Winter (Economic and Market) Watch

Any good armchair general with a good search engine and time on their hands can figure out in a hurry that the song and dance about Iran being unable to close the Strait if Hormuz for long  is just a plain crock. Worse than a crock. Yet, this big Orwellian lie persists, so once again I have to set the record straight. Iran has the capability of not only closing the Strait for some time, but creating a world of hurt for the U.S. Navy’s 5th Fleet.

Iran possesses a build up of anti-ship weapons called Sunburn missiles, which it has procured from Russia and China over the last decade. These are top-notch weapons developed by the Russians as a low-cost challenge to the expensive, tech-heavy weaponry of the U.S., and specifically the aircraft carrier task force.  A conflict, which I now assign a high probability to [see Scenario for an Israel Attack on Iran], is going to be a huge test of a global-naval doctrine that Russia and China will watch with tremendous interest. That’s why I think they have armed Iran to the teeth. The big question: How many of these weapons does Iran have? I would suggest thousands, and that this is the real show.

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There has been much ado about the US employment numbers both from surveys and the BLS.  Most of this centers around bogus numbers from the BLS, but I prefer to jump to the quick, and look at withholding taxes. Really what difference does it make if there are few hundred thousand new jobs if they are part time, pay low wages, and have no benefits.

The bottom line comes from stepping back and looking through the lens of the last four months, using the government fiscal year to date (October to now) , which incorporates XMAS hiring.  Lee Adler noted a surge in January which is now fading.  In using this data in the past, anytime you get something spiky it will usually have to do with YoY timing or an outlier.  Charles Biderman at Trim Tabs sees nothing here. The four month wages withheld data shows very little improvement either, which to me casts serious doubt at least on the quality of any job improvement.

Per the Daily Treasury Statement, so far in the current fiscal year total withholding is 618.5 bn vs 616.7 bn YoY, hardly an employment boom. Corporate taxes collected are 74.5 bn vs 68.9 bn.  If you are wondering how corporations do so well, their tax  level is scrapping along the lowest to GDP in forty years. It seems that an” unexpected” $100 billion hole has appeared in corporate tax revenues caused by the aforementioned bonus equipment depreciation. [NYT]   If we have such a great economy wouldn’t be nice if taxes picked up a few degrees?  Instead total taxes collected fiscal year to date is 726.6 bn vs 715.0 bn YoY, about a 1 1/2% increase. Still the CBO is still looking for a 14.7% increase in revenue, due any time from outer space apparently. Unless the payroll tax cut is dropped, at this run rate federal tax revenue is going to fall far short of the lofty projection for FY 2012.

“Unity is the cure to lots of ailments in our country.” -Iran’s Supreme Leader Ali Khamenei

The threat of U.S. military presence and western economic sanctions in itself seems unable to detour Iran from wrapping up its nuclear program. In fact they seem only to raise Iran’s ire even more. Therefore, I see U.S. moves as nothing more than running down the clock on non-military tactics. Meanwhile, this weekend Iran is starting new military exercises on the ground. What’s interesting about this exercise is that it involves Revolutionary Guards and not Iran’s navy. This suggests to me that Iran will employ asymmetric and non-conventional tactics to close the Strait of Hormuz.

Iranian (and American) politics are also playing a role. In a stacked election coming on March 2, the new Iranian parliament (the Majles) will be made official. With  its arrival, all remaining vintages of  a moderate faction will be swept out. This is a power consolidation by religious Supreme Leader Ali Khamenei to eliminate all opposition from Ahmadinejad, as well as any surviving moderates. In some respects, Khamenei makes Ahmadinejad seem a bit tame. He is convinced that the West’s political-economic system is decayed and is ripe for a fall, and he seems more than willing to put his theory to the test. He compares the West today to the crumbling Soviet Union of the late 1980s, which was “swept  away” because it had “no logic.”  ["Khamenei Won't Retreat"]

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“In economics, things take longer to happen than you think they will, and then they happen faster than you thought they could.” – Rudiger Dornbusch

Ben Bernanke made some surprisingly frank confessions in his House testimony about Fed portfolio risk. When asked what the effects of a mortgage refi program would be on his trillion mortgage portfolio, Ben responded that the Fed would suffer losses. He then said he couldn’t really quantify how much. In another sly legend in his own mind statement Ben warned that if “investors lost confidence” in US fiscal policy (but certainly not his policy), there would be nothing the Fed could do about arresting higher rates. He should have added that marked to market and given the duration of its holdings, that the Fed will lose $2 billion on every basis point increase in rates.  That’s $200 billion for a modest one percent uptick in rates.

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In November, Gretchen Morgenson of the New York Times wrote a story describing the “voluntary” debt restructuring process that may give clues as to why the latest Greek “deal” can’t seem to be concluded. Once again, a rumor surfaced Wednesday (apparently out of France) that a deal was “hours away.” Sure enough, back when the Morgenson piece came out, the counterattack to it began and the point she put forth faded. Felix Salmon wrote a rebuttal to her tract with the nifty title “CDS conspircy theory de jour.” I found Salmon’s logic circular and painful to read, but decide for yourself. He even claimed Greek CDS issuance is “minuscule” and writes, “I can’t think of any bank who has ever amassed a big position on Greek CDS,” as if he were privy.

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When you hear talk about expanding the European LTRO funding, is is important to go straight to the mechanics of the exercise, and then ask what does the new round of exposure mean to the ECB. The LTRO is a repo transaction where the ECB takes in collateral in order to back any loans. The ECB will swap cash in exchange for questionable assets so that insolvent banks can replace funding caused by defacto bank runs. If they choose they can then double down on sovereign bets, or pay off creditors. Italian banks in particular are so exposed to their own sovereign debt that they may have decided to gamble away, figuring they are dead anyway. Might as well take the ECB with them. But we need to constantly ask ourselves what is the risk to the ECB itself, and by extension Germany, France, Italy and Spain, who are the principal sponsors of the ECB. What happens when the banks evaporate in the next debt hiccup and the ECB needs to seize the collateral.

This article at FT Alphaville by Joseph Cotterill provides the gory details. It appears the LTRO has mostly been about a cozy arrangement with French banks, and to a lesser extent Italian banks. The ECB quietly expanded the list of collateral it would accept by more than a third at the start of the year. Almost all the 10,599 debt instruments it added were from banks – and more than 8,000 of them from French banks. The ECB is going about accepting unlisted bank bonds — i.e., bonds that the banks could have issued purely to themselves solely in order to pledge them as collateral for central bank funding. They carry no prospectus, etc. If the ECB we-take-no-losses-in-defaults model holds true, then other bank bondholders will be further subordinated down the capital structure.

Wonderful, the ECB can secure its lending to these already hyper-leveraged exposed banks, with flaky bonds issued by the same cast of characters. How is that going to work in a pinch?  Oh we already are in a pinch. It is obvious that Europe is now “all in” and fully prepared to go down with their bankster cronies.

I follow up at Actionable with a discussion on the impact of the approaching French elections. Click here to subscribe.