James Saft

James Saft is a Reuters columnist. The opinions expressed are his own.

China’s Christmas day interest rate hike may prove to be bad for global growth but good, at least for a time, for risky assets.

From that perspective, the Chinese policy change could end up being a much-needed helping hand to Federal Reserve chief Ben Bernanke, who has engineered a policy partly aimed to boost economic growth through the false miracle of asset price inflation.

The Chinese rate hike, taking the benchmark interest rate up by a quarter of a percentage point, signals an increased willingness by Chinese authorities to do what they must to dampen the party domestically. The move increased the one-year lending rate to 5.81 percent and one-year deposit rate to 2.75 percent.

It is aimed at cooling inflation, which is running at 5.1 percent annually on the consumer level, not to mention making itself felt through a booming property market and gold-rush-like appreciation in things like herbal remedies and rare delicacies.

Of course, higher interest rates, while they may cool speculation domestically, will only make China more attractive to international capital, which is already slavering at the prospect of an eventual appreciation of the yuan.

This is well understood within the People’s Bank of China: “Many domestic academics are worried that interest rate rises may accelerate global speculative inflows into China,” Sheng Songcheng, the head of statistics at the PBOC, wrote in a piece published on the bank’s website, warning that these flows were exacerbating inflation.

That implies that China may be steeling itself to more effectively block international capital flows.

But these flows, so-called hot money, don’t just exist because people think China is going to be a good investment over the next few years.

Those flows are, at least in part, a function of the extremely easy monetary policy in the United States and Europe, policy that is aimed at forcing money from the sidelines into risk asset markets. For a time, the easy implication of that easy policy appeared to be a grand carry trade, in which  investors partook of the generous liquidity and terms available in Frankfurt and New York and plonked it down in emerging markets, notably China.

MONEY NEEDS A HOME

China appears to be becoming less hospitable to that money, but it will not cease to exist. It will find a way into other markets, perhaps other emerging markets or places like Australia that are a play on emerging markets. It will also drive the developed markets of Europe and the United States.

This is not because growth prospects have improved in the West — given that Chinese growth may be capped by the rate rise, they haven’t — it is because it is cheap money that is seeking some sort of a home.

Federal Reserve officials have been relatively upfront that the second round of quantitative easing was aimed in part at fomenting a rally in asset prices and with it an increase in consumption and demand. Thanks to the latest PBOC hike, they may find that more of that wealth effect is concentrated in the United States.

This is not to say that a U.S. monetary policy aimed at boosting consumption by inflating asset markets is a good thing; it worked out badly the last 10 years and very likely will work out badly this time as well.

For the time being at least, that will not be in the front of investors’ minds. They will see that markets are going up, and if they are fund managers whose performance is tied to a benchmark, that will compel them to take on risk. This in turn will make a lot of economists inclined to see the glass as half full and the talk will be of how the recovery is becoming something worthy of the name.

One crucial hurdle will be the behavior of companies, which have been sitting on billions in cash and have been reluctant to add jobs even if they have been forced to add hours. Will they see a sustainable increase in demand and put money back to work? Or will it be simply another round of speculative frenzy, profitable for some but disruptive for the economy as a whole?

Ultimately China will likely have to raise rates repeatedly and take other strong steps to brook bank-fueled speculation, none of which will do anything good for global demand.

Even so, unless the market gets a shock, most likely from a troubled euro zone, it is fair to expect risky assets to continue to rally, seemingly without reference to the underlying fundamentals.

(At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund.)

James Saft is a Reuters columnist. The opinions expressed are his own.

HUNTSVILLE, Ala — It is going to be an interesting 2011 for British banks, which face funding hurdles and exposure to troubled sovereign debt and property markets.

After the carnage of 2008, the de-facto nationalizations, and the euro zone exposure scares this year, Britain’s large international banks could be forgiven for hoping at year’s end for a bit of peace.

That may not be the result, at least according to a reading of the Bank of England’s Financial Stability Report released this week.

The Bank highlighted a range of dangers, but one looms above the others: funding.

British banks have on the order of $525 to $600 billion of wholesale debt maturing in the coming year, according to the Bank of England, money that must either be refinanced or obtained by cutting back on lending or selling assets.

Partly because their size is so out of proportion to the economy which serves as their host, British banks are heavily reliant on loans, wholesale funds, and short term deposits which are far more likely to take fright and run when threats to stability arise.

The largest looming threat is the bailout or otherwise of the weak euro zone “peripheral” countries, to which the big UK banks are substantially exposed. While British bank funding costs have not been tracking the fortunes or Greece or Ireland closely in recent weeks, there is no logical reason this should persist.

Large British banks are not, as a rule, heavily exposed to the sovereign debt of the weak euro zone countries, but are, in many cases, up to their elbows in mortgage and other types of loans.

Median total exposure to Ireland among the five large banks — Barclays, HSBC, Lloyds, Nationwide Building Society and RBS — was equal to about 45 percent of their Tier 1 Capital, that bit of the banks’ balance sheets that would have to absorb losses. For Spain median total exposure was a bit more than 20 percent of Tier 1 Capital.

That means that should things turn really awful, or more to the point, should the EU waver in its apparent resolve to bail out banks rather than taxpayers, the wholesale markets could easily turn very hostile for British banks needing a hand. Of particular concern, according to the BOE, are money market funds, which are an important source of short-term funds. Money funds took embarrassing losses in 2008 and may well bolt under pressure.

TROUBLE BACK HOME?

Regardless of the funding market, the crumbling Irish economy is already hitting UK banks badly. Lloyds Bank, which is 41 percent owned by the UK following a bailout, last week made a $4.6 billion provision against its deteriorating book of Irish loans, meaning that more than half of its $42 billion exposure to the Irish private sector is now impaired.

Lloyds shares fell sharply on the news, as did those of RBS, its ward-of-the-state peer, as investors reasoned that it too would face increasing writdowns as Irish GDP shrinks under an austerity plan.

The irony, of course, is that Ireland is doing particularly badly in part because it is starving itself in order that no bank senior creditor might take a loss on exposure to Irish banks. Should losses elsewhere in Ireland, Greece or Spain bring down these very same banks in the end the irony will be complete.

Exposure closer to home may prove just as daunting. Thus far the British property market has remained miraculously resilient, despite its still high cost and the high debt burden of the typical British household. This has been a tremendous boon to the banks, with losses on secured lending — mostly mortgages — accounting for less than five percent of total losses in the nine months of 2010.

That may change, however, as British households take a hit from their own version of government austerity, plans that entail deep budget cuts and will eliminate nearly a half a million jobs.

Even before this, however, there is a chill spreading over the British property market, with mortgage approvals stagnating and prices now falling. Prices of houses fell 0.7 percent in November, according to a survey by Halifax, leaving them just 2.8 percent below their January peak.

While British banks can generally pursue borrowers other assets if they default, unlike in much of the U.S., that as a mitigating factor will only last so long as unemployment remains at manageable levels. If unemployment rises sharply, so will defaults.

It is not too hard to construct a scenario in which international capital makes things very difficult for British banks before the next year is out. If so, the BOE will likely step in and provide support.

Support they may, but depending on the kindness of central banks is, both for banks and their investors, a risky strategy.

(At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund.)

You can lie to taxpayers or you can lie to creditors, European authorities are learning, but doing both at the same time is very hard.

The proposed policy that current senior creditors to troubled states will not face losses on their loans but future private lenders will be forced to share in losses with taxpayers is so irrational, so bound to fail that it falls out of the realm of economics and into the ambit of brain injury.

European Union member states will this week hold a summit at which they will create a permanent fund to lend to troubled members under co-called strict conditions of fiscal responsibility.

At the very same time, leaders of the 27-country European Union will sign on to a pronouncement by euro zone finance ministers saying that private lenders will have to share the pain, on a case-by-case basis, of any sovereign debt restructuring after 2013.

So let’s recap, because this is truly bizarre: Lenders to Ireland or the other troubled states won’t take a hit now but if they stick around until 2013 then they will take losses along with the taxpayers. Oh yeah, and the current round of bailouts are aimed at seeing Ireland and Greece through the next couple of years, at which point it will become extremely dangerous to lend to them, as their economies will have shrunk, their debt burdens bloomed and private lenders will be on the hook.

To add to this, the European Stability Mechanism, the name of the new fund, will be senior to all creditors except the International Monetary Fund, meaning that in the event of a bankruptcy it would be paid first. Ratings agency Fitch looked at this provision and quite rightly said that it might lead to lower ratings on shaky euro zone sovereigns.

The only way you could make this policy mix work was if you could find a very rich lender with no ability to conceptualize the future. Hmm, let’s see  a rich entity with limited ability to fully imagine a future state – it must be the European Union!

Few private lenders will stick around, they will sell their bonds and the only buyers will be the EU or ECB, which itself as it understands this predicament is hugely unwilling to play along.

Germany and France are both so unwilling to both have principles and pay for them that they are refusing to act on proposals for common European bonds and are expected to resist moves to increase the size of the European Financial Stability Fund, the vehicle now being used for bailouts.

LIMITED OPTIONS

Germany and France in October began to insist that private creditors would share the pain, thus touching off the current euro zone mini-crisis and bringing forward the ” rescue” of Ireland. I say bring forward because most rational observers realized that Ireland could not pay the debts of its banks, despite having pledged to do so.

Private creditors knew that Ireland is insolvent, as is Greece and very likely Spain, but also knew that since there is no escape hatch from the euro and no apparent will to end the union or bring down insolvent banks that their loans were reasonably safe.

German and French taxpayers know this too and are not happy, as it means their tax money will be flowing to the periphery for years to come. Hence, German and French tough talk and insistence that private creditors will pay in future, which in turn forces investors to act on their analysis of insolvency and sell.

Private money is quite happy to keep funding a bankrupt entity but only so long as the moral hazard play, the implied guarantee from on high, is still in force.

Why then haven’t spreads on weak euro zone bonds risen even higher? Well, besides the fact that the European Central Bank is actively buying, it is the fact that investors can’t quite believe that the European Union is serious.

They know that getting out will be a disaster and a humiliation but that forcing private creditors to take haircuts could cause a banking crisis. So, no haircuts and no reckoning.

Investors are betting, at least for now, that the EU is lying to taxpayers, or to itself, rather than to them.
My guess is that we go on like this for a while; periodic crises that force the EU to pledge ever more money to member states without ever acknowledging that they are insolvent or forcing their private creditors to swallow losses.

That ends only if one of three things happens; the market decides that it won’t lend to Germany and France anymore, the weak nations revolt from austerity or the taxpayers of Germany and France decide that euro-geddon is better than picking up every check.

(At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund.)

The revolving door between government and Wall Street is wrong, antithetical to both democracy and capitalism and ought to be stopped.

For the second time in two weeks a high-ranking recent U.S. public servant has traded a position of influence in the corridors of power for a massive paycheck working for an institution that owes its very existence to government largess.

This time it is Theo Lubke, who has transitioned smoothly from heading the New York Federal Reserve Bank’s derivative regulation effort to working for Goldman Sachs, where he can be expected to, well, help it do well out of regulation, current and future.

Last week it was Peter Orszag, who until July was the Obama administration’s Director of the Office of Management and Budget, joining Citigroup’s investment banking unit as a vice chairman. Several days before that Citi hired George W. Bush’s Commerce Secretary, Carlos Gutierrez, as vice chairman for its institutional clients group.

To be clear, none of the parties is doing anything illegal and there is no suggestion that any of them wittingly acted against the public interest while in government service.

That, however, is a very low standard and far from an argument for a system in which regulators and high-ranking political appointees oversee the financial industry while at the same time having a near guarantee of being in line to be made rich by it a short time after leaving office.

It would take an angel to stand aloof from that kind of money, especially after having rubbed shoulders for years with their better paid, better shod but not better qualified peers in banking.

Money gives people a warm fuzzy feeling, and so does the prospect of it; it is little wonder that financial regulation has been so loose and so poorly enforced.

And please, don’t tell me that the right to go and make a fortune in finance afterwards is the price a people must pay for the services of the most able policymakers. Larry Summers is a genius and Bob Rubin evidently the wonder of the world, but having them at the center of banking and regulation has hardly been a boon for either taxpayers or investors these past 15 years.

The United States would have been far better off, as it was until the 1980s, with a set of regulations so tight it could be administered by plodders and a banking industry peopled by able but unimaginative types making a decent living.

That, of course, would lower the rewards on offer in banking, both in terms of the money banks could produce and their motivation to offer it. And don’t believe that simple banking can be equated to simple medicine or technology; on the evidence growing complexity in financial services has hurt clients, shareholders and taxpayers, leaving the sole certain winner bank employees. Future bankers in public service have done rather well out of it too, you could say.

NUPTIAL LOGIC

The Orszag-Citigroup marriage is particularly striking, given that he was in the inner circle of an administration that made the controversial decision to keep the bank alive despite ample evidence that it richly deserved to fail. If that does not give you a queasy feeling, and on the evidence it did not for Orszag, consider that Citigroup is now the lucky owner of too-big-to-fail status, giving it an unfair advantage over smaller competitors who haven’t convinced those in power that they are indispensable.

Hanging on to the too-big-to-fail brass ring is arguably job 1 for Citigroup going forward and having someone with Orszag’s experience and, er, contacts is obviously useful. Gutierrez can be viewed as an insurance policy against the fickle winds of political fortune.

As for the Lubke-Goldman nuptials, the attractions and dowry are pretty much the same. While Lubke can’t claim credit for seeing Goldman through its rough patch during the crisis, he was, as head of the New York Fed’s Financial Infrastructure Department instrumental in derivative regulation reform efforts. He is reported to have pushed for on-exchange trading, a policy that is almost certainly against Goldman’s best interest, it must be said. As a former top Fed official he will be banned from any Fed-Goldman meetings or from contacting his former colleagues on matters in the area he once worked, according to Bloomberg News.

That is something, but not nearly enough.

It is all quite a contrast with Kansas City Fed President Thomas Hoenig, who asked by the New York Times about his plans after his coming retirement, said:

“I can tell you one thing. I’ll never work for a too-big-to-fail bank.”

Hoenig, cussed as he is, is a bit of an angel, and so may be Lubke, Orszag and Gutierrez, but depending on angels is a lousy policy.

(At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund.)

Iceland’s remarkable return to growth shows once again that in this crisis the best policy is often the one that will make international partners most angry.

Having been reviled and chastised when it refused to make good the outsize debts of its banks, Iceland this week capped a striking turnaround when it announced that its economy expanded by 1.2 percent in real terms in the most recent quarter, its first such rise in two years.

This is in stark contrast to Ireland, whose pliability and inability as a member of the euro zone to act unilaterally leaves it with a still crashing economy which must service ever more debt by making ever deeper cuts to public spending.

Iceland, which sailed into the crisis in 2008 as essentially a small fishing fleet with a massive hedge fund attached, looked its predicament square in the eye and followed a set of policies seemingly designed to tick off both its friends and enemies, doing its small but mighty best to beggar its neighbors by letting its currency crash, imposing capital controls and, crucially,  refusing to make whole the global creditors of its three failed international banks.

While an International Monetary Fund and multilateral package was eventually agreed, and a deal with Britain and the Netherlands over debts from Icesave Bank are currently being hammered out, Iceland’s leaders, at least the current ones, seem convinced that making bank creditors share its pain was the right course.

“The difference is that in Iceland we allowed the banks to fail. These were private banks and we didn’t pump money into them in order to keep them going; the state should not shoulder the responsibility,” Iceland’s president, Olafur Grimsson, said last month, tweaking the nose of EU officials who are insisting that Ireland make good all senior creditor calls on its own distended banking system.

“Bondholders should not rely on the government stepping in and bailing them out,” Iceland Central Bank governor Mar Gudmundsson said last week. “They should do their due diligence.”

“I think the Irish are accepting that they were probably too fast in guaranteeing the whole liabilities of banks. Now this is turning out to be a big burden because the assets of these banks turned out to be much worse than they thought.”

Indeed. Though Iceland has a 6.3 percent budget deficit this year, it is on track to soon record a surplus, while Ireland’s deficit this year is 32 percent if the cost of bank bailouts is included. Similarly, Iceland’s unemployment rate has fallen by almost a quarter to 7.3 percent, as against more than 14 percent in Ireland.

LEARNING FROM MAHATHIR
It is all strangely reminiscent of Malaysian leader Mahathir Mohamad, who attracted international condemnation when in 1998 he rejected IMF measures, instead pegging the ringgit to the dollar and imposing widespread capital controls. Your correspondent was among those who stroked his chin and said that Malaysia would rue the day it cut itself off from international capital, but of course this proved to be far off the mark.

Malaysia recovered robustly, foreign capital eventually flowed and more to the point, the country and its Asian neighbors learned the importance of being able to self-insure against the vagaries of global capital flows, leaving them by and large better prepared for the most recent crisis than the rest of the world.

While Mahathir was a strongman acting against international and internal advice, Iceland’s mulishness has been a model of democracy. In a March referendum 93 percent of voters rejected a deal with Britain and the Netherlands to repay 3.9 billion euros of Icesave losses. Even more striking, and a contrast with a singular lack of prosecutions elsewhere, was the decision of Iceland’s parliament to refer to the legal system  criminal charges surrounding the crash against former Prime Minister Geir Haarde.

To be sure, Iceland may have succeeded in rejecting the international consensus precisely because it is so small — many argue that a default by Irish banks would cause another global banking crisis costing far more than 30 or 50 percent of Irish GDP.

Quite possibly it would, but that does not mean that the policy of pretending that banks are not insolvent and loans not underwater is wise. The tepid, halting and largely jobless recovery argues that it is not, that debts need to be properly purged before both borrowers and lenders can play their respective roles.

Regardless, the great victory of Icelandic stubbornness is not just in its recovery but in winning a fairer division of the burden than in Ireland, Greece, or for that matter, the U.S.

(At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund. email: jamessaft@jamessaft.com)

James Saft is a Reuters columnist. The opinions expressed are his own.

The move to reform taxation of billions of dollars in so-called carried interest paid to hedge fund and private equity executives is dead and prominent among the mourners should be investors in U.S. debt.

A country that can’t even get it together to ensure that some of its highest paid people pay as much proportionally in tax as their secretaries and personal trainers is a country with very little hope of effecting meaningful budgetary reform.

Suffice to say that the long bond didn’t sell off on news that U.S. Senate Finance Committee Chairman Max Baucus has dropped a higher carried interest provision from his since-defeated tax bill, a sign that the Democrats have effectively given up hope of the measure. The news should, however, make holders of U.S. debt even more willing to sell to the Federal Reserve, currently buying Treasuries often and in size. The script has been written for tax and spending reform over the next two years and for lenders to the U.S. the story does not end happily.

As it stands private equity and other investment managers pay the lower capital gains rate on “carried interest,” their share of the takings when a holding such as a start-up or turnaround is sold at a profit. That means many pay taxes for the bulk of their compensation for their labor at a lower rate than many middle-class earners, an injustice so patent as to be seemingly unarguable.

Arguable of course it was, and the private equity industry mounted a lobbying campaign that has had a return on investment most of us can only dream of, painting the proposed reforms as an attack on funding for innovative job-creating start-up businesses and even, unbelievably, as against the best interests of pension savers. And while I am sure that the anti-carried-interest lobby is talented, well funded and smart, I doubt very much that they are that much better than the lobbies that will work against most other tax rises or spending cuts over the next two years.

The industry argued both that a rise in tax on carried interest would fall on the savers putting money into the industry and on the businesses that it finances, but this is far from evident.

“The tax on carried interest is a tax on the fund mangers and not the enterprise. In competitive markets the burden of taxation is borne by the employee. If (fund managers) could demand more they would already be doing it,” said Victor Fleischer, an associate professor of law at the University of Colorado, whose work on tax policy underpinned the original effort to reform carried interest treatment in 2007.

“This encapsulates the political problems in our country, this is why it is difficult to get good public policy done.”

A GIANT MISALLOCATION OF TALENT

Some even argued that even if a higher tax on carried interest fell solely on investment managers this was bad policy because it would drive talent from the industry, to the detriment of all of us who are depending on it to earn enough so that we can keep the heat on once we retire.

Besides being maddeningly self serving, this argument is probably just about the opposite of true.

Something that lowers hedge fund and venture capital compensation, especially if it is done via righting an inequity, is precisely what the U.S. needs.

Over the past generation out-sized compensation in financial services has, in combination with other factors, driven an increase in financial engineering and other activity that has not driven growth, has not allocated capital well and has served as an effective tax, or rent charge, on the rest of the economy.

So if you are telling me that eliminating the carried interest tax break means that the smart people won’t go into finance, then I’ll take it. That’s what prevailed in the U.S. in the 1940s through the 1960s, periods when growth was robust, well distributed and less liable to be financed with too much debt. Let those with great quantitative skills go into engineering not securitization, and the best managers go to GM rather than Carlyle Group.

So, the death of carried interest tax reform is indicative of two large negatives for the U.S. economy, and by extension for holders of U.S. debt.

First, despite the crisis there are few signs that the financialization of the economy will be reversed. Indeed, most policy changes since the storm broke are aimed at supporting that industry rather than effectively controlling its size and risk.

Second, the political process in the U.S. shows few signs of being able to effectively grapple with the unpleasant choices presented by the debt built up these last 40 years.

At some point, probably not soon, this will become apparent in the Treasury market.

(At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund.)

The good news is that the European Central Bank will probably start a massive additional round of quantitative easing to fight the break-up of the euro zone.

The bad news is that they will, as ever, only choose the right policy, as Winston Churchill said of the Americans, after exhausting all of the alternatives.

Global share markets rallied furiously on Wednesday, fed by hopes that the ECB would increase its bond-buying efforts, a possibility raised by its chief Jean-Claude Trichet in an appearance before the European Parliament. Trichet faces stern opposition inside the ECB from fellow central bankers, notably German Axel Weber, who believe that policy should be normalized rather than loosened.

This opposition, in combination with an unsure political climate, means that euro zone authorities will probably continue to try to buttress, enlarge and formalize the bailout mechanism while trying to maintain the fiction that something approaching normality reigns in European money and bank funding markets.

Why would QE be used to fight the break-up of the euro zone, now being widely discussed as the crisis spreads to ever larger member states?

Because QE, or really we should simply call it the monetization of government borrowing, offers some hope of easing the austerity now being imposed on Ireland and soon to come in Portugal and Spain.

Europe has made a choice to not allow member states to default or to allow their weakened banks to default, as default would threaten banks elsewhere. That leaves weakened economies carrying a crushing amount of debt, debt they will attempt to repay by budget cuts. This is a recipe for an economic death spiral, as a smaller and smaller economy becomes less and less able to shoulder its debt service.

Without their own currencies to devalue, the weak of Europe have no other safety valves.

While QE is genuinely dangerous, it will ease conditions and can be directed at peripheral bond markets.Default is a better option, but Europe is unwilling to go there, at least not yet.

So, QE it will be, but the issue becomes when and how large.

“If the political masters in Europe wish to maintain the status quo then the answer lies in the monetization of debt. The ECB, with the ability to print money, can support the market by buying government bonds,” Stefan Isaacs, of fund manager M&G Investments, wrote in a note to investors.

“However what is needed is ‘shock and awe’ rather than tentative, reactionary responses, if indeed the ultimate goal is to support the euro in its current guise. That said, I’m not convinced that an about-turn is likely any time soon. The hawks in the ECB remain, for now, firmly attached to their mandate of price stability.”

EUROPE LOOKS FOR A BAZOOKA
For now, the ECB is likely to do what it can by way of bond purchases and liquidity support while temporizing over the pace and scale of returning the system to normality.

The focus of action, then, will be on increasing the size and prestige of the European Financial Stability Facility,  created in May and so far employed to help both Greece and Ireland. ECB council member Weber suggested in November this could be increased and there have been some indications that both the euro zone and IMF are discussing this.

This strategy is appealing to Weber and to others in Europe because it emphasizes euro zone strength and resolve, taking real money and lending it to allow member states time to pay back their debts, rather than printing up a mess of inflation and euro weakness to ease the pain.

A muscular strategy, but also a failing one. The 750 billion euros was meant to be big and intimidating back in May, but now looks paltry. If Spain needs help would 1.5 trillion euros look much better? Not if the debts of the weak Spanish regional banks are not partly extinguished. The same math of austerity and growth that applies now to Ireland will apply to Portugal and Spain in time.

So, QE, preferably large, from the ECB, but likely not until they are pushed early next year.

If this happens, or rather as its likelihood rises, it will drive a massive rally in risk assets and drive even more liquidity to Asia. Many investors will be giddy that the ECB and Federal Reserve are both driving asset prices higher, while a substantial minority, fearing inflation, will flee government debt and buy energy, commodities and gold.

The big loser, in the near term, will be China, which will have to eat European- and U.S.-exported inflation and will fret over its trillions in euro and dollar reserves.

(At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund.  email Saft at: jamessaft@jamessaft.com)