Tuesday, November 25, 2008

Off for Thanksgiving

I'll be taking a break from posting until Monday morning, unless something crazy happens like a War, Gold breaking $1000, etc.. Have a good holiday (If you live in the US).

On a holiday type note, I found this Typealyzer site which analyzes blogs.

My Blog type is: INTP - The Thinkers

The logical and analytical type. They are especialy attuned to difficult creative and intellectual challenges and always look for something more complex to dig into. They are great at finding subtle connections between things and imagine far-reaching implications. They enjoy working with complex things using a lot of concepts and imaginative models of reality. Since they are not very good at seeing and understanding the needs of other people, they might come across as arrogant, impatient and insensitive to people that need some time to understand what they are talking about.

What do you readers think about that? accurate?

....as if I care.

A more expanded view of the INTP Type on the Myers-Briggs scale can be found here.

Geithner is a Monetary Arian too

There are other factors at work as well, however, that have less favorable implications. Part of this recent dynamic in financial markets is a consequence of the present state of the international monetary system, in which a substantial part of the world economy runs exchange rate regimes tied in some way to the dollar. This has entailed a sustained period of very substantial official accumulation of dollar reserves, putting downward pressure on U.S. interest rates and upward pressure on U.S. asset prices.

These forces are surely transitory, but their impact on capital flows, interest rates and asset prices are important, not just in terms of their short-term impact on growth. If they are large enough, they have the potential to alter or distort current decisions about investment and consumption in a way that could be detrimental to our longer-run growth prospects. And they are important because they work to mask or dampen the effects on risk premiums in financial markets that we might otherwise expect to be associated with the expected trajectory of the fiscal and external imbalances in the United States. Tim Geithner, NY Fed Jan. 11, 2007

The first thought that came to mind upon reading of Obama's selection of Tim Geithner as Treasury Secretary was, "at least Larry Summers (whose decision to reduce the duration of US Federal Debt by, inter alia, repay old and slow issuance of 30 year Bonds set the stage for our current explosion in short term finance) didn't get the job." Mr. Summers is, by all accounts, very intelligent, which, in light of that decision, should not be confused with far-sighted.

The second thought was, "what are Mr. Geithner's views on finance?"

A check of the NY Fed site led me to a few speeches of his and I was pleased to find he too was concerned about the effects of officially induced stable exchange rates on US monetary policy.

Further research shows Mr. Geithner has been concerned about the link between (mainly) Asian Economies and the US$ for years.

As he argued early in 2006: this pattern [FX "pegs"- formal or informal, which necessitate increased purchases of US Treasury Debt] of exchange rate and monetary policy arrangements and the associated scale of official intervention in markets complicate our ability to assess the underlying economic conditions in our economies and to forecast the future path of output and inflation. If the effects of these policies are large enough to alter or distort the relationship between asset prices and the underlying fundamentals in our economies, and this seems likely to be the case, then we can take less comfort from traditional relationships between those variables.

The fact that official purchases of financial assets are driven by different factors than those driving private investors suggests that we would probably see a somewhat different combination of capital flows, exchange rates and interest rates in the absence of official intervention. This makes the task of assessing the probable trajectory of growth and inflation more complicated. It makes it harder to assess the likely evolution in financial conditions and asset prices. And it makes it harder to assess the effects of the present stance of monetary policy on aggregate demand and inflation.

He continues: To the extent that these forces act to raise asset prices, lower interest rates and reduce risk premia, it is harder for the markets to assess how much of the very favorable conditions are likely to reflect fundamentals and prove more durable. This can contribute to an increased willingness to raise leverage in the investment community and to take on more exposure to risk. [and so it did]

For the same reason, this phenomenon can act to mask or offset the effects of high levels of present and expected future government borrowing on interest rates, perhaps contributing to a false sense of reassurance that we can continue to run large structural deficits without risk of crowding out private investment and damaging future growth.

If Obama was looking for a guy at Treasury who saw some of our current problems before they manifested, Geithner seems a wise choice.

I'm intrigued to discover how he intends to fix the problem.

Monday, November 24, 2008

Finally- an Economic Bail-In

We’ll be working out the details in the weeks ahead, but it will be a two-year, nationwide effort to jumpstart job creation in America and lay the foundation for a strong and growing economy. We’ll put people back to work rebuilding our crumbling roads and bridges, modernizing schools that are failing our children, and building wind farms and solar panels, fuel-efficient cars and the alternative energy technologies that can free us from our dependence on foreign oil and keep our economy competitive in the years ahead. President-elect Obama

Most of the "bail-outs" lately have been aptly named. They seem to bail liquidity out of the real sector as if the real sector is weighing down the financial sector when the opposite seems to me more the case.

For whatever reason, the financial sector has not done its job of guiding investment flows such that the real sector can generate the profits which allow job creation, tax revenues and repayment to the financial sector. Bailing-out the financial sector so that it can keep doing what it has been doing seems about as wise as Senator McCain's notion of keeping Greenspan at the helm of the Fed even after death- call it Weekend at Alan's.

Aside from a lack of discussion of a shift towards more rail-based goods distribution in the US, I think Mr. Obama's bail-in plan for the real sector should pay dividends in the future. These dividends may well come at the cost of the loss of global US$ sovereignty but as economists say- there is no such thing as a free lunch.

Friday, November 21, 2008

The Myth of Economic Trinitarianism

The Fed’s ability to set the short-term interest rate independently of foreign financial conditions depends critically, of course, on the fact that the dollar is a freely floating currency whose value is continuously determined in open, competitive markets. If the dollar’s value were fixed in terms of another currency or basket of currencies, the Fed would be constrained to set its policy rate at a level consistent with rates in global capital markets. Because the dollar is free to adjust, U.S. interest rates can differ from rates abroad, and, consequently, the Fed retains the autonomy to set its federal funds rate target as needed to respond to domestic economic conditions. Ben Bernanke

Early in 2007 I dubbed Fed Chairman, Ben Bernanke, the Super (as in Superman) Central Banker in response to the above claim. While mere mortals, like BoE head, Mervyn King, worry about the effects of stable exchange rates on monetary policy, Mr. Bernanke leaps over this concern with a single assertion- FX markets are open and competitive. In a sense, shifting from a comic book to a Theological metaphor, Mr. Bernanke is an Economic Trinitarianist- he believes in the consubstantiality of stable exchange rates, open capital accounts and domestic monetary autonomy.

That makes me, and, it would seem, Mr. King, heretics. We believe this Trinity to be impossible.

To be fair to my Catholic, Anglican and other Trinitarian (including Hindu) friends, I'm not arguing against Theological Trinitarianism, just using the metaphor as heuristic device.

17 Centuries ago, Emperor Constantine, in an attempt to unify the Christian faith he had adopted, called an Ecumenical Council to Nicaea to define the Christian God-head. At the time a debate was raging about the divinity of Christ. Was Christ a man who became God, as the Arian Heretics argued, or was he always God, as Athanasius argued for the majority.

In the end, the Trinitarian Orthodox view won out- the "Father, Son and Holy Ghost" were declared consubstantial (thus the importance of that phrase) or, in Latin, homoousian. Those who believed this Trinity impossible were branded heretics and persecuted with varying vigor for centuries. Defense of Arianism was a rallying cry for Goths and Vandals in their conflicts with Rome.

Fortunately, Economic Trinitarianism is an empirically testable theory which few economists hold. Even Mr. Bernanke, I'm sure, would dispute it in theory. It is the application in practice where I believe he errs, and which is a growing impediment to US real sector recovery.

The creed of Economic Arianism, if you will, is aptly put by Mervyn King:

Perhaps the key difference between the world of Bretton Woods and the world today is the size and volatility of private capital flows. Then, as now, it was recognised that no system could ensure the compatibility of:

(i) Domestic monetary autonomy; (ii) Stable exchange rates; (iii) Free capital mobility.

This "impossible trinity" has been at the heart of the debate on the international monetary and financial system for many years. A sustainable system must sacrifice one of these three objectives

Notice Mr. King places no emphasis on "open and competitive FX markets." For him, FX market stability, such as results from an exchange rate "peg" or even, as Mr. King knows all too well from the Bank of England's attempt to maintain the value of the British Pound in the European Exchange Rate mechanism, simple intervention to support a currency when private sector flows are outgoing, is enough to reduce domestic monetary autonomy.

Mr. Bernanke engages in a bit of mental slight of (invisible) hand with his assertion that the dollar is a freely floating currency whose value is continuously determined in open, competitive markets. This dogma disregards public sector efforts to support the US$, both domestically, such as occurs when the Fed buys US$s, or internationally, such as occurs when the ECB, Central Bank of China or SAMA (to name a few) intervene to stop their currencies from appreciating against the US$. Contra Mr. Bernanke, I argue, the US$ would be much lower if it was freely floating- its current stability debunks his premise.

Decades ago, when international capital flows were smaller, and the US economy (and Fed balance sheet) was much larger relative to the rest of the dollarized world (i.e. when Russian and Chinese capital markets were mainly closed and the emerging world's GDP was small) the effect of exchange rate pegs had much less effect on US monetary policy.

As Russian and Chinese capital markets opened and, in a sense, dollarized and as the third world developed their own capital markets, and domestic savings to invest therein, the effects of exchange rate pegs grew.

The Asian, Russian and LatAm crises of the late 90s were the first warning that the rest of the world was no longer the tail to the US's dog. The Fed was forced to accept easier money than it desired in 1998 (thus adding further fuel to to Tech Boom) or risk an even more severe contraction in Asian and Latin American markets. The tail of the developing world was starting to wag the US dog.

The rapid growth of the BRICs (Brazil, Russia, India and China) and Middle Eastern oil exporters has, in my view, as I've recently been arguing, reversed their position vis-a-vis the US. The rest of the world is the dog and the US is the tail.

The US$ is too small, if you will, to serve as anchor for the world. If we are to regain domestic monetary autonomy, and get the stimulus, currently in the form of increased financial sector recapitalization, flowing to the US real sector, the US$ must float freely- pegs must be cut.

The recent collapse of US real sector activity contrasts sharply with the more robust (albeit inflationary) growth apparent earlier in the year when the US$ was sinking and seems to me proof enough that Mr. Bernanke's faith (via his mental slight of (invisible) hand) in Economic Trinitarianism was misplaced.

As Mr. King argued in 2001: what is clear is that both in theory and practice there is now a recognition that pegged (fixed but adjustable) exchange rates do not provide a viable long-term middle course. More interesting, perhaps, is the absence of serious debate on the merits of the third position, namely the willingness to forego freedom of capital movements in order to retain domestic monetary autonomy and stable exchange rates. That is perhaps surprising in the light of the experience of the two major countries in Asia that escaped the financial crisis of 1997-98, namely India and China, which had in common the presence of capital controls.

Either the US$ floats freely, perhaps sinks would be more appropriate, or if the current US$ stability is desired, capital control are imposed if the US wants domestic monetary autonomy. If the latter option is chosen, US rates (due to capital restrictions into Treasuries) and inflation will rise rapidly and substantially, while the former course will extend and mitigate the transition.

Foreign Official inflows to US Treasuries are hindering what I believe to be a necessary shift in global manufacturing distribution (and goods production in general) given (despite recent declines) rising transportation costs and decades of US trade deficits.

Even Brad Setser is troubled by the rapid decline in US Treasury rates. Without faith in the stability of the US$, those rates would be much higher, i.e. the risk of such flows would be much more apparent.

Outsourced US manufacturing needs to return home (and, as my friend, James Howard Kunstler has long been arguing, become more regionalized, i.e. more widely distributed). A weak US$ seems to me a great tool to achieve this goal as it will both make US exports more attractive and increase the risk of holding US Treasuries, which in turn will make real sector investments more attractive.

Wednesday, November 19, 2008

Time to "Nationalize" the US Financial Sector

In The TARP Fund? and Empire I argued (perhaps with too much emphasis on the effects thereof being caused by the US powers that be) that TARP financed a US$ strengthening effort. This essay will expand on that theme.

A few months back I argued, The old trading mantra; "Don't Fight the Fed" may soon be replaced by; "Don't Fight the SWFs." During the same month I (in hindsight, quite foolishly) predicted The last hurrah for the "strong dollar" policy. Had I placed more emphasis on the former and less on the latter I could have scalped a few $100s on Gold.

While the Fed and Treasury didn't have the firepower to strengthen the US$, foreign interests did, and it was used. The SWFs (shorthand for foreign interests both public and private) are having more of an effect on the US economy than the Fed and Treasury.

As Brad Setser recently noted: Total Treasury purchases over the last 3 months totaled $214 billion. That’s huge.

Combining that inflow with $92 billion in net sales of foreign assets by American investors implies that the “flight to Treasuries” and “deleveraging” combined to provide about $300 billion in net financing to the US. That, in broad terms, allowed the US to run a roughly $175-200b current account deficit and cover a huge outflow from the Agency market.

China is particularly interesting case. SAFE clearly has added to the instability in the credit market over the past few months — and equally clearly contributed to low Treasury yields. That isn’t a criticism — it is just a statement of fact.

At the end of July, China stopped buying Agencies and corporate bonds and started to pile into Treasuries. Over the last three months of data (i.e. the third quarter), the US data indicates that China has bought $81.1 billion in Treasuries ($45 billion short-term) and added $17.4 billion to its bank accounts — that is a flow of nearly $100 billion into the safest US assets China can find. Conversely, China sold $16 billion of Agencies, $1.8 billion of corporate bonds and a bit less than a billion of equity

In brief, the SWFs (mainly China) supported the US$ through massive purchases of (mainly short term) Treasuries. The corporate and mortgage sectors, however, experienced a capital drain. SWF policy (if one can infer such from the data) is to keep the US public sector afloat while starving the real sector. Right-wing talk radio fears of Obama "socializing" the US are misdirected. It is the SWFs that are driving that change.

Not only are the SWFs socializing the US, they are (with complicity of the Treasury through their choice of short term financing) hanging a Sword of Damocles over the US government's head. The graph below depicts externally held short term (under 1 year) Treasury debt with interest. As of Sept. 2008, I estimate (using Treasury external debt data and recent TIC data) that total as $940B or 6.5% of GDP. I wonder how many strings will attach to our need to roll that over.

While we were electing a new President real control over economic policy, in a sense, has been outsourced.

Thus my call for "nationalizing" the US financial sector. I don't mean the government should buy it (although if that is the only way forward, so be it). I mean we need to regain control over US financial flows. As I've been arguing, a strong US$ that serves as global reserve currency is, in my view, no longer in US interests.

Years ago Warren Buffett warned of the US becoming a "sharecropper society." It seems as if we are rapidly moving in that direction.

Ironically, if current trends continue for long America may become an Empire, but we won't be calling the shots. Niall Ferguson coined the term Chimerica. Viewing that future through a historical lens, the Rome in Washington DC may be led by the Constantinople in Beijing.

To be on the safe side, I've been sending my son to Chinese School for 3 years.

你 好

Tuesday, November 18, 2008

Root cause of the crisis...same as it ever was

The salient feature of the current financial crisis is that it was not caused by some external shock like OPEC raising the price of oil or a particular country or financial institution defaulting. The crisis was generated by the financial system itself. George Soros

We are going through a financial crisis more severe and unpredictable than any in our lifetimes. Hank Paulson

Unprecedented. Unpredictable. Not exogenously caused.


One of the essential features of a scientific view of the universe is the notion that (at least some) events can be viewed from a general perspective. Once you decide that certain events are unprecedented and unpredictable you can throw any hope of a scientific response out the window.

That the Secretary of the Treasury is willing to argue thusly in the NYTimes is not a credit to his wisdom, but it is par for the course for a politician. After all, if the economic downturn was predictable, then he obviously failed, at the very least by failing to warn, if not avoid.

Far more curious, to me than a politician engaging in a bit of C.Y.A., is Mr. Soros take on recent events, particularly given his acceptance of the "mind-body" (or dualist) philosophy as basis for his economic view, reflexivity. The dualist premise is that there is always a dance between reality and conception- nothing is totally "end" or "ex" ogenous.

In his words: As a way of explaining financial markets, I propose an alternative paradigm that differs from the current one in two respects. First, financial markets do not reflect prevailing conditions accurately; they provide a picture that is always biased or distorted in one way or another. Second, the distorted views held by market participants and expressed in market prices can, under certain circumstances, affect the so-called fundamentals that market prices are supposed to reflect. This two-way circular connection between market prices and the underlying reality I call reflexivity.

This view is a specific application of a very old philosophical conception of consciousness which can be simply stated: there is a (variable) difference between what we think and what is. Plato wrote about his cave of shadow truth and the need to step into the light 2400 years ago. More recently and familiarly, Korzybski argued, the map is not the territory.

Soros' reflexivity is the same- the financial market map is not the real sector territory. When markets are operating efficiently, that map is a good facsimile and when they aren't, we get lost.

My argument with Soros (and his argument with himself) is that an endogenous financial sector crisis could only occur in the absence of real sector change. He makes this argument to push his view that more regulation would have helped avoid the crisis.

To stick with the map-territory analog, each time a new road is built, or an old road is washed away, burned out or becomes otherwise impassable, a (previously) perfectly good map needs to be updated. Soros is arguing that the territory is unchanged. The map, of itself, has been changed. Soros goes on to argue that if we had better regulated the map-makers, ensuring that they didn't change the map, we wouldn't have run into this problem.

I disagree.

Our crisis, in my view, is not entirely endogenously caused. There have been many changes in the underlying territory:

1) Increased competition for natural resource
2) decaying US infrastructure (the bricks and mortar mocked during the Tech Boom days)
3) redirection of resource towards destruction (with presumed hopes of loot at the end) rather than construction for almost 6 years

There are, of course, in addition, the chickens coming home to roost issue of our long standing abuse of the $ based international system to run perpetual and increasing current account deficits which increasingly constrains our options.

Our crisis, as are most financial crises, (and, in general, the root cause of most personal crises) is a result of denial of the potential (which continues as potential has become actual) consequences of our economic choices. The US went "all-in" on a Pax Americana and the cards didn't turn our way. The problem isn't, in a sense, a lack of regulation, as Soros argues, but a lack of vision.

Remember back a few years (and, if you listen to right-wing talk radio, even today...surrender monkeys) when dissent against the war, even if the dissent was couched in the form of "we need to rebuild our infrastructure and thus can't afford this Iraqi adventure," could cost one his or her job? Public opinion, which includes the financial type, became increasingly myopic- focused only on events or issues that reinforced the preferred view of reality.

Explanatory note: I'm not suggesting there is some grand conspiracy. Ever since humans became conscious we have exhibited a repeated tendency to self-deception with sometimes disastrous results. (This ability can, however, be a wonderful facility during periods of tragedy- not everyone can look grim truth in the eye all the time). The same myopia that can keep one on a very difficult path through terrible conditions with a happy ending can keep one on a very difficult path through terrible conditions with no pot of gold at the end of the rainbow.

In his American Theocracy, Kevin Phillips argues that this myopia is a recurring feature of modern western empires. A nation rises by virtue of a capital stock geared to a reality. Success in that context of reality leads the owners of the capital stock to take the reins of the country. As the underlying reality (as it always does) shifts, begging a redirection of the capital stock, the owners of the now increasingly obsolete capital stock fight the change by, inter alia, propagandizing a self-serving view of reality which becomes increasingly at odds with the facts on the ground.

Recapitalizing (and/or re-regulating) a financial sector that continues to adhere to a view of American dominance of natural resource flows will not help if, in truth, America is not directing those flows. The financial sector map won't match the real sector territory.

This, in my view, is the root cause of our crisis- political/economic inertia from a nation that had risen to the top of the food chain.

And that is one of the oldest stories around.

As the Talking Heads used to sing back when I was in school:

And you may ask yourself-well...how did I get here?

Letting the days go by/let the water hold me down
Letting the days go by/water flowing underground
Into the blue again/after the moneys gone
Once in a lifetime/water flowing underground.

And you may ask yourself How do I work this?
And you may ask yourself Where is that large automobile?
And you may tell yourself This is not my beautiful house!
And you may tell yourself This is not my beautiful wife!

Same as it ever was...same as it ever was...same as it ever was...Same as it ever was...same as it ever was...same as it ever was...Same as it ever was...same as it ever was...

Sunday, November 16, 2008

If only he kept his fly zipped

Eliot Spitzer's editorial in today's Washington Post, How to Ground the Street, makes me wish he had kept his fly zipped (or frequented cheaper hookers and thus stayed off the radar).

excerpt: When my office, along with the Department of Justice, warned that some of American International Group's reinsurance transactions were little more than efforts to create the false impression of extra capital on the company's balance sheet, we were jeered at for attacking one of the nation's great insurance companies, which surely knew how to balance risk and reward.

And when the attorneys general of all 50 states sought to investigate subprime lending, believing that some lending practices might be toxic, we were blocked by a coalition of the major banks and the Bush administration, which invoked a rarely used statute to preempt the states' ability to probe. The administration claimed that it had the situation under control and that our inquiry was unnecessary.

Time and again, whether at the state level, in Congress or at the
Securities and Exchange Commission under Bill Donaldson, those who tried to enforce the basic principles that would allow the market to survive were told that the "invisible hand" of the market and self-regulation could handle the task alone.

Saturday, November 15, 2008

The TARP Fund? and Empire

A few weeks back I almost felt hopeful.

The Fed and Treasury had decided to take some of the more toxic "assets" off US banks, and gotten funding therefore. The Fed had substantially expanded its balance sheet. A new President who had been listening to Buffett and Volcker, and seemed keen to rebuild American infrastructure, was elected.

"Maybe," I thought, "inflation, even if it meant the end of US$ hegemony, would finally be embraced."

By embracing inflation I mean accepting that US imbalances are so large that a deflationary resolution would ignite a depression that would make the Great one of the 30s seem minor. It would be a sign of submission to economic reality- the US$ as currently constituted is doomed. Let's stop fighting it. Let it find its level. Let's devise a new international financial architecture within which all particiapting nations are expected to play by the rules instead of one nation dictating to the others.

Alas, my hopes have faded. President-elect Obama, in my view and as of this moment, is not the radical, right-wing talk radio claims. Ex-Clintonite men like Rahm Emanuel and (horror of horrors) Larry Summers were on the short list of his Cabinet (or already there). These men are not radical "new ideas" men. They are status quo perpetuators.

Perhaps, like Winston Churchill, who famously quipped, "I have not become the King's First Minister in order to preside over the liquidation of the British Empire," but was clever enough to realize his error and begin liquidation, President Obama will see that our Empire too begs liquidation. America as a nation, even now, seems to me without peer. The American Empire, however, seems a fast fading pipe dream.

Or it would if certain people would stop filling the pipe.

Was life in America so horrible before we opted for Empire- before we decided (inter alia) to issue the world's reserve currency? Has our quality of life, in all senses of that phrase, actually improved since we started walking this path? We were a Nation that used to believe in a better tomorrow and have become an Empire that requires it- for we have already borrowed against it.
One of the key features of a stable and enduring Empire is a strong currency that facilitates rather than hampers commerce throughout the Empire. That strength, however, should flow from wise economic policies- whether that wisdom is gleaned, as in the ideal of capitalism, from the action of free markets discovering prices and allocating investment accordingly, or elsewhere. Like the stock price of a well managed company, the value of the US$ (the currency of our Empire) should rise in a sense, of its own accord. Just as a well managed company's stock price should not require stock buy-backs to rise, so too should our US$ not need intervention.

Yet, it seems to me that is just what is happening. The vehicle by which this is financed, I speculate, is TARP.

Reflective pause: My view is not that those at Treasury and the Fed are operating under some grand plan but rather that they are fumbling, partially in the dark, trying to maintain US$ supremacy between the two ever narrowing, by virtue of the ever increasing imbalances, constraints of a crippling depression and a hyper-inflation that makes international use of the US$ as reserve undesirable.

After Bear Stearns collapsed, the chosen policy seemed to me to be $ depreciation, but this soon led the international community, Europe in particular, to complain about "beggaring thy neighbor." The inflationary constraint of loss of US$ supremacy had been reached. Accepting loss of US$ supremacy is part of what I mean by embracing inflation in the same way a chemo patient in embracing his treatment must accept the loss of hair and otherwise ill health.

What happened in the middle of September that drove Hank Paulson to Congress for funds? Why did he wish to keep the disposition thereof a secret? Why, even though the legislation requires transparency, is that disposition still a secret?

Few things inspire true confidence more than transparency.

Perhaps there are good reasons for the opacity about TARP, not the least of which is the sense that there is not now nor was there ever a clear plan but rather a fear of being exposed as fumblers in the dark. My speculation is but one of many theories that fit the facts.

Yet the government's embrace of Goldman Sachs, and its predatory (as in market forcing) Hedge Fund mentality makes me suspicious. These folk believe the financial cart pulls the real sector horse with or without consent. Recent history demonstrates their tendency to bump into constraints rather than anticipate them. Thus the wisdom, to those in charge, of recapitalizing a banking sector without requiring change in the way it does business. If the dead horse won't run, flog it harder.

But, back to my earlier question. What happened in the middle of September? What drove the Republican Executive Branch to the Democratic Congress hat in hand, destroying their (admittedly small) chance of retaining control of that office? What difference would a few weeks have made?

In a word, disintermediation. In a short span of time, the US$, which had been rallying, suddenly began to fall. LIBOR jumped. Oil prices rose, and for one day exploded. Gold prices jumped $100. Background complaints about the need to move away from the US$ as anchor of world trade came to the foreground with a bang.

Again, the inflationary constraint of fear of loss of US$ supremacy had been reached.

Since then, $100s of billions have been allocated, but for what? Credit conditions for trade, housing and other real sector investment remain tight. Yet reserves for Federal Reserve System banks have increased by a factor of 10 (check it out). Money is flowing, but not to the real sector.

Imagine the boom (albeit of a sufficiently inflationary type that would likely have put paid to the US$'s days as major global reserve) that would result from those billions flowing into infrastructure rebuilding. The absence of a boom tells me that money is staying in the financial sector enforcing prices (like a strong US$ on FX markets, weaker Gold and strong US Treasuries) which quiet calls for a shift away from the US$.

Enron, a corporation that turned its back on organic growth and opted for increasingly short term (and opaquely financed) leverage to finance stock buy-backs to keep its "currency" (i.e. stock price) strong collapsed in the first year of the Bush Administration. It would be ironic if our currency collapsed just the same way in the last year of that administration.

Regardless of the timing, it seems to me the stage is set. Barring a swift turn in the real sector, the TARP fund, whose financing is on the shortest terms, will, in a sense, go bust as well. Prices that justify the US$'s status as major global reserve are, in my view, inconsistent with those which will improve the real sector, both domestically and internationally. A strong $ is no longer in US interests.

The financial cart has long been leading the real sector horse, fortunately, horses are (usually) smart enough to not follow off a cliff.

Tuesday, November 04, 2008

The end of voting season

Over the past few weeks I've felt like a kid waiting for Christmas- stuck, as time seems to pass slower and slower.

"Are we there yet, Daddy?"

Yes we are.

The day I've been waiting for has arrived.

"Voting" season will pass....and weighing season will commence.

Threw you a curve on that one, eh?

While election day was one of the milestones on my calendar, a more pressing issue was the election mind-set wherein impressions and popularity outweigh reason. After the elections markets, recalling Buffett's quip about voting and weighing machines, are more apt to weigh- which would be a welcome change.

A glance at election cycles past informs me that election years (up to election day) are those least likely to contain "unwelcome" surprises while the 12 months thereafter are far more likely to contain those same surprises.

"Hey," you might be thinking," didn't the Nasdaq crash in 2000 and what about this year?"

A closer look at equity price action in 2000 shows that the Nasdaq did crash in April of 2000 (I still vividly remember getting that phone call in Motown, a bar in Roppongi, Tokyo) but recovered substantially into September and didn't break into new low territory until after the election.

The Nasdaq lost another 65% (double the % losses during the earlier "crash") in the 10 months after election day.

As to this year, we'll just have to see how the next 12 months unfold. I suspect the worst is yet to come.

In addition to election day, I've been waiting for the Treasury's refunding statement, which was issued (in part) yesterday. The Treasury plans to borrow $550B this quarter- a record by large measure. Tomorrow they should inform us how they plan to borrow, i.e. what mix of bills to notes to bonds.

Within the next few weeks the Treasury will then begin implementing their plan, and finding out how much appetite exists for US debt.

At the end of the month, we'll see if the COMEX has enough Gold warehoused to met delivery desires for the widely held December Gold Futures contract.

Yes, this November should be like Christmas to a finance geek like myself.

Let's hope I have reason to give Thanks when the month ends.