Zero In

Let's zero-in on some recent market news and data.

The International Monetary Fund (IMF) Financial Stability Report, published during the first half of October, flagged up losses to the tune of 3.8 trillion US dollars to global bond portfolios.

This is a staggering loss in a relatively risk free asset class and it's no storm in a teacup. A loss of such magnitude has the makings of a credit squeeze that could dwarf the last 2008 financial crisis.

To realize the impact that these losses could have on the money supply and in turn the economy, we need to understand the role that collateral and leveraging plays in a modern economy. Collateral as we know, from my previous article, entitled Great Depression II, refers to property or other assets that a borrower offers typically to a bank to secure a loan. If the borrower stops making the promised loan payments, the lender can seize the collateral to recoup its losses. This is known as secured lending. where the borrower pays less interest because they are pledging collateral against the debt.

When you take out a bank loan for a car or a home the bank wants something pledged as collateral, in the event that, for whatever reason you fail to pay the money back.

Collateral for the bank then is like an insurance policy, should the deal not workout and the loan goes bad the bank can grab the asset pledged against the loan.

But Collateral can also be an intangible asset. Financial firm at the top of the corporate food chain pledge corporate bonds, government bonds, also known as sovereign-debt, as collateral to raise finance. They then leverage their investments, sometimes investments are levered 10:1. So for example, a 10 million dollar investment might be made with a 1 million dollar loan pledging 1 million dollars of bonds as collateral. But what happens when the collateral, in this case bonds, which is perceived as a relatively safe asset class becomes worthless, the lender then demands more collateral as security, or increases the interest payments on the loan. When the borrower can't make the higher interest payment we have a default, which then has a knock on effect. Play this scenario out multiple times and throw leveraging into the equation and we end up with a mega problem.

Moreover, the availability of high grade debt such as US, UK, Japanese and German sovereign debt, has been soaked up from the system due to the quantitative easing policies carried out by the central banks. In other words, approximately 10 trillion USD worth of high grade collateral has been withdrawn from the system. So with no collateral there's no trust and no lending and in this scenario the money supply sinks resulting in a credit squeeze. The IMF report of 3.8 trillion US dollars losses to global bond portfolios confirms that this scenario is regretfully now at play.

Meanwhile, the euro zone is in a free fall. Germany was hit with another piece of bad economic data with exports tumbling 5.8 percent in August. Deflation in Greece is deepening. The Greek consumer prices index fell to -0.8% in September, showing that deflation accelerated after August’s -0.3%.

The decline was even sharper, -1.1%, when measured on an EU-harmonised basis.

This means that prices have now fallen for the last 19 months in a row, as wages and pensions have shrunk amid its austerity programme. Greece’s unemployment rate has fallen, but still remains extremely high. The jobless rate dipped to 26.4% in July, down from 26.7% in June. The jobless rate for those between 15 and 24 was 50.7%, down from 58.2% a year ago.

Auditors representing the country’s “troika” of creditors have abruptly ended their latest inspection tour. Basically, the auditors regard the Greek government figures as overly optimistic and it was deemed “more diplomatic” if the negotiators disappeared. Obviously, there are major disagreements going on there.

France has revised down its growth forecasts and says it will miss its deficit target for another three years. Finance Minister Michel Sapin said Wednesday that the budget deficit would be around 4.3 percent of GDP in 2015 and would not dip under the 3 percent dept to GDP ratio target for European Union countries until 2017. That is causing a rift in Brussels, particularly with Germany who is pushing for a 3 percent target for European Union countries.

Italy is also unlikely to meet the EU deficit targets. Protests in Naples have broken out with thousands of demonstrators marching as the European Central Bank holds its monthly monetary policy meeting. Police used tear gas to contain the protests.

Over to the US, the view now is that this economic miracle is being pumped up with fake debt money creation and hidden behind data manipulation just to get through the mid term elections, but it cannot last. Some of the nation's biggest money managers are now openly expressing the same doubts. Mark Grant, Managing Director of Southwest Securities; was recently interviewed on Bloomberg radio an when asked whether the US economy is looking healthy he said; “I am sorry to say this about America, but the numbers that are being put out right now-it is difficult to place much faith in them. Almost 35 percent of workforce is on welfare so the data is being skewed by Gov and I don't have a lot of faith in it.”

The number of Americans on food stamps has topped 46,000,000 for 35 straight months, according to data from the Department of Agriculture (USDA), which amounts to approximately the population of Spain.