Smuggled US Bonds in Italy - An Update

The Smuggled Bonds

I am getting a considerable amount of traffic to my post on the smuggled bonds in Italy, and you may wish to read the original and the comments at the end if you have not already done so (post here).

Since my post the US has finally confirmed that the bonds are fake:

WASHINGTON, June 19 (Reuters) - A purported $134 billion in U.S. government bearer bond certificates seized by police near the Italian-Swiss border are fake, the U.S. Treasury said on Friday.

"Based on the photograph we've seen online, they are clearly fake. And not even good fakes," said Stephen Meyerhardt, a spokesman for the Treasury's Bureau of the Public Debt.

However, the actual details on this story remain very patchy and contradictory which is still giving me pause for thought. Who are the two individuals, why did the confirmation that they were fake take so long, what were the forgers trying to achieve with such apparently useless bonds? Just to add fuel to the conspiracy fires, it transpires that the two individuals with the bonds have been released from custody without charge! The reason given is that they did not try to pass off the bonds as genuine.....

This seems very odd.

Another concern is that the original reason for my belief that the bonds were forged was an article detailing a bond forgery operation in the Philippines, which appeared to match the bonds that were found. This from the FT:

Whether the men are really Japanese, as their passports declare, is not entirely clear, but Italian and US secret services working together soon concluded that the bills and accompanying bank documents were most probably counterfeit, the latest handiwork of the Italian Mafia.

Few details have been revealed beyond a June 4 statement by the Italian finance police announcing the seizure of 249 US Treasury bills, each of $500m, and 10 "Kennedy" bonds, used as inter-government payments, of $1bn each. The men were apparently tailed by the Italian authorities.

Yesterday the mystery deepened as an Italian blog quoted Colonel Rodolfo Mecarelli of the Como provincial finance police as saying the two men had been released. The colonel and police headquarters in Rome both declined to respond to questions from the Financial Times.

In the story above, it is apparent that the 'authorities' were tailing the men, but the original story proposed that they were stopped in a random check. This is a very different story to how the men were intercepted to that which was previously released. Of course, it is possible that this is just more details being released, but the original stories appeared to be quite clear.

The article above goes on to detail another related scam, involving $1 billion in bonds in relation to the Venezuelan central bank. The scale and nature of the fraud detailed looks very different from the case in question. This is rather odd:

Italian officials, while pointing out that hauls of counterfeit money and Treasury bills were not unusual, were stunned by the amount involved. Investigators are looking into the origin and destination of the fakes.

Last month Italian prosecutors revealed they had cracked a $1bn bond scam run by the Sicilian Mafia, with the alleged aid of corrupt officials in Venezuela's central bank. Twenty people were arrested in four countries.

The fake bonds were to have been used as collateral to open credit lines with banks, Reuters news agency reported. The Venezuelan central bank denied the accusations.By FT staff in Rome, Tokyo, New York and Washington

Not only are they not connecting the bonds in this case to the Philippines forgeries, they are proposing the mafia are responsible. This seems highly unlikely. I really can not believe that the mafia are that idiotic. According to one unnamed US official, the bonds included a picture of the space shuttle, even though they are dated from a time long before the space shuttle. And the mafia were involved in such stupidity???

In the last two years, Italian authorities have seized some $800 million of U.S. bonds in the Como area in northern Italy.

Meyerhardt said U.S. government investigators believe that the seized bond forgeries were made using commercial photo enhancement software to alter the image of a $100 bill to increase the amount into millions or billions and add what appear to be interest coupons.

Another U.S. official said the seized bonds were purported to be issued during the Kennedy administration in the early 1960s, but the certificates showed a picture of a space shuttle on it -- a spacecraft that first flew in 1981. Some of the bonds were purportedly issued in a $500 billion denomination that never existed.

This really does not sound like a mafia operation....

Had the news simply confirmed the identity of the individuals, and linked them to the Philippines forgery operation, I would have quietly accepted the story as a simple piece of idiocy. However, the muddying of the waters does give me some concern. I am not inclined to conspiracy theory but, as one commentator pointed out, governments do indulge in skulduggery. I am still not convinced that there is something amiss here, but there is also nagging sense that all is not as it appears. I can not quite convince myself either way. The FT Alphaville article on the latest news also appears to share this sense of unease.

Altogether, this is a very, very odd story. I do feel like I am sounding a little bit like a deranged conspiracy theorist, so please feel free to comment on whether the latest news makes sense to you.

However, I do not want to just focus on the bond story, and thought I would also add some commentary on other news that is current. As such, some other points follow:

Protectionism

The first story that has struck me, is the 'Buy China' rules being implemented in conjunction with China's stimulus measures. As you would expect, the rules are not quite as crude as the 'Buy China' quote suggests. The Chinese government are doing implementing this policy indirectly by asking that any imports used in the stimulus must first have a government permission. In other words, there is an administrative barrier to trade that will no doubt work in conjunction with nationalist sentiment.

As one article makes clear, this appears to be (at least in part) a tit-for-tat response to the 'Buy US' policy in the US, and that this kind of trade discrimination is, in any case, not something new:

China's World Trade Organization commitments require it to treat foreign and domestic goods equally in commercial trade. But Beijing has not signed a WTO treaty that extends such requirements to government procurement, which might limit options for challenging Beijing's "Buy China" order.

Beijing has imposed similar requirements on government projects such as China's giant Three Gorges Dam to favor domestic suppliers of equipment and services.

Ambrose Evans-Pritchard in the Telegraph calls this a 'suicidal' policy, and suggests that it hints that the Chinese recovery is not as strong as has been suggested. If China were to pursue such a policy, in an attempt to protect domestic jobs, it will provide ammunition for those who have been pushing for restrictions on trade with China.

It is hard to disagree with Ambrose Evans-Pritchard, but lurking beneath this may be a reason why China has taken such a bold and inflammatory move. It might just be a signal of the confidence in China that, with their massive holdings of US debt, they hold the whip hand. It could simply be a sign that China now sees the US as impotent, and that China's position allows them to dictate the terms of trade. This is not to say that suicide thesis is wrong, as it is quite possible that China has made a miscalculation, but rather that the possibility of Chinese confidence should not be ignored. We are not privy to the meetings behind closed doors between the governments of both countries, and can only guess at how the shift in relative economic power has actually played out.

What is certain from this latest move is that a significant impetus towards wider protectionism has now taken place. How it plays out may be very significant to the outcome of the economic crisis, but this will rest in the hands of political decisions, rather than any underlying economic drivers.

Instability

A short while ago, I was discussing how there may be wild swings in sentiment, due to investors being unable to decide on a place of safety for their investments. Below is an article on treasuries over the last few days:

TOKYO, June 17 (Reuters) - U.S. Treasuries fell on Wednesday as investors took profits from a four-day rise and avoided adding positions ahead of a Federal Reserve policy meeting next week.

The benchmark 10-year yield had fallen near 3.65 percent on Tuesday, after climbing as high as 4 percent last week, helped by weaker data on manufacturing and industrial output which in part caused a two-day stock slide this week.

Still, price falls were limited as investors continued to unwind trades made on economic recovery hopes and sold stocks and commodities, and shifted some funds back into safe-haven debt.

Prospects of further Fed purchases later in the day after the central bank bought $6.45 billion of Treasury debt on Tuesday also provided some support to the debt market.

But investors were unsure about the direction for Treasuries once profit-taking runs its course, as views remain that the economy has seen the worst of the recession and before hearing the Fed's stance on bond buying at its two-day meeting next week after a spike in long-term yields this month.

I have highlighted this story, as it illustrates the nature of markets at present. They are, quite literally, in a funk of uncertainty. Nobody is entirely sure of the economic data or the economic situation.

Likewise, the roller-coaster ride of the £GB continues, with this story from Bloomberg:

June 17 (Bloomberg) -- The pound dropped by the most in almost two weeks against the euro as stocks retreated and minutes showed Bank of England policy makers voted unanimously to continue their asset-purchasing program.

The British currency also slid versus the dollar after a government report showed claims for U.K. jobless benefits rose in May. The minutes of the central bank’s June 4 meeting showed policy makers decided it was too early to know if the measures designed to lower borrowing costs were working. The FTSE 100 Index fell to its lowest level since May 5, losing 1.2 percent.

“Stocks have been pummeled today as we shift toward a more risk-averse mentality and that’s conspiring to hit sterling,” said Jeremy Stretch, a senior currency strategist in London at Rabobank International. “The pound never does well in this sort of environment.”

The pound weakened 0.8 percent to 85.01 pence per euro by 5:05 p.m. in London, after earlier sliding as much as 1.2 percent, its steepest intraday decline since June 4. It depreciated 0.7 percent to $1.6296.

Claims for jobless benefits rose 39,300 to 1.54 million last month, the Office for National Statistics said today. A broader measure of U.K. unemployment climbed 232,000 to 2.26 million in the three months through April, the statistics office said. The Confederation of British Industry expects the jobless total to peak in the second quarter of 2010 at 3.03 million.

If you review the day to day news that pours from Bloomberg and Reuters, it is apparent that the wild swings seem to gyrate as positive indicators are followed closely by negative indicators. As each 'green shoots' story emerges, another closely follows pointing in the opposite direction. What then appears to follow is a wild swing in sentiment. However, the underlying trajectory of the OECD economies continues in a downwards direction.....making a mockery of each swing to illusory safety.

Fiscal Responsibility?

Perhaps the Bank of England has recognised that it can only prop up the bond market for so long. In a recent speech, the governor has made an explicit call for fiscal responsibility from the government.

The news follows on the heels of the G8 conference, in which exit strategies from stimuli were a subject of debate:

June 15 (Bloomberg) -- Group of Eight finance ministers began drawing up contingency plans for rolling back budget deficits and bank bailouts as the economy shows signs of recovery and investors start worrying about inflation.

Officials meeting in Lecce, Italy, over the weekend said it’s prudent to consider what exit strategies to deploy once global growth is secured and asked the International Monetary Fund to examine how to do so without reigniting the two-year crisis. At the same time, they said it’s premature to rein back more than $2 trillion in stimulus packages.

“Growth should remain the principal focus of policy,” U.S. Treasury Secretary Timothy Geithner said after the meeting ended on June 13. “It is too early to shift toward policy restraint.”

Policy makers trod a fine line in the knowledge that withdrawing stimulus measures too soon could choke the recovery before it starts, and allowing them to last too long might push up borrowing costs. They are also trying to reassure markets after the yield on the 10-year U.S. Treasury note rose last week to the highest since October.

“Markets aren’t looking for specific exit strategies now, but want governments to start thinking about them,” said Bill Witherell, chief global economist at Cumberland Advisors Inc. in Vineland, New Jersey, which oversees $1 billion in assets. “They worry that inflation is going to build up if nothing is done to withdraw the stimulus.”

The interesting point in all of this is that there is an admission implicit in this discussion. There is currently no solid plan of how or when it will be possible to reverse the massive measures taken to support the financial system and 'stimulate' the economy.

As an analogy to this we might think of a corporation going to a bank during troubled times to consider further lending. The bank might ask how long and how severe the downturn might be, and demand firm timescales for when and how the company will turn itself around. If sales are low, where will the new sales come from, if costs exceed revenues, how might the differences be resolved, if there are new competitors stealing market share, how might they regain their share? What new products are in the pipeline, when will they come to market, and what will their impact be on revenue?

Many, many posts ago last year I made a comparison between the US economy and the US automotive manufacturers. The comparison still stands, but now with the story of GM as an indicator of the inevitable ending when basic questions can not be answered. The US economy is in the same place as GM was when the first bailout of GM was issued. The answer at that time given by GM was that company would use the money to tide them over until they worked out a plan for restructuring....in the case of governments, they are not even beholden to any timetable on when they need to even put the plan together. They will get around to it at some point in the future.....

That people like the chief economist at Cumberland Advisors accepts this situation is more than a little baffling. However, I must accept that this is the world view of many who are driving markets. If these people were to have reviewed the situation of GM, they would not be looking at long distant economic performance, but the recent record of failure, and how that failure might be turned to success again. However, in the case of the US economy, they seem to see the equivalent of GM in 1950...and imagine that such long past performance would be an assurance of success for GM now.

Returning to the Bank of England, whilst disagreeing with them on so much, it is at least encouraging that they are pressing for answers from government, albeit whilst adding to problems by continuing to print money to support the financial system.

Anchoring goes Mainstream

In a current Telegraph article, it seems that Tom Stevenson may have picked up on my adaptation of Dan Ariely's anchoring theory.

There are many reasons why those decisions are invariably irrational. These heuristics, or psychological biases, are beginning to be unpicked by the new science of behavioural finance.

One is "anchoring", the tendency of people to measure the value of an asset against some wholly irrelevant number. A study of this asked groups of people to estimate the number of doctors in London but only after they had first provided the last four digits of their phone number. People with the highest phone numbers consistently gave higher estimates of the number of doctors. Completely irrational, of course, but no different from fixating on RBS's share price two years ago when assessing whether it is good value now.

You can find my articles in which I discuss anchoring here and here. Of course, Dan Ariely is well known, and this could be coincidence. However, it would be nice to think that the posts on this blog might seep into the mainstream.

Inflation (again)

For regular readers, it will come as no surprise to find that CPI inflation is above expectations, according to a Telegraph article. As expected, the price of imports is now feeding into the prices of goods on the shelves. Apparently, there are something like £10billion worth of price increases on their way, according to a PWC report (no link for this). I have consistently argued that there will be no deflation for this reason.

In a very odd article, the Telegraph a few days ago came up with an alternative index of inflation, in which they proposed the UK was seeing deflation at -10%. On viewing the figures, it is apparent that the key variables are oil, the price of which again can be partly attributed to the £GB and partly to price rises out of the UK's control, and housing costs, which have been directly influenced by interest rates. The reason for publishing such an article, is completely unclear.....there is not even a source for the figures. Meanwhile a Mail article from April tells a story of soaring prices, according to their own index.

The reality is that, the CPI is the key index for the Bank of England, and the long promised deflation against the index has still not materialised. However, this was one of the great justifications for printing money......I guess that they might (at a push) claim the policy is working, but am not sure that they would want to bring attention to the policy in this context, in case it be subject to serious scrutiny.

Note 1: I am hoping to write an article on a fixed fiat currency system, and will try to put the thoughts that have appeared in different posts into a single post. I am not sure that the idea of a fixed currency could work, but my thoughts on the idea are becoming increasingly positive.

Note 2: I am publishing this in a bit of a rush, so I hope that there are no errors. Please feel free to identify any problems.....