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      • Two videos aus Deutschland
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Monday, March 26, 2012

Two videos aus Deutschland


The first starts with Dirk "Mr.Dax" Müller, slamming the door pretty hard on those that only see an unlikely interest rate in a brilliant exposition about economic growth:


On the other hand, here is some common wisdom out of Berlin, by Prof. Bernrd Senf, in two series



Posted by Analytic Bastard at 11:12 AM 0 comments
Labels: Central banks, commodities, debt, Economics, Economy, Energy, Germany, Gold, interest rates, Money

Sunday, March 25, 2012

Not everybody drives a BMW in Germany

A study conducted by the University of Duisburg-Essen, cited by Deutsche-Welle indicates that the working poor in Germany increased by 2.3 million to 8 million people arriving in 2010, equivalent to 23.1% of the working population the country. The report was also cited in Süddeutsche Zeitung, noting that one of every 4 workers receive low wages, i.e. well below 9.15 euro per hour.

This percentage was slightly higher before the outbreak of the crisis (24.2% in 2007), which has allowed German authorities to diminish its importance. While unions fighting for the introduction of a minimum wage of 8.50 euro per hour, the study reports that 19.9% of employees are currently below this threshold and 11.4% earn less 6 euro per hour. Young people under 25 years of age are the most affected by low wages. These figures are astonishing the world since the rise of poverty in Europe's largest economy was not expected by anyone.

The study by the University of Duisburg-Essen does not say in which areas these workers work with little reward, but many of them are concentrated in trade and personal services. The chart below I have drawn from the OECD and also shows the fall in wages.


We must also factor in the importance of the so-called "mini-jobs". With this type of job contract, the worker earns less than 400 euro a month. However, if this worker is not previously insured, German laws require that the worker him/herself pays the compulsory medical insurance, costing up to 150 euro a moth, making it impossible for non-covered immigrant workers to have a regularized situation that deals both with the legal requirements and rent payments and living costs.


These "mini-jobs" were designed to promote a return to regular job contracts, but have become the way many employers have access to cheaper workers and without the constraints of a contract. Hence Angela Merkel is considering the idea of ​​a higher minimum wage, closer to 9 euro per hour. Unions  in the rest of Europe also expect a higher minimum wage in Germany, in order to improve the competitiveness of their countries. But the idea comes in bad times, as the coming contraction will lower exports and will induce a reduction in employment. This will render considering increasing wages impossible.
Posted by Analytic Bastard at 8:30 AM 0 comments
Labels: Economy, Germany, wages

Prices gone berserk in Germany

There are many news reporting high inflation in Europe in general: food, fuel, and so on. But, how bad are the money shots in real estate prices in Germany? this is very serious. This fresh credit and money printing via the ECB's balance sheet expansion is doing a very pernicious effect, i.e., raising prices, which reduces competitiveness. Merkel knows this well, and knows that this inflation and these money shots are not what Germany needs.

Furthermore, this creates the same housing bubble that was created in southern countries, especialy Spain. Here are some news signal an active inflating market:
Warum der deutsche Häusermarkt jetzt boomt 
Makler sehen jetzt die richtige Zeit zum Kauf 

What is happening, as I say, is that many banks in Germany and Austria are not funding commercial projects, but simply going into real estate. This produces a corrosive inflation: rising property prices hinders productive investment, as the growing costs of premises and the flow of money out of the industry makes it impossible to undertake a project, leading to an erosion of Germany's industrial economic edge. Do you really think that Merkel will let house prices to continue to rise by 10-15% annually? This is not sustainable and I expect the German government to take action in some way, most likely confronting ECB's president Draghi. On the other hand, housing prices in Austria are going crazy. An acquaintance reported a fifth-floor, 140 square meters penthouse selling for 1.2M €. This acquaintance, who has lived there for 25 years, has never seen anything like it: many food items have doubled in just one year, and certain not so basic, but necessary products have tripled in nine months. Inflation is also inflating commodity prices, it is not uncommon to find bread for 4 € in Billa or Merkur supermarkets, which would be unthinkable just a year ago. What this means is that money thought to reactivate Portugal or Spain is moving around and wreaking havoc in European creditor countries.

At this juncture, I believe that some action to move rates higher will be taken. They will, or maybe already have, abandoned Spain and Greece, Ireland and Italy, and the Euribor, the main housing rates index, will go to levels close to those of 2008 and 2009. This would be a death sentence for those countries industries.


We can therefore say that the era of low interest rates in Europe is over. For those having a mortgage, especially in the peripheral countries, brace yourselves.
Posted by Analytic Bastard at 7:00 AM 0 comments
Labels: Central banks, commodities, debt, ECB, Germany, inflation, interest rates, real estate

Sunday, March 18, 2012

Smoothing splines and interest rate curves

Yield curves are important in Economics and used by finance professionals to analyze bonds and look for trading opportunities and by economists, to try to understand economic conditions.

The yield is the amount in cash that returns to the owners of a security, for example, if a sovereign bond with maturity at time $T$ is bought at time $t$ for a price $P(t,T)$, the yield would be high if $P(t,T)$ is much less than the maturity price $P(T,T)$ (which would obviously be the risk-free amount received by the lender). A higher yield allows the owner to make more profit from the investment, but it may also mean that the security is being sold at a discount as a result of some risk related to the security. For a recent example of this, Greek bonds, which were sold at such discounts because the market anticipated a default, this made yields soar, with risk-averting investors unloading bonds at the lower prices that risk-taking investors were comfortable buying in. Ultimately everybody took a haircut.

For fixed income mathematics, a set of axioms must be assumed, namely:
  1. The market trades continuously over its trading horizon: it extends from the current time to some distant future time such that the maturities of all the instruments to be valued fall between now and the trading horizon..
  2. The market is efficient: information is available to all traders simultaneously, and every trader makes use of all the available information, also related to the axiom that
  3. There are no arbitrage opportunities: the price of a portfolio is the sum of its constituent parts.
  4. The market is complete: any desired cash flow can be obtained from a suitable self-financing strategy based on a portfolio of discount bonds.

It is assumed further that there are no legal barriers to trading and that the market is rational (traders try to maximize their profits).

Now, define the zero yield in terms of the bond price above. The zero yield, as seen at time $t$, of a bond that matures at time $T$, is denoted by $y(t,T)$ and is defined by
$$
P(t,T)=e^{-(T-t) y(t,T) }
$$
for every $t<T$, which means that the current price of the bond is equal to discounted price at maturity (using compound interest).

Suppose that at time $t$ we enter into a forward contract to deliver at time $T_1$ a bond that will mature at time $T_2$ (obviously $T_2>T_1$). Let the forward price of the bond be denoted by $P(t,T_1,T_2)$. At the same time, a bond that matures at time $T_1$ is purchased at a price of $P(t,T_1)$. Again at time $t$, a bond that matures at time $T_2$ is bought with a price of $P(t,T_2)$. Notice that the axiom specifying that there are no arbitrage opportunities implies that the price of the bond maturing at time $T_2$ must be equal to the product of the price of the bond maturing at time $T_1$ and the forward price $P(t,T_1) P(t,T_1,T_2)$. Let the implied forward rate $f(t,T_1,T_2)$, valued at time $t$, for the period $(T_1,T_2)$ as
$$
P(t,T_1,T_2)=e^{-(T_2-T_1) f(t,T_1,T_2) }
$$
Notice that $P(t,T_2) =P(t,T_1) P(t,T_1,T_2)=e^{-(T_1-t) y(t,T_1) } e^{-(T_2-T_1) f(t,T_1,T_2) }$ and, summing the exponents, we get
$$
f(t,T_1,T_2)= \frac{(T_2-t) y(t,T_2) - (T_1 - t) y(t,T_1)}{T_2 - T_1}
$$
which is the period forward rate. However, the instantaneous forward rate is of much greater importance in the theory of the term structure. The instantaneous forward rate for time $T$, as seen at time $t$, is denoted by $f(t,T)$ and is the continuously compounded rate defined by
$$
f(t,T)= \lim_{h \rightarrow 0} {f(t,T,T+h) } = y(t,T) + (T-t) y_T (t,T)
$$
where $y_T = \frac{\partial}{\partial T} y(t,T)$. We can interpret the previous equation as the current  yield value plus the instantaneous change of the yield with the maturity time.

To interpolate curves, and thus have values for all the points within the interval and not only the data points that are made available to us by the problem, we can use a number of different methods. One needs some complexity to be able to capture what the nature is saying, but at the same time this complexity might be cause by some "noise", or perturbations that we want to avoid (market panics, manipulations or poorly registered data). We can choose a parametric family, such as polynomials, fix the order and fit the coefficients. However, this appears as somehow arbitrary. One can choose to interpolate with a non-parametric method such as splines. When using some functional space, one must restrict himself to functions that meet some criteria, not only that approximate well (or maybe the best approximation in that space). This is to avoid overfitting the said noise.

Now we can choose to fit an approximating yield or the forward curve that approximates the true yield or forward curves, with the information given by actual bond prices as of time $t$, by minimizing the following functional (assuming we fit the yield curve $\varphi$):
$$
R(\varphi,t) =  \sum_{i=1}^n (P(t,T_i) - P(t,T_i,\varphi))^2 + \lambda \int \left( \frac{\partial^2}{\partial s^2} \varphi(s) \right)^2 ds.
$$
Where $\lambda$ is a regularization parameter, and $P(t,T_i,\varphi)$ is a functional that prices a bond of maturity $T_i$ at time $t$ with the yield curve $\varphi$. We change formulation, for practical derivation purposes (we now compute the observed yield $y(t,T_i)$ from the observed bond price)
$$
R(\varphi,t) = \sum_{i=1}^n (y(t,T_i) - \varphi(T_i))^2 + \lambda \int \left( \frac{\partial^2}{\partial s^2} \varphi(s) \right)^2 ds.
$$
And then we apply the standard smoothing splines theory to compute the solution, which is:
$$
\mathbf{w} = (I+\lambda K)^{-1} \mathbf{y}
$$
Where $\mathbf{y}$ is a vector with elements $y(t,T_i)$, $K$ is a matrix whose elements are of the form $\int \frac{\partial^2}{\partial s^2} \phi_i (s)  \frac{\partial^2}{\partial s^2} \phi_j (s) ds$, with $\phi$ is a choosen spline basis (notice the dot-product structure) and $\mathbf{w}$ is a vector with the coefficients on that basis, so that the estimated function is
$$
\varphi = \sum_i w_i \phi_i
$$



Posted by Analytic Bastard at 1:55 PM 0 comments
Labels: Bonds, Fed, Greece, interest rates, regularization, splines

Friday, March 16, 2012

Get yourself some gold

Debt is imploding. Our ability to pay our debts is impaired. The system requires a sistematic growth in energy consumption to pay the debt and the compound interest (I will be back with the topic of energy, wealth, money, credit and debt). When energy is limited, as it appears today, wealth is limited, but the monetary base is not, so the correspondence, once deemed to be stable or even fixed, is no longer so, creating an effective wealth transfer of those who hold paper assets to those who hold hard assets or a better access to cheap credit and free money.

Gold is an easy way of protecting yourself for the fall of the monetary system. Gold bullion coins is the most recognized way of doing so. I recommend Krugerrands and Maples.

Canadian Gold Maple Leafs are minted by the Royal Canadian Mint, and picture a maple leaf and ist 0.9999, one of the purest gold bullion coins.



Krugerrands are minted by the South African Mint and are the best known gold coins. They feature an antelope and a more orange color due to the high amount of copper (their purity is the lower than Maples, .9167), which also makes them harder and less likely to be scratched. The copper also makes them weight more 33.93 grams  (1.09 troy oz) and be larger that other purer gold coins.
  
With the state of the monetary base and the central banks' balance sheets, being a goldbug is not a choice anymore.

Posted by Analytic Bastard at 2:04 PM 0 comments
Labels: Credit, debt, Economics, Energy, Gold, inflation, Money

Thursday, March 15, 2012

Beautiful spectacle in the sky

I enjoy Astronomy so much that I examine the night sky every time I can. Tonight I couldn't wait to describe the delightful sight in the sky I was witnessing: Jupiter and Venus almost at the closest distance (as they meet the eye, not actual Euclidean distance, they were closest two days ago). And these are some beautiful pictures on the Internet (you may see them in space.com) so that the blog records this spectacular celestial art.

 Mostar in Bosnia-Herzegovina

Eagle Harbor, Mich. USA

As per the fabulous site http://www.solarsystemscope.com, the current planet locations are like this, observe the narrow angle in which we can see Jupiter and Venus.

An observer from California at the time of this post would see Venus on the top right of Jupiter in the sunset (in the previous picture of the solar system, put your head horizontally to the left, and see that this would indeed be true).

If the doors of perception were cleansed every thing would appear to man as it is, infinite
William Blake

One feels blessed to having been granted the opportunity to grasp such a marvelous look into infinity.

Posted by Analytic Bastard at 7:05 PM 1 comments
Labels: Astronomy

Wednesday, March 14, 2012

Mike Maloney's Debt Collapse

Oldie but classy, good showman, fine Economy lecture, Mike Maloney at his best...

Posted by Analytic Bastard at 4:33 PM 0 comments
Labels: Central banks, Credit, debt, deflation, Economics, Gold, inflation, Money, Silver

Tuesday, March 13, 2012

Fed Tricks

Kudos to Andrew Yorks via Zerohedge! In this magnificent [insert surrogate for article] and chart, they illustrate that yields have not followed the positive pseudo-polynomic relationship with the nominal USD-denominated SP500 index. My explanation is that the market is levitating with the help of the liquidity pumping of late 2011, in which bond prices and yields don't move where they should, generally responding badly to an equity bull market (bond prices falling). If you price the SP500 in gold you see the excess liquidity and that, since investors do not demand higher yields, there is no such a bull market.

Let's see what happens with some shiny stock that has a RSI over 70, all hedge funds in da house and no suckers left to buy (hint: AAPL).

On the other hands, one must take off his hat to the Houdini Fed guys.
Posted by Analytic Bastard at 6:04 PM 0 comments
Labels: Bonds, Central banks, Credit, debt, Economics, Fed

Monday, March 12, 2012

Cotton will be the place to be, just not yet

I look at this chart and I see a lot of pain



Last October, an Indian cotton broker told me that with the rapid increase in cotton prices, farmers took heavy loans to leverage their production. The sharp decline in price left them with a huge amount of debt. With this season's record harvest, Indian farmers need to flood foreign markets to compensate domestic loses. This, along with the Chinese request to lift the one-week-old export ban, forced the Indian government to go back on the only near-term price supporting force. If the foreign buyers (mainly Chinese) don't buy right now (and last Fall they seemed to have hoarded a whole lot of bales), the price is very likely to take another dip, especially in a deflationary environment coupled with a dollar bull market. If that happens, debt will weight on Indian farmers (extend that to any other cotton farmer who tried to leverage in 2010), and either they will refinance or they will lose a lot more than a season's harvest. Sadly, India is known for its problems related to agricultural businesses.

This leaves us with a production deleverage for the next season/couple of seasons that will coincide with the depletion of the current stock that will surely unbalance the supply and demand and price will have to move a lot higher. This rally will make cotton catch up with the rest of commodities as the liquidity leaves the banks and major players diversify.

Definitely, cotton will be the place to be... just not yet.
Posted by Analytic Bastard at 4:54 PM 0 comments
Labels: commodities, cotton, debt, deflation, Economy, India

Sunday, March 11, 2012

With Greece in default, what will happen with the CDS writers?


Greece has defaulted, not only de facto, but also officially, as ruled by multiple financial agencies such as Moody's. After the credit and financial derivatives party up until 2008, somebody is doing what they are supposed to do. The statement:
 "According to Moody's definitions, this exchange represents a 'distressed exchange,' and therefore a debt default," the US rating firm said. "This is because (i) the exchange amounts to a diminished financial obligation relative to the original obligation, and (ii) the exchange has the effect of allowing Greece to avoid payment default in the future."
Remember that Greece has forced its creditors to swap near-term maturing debt by debt maturing in the middle of the next decade. But the most important financial agency in this regard is the International Swaps and Derivatives Association (ISDA), whose role is to decide whether the CDS sold by banks and insurers must be triggered, this is, used by their counterparties (who bought them as protection against Greece's default) to minimize losses on this event.
The International Swaps and Derivatives Association determined today that Greece's bond swap has triggered a credit event. That will lead to payouts of credit default swaps—essentially, securities contracts on holdings of Greek bonds—that investors purchased to hedge against the risk of holding Greek sovereign debt.
Where do we stand? Given that the CDS business has been such a ludicrous business for the sellers, will it be today the day they will have to give up all the succulent profits they made over the past decade? We remember the bankruptcy of MF Global did not carry a decision to activate the corresponding insurance, forcing a bankruptcy wave on the insurance holders. Is this the reason why the central banks have released such a huge liquidity over the past months? We will certainly be watching the ECB's deposit facility.

Posted by Analytic Bastard at 2:37 PM 0 comments
Labels: CDS, Credit, debt, ECB, Economy, Greece, Money
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