Illiquidity Crisis
Near on three weeks ago the first we witnessed the first major Central Bank policy “pivot” from the Bank of England as it changed its fiscal rhetoric from tightening to “accommodative”, within 24 hours as UK Pension Funds started panic selling Bonds to meet Margin Calls (very 2007).
Global Markets were in freefall and desperately needed some words of “encouragement”. Enter the Grand Poo Bah of Central Banks, the US Fed.
A US Fed announcement centred around the use of USD Swap Lines, and the reassurance that someone can and will print as much as is needed to avoid systemic collapse. Yep, same as it was in 2008 right up to today.
So, how and when do the said swap lines come into action? The first was on October 5th, when the Fed quietly shuffled $3.1 billion to the Swiss National Bank, to cover an emergency dollar shortfall.
We wondered at the time how long it would be before the next and the next. Didn’t have to wait long as the Fed announced last Thursday that it doubled the size of its USD swap to the Swiss National Bank, sending some $6.27 BILLION to avoid an emergency funding crunch. Presenting, the largest swap transfer in history.
The question then arises, why does Switzerland or a Swiss financial institution need $6.3B in overnight funding for the second week running?
Credit Suisse?… was the word on the street or could even be the Swiss NB itself given it’s well known to have been acting as an unhinged hedge fund in the hunt for returns in an era of negative interest rates.
There are some very nervous Central Bankers across the globe at the moment. The EU and Japan remain as “accommodative” as they’ve been (hence the crushing of their currencies v USD or Gold) yet markets are extremely stressed out.
Backing back up to a few weeks ago we thought there could be no bigger news than “someone” blowing up two of the most strategically important energy arteries in the world!! More on that later.
But no, from a financial perspective, the UK preventing a “Lehman moment” in its Pension system was the one for us. Remember the good old Margin Call?
Why were “safe as houses” UK Pension funds panic selling Bonds to meet Margin Calls anyway? Rhetorical question, as we all know we’ve had no reform of the financial system since 2008, when the opportunity presented itself to de leverage and flush some leveraged turd down the drain.
Didn’t happen and now, after 14 years of kicking the can down the road we’re back to this, margin calls on derivative products. Derivatives designed to “mitigate” risk, ironically moronic.
As an investor, we hope you remember the importance of collateral, or more specifically, what happens when one lacks collateral and still participates in the absolute leverage that the derivative complex overlays on the entire system.
It’s appreciated that many readers may have tuned out by now due to other pressing matters, Santa is coming, holiday planning in full swing, she’ll be right, we’ll worry about it when we have to, which will be too late.
For those still interested in how things got to this point let’s start with a step back to 1998, when the Crimton Administration and its main economic advisers, “fat” Larry Summers and Robert Rubin (still considered reliable economic advisers) recommended the Prez “deregulate” the banking system, at the behest of the banking system.
The result? Banks were able to “create” financial product upon financial product, then “sell protection” on the newly created financial product in the form of derivative contracts, creating a labyrinth of additional leverage that the smartest guys in any room will tell you, “there are no risks as it all nets out”. The ol VaR model.
Yes, that statement of it all netting out maybe true, until the first counterparty can’t pay. To help you appreciate the size of the issue, you might find this 2020 chart from the Visual Capitalist of use.
Investors now need to understand, the bubble in everything has burst, inflation is a rampant permanent feature and Central Banks have no intention of reforming any part of the system voluntarily so they will persist with the same policies that got us here, until…….
It’s also important to remember that the bursting of a bubble takes a long time to play out. It may feel fast and chaotic at various points in the process, but it isn’t really. Look at 2007/08. Everyone thinks of Lehman’s Bankruptcy on September 15, 2008, as the big catalyst for that crisis, but the S&P 500 had peaked the previous November, “Sub Prime” kicked off March 2007. Bear Sterns failed on March 13th, 2008. From the Friday before Lehman’s bankruptcy to the end of that month, the S&P was only down 7%. The real weakness was in October!
The final bottom wasn’t until March of the next year. The bubble was bursting way before Lehman Brothers. That was just the large cathartic event that caught our attention, ignited our imagination, even after that it took months for the market to bottom. Markets don’t clear imbalances instantaneously. Preparing accordingly.
If one contemplates what might be the policy response to all this, even in the face of serious inflation issues, you can be sure Government/Central Banks will double down and go harder on the printing press, there is no other play.
For investors, know what you own and take advantage of the fire sale in precious metals, they might come in handy!!
As will investment in the most stable businesses you can find, AT THE RIGHT PRICES, of course. Luck will favour the prepared.
We don’t yet think stock markets have bottomed or even properly considered earnings damage caused by higher interest rates, higher labour costs and higher input costs.
As it was in 2008, before markets bottom out, we will see something/somebody BIG go out of business amidst revelations of massive fraud, badly shaking confidence along the way.
Our guess is……Softbank, given Credit Suisse (and others) have already been bailed out.
Anyways, how’s that 60:40 balanced portfolio working out?
It’s hard to imagine there is an equally important (connected) systemic issue to go with the ones above but there is.
The Energy Shock
One forgets that for many years post WW2 the US had the best balance sheet of all (most gold, little debt) and an abundance of cheap energy. Think about what happens if these two items matter as they used to.
World Economic Forum types care little for these matters as they continue to fly privately across the globe, using any and all opportunities to virtue signal their commitment to “the climate emergency”, without any viable plan to replace fossil fuel generation in the short term.
The aim to choke off (all investment into) fossil fuels before having a viable alternative has always seemed ludicrous.
Do not forget that climate change/ESG policies had “The West”, particularly Europe, headed for massive Energy shortages way before “Putin” and Ukraine.
The HUGE issue now is that the Energy Crisis and Geopolitical tensions continue to rachet up dangerously, with no greater example being the “sabotage” of the two Nord Stream pipelines connecting Germany/Europe to Russia, guaranteeing a humanitarian energy crisis in parts of Europe.
There is no point going through a “whodunnit” with this one. People seem to be on one side or the other, without any ability to discuss.
And NO, Europe does not have the domestic storage to deal with no Russian gas.
Here’s how The Wall Street Journal Reported the “leak”.
“The incidents have no impact on Europe’s gas supply because both links aren’t currently in use. Germany halted the Nord Stream 2 pipeline in February over Russia’s aggression in Ukraine, while Moscow this month indefinitely stopped flows via Nord Stream. Experts, however, said the gas leaks could damage the climate.”
Meanwhile, the Biden administration thought it could recoup its own depleting Strategic Oil Reserves (released for political reasons to manage prices before mid term elections) with cheap Saudi Oil.
Biden went to Saudi Arabia for a fist pump only to be fisted at the pump. The Saudi’s refused to increase production as asked and, in the end, CUT production, as announced last week.
This was a huge statement. A tick of support to Russia. The US and USD global position is now deteriorating as fast as its balance sheet.
Furthermore, to add to US woes, where and in what currency do you think Russia has been selling all its energy?
- India
- China
- Europe (via middle east)
- South East Asia
- All of the above, in many cases in local currency or Rubbles, as is their right.
One thing is for sure. Energy seems more valuable than the USD, don’t forget that.
With that in mind, we’ve said for some time that commodities are the new currency. Don’t forget that either, it may help investors with asset allocation.
This time we really mean it, Peace.
