is indeed tops in the OECD, and the effective rate of 12.1%, one of the lowest in the OECD.

Apple is not an outlier in its efforts to produce 'stateless income'; income that is taxed neither in the US nor in the countries where its foreign customers are located, but it is audacious in its tax avoidance strategies. Apple shifted tens of billions of dollars of income without even breaking a sweat. Google followed the Apple playbook by using a low-tax Irish subsidiary to avoid taxes; Google is now under investigation in the UK. Starbucks' tax dodge was so blatant British consumers began boycotting the firm until it reversed course. In the US, we aren't indignant. Today, senators talked about how they considered Apple to be a great company, even if they did have concerns about the tax thing.

We have lots of great American companies that operate in a more or less free-market system that has allowed them to thrive on publicly-funded research, infrastructure, defense, and in the case of Apple – patent and intellectual property protections. And they show their gratitude by choosing to cut their taxes in half – or actually closer to one-third despite doubling their profits, so they may hold more than $1 trillion dollars of cash off-shore, and eliminate workers rather than create jobs. Or, as one Apple executive explained: “We don't have an obligation to solve America's problems.”

Which raises an interesting question; why should America have an obligation to solve Apple's problems? Apple enjoys the protections of US laws against patent and intellectual property infringement. Apple enjoys the ability to ship its products around the world, in part because the US has the largest, most powerful military making sure the avenues of commerce aren't crowded out by pirates on the high seas or in the skies. If Apple doesn't want to pay for those protections, they shouldn't be forced to. They could just stop using those services. You don't pay; you don't get – no gimmicks in that equation.

The scandals in Washington remind us to be ever vigilant about the dangers of government overreaching its authority, whether by the long arm of the IRS or the Justice Department, but that doesn't mean that we accept anarchy. We need to remember that government does provide important services and protections, and somehow we have to pay for that. Tim Cook and Apple don't want to pay. Nobody wants to pay. I understand. And so, not much changes

By the way, the World Bank estimates the total cost for a successful attack on malnutrition would be approximately $10.3 to $11.8 billion annually. Apple alone underpaid its 2012 taxes by $11 billion, based on a 35% rate. So, we could literally put an end to hunger in this world, if Apple paid it's taxes, but you know, it's not Apple's obligation to solve the problems of the world. 

Monday, May 20, 2013 - Daily Scandals and Distractions

Daily Scandals and Distractions

by Sinclair Noe

DOW – 19 = 15,335
SPX – 1 = 1666
NAS – 2 = 3496
10 YR YLD + .02 = 1.96%
OIL + .58 = 96.87
GOLD + 33.90 = 1395.10
SILV + .66 = 23.02

I suppose we should start with the scandal du jour, since this is where most of the news has been fixated recently. I'll try to focus on how it affects the economy and the markets, but it's hard to ignore the bluster. One quote I heard over the weekend was "add Watergate and Iran Contra together and multiply by ten" to calculate the tyrannical evil of the Obama scandals.

Actually, the current scandals are not even close (I'm old enough to remember the enemies list and plumbers). I don't think the scandals are inconsequential but I think some historical perspective might help. The rhetoric without perspective might actually backfire. But what we concern ourselves with here is the economic and financial impact. And it's likely there will be limited economic impact. We've seen worse, and the markets survived and sometimes even prospered.

Remember Iran Contra? It happened to coincide with one of the greatest bull runs the market has ever seen. And remember the Lewinsky scandal? It coincided with a market that was described as irrationally exuberant; this is often attributed to gridlock in Washington, or some sort of moderation. Actually, the old idea of gridlock being good for markets, doesn't really hold water.

When one party controls both the White House and Congress – Republicans or Democrats – the markets perform about 5 times better than when the president and Congress are from opposite parties. It doesn't seem to matter for the current administration; the market is enjoying big gains, with the S&P 500 up 149% since the lows of March 2009. And when things look bad, the market goes higher.

The explanation may come from the Federal Reserve. Weak numbers on any front are viewed as a sign that the Fed will remain accommodative as will other central banks around the world. The old adage "don't fight the fed" has really become "don't fight the feds' - as in plural. Trillions of dollars on the sidelines have to be put to work and are hungry for yield, especially from stocks. 

The trillions of dollars worth of central banks stimulus has put into play the past few years have socialized risk. The game used to be private gains and private losses. Now it's private gains and socialized losses. Businesses that have under-invested for years are beginning to capitalize on a distracted Washington using the breathing room to make new investments.

Anyway, the markets appear to be propped up, for now at least.

Remember the Libor rate rigging scandal? Several of the biggest banks were rigging Libor, the interest rate that is used worldwide for just about everything. When the Libor Scandal broke it raised the question, what else is rigged? We learned that derivatives, specifically the nearly $400 trillion dollar market in interest rate swap prices were subject to possible manipulation of the ISDA fix.

The latest revelation is oil price rigging. A review ordered by the British government last year in the wake of the Libor revelations cited “clear” parallels between the work of the oil-price-reporting agencies and Libor.

They are both widely used benchmarks that are compiled by private organizations and that are subject to minimal regulation and oversight by regulatory authorities. To that extent they are also likely to be vulnerable to similar issues with regards to the motivation and opportunity for manipulation and distortion.

Last week, the European Commission raided the offices of Shell, BP and Norway’s Statoil as part of an investigation into suspected attempts to manipulate global oil prices spanning more than a decade. None of the companies have been accused of wrongdoing, but the controversy has brought back memories of the Libor rate-rigging scandal.

The inquiry also involves Platts, the world's largest oil price reporting agency. Europeans have long complained that retail gas prices have not seemed to match wholesale prices. In fact, complaints that retail prices at gas stations were noticeably slow to fall when wholesale prices fell prompted the U.K.-based Office of Fair Trading last year to conduct a cursory inquiry into possible anti-competitive behavior in the fuel markets.Early this year, they announced that they hadn't found enough evidence to warrant a full-blown investigation. But complaints persisted.

Reuters points out that the probe may be expanding to the U.S.:

“In Washington, the chairman of the Senate energy committee asked the Justice Department to investigate whether alleged price manipulation has boosted fuel prices for U.S. consumers.

“Efforts to manipulate the European oil indices, if proven, may have already impacted U.S. consumers and businesses, because of the interrelationships among world oil markets and hedging practices,” Sen. Ron Wyden (D-Ore.), chairman of the Senate Energy and Natural Resources Committee, wrote in a letter to Attorney General Eric H. Holder Jr. Wyden also asked Justice to investigate whether oil market manipulation was taking place in the United States.”

Not only are petroleum products a multi-trillion dollar market on their own, but manipulation of petroleum prices would effect virtually every market in the world.

There's a lot riding on the price of oil, including how much money OPEC nations need to keep their governments funded. At $100 a barrel, there's enough profit to produce the oil and to fund the governments. Things get dicey around $80 a barrel; $60 dollar a barrel oil spells big problems for almost all OPEC countries.

Meanwhile, the International Energy Agency (IEA) in its Oil Market Report claimed that America's shale boom is growing even larger than expected. It's also set to have a profound effect on OPEC. OPEC is also set to produce, or have the capability to produce, a lot more oil. One main driver of that supply growth is Iraq. After a turmoil-filled decade, Iraq is coming back on line in a big way -- and could add another 3 million barrels per day to the oil mix by 2018.

So the U.S. has lots of oil, and we're producing it at an ever-growing rate. And OPEC has a lot of oil and is either producing it or sitting on it.

And what's funny is that if OPEC continues to cut supply via quotas, all it will do is help the U.S. oil boom. They'll essentially be crimping supply to boost prices... and we'll benefit. So why are prices still high? Central banks are still printing money. The Fed and the BOJ are printing away, and it's probably only a matter of time before the ECB joins in. Maybe that explains something. Then there is the fear premium. Then there is the idea that prices are rigged. Nobody wants to upset the situation, at least not right now.

The Saudis aren't happy that Iraq is coming online with about 3 million barrels a day by 2018. This could lead to a round of infighting among OPEC -- with each nation trying to eke out the most money. Frankly, the Saudis have massive incentive to see Iraq fail. The same goes for Iran. There are sanctions against Iranian oil, and that has as much to do with the price of oil as any specific act of craziness from the Iranian crazies.

The U.S. and OPEC are set to produce much more oil. And even though US and Euro demand is falling, demand from the oil-thirsty East is set to ramp up. So, we have an uneasy equilibrium in the oil markets right now.

The Federal Reserve Bank of San Francisco points out: When gasoline prices increase, a larger share of households’ budgets is likely to be spent on it, which leaves less to spend on other goods and services. The same goes for businesses whose goods must be shipped from place to place or that use fuel as a major input (such as the airline industry). Higher oil prices tend to make production more expensive for businesses, just as they make it more expensive for households to do the things they normally do.

Oil prices indirectly affect costs such as transportation, manufacturing, and heating. The increase in these costs can in turn affect the prices of a variety of goods and services, as producers may pass production costs on to consumers. Oil price increases are generally thought to increase inflation and reduce economic growth.

Oil price increases can also stifle the growth of the economy through their effect on the supply and demand for goods other than oil. Increases in oil prices can depress the supply of other goods because they increase the costs of producing them. In economics terminology, high oil prices can shift up the supply curve for the goods and services for which oil is an input. One major area that could feel the pinch is agriculture, and the prices of the food we eat.

There are some important scandals, just don't get distracted.

Friday, May 17, 2013 - Squirrel

Squirrel

by Sinclair Noe

DOW + 121 = 15354
SPX + 17 = 1667
NAS + 33 = 3498
10 YR YLD +.08 = 1.95%
OIL + .83 = 95.99
GOLD – 25.70 = 1361.20
SILV - .43 = 22.36

Record highs for the Dow and the S&P 500; marking the fourth consecutive week of gains. For the week, the Dow gained 1.6%, the S&P 500 gained 2%, and the Nasdaq was up 1.8%. The S&P 500 is up about 13% year to date.

Someone asked me yesterday if I intended to talk about the scandals in Washington; you know, the Benghazi scandal, the IRS scandal, and the Associated Press scandal. I suppose we can talk about that if you want.The issue I might address right now is, what does all the scandal-mongering mean for the economy?

Well, we could look to the Clinton years, which continued to perform handsomely, but I think that had more to do with the dot.com boom than with Clinton's proclivity. Greenspan warned about irrational exuberance while fostering policy that just pumped the markets to higher highs. Not so different really from Bernanke's warnings about excessive risks while continuing with QE to infinity and beyond.

The market has been profiting from the indulgences of the Fed's easy money, and the Chairman seems more worried that Congress will busy itself with more fiscal austerity in the form of quick-timed spending sequesters and additional tax increases than he is about inflation from easy money. Unspoken is the fear certainly in the Fed quarters and lurking in the markets' subconscious that Congress will go even further and again set up another credit-rating political cliffhanger over the debt ceiling extension.

Maybe, the politicians can pull themselves away from their compulsive partisanship to recognize that the deficit is getting better. The Congressional Budget Office revise its budget projections. The short-term deficit, in particular, is way lower; $200 billion lower; or a $643 billion deficit for 2013 rather than an $845 billion deficit. That should be really big news, just not this week. Both sides of the aisle could take credit for that, but it barely gets a nod. Congress is distracted, like a dog in the presence of a squirrel.

And the longer they keep up their nonsense, the less time they have to meddle with the economy; which might not be such a bad thing. No time to come up with a Grand Bargain on Social Security and Medicare; no time to figure out entitlement cuts; nothing but gridlock through the hazy days of summer.

For a business community that constantly begs for certainty, maybe they would enjoy a lazy summer of slow, steady growth without the distractions from Washington. Fed Chairman Bernanke has begged for Congress to come up with fiscal policy that might help grow the economy, but would probably be happy to see Congress stop stepping on the economy's tail with it's austerity obsession. The politicians are clueless about the economy and they could only screw things up.

Case in point; last week the US House passed the Full Faith and Credit Act, which quickly gained the nickname “Pay China First Act”. The supposed purpose of the act is to prevent default on the public debt as a result of the debt ceiling.

The idea was the act prioritizes the financial obligations of the US government, and authorizes the Secretary of the Treasury to meet only the highest priority obligations when at the debt ceiling; that is how the act is described by its own authors, since the head of the resolution contains the description, “A bill to require that the Government prioritize all obligations on the debt held by the public in the event that the debt limit is reached.”

The act seems to have been designed to provide the Secretary of the Treasury with an alternative mechanism for paying off public debt and meeting Social Security obligations once the government has reached the statutory debt limit. But the new mechanism cannot be applied directly to other government spending commitments, and so Congress would still apparently have the ability use the debt ceiling as a tool for shutting down other government payments and forcing the executive branch to accept further spending cuts.

But remember the politicians are not real strong on economics and it appears this act would provide the Secretary of the Treasury with the power to meet all US spending obligations, and effectively eliminate the debt ceiling as a serious political and operational consideration going forward.

The act specifically authorizes the Treasury to issue “obligations … to pay with legal tender”, the principal and interest on the obligations described in subsection 2(b). Now, an obligation is just another debt instrument. So the act basically permits the Treasurer to issue IOUs to pay the principal and interest on public debt. It permits the Treasurer to redeem conventional government debt obligations – all of the usual bills, notes and bonds the government issues, and that count against the debt subject to the debt limit – with a new kind of debt obligation.

Basically, the Treasury could write IOU's and put them in the Treasury coffers to reduce the debt, and then issue fresh bonds to raise cash to pay for whatever they want to pay for.

Squirrel.

The one thing that has roiled the markets lately is talk of the Federal Reserve tapering off Quantitative Easing. While the economy has shown signs of improvement, it is still a long way from a strong economy. Inflation remains under control, so that's not a problem. Unemployment is still a problem, so that's reason to increase stimulus, not taper off. Several regional Fed presidents have weighed in recently, and yesterday, Fed governor Sarah Bloom Raskin raised the possibility that rising inequality may restrain growth for years to come.

In a speech delivered in Washington, Raskin said: “In my view, the large and increasing amount of inequality in income and wealth, which has been an ongoing development for decades, may have exacerbated the crisis. More research is required to determine whether it may also pose a significant headwind to the recovery from the crisis for years to come.”

Raskin’s comments are among the most forceful to date from any current member of the Fed’s seven-person Board of Governors regarding wealth, income inequality, and how dynamics in household wealth may be impeding growth and prolonging the realization of a full-fledged recovery

Between 1979 and 2007, inflation-adjusted, pretax income for households in the top 1 percent more than doubled, while middle-income households experienced earnings growth of less than 20 percent, according to Congressional Budget Office data. A recent survey by the Fed found that households in the top fifth of annual income owned 72 percent of the total wealth in the economy in 2010, while those in the bottom fifth owned just 3 percent.

Maybe this is the excessive risk Bernanke has been harping on lately.

Here's your weekend reading list:

From the Guardian: A Look at How Apple will petition Washington for a Tax Holiday and what history tells us about tax holidays.

Matt Taibbi continues to dig up wrongdoing by banksters; Everything is Rigged