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1 December 2012 Edition Restricted & Confidential

Copyright 2012 Gordon T. Long All Rights Reserved [email protected]

FISCAL CLIFF: US Capitulates on 'RISK FREE'The US$ as the Global Reserve Currency Has Officially Entered It's Twilight Era

GLOBAL MACRO TIPPING POINTS - DECEMBER 2012

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2December 2012 Edition Restricted & ConfidentialCopyright 2012 Gordon T. Long All Rights Reserved [email protected]

FISCAL CLIFF: US Capitulates on 'RISK FREE'The US$ as the Global Reserve Currency Has Officially Entered It's Twilight Era

GLOBAL MACRO TIPPING POINTS - DECEMBER 2012

TIPPING POINTS........................................................................................................................................................................................ 8

GLOBALMACRO:RISKASSESSMENT ...................................................................................................................................................... 8

SITUATIONAL ANALYSIS ...................................................................................................................................................... 8WE ARE HERE................................................................................................................................................................................................................. 8TROUBLING Q3 2012 DEVELOPMENTS..................................................................................................................................................................... 9RISK CONTINUUM......................................................................................................................................................................................................... 15

MACRO MONITORING INSTITUTIONS ............................................................................................................................... 16WEF (WORLD ECONOMIC FORUM) .......................................................................................................................................................................... 16IMF (INTERNATIONAL MONETARY FUND) .............................................................................................................................................................. 23OECD (ORGANIZATION FOR ECONOMIC COOPERATION & DEVELOPMENT) .............................................................................................. 38NIELSEN (GLOBAL CONSUMER SENTIMENT) ....................................................................................................................................................... 40MAPLECROFT (SCANNING THE GLOBE) ................................................................................................................................................................ 46

GLOBAL RISK SIGNALS ...................................................................................................................................................... 48RISK - RISING GEO-POLITICAL EVENT RISK.......................................................................................................................................................... 49RISK - UNCHARTERED MONETARY POLICY WATER........................................................................................................................................... 53RISK - FOOD INFLATION RETURNING..................................................................................................................................................................... 55RISK - SLOWING GLOBAL ECONOMIES.................................................................................................................................................................. 56RISK -INCREASINGLY DYSFUNCTIONAL CAPITALS MARKETS........................................................................................................................ 57

GLOBALMACRO:RISKLEVELS .................................................................................................................................................... ............ 59

AGGREGATED GLOBAL FINANCIAL RISK INDEX .............................................................................................................. 59BANKING RISK - LIBOR-OIS SPREAD (Updated) .................................................................................................................................................... 60BANKING RISK - TED SPREAD (Updated) ................................................................................................................................................................ 60CREDIT RISK - GLOBAL CREDIT DEFAULT SWAPS (Updated).......................................................................................................................... 61CREDIT RISK - EU CREDIT DEFAULT SWAPS (Updated) ..................................................................................................................................... 62CONSUMER RISK - HOUSING - RATE OF CHANGE (Reference) ........................................................................................................................ 63ECONOMIC RISK - ECRI LEADING INDEX (Updated) ............................................................................................................................................. 64INFLATION RISK - MONEY SUPPLY GROWTH - M3 (Updated) ............................................................................................................................ 65INFLATION RISK - MONEY VELOCITY (Updated) .................................................................................................................................................... 66MONETARY RISK - BANK LIABILITIES (Updated) ................................................................................................................................................... 66

COST OF MONEY RISK - INTEREST RATES (Updated)........................................................................................................................................ 68AGGREGATED RISK LEVEL ................................................................................................................................................ 70

TIPPINGPOINTS:CHANGES................................................................................................................................................................ ...... 71

TIPPING POINT MAPPING: 2012 UPDATE .......................................................................................................................... 71SHIFTS TO WATCH IN 2012 ................................................................................................................................................ 74

TIPPINGPOINTS:TOP5FOCUS-SEPTEMBER 2012.......................................................................................................................... 81

I - EU BANKING CRISIS ....................................................................................................................................................... 81II - SOVEREIGN DEBT ......................................................................................................................................................... 83III - RISK REVERSAL ............................................................................................................................................................ 85

IV - CHINA HARD LANDING ................................................................................................................................................. 86V - JAPAN DEBT DEFLATION .............................................................................................................................................. 89

DRIVER$:RISK-ON-RISK-OFFANALYTICS........................................................................................................................................... 91

1- G10 MACRO SURPRISE INDEX ...................................................................................................................................... 942- CUMULATIVE GLOBAL PMI ............................................................................................................................................. 973- SLOWING GLOBAL EXPORTS ...................................................................................................................................... 1034- US NON-REVOLVING CONSUMER CREDIT ................................................................................................................. 1065- IBES' RELATIVE GLOBAL PE RATIOS .......................................................................................................................... 1096- CONSENSUS EARNINGS ESTIMATES - Sell Side Analysts .......................................................................................... 1157- INFLATION PRESSURES - Global Food Prices.............................................................................................................. 117

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GLOBAL MACRO.................................................................................................................................................................................... 121

GLOBALECONOMICOUTLOOK .................................................................................................................................................... .......... 123

IMF CUTS ECONOMIC OUTLOOK ..................................................................................................................................... 123IMF Cuts Advanced Economies Growth by 25% f rom 2.0% to 1.5%..................................................................................................................... 123

IMF Cuts Growth from 3.9% to 3.6% and Increases Deficit Multiplier by 100 to 200%........................................................................................ 130

WARNINGS ........................................................................................................................................................................ 132IMF WARNS ....................................................................................................................................................................... 132

Japanese & Spanish Debt Unsustainable.................................................................................................................................................................. 132Global Recovery Faltering, Reduces Global Growth to Just Above 3% Global Recession Level....................................................................... 134

BIS WARNS ........................................................................................................................................................................ 136Monetary Policy At Its Limits........................................................................................................................................................................................ 136

WORLD BANK WARNS ...................................................................................................................................................... 137Social Unrest Stems from Shrinking Disposable Income. Jobs are the central issue. ......................................................................................... 137

GLOBALCENTRALBANKING ................................................................................................................................................................ ... 139Global Balance Sheet Expansion................................................................................................................................................................................ 139First Remove Gold Standard, Now Remove Debt.................................................................................................................................................... 142

GLOBALINDICATORS ............................................................................................................................................................................... 145

GROWTH............................................................................................................................................................................ 145Slowing Global Growth - Air Cargo Shipments......................................................................................................................................................... 145Global Slwoing- Export / Import Confirmations.......................................................................................................................................................... 146Further Confirmations Global Growth Has Collapsed............................................................................................................................................... 147Europe Continues to Force Global Growth Estimate Reductions........................................................................................................................... 148GDP Reductions - By Region...................................................................................................................................................................................... 149Manufacturing PMI - By Country................................................................................................................................................................................ 155

SENTIMENT ....................................................................................................................................................................... 158Europe has a Growing Sentiment /Confidence Problem.......................................................................................................................................... 158

CREDIT MARKETS............................................................................................................................................................. 165Stable but Tenuous....................................................................................................................................................................................................... 165

INFLATION ......................................................................................................................................................................... 167Food Prices, Driver of Social Unrest........................................................................................................................................................................... 167Where Do these Deflators Come From?.................................................................................................................................................................... 168

TRENDS ............................................................................................................................................................................. 169Commodities and Brands Tell the Global Story......................................................................................................................................................... 169

GEO-POLITICALTENSIONS ................................................................................................................................................................ ..... 181

IRAN ................................................................................................................................................................................... 181Watch Out for a "False Flag" or "Covert" Activity Event........................................................................................................................................... 181Who Is Threatening Who Here?.................................................................................................................................................................................. 181

CURRENCY WARS ............................................................................................................................................................ 183The Race to Debase..................................................................................................................................................................................................... 183

EUROPE-MUDDLESTAGEENDS-CRISISSTAGEBEGINS........................................................................................................................ 185

SUMMITS ........................................................................................................................................................................... 186The 20th Summit........................................................................................................................................................................................................... 186Muddle" Stage has ended. "Crisis" Stage has Begun.............................................................................................................................................. 186A Banking Union & Central Budget............................................................................................................................................................................. 188

Government Debt Dynamics Interactive Model......................................................................................................................................................... 189Roadmap of EU Hurdles and Surprises Ahead......................................................................................................................................................... 190"19th Nervous Breakdown".......................................................................................................................................................................................... 192

MEDICAL CHARTS -Situation Critical ............................................................................................................................... 199Perceived Reduction in Risk - A Temporary Aberration........................................................................................................................................... 199Dangerous Delusional Divergences............................................................................................................................................................................ 201IMF Projections for Euro Area and GIIPS.................................................................................................................................................................. 202Euro-Area Manufacturing Shrank in September....................................................................................................................................................... 203Misery Indices Never Been Higher.............................................................................................................................................................................. 203

EUROSIS -A Terminal Disease ........................................................................................................................................ 210

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PROGNOSIS: Why the European Situation Will Get Worse................................................................................................................................... 210PROGNOSIS: Increasing Structural Imbalances...................................................................................................................................................... 213PROGNOSIS: $22T Unaccounted - A Hidden World of Contingent Liabilities, Government Backing & Guarantees. ................................... 215PROGNOSIS: Monetary Malpractice - ECB's LTRO Not a Solution but................................................................................................................ 219PROGNOSIS: Monetary Malpractice - ECB's SMP Effort Futile............................................................................................................................. 222PROGNOSIS: Monetary Malpractice - ECB Accepts BBB Collateral..................................................................................................................... 224PROGNOSIS: EU Banking Overbanked, Undercapitalized and Now Insolvent.................................................................................................... 225PROGNOSIS: Monetary Malpractice - TARGET2 "Contingent Liabilities"............................................................................................................. 226PROGNOSIS: Bailouts - Unsustainable & Unfundable............................................................................................................................................ 232

IBERIAN PENINSULA - Spain & Portugal Imploding ........................................................................................................... 234Credit Downgrades - At Precipice of "Non Investment Grade"................................................................................................................................ 234Regional Bailout Bailouts a Massive Problem........................................................................................................................................................... 235NPL Going Ballistic....................................................................................................................................................................................................... 236Spanish Funding Problem............................................................................................................................................................................................ 237Banks on Artificial "Ponzi Bond" Life Support............................................................................................................................................................ 246

ITALY - Cracks Impossible to Hide and Contain .................................................................................................................. 253Bad Debt Continue to Soar.......................................................................................................................................................................................... 253

UK ....................................................................................................................................................................................... 258QE Extension Coming.................................................................................................................................................................................................. 258

FRANCE ............................................................................................................................................................................. 260Has Turned back to Socialism..................................................................................................................................................................................... 260

ASIA-CHINA-JAPANCONFLICTEMERGES................................................................................................................................................... 262

CHINA - POLITICAL TRANSITION ..................................................................................................................................... 264China' Political Transition & Ongoing Emergence as a Super Power..................................................................................................................... 266An Implicit Social Contract........................................................................................................................................................................................... 268ChinaManipulated Statistics due to Upcoming Decade Long Regime Change..................................................................................................... 270Declining Reserve Accumulation................................................................................................................................................................................. 271China Has Caught the Gold Bug big time!................................................................................................................................................................. 273Increasing Leverage is China's Way of Monetary Easing........................................................................................................................................ 274Possible Interest-Rate Liberalization.......................................................................................................................................................................... 275Shanghai Composite at 2008 Low Levels.................................................................................................................................................................. 276Shanghai Composite Warnings Signs........................................................................................................................................................................ 277China's Credit to GDP.................................................................................................................................................................................................. 279A Slow Recovery Through 2013.................................................................................................................................................................................. 280Manufacturing PMI in Contraction Territory............................................................................................................................................................... 282SHADOW BANKING.................................................................................................................................................................................................... 283Shadow Banking System Report................................................................................................................................................................................. 283Shadow Banking in China............................................................................................................................................................................................ 284Socit General Sees a Likely Soft Landing!............................................................................................................................................................ 285

JAPAN: AUTO EXPORTS TO CHINA PLUMMET 44.5%. JAPAN'S LARGEST EXPORT MARKET ................................... 293Exports Continue To Tumble....................................................................................................................................................................................... 295Intervention Fails Again - It's a Whole new Ball Game............................................................................................................................................. 296Japan in Negative PMI and GDP Territory................................................................................................................................................................. 298

EMERGINGMARKETS-SYNCHRONIZEDMARKETS................................................................................................................................. 301Synchronized Markets.................................................................................................................................................................................................. 302Export Growth Looks Similar to pre-2008.................................................................................................................................................................. 304Global Slowing: A Quickly Worsening Situation Across Asia................................................................................................................................... 305Risks All on the Downside for Asia............................................................................................................................................................................. 306Demographic Headwinds............................................................................................................................................................................................. 308Pronounced Flight to Safety......................................................................................................................................................................................... 309India: Watch Out For RE-Emergence of Food Price Inflation.................................................................................................................................. 310

US ECONOMY......................................................................................................................................................................................... 312

THEGLOBALMACROOVERLAY ................................................................................................................................................... .......... 313

MACRO POSITIONING: A Serious Global Slowdown Underway ........................................................................................ 313MACRO POSITIONING: Credit Fueled Globalization in Retreat .......................................................................................... 317MACRO POSITIONING: Notion of Eurozone "Decoupling" Has Ended. .............................................................................. 319MACRO POSITIONING: Nielsen's Global Survey - "Consumers Cutting Back & Worrying about a Recession" ................... 322MACRO POSITIONING: Executives Report Deteriorating Economic Environment .............................................................. 325PROSPERITY AT RISK: Harvard Strategy Study Spells Out US Problem ........................................................................... 328

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USINVESTMENTCYCLE................................................................................................................................................................. .......... 332

GORD'S BIG PICTURE ECONOMIC CYCLE ...................................................................................................................... 332ECONOMIC INDICATORS .................................................................................................................................................. 333

MONTHLY INDICATORS OF NOTE.......................................................................................................................................................................... 333

THE CURRENT BUSINESS CYCLE - SITUATIONAL ANALYSIS ....................................................................................... 339ECONOMIC CYCLE, INVESTMENT CYCLE, SECTOR ROTATION.................................................................................................................... 339JOBS - CONFIDENCE - CONSUMPTION - GROWTH CYCLE............................................................................................................................. 343

JOBS......................................................................................................................................................................................................................... 344CONSUMER & BUSINESS SENTIMENT.............................................................................................................................................................. 353CONSUMPTION........................................................................................................................................................................................................ 370GROWTH................................................................................................................................................................................................................... 384

USGOVERNMENTSURRENDERS 'RISKFREE" .................................................................................................................................. 396

Exorbitant Privilege ............................................................................................................................................................. 396US Firmly in Stage 5 of the "Sovereign Life Cycle" .............................................................................................................. 401The Price of Political Chicanery ........................................................................................................................................... 404

"Kick the Can" Politics.................................................................................................................................................................................................. 404

USPUBLICPOLICY-SOMENOTABLEPOLICYPROBLEMS............................................................................................................. 405

POLICY: Congressman Ron Paul's Farewell Speech to Congress ...................................................................................... 407POLICY: Credit Growth Solely Government Funded ........................................................................................................... 412POLICY: Government's Consumption Spending versus Investment Spending .................................................................... 414POLICY: FHA is a Case Study in Failed Public Policy ......................................................................................................... 416POLICY: What Was Intentionally Avoided During the Election Promises By Both Parties .................................................... 420

What about the $84T in Unfunded Federal Entitlements?....................................................................................................................................... 420What about the $5T in Unfunded State & Local Government Pension Obligations?............................................................................................ 421What about the $1T in Student Loan Bubble?........................................................................................................................................................... 424What about the ...... ?................................................................................................................................................................................................... 425

POLICY: Failure to Recognize & Alter Policy When it is Clearly Not Working ...................................................................... 425Stimulus Hasn't Worked. It is Camouflaging Something Deeper..................................................................................................................... 430

POLICY: A Capitalist System No Longer Realistically Operate When the State Borrows at a Negative Cost ....................... 432

MONETARYPOLICY-ELECTILEDYSFUNCTIONAL.................................................................................................................................... 435

HIGHLIGHTS ...................................................................................................................................................................... 435QE III POST MORTEM - BROKEN FED MODEL ................................................................................................................ 437

POST MORTEM: Market Reacts Badly...................................................................................................................................................................... 437

POST MORTEM: Currency War Salvos & The $67T Shadow Banking Currency Cartel..................................................................................... 439POST MORTEM: Fed's Broken Model....................................................................................................................................................................... 448POST MORTEM: QEfinity Working Psychologically the same as 1987 Pre-Crash Portfolio Insurance............................................................ 450

FED'S NEXT STEP ............................................................................................................................................................. 452NEXT STEP: Current Fed Thinking............................................................................................................................................................................ 452NEXT STEP: Fed Lays Foundation for Further Policy Changes............................................................................................................................. 453NEXT STEP: High Probability Direction..................................................................................................................................................................... 459NEXT STEP: Communications to Ensure "Duration" Understood.......................................................................................................................... 461

FED INDICATORS .............................................................................................................................................................. 462PATTERNS: Velocity of Money................................................................................................................................................................................... 462PATTERNS: Real Negative Rates.............................................................................................................................................................................. 464PATTERNS: Short Interest Rates a Fed Problem.................................................................................................................................................... 466CHARTS: Fed Deliberately ignoring data on both growth and inflation.................................................................................................................. 467

PREVIOUSQUARTERLYSUMMARY-REFERENCE............................................................................................................................... 469

FISCALPOLICY-FROMPOLITICALPOLLINGTOPOLITICALBRINKSMANSHIP......................................................................... 470

HIGHLIGHTS ...................................................................................................................................................................... 470TIMELINE: Calendar of Events Ahead ................................................................................................................................ 474

PREDICTIONS.................................................................................................................................................................... 475PREDICTION: The High Probability Outcome.......................................................................................................................................................... 475PREDICTION: Political Brinksmanship & Vigilantes................................................................................................................................................. 476PREDICTION: US Unwittingly Surrenders "Risk Fee" Status.................................................................................................................................. 484

PERSPECTIVES ................................................................................................................................................................. 485

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PERSPECTIVE: One Non-Mainstream Analyst's Views.......................................................................................................................................... 485PERSPECTIVE: One Mainstream Analyst's Views.................................................................................................................................................. 488PERSPECTIVE: A Collection of Wall Street Views................................................................................................................................................... 493PERSPECTIVE: Barron's Weigh In............................................................................................................................................................................ 495PERSPECTIVE: Goldman's Fiscal Cliff Scenarios................................................................................................................................................... 498

CHARTS ............................................................................................................................................................................. 502KEY CHARTS: Growth & Jobs.................................................................................................................................................................................... 502KEY CHARTS: Taxes & Spending.............................................................................................................................................................................. 505KEY CHARTS: Politics & Policy.................................................................................................................................................................................. 508KEY CHARTS: The Stakes.......................................................................................................................................................................................... 509KEY CHARTS: Payroll Tax Holiday............................................................................................................................................................................ 512CHARTS: Tax Rate Comparisons............................................................................................................................................................................... 513CHARTS: Risk Perceptions......................................................................................................................................................................................... 514CHARTS: 2013 Quarterly Impact................................................................................................................................................................................ 515CHARTS: Budget Deficit.............................................................................................................................................................................................. 516CHARTS: Sovereign Debt............................................................................................................................................................................................ 518CHARTS: State & Local Government Drag............................................................................................................................................................... 519CHARTS: Government Dependence.......................................................................................................................................................................... 522CHARTS: Coming Demographic Shock..................................................................................................................................................................... 522

TREASURY FUNDING ....................................................................................................................................................... 525TREASURY DEBT: Latest TIC Table......................................................................................................................................................................... 525

TREASURY DEBT: Who is Buying?........................................................................................................................................................................... 526

BUDGET ............................................................................................................................................................................. 528

STATEMENTS: As A Corporation it is Both Insolvent & Exhibits Fraudulent GAAP Accounting Practices....................................................... 528QUARTERLY US BUDGET UPDATE........................................................................................................................................................................ 535

PREVIOUS QUARTERLY SUMMARY - Reference ............................................................................................................. 539

KEYDRIVERS-CATALYSTSOFCHANGE............................................................................................................................................ 540

EMPLOYMENT ................................................................................................................................................................... 5441- CAPITAL SPENDING.............................................................................................................................................................................................. 5442- SMALL BUSINESS OPTIMISM.............................................................................................................................................................................. 5473- DEMOGRAPHIC SHIFT.......................................................................................................................................................................................... 551

RESEARCH OF NOTE................................................................................................................................................................................................. 556

REAL DISPOSABLE INCOME ............................................................................................................................................ 561

RESEARCH OF NOTE................................................................................................................................................................................................. 565

US RESIDENTIAL REAL ESTATE ...................................................................................................................................... 570OVERVIEW.................................................................................................................................................................................................................... 570CURRENT SITUATIONAL ANALYSIS....................................................................................................................................................................... 574CURRENT HOME OWNERSHIP TRENDS............................................................................................................................................................... 574NEW HOME SALES - Not as Strong as Headlines & Excitement Suggests......................................................................................................... 578HOUSING - Potentially Increasing Supply v Demand Problem............................................................................................................................... 582NATIONAL STATISTICS: PRICE............................................................................................................................................................................... 584NATIONAL STATISTICS: EXISITNG HOME SALES............................................................................................................................................... 586NATIONAL STATISTICS: NEW HOME SALES........................................................................................................................................................ 588

RESEARCH OF NOTE................................................................................................................................................................................................. 589

US COMMERCIAL REAL ESTATE ..................................................................................................................................... 595OVERVIEW.................................................................................................................................................................................................................... 595

NATIONAL STATISTICS: COMMERCIAL REAL ESTATE...................................................................................................................................... 596RESEARCH OF NOTE................................................................................................................................................................................................. 597

CAPITALSHRUGGED ................................................................................................................................................................................ 601

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