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'Event' Risk - Geo-Political or Natural Disaster All Artificial Economies are Exposed to sudden Event Risks

GLOBAL MACRO TIPPING POINTS - APRIL 2011 3/19/2011

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'Event' Risk - Geo-Political or Natural Disaster All Artificial Economies are Exposed to sudden Event Risks

GLOBAL MACRO TIPPING POINTS - APRIL 2011

TIPPING POINTS ........................................................................................................................................................................................ 4

WE ARE HERE ................................................................................................................................................................................................. 4 SHIFTING TIPPING POINTS - CHANGES TO WATCH .................................................................................................................................... 5 RISK LEVELS ................................................................................................................................................................................................... 9 IN FOCUS - APRIL 2011 ................................................................................................................................................................................. 11

I - NATURAL DISASTER ...................................................................................................................................................................................................... 11 II - GEO-POLITICAL EVENT ................................................................................................................................................................................................ 11 III - SOCIAL UNREST ........................................................................................................................................................................................................... 11 IV - FOOD PRICE PRESSURES ......................................................................................................................................................................................... 12 V - OIL PRICE PRESSURES ............................................................................................................................................................................................... 13 VI - INFLATION & INTEREST PRESSURES ..................................................................................................................................................................... 13 OTHER HIGHTLIGHTS ........................................................................................................................................................................................................ 14

XVIII - Bond Bubble: Who Will Buy US Bonds? .......................................................................................................................................................... 14 XIX - Pension - Entitlement Crisis: Collapsing Western Social Net .......................................................................................................................... 14

GLOBAL MACRO......................................................................................................................................................................................15

JAPAN .............................................................................................................................................................................................................. 18 GLOBAL IMPLICATIONS: EARTHQUAKE, TSUNAMI & NUCLEAR CRISIS ............................................................................................................... 18 YEN INTERVENTION: GLOBAL G7 COORDINATION .................................................................................................................................................... 19

NORTH AFRICA & MIDDLE EAST ............................................................................................................................................................... 20 NORTH AFRICA:TUNISIA, EGYPT & LIBYA ..................................................................................................................................................................... 20 MIDDLE EAST: BAHRAIN, YEMEN & SAUDI ARABIA .................................................................................................................................................... 20

EU SOVEREIGN DEBT ................................................................................................................................................................................. 21 AGREEMENT ......................................................................................................................................................................................................................... 21 RISK ........................................................................................................................................................................................................................................ 23 PIIGS ....................................................................................................................................................................................................................................... 25

VIII - Sovereign Debt - Unaffordable PIIGS Bond Yields .......................................................................................................................................... 25

GLOBAL IMBALANCES ................................................................................................................................................................................ 30 VII JAPANESE DEBT CONCERNS .................................................................................................................................................................................... 31

BEGGAR-THY-NEIGHBOR .......................................................................................................................................................................... 34

US ECONOMY ...........................................................................................................................................................................................35

KEY MONTHLY ECONOMIC INDICATORS – HAVE A CLOSER LOOK AT WHAT THE MAINLINE MEDIA DOESN’T DISCUSS. ...................... 36 2011 US ECONOMIC IMPEDIMENTS ......................................................................................................................................................... 37 OBAMA'S 2012 BUDGET - CBO'S ASSESSMENT .................................................................................................................................... 38

XVII - PUBLIC POLICY MISCUES ...................................................................................................................................................................................... 40 USA INC. ................................................................................................................................................................................................................................ 40

KEEP YOUR EYE ON THE REAL ESTATE 'DOUBLE DIP' ...................................................................................................................... 43 XIV - RESIDENTIAL REAL ESTATE ................................................................................................................................................................................... 43 XV - COMMERCIAL REAL ESTATE ................................................................................................................................................................................... 47

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MONTHLY PROCESS OF ABSTRACTION

The Global Macro Tipping Points Service is part of the Process of Abstraction which we conduct monthly.

Focus Coverage

Global Macro Tipping Points Tipping Points Tipping Points

Abstraction Global Macro

US Economy

Market Analytics and Technical Analysis Market Analytics Technical Analysis

Fundamental Analysis

Risk Analysis

Monthly Market Commentary Synthesis Commentary

Thesis Conclusions

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TIPPING POINTS

WE ARE HERE

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SHIFTING TIPPING POINTS - Changes to Watch

INCREASES CURRENT Q4 '10 CHANGE

Natural Physical Disaster 1 31 +30

Geo-Political Event 2 37 +34

Social Unrest 3 36 +35

Food Price Pressures 4 15 +11

Oil Price Pressures 5 30 +25

Rising Inflation & Interest Pressures

6 14 +8

MAJOR DECREASES

North & South Korea 35 12 -23

Bond Bubble 18 3 -15

Central & eastern Europe 21 8 -13

We need to carefully watch:

1) The increasing & broadening potential for Global Contagion out of: - Japan: Yen Carry Trade Unwind & FX fallout, - North Africa: A Libyan Civil war and Un Military involvement , - Middle East: Escalating pressures on oil prices due to broadening social unrest. - EU PIIGS: Sovereign debt crisis and EU Banking problems 2) How and if global Central Banks actually do unwind their crisis ‗triage‘ programs or are they permanent? Specifically, what will the US Federal Reserve signal in April and May about

the expiration of Quantitative Easing (QE) II. It was originally planned to expire in June 2011. 3) What G7 Government public policy initiatives will be concerning: - Weakening economic conditions - Chronic unemployment levels.

These events will allow us to determine if our roadmap is still valid or if we are going to see an acceleration in weakening global financial conditions.

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Social Unrest Our 2011 Thesis analysis signaled that we needed to be watching for a major shift towards Conflict and Tension in 2011. This prediction has arrived with an unexpected jolt in Q1 2011, even to us! Social Unrest and Geo-Political Tensions seem to have broken out globally in a wide spread fashion. It is our opinion that the drivers behind these tensions are rising food, energy and cost of living prices that coupled with extreme levels of unemployment is heralding this unprecedented levels of global unrest.

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NOW Q4

2010

Diff.

NATURAL PHYSICAL DISASTER Presently: Gulf Oil Spill Economic fallout and

possible hurricane impact

1 31 +30

GEO-POLITICAL EVENT A sovereign country overthrow, rebellion or

insurrection

2 37 +35

SOCIAL UNREST Public rallies, protests and rioting against the

government.

3 36 +33

FOOD PRICE PRESSURES Production shortages, distribution break-

downs with growing Asian demand

4 15 +11

OIL PRICE PRESSURES Shortages, Peak Oil & Asian Growth demand. 5 30 +25

RISING INFLATION PRESSURES &

INTEREST RATES

Reversal in Interest rate and impact on

government financing budgets

6 14 +8

JAPAN DEBT DEFLATION SPIRAL Ability for Japan to continue to fund national

debt with shifting demographic patterns.

7 18 +11

SOVEREIGN DEBT - PIIGS Insolvency and Inability to stimulate

economies

8 1 -7

EU BANKING CRISIS Bank Ratios of 50:1 and toxic debt on and off

the balance sheet

9 2 -7

RISK REVERSAL Historic level of financial market participation

and dependency (i.e. pension entitlements)

10 5 -5

US STATE & LOCAL GOVERNMENT Unprecedented budget shortfalls & funding

problems

11 4 -7

CHRONIC UNEMPLOYMENT Historic Unemployment rates in G7 12 9 -3

CHINA BUBBLE Real Estate & speculative bubbles 13 22 +9

RESIDENTIAL REAL ESTATE –

PHASE II

Shadow Inventory, Strategic Defaults,

Looming Option ARMS ‗python‘, LTV levels.

14 6 -8

COMMERCIAL REAL ESTATE Market Values are down 45 - 55% with little

write downs as of yet being taken by banks,

insurance or financial holders.

15 7 -8

US BANKING CRISIS II Deferred accounted write-downs for Real

Estate, Commercial Real Estate & HELOCS

16 10 -6

PUBLIC POLICY MISCUES Impact of Obamacare, Dodd-Frank Bill and

others in reaction to present environment.

17 13 -4

BOND BUBBLE Historically high Bond Prices 18 3 -15

PENSION – ENTITLEMENT CRISIS Unfunded Pension Liabilities - > $100T in US 19 11 -8

US DOLLAR WEAKNESS Domestic Inflationary Pressures 20 28 +8

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CENTRAL & EASTERN EUROPE The Sub Price of Europe – Level of borrowing

in non sovereign currency (EU loans)

21 8 -13

US FISCAL, TRADE AND ACCOUNT

IMBALANCES

Inability of the US to finance imbalances 22 21 -1

CREDIT CONTRACTION II Bankruptcy & Mal-Investment Catalyst 23 18 -5

FINANCE & INSUR. BALANCE SHEET

WRITE-OFFS

Accounting for Commercial Real Estate

market values, loan loss reserves

24 17 -7

US STOCK MARKET VALUATIONS Over-Valuation and unrealistic earnings

estimates.

25 16 -9

GOVERNMENT BACKSTOP

INSURANCE

Fannie, Freddie, Ginnie, FHA, FDIC, Pension

Guarantee backstop funding.

26 23 -3

SHRINKING REVENUE GROWTH

RATE

Slowing Corporate Top-Line revenue growth

rates

27 27

GLOBAL OUTPUT GAP Global Overcapacity & Underutilization 28 29 +1

US RESERVE CURRENCY Emergence of alternative solutions such as

SDRs. Inflationary repatriation impact

29 20 -9

PUBLIC SENTIMENT & CONFIDENCE Growing social unrest and public rage 30 26 -4

SLOWING RETAIL & CONSUMER

SALES

Impact of slowing consumer sales and

increasing savings rate on 70% consumption

US Economy

31 25 -6

CORPORATE BANKRUPTCIES Reverse Gearing & margin pressures 32 24 -8

TERRORIST EVENT Unknown black swan 33 35 +2

FINANCIAL CRISIS PROGRAMS

EXPIRATION

Withdrawal of Financial Crisis Triage

Programs and interest rate normalization

34 24 -10

NORTH & SOUTH KOREA Geo-Political tensions - Escalating 35 12 -23

IRAN NUCLEAR THREAT Israeli attack on Iran - Middle East escalation 36 33 -3

PANDEMIC /EPIDEMIC Unknown black swan 37 32 -5

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RISK LEVELS

Credit Metrics

On the surface there would appear to presently be no major worries in the credit markets. The Libor-OIS spread and the TED spread are at acceptable lower levels. The EUR 2 Year Currency Swap does however show an increasingly elevated level.

Divergence

One of the things to watch for in the markets is divergence. Divergence are one of the best warnings that something is wrong somewhere. It often tells you that there are unbalanced forces at play in the market. These forces will resolve themselves but often do this via gradual reversal in trend or a sudden surprise shock to the markets. The ECRI Weekly Leading Index is presently showing a divergence with the S&P 500 Index.

While the S&P 500 is setting a higher high, the ECRI on a longer term weekly basis is setting lower highs. This suggests that the stock market may be pricing in more economic good news than it should. Corporate Earnings are at historically very high levels and have expanded rapidly. CAPE (Cyclically Adjusted PE) are also at extremes.

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Money Supply Growth - M3

Though the government no longer releases the M3 money supply statistics, they are put together by such organizations as ShadowStats.com. Despite the massive efforts by the US Federal Reserve the overall money supply as represented by this broadest measure of money and credit continues to contract.

What has become even more worrying is that M3 is now beginning to show signs of rolling over.

Bank Liabilities

The Shadow Banking System as the

prime pusher of toxic debt

instruments collapsed in the 2008

financial crisis and so far it simply

has not re-emerged in some sort of

hybrid fashion. The Federal Reserve

desperately needs this to happen and

this has been another reason for the

Fed's "Extend & Pretend" policy.

To the right is the latest figures from

the Federal Reserve's Flow of Funds

report for Q4 2010. The report was

startling since Q3 2010 was even

worse than thought after final

adjustments were made.

We had aQ4 2010 decline of $206.4

Billion in Shadow Banking liabilities

with $440 Billion in combined

Shadow and Conventional Banking

System Liabilities.

This almost guarantees that the

Federal Reserve must continue QEX.

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IN FOCUS - April 2011

I - NATURAL DISASTER

First an Earthquake, then a Tsunami and then a full scale Nuclear Disaster! This is as big a natural disaster as we have had in the last 50 years! With the Japanese Carry Trade having been one of the largest sources of hot money for over a decade and a half, this carry trade it is now exposed to massive repatriation to stop the losses from a possible rising yen. The bigger crisis may not be natural but rather financial. It cannot be understated how serious this could be to global markets unless the rise in the Yen is quickly stabilized. Though G7 intervention has already been initiated to address this it is going to face major head winds as money is increasingly brought home from foreign holdings to fund the rebuilding and reconstruction efforts required after the devastation.

II - GEO-POLITICAL EVENT

YET ANOTHER MILITARY BATTLE OVER OIL A UN sanctioned "no fly zone" over Libya and "military intervention" has given the green light to France and UK's push for immediate military action against Libyan leader Moammar Gaddhafi. Saturday March 19th saw the first show of foreign force when a French Rafale fighter shot down a Libyan air force fighter jet over Benghazi while it

was enforcing the UN no fly zone mandate. Make no mistake about what is going on here. This is about taking full advantage of an opportunity to secure the rich oil supplies of Libya. The G7 now have military presence in every major oil producing nation in the world with two excepts - Iran and Russia. With the US having control of the Caspian basin and its former Russian states, it has effectively already neutralized Russia.

III - SOCIAL UNREST The map to the right from the Economist shows the members of the Arab League. Starting with Tunisia's overthrow of the 23 year rule of Zine el-Abidine Ben Ali, the rage has spread like a wild fire

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through the Arab world. Egyptian protesters replaced President Hosni Mubarak in just 18 days, after 3 decades under his rule. More recently Algeria, Bahrain, Yemen, Jordan, and Libya have all seen major demonstrations by people fed up with

the living standard they face on a daily basis. It appears to get worse and more deeply rooted each day. The conflict in North Africa was a predictable outcome of the US Monetary Policy of Quantitative Easing. It is not plausible that the US Federal Reserve, as the manager of the world's Reserve Currency, did not fully recognize the global ramifications of such monetary inflationary actions well in advance. Quantitative Easing like the Intercontinental Ballistic Missiles (ICBM) of the cold war era has had the same devastating pre-emptive impact on Libya. There can also be little doubt that the bi-monthly meetings of the Bank of International Settlements (BIS) board of directors, which specifically meet to discuss coordinated monetary policy outcomes, did not consider this eventuality. The board of directors of this global power center includes all G7 Central Banks chiefs, with the conspicuous absence of a single member of the Arab League not receiving US military financial aid.

See Article: Flash Points in the "Age of Rage"

IV - FOOD PRICE PRESSURES

The United Nations reckons countries spent at least $1 trillion on food imports in 2010, with the poorest paying as much as 20 percent more than in 2009. These increases are just getting started. In January, world food prices rose to another record on higher dairy, sugar and grain costs. Unlike the food-price spike of 2008, this one may be more secular than cyclical. Asia alone, for example, will have another 140 million mouths to feed over the next four years. Add that to almost 3 billion people in the fast-growing region and you have a recipe for booming demand. What‘s killing households surviving on a few dollars

a day is price volatility. If you spend almost half of

your income to fill bellies, a 10 percent surge in

cooking oil, wheat or chili peppers is devastating.

It‘s hard enough to pay rent and handle health-care

costs today, never mind investing in education.

Obviously, the poorer the country the bigger the

percentage food is of disposable income. Food

increases and volatility devastates the poor but it

also cripples the middle class.

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V - OIL PRICE PRESSURES

Oil prices have shot up and appear to have established a new level of over $100/ barrel. Both the level of oil and the percentage increase have been precursors of recessions in the past. G7 countries are least equipped today to face the possibility of a recession with no bullets left in the monetary and fiscal policy arsenal. It is tough to stimulate an economy when interest rates are already near zero and fiscal budgets are at record deficit levels.

VI - INFLATION & INTEREST PRESSURES Interest Rates Are on the Launch Pad - therein lies the problem for the Fed. Any further debt

monetization by the central bank now becomes counterproductive. That‘s because as inflation rates climb, bond investors demand higher interest rates. The lower real interest rates become, the less participation there will be in the bond market from private sources. If you don‘t believe me, ask Bill Gross. The Fed is now damned if it does and damned if it doesn‘t. Interest rates have been artificially suppressed for such a long time that no matter what Bernanke does come June, interest rates will rise. If it enacts another iteration of Quantitative Easing, the Fed may find itself the only player in the bond market. The truth is that only a central banker could afford to own bonds that are yielding rates well below inflation, and growing even more so.

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OTHER HIGHTLIGHTS

XVIII - Bond Bubble: Who Will Buy US Bonds? Is This Why Bill Gross Dumped Treasuries? Global Monitor "QE2 flushed domestics out of Treasuries and effectively funded 63 percent of the budget deficit in Q4. The Treasury is prohibited from directly selling bonds to the central bank, but effectively finances the government through POMO. Given that a large portion of the Rest of World category are central banks recycling BOP surpluses, it‘s likely that 90 percent of the U.S. budget deficit in Q4 was funded by central banks. You think this may have anything to do with what‘s

happening in the commodity markets? That is, the central banks‘ printing presses providing the fuel for speculators? Furthermore, we ask: who is going to finance the U.S. budget deficit when QE2 ends, especially at a sub 3.50 percent 10-year Treasury rate? Bill Gross knows!"

XIX - Pension - Entitlement Crisis: Collapsing

Western Social Net

From the Wisconsin State legislature to the most recent EU Summit meeting the discussions are how do governments get out from under their pension and entitlement promises. Government budgets can no longer be balanced as entitlement payouts now overpower payments made. Unlike corporations, the US government has not set

aside entitlement contributions, but rather has spend them. The unfunded liabilities have been calculated to be $204T by some estimations and $62T by official government estimates. The gig is finally up as the post World War II generation now begins to retire in waves and claim the rich promises made to them by their governments. Bernie Madoff referred to the US Government as a giant Ponzi scheme precisely for this reason. He should know how to identify a Ponzi scheme!

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GLOBAL MACRO In the last month we have all had our investments exposed to what is called Event Risk or "Tail" Risk. Whether it is the Earthquake, Tsunami or Nuclear Fallout in Japan, the overthrow of governments in Egypt and Tunisia, civil war in Libya or social unrest in Bahrain, Yemen, Saudi Arabia; all have been unexpected and caught the financial markets by surprise.

As we pointed out earlier in this report, our 2011 Thesis: "Beggar-thy-Neighbor" fully identified the social unrest and political tensions now being experienced globally as a major new emerging theme in 2011.

We called it the "Age of Rage" as the days of plenty come to a close for the Western powers. Soon the populations of these countries will witness changes that make them realize that: - Gone are the days of plenty of Job for those who are willing to work, - Gone are the days of plenty of food, energy and water, - Gone are the days of secure pensions and retirement benefits - Gone are the days of affordable education to build a future on,

- Gone are the days of affordable and available health coverage, - Gone are the days of plenty of disposable income to maintain a middle class lifestyle, - Gone are the days when children could expect to have a higher standard of living than their parents, - Gone are the days of trust in government. As we experience a massive shift in economic and political power to the East from the West, we will see more tension and conflicts. We will see more confrontations for scarcer and scarcer resources to compete with. We are already seeing the above emerge in many ways. One that is not talked about often enough is RISK.

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I have written extensively of Regulatory Arbitrage being the dominate strategy over the last few years where risk has been shifted to sovereign governments by the financial sector (See Sultans of Swap article series).

An easy way to consider RISK is by examining Credit Default Swaps (CDS) rates. I have included a large number of these charts in the next few sections to give you a perspective of the elevated risk levels we are now operating at around the world. Yes they are lower than during the 2008 financial crisis but I would argue they are now broader based and showing visible upward trends. A CDS level of 300 means that a financial party is willing to pay 3%, 300 basis points or $300K for every $10M, to ensure against loss. Consider it as a form of financial risk insurance. Anything at or above 300 is considered elevated and for a lot of investments, excessive risk. I have drawn horizontally red lines to mark this demarcation.

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In the lower part of the above chart we see the PIIGS (Portugal, Ireland, Italy, Greece, Spain), European Financials (Investment Grade) and Emerging Markets (as a group) all at or above the 300 threshold level. You will also see a biased rise since March of 20101. Even the states of California, New York, New Jersey and Illinois as a group have been above this threshold in the last 12 months for the first time. The chart below ads some of the Middle East countries as they experience growing social unrest.

Notice that Japan at the bottom of the chart, as

would be expected based on current

developments, has now begun to rise.

The "Age of Rage" has begun and the social

unrest it is causing is effecting financial markets

and tensions not only between the people and

their leaders but additionally between countries.

The Global Macro is best typified as entering an

era of "Conflict and Tension".

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JAPAN GLOBAL IMPLICATIONS: EARTHQUAKE, TSUNAMI & NUCLEAR CRISIS The horrific events in Japan has gripped global attention as ever worsening developments unfold. As bad as the natural disasters associated with the earthquake and Tsunami are, as worrying as the potential nuclear fallout is; it all may pale in comparison to the potential financial and economic fallout. In 1989 the recognized author Michael Lewis wrote an article entitled: "How A Tokyo Earthquake could devastate Wall Street and the World Economy". In this article the author lays out six shocks Japan could go through as a result of such an event. it may be a pretty good roadmap for consideration. His underlying theme is that Japan will want, or at least need, its money back. Japan has had a positive current account for years and has accumulated huge wealth which has generally been invested outside of Japan where it often receives highly leveraged yields. Additionally, Japan because of its low Zero interest policy has been the source of one of the world's

largest carry trades for years. A repatriation of any significant amount of this money could be devastating to the global economy. This repatriation would be the same as a financial tsunami. Lewis lays out the following: Shock 1 => Earthquake/Tsunami, Shock 2 => Surge in Yen as initially Insurance companies repatriate funds, Shock 3 => Broad based Japanese Overseas Liquidation to finance rebuilding infrastructure at home, Shock 4 => A collapse in the US Bond Market and a spike upward in US Interest rates, Shock 5 => US Economic slowdown based on the impact of higher rates, Shock 6 => The Western G7 trading nations faces years of declining growth.

I think this is a fairly could roadmap if it was 1989. There are however obviously some major differences 22 years

later.

First, the debt levels around the world are so large that the rates being paid on this ever increasing debt level

cannot be allowed to rise. Rates have been cleverly manipulated through QE II so that they are presently held

down while duration is additionally shortened. Even a small increase of 1% from present historic interest rate lows

would have profound impacts on already deficit plagued government budgets. A 1% increase in the US would

approximate $150B which is close to double what the current congress, after much machinations, has been able to

cut from this year's fiscal budget.

A rising Yen would force an unwinding of the Yen Carry Trade. With Japan being the second largest sovereign

holder of US Treasury debt there would be forced wholesale selling of US Treasuries. For years the Yen Carry Trade

meant the banks could borrow in Japan at close to zero under the Japanese ZIRP policy and buy US Treasuries

yielding 4-8%. Fortunes have been made and are still being made. They all go away in a blur if the YEN increases

significantly in value.

Secondly, participants in the $620T Interest Rate and Currency SWAPS market would face monumental collateral

calls and forced selling. The world would immediately face an unprecedented liquidity squeeze.

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Thirdly, a higher Yen would mean higher costs for Japanese products.

The global supply chains are so integrated today that a stronger Yen

would act as an inflation shock to global producers until alternative

sourcing could be established. The fragile global economy could not

withstand the shock.

YEN INTERVENTION: GLOBAL G7 COORDINATION As a result the G7 took coordinated joint intervention for the first time in more than a decade to weaken the Yen. (See chart to the right) The Yen intervention will not work because: 1- It has never worked in the past other than for very brief durations. 2- The size of the Foreign Exchange market and the volumes traded,

make it near impossible for a group of central banks to overpower it for any sustained period of time. 3- Participation must be much broader today than in past attempts. It would minimally take a coordinated G20 initiative today versus a economically weakened G7 effort. 4- The SWAPS market will price in the real Japanese risk. The size and scope of the SWAPS market momentum will be unstoppable over time.

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NORTH AFRICA & MIDDLE EAST

NORTH AFRICA:TUNISIA, EGYPT & LIBYA Tunisia and Egypt have both overthrown their governments; we have civil war in Libya; and we have the Moroccan King Mohammed VI appeasing his people by promising "comprehensive constitutional reform". What suddenly changed to cause such a wildfire of unrest? If you listen to the protestors and not to the western media coverage you will hear words like: "Food", Jobs", Cost to Live", "Fuel Costs". Corruption has always been a way of life in this area but it becomes intolerable when the disparity is such that people can no longer get by and their family is hungry. MIDDLE EAST: BAHRAIN, YEMEN & SAUDI ARABIA It is the same situation in the middle east with both the monarchy of Saudi Arabia and Bahrain making promises. Yemen declared a state of emergency on March 18th after dozens of protestors were killed.

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EU SOVEREIGN DEBT

AGREEMENT

Eurozone debt deal struck - Governments to cut borrowing costs for peripheral economies Financial Times

Germany wanted and more or less got the measures they were calling for in a new EU agreement to address the ever worsening PIIGS sovereign debt problems.:

1- Raising retirement ages to reduce the burden on pension funds, 2- Ending the linking of wages to increases in the cost of living, 3- Committing to debt reduction and 4- Submitting to a level of budget scrutiny that was until recently considered anathema — and is still viewed by many as a step too far.

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Germany must agree to act as the region‘s lender of last resort. And for that, Chancellor Angela Merkel, with

political problems even within her own governing coalition, has a steep price. She has moved into a visible position of European leadership, trying to frame the debate in German terms and impose her will on her neighbors. ―There‘s a common understanding that we need to help Merkel get something that looks like a victory,‖ said a senior European Union official

The Germans would also force private bondholders who bought the high-yielding debt of the most troubled euro-zone countries to bear part of the burden if countries defaulted or needed to restructure their debt — and not be protected by taxpayers.

They have been working on at least three levels for a comprehensive package.

1- The most important is a ―permanent regime‖ — the so-called European Stability Mechanism, which will replace the temporary bailout fund called the European Financial Stability Facility, set up during the Greek crisis last May. That fund ends in June 2013, and the Germans want a permanent fund of perhaps 500 billion euros ($695 billion) to show the markets that the euro zone is prepared for future problems. But that fund must also show Germans that private investors will not be bailed out by taxpayers, that no country will assume the debts of another and that there will be collateral offered and penalties for bad behavior.

2- The governments are also in heated discussions about whether and how to strengthen and extend the existing temporary fund of 440 billion euros ($612 billion), intended to help Greece and Ireland, to allow it to lend the entire amount, which could then cover Portugal and Spain. But Berlin does not want the fund to be used to buy back Greek or Irish bonds.

3- The issue that has gotten the most attention is the German-French Pact for Competitiveness, a name chosen for German ears. The intention was to lay down specific commitments to coordinate euro-zone economies — a common basis for corporate taxes for instance, or a common age for retirement — intended to unify policies across the region while raising tax revenue and reducing spending. Wage indexation was to be banned and high deficits punished.

And here I thought 'mashing teeth' over an agreement meant something

different!

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RISK

Interactive Graphic: Europe’s financial contagion Washington Post

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The top charts above assesses credit connectivity risk versus local sustainability risk. Clearly the PIIGS stand out but we need to also pay attention to the US and Japan. A downgrade on US debt or a change in Japanese savings and investment habits could have significant cascading impacts. The lower chart shows the interconnectivity associated with loans extended as a percentage of GDP and Exports as a percentage of GDP. IX - EU Banking Crisis It cannot be stressed enough how interconnected the banking sector in within the EU and Central & Eastern Europe. A failure anywhere within the financial infrastructure WILL cascade throughout the sector. This is clearly shown in the schematic representation below.

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PIIGS

We have shown a dearth of CDs charts in this month's report but it would be helpful to match those up with sovereign bond yields. The following charts all use the 10 year duration for comparison purposes. The charts indicate that the sovereign debt crisis in the PIIGS is a long way from being addressed. There is little doubt that the EU must immediately increase the scope of the bailouts or face these PIIGS will collapse.

VIII - Sovereign Debt - Unaffordable PIIGS Bond

Yields The summary chart below shows that yields are still rising on all PIIGS 10 year sovereign bonds despite EU aid. Rates for Greece, Ireland and Portugal are simply not fundable.

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GERMANY

3.237%

FRANCE

3.615%

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BELGIUM

4.23%

ITALY

4.731%

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SPAIN

5.455%

PORTUGAL

7.41%

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IRELAND

9.148%

GREECE

11.859%

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GLOBAL IMBALANCES The Economist reports:

Last year was only the second since 2004 when the

current-account balances of the world‘s big surplus economies added up to less than 2% of global GDP. But at 1.93% of world output, last year‘s surplus was higher than 2009‘s 1.75%.

The IMF predicts that imbalances will rise again, to over 2% this year.

The surplus of emerging economies in Asia fell to 0.78% of world output last year, the lowest since 2005, but will cross 1% of world GDP by 2013 (not shown) for the first time since 2007.

International deficits and surpluses should offset each other. But because of errors in measurement, the world appears to have been running a surplus with itself since 2004. The discrepancy is thought to be due to delays in recording imports.

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VII JAPANESE DEBT CONCERNS

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THE LOST DECADE (Actually the last 20 years)

- Over the last twenty years, asset prices are down by 65% for the Nikkei stock index, 50% for residential real estate, and 70% for commercial real estate. - Public debt rose from virtually nothing to 225% of gross domestic product (GDP), - Central government debt approaching one quadrillion (one thousand trillion) Yen and central government revenues are approx ¥48 trillion. Their ratio of central government debt to revenue is a fatal 20X. (1000Y supported by 48Y ~ 20:1)

INTEREST RATE INCREASE EXPOSURE

- According to J. Kyle Bass' Hayman Capital, every 100 basis point change in the weighted-average cost of capital (interest rates) is roughly equal to 25% of Japan's central government's tax revenue. (12Y) - A 200 basis point move higher over time in Japan's interest rates will increase their interest expense by more than ¥20 trillion.

1% = 12Y 2% = 20Y

- Over the last year Greece with a 1/3 less and Ireland with less than 1/2 the debt to GDP ratio of Japan, imploded when foreigners refused to invest. - If Japan had to borrow at France's rates (a AAA-rated member of the U.N. Security Council), the interest burden alone would bankrupt the island nation.

ABILITY TO SELF FINANCE

- Japan has avoided this deficit financing end-game, because the nation has been able to finance 95% of its debt at home. Lower family formation has caused the household savings rate for the thrifty Japanese to fall from 5% at the end of the 1990's to just above 2% currently.

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- Millions of Japanese savers are about to start spending their savings on essentials, since they have lost their jobs and businesses due to the damage - Japan has maintained a 41% corporate tax rate; the highest in the world, 10% above the US and Europe and triple the fast growing Asian economies of Taiwan and Singapore. This has made Japan an unattractive location for private investment.

PARADOX

- Has maintained current-account surplus and has been sending more than 3% of its GDP abroad, providing more than $175 billion of funds this year for other countries to borrow. - A combination of high corporate saving and low levels of residential and non-residential fixed investment due to poor investment opportunities in Japan.

INSURANCE

- Earthquake insurance in Japan is very expensive and only 10% of homeowners buy coverage. Therefore, the Japanese government will be on the hook for several hundred billion in infrastructure and reconstruction costs.

RECENT SITUATION

- Standard & Poor's credit rating service had just downgraded Japan's sovereign debt to AA- in mid-January. - The huge increase in the costs for welfare and unemployment payments, the economic disruption, the scale of the devastation, the lack of insurance and the minimum five years to rebuild the country may take Japan's credit rating down to "junk bond" levels. ==> DOWNGRADE AHEAD

The debt crisis tsunami has been building for twenty years and may be much more devastating to the future of Japan. Based on all the above, then the recent earthquake, tsunami and nuclear disaster, the following chart is even more frightening!

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BEGGAR-THY-NEIGHBOR Beggar-thy-Neighbor policies involve gaining trade advantage by disadvantaging another country. It is a zero sum game were what helps one country directly takes away from another country with no net gain. Nothing is gained - only transferred. Therefore it is unsound economic policy.

There can be little doubt that we are moving towards an era of Beggar-thy-Neighbor foreign policy. We have recently heard Brazil public shout about emerging Currency Wars & Capital Controls and from Argentina about Protectionism & Tariffs. The US Smoot-Hawley Tariff Act of June 1930 that ushered in the Great Depression was the protectionist policy that was felt to have caused the global slowdown that led to the Great Depression in the US. Today the World Trade Organization (WTO) bans a lot of the protectionist policies that might otherwise be implemented, as does Free Trade agreements or Regionalization pacts such as the Euro Zone and the International Co-operative Alliance-Asia & Pacific which additionally restrict broad brush protectionist

responses. However, you can expect more manipulation of currencies for competitive advantage as well as creative protectionism policies that use tariffs, surtaxes, capital controls and other regulations to gain advantage at the expense of other trading partners.

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US ECONOMY

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KEY MONTHLY ECONOMIC INDICATORS – Have a closer look at what the mainline media doesn’t discuss.

REAL Earnings (Production/Non-Supervisory)

Average Weekly Earnings DECELERATING

Disposable Income Now Comes from Government

Commodity Price Index

Profits without Increasing Workforce!

Profits without Wage Increases!

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2011 US ECONOMIC IMPEDIMENTS We agree with Hoisington & Lacy and see seven main impediments to economic progress in 2011 that will slow real GDP expansion to the 1.5%-2.5% range.

1- Fiscal policy actions are neutral for 2011.

- Personal taxes, including federal and non-federal, rose to 9.44% of personal income in November, up from a low of 9.1% in the second quarter of 2009. Even with the tax compromise this effective tax rate will continue moving higher as a result of higher state and local taxes.

- Total real federal expenditures are likely to contract (in real terms) this year. 2- State and local sectors will continue to be a drag on the economy and labor markets in 2011.

- Municipal governments face substantial cyclical deficits and significant underfunding of their employee pension plans. - Municipal bond yields rose sharply in the second half of 2010 and will continue increasing borrowing costs. Any trend toward increased bankruptcy would raise caution in the broader municipal market and add to higher borrowing costs.

- (1) cut personnel; (2) reduce expenditures including retirement benefits; (3) raise taxes; (4) borrow to fund operating deficits; or (5) declare bankruptcy. All retard economic growth.

3- Quantitative Easing round 2 (QE2) will likely produce only a slight economic benefit as the Fed continues to encourage additional leverage in an already over-indebted economy.

- Fed actions have affected stock and commodity prices. The benefits from higher stock prices accrue very slowly, are small, and are slanted to a limited number of households. Conversely, higher commodity prices serve to raise the cost of many basic necessities that play a major role in the budget of virtually all low and moderate income households.

4- While consumers boosted economic growth in the second half of 2010 by sharply reducing their personal saving rate, such actions are not sustainable.

- From 6.3% in June 2010, the personal saving fell by a significant 1%, to 5.3% in November (Table 1). Consumer spending is slightly in excess of 70% of real GDP. Without the one percentage point reduction in the personal saving rate, the second half growth rate would have been 2.6%, a shade slower than the first half growth pace, and materially less than the presumed second half growth rate. - When job insecurity is high, and defaults, delinquencies and bankruptcies are at or near record levels, a drawdown in the saving rate would seem to be an unlikely event.

5- Expanding inventory investment, the main driver of economic growth since the end of the recession in mid-2009, will be absent in 2011.

- In the second half of 2010, real GDP grew at an estimated 3.3% annual rate (assuming the fourth quarter growth rate was 4%), up from 2.7% in the first half of the year. Transitory developments in two of the most erratic and unpredictable components of the economy---the personal saving rate and inventory investment---accounted for all of this acceleration. - Inventory investment was the main driver of economic growth since the recession ended in mid-2009. Based on published data, real GDP grew at a 2.9% annual rate over this span. However, real final sales, which excludes inventory investment from GDP, increased at a paltry 1.1% pace. - At a minimum, the dominant source of aggregate economic strength will not repeat in 2011.

6- Housing will continue to be a persistent drag on growth.

- Prices have re-accelerated to the downside over the past four months, as mortgage yields have risen and the housing overhang has increased. - As gauged by an aggregate of housing indexes dating to 1890, real home prices rose 85% to their highest level in August 2006. They have since declined 33 percent... In fact, home prices still must fall 23% if they are to revert to their long-term mean

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7- External economic conditions are likely to retard U.S. exports.

- Higher food and fuel prices will serve to significantly depress growth in countries like China, India and Brazil where food and fuel are known to be a much higher percentage of household budgets. Already reports have surfaced from international agencies on the growing adverse consequences of higher food prices, and social unrest has also been witnessed on a limited basis. - Chinese economic policy is designed to slow growth and reduce inflationary pressures. Thus, changing global conditions should serve to moderate U.S. exports. - A firm dollar will serve to keep U.S. disinflationary trends intact.

OBAMA'S 2012 BUDGET - CBO's ASSESSMENT

Compared with the Administration's estimates, CBO's estimates of the deficit under the President's budget are lower for 2011 (by $220 billion) but higher for each year thereafter (by a total of $2.3 trillion over the 2012–2021 period). That disparity stems from differences in the underlying projections of what would happen under current law ($1.3 trillion) as well as from differing assessments of the effects of the President's proposals ($1.0 trillion).

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As a basis for analyzing the President's budget, CBO updated its baseline budget projections, which were last issued in January 2011. Unlike its estimates of the President's budget, CBO's baseline projections largely reflect the assumption that current tax and spending laws will remain unchanged. Under that assumption, CBO estimates that the deficit will total $1.40 trillion in 2011—$81 billion less than the agency estimated in January. For the following 10 years (2012 to 2021), CBO now projects a cumulative deficit of $6.7 trillion—$234 billion less than the amount in the previous baseline. CBO has not modified its economic forecast since January, so the updated baseline projections mainly reflect new information that the agency has obtained about various aspects of the federal budget since the previous projections were completed.

The President's policy proposals mostly affect the revenue side of the budget. Those proposals would reduce revenues, compared with CBO's baseline projections, in every year of the coming decade—for a total reduction of about 6 percent over the 2012–2021 period. Nevertheless, revenues would rise relative to GDP: from 16.2 percent in 2012 to 19.3 percent in 2021. The 19.3 percent figure is 1.5 percentage points below CBO's baseline projection for 2021 but 1.3 percentage points above the average ratio of revenues to GDP seen over the past 40 years.

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XVII - PUBLIC POLICY MISCUES USA INC.

HOUSTON, WE HAVE A PROBLEM HERE!

Remember - The government has already spent ALL taxed Entitlement Revenues.

Now that the Baby Boomer is ready to retire, the government has no money set aside for it.

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On Facebook, Sarah Palin (predictably) lashes out at Obama's budget plan, and she links to this series of charts by Doug Ross posted at The Blaze. They certainly put the cutting in perspective. First, the budget:

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Can't see the cuts? Here's a zoom-in:

And here's a further zoom-in:

Image: Doug Ross

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KEEP YOUR EYE ON THE REAL ESTATE 'DOUBLE DIP'

XIV - RESIDENTIAL REAL ESTATE

The facts below are taken from: Nearly 11% of Houses Empty CNBC

HOME OWNERSHIP

- America's home ownership rate, after holding steady for a while, took a pretty big plunge in Q4, from

66.9 percent to 66.5 percent.

- That's down from the 2004 peak of 69.2 percent and the lowest level since 1998.

- Homeownership is falling at an alarming pace, despite the fact that home prices have fallen, affordability

is much improved and inventories of new and existing homes are still running quite high.

- Bargains abound, but few are interested or eligible to take advantage.

OCCUPANCY RATE

- Of the nearly 131 million housing units in this country:

- 112.5 million are occupied.

- 74.8 million are owned - only dropped by about 30 thousand in the past year.

- 38 million are rented, but that's up by over a million year over year.

- That means more new households are choosing to rent.

VACANCY RATE

- More concerning than the home ownership rate is the vacancy rate.

- There were 18.4 million vacant homes in the U.S. in Q4 '10 (11 percent of all housing units vacant all

year round), which is actually an improvement of 427,000 from a year ago, but not for the reasons you'd

think.

- The number of vacant homes for rent fell by 493 thousand, as rental demand rose.

- 471,000 homes are listed as "Held off Market" about half for temporary use, but the other half are likely

foreclosures. And no, the shadow inventory isn't just 200,000, it's far higher than that.

So think about it. Eleven percent of the houses in America are empty. This as builders start to get more bullish,

and renting apartments becomes ever more popular. Vacancies in the apartment sector have been falling steadily and dramatically, why? Because we're still recovering emotionally from the toll of the housing crash.

Younger Americans have seen what home ownership has done to their friends and families, and many want no part of it.

Credit has become very nearly elitist. Home prices, whatever your particular data provider preference might be, are still falling.

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The year-over-year decline in home prices, as measured by the Case-Shiller, accelerated to 2.4% from over 1.5% in November.

Don't buy the real estate spin that this downturn is regional. This is a National Double Dip in Housing. You see all major metropolitan areas peaking between March and May 2010 (the end of the first-time home-buyer tax credit). After only 8 months in positive territory, the overall index comprising 20 cities is back into the red (-1% in October and -4.1% in November).

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18 out of 20 regions now show declining house prices. It's another bust. Things are good in WASHINGTON however!! Lots of well paying jobs there!

Prof. Robert Shiller (one of the creators of the index) pointed out that 6 out of 20 cities in the

index have hit new lows (even lower than in early 2009). He said that the economy would face “serious worries” if house prices kept falling this fast Why did he say ―this fast‖? To understand, you have to look at the annualized rate of change of the last 3 month. And it is not a pretty picture. While the 10-city index dropped an annualized 8.8% in the three-month period from July to October 2010, the 20-city index fell at a rate of 10.4%. The annualized three-month rate of change gave an early warning sign went it went into negative territory in June 2006, while both the 10-city and 20-city only showed declining house prices in January of 2007.

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New Home Sales continue to fall from already low levels.

Total housing starts slumped by 22.5% during February versus January to the lowest level of the economic recovery. The decline to 479,000 starts was from an upwardly revised 618,000, initially reported as 596,000. The latest figure disappointed Consensus expectations for 570,000 starts. Building Permits declined 20.5% Y-o-Y

Lower Lowers and Lower Highs defines a trend -- and its DOWN.

New Eight Year Low in Housing Prices.

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XV - COMMERCIAL REAL ESTATE The following analysis was done by MyBudget360. Their findings tell the story very clearly.

The media has done a fantastic job painting over the enormous sinkhole of a problem that is commercial real estate (CRE). U.S. banks hold over $3 trillion in commercial real estate loans on properties that were once valued at over $6 trillion. Today those values are down to roughly $3 to $3.5 trillion depending on what metric you believe. How is it possible for a market that has lost $2.5 to $3 trillion to become largely hidden in the dark from the mainstream media? We constantly hear about $3 billion deficits or other issues but is the trillion dollar figure just so enormous that they don‘t even bother investigating? It is probably more likely that the Federal Reserve has concealed massive failures in CRE by allowing banks to play a game of extend and pretend that continues today. The shadowy problems of empty shopping centers, vacant car dealership lots, and misplaced strip malls is largely a taxpayer problem now. Banks made these irresponsible loans but had the Fed hand over taxpayer loot in exchange for worthless real estate.

Source: MIT

CRE values are still hovering near their trough and are likely to move lower. The only reason these prices haven‘t moved lower is because banks are more generous with the borrowers of CRE debt since these holders are grappling with multi-million dollar cuts in each deal. Banks would rather pretend a mall is valued at $100 million instead of marking it to a real value of $40 million or less. The fact that the Federal Reserve allows this to happen is financial chicanery. Can you pretend to the government that you really don‘t make $100,000 a year so instead you will act as if you make $30,000 a year and act

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accordingly? This is what is happening here. Banks are essentially allowing these toxic loans to be laundered through the system in exchange for taxpayer dollars. The Fed is betting that the public doesn‘t wake up to this scam. CRE is a giant and pernicious problem. With residential real estate it hits directly home and many American families are considered home owners. This bubble has garnered most media attention as it should. Yet CRE debt is enormous, larger than every state budget deficit combined by many times! In fact, the losses on CRE loans is larger than the state budget issues. Of course the Fed wants the public to look away from the real culprit behind the decline of the American middle class. The scheme was to build junk and pawn off the loans to average Americans whether they wanted to accept the debt or not.

The cost of CRE problems

Banks have no faith in this recovery. Look at the above regarding commercial loans. Banks continue to claim that the reason for the taxpayer bailouts was to help the American public weather the economic storm and for banks to continue lending to average Americans. Instead, as you can see above, commercial loan lending has collapsed and banks have hoarded money and speculated on the stock market casino on the taxpayer dime. This money was used to shore up bad balance sheet problems and for gambling on the stock market to boost profits. In short it was one giant swindle perpetrated on the public. And think about the supposed recovery we are experiencing. If we were truly growing and expanding don‘t you think there would be healthy demand for loans as businesses expand their workforce? Wouldn‘t it be logical to conclude that commercial loans would reflect the supposed increased demand from a booming American economy? Of course the only boom occurring is for the top 1 percent who are siphoning off the wealth from average Americans to spin their continuing speculation in the stock market. Many are starting to wake up from this collective sleepwalk where taxpayers were robbed in open daylight.

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The problems are coming up

Source: ZeroHedge

What is even more problematic is many of the CRE loans are going bad in the next few years. Just like residential real estate is now experiencing a second collapse, CRE will have another move lower. Banks can only carry fantasy paper for so long. So far we have been paying for it through QE1, QE2, TARP, and other convoluted programs to launder money and devalue the U.S. dollar and decrease the quality of life of average Americans. The public did not sign up for this. The banks talk about shared responsibility and many are paying for it by losing their homes and going bankrupt. Millions are facing this economic ―responsibility‖ on a daily basis. What penalty for the banks? Instead, they get bailouts and continue to pretend the junk loans they made on concrete disasters are worth inflated values only to shovel them off to taxpayers. How is it that there are no buyers for these supposedly highly priced items? CRE debt exposes the worst aspect of the bubble. Pure profit motive by supposed sophisticated investors on both sides of the coin with no financial responsibility or ownership. This isn‘t some poor family in a low-income neighborhood taking out a subprime loan. This is actually a supposed responsible bank and a supposed financially savvy investor. There is no justification for one penny of a bailout here. Yet the Federal Reserve continues with their hidden bailout where they support malls in Oklahoma to Chick-fil-A. Don‘t expect to hear about this on your nightly news.

Gordon T Long gtlong@comcast.net Web Page Tipping Points (http://lcmgroupe.home.comcast.net/Tipping_Points.htm) Gordon T Long is not a registered advisor and does not give investment advice. His comments are an expression of opinion only and should not be construed in any manner whatsoever as recommendations to buy or sell a stock, option, future, bond, commodity or any other financial instrument at any time. While he believes his statements to be true, they always depend on the reliability of his own credible sources. Of course, he recommends that you consult with a qualified investment advisor, one licensed by appropriate regulatory agencies in your legal jurisdiction, before making any investment decisions, and barring that you are encouraged to confirm the facts on your own before making important investment commitments. © Copyright 2010 Gordon T Long. The information herein was obtained from sources which Mr. Long believes reliable, but he does not guarantee its accuracy. None of the information, advertisements, website links, or any opinions expressed constitutes a solicitation of the purchase or sale of any securities or commodities. Please note that Mr. Long may already have invested or may from time to time invest in securities that are recommended or otherwise covered on this website. Mr. Long does not intend to disclose the extent of any current

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holdings or future transactions with respect to any particular security. You should consider this possibility before investing in any security based upon statements and information contained in any report, post, comment or suggestions you receive from him.