bearmarket

By Gainesville Coins….
 

The dollar pulled back from its recent bull run, helping both crude oil prices and precious metals advance. Equities were mostly sideways this week as economic indicators in the U.S. continued to disappoint.

GOVERNMENT & POLICY

The Price Tag for Bad Behavior by Big Banks

There are certain forms of crime, and certain guilty parties, that are above the law.

As wrong as this notion is in principle, it is impossible to ignore in practice. Yes, some large institutions are essentially above the law: just like a government would never hold itself liable for war crimes, big banks are never fully held accountable for financial crimes because bringing them to justice would essentially entail their dissolution. The elimination and possible replacement of the entire financial system is too costly for all of that.

Consequently, any form of financial impropriety that a bank could engage in doesn’t realistically carry the risk of a “death penalty.” No, each infraction is merely accompanied by a price tag.

I understand that taking a hit in their bottom line is probably the surest way to punish the banks, but this nevertheless creates a situation for the banks where it’s only a matter of risk-reward analyses and delayed prosecution: if Infraction X would cost us $50 million in fines, but generate $100 million in profits, and we won’t have to face that penalty until years after the fact, it’s only rational to go ahead and commit that infraction.

This kind of reasoning–without logical flaw, I must say–is likely what landed Barclays in its current situation under the microscope of regulatory agencies. After already paying more than $400 million in fines relating to its role in the 2012 LIBOR rigging scandal, Barclays may face another $100 million in fines for subsequent forex manipulation, which would break the promises it made to operate within the law as part of the 2012 settlement.

When these financial institutions know they only face a fine, they can crunch the numbers and justify any sort of misdeed, so long as it results in a profit.

UBS is looking at actual criminal charges for essentially the same offense (and information provided by the recent whistleblower on its policy of abetting tax evasion). I’m not interested in defending the Swiss bank, but it seems to me that all of these guilty institutions ought to receive the same sort of treatment.

In total, billions of dollars have been extracted from big banks like Barclays, Bank of America, Citigroup, Deutsche Bank, and others by the Department of Justice, the CFTC, and Britain’s Financial Conduct Authority. The regulators’ cut of the scam, you might say.

Or, more accurately, the price tag for illegal behavior.

MARKETS

Metals Rally as Bond, Dollar Bears Awaken

The equities markets appeared to hit the doldrums, as shares were mostly flat throughout trading this week. This followed last week’s flight out of the global bond markets, a trend that eased up as bearish traders took profits and helped bonds rise slightly by Friday. The yield on 10-year U.S. Treasuries hit as high as 2.29% midweek before recovering slightly to 2.19%.

While the bears wrested control of the bond market, a similar pattern emerged in forex trading, as the dollar slumped from its position of strength to a new four-month low, registering at just 93.5 on the DXY index after flirting with 100.0 in mid-April. This has helped the euro firm back up to about $1.13, though the yen is still trading over 119 per dollar.

Several developments led to the dollar’s drop, chief among them concerns over the direction of the U.S. economy. Despite the labor market appearing to hold steady, with jobless claims remaining near 15-year lows, wage growth has been essentially nonexistent. Though headline inflation data has continued to trend well below the Federal Reserve’s target of 2%, stagnant wages are really a form of inflation for consumers. Not surprisingly, consumer confidence gauges have dropped for five consecutive weeks, and showed its worst drop in nearly two years this month. This also helps account for the poor retail sales report for April, which actually caused shares to rise on the expectation that the Fed will delay raising the federal funds rate even longer due to the poor data. The reality, however, that retail sales comprise nearly 70% of economic activity in the U.S. tempered this rate hike optimism.

Crude oil prices have been stronger of late, recovering somewhat from their winter lows as the high-demand summer months for energy consumption are approaching. By Thursday’s open, WTI crude was back above $60.50/bbl while Brent crude was approaching $67/bbl. The two crude benchmarks slid back modestly during trading Thursday before each giving up about 2% on Friday.

Although stocks were expected to break out on Friday thanks to the first acceleration in the Empire State manufacturing survey in three months, the continued fall in U.S. consumer confidence saw Wall Street open in the red. Netflix shares did jump about 3% on news that the company is exploring ways to expand its business by entering the Chinese market. Meantime, shares of cosmetics company Avon were returning to normal after the announcement earlier in the week of an apparently false bid to buy the company at several times its market value of about $3 billion. Avon shares jumped as much as 20% on the spoof news before coming back to earth.

With the economy seeming to take a step back, the precious metals rallied this week. Gold steadily rose back above $1,200/oz, settling around the $1,225 level by week’s end. Silver saw considerable demand, lifting off to $17.50/oz, a fresh three-month high. Even though palladium was essentially flat around $790/oz, platinum also showed renewed strength, maintaining its $50 spread with spot gold by rising back to $1,175/oz. So long as bears remain in command of the bond markets and how the dollar trades against other currencies, expect the precious metals to remain the beneficiaries of such developments.

GEOPOLITICS & WORLD EVENTS

Germany Calls Greece’s Bluff

greecegoldAs the tug-of-war between the powers of Europe and the indebted Greek government continues, it now appears as if one of Greece’s strongest negotiating points has just been rendered moot.

Since the beginning of the talks between the two sides, Greek officials have maintained that their first loyalty belongs to their electorate, and fulfilling the promises of the Syriza election victory. The rest of Europe has pressured the Greeks to make structural reforms to its economy–how it pays pensions, how it taxes its citizens, etc.–even if these changes are difficult or painful. In response, Prime Minister Alexis Tsipras has consistently threatened to put the notion of a “Grexit” (a Greek exit from the EU) to a referendum among Greek voters.

While this is largely a negotiating tactic, it still carries some clout. Technically, no nation can be forced to leave, or be removed from, the European Union. The only measure that might produce a “Grexit” is, in fact, a national referendum. Greece itself must decide to break from the eurozone, not the other way around.

It seemed that officials from Germany had grown tired of this line of threatening from the Greek contingency; the Germans are now in support of a Greek referendum, calling out the government on its bluff. The implication is pretty clear: although there is a great deal of fiery rhetoric from Greece about leaving the euro, polls have shown that a majority of voters would prefer that their government work out a solution that retains the euro–just not one that calls for greater austerity.

This is where the rubber meets the proverbial road: if a “Grexit” scenario is put to a referendum among the public, it becomes far less likely. A national vote in favor of remaining in the euro area would largely tie the Greek government’s hands. Germany and others could then point to the results as the will of the electorate, the obligation of the Syriza administration to uphold. On the other hand, if the Greeks voted to leave the EU, the short time span to reintroduce the drachma could be an even bigger headache than the austerity measures that Germany and Europe want.

Unless they are resigned to exiting the eurozone, the Syriza government may need to find a new axe to grind in order to appeal to their European creditors. If they do leave, then all bets on the sustained existence of the European Union are off: with the Tory victory in last week’s U.K. elections, there will likely be a similar “Brexit” plebiscite in Great Britain in 2017. Depending on which way Greece goes, the EU could rapidly unravel in a matter of just a few years.

For Brazil, Corruption Has Stifled Progress

Less than 10 years ago, Brazil was a country ripe for growth, poised to emerge from the developing world as one of the new leaders of the 21st century. Limits to its potential were boundless; finally, after decades of military dictatorship to keep the country afloat, a new paradigm was to take hold.

This was a time when the Brazilian economy nearly tripled in size thanks to an incredible rise in the prices of important commodities, with which Brazil is rather richly endowed. Energy, foodstuffs, raw materials–all abundantly available in the country, and all saw record-high prices during the middle of the last decade.

If Brazil had used this hot period of high prices and profits almost exclusively to build infrastructure, it is unlikely that the recent downturn over the last five years would be able to erode all of the economy’s gains. It would simply be a slump in the business cycle. Alas, when an economy is inflated with corruption and cronyism–especially in a predominantly socialist country–the inevitable slump or downturn can fracture everything to pieces.

Petrobras, Brazil’s state-owned oil giant, is at the center of an enormous scandal that involved bribing government officials, money laundering for a drug cartel and other criminals, and myriad forms of embezzlement. Billions upon billions of reais were secretly laundered to ensure that the nouveau riche plutocracy and its cronies could guarantee government contracts to preferred bidders, even when lower bids for those contracts were available.

This type of corruption permeated the government, and is only now being seriously addressed in Brazil. When the economy was booming, hardly anyone had reason to notice or care about corruption. Now that the global economy has dried up relative to a decade ago, it’s not nearly as easy to keep such cronyism under wraps. When people are struggling, impoverished, and disillusioned, they are much more apt to demand justice.

If there is a silver lining to any period of economic hardship, let it be the cleansing of corruption from the halls of power. It can’t be eliminated completely, but it can at least be kept in check.

News & Notes

Saudi Arabia asserts its intention to develop nuclear energy (likely with the help of Pakistan), if the Iranian nuclear deal goes through.

In a step to placate its creditors, Greece decides to privatize certain ports and airports in order to generate revenue with private investment.

A LOOK AHEAD: Japan releases its tertiary industrial index data and new machine orders on Sunday night. Throughout next week, meeting minutes from several countries’ central banks are expected, including the Reserve Bank of Australia (Monday), the Bank of England and the FOMC (Tuesday), and the Bank of Japan (Thursday).

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