Saturday, May 21, 2005
Saturday, May 14, 2005
Saturday, May 07, 2005
Friday, April 29, 2005
Horror
Horror
I been to the lands of the Mountains, and the Rising and Setting Sun - oh, the horror, I see... I been to the lands of the Shining Seas, Eagles and Condors, and the horror, I see... I been to the land of the Bear, and oh, the horror, I see... I also been to the land of the Koala, and again, the horror, I see...
Oh yes, they all have their elite millionaires and billionaires, this is true enough, but the horror of their malnourished and starving children, is more than a soul can bear. They all have their under-country of misery and dispair...
My capitalism... my love, where are you? Are you in Africa, that once most beautiful of all the lands of free roaming animals, peoples and spirits? - How did you create this level of horror, my soul must see? Did you lose track of the lesser world's needs? Did you go to sleep at the wheel of excess, imbalanced profits? Can you awake?! Horror, oh horror - I honor you, to become the spirit of universal, balanced integrity... Rise up to your true calling and feed these poor, starving peoples and lands. - please, please, please!
L.A.Gillespie
I been to the lands of the Mountains, and the Rising and Setting Sun - oh, the horror, I see... I been to the lands of the Shining Seas, Eagles and Condors, and the horror, I see... I been to the land of the Bear, and oh, the horror, I see... I also been to the land of the Koala, and again, the horror, I see...
Oh yes, they all have their elite millionaires and billionaires, this is true enough, but the horror of their malnourished and starving children, is more than a soul can bear. They all have their under-country of misery and dispair...
My capitalism... my love, where are you? Are you in Africa, that once most beautiful of all the lands of free roaming animals, peoples and spirits? - How did you create this level of horror, my soul must see? Did you lose track of the lesser world's needs? Did you go to sleep at the wheel of excess, imbalanced profits? Can you awake?! Horror, oh horror - I honor you, to become the spirit of universal, balanced integrity... Rise up to your true calling and feed these poor, starving peoples and lands. - please, please, please!
L.A.Gillespie
Tuesday, April 26, 2005
Tuesday, April 19, 2005
'Global Conspiracy of Fools,' Perhaps?
Global Conspiracy of Fools
Also Stephen Roach - Tilt
Edmund M. McCarthy is President and CEO of Financial Risk Management Advisors Company. This piece was originally published in his January newsletter.
A detailed account, superbly researched and documented, of the Enron debacle under the title “A Conspiracy of Fools” by Kurt Eichenwald, recently read, is the inspiration for the question above. There is, at least, a workable hypothesis that the Enron rise and collapse is a possible microcosm of the global bubble ongoing, stoked by massive credit emanation currently believed to be the New Wave of Economic Growth. In it’s time, Enron was believed to be the new model of corporate growth, expanding exponentially more rapidly than prosaic forebears, incorporating marketing and financial genius, transforming industries and economies and enriching vast constituencies. It was, in fact, a gigantic scam and sham able to deceive with aplomb virtually all areas of expertise in understanding and analyzing risk and reward. A combination of fraud, greed, obliviousness, unbridled ego, unquestioned belief in growth, and fascinated obsession with financial innovation catalogues the “E” debacle. Virtually all these elements are in plentiful supply in global financial markets and the players therein as the world “reflates” with a vengeance in every nook and cranny having a medium of exchange and the means to exchange it.
There is no question of the criminality of many of the players in the Houston company’s demise, however, there is also clear proof that the complexities of modern finance are beyond the comprehension and understanding of many extremely intelligent and supposedly well informed “leaders” of the mammoth organizations now proliferating at excessively rapid growth rates across the global economy. In the abbreviated mini-downturn of 2000-2002, abruptly terminated by plummeting Fed rate cuts and massive liquidity injections (First in the $ Trillions from the GSE’s and latterly in the $ Trillions from the Primary dealer, hedge fund and bank lending arenas), there were quite a few Enron-like disasters such as the two currently in the trial headlines, Worldcom and Tyco. Again, there is criminality aplenty but also plentiful further evidence of inability of supposedly astute “leaders” and observers to unravel what seemingly are relatively complex but not insuperably difficult frauds and misuses. More recently, the burgeoning AIG scandal, the shocking GM cash flow reversal and the ongoing flow of announcements from the Citi’s and BofA’s confirm the following thesis:
MARKET AND CORPORATE GROWTH HAVE EXPANDED BEYOND THE ABILITY OF THOSE IN CHARGE TO BE AWARE OF AND COMPREHEND THE INCREDIBLY RAPIDLY GROWING RISKS, BOTH BUSINESS AND ETHICAL/INTEGRITY, ASSUMED IN THIS GROWTH!
This growth, unprecedented during the 1990’s, although marred by episodic blow-ups easily quelled by Fed/Central Bank/GSE liquidity emanation, has expanded exponentially globally since the Greenspan demotion of interest rates below 0%, inflation adjusted, in 2002 and the maintenance at that level until succeeded by, in effect, a guaranteed “contract” between the Fed and the Brobdingnagian financial colossus labeled the “Leveraged Speculative Community” by Doug Noland, of a “measured” policy enabling ongoing profitable speculation. The “policy/contract” even produced a “conundrum” for the redoubted Sir Alan when long rates fell as he “measuredly” raised the short end.
Some rational observers have noticed that a “guaranteed” spread, even when shrinking, is just as possibly profitable with a concomitant increase in leverage!
In the “carry trade” a massive increase in leverage is a massive increase in demand creating part of the Fedheads conundrum. He has had to actually mutter the “bogeyman” word (inflation) to try to, belatedly, stem the onrush into longer dated instruments by the “carry traders” and the vitiation of spreads out along the risk curve. (The rest of Greenie’s conundrum, if he would bother to look at the Fed Z1 report, is from what Anatole Kaletsky calls the three brain dead zombie fixed income investors, Asian central banks, Western pension and insurance funds and, most importantly, Japanese private investors. John Mauldin included a piece entitled “Of Bonds and Zombies” by Kaletsky in one of his recent fascinating “Outside the Box” efforts and more detail on the underlying support for long fixed income exacerbated by the hedgies playing the carry can be found at GaveKal.com.) The aforementioned zombies have provided the unlikely “ceiling” for longer U.S. rates in a seeming anomaly, permitting the continued chase for performance fees by the burgeoning hedge fund community using the carry trade as a significant part of their strategy. Foreign holders of Treasuries have accumulated $1,385 Trillion!
In a recent Credit Bubble Bulletin, Doug Noland summarized the credit sources available to the “Leveraged Speculators” just recently. The big 5 of Bear, Lehman, Goldman, Morgan Stanley and Merrill have expanded their borrowings 24% year over year to February and 44% over 2 years to a total of $2.60 Trillion. Bank credit is up $252 Billion so far in 2005 (a 19.4% annualized rate). In its infinite wisdom, the Fed Z1 report omits repos/reverse repos of $3.2 Trillion thereby vastly understating the blowout, in recent times, in credit available for speculation.
GROWTH RATES IN CREDIT IN THE HIGH TEENS/TWENTIES IN % OUTRUN BOTH CREDIT DETERIORATION AND THE ABILITY OF MANAGEMENT, NO MATTER HOW PRAISED AND SOPHISTICATED, TO COMPREHEND AND MASTER THE AFOREMENTIONED RISKS OF BOTH THE QUALITY OF THE BUSINESS BEING DONE AND THE ETHICS/INTEGRITY OF THOSE WRITING IT!
Layered on top of the “visible” credit expansion (balance sheet) and the aforementioned “repo” world of credit is a new game rapidly reaching prodigious proportions. CDS (Credit Default Swaps) is the fastest growing game in Speculation Town, the fastest growing gambling town in human financial history. A survey done by Fitch found the total under the purview of U.S. banking regulators at $3.1 Trillion by the end of 2004, having DOUBLED during the course of the preceding year. A recent look at the Bank for International Settlements year end derivatives numbers showed this category globally at $6.4Trillion and Bloomberg totals $8.4Trillion throughout all markets. By the way, the same annual compilation by the BIS showed total notional derivatives outstanding at the end of 2004 of $221 Trillion! The mind boggles.
Obviously, the bulk of this stuff is interest rate and foreign exchange, not to say that it is not potentially explosive in nature (Anybody remember Bankers Trust, Orange County, Gibson Greeting et al 1994?) and it is significantly obscure, given the willingness of the authorities to allow netting among the larger participants, but the credit default stuff is fuel for speculation and explosion where the notional category total in terms of “real” risk is not some computer derived tiny fraction but the actual amount at risk. “Financial Engineering, applauded by the eminent Alan, may disperse risk, thereby reducing it, or it may contain the seeds of greater risk an/or deals of questionable or even fraudulent provenance. Warren Buffett, of unquestioned integrity, is now caught up in the Greenberg/AIG deal, of which he knew. The fact that on March 29, Berkshire said in a statement repeated in the WSJ 3/30 that Mr. Buffett “WAS NOT BRIEFED ON HOW THE TRANSACTIONS WERE STRUCTURED OR ON ANY IMPROPER USE OR PURPOSE OF THE TRANSACTIONS.” Leaves two possibilities. 1) He is dissimilating or 2) the size of Berkshire and General Re, the complexity of financial engineering and some generalizations by a, presumably, trusted subordinate after a non-detail conversation with Greenberg previously, left Buffett feeling comfortable about a questionable transaction.
We are inclined towards 2 above and that makes the point of the thesis: The best, most honest, brightest of CEO’s cannot possibly stay on top of what goes on in these complicated financial megaliths. If the presumed honest, such as Buffett cannot, how can anybody believe that it is possible in the convoluted world of an AIG, driven by a CEO consumed by the company’s stock price (per statements by Wall St. analysts on the pressure from “Hank” for laudatory comments) and executives, motivated by excessive compensation for achievement of outlandish financial goals, that anyone within the company actually knows what is really going on. AIG is clearly out of control and only time will tell the order of magnitude. The question is how many other Financial Giants and BFB’s (Big Famous Banks) are in similar condition. The bonuses to the CEO’s are still given a la B of A where there is clear evidence the troops were out of control, based on a Board’s ridiculous excuses for “performance against goals” which obviously did not include having a spotless record in terms of regulatory, compliance or integrity to customers. Buffett himself has said that nobody can analyze entities such as Fannie Mae and he has likened derivatives to “financial weapons of mass destruction” but, nevertheless, finds himself beset within his own company. Jim Grant, of Grant’s Interest Rate Observer, an analyst truly worthy of respect, finds the FNM’s and JPM’s beyond analysis, as does this writer.
Speaking of Grant’s Interest Rate Observer (your writer is a “paid up subscriber” as Jim likes to refer to us and a member of a “small, perverse cult” as some commentators like to refer to such subscribers), in a recent issue, “deconvergence” was one of the articles. In it, a strategy is propounded. The concept is to use credit default swaps as a way to prosper if 1) credit analysis ever comes back into vogue and spreads go rational and 2) the euro gets into difficulty. Until reading this article, the writer was unaware of the current cost of obtaining credit protection on some of the various sovereign country European debt. Greece recently sold some 30 year paper at 4.45% or 26 basis points above the yield on German 30 year paper! As Jim says in the article: “Greece may be many things, but it is not 26 basis points removed from AAA quality.” We spent a couple of years lending to the country’s banks and we could not agree more. A Greek credit default swap for 10 years is available, according to the article and Bloomberg, at 14 basis points per year. The counterparty is not mentioned. The point is that if Greece were only to widen out by more than 14 bps, the deal goes into the money. Our point is that the counterparty is either some gigantic financial institution or a hedge fund. Likely, if a hedge fund, they are hedging the risk with a giant. Does anybody think Purcell, for instance, at Morgan Stanley, knows the details of the hundreds of billions of pieces of financial engineering being done. We happen to be a little more pro-euro than Grant but are still dubious on this bet. On the other hand, it is an example of the finest kind of credit default swap, a sovereign government which can actually print it’s way to payment. (They may elect to only print 30% a la Argentina) but at least the buyer of the swap won't get 100% probably of the face amount with 0% for the counterparty/swap seller. Citi managed to find $400 Million of sellers of CDS for Enron. Probably an example of the worst type of CDS back in 2002.
We wonder, in the halcyon days of of 4 ½ years of economic expansion, 2 ½ years of rising equity markets, falling unemployment and bad credit percentages and astronomically rising house prices, whether there may be some or a lot of deals being done in the CDS market which will provide the next “GREAT SURPRISE” for some CEO of one of these giants. In fact we like this bet as much as Grant’s bet against the CDS seller which we, not a GIANT institution, cannot participate in. It is about the only thing about CDS we like. Since all of this product is one-off, customized and “financially engineered,” our dim view of inherent risk and lack of understanding of such risk as it escalates continues to grow dimmer.
In a previous missive, we described the emergence of CDO SQUARED’S, debt obligations made up of synthetic CDO’s (CDS’s) leveraged into a higher yielding instrument. Now we have CDO CUBED’s, debt instruments leveraged another level filled with CDO SQUARED’s. We understand that at least one of the BFB’s is suffering significant problems with deterioration unexpected and premature in some of these. GM alone could cause such a problem, although we are unaware (as is virtually everybody) of the exact content of the CDO CUBED’s. As usual, total opacity in this over the counter, each issue unique world prevails. The March 31 WSJ has an article entitled “Amid Corporate-Bond Sell-Off, Risky Loan Market Chugs On. The presumption by the Journal is that this paper is favored over bonds because the loan “sits higher than bonds in a company’s capital structure” and mostly float in terms of interest rate. In passing, to this observer, if buying something for better bankruptcy protection, does it help to have rates cause an earlier possible bankruptcy? Leaving that aside, we posit that the real reason for the strength in this arena is the availability of such fodder for CDO’s and their combinations. Equally fascinating is the bailout of Krispy Kreme by CSFB and a hedge fund. Are we really to believe that this is a “relationship” deal or is the answer more fodder for a CDO. Anybody got a ready quote for a CDS on this one?
After many years of licking their wounds after the real estate disasters of the late ‘80’s and early 90’s, the Banking industry has really returned to the game with a vengeance. In the 1st 10 weeks of 2005, the industry grew real estate loans on an annualized basis of 19%. Home equity loans did even better at 21% year over year in the last report. Musing about the constant good health of the housing industry from the National Association of Realtors stating that the supply of homes for sale stays at lows of months of sale, we stumbled upon our old friend the numerator/denominator equation. Given that the 1980’s saw 400-500 thousand new homes sold per annum, the 1990’s some 800-900 thousand and recently, an annualized rate approaching 1,400,000, we are not surprised that the month’s sales number from the “unbiased” NAR stays low! Having been through a few housing busts, we know that this market doesn’t slow, it freezes. Say we have 700,000 supply at the moment, how much supply is there in terms of “month’s sales” at an annual sales rate of the 1980’s?
Recently, we have become aware of some statistics on the front end of this “market on fire”. 1.) Homes for sale, not yet started, have accelerated from a 1998 low of some 30M to in excess of 80M, exceeding the previous bubble number in 1991 of 70M. The rate of change recently growing over 60% yr over yr. 2) Homes not sold, still under construction has shot up from the 1993 low of 130M to over 260M, way over the previous bubble of 1989 of 220M. 3) Total New Homes for sale are headed for half a MILLION in a spike blowout 50% higher than anything previously seen. Admittedly, the extreme points of heat in this “market on fire” are concentrated geographically but so was the previous housing debacle that extinguished the S&L industry. Remember also, that the previous era did not have 0% down 5 yr I/O “financial engineering” to help it along. It also did not have the Trillions of $ of “financially engineered” mortgage backed securities.
The April 4 WSJ has an article on the OFHEO (Those nasty regulators of Fannie who doubted their accounting) that these persecutors are now looking at the “TRUSTS” used by Fannie to offload their guaranteed mortgages. Need we repeat our obvious theme that these indentures, created with exquisite “financial engineering” are complex, nearly innumerable at this point, and examined, if at all, on ratios and legality. Subsequent review after issue, is at best, perfunctory. Covenants on substitution in some we have seen are generally permissive and provide opportunities for Enron-like manipulation. Admittedly a “perverse cult” cynic, I cannot help but have the suspicion that a lot of these indentures are, upon close examination have everything from flaws to frauds contained therein. When that great denominator of housing sales slackens or, Heaven help and forfend, declines, the numerator may worsen by orders of magnitude more viciousness than the pedants of real estate currently foresee. The aforementioned article briefly hints at the possibility that some of these trusts, if flawed, may not flow back onto Fannie’s books but onto the banks that did the origination.
BAD ENOUGH THAT THE CURRENTLY WOEFULLY UNDERCAPITALIZED FANNIE MAY HAVE TO SWALLOW SOME OF THIS BUT WHAT A SHOCK TO THE MARKETS OF ANY WHOLESALE REPATRIATION OF THE TRILLIONS OF BANK INVOLVED BUT “OFF THE BALANCE SHEET” MORTGAGE CREDIT WOULD BE! ALL OF THIS, WE ADMIT, FROM A SINGLE DATA POINT/ARTICLE BUT NOT TO BE SHRUGGED OFF GIVEN THE OPACITY OF THE PROCESS.
Just to be totally ridiculous, let’s hypothesize that some number of these trusts are deemed flawed by OFHEO. Instead of, theoretically, flowing back onto Fannie’s balance sheet, they are deemed to be the obligation of the originator bank. Would it not be quite an irony for that bank to also hold the security as an asset!? Possible? Yes! What strange webs we mortal spin. The forgoing absurd soliloquy in aid of further demonstration of how complex this whole financial enterprise mechanism has become and further demonstration of how unlikely the risks are truly known, dimensioned and prepared/reserved for.
Throughout our experience, there have been two truly lagging indicators in the Financial Institution business 1.The Rating’s Agencies and 2 The Regulatory Agencies. Should we use Enron or AIG as the best example of the first category? How about the vintage 1983 Texas Commerce Bank, trumpeting itself in full page WSJ ads as one of two AAA banks not much before dropping a multi-hundred million clanger on the way to a distressed sale. “Nuff said.” Point is that the FDIC has just started to publish some cautionary commentary to it’s constituency and even the OCC seems to getting nerves/hives? The Fed doesn’t dare. All of this has been complicated by Sarbox and the SEC’s historic tendency to try and evaporate any “Unallocated” and therefore presumabllly “hidden earnings pocket” loan loss reserve just as the credit cycle turns. In the age of Enron, some financial institutions are not all that adverse to being “forced” to feed “excess” loan loss reserve into the earnings stream.
A reasonable observer of financial institutions might, at this point, have some reservations. One reasonable observer we are privileged to read, Charles Peabody of Portales Partners, the only “Street” analyst of Financial Institutions we respect, has lot’s of reservations. Cost of goods is going up, spreads are squeezed, there are lots of held to maturity assets which look to be in jeapoardy, branch expansion is rampant, competition on both price and credit standards is fierce and the economy just don’t seem to be hiring that many people. The Fed had to jigger the Z1 report in the last year by revaluing upward U.S. held “Non-Financial” assets(old bricks and mortar) by $900 billion to keep our net due foreigners below $5Trillion (It just exceeded that amount again)., and the current account deficit will accelerate as rates rise and what we have to pay accelerates. The domestic deficit is exploding and the consumer is sucking wind. If the market and/or the regulators slow the breakneck pace of credit creation previously detailed, the worst numerator (Bad Loans) is going to inexorably rise. Even if another $1.4-1.5 trillion in new mortgage credit plus corporations going berserk in capital spending were to be in the cards, there are ripplings of discontent in some of the zombie buyers in Asia. The Fed either has to keep raising rates or lose credibility and the famous “carry” will either require leverage even the prime brokers must be able to smell or will start to diminish. Two of the pillars of purchase of the four therefore look shaky. Three legged stools have a problem; two legged one’s collapse. When? Who knows? Whether-FOR CERTAIN.
The glorious days of burgeoning appraisals, magnificent cash-outs and “flipping” real estate for beginners are now turned over to home equity drawdown desperation, 0% down and no/low I/O mortgages, return to what is left of the credit card line and, finally, re-entry into lending on the most magnanimous basis by a banking system bereft of Fannie and Freddy.
The zombie buyers are not dead after all and are becoming restless. Brain death, if any is to be found, may be more domestic than foreign. All the Fed’s men and all the Fed’s horses (LIQUIDITY) have not resurrected Japan nor staved off EU recession. China and the U.S. are at the ends of their respective ropes.
CONCLUSION: OUR THESIS IS THAT THE GLOBAL FINANCIAL SYSTEM HAS UNWITTINGLY AND/OR GREEDILY GONE PAST ANY SAFE EXIT FROM A HUMONGOUS GLOBAL CREDIT BUBBLE. WHILE MALFEASANCE AND FRAUD WILL EMERGE IN THE AFTERMATH A LA LINCOLN SAVINGS AND PENN SQUARE; MUCH OF THE DAMAGE WILL HAVE BEEN DONE BY A CORPORATE/BANK/CENTRAL BANK LEADERSHIP OVERWHELMED BY A NEW, COMPLEX BREAKNECK, FINANCIALLY ENGINEERED CREDIT EXPLOSION A LA LTCM. HISTORY AND FORENSIC ACCOUNTING WILL JUDGE WHAT LEADERS WERE LARCENOUS, WHICH FRAUDULENT, WHOM WILLFULLY BLIND AND, FINALLY, THOSE OF THE EGO-DRIVEN OBLIVIOUS PERSUASION. THE COURTS AND PUBLIC OPINION WILL SORT THEM OUT!
Also Stephen Roach - Tilt
Edmund M. McCarthy is President and CEO of Financial Risk Management Advisors Company. This piece was originally published in his January newsletter.
A detailed account, superbly researched and documented, of the Enron debacle under the title “A Conspiracy of Fools” by Kurt Eichenwald, recently read, is the inspiration for the question above. There is, at least, a workable hypothesis that the Enron rise and collapse is a possible microcosm of the global bubble ongoing, stoked by massive credit emanation currently believed to be the New Wave of Economic Growth. In it’s time, Enron was believed to be the new model of corporate growth, expanding exponentially more rapidly than prosaic forebears, incorporating marketing and financial genius, transforming industries and economies and enriching vast constituencies. It was, in fact, a gigantic scam and sham able to deceive with aplomb virtually all areas of expertise in understanding and analyzing risk and reward. A combination of fraud, greed, obliviousness, unbridled ego, unquestioned belief in growth, and fascinated obsession with financial innovation catalogues the “E” debacle. Virtually all these elements are in plentiful supply in global financial markets and the players therein as the world “reflates” with a vengeance in every nook and cranny having a medium of exchange and the means to exchange it.
There is no question of the criminality of many of the players in the Houston company’s demise, however, there is also clear proof that the complexities of modern finance are beyond the comprehension and understanding of many extremely intelligent and supposedly well informed “leaders” of the mammoth organizations now proliferating at excessively rapid growth rates across the global economy. In the abbreviated mini-downturn of 2000-2002, abruptly terminated by plummeting Fed rate cuts and massive liquidity injections (First in the $ Trillions from the GSE’s and latterly in the $ Trillions from the Primary dealer, hedge fund and bank lending arenas), there were quite a few Enron-like disasters such as the two currently in the trial headlines, Worldcom and Tyco. Again, there is criminality aplenty but also plentiful further evidence of inability of supposedly astute “leaders” and observers to unravel what seemingly are relatively complex but not insuperably difficult frauds and misuses. More recently, the burgeoning AIG scandal, the shocking GM cash flow reversal and the ongoing flow of announcements from the Citi’s and BofA’s confirm the following thesis:
MARKET AND CORPORATE GROWTH HAVE EXPANDED BEYOND THE ABILITY OF THOSE IN CHARGE TO BE AWARE OF AND COMPREHEND THE INCREDIBLY RAPIDLY GROWING RISKS, BOTH BUSINESS AND ETHICAL/INTEGRITY, ASSUMED IN THIS GROWTH!
This growth, unprecedented during the 1990’s, although marred by episodic blow-ups easily quelled by Fed/Central Bank/GSE liquidity emanation, has expanded exponentially globally since the Greenspan demotion of interest rates below 0%, inflation adjusted, in 2002 and the maintenance at that level until succeeded by, in effect, a guaranteed “contract” between the Fed and the Brobdingnagian financial colossus labeled the “Leveraged Speculative Community” by Doug Noland, of a “measured” policy enabling ongoing profitable speculation. The “policy/contract” even produced a “conundrum” for the redoubted Sir Alan when long rates fell as he “measuredly” raised the short end.
Some rational observers have noticed that a “guaranteed” spread, even when shrinking, is just as possibly profitable with a concomitant increase in leverage!
In the “carry trade” a massive increase in leverage is a massive increase in demand creating part of the Fedheads conundrum. He has had to actually mutter the “bogeyman” word (inflation) to try to, belatedly, stem the onrush into longer dated instruments by the “carry traders” and the vitiation of spreads out along the risk curve. (The rest of Greenie’s conundrum, if he would bother to look at the Fed Z1 report, is from what Anatole Kaletsky calls the three brain dead zombie fixed income investors, Asian central banks, Western pension and insurance funds and, most importantly, Japanese private investors. John Mauldin included a piece entitled “Of Bonds and Zombies” by Kaletsky in one of his recent fascinating “Outside the Box” efforts and more detail on the underlying support for long fixed income exacerbated by the hedgies playing the carry can be found at GaveKal.com.) The aforementioned zombies have provided the unlikely “ceiling” for longer U.S. rates in a seeming anomaly, permitting the continued chase for performance fees by the burgeoning hedge fund community using the carry trade as a significant part of their strategy. Foreign holders of Treasuries have accumulated $1,385 Trillion!
In a recent Credit Bubble Bulletin, Doug Noland summarized the credit sources available to the “Leveraged Speculators” just recently. The big 5 of Bear, Lehman, Goldman, Morgan Stanley and Merrill have expanded their borrowings 24% year over year to February and 44% over 2 years to a total of $2.60 Trillion. Bank credit is up $252 Billion so far in 2005 (a 19.4% annualized rate). In its infinite wisdom, the Fed Z1 report omits repos/reverse repos of $3.2 Trillion thereby vastly understating the blowout, in recent times, in credit available for speculation.
GROWTH RATES IN CREDIT IN THE HIGH TEENS/TWENTIES IN % OUTRUN BOTH CREDIT DETERIORATION AND THE ABILITY OF MANAGEMENT, NO MATTER HOW PRAISED AND SOPHISTICATED, TO COMPREHEND AND MASTER THE AFOREMENTIONED RISKS OF BOTH THE QUALITY OF THE BUSINESS BEING DONE AND THE ETHICS/INTEGRITY OF THOSE WRITING IT!
Layered on top of the “visible” credit expansion (balance sheet) and the aforementioned “repo” world of credit is a new game rapidly reaching prodigious proportions. CDS (Credit Default Swaps) is the fastest growing game in Speculation Town, the fastest growing gambling town in human financial history. A survey done by Fitch found the total under the purview of U.S. banking regulators at $3.1 Trillion by the end of 2004, having DOUBLED during the course of the preceding year. A recent look at the Bank for International Settlements year end derivatives numbers showed this category globally at $6.4Trillion and Bloomberg totals $8.4Trillion throughout all markets. By the way, the same annual compilation by the BIS showed total notional derivatives outstanding at the end of 2004 of $221 Trillion! The mind boggles.
Obviously, the bulk of this stuff is interest rate and foreign exchange, not to say that it is not potentially explosive in nature (Anybody remember Bankers Trust, Orange County, Gibson Greeting et al 1994?) and it is significantly obscure, given the willingness of the authorities to allow netting among the larger participants, but the credit default stuff is fuel for speculation and explosion where the notional category total in terms of “real” risk is not some computer derived tiny fraction but the actual amount at risk. “Financial Engineering, applauded by the eminent Alan, may disperse risk, thereby reducing it, or it may contain the seeds of greater risk an/or deals of questionable or even fraudulent provenance. Warren Buffett, of unquestioned integrity, is now caught up in the Greenberg/AIG deal, of which he knew. The fact that on March 29, Berkshire said in a statement repeated in the WSJ 3/30 that Mr. Buffett “WAS NOT BRIEFED ON HOW THE TRANSACTIONS WERE STRUCTURED OR ON ANY IMPROPER USE OR PURPOSE OF THE TRANSACTIONS.” Leaves two possibilities. 1) He is dissimilating or 2) the size of Berkshire and General Re, the complexity of financial engineering and some generalizations by a, presumably, trusted subordinate after a non-detail conversation with Greenberg previously, left Buffett feeling comfortable about a questionable transaction.
We are inclined towards 2 above and that makes the point of the thesis: The best, most honest, brightest of CEO’s cannot possibly stay on top of what goes on in these complicated financial megaliths. If the presumed honest, such as Buffett cannot, how can anybody believe that it is possible in the convoluted world of an AIG, driven by a CEO consumed by the company’s stock price (per statements by Wall St. analysts on the pressure from “Hank” for laudatory comments) and executives, motivated by excessive compensation for achievement of outlandish financial goals, that anyone within the company actually knows what is really going on. AIG is clearly out of control and only time will tell the order of magnitude. The question is how many other Financial Giants and BFB’s (Big Famous Banks) are in similar condition. The bonuses to the CEO’s are still given a la B of A where there is clear evidence the troops were out of control, based on a Board’s ridiculous excuses for “performance against goals” which obviously did not include having a spotless record in terms of regulatory, compliance or integrity to customers. Buffett himself has said that nobody can analyze entities such as Fannie Mae and he has likened derivatives to “financial weapons of mass destruction” but, nevertheless, finds himself beset within his own company. Jim Grant, of Grant’s Interest Rate Observer, an analyst truly worthy of respect, finds the FNM’s and JPM’s beyond analysis, as does this writer.
Speaking of Grant’s Interest Rate Observer (your writer is a “paid up subscriber” as Jim likes to refer to us and a member of a “small, perverse cult” as some commentators like to refer to such subscribers), in a recent issue, “deconvergence” was one of the articles. In it, a strategy is propounded. The concept is to use credit default swaps as a way to prosper if 1) credit analysis ever comes back into vogue and spreads go rational and 2) the euro gets into difficulty. Until reading this article, the writer was unaware of the current cost of obtaining credit protection on some of the various sovereign country European debt. Greece recently sold some 30 year paper at 4.45% or 26 basis points above the yield on German 30 year paper! As Jim says in the article: “Greece may be many things, but it is not 26 basis points removed from AAA quality.” We spent a couple of years lending to the country’s banks and we could not agree more. A Greek credit default swap for 10 years is available, according to the article and Bloomberg, at 14 basis points per year. The counterparty is not mentioned. The point is that if Greece were only to widen out by more than 14 bps, the deal goes into the money. Our point is that the counterparty is either some gigantic financial institution or a hedge fund. Likely, if a hedge fund, they are hedging the risk with a giant. Does anybody think Purcell, for instance, at Morgan Stanley, knows the details of the hundreds of billions of pieces of financial engineering being done. We happen to be a little more pro-euro than Grant but are still dubious on this bet. On the other hand, it is an example of the finest kind of credit default swap, a sovereign government which can actually print it’s way to payment. (They may elect to only print 30% a la Argentina) but at least the buyer of the swap won't get 100% probably of the face amount with 0% for the counterparty/swap seller. Citi managed to find $400 Million of sellers of CDS for Enron. Probably an example of the worst type of CDS back in 2002.
We wonder, in the halcyon days of of 4 ½ years of economic expansion, 2 ½ years of rising equity markets, falling unemployment and bad credit percentages and astronomically rising house prices, whether there may be some or a lot of deals being done in the CDS market which will provide the next “GREAT SURPRISE” for some CEO of one of these giants. In fact we like this bet as much as Grant’s bet against the CDS seller which we, not a GIANT institution, cannot participate in. It is about the only thing about CDS we like. Since all of this product is one-off, customized and “financially engineered,” our dim view of inherent risk and lack of understanding of such risk as it escalates continues to grow dimmer.
In a previous missive, we described the emergence of CDO SQUARED’S, debt obligations made up of synthetic CDO’s (CDS’s) leveraged into a higher yielding instrument. Now we have CDO CUBED’s, debt instruments leveraged another level filled with CDO SQUARED’s. We understand that at least one of the BFB’s is suffering significant problems with deterioration unexpected and premature in some of these. GM alone could cause such a problem, although we are unaware (as is virtually everybody) of the exact content of the CDO CUBED’s. As usual, total opacity in this over the counter, each issue unique world prevails. The March 31 WSJ has an article entitled “Amid Corporate-Bond Sell-Off, Risky Loan Market Chugs On. The presumption by the Journal is that this paper is favored over bonds because the loan “sits higher than bonds in a company’s capital structure” and mostly float in terms of interest rate. In passing, to this observer, if buying something for better bankruptcy protection, does it help to have rates cause an earlier possible bankruptcy? Leaving that aside, we posit that the real reason for the strength in this arena is the availability of such fodder for CDO’s and their combinations. Equally fascinating is the bailout of Krispy Kreme by CSFB and a hedge fund. Are we really to believe that this is a “relationship” deal or is the answer more fodder for a CDO. Anybody got a ready quote for a CDS on this one?
After many years of licking their wounds after the real estate disasters of the late ‘80’s and early 90’s, the Banking industry has really returned to the game with a vengeance. In the 1st 10 weeks of 2005, the industry grew real estate loans on an annualized basis of 19%. Home equity loans did even better at 21% year over year in the last report. Musing about the constant good health of the housing industry from the National Association of Realtors stating that the supply of homes for sale stays at lows of months of sale, we stumbled upon our old friend the numerator/denominator equation. Given that the 1980’s saw 400-500 thousand new homes sold per annum, the 1990’s some 800-900 thousand and recently, an annualized rate approaching 1,400,000, we are not surprised that the month’s sales number from the “unbiased” NAR stays low! Having been through a few housing busts, we know that this market doesn’t slow, it freezes. Say we have 700,000 supply at the moment, how much supply is there in terms of “month’s sales” at an annual sales rate of the 1980’s?
Recently, we have become aware of some statistics on the front end of this “market on fire”. 1.) Homes for sale, not yet started, have accelerated from a 1998 low of some 30M to in excess of 80M, exceeding the previous bubble number in 1991 of 70M. The rate of change recently growing over 60% yr over yr. 2) Homes not sold, still under construction has shot up from the 1993 low of 130M to over 260M, way over the previous bubble of 1989 of 220M. 3) Total New Homes for sale are headed for half a MILLION in a spike blowout 50% higher than anything previously seen. Admittedly, the extreme points of heat in this “market on fire” are concentrated geographically but so was the previous housing debacle that extinguished the S&L industry. Remember also, that the previous era did not have 0% down 5 yr I/O “financial engineering” to help it along. It also did not have the Trillions of $ of “financially engineered” mortgage backed securities.
The April 4 WSJ has an article on the OFHEO (Those nasty regulators of Fannie who doubted their accounting) that these persecutors are now looking at the “TRUSTS” used by Fannie to offload their guaranteed mortgages. Need we repeat our obvious theme that these indentures, created with exquisite “financial engineering” are complex, nearly innumerable at this point, and examined, if at all, on ratios and legality. Subsequent review after issue, is at best, perfunctory. Covenants on substitution in some we have seen are generally permissive and provide opportunities for Enron-like manipulation. Admittedly a “perverse cult” cynic, I cannot help but have the suspicion that a lot of these indentures are, upon close examination have everything from flaws to frauds contained therein. When that great denominator of housing sales slackens or, Heaven help and forfend, declines, the numerator may worsen by orders of magnitude more viciousness than the pedants of real estate currently foresee. The aforementioned article briefly hints at the possibility that some of these trusts, if flawed, may not flow back onto Fannie’s books but onto the banks that did the origination.
BAD ENOUGH THAT THE CURRENTLY WOEFULLY UNDERCAPITALIZED FANNIE MAY HAVE TO SWALLOW SOME OF THIS BUT WHAT A SHOCK TO THE MARKETS OF ANY WHOLESALE REPATRIATION OF THE TRILLIONS OF BANK INVOLVED BUT “OFF THE BALANCE SHEET” MORTGAGE CREDIT WOULD BE! ALL OF THIS, WE ADMIT, FROM A SINGLE DATA POINT/ARTICLE BUT NOT TO BE SHRUGGED OFF GIVEN THE OPACITY OF THE PROCESS.
Just to be totally ridiculous, let’s hypothesize that some number of these trusts are deemed flawed by OFHEO. Instead of, theoretically, flowing back onto Fannie’s balance sheet, they are deemed to be the obligation of the originator bank. Would it not be quite an irony for that bank to also hold the security as an asset!? Possible? Yes! What strange webs we mortal spin. The forgoing absurd soliloquy in aid of further demonstration of how complex this whole financial enterprise mechanism has become and further demonstration of how unlikely the risks are truly known, dimensioned and prepared/reserved for.
Throughout our experience, there have been two truly lagging indicators in the Financial Institution business 1.The Rating’s Agencies and 2 The Regulatory Agencies. Should we use Enron or AIG as the best example of the first category? How about the vintage 1983 Texas Commerce Bank, trumpeting itself in full page WSJ ads as one of two AAA banks not much before dropping a multi-hundred million clanger on the way to a distressed sale. “Nuff said.” Point is that the FDIC has just started to publish some cautionary commentary to it’s constituency and even the OCC seems to getting nerves/hives? The Fed doesn’t dare. All of this has been complicated by Sarbox and the SEC’s historic tendency to try and evaporate any “Unallocated” and therefore presumabllly “hidden earnings pocket” loan loss reserve just as the credit cycle turns. In the age of Enron, some financial institutions are not all that adverse to being “forced” to feed “excess” loan loss reserve into the earnings stream.
A reasonable observer of financial institutions might, at this point, have some reservations. One reasonable observer we are privileged to read, Charles Peabody of Portales Partners, the only “Street” analyst of Financial Institutions we respect, has lot’s of reservations. Cost of goods is going up, spreads are squeezed, there are lots of held to maturity assets which look to be in jeapoardy, branch expansion is rampant, competition on both price and credit standards is fierce and the economy just don’t seem to be hiring that many people. The Fed had to jigger the Z1 report in the last year by revaluing upward U.S. held “Non-Financial” assets(old bricks and mortar) by $900 billion to keep our net due foreigners below $5Trillion (It just exceeded that amount again)., and the current account deficit will accelerate as rates rise and what we have to pay accelerates. The domestic deficit is exploding and the consumer is sucking wind. If the market and/or the regulators slow the breakneck pace of credit creation previously detailed, the worst numerator (Bad Loans) is going to inexorably rise. Even if another $1.4-1.5 trillion in new mortgage credit plus corporations going berserk in capital spending were to be in the cards, there are ripplings of discontent in some of the zombie buyers in Asia. The Fed either has to keep raising rates or lose credibility and the famous “carry” will either require leverage even the prime brokers must be able to smell or will start to diminish. Two of the pillars of purchase of the four therefore look shaky. Three legged stools have a problem; two legged one’s collapse. When? Who knows? Whether-FOR CERTAIN.
The glorious days of burgeoning appraisals, magnificent cash-outs and “flipping” real estate for beginners are now turned over to home equity drawdown desperation, 0% down and no/low I/O mortgages, return to what is left of the credit card line and, finally, re-entry into lending on the most magnanimous basis by a banking system bereft of Fannie and Freddy.
The zombie buyers are not dead after all and are becoming restless. Brain death, if any is to be found, may be more domestic than foreign. All the Fed’s men and all the Fed’s horses (LIQUIDITY) have not resurrected Japan nor staved off EU recession. China and the U.S. are at the ends of their respective ropes.
CONCLUSION: OUR THESIS IS THAT THE GLOBAL FINANCIAL SYSTEM HAS UNWITTINGLY AND/OR GREEDILY GONE PAST ANY SAFE EXIT FROM A HUMONGOUS GLOBAL CREDIT BUBBLE. WHILE MALFEASANCE AND FRAUD WILL EMERGE IN THE AFTERMATH A LA LINCOLN SAVINGS AND PENN SQUARE; MUCH OF THE DAMAGE WILL HAVE BEEN DONE BY A CORPORATE/BANK/CENTRAL BANK LEADERSHIP OVERWHELMED BY A NEW, COMPLEX BREAKNECK, FINANCIALLY ENGINEERED CREDIT EXPLOSION A LA LTCM. HISTORY AND FORENSIC ACCOUNTING WILL JUDGE WHAT LEADERS WERE LARCENOUS, WHICH FRAUDULENT, WHOM WILLFULLY BLIND AND, FINALLY, THOSE OF THE EGO-DRIVEN OBLIVIOUS PERSUASION. THE COURTS AND PUBLIC OPINION WILL SORT THEM OUT!
Friday, April 08, 2005
The Demise of The Dollar
MacroMouse
THE DEMISE OF THE DOLLAR [anonymous]
The Dollar was in a panic. He had lost a lot of weight and was suffering from teeth rattling chills. He called on its old friends the Yen and the Pound to hop into bed with him to warm him up, but they refused. Then he called his newest buddy, the Euro, who was putting on weight as if he were on steroids.
“Say buddy, how about climbing in bed with me so I can warm up,” pleaded the Dollar.
“Sorry, pal,” said the Euro, “You look like you’ve got some horrible disease and I make it a policy to keep out of sick beds. Why not try a hot water bottle?”
The Dollar concluded it was time to see a physician. The doctor prescribed moderation in his eating and drinking habits, for he was consuming far more than his system could tolerate, Then he handed the patient a prescription for a hefty daily dose of taxes. The Dollar ripped it up.
“Taxes, never! Dieting never!” After all, what was life for if not to be fat and happy and lord it over the rest of the world.
Soon there came a time when he could no longer stand on his own feet and begged his old buddies for help in keeping him up.
But they were afraid that when he fell, they would collapse with him and be crushed for he was much larger than they. The only one who could possibly keep him up was the Euro who would have been happy to give him ice in the winter.
Their universal refusal for help caused him to be placed in a nursing home for failing currencies. Yet even there, he refused to take tax pills and kept consuming more than he could pay for and he became a mere skeleton of his former self. Even his bones lost weight.
Thus ended the career of the almighty Dollar; sickly, confined to bed and powerless. And when he looked around, and saw what the other currencies were doing, he wept over his lost strength. However, he tried to keep his spirits up by finding new meaning to his life as wall paper and being recycled into toilet tissue. It didn’t make him very happy but as some consolation, he still had his memories.
THE DEMISE OF THE DOLLAR [anonymous]
The Dollar was in a panic. He had lost a lot of weight and was suffering from teeth rattling chills. He called on its old friends the Yen and the Pound to hop into bed with him to warm him up, but they refused. Then he called his newest buddy, the Euro, who was putting on weight as if he were on steroids.
“Say buddy, how about climbing in bed with me so I can warm up,” pleaded the Dollar.
“Sorry, pal,” said the Euro, “You look like you’ve got some horrible disease and I make it a policy to keep out of sick beds. Why not try a hot water bottle?”
The Dollar concluded it was time to see a physician. The doctor prescribed moderation in his eating and drinking habits, for he was consuming far more than his system could tolerate, Then he handed the patient a prescription for a hefty daily dose of taxes. The Dollar ripped it up.
“Taxes, never! Dieting never!” After all, what was life for if not to be fat and happy and lord it over the rest of the world.
Soon there came a time when he could no longer stand on his own feet and begged his old buddies for help in keeping him up.
But they were afraid that when he fell, they would collapse with him and be crushed for he was much larger than they. The only one who could possibly keep him up was the Euro who would have been happy to give him ice in the winter.
Their universal refusal for help caused him to be placed in a nursing home for failing currencies. Yet even there, he refused to take tax pills and kept consuming more than he could pay for and he became a mere skeleton of his former self. Even his bones lost weight.
Thus ended the career of the almighty Dollar; sickly, confined to bed and powerless. And when he looked around, and saw what the other currencies were doing, he wept over his lost strength. However, he tried to keep his spirits up by finding new meaning to his life as wall paper and being recycled into toilet tissue. It didn’t make him very happy but as some consolation, he still had his memories.
Monday, March 28, 2005
Wednesday, March 23, 2005
Waiting For The Big Wave!
Waiting for the big wave
Katy Delay is a freelance columnist in economics and government, and maintains a blog at Link.
By all logic, this nation should be in deep water right about now. In the 1980s, wise kahunas foretold a watery day of reckoning within the following two or three decades if nothing were done to counteract the scourge of chronic inflation that has proceeded unhampered since the early 20th Century.
We all note that indeed nothing has been done. On the contrary, the waves of increasing prices haven't let up for a moment, growing at a rate of at least 2-3% a year since 1900. So, since the dollar is now falling on the international marketplace, should we begin preparing for the crashing Big Wave as predicted? History says there will be retribution in the long run; but there are at least four elements of our modern economy that might explain the stealth with which it is approaching.
One of those is the extent of the recent technology boom. The discovery of electronics is the equivalent of the wheel in its significance to the economy. Computers and high-speed communications have brought productivity not only to an all time high, but frankly to another cosmic level; and through this factor alone, general prices should have decreased several points, just as they did back in the 1800s during the industrial revolution. (By the way, contrary to popular opinion, natural, gradual price deflation enriches everyone equitably and indiscriminately, by increasing our purchasing power. As prices decrease, relative or "real" wealth – i.e. our ability to raise our standard of living and save for the future – increases.)
Yet this hasn't happened. Why? Because the expected price decreases have been offset every year by a lowering of the dollar's value through "out of thin air" credit creation and currency inflating that camouflages improper price increases. Both the wasted cost devaluation and the parallel dollar debasement can remain invisible for years – at least until people wake up, as they are beginning to do.
But you will say, "Then why doesn't the CPI (consumer price index) reflect this inflating theft properly?" This is the second reason for our Big Wave's invisibility: economic statistics are misleading and inaccurate, to the point where one wonders just how naive economists must think we are. The dirty little secret is that they have always had difficulty measuring even something as "simple" as true output, or gross domestic product (GDP); and more complicated economic variables such as what I call "IEI," for "inflating embezzlement index" (the amount of hot-air credit in our economy) remain even more elusive. Believe it or not, the experts are just estimating the figures, hoping to possess the right data to start with (like the M1 and M2 aggregates you've heard of) and praying – or in some cases assuming with the hubris typical of far too many in the scientific community – that it is not garbage in, garbage out. IEI has proven to be particularly quixotic. No economist has come anywhere near accuracy, except perhaps Edward C. Harwood of the American Institute for Economic Research; and even AIER admits to having difficulty since the 1970s, given the arduous and all but impossible underlying statistics-gathering involved.
So let's have some fun conjecturing: How much purchasing power might we really be losing on an annual basis, above the 3% the Fed has already admitted to? If our measurement of GDP were more in tune with reality, we just might find that real national wealth should have increased by something on the order of – just to take a wild guess based on the contribution of new technologies in my personal life – some 7 to 10% per year since 1980. This should bring about a lowering of CPI (remember, lowering of prices is the equivalent of an increase of the populace's wealth) of at least a few percentage points a year, say 2%, to be modest. That, added to the 3% so-called "inflation" rate we are seeing in our CPI basket of prices, makes a total of 5% a year, or 100% of our wealth confiscated over a 20 year period, at the very minimum; and that's based on these GDP estimates alone. The punch line is that no one can certify that this is incorrect. Do you suppose this is one explanation why our dollar can't get no respect these days?
A third element that may be contributing to this exquisite prolongation of our Big Wave's dénouement is that the US is perceived as a bastion of economic strength compared to every other nation in the world. We're called the "world's tallest midget." Based on that, billions of our "good-as-gold" dollars, stocks, and US bonds and assets are being held as the safest investments. To top it off, the dollar is also used as a substitute money by foreign citizens of less financially secure countries. For example, no one is really certain just how many of our dollar bills are hidden in the coffers of the likes of Saddam Hussein, or held by Russian mafiosi, ready to pay for that chalet in the Swiss alps or a mansion on the Cote d'Azur. The money simply changes hands, never returning to its berth.
More recently, however, these dollars are buying less and less, and the bonds are decreasing in worth, so our fiscal rogues and central bankers are wont to diversify. By way of illustration, a recent Columbian street gang bust turned up a suitcase full of euros. Now, this alone does not constitute a direct challenge to the dollar's esteemed status (it may simply be a reflection of evolving European drug preferences); but one thing is certain: the dollar is no longer the only game in town.
If the drug lords and OPEC are already getting skittish, what will happen when the world's central bankers decide to act upon the realization that the dollar is not as good as gold, releasing a tidal wave of currency and bonds that will head home for lack of takers? The Fed will have to get the excess cash off the American streets in order to avoid pandemonium (imagine the scene: too many greenbacks chasing too few goods, and Greenspan in pursuit at the rear) they will also have to increase Fed rates further, which may slow the American economy and force prices to move erratically. But wait: the Fed has led us to believe that they have prices under control. They will be in a quandary. I wish I could be a fly on the wall of their boardroom when it happens.
But you can't be in two places at once, so I prefer to perch under this huge wave's crest, hoping to catch another good ride when the devil's plans play out. It's sad: if only all of humanity – not just the bankers, the US government and the smart speculators – could ride at the pinnacle of this technological progress that is holding us afloat today. Instead, the usual losers will remain clustered in herds along its flanks, trying to go about their business of competing sportsmanlike for the small swells, though increasingly unnerved by the moody seas and disrupting gulps of salt water. Like our Asian friends, their short memories will not allow them to conceive of the tsunami that may be about to bowl them ashore – or maybe even tumble us all asunder.
Katy Delay is a freelance columnist in economics and government, and maintains a blog at Link.
By all logic, this nation should be in deep water right about now. In the 1980s, wise kahunas foretold a watery day of reckoning within the following two or three decades if nothing were done to counteract the scourge of chronic inflation that has proceeded unhampered since the early 20th Century.
We all note that indeed nothing has been done. On the contrary, the waves of increasing prices haven't let up for a moment, growing at a rate of at least 2-3% a year since 1900. So, since the dollar is now falling on the international marketplace, should we begin preparing for the crashing Big Wave as predicted? History says there will be retribution in the long run; but there are at least four elements of our modern economy that might explain the stealth with which it is approaching.
One of those is the extent of the recent technology boom. The discovery of electronics is the equivalent of the wheel in its significance to the economy. Computers and high-speed communications have brought productivity not only to an all time high, but frankly to another cosmic level; and through this factor alone, general prices should have decreased several points, just as they did back in the 1800s during the industrial revolution. (By the way, contrary to popular opinion, natural, gradual price deflation enriches everyone equitably and indiscriminately, by increasing our purchasing power. As prices decrease, relative or "real" wealth – i.e. our ability to raise our standard of living and save for the future – increases.)
Yet this hasn't happened. Why? Because the expected price decreases have been offset every year by a lowering of the dollar's value through "out of thin air" credit creation and currency inflating that camouflages improper price increases. Both the wasted cost devaluation and the parallel dollar debasement can remain invisible for years – at least until people wake up, as they are beginning to do.
But you will say, "Then why doesn't the CPI (consumer price index) reflect this inflating theft properly?" This is the second reason for our Big Wave's invisibility: economic statistics are misleading and inaccurate, to the point where one wonders just how naive economists must think we are. The dirty little secret is that they have always had difficulty measuring even something as "simple" as true output, or gross domestic product (GDP); and more complicated economic variables such as what I call "IEI," for "inflating embezzlement index" (the amount of hot-air credit in our economy) remain even more elusive. Believe it or not, the experts are just estimating the figures, hoping to possess the right data to start with (like the M1 and M2 aggregates you've heard of) and praying – or in some cases assuming with the hubris typical of far too many in the scientific community – that it is not garbage in, garbage out. IEI has proven to be particularly quixotic. No economist has come anywhere near accuracy, except perhaps Edward C. Harwood of the American Institute for Economic Research; and even AIER admits to having difficulty since the 1970s, given the arduous and all but impossible underlying statistics-gathering involved.
So let's have some fun conjecturing: How much purchasing power might we really be losing on an annual basis, above the 3% the Fed has already admitted to? If our measurement of GDP were more in tune with reality, we just might find that real national wealth should have increased by something on the order of – just to take a wild guess based on the contribution of new technologies in my personal life – some 7 to 10% per year since 1980. This should bring about a lowering of CPI (remember, lowering of prices is the equivalent of an increase of the populace's wealth) of at least a few percentage points a year, say 2%, to be modest. That, added to the 3% so-called "inflation" rate we are seeing in our CPI basket of prices, makes a total of 5% a year, or 100% of our wealth confiscated over a 20 year period, at the very minimum; and that's based on these GDP estimates alone. The punch line is that no one can certify that this is incorrect. Do you suppose this is one explanation why our dollar can't get no respect these days?
A third element that may be contributing to this exquisite prolongation of our Big Wave's dénouement is that the US is perceived as a bastion of economic strength compared to every other nation in the world. We're called the "world's tallest midget." Based on that, billions of our "good-as-gold" dollars, stocks, and US bonds and assets are being held as the safest investments. To top it off, the dollar is also used as a substitute money by foreign citizens of less financially secure countries. For example, no one is really certain just how many of our dollar bills are hidden in the coffers of the likes of Saddam Hussein, or held by Russian mafiosi, ready to pay for that chalet in the Swiss alps or a mansion on the Cote d'Azur. The money simply changes hands, never returning to its berth.
More recently, however, these dollars are buying less and less, and the bonds are decreasing in worth, so our fiscal rogues and central bankers are wont to diversify. By way of illustration, a recent Columbian street gang bust turned up a suitcase full of euros. Now, this alone does not constitute a direct challenge to the dollar's esteemed status (it may simply be a reflection of evolving European drug preferences); but one thing is certain: the dollar is no longer the only game in town.
If the drug lords and OPEC are already getting skittish, what will happen when the world's central bankers decide to act upon the realization that the dollar is not as good as gold, releasing a tidal wave of currency and bonds that will head home for lack of takers? The Fed will have to get the excess cash off the American streets in order to avoid pandemonium (imagine the scene: too many greenbacks chasing too few goods, and Greenspan in pursuit at the rear) they will also have to increase Fed rates further, which may slow the American economy and force prices to move erratically. But wait: the Fed has led us to believe that they have prices under control. They will be in a quandary. I wish I could be a fly on the wall of their boardroom when it happens.
But you can't be in two places at once, so I prefer to perch under this huge wave's crest, hoping to catch another good ride when the devil's plans play out. It's sad: if only all of humanity – not just the bankers, the US government and the smart speculators – could ride at the pinnacle of this technological progress that is holding us afloat today. Instead, the usual losers will remain clustered in herds along its flanks, trying to go about their business of competing sportsmanlike for the small swells, though increasingly unnerved by the moody seas and disrupting gulps of salt water. Like our Asian friends, their short memories will not allow them to conceive of the tsunami that may be about to bowl them ashore – or maybe even tumble us all asunder.
Wednesday, March 16, 2005
"Throw the Book at China!"
Throw the Book at China - Kirchner:
The IIE's Fred Bergsten says it is time the IMF and US Treasury started enforcing the rule book on China's manipulation of its exchange rate:
Fred Bergsten even goes so far as to call for IMF counter-intervention in foreign exchange markets and the erection of trade barriers under WTO auspices. This is dangerous and unnecessary in my view. But if the IMF will not enforce its own rule book, we have to ask, what is it good for?"
The IIE's Fred Bergsten says it is time the IMF and US Treasury started enforcing the rule book on China's manipulation of its exchange rate:
key industrial countries and international institutions have done virtually nothing to counter these blatant market distortions. Despite their professed fealty to market principles, the US and European governments have limited themselves to ineffectual consultations with the perpetrators. Massive currency interventions by the Asian countries directly violate the charter of the International Monetary Fund, which calls on members to avoid manipulating exchange rates in order "to prevent effective balance of payments adjustment". The chief culprit is China, whose continued dollar peg has helped weaken its currency by more than 10 per cent since 2002.
The US and the Europeans, the IMF's leading shareholders, must insist the fund start implementing its rules. This calls for the managing director to send a consultation mission to each member country suspected of "manipulation" and, if resolution is not prompt, then to refer the problem to the fund's executive board. The list of target countries should start with China. In addition, the Treasury Department must start fulfilling its legislative requirement to label these countries, most notably China, as "currency manipulators" in its next semi-annual report to Congress on the topic due later this month.
Fred Bergsten even goes so far as to call for IMF counter-intervention in foreign exchange markets and the erection of trade barriers under WTO auspices. This is dangerous and unnecessary in my view. But if the IMF will not enforce its own rule book, we have to ask, what is it good for?"
Monday, March 14, 2005
Monday, March 07, 2005
The Liquidity Conundrum
China, the global wages dynamic and the global resources dynamic - is this all the story or is this a much more complex dynamic? My answer to this is one you may never have thought of. I've recently been involved with many academic and intellectual groups pouring over the world's problems, and mainly from economic perspectives. What has struck me as novel is the fact the U.S. and many western nations preached for the downfall of Marxist pholosophy nations for over 75 years, yet never penned hardly a word about what the world would be like if their dream came true - what the economic, ie., wage, inflation and resource dynamics set in play would truly be. By this I mean Marxist nations for all these years had barely any inflation in wages and internal resource prices compared to the western world. Then I got thinking about colonialism and imperialism exerting a very similar economic dynamic in the countries where practiced for centuries - and then them also re-entering the free capitalist system mostly after WWII. Most of the colonial nations didn't experience the rates of inflation their host countries did either, much the same as the Marxist countries, since they were manipulated low - kind of like capitalism's socialist surrogates. This means that a huge, more than huge, economic dynamic has been released on the world, first by the post colonial period after WWII, and then by the post Marxist period since the early `90's.
After thinking about the above I got thinking about what my grandfather had told me about time - ie., empire time and timing of nations' integrations and re-integrations. Looking back over history we all recognize the many great, and not so great empires that have existed. They all existed for a time - time and the timing of empires and nations' existence is key to my thinking. If we boil this down to a basic model of ET=WIR, or empire time equals wages, inflation and resources, I think we can see quite a simple example of otherwise complex data. It matters not which empire or nation we use as our model as all work the same to these four factors - time, wages, inflation and resources, since these four items can represent everything present in any and all empires and nations. Nations and empires all started out with cheap wages, low inflation and cheap reasources. Time, there it is again, time changes this dynamic and only time does. Now, that may seem quite obvious but, over time any empire or nation, such as the U.S., starting out with practically free for the taking resources, which in itself would have created cheap wages, was a huge dynamic on the then existing capitalist world. Defining this further, we were a mercantilist nation entering the hegemonic capitalist world of the European empires. By us haveing such cheap wages and resources we couldn't help but accidentally grow into the greatest power and wealth nation the world has ever known, but now we face the same problem from China that we then posed on the capitalist hegemonic world of 1791. We are now the hegemon and China is the mercantilist with the cheap wages and internal resources - not to mention her mercantilist minions all over the globe.
This timing dynamics has been going on since the dawn of economic time. Any one nation or potential empire starts out with the cheapest wages and resources, whether it be Egypt or the Myan's, and over time inflates to higher levels than the periphery, and at some point the periphery becomes a new center. This happens due to nothing more than the time and timing growths and integrations of wage prices, inflation rates and resource prices. Low price nations and empires become high price nations and empires over time, and thus trade places one after another through the process of perpetual economic suzerainty - the never ending cycly of the circle of nations' time cycles. So time and re-timing the global cycles into and by global re-balancing through sliding time scale law structures is the only way this author sees to solving this greatest of history's global problem.
After thinking about the above I got thinking about what my grandfather had told me about time - ie., empire time and timing of nations' integrations and re-integrations. Looking back over history we all recognize the many great, and not so great empires that have existed. They all existed for a time - time and the timing of empires and nations' existence is key to my thinking. If we boil this down to a basic model of ET=WIR, or empire time equals wages, inflation and resources, I think we can see quite a simple example of otherwise complex data. It matters not which empire or nation we use as our model as all work the same to these four factors - time, wages, inflation and resources, since these four items can represent everything present in any and all empires and nations. Nations and empires all started out with cheap wages, low inflation and cheap reasources. Time, there it is again, time changes this dynamic and only time does. Now, that may seem quite obvious but, over time any empire or nation, such as the U.S., starting out with practically free for the taking resources, which in itself would have created cheap wages, was a huge dynamic on the then existing capitalist world. Defining this further, we were a mercantilist nation entering the hegemonic capitalist world of the European empires. By us haveing such cheap wages and resources we couldn't help but accidentally grow into the greatest power and wealth nation the world has ever known, but now we face the same problem from China that we then posed on the capitalist hegemonic world of 1791. We are now the hegemon and China is the mercantilist with the cheap wages and internal resources - not to mention her mercantilist minions all over the globe.
This timing dynamics has been going on since the dawn of economic time. Any one nation or potential empire starts out with the cheapest wages and resources, whether it be Egypt or the Myan's, and over time inflates to higher levels than the periphery, and at some point the periphery becomes a new center. This happens due to nothing more than the time and timing growths and integrations of wage prices, inflation rates and resource prices. Low price nations and empires become high price nations and empires over time, and thus trade places one after another through the process of perpetual economic suzerainty - the never ending cycly of the circle of nations' time cycles. So time and re-timing the global cycles into and by global re-balancing through sliding time scale law structures is the only way this author sees to solving this greatest of history's global problem.
Andy Xie "The End Is Debt Deflation":
The global economy is experiencing the biggest bubble ever. The bubble began with the Asian Financial Crisis and went through the tech bubble, the property bubble and, finally, the China bubble. It has been one big and long bubble. The main reason is because the major central banks have been targeting inflation in a fundamentally deflationary environment, releasing too much liquidity into the global economy. How is it going to end?
There are two obvious trends in this bubble: Anglo-Saxon consumers have been borrowing a lot against their rising property values to support consumption, and Chinese companies (actually, government-related entities) have been borrowing a lot to create production capacities. To mirror the surge in liquidity, the indebtedness of Anglo-Saxon consumers and Chinese investors has risen sharply. The current boom, therefore, is debt-funded. Debt levels can continue to rise as long as asset prices keep rising.
Whatever triggers the collapse, it will show up first in declining asset prices. Property is the likely candidate. Property prices in New York, London, and Shanghai could decline at the same time. When property prices begin to decline, it would cause the global economy to weaken. The weakening economy would decrease the cash-flow of property speculators who would have to sell to unwind. The unwinding would lead global asset prices to collapse in general.
The major central banks may try to ease aggressively to fight the unwinding spiral. However, it would be too late to revive money demand. Most speculators who are driving demand for money today would have been cut down already. The global economy is likely to experience a period of debt deflation."
Friday, March 04, 2005
‘Bretton Woods II’ and Sino-Mercantilism
‘Bretton Woods II’ and Sino-Mercantilism, Kirchner
The ‘Bretton Woods II’ appellation for East Asia’s managed exchange rate regimes is misleading in almost every respect. IIE scholars have been taking issue with ‘BW II’ as a framework for analysis and are appropriately sceptical about its sustainability. Whereas many see this as a potential problem for the US, it is a much larger problem for those economies in East Asia running managed exchange rate regimes. Morris Goldstein and Nicholas R. Lardy highlight some of the problems the ‘BW II’ framework poses for China:
the revived Bretton Woods system is just another ill-informed employment-oriented case for exchange rate undervaluation…the approach underestimates the costs of sterilization, particularly those associated with financial repression. If, as seems likely, both the US current account deficit and China’s reserve accumulation, currently $610 billion, (£318 billion), become much larger, these sterilization costs will rise…
The revived Bretton Woods system sets out a faulty development strategy for China. Rather than seeking to promote an enclave economy based on an undervalued exchange rate and on domestic financial repression, China must expedite financial reform, particularly in banking; liberalise interest rates and reduce reliance on administrative controls and guidance. It must move towards greater flexibility in the exchange rate over the medium term, including an immediate 15-25 per cent appreciation of the renminbi relative to a currency basket. These policies will promote domestic financial stability and more balanced employment growth, improve the allocation of investment and the management of the economy, and help ensure continued access for China’s exports.
The ‘Bretton Woods II’ appellation for East Asia’s managed exchange rate regimes is misleading in almost every respect. IIE scholars have been taking issue with ‘BW II’ as a framework for analysis and are appropriately sceptical about its sustainability. Whereas many see this as a potential problem for the US, it is a much larger problem for those economies in East Asia running managed exchange rate regimes. Morris Goldstein and Nicholas R. Lardy highlight some of the problems the ‘BW II’ framework poses for China:
the revived Bretton Woods system is just another ill-informed employment-oriented case for exchange rate undervaluation…the approach underestimates the costs of sterilization, particularly those associated with financial repression. If, as seems likely, both the US current account deficit and China’s reserve accumulation, currently $610 billion, (£318 billion), become much larger, these sterilization costs will rise…
The revived Bretton Woods system sets out a faulty development strategy for China. Rather than seeking to promote an enclave economy based on an undervalued exchange rate and on domestic financial repression, China must expedite financial reform, particularly in banking; liberalise interest rates and reduce reliance on administrative controls and guidance. It must move towards greater flexibility in the exchange rate over the medium term, including an immediate 15-25 per cent appreciation of the renminbi relative to a currency basket. These policies will promote domestic financial stability and more balanced employment growth, improve the allocation of investment and the management of the economy, and help ensure continued access for China’s exports.
Monday, February 28, 2005
Federal Reserve Governor Ben Bernanke: Warnings?
Federal Reserve Governor Ben Bernanke: Doug Noland
And the counterpoint view to this article: The Overstretch Myth
The U.S. economy generates $600 billion-plus Current Account Deficits because we “invest” so much? Such econobabble from a prominent central banker does not inspire confidence. And, more than ever, instilling dollar confidence is an imperative. Tuesday the dollar was hammered on news of the Bank of Korea’s plan to diversify its dollar-denominated reserves. There was also the revelation of an Asian policymakers meeting this week to discuss “global economic imbalances” and how to deal with the faltering dollar. And from today’s Australian: “[Australia’s Treasurer] Peter Costello’s closest advisor fears the US is heading for a devastating financial crash that could ravage Australia’s economic growth. …Treasury Secretary Ken Henry likened the flood of money pouring into the US to support its budget and current account deficits to the stockmarket’s dotcom bubble of the late 1990s. Were it suddenly to stop, there would be shockwaves felt throughout the world’s economies.”
Languish over the likelihood that the U.S. is on course to precipitate global financial crisis has spilled out into the open. This is surely related ot the heightened appreciation by market participants and global policymakers that the Federal Reserve is not up to the task of reining in U.S. financial and economic excess. Moreover, the much anticipated marketplace-induced adjustment process has failed to materialize. Indeed, exuberant global markets and propagating asset Bubbles ensure a calamitous future “adjustment.” Global policymakers and central bankers should be apprehensive.
The weak dollar has certainly failed to rectify or even slow imbalances – global, domestic or otherwise - and there is little prospect that further devaluation will be any more successful. In the past, a weak currency would induce higher market rates – rates necessary to tighten financial conditions, temper over-consumption and undermine speculative dynamics. Yet the old rules no longer apply to contemporary finance, a momentous blow to the capacity for orderly market-based corrections and adjustments. The need for strong-minded central bankers to guard against inexorable market distortions has never been as great, while, ironically, never has a central bank (the Greenspan Fed) placed greater faith in the efficiency of market processes. And Dr. Bernanke’s comments above suggest that policy efforts to constrain American consumption aren’t on the table – “consumption” being a four-letter word not even open to discussion. Accordingly, the prospect of the Fed purposely precipitating a meaningful economic slowdown to assist the U.S. Current Account Deficit “unwind” is nonexistent. Commencing the arduous process of reestablishing Monetary Order is, then, at a logjam.
This week from Morgan Stanley’s Stephen Roach: “Global rebalancing does not occur spontaneously. It takes adjustments in economic policies and asset prices to spark a meaningful realignment in the mix of global growth. Shifts in currencies and real interest rates are the two major instruments of rebalancing… In the end, it will also require a narrowing of the growth differentials between the US and the rest of the world… A narrowing of the growth spread between the US and the rest of the world is key for a resolution of America’s trade- and current-account imbalances.”
These excerpts do not do Mr. Roach’s exceptional analysis justice; they instead provide the opportunity to distinguish the focal points of my analysis: I have reached the point of having lost what little faith I had in the efficacy of “global rebalancing.” Imbalances simply cannot be rectified by heady non-U.S. global growth. Such a scenario would ensure myriad problematic bottlenecks, shortages and price pressures including significantly inflating global energy and commodities prices. At the same time, global policymakers – especially the Fed – refuse to take decisive action. They respectively missed their opportunities to act. The costs and risks are these days much too high for aggressive policy response – individually or in concert. There is no will to face The Bubble Issue.
Importantly, asset inflation has become a global systemic issue. Mortgage Credit is growing at double-digit rates in the U.S., Europe, and China (and elsewhere). Meanwhile, speculative securities leveraging and attendant liquidity creation is endemic internationally, and there is no international body or coordinated central bank policy response to moderate – let alone rein in - Global Wildcat Finance. Resulting uncontrolled liquidity excess is The New Global Phenomenon, nonetheless central bank balance sheets balloon on the back of unrelenting dollar flows. It is amazing that marketplace perceptions of quiescent inflation persist in the face of today’s unparalleled global backdrop of abundant liquidity and Endemic Easy Credit Availability.
Importantly, global interest rates have converged like never before, and they have consolidated right down toward artificially low U.S. levels. Moreover, the massive international liquidity pool offers an overhang of constant downward pressure on the converged price of global finance. Less appreciated but no less significant, financial systems internationally have “converged” toward the U.S. model. Depressed interest rates augment already intense worldwide asset-based lending and securities speculation, only exacerbating the Global Liquidity Bubble. The dysfunctional U.S. Credit system has now fully impaired the global financial system, leaving faint hope that market pricing mechanisms will instigate either a gradual or orderly “adjustment process.”
The bottom line is that the entire spectrum of international rates – the global price of finance - needs to shift meaningfully higher. This amounts to the only effective policy measure to rein in asset-based lending and speculating excess. The dilemma is that central bankers from the ECB to China and Asia are frozen by the vulnerable dollar and the prospect of financial crisis. To raise rates would only incite greater financial flows away from the U.S. and its ailing currency. There is, as well, the issue of massive speculative leveraging throughout. The Fed is locked into a policy of “baby steps” that ensures that U.S. rates at best stay barely a half-step ahead of rising inflationary pressures, while inciting only greater speculative excess.
There is much written these days referencing “real” and “neutral” rates, but these notions have little practical meaning without an effort to factor in asset inflation. Asset prices are, after all, the centerpiece of contemporary Credit and liquidity creation. To instead fixate on CPI – the misplaced contemporary inflation target – guarantees ineffectual monetary management. Having succumbed to this analytical misjudgment and, in the process, having fallen so far behind the curve, there is now the prospect that much higher Fed funds may be required to garner any meaningful impact on U.S. and global excesses and imbalances.
Dr. Bernanke is deluding himself if he actually believes that stronger global growth and more equitable trade treaties and practices will work to rectify our Current Account Quagmire. I also think he is too optimistic in expecting that today’s deficits can be sustained “for awhile” and “take awhile to unwind.” The inevitable adjustment period will commence only with the problematic bursting of the Mortgage Finance Bubble; no more, no less. And, not surprisingly, this Mighty Bubble scoffs at Cowardly Little Baby Steps. Are speculators suffering from higher financing costs? Are 4% ARMs to dissuade manic California, Florida, or Manhattan mortgage borrowers? Then how about even lower teaser and interest-only mortgages? And let’s not forget that 2004 saw the greatest inflation of home equity in history, and it’s there just waiting to be tapped to upgrade to a more appealing residence or to boost consumption. January then brought another $10,000 windfall to the average California homeowner. Credit conditions are easier today than they were a year ago – or ever were.
My fear that we are heading toward financial crisis is not rooted in the mindless ranting of an embittered permabear – but from the discipline of my analytical framework. The U.S. Credit Bubble is creating unrelenting and unwieldy dollar liquidity that continues to inundate global financial systems. The marketplace pricing mechanism for global finance is severely impaired, while speculative dynamics are empowered. Excess is only begetting greater excess, and policymakers, meanwhile, function like deer caught in headlights.
The question I ponder this evening is how this expected crisis manifests. Does it unfold first in the currency or interest-rate markets? Is it precipitated by a spike to $60 or $70 crude and a panic “melt-up” in global commodity markets? What market “accident” could set off a chain reaction of speculator unwind? Are spreads an accident in wait? The ten year? MBS? And, of course, the dollar is certainly vulnerable to a marketplace dislocation, although we can also assume that global central bankers are now on heightened alert. I will admit to being absolutely intrigued by the degree of complacency that is now ingrained in The Bulletproof Bond Market. All the recent talk of a shortage of bonds recalls major Bubble tops of years past. The reality of the situation is that it would require only a marginal bout of de-leveraging to create way more than adequate supply.
Out of Aces - 1907
And the counterpoint view to this article: The Overstretch Myth
“The current account deficit is a concern. What that is basically – there are two ways of looking at the current account deficit. One is looking at it from the trading perspective, which most people are familiar with the idea that we are actually importing a lot more than we are exporting. So, in that sense we have a current account deficit. But another way to look at it is that we are investing more than we’re saving. If you look at investment in terms of capital investment by firms, you look at residential investment - that is building new houses. You have seen a lot of investment but we have a relatively low savings rate. And so, having a low savings rate, we have to borrow from foreigners to make up the difference between our saving and the investment we want to do. So, what’s called capital inflows – the money flowing in from foreigners to finance our investment is another way of looking at the current account deficit. So these different perspectives give you different ways of thinking about how you would address this problem. The trade perspective says, yes, part of the issue is getting balance in our trade. And that suggests that we should work with the world trade organization and other trade agencies to try to get fairer and free trade with other countries... On the other side, we have the savings and investing perspective. We have relatively low savings, we have a federal deficit which is subtracting from our savings. And that suggests that part of reducing the current account deficit would be to try to stimulate our savings. Reduce the deficit and take other actions that would increase our savings and therefore reduce capital inflows that are coming in – which is the other face of the current account deficit. Depending how you look at it, there are a variety of policies that should be undertaken. I think the current account deficit is going to be with us awhile. It will take a while to unwind. It can’t go on at this level for ever. It is going to eventually have to come down. And I think it will eventually come down. But policies like increasing our savings would probably be a step in the right direction to help that happen.”
The U.S. economy generates $600 billion-plus Current Account Deficits because we “invest” so much? Such econobabble from a prominent central banker does not inspire confidence. And, more than ever, instilling dollar confidence is an imperative. Tuesday the dollar was hammered on news of the Bank of Korea’s plan to diversify its dollar-denominated reserves. There was also the revelation of an Asian policymakers meeting this week to discuss “global economic imbalances” and how to deal with the faltering dollar. And from today’s Australian: “[Australia’s Treasurer] Peter Costello’s closest advisor fears the US is heading for a devastating financial crash that could ravage Australia’s economic growth. …Treasury Secretary Ken Henry likened the flood of money pouring into the US to support its budget and current account deficits to the stockmarket’s dotcom bubble of the late 1990s. Were it suddenly to stop, there would be shockwaves felt throughout the world’s economies.”
Languish over the likelihood that the U.S. is on course to precipitate global financial crisis has spilled out into the open. This is surely related ot the heightened appreciation by market participants and global policymakers that the Federal Reserve is not up to the task of reining in U.S. financial and economic excess. Moreover, the much anticipated marketplace-induced adjustment process has failed to materialize. Indeed, exuberant global markets and propagating asset Bubbles ensure a calamitous future “adjustment.” Global policymakers and central bankers should be apprehensive.
The weak dollar has certainly failed to rectify or even slow imbalances – global, domestic or otherwise - and there is little prospect that further devaluation will be any more successful. In the past, a weak currency would induce higher market rates – rates necessary to tighten financial conditions, temper over-consumption and undermine speculative dynamics. Yet the old rules no longer apply to contemporary finance, a momentous blow to the capacity for orderly market-based corrections and adjustments. The need for strong-minded central bankers to guard against inexorable market distortions has never been as great, while, ironically, never has a central bank (the Greenspan Fed) placed greater faith in the efficiency of market processes. And Dr. Bernanke’s comments above suggest that policy efforts to constrain American consumption aren’t on the table – “consumption” being a four-letter word not even open to discussion. Accordingly, the prospect of the Fed purposely precipitating a meaningful economic slowdown to assist the U.S. Current Account Deficit “unwind” is nonexistent. Commencing the arduous process of reestablishing Monetary Order is, then, at a logjam.
This week from Morgan Stanley’s Stephen Roach: “Global rebalancing does not occur spontaneously. It takes adjustments in economic policies and asset prices to spark a meaningful realignment in the mix of global growth. Shifts in currencies and real interest rates are the two major instruments of rebalancing… In the end, it will also require a narrowing of the growth differentials between the US and the rest of the world… A narrowing of the growth spread between the US and the rest of the world is key for a resolution of America’s trade- and current-account imbalances.”
These excerpts do not do Mr. Roach’s exceptional analysis justice; they instead provide the opportunity to distinguish the focal points of my analysis: I have reached the point of having lost what little faith I had in the efficacy of “global rebalancing.” Imbalances simply cannot be rectified by heady non-U.S. global growth. Such a scenario would ensure myriad problematic bottlenecks, shortages and price pressures including significantly inflating global energy and commodities prices. At the same time, global policymakers – especially the Fed – refuse to take decisive action. They respectively missed their opportunities to act. The costs and risks are these days much too high for aggressive policy response – individually or in concert. There is no will to face The Bubble Issue.
Importantly, asset inflation has become a global systemic issue. Mortgage Credit is growing at double-digit rates in the U.S., Europe, and China (and elsewhere). Meanwhile, speculative securities leveraging and attendant liquidity creation is endemic internationally, and there is no international body or coordinated central bank policy response to moderate – let alone rein in - Global Wildcat Finance. Resulting uncontrolled liquidity excess is The New Global Phenomenon, nonetheless central bank balance sheets balloon on the back of unrelenting dollar flows. It is amazing that marketplace perceptions of quiescent inflation persist in the face of today’s unparalleled global backdrop of abundant liquidity and Endemic Easy Credit Availability.
Importantly, global interest rates have converged like never before, and they have consolidated right down toward artificially low U.S. levels. Moreover, the massive international liquidity pool offers an overhang of constant downward pressure on the converged price of global finance. Less appreciated but no less significant, financial systems internationally have “converged” toward the U.S. model. Depressed interest rates augment already intense worldwide asset-based lending and securities speculation, only exacerbating the Global Liquidity Bubble. The dysfunctional U.S. Credit system has now fully impaired the global financial system, leaving faint hope that market pricing mechanisms will instigate either a gradual or orderly “adjustment process.”
The bottom line is that the entire spectrum of international rates – the global price of finance - needs to shift meaningfully higher. This amounts to the only effective policy measure to rein in asset-based lending and speculating excess. The dilemma is that central bankers from the ECB to China and Asia are frozen by the vulnerable dollar and the prospect of financial crisis. To raise rates would only incite greater financial flows away from the U.S. and its ailing currency. There is, as well, the issue of massive speculative leveraging throughout. The Fed is locked into a policy of “baby steps” that ensures that U.S. rates at best stay barely a half-step ahead of rising inflationary pressures, while inciting only greater speculative excess.
There is much written these days referencing “real” and “neutral” rates, but these notions have little practical meaning without an effort to factor in asset inflation. Asset prices are, after all, the centerpiece of contemporary Credit and liquidity creation. To instead fixate on CPI – the misplaced contemporary inflation target – guarantees ineffectual monetary management. Having succumbed to this analytical misjudgment and, in the process, having fallen so far behind the curve, there is now the prospect that much higher Fed funds may be required to garner any meaningful impact on U.S. and global excesses and imbalances.
Dr. Bernanke is deluding himself if he actually believes that stronger global growth and more equitable trade treaties and practices will work to rectify our Current Account Quagmire. I also think he is too optimistic in expecting that today’s deficits can be sustained “for awhile” and “take awhile to unwind.” The inevitable adjustment period will commence only with the problematic bursting of the Mortgage Finance Bubble; no more, no less. And, not surprisingly, this Mighty Bubble scoffs at Cowardly Little Baby Steps. Are speculators suffering from higher financing costs? Are 4% ARMs to dissuade manic California, Florida, or Manhattan mortgage borrowers? Then how about even lower teaser and interest-only mortgages? And let’s not forget that 2004 saw the greatest inflation of home equity in history, and it’s there just waiting to be tapped to upgrade to a more appealing residence or to boost consumption. January then brought another $10,000 windfall to the average California homeowner. Credit conditions are easier today than they were a year ago – or ever were.
My fear that we are heading toward financial crisis is not rooted in the mindless ranting of an embittered permabear – but from the discipline of my analytical framework. The U.S. Credit Bubble is creating unrelenting and unwieldy dollar liquidity that continues to inundate global financial systems. The marketplace pricing mechanism for global finance is severely impaired, while speculative dynamics are empowered. Excess is only begetting greater excess, and policymakers, meanwhile, function like deer caught in headlights.
The question I ponder this evening is how this expected crisis manifests. Does it unfold first in the currency or interest-rate markets? Is it precipitated by a spike to $60 or $70 crude and a panic “melt-up” in global commodity markets? What market “accident” could set off a chain reaction of speculator unwind? Are spreads an accident in wait? The ten year? MBS? And, of course, the dollar is certainly vulnerable to a marketplace dislocation, although we can also assume that global central bankers are now on heightened alert. I will admit to being absolutely intrigued by the degree of complacency that is now ingrained in The Bulletproof Bond Market. All the recent talk of a shortage of bonds recalls major Bubble tops of years past. The reality of the situation is that it would require only a marginal bout of de-leveraging to create way more than adequate supply.
Out of Aces - 1907
Thursday, February 24, 2005
"Will the Bretton Woods 2 Regime Unravel Soon? The Risk of Hard Landing in 2005-2006".
"Will the Bretton Woods 2 Regime Unravel Soon? The Risk of Hard Landing in 2005-2006".
The paper can be found online at: Link
The paper can be found online at: Link
Wednesday, February 16, 2005
Debt Trap Dynamics: Time To Think The Unthinkable
Marshall Auerback
With the government and external deficits both so large and the private sector so heavily indebted, it is said that satisfactory growth in the US cannot be achieved without a large, sustained and discontinuous increase in net export demand. After perusing the trade data from last year, it is doubtful whether this will happen spontaneously through a continuous fall in the external value of the dollar, and it certainly will not happen without a cut in domestic absorption of goods and services by the US which would impart a deflationary impulse to the rest of the world.
The truth of the matter is this: Across three decades, only one economic event has been guaranteed to produce balanced US trade: a recession. When the economy is contracting, people naturally buy less of everything, including imports. Historically, on the four occasions when the line of exports briefly converged with the line of imports in the post-war period, the country was in recession. Each time economic growth was restored, the trade deficits resumed. A more ominous contradiction occurred during the 2001 recession: The trade gap was so enormous it persisted throughout. Again, in 2004, despite a significant fall in the dollar’s trade weighted index, the external account continued to haemorrhage. This suggests that American dependency on foreign producers has advanced to a dangerous new level.
Economists, politicians, and business executives have repeatedly voice unease about the imbalances in the global financial system, which have been reflected in the dollar's steep fall against the euro and other currencies until recently. But most expressed skepticism that the Bush administration would reduce the trade and budget deficits, which have fed those imbalances. The White House has said that it does not view these issues as a major problem because foreigners still view the American economy as an attractive investment, and Mr Greenspan has recanted some of his earlier expressed concern about the dangers of ignoring America’s mounting imbalances.
The scope of the global imbalances and the potential for crisis makes piecemeal, orthodox solutions to the global imbalance problem unworkable and far too slow. The U.S. service-based economy, with more limited economies of scale than those of newly industrializing economies such as China, will not be able to export its way out of the problem. The only demand left for US goods is largely concentrated in industries such as aerospace and high technology. But these are industries where exports pose national security risks, particularly if the exports are directed toward “strategic competitors” such as China, which generally have extremely poor records in terms of safeguarding intellectual property rights.
As we have noted many times before, there is a danger that over time, the US economy will find itself in a “debt trap”, with an accelerating deterioration in its net foreign asset position and its overall current balance of payments (as net income paid abroad begins to explode). We have never been in a position before where the world’s leading economy has been subject to this condition, so it is difficult to make the case for traditional remedies, such as trade devaluation (where the corresponding knock-on effects would invariably create a huge international growth shock, thereby throwing into doubt the strategy of the US achieving net export growth). Because the US is such a vast economy, it cannot eliminate its current account deficit as readily as a smaller economy. When it tries to improve its trade balance through devaluation or through restrictive demand management, its sheer size affects the economies of its trading partners adversely and to an appreciable degree. Understandably, they object and resist. When foreign economies resist dollar devaluation and the dissipation of their current account surpluses, the U.S. may have to raise interest rates in order to induce creditors to continue financing its debt build-up.
So the problem is likely to get worse, which could ultimately lead to “solutions” that prove highly disruptive to the existing system of multilateral trade and cooperation which has developed over the past several generations. A resort to out and out military force cannot ultimately be ruled out.
If a full-blown crisis does occur, the macroeconomic challenge would be unlike anything the United States has faced in more than half a century. While this would be a time of wrenching, painful change, the new adverse circumstances might also inspire a great shift toward radically different political solutions than have hitherto been considered within the realm of acceptability.
The first imperative--an unavoidable necessity--would be to suppress consumption through credit-restraining measures, fiscal caution or tax reform, and to stimulate greater domestic savings, yet somehow to keep the economy growing. If this great adjustment is left to market forces alone, the predictable consequences will be to punish the innocent--struggling households and small businesses--first.
The jump-shift strategy may ultimately take the form of a “wartime strategy” – not the phony “war on terror” strategy invoked after the September 11, 2001 attacks (in which Messrs O’Neill and McTeer, amongst others, exhorted Americans to go back to the shopping malls, to show the terrorists that they “couldn’t win”). A more accurate precedent is World War II, an extraordinary era of economic development that virtually shut down many forms of domestic consumption (cars and housing) while the government's spending on war production launched major new industries (electronics, petrochemicals, modern aircraft and many others). Essentially, accelerated investment and forced savings replaced consumer spending as the leading fuel for economic growth. After the war, pent-up desires and needs became the economic demand that drove the long postwar era of prosperity.
Of course, an important difference from the World War II example is that it is difficult to see how reconstruction could be financed primarily through deficit spending, given that the country is already burdened by growing indebtedness. This leads to the possibility of the US repudiating its existing debt obligations to external creditors. A decisive President might start by bringing up a taboo subject--tariffs--and inform the world that the United States is prepared to impose a temporary general tariff of 10 or 15 percent on all US imports. Every multinational would have to rethink its industrial strategy, because some of its production might be stranded in the wrong country.
The idea of tariffs is so alien to conventional wisdom it probably sounds illegal. In fact, there is provision for “temporary adjustments” under the new World Trade Organisation rules. It is also worth noting in any case that the legal technicalities of a global multilateral system didn’t stop Richard Nixon, who stunned the world in 1971 when he abruptly announced a 10 percent import surcharge, devalued the dollar and unilaterally discarded the Bretton Woods monetary system. Nor did it stop President Roosevelt in the 1930s, during which he declared it illegal to own circulating gold coins, gold bullion, and gold certificates. In essence, the federal government forced itself into the position by refusing to repay its bond holders in gold coin, forcing them to accept US dollars instead. Hence, subsequent to FDR’s executive order, all holders of such bonds were forced to accept legal tender currency instead of "gold coin of the present standard of value." The act of confiscating gold itself was a violation of private property rights and was illegal – but the taboo was broken. As author Eric Englund notes, “[B]y not paying bondholders in gold coin, the U.S. government has technically defaulted on past Treasury bond obligations.” Americans (and their foreign creditors) might come to see more of these types of actions from future American President.
It is true that such actions on the part of the US may well provoke reactions in kind. On the other hand, given the lack of restraint evident in the country’s current foreign policy aspirations, it is hard to envisage that an economic response to the Americans’ abrogation of existing obligations would come without some possibility of a robust military response (or at least the threat of one). The US has already show itself willing to address the problem that it does not make enough of what the rest of the world wants by going to war to monopolise control of the supply and distribution of what the world needs, petroleum. There are other war aims, of course, but control of the global hydrocarbon net is certainly the most important. As market strategist Chris Sanders has noted, “The truth is that the dangerously destabilising idea has rooted in Washington that, in the words of Vice President Cheney, ‘deficits don’t matter (we proved that in the 90s).’ He is right of course in pure power terms; a fuller expression of Cheney’s dictum might well add, ‘as long as we are able to force everyone else to accept them (deficits).’”
Already, it appears clear that the US is driven to rely more on military adventure because the economic house is in disarray and "overstretched". They can't just bludgeon their way economically anymore. They have to use the stick. Any close look at the inauguration speech bears out the reliance on forcing the world to conform to us dictates. Why should this not extend ultimately to existing debt arrangements if the US finds itself facing an Argentina-like predicament? All these outcomes may sound quite improbable at this moment. Certainly, the establishment would brush them aside. But do not dismiss the possibility that dramatic change and epic political reforms lie ahead. As we have said many times before, Washington’s elites will not go down without a fight.
With the government and external deficits both so large and the private sector so heavily indebted, it is said that satisfactory growth in the US cannot be achieved without a large, sustained and discontinuous increase in net export demand. After perusing the trade data from last year, it is doubtful whether this will happen spontaneously through a continuous fall in the external value of the dollar, and it certainly will not happen without a cut in domestic absorption of goods and services by the US which would impart a deflationary impulse to the rest of the world.
The truth of the matter is this: Across three decades, only one economic event has been guaranteed to produce balanced US trade: a recession. When the economy is contracting, people naturally buy less of everything, including imports. Historically, on the four occasions when the line of exports briefly converged with the line of imports in the post-war period, the country was in recession. Each time economic growth was restored, the trade deficits resumed. A more ominous contradiction occurred during the 2001 recession: The trade gap was so enormous it persisted throughout. Again, in 2004, despite a significant fall in the dollar’s trade weighted index, the external account continued to haemorrhage. This suggests that American dependency on foreign producers has advanced to a dangerous new level.
Economists, politicians, and business executives have repeatedly voice unease about the imbalances in the global financial system, which have been reflected in the dollar's steep fall against the euro and other currencies until recently. But most expressed skepticism that the Bush administration would reduce the trade and budget deficits, which have fed those imbalances. The White House has said that it does not view these issues as a major problem because foreigners still view the American economy as an attractive investment, and Mr Greenspan has recanted some of his earlier expressed concern about the dangers of ignoring America’s mounting imbalances.
The scope of the global imbalances and the potential for crisis makes piecemeal, orthodox solutions to the global imbalance problem unworkable and far too slow. The U.S. service-based economy, with more limited economies of scale than those of newly industrializing economies such as China, will not be able to export its way out of the problem. The only demand left for US goods is largely concentrated in industries such as aerospace and high technology. But these are industries where exports pose national security risks, particularly if the exports are directed toward “strategic competitors” such as China, which generally have extremely poor records in terms of safeguarding intellectual property rights.
As we have noted many times before, there is a danger that over time, the US economy will find itself in a “debt trap”, with an accelerating deterioration in its net foreign asset position and its overall current balance of payments (as net income paid abroad begins to explode). We have never been in a position before where the world’s leading economy has been subject to this condition, so it is difficult to make the case for traditional remedies, such as trade devaluation (where the corresponding knock-on effects would invariably create a huge international growth shock, thereby throwing into doubt the strategy of the US achieving net export growth). Because the US is such a vast economy, it cannot eliminate its current account deficit as readily as a smaller economy. When it tries to improve its trade balance through devaluation or through restrictive demand management, its sheer size affects the economies of its trading partners adversely and to an appreciable degree. Understandably, they object and resist. When foreign economies resist dollar devaluation and the dissipation of their current account surpluses, the U.S. may have to raise interest rates in order to induce creditors to continue financing its debt build-up.
So the problem is likely to get worse, which could ultimately lead to “solutions” that prove highly disruptive to the existing system of multilateral trade and cooperation which has developed over the past several generations. A resort to out and out military force cannot ultimately be ruled out.
If a full-blown crisis does occur, the macroeconomic challenge would be unlike anything the United States has faced in more than half a century. While this would be a time of wrenching, painful change, the new adverse circumstances might also inspire a great shift toward radically different political solutions than have hitherto been considered within the realm of acceptability.
The first imperative--an unavoidable necessity--would be to suppress consumption through credit-restraining measures, fiscal caution or tax reform, and to stimulate greater domestic savings, yet somehow to keep the economy growing. If this great adjustment is left to market forces alone, the predictable consequences will be to punish the innocent--struggling households and small businesses--first.
The jump-shift strategy may ultimately take the form of a “wartime strategy” – not the phony “war on terror” strategy invoked after the September 11, 2001 attacks (in which Messrs O’Neill and McTeer, amongst others, exhorted Americans to go back to the shopping malls, to show the terrorists that they “couldn’t win”). A more accurate precedent is World War II, an extraordinary era of economic development that virtually shut down many forms of domestic consumption (cars and housing) while the government's spending on war production launched major new industries (electronics, petrochemicals, modern aircraft and many others). Essentially, accelerated investment and forced savings replaced consumer spending as the leading fuel for economic growth. After the war, pent-up desires and needs became the economic demand that drove the long postwar era of prosperity.
Of course, an important difference from the World War II example is that it is difficult to see how reconstruction could be financed primarily through deficit spending, given that the country is already burdened by growing indebtedness. This leads to the possibility of the US repudiating its existing debt obligations to external creditors. A decisive President might start by bringing up a taboo subject--tariffs--and inform the world that the United States is prepared to impose a temporary general tariff of 10 or 15 percent on all US imports. Every multinational would have to rethink its industrial strategy, because some of its production might be stranded in the wrong country.
The idea of tariffs is so alien to conventional wisdom it probably sounds illegal. In fact, there is provision for “temporary adjustments” under the new World Trade Organisation rules. It is also worth noting in any case that the legal technicalities of a global multilateral system didn’t stop Richard Nixon, who stunned the world in 1971 when he abruptly announced a 10 percent import surcharge, devalued the dollar and unilaterally discarded the Bretton Woods monetary system. Nor did it stop President Roosevelt in the 1930s, during which he declared it illegal to own circulating gold coins, gold bullion, and gold certificates. In essence, the federal government forced itself into the position by refusing to repay its bond holders in gold coin, forcing them to accept US dollars instead. Hence, subsequent to FDR’s executive order, all holders of such bonds were forced to accept legal tender currency instead of "gold coin of the present standard of value." The act of confiscating gold itself was a violation of private property rights and was illegal – but the taboo was broken. As author Eric Englund notes, “[B]y not paying bondholders in gold coin, the U.S. government has technically defaulted on past Treasury bond obligations.” Americans (and their foreign creditors) might come to see more of these types of actions from future American President.
It is true that such actions on the part of the US may well provoke reactions in kind. On the other hand, given the lack of restraint evident in the country’s current foreign policy aspirations, it is hard to envisage that an economic response to the Americans’ abrogation of existing obligations would come without some possibility of a robust military response (or at least the threat of one). The US has already show itself willing to address the problem that it does not make enough of what the rest of the world wants by going to war to monopolise control of the supply and distribution of what the world needs, petroleum. There are other war aims, of course, but control of the global hydrocarbon net is certainly the most important. As market strategist Chris Sanders has noted, “The truth is that the dangerously destabilising idea has rooted in Washington that, in the words of Vice President Cheney, ‘deficits don’t matter (we proved that in the 90s).’ He is right of course in pure power terms; a fuller expression of Cheney’s dictum might well add, ‘as long as we are able to force everyone else to accept them (deficits).’”
Already, it appears clear that the US is driven to rely more on military adventure because the economic house is in disarray and "overstretched". They can't just bludgeon their way economically anymore. They have to use the stick. Any close look at the inauguration speech bears out the reliance on forcing the world to conform to us dictates. Why should this not extend ultimately to existing debt arrangements if the US finds itself facing an Argentina-like predicament? All these outcomes may sound quite improbable at this moment. Certainly, the establishment would brush them aside. But do not dismiss the possibility that dramatic change and epic political reforms lie ahead. As we have said many times before, Washington’s elites will not go down without a fight.
Friday, January 28, 2005
The #1 Law of Economics
The #1 law of economics is; You can only free-trade until cheaper labor out-trades you!
Mercantilism is a great way to advance statecrafted wealth!:-) It's how the U.S. started out in 1791. Alexander Hamilton was a genius at setting up our first great mercantilist system to counter England's Hegemony and real financial suzerainty. Well, 200 yrs. later and the table's been reversed. Now, we face China with her powerful statecrafted mercantilist system attacking America's statecrafted hegemony, and our actual financial suzerainty. How long can America survive supporting the rest of the world? Good question, I can't answer that, but I do know unless our hegemonic law structures are changed back toward real world balances, we will face financial destruction by, not only China, but all her mercantilist minions all over the globe.
It's really a sad state of affairs when the greatest economists and nation on earth can't figure out the simplicity of the above. The battles of hegemony, mercantilism and the cheapest labor have been going on since the beginning of organized economic societies, whether Egyptian, Greek, Roman, Myan, Hapsburg, Spanish, or English and American. What's it take to see logical common sense? Does everyone think China will go the way of Japan's mercantilism? They should think again because either way China goes, success or collapse, collapses the entire system this time. There won't be a second chance. So, I would suggest we start looking seriously at a little repair work here at home. There are many solutions. The one I would suggest is a sliding scale law structure of say 10% per year change, toward rebalancing the global economies through the anti-hegemonist anti-mercantilist policies of J.M. Keynes' full and fair balance of payments system, that was never enacted in the `40's.
More On Mercantilism.
Mercantilism is a great way to advance statecrafted wealth!:-) It's how the U.S. started out in 1791. Alexander Hamilton was a genius at setting up our first great mercantilist system to counter England's Hegemony and real financial suzerainty. Well, 200 yrs. later and the table's been reversed. Now, we face China with her powerful statecrafted mercantilist system attacking America's statecrafted hegemony, and our actual financial suzerainty. How long can America survive supporting the rest of the world? Good question, I can't answer that, but I do know unless our hegemonic law structures are changed back toward real world balances, we will face financial destruction by, not only China, but all her mercantilist minions all over the globe.
It's really a sad state of affairs when the greatest economists and nation on earth can't figure out the simplicity of the above. The battles of hegemony, mercantilism and the cheapest labor have been going on since the beginning of organized economic societies, whether Egyptian, Greek, Roman, Myan, Hapsburg, Spanish, or English and American. What's it take to see logical common sense? Does everyone think China will go the way of Japan's mercantilism? They should think again because either way China goes, success or collapse, collapses the entire system this time. There won't be a second chance. So, I would suggest we start looking seriously at a little repair work here at home. There are many solutions. The one I would suggest is a sliding scale law structure of say 10% per year change, toward rebalancing the global economies through the anti-hegemonist anti-mercantilist policies of J.M. Keynes' full and fair balance of payments system, that was never enacted in the `40's.
More On Mercantilism.
Wednesday, January 26, 2005
Davos - US Consumer - Weakest Link In World Economy
DAVOS US consumer ´weakest link´ in world economy - Morgan Stanley UDPATE
Wednesday, January 26, 2005 11:24:51 AM
Link
In a bearish assessment of global economic prospects for 2005, Roach told an introductory meeting of the World Economic Forum that rampant US consumption had been the main driver of the spectacular rates of growth achieved in 2004
However, with economies all around the world increasingly reliant on exporting their goods to the US, a moderation in US spending could have serious repercussions for the global economy
"For me, something just doesn't add up. The self indulgent American consumer ... is an accident waiting to happen," said Roach, a long-time pessimistic on the US economy
Rather than using the fruits of the increased economic activity, US consumers are funding their massive spending spree through borrowing against the inflated values of their homes. "We are in the early stages of a residential property price bubble in the US. Consumers know this and that is why they are turning their homes into a massive ATM machine," explained Roach
US consumers "suck money" out of their properties to fuel imports from Asia. In turn Asian countries buy US dollars, keeping interest rates low and allowing US householders to borrow even more, according to Roach
"This is an utterly insane way to run the world economy. You know that, we know that, but the Federal Reserve is in denial about that," he said
Roach suggested that the Federal Reserve had engineered the boom in the US property market as a means of bolstering the US economy. By stoking house prices through low borrowing costs, the Fed ensured that US consumption and, by extension economic growth, remained robust, he said. "The Fed knows it is culpable as the bubbleblowers in keeping this asset-driven US economy alive," he said. With US rates rising from the "unconscionably" levels of recent years, there will inevitably be a fall back in US property price inflation and hence consumer spending, explained Roach. "When the music stops ... and US rates go up we'll see how asset-dependent the US consumer has become," warned Roach
Jacob Frenkel, vice chairman of US insurance giant American International Group, said rampant US consumption was just one of the economic imbalances capable of wreaking havoc on the world economy. The massive trade deficit the world's largest economy is running could also stop global economic growth in its tracks
"The US current account is not a a problem for the US. It brings about risks for the world economy," he said. "I'm not concerned not because of the fact that there is no way to deal with it (the current account deficit) but because of the way it is not being dealt with," he said. He called on the newly elected US government to face up to the soaring budget and account deficits by introducing measures to encourage saving and discourage consumption
Frenkel, a former head of the Israeli Central Bank, urged representatives at a forthcoming G7 Meeting of Finance Ministers to address profligate US fiscal spending. "There must be debates on US policy measures. They must not just a focus on the dollar," as a remedy for the US trade deficit, said Frenkel
Link
Wednesday, January 26, 2005 11:24:51 AM
Link
In a bearish assessment of global economic prospects for 2005, Roach told an introductory meeting of the World Economic Forum that rampant US consumption had been the main driver of the spectacular rates of growth achieved in 2004
However, with economies all around the world increasingly reliant on exporting their goods to the US, a moderation in US spending could have serious repercussions for the global economy
"For me, something just doesn't add up. The self indulgent American consumer ... is an accident waiting to happen," said Roach, a long-time pessimistic on the US economy
Rather than using the fruits of the increased economic activity, US consumers are funding their massive spending spree through borrowing against the inflated values of their homes. "We are in the early stages of a residential property price bubble in the US. Consumers know this and that is why they are turning their homes into a massive ATM machine," explained Roach
US consumers "suck money" out of their properties to fuel imports from Asia. In turn Asian countries buy US dollars, keeping interest rates low and allowing US householders to borrow even more, according to Roach
"This is an utterly insane way to run the world economy. You know that, we know that, but the Federal Reserve is in denial about that," he said
Roach suggested that the Federal Reserve had engineered the boom in the US property market as a means of bolstering the US economy. By stoking house prices through low borrowing costs, the Fed ensured that US consumption and, by extension economic growth, remained robust, he said. "The Fed knows it is culpable as the bubbleblowers in keeping this asset-driven US economy alive," he said. With US rates rising from the "unconscionably" levels of recent years, there will inevitably be a fall back in US property price inflation and hence consumer spending, explained Roach. "When the music stops ... and US rates go up we'll see how asset-dependent the US consumer has become," warned Roach
Jacob Frenkel, vice chairman of US insurance giant American International Group, said rampant US consumption was just one of the economic imbalances capable of wreaking havoc on the world economy. The massive trade deficit the world's largest economy is running could also stop global economic growth in its tracks
"The US current account is not a a problem for the US. It brings about risks for the world economy," he said. "I'm not concerned not because of the fact that there is no way to deal with it (the current account deficit) but because of the way it is not being dealt with," he said. He called on the newly elected US government to face up to the soaring budget and account deficits by introducing measures to encourage saving and discourage consumption
Frenkel, a former head of the Israeli Central Bank, urged representatives at a forthcoming G7 Meeting of Finance Ministers to address profligate US fiscal spending. "There must be debates on US policy measures. They must not just a focus on the dollar," as a remedy for the US trade deficit, said Frenkel
Link
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