The Big Picture - Macro Perspective on the Capital Markets, Economy, Technology, and Digital Media

Here I am in Central Park in Tokyo. The park is situated on reclaimed ground. It’s filled in harbor from what I’m told. Here is a video showing the ground cracking open, liquefaction, water gushing up through the ground. It’s really scary and crazy to witness from so close a vantage point. Thanks for watching,

Hat tip American Geophysical Union

click for larger chart

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No, we are not profitable on the bailouts. TARP has $123B to go before breakeven, and the GSEs are $133B in the hole.

All told, the Taxpayers have a long way to go before we are breakeven. That’s before we count lost income from savings, bonds, etc., the increased costs of food stuff and energy due to inflation (the Fed’s has done this on purpose as part of their rescue plan), the higher fees the reduced competition of megabanks has created, and the future costs our Moral Hazard will have wrought in increased risks and disasters.

As the nearby charts show, we are far far from breakeven:

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Sources:
Behind Administration Spin: Bailout Still $123 Billion in the Red
Paul Kiel
ProPublica, March 17, 2011, 10:27 a.m
http://www.propublica.org/article/behind-administration-spin-bailout-still-123-billion-in-the-red

The State of the Bailout
http://projects.propublica.org/bailout/main/summary

The G7 is Not Permanent Manna from Heaven!
March 18, 2011
David R. Kotok

http://www.cumber.com

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“We need to be sure to note in any comments that the G7 move was decided by the finance ministers, not the central banks. Foreign exchange intervention decisions are the responsibility of finance ministries. Central banks then carry out the intervention. The Fed actually does not hold much yen to sell. The ECB has more, and the Japanese have an unlimited amount. I expect the intervention will target the price of 80, countering speculative moves for a higher yen, and eventually fundamental forces will likely bring the yen lower.” Source: Bill Witherell, Cumberland’s Chief Global Economist, Friday morning, March 18, 2011, and following the Thursday night announcement of the G7 “secret” agreement.

I have excerpted the above from our internal Cumberland exchanges this morning. Bill summarized it well, so there is no reason for me to paraphrase it. Readers may not know that Bill Witherell spent many years at the OECD in Paris and headed the Finance Directorate there. In his previous role, he participated in many of these “secret” or closed meetings. Last night and this morning we had dialogue as we dissected the G7 action.

In this morning’s news, we have heard several erroneous statements coming from anchors who were not reading a teleprompter, or from TV guests. Let’s try to add clarity.

The Group of Seven countries are Canada, France, Germany, Italy, Japan, the United Kingdom, and the United States. They each have a national central bank and a finance ministry. In the US, we have the Federal Reserve (Bernanke) and the US Treasury (Geithner). France, Germany and Italy each have a national central bank. They are also in the Eurozone and coordinate their monetary polices at the European Central Bank (Trichet).

Central bankers usually participate in these types of discussions because they are the ones who have to execute them. In the US, the execution will be carried out at the Federal Reserve Bank of New York; it will represent the US Federal Reserve. The NY Fed does not make the intervention policy; they are the administrative arm of the US. For the US, the decision is made by the Treasury Secretary, with the approval of the President.

This intervention means selling yen in order to weaken the yen in the foreign exchange markets. In order for one of the nations involved to sell yen, they have to hold it. They hold some for commercial trade purposes and they hold some as reserves. As Bill notes, some of those holdings are relatively small. If they do not hold enough yen, they may borrow it from the Bank of Japan and then sell it. This is an indirect form of the Bank of Japan selling it themselves. The borrowed yen is likely to be paid back at a later date when the markets have calmed and are stable.

A key issue is whether the intervention will be sterilized. Sterilization means offsetting transactions. In this case, the intervention will be unsterilized, according to the Bank of Japan. That is the only way it can achieve any success.

The G7 have not said what their targets are; however, they may be easily surmised. Bill emailed me that he concurs with the analysis that was on CNBC this morning. He notes, “David Kan just gave a great analysis of the yen situation on CNBC. It may shortly be available on their web site. He argued the G7 intention is to bring the yen back to where it was before the quake and stabilize the market. Then yen is likely to ease thereafter from market forces.”

Bill Witherell is on his way to Chicago. I’m now going to the office. Next week, we can ask Bill to elaborate. All errors in this morning’s commentary are mine.

A final note: this intervention will certainly be added to the discussion in Rome at the GIC conference on April 6-7-8. Any last minute registration may be accomplished at www.interdependence.org.

David R. Kotok, Chairman and Chief Investment Officer

“In response to recent movements in the exchange rate of the yen associated with the tragic events in Japan, and at the request of the Japanese authorities, the authorities of the US, the UK, Canada, and the ECB will join with Japan, on March 18, 2011, in concerted intervention in exchange markets,” said the G7 statement. While the news has been highly effective in reversing the strength of the yen, it is just a one day act for now. With this said though, coordinated intervention has historically been much more effective than unilateral action in having a longer lasting impact. Buying the euro in Sept 2000 was the last time we’ve seen such a G7 move. Then, the euro immediately spiked, then fell to new lows one month later but has of course risen steadily ever since. An aside, China followed India’s rate hike with another rise in reserve requirements to quell inflation.

The Prime Minister of Japan recently stated that his nation was facing its worst crisis since World War II. While most of the world is focused on tragic images of floodwater and rubble, and fixated on radiation levels, there is a bigger picture to be examined – one that also includes  energy, coal and the Strait of Hormuz.

Human nature draws our focus to the present. We look for immediate repercussions to a devastating world event. But the real advantage lies in understanding the broader perspective. In order to get this deeper understanding, you could choose to spend endless hours scouring global new sources day and night, constantly questioning their legitimacy and bias. Or you could take a better approach and hire a team of geopolitical experts and uber-intelligent analysts.

I use STRATFOR, a geopolitical intelligence firm, to keep me aware of the why and what comes next of situations I know will, in some form or fashion, affect me and my investments. For those of you currently experiencing full STRATFOR access via their 3-month free trial earlier this year (exclusively for Outside the Box readers), you know what I mean. For those new to this e-newsletter or if you’ve been hesitant to take the plunge into the thought-changing world of geopolitics – these guys are hard to beat.

In today’s Outside the Box I’m including this week’s edition of their Geopolitical Weekly report, which fully explains the Japanese PM’s concerns and puts the recent major world events, from the Middle East to the Far East, in a context we all can understand. Give it a read, and if you like what you see, <<join their mailing list>> to receive free reports like this directly to your inbox every week.

John Mauldin, Editor
Outside the Box

Created Mar 15 2011 – 14:05

Related Special Topic Pages

• Japanese Earthquake: Full Coverage
• Middle East Unrest: Full Coverage

By George Friedman

Over the past week, everything seemed to converge on energy. The unrest in the Persian Gulf raised the specter of the disruption of oil supplies to the rest of the world, and an earthquake in Japan knocked out a string of nuclear reactors with potentially devastating effect. Japan depends on nuclear energy and it depends on the Persian Gulf, which is where it gets most of its oil. It was, therefore, a profoundly bad week for Japan, not only because of the extensive damage and human suffering but also because Japan was being shown that it can’t readily escape the realities of geography.

Japan is the world’s third-largest economy, a bit behind China now. It is also the third-largest industrial economy, behind only the United States and China. Japan’s problem is that its enormous industrial plant is built in a country almost totally devoid of mineral resources. It must import virtually all of the metals and energy that it uses to manufacture industrial products. It maintains stockpiles, but should those stockpiles be depleted and no new imports arrive, Japan stops being an industrial power.

The Geography of Oil

There are multiple sources for many of the metals Japan imports, so that if supplies stop flowing from one place it can get them from other places. The geography of oil is more limited. In order to access the amount of oil Japan needs, the only place to get it is the Persian Gulf. There are other places to get some of what Japan needs, but it cannot do without the Persian Gulf for its oil.

This past week, we saw that this was a potentially vulnerable source. The unrest that swept the western littoral of the Arabian Peninsula and the ongoing tension between the Saudis and Iranians, as well as the tension between Iran and the United States, raised the possibility of disruptions. The geography of the Persian Gulf is extraordinary. It is a narrow body of water opening into a narrow channel through the Strait of Hormuz. Any diminution of the flow from any source in the region, let alone the complete closure of the Strait of Hormuz, would have profound implications for the global economy.

For Japan it could mean more than higher prices. It could mean being unable to secure the amount of oil needed at any price. The movement of tankers, the limits on port facilities and long-term contracts that commit oil to other places could make it impossible for Japan to physically secure the oil it needs to run its industrial plant. On an extended basis, this would draw down reserves and constrain Japan’s economy dramatically. And, obviously, when the world’s third-largest industrial plant drastically slows, the impact on the global supply chain is both dramatic and complex.

In 1973, the Arab countries imposed an oil embargo on the world. Japan, entirely dependent on imported oil, was hit not only by high prices but also by the fact that it could not obtain enough fuel to keep going. While the embargo lasted only five months, the oil shock, as the Japanese called it, threatened Japan’s industrial capability and shocked it into remembering its vulnerability. Japan relied on the United States to guarantee its oil supplies. The realization that the United States couldn’t guarantee those supplies created a political crisis parallel to the economic one. It is one reason the Japanese are hypersensitive to events in the Persian Gulf and to the security of the supply lines running out of the region.

Regardless of other supplies, Japan will always import nearly 100 percent of its oil from other countries. If it cuts its consumption by 90 percent, it still imports nearly 100 percent of its oil. And to the extent that the Japanese economy requires oil — which it does — it is highly vulnerable to events in the Persian Gulf.

It is to mitigate the risk of oil dependency — which cannot be eliminated altogether by any means — that Japan employs two alternative fuels: It is the world’s largest importer of seaborne coal, and it has become the third-largest producer of electricity from nuclear reactors, ranking after the United States and France in total amount produced. One-third of its electricity production comes from nuclear power plants. Nuclear power was critical to both Japan’s industrial and national security strategy. It did not make Japan self-sufficient, since it needed to import coal and nuclear fuel, but access to these resources made it dependent on countries like Australia, which does not have choke points like Hormuz.

It is in this context that we need to understand the Japanese prime minister’s statement that Japan was facing its worst crisis since World War II. First, the earthquake and the resulting damage to several of Japan’s nuclear reactors created a long-term regional energy shortage in Japan that, along with the other damage caused by the earthquake, would certainly affect the economy. But the events in the Persian Gulf also raised the 1973 nightmare scenario for the Japanese. Depending how events evolved, the Japanese pipeline from the Persian Gulf could be threatened in a way that it had not been since 1973. Combined with the failure of several nuclear reactors, the Japanese economy is at risk.

The comparison with World War II was apt since it also began, in a way, with an energy crisis. The Japanese had invaded China, and after the fall of the Netherlands (which controlled today’s Indonesia) and France (which controlled Indochina), Japan was concerned about agreements with France and the Netherlands continuing to be honored. Indochina supplied Japan with tin and rubber, among other raw materials. The Netherlands East Indies supplied oil. When the Japanese invaded Indochina, the United States both cut off oil shipments from the United States and started buying up oil from the Netherlands East Indies to keep Japan from getting it. The Japanese were faced with the collapse of their economy or war with the United States. They chose Pearl Harbor.

Today’s situation is in no way comparable to what happened in 1941 except for the core geopolitical reality. Japan is dependent on imports of raw materials and particularly oil. Anything that interferes with the flow of oil creates a crisis in Japan. Anything that risks a cutoff makes Japan uneasy. Add an earthquake destroying part of its energy-producing plant and you force Japan into a profound internal crisis. However, it is essential to understand what energy has meant to Japan historically — miscalculation about it led to national disaster and access to it remains Japan’s psychological as well as physical pivot.

Japan’s Nuclear Safety Net

Japan is still struggling with the consequences of its economic meltdown in the early 1990s. Rapid growth with low rates of return on capital created a massive financial crisis. Rather than allow a recession to force a wave of bankruptcies and unemployment, the Japanese sought to maintain their tradition of lifetime employment. To do that Japan had to keep interest rates extremely low and accept little or no economic growth. It achieved its goal, relatively low unemployment, but at the cost of a large debt burden and a long-term sluggish economy.

The Japanese were beginning to struggle with the question of what would come after a generation of economic stagnation and full employment. They had clearly not yet defined a path, although there was some recognition that a generation’s economic reality could not sustain itself. The changes that Japan would face were going to be wrenching, and even under the best of circumstances, they would be politically difficult to manage. Suddenly, Japan is not facing the best of circumstances.

It is not yet clear how devastating the nuclear-reactor damage will prove to be, but the situation appears to be worsening. What is clear is that the potential crisis in the Persian Gulf, the loss of nuclear reactors and the rising radiation levels will undermine the confidence of the Japanese. Beyond the human toll, these reactors were Japan’s hedge against an unpredictable world. They gave it control of a substantial amount of its energy production. Even if the Japanese still had to import coal and oil, there at least a part of their energy structure was largely under their own control and secure. Japan’s nuclear power sector seemed invulnerable, which no other part of its energy infrastructure was. For Japan, a country that went to war with the United States over energy in 1941 and was devastated as a result, this was no small thing. Japan had a safety net.

The safety net was psychological as much as anything. The destruction of a series of nuclear reactors not only creates energy shortages and fear of radiation; it also drives home the profound and very real vulnerability underlying all of Japan’s success. Japan does not control the source of its oil, it does not control the sea lanes over which coal and other minerals travel, and it cannot be certain that its nuclear reactors will not suddenly be destroyed. To the extent that economics and politics are psychological, this is a huge blow. Japan lives in constant danger, both from nature and from geopolitics. What the earthquake drove home was just how profound and how dangerous Japan’s world is. It is difficult to imagine another industrial economy as inherently insecure as Japan’s. The earthquake will impose many economic constraints on Japan that will significantly complicate its emergence from its post-boom economy, but one important question is the impact on the political system. Since World War II, Japan has coped with its vulnerability by avoiding international entanglements and relying on its relationship with the United States. It sometimes wondered whether the United States, with its sometimes-unpredictable military operations, was more of a danger than a guarantor, but its policy remained intact.

It is not the loss of the reactors that will shake Japan the most but the loss of the certainty that the reactors were their path to some degree of safety, along with the added burden on the economy. The question is how the political system will respond. In dealing with the Persian Gulf, will Japan continue to follow the American lead or will it decide to take a greater degree of control and follow its own path? The likelihood is that a shaken self-confidence will make Japan more cautious and even more vulnerable. But it is interesting to look at Japanese history and realize that sometimes, and not always predictably, Japan takes insecurity as a goad to self-assertion.

This was no ordinary earthquake in magnitude or in the potential impact on Japan’s view of the world. The earthquake shook a lot of pieces loose, not the least of which were in the Japanese psyche. Japan has tried to convince itself that it had provided a measure of security with nuclear plants and an alliance with the United States. Given the earthquake and situation in the Persian Gulf, recalculation is in order. But Japan is a country that has avoided recalculation for a long time. The question now is whether the extraordinary vulnerability exposed by the quake will be powerful enough to shake Japan into recalculating its long-standing political system.

Insight on whether the worst is over for investors, with Jim Iuorio, Director, TJM Institutional Services; Barry Ritholtz, Fusion IQ and Mario Gabelli, GAMCO Investors, Inc.

Airtime: Thurs. Mar. 17 2011 | 7:00 PM ET

You are a probability machine, a statistician, a mathematical wizard.

You may not be aware of this simple fact, but its true: Every day, you engage in a series of probabilistic decision-making. You choose based on the probabilities of various outcomes taking place. This occurs whether you are changing lanes on the highway or deciding what food to eat.

Consider some decisions many of you are likely to make over the next 24 hours:

• You will get in a car, and most of you will wear a seat belt (25% will not);

• For breakfast, some of you will have fruit and yogurt (or eggs and bacon);

• Lottery tickets will be purchased

• 2 million people will get on 87,000 flights on commercial airlines

• Money will be saved for retirement

• Homeowners will continue to have fire insurance.

• Casinos in Las Vegas, Monte Carlo and Macau will be visited by 100,000 people

• Several billion equity shares will be traded on the NYSE

Every one of the above actions are based on a probability analysis of a possible, probable and unlikely events occurring, and the resulting outcomes over time. We consider the facts we have, the things we do not know, and what information we might come to learn that applies to our next decision.

Us Humans have some problems with many of these elements. We tend to think we know much more than we actually do; we ignore the things we do not know or may not even be aware of; and when it comes to time, we over-emphasis immediate consequences and greatly discount future possibilities.

Consider the following:

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When we see people debating decision-making, be it government policy or investments or what have you, it is often a probabilistic exercise. These disagreements are often actually a discussion as to which box to place the issue — what are the odds of occurrence? How negative are the consequences?

Now consider some of the flawed judgment calls we, as a species, makes. Our assessment of reality is at best, flawed, so we know less about the facts going into these probabilistic decisions than is ideal. We tend to be comfortable with high probablity, modest outcomes. We have trouble conceptualizing longer term outcomes. We have difficulty with low probability, catastrophic outcomes.

What statistical bets are you making today?

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* I am not sure about Universal Entropy, but I thought it was a good factor to stimulate thought.

A couple of revealing charts from the Fed’s Flow of Funds data.   Both show net flows into Treasuries by creditor type and the Federal Government’s borrowing during each quarter.   Note, the quarterly data is annualized.

Interesting slide show on social media . . .

So on a lark today, I grabbed a new URL: IHateCornEthanol.com

I was thinking that with all this newfound talk about fiscal responsibility, perhaps it might be time to put an end to one of the dumbest Energy/Ag subsidies in the history of the US: Burning food (corn) for fuel.

I do not have any issue with alt.fuels — but they have to make sense. Ethanol does not.

I am thinking of some interesting ideas to use this with in the coming 2012 Electoral season:

• Get candidates to sign a pledge to do away with Corn Ethanol Subsidies

• Clearing house for all corn ethanol related research, news, data.

• Community / Message board for ethanol related haters

Any ideas? What should be done of value with this web site?

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PS: I have the domain set to auto-forward to the energy category of TBP (Try it: IHateCornEthanol.com)