Friday, November 12, 2010

Turmoil in Broad Financial Markets

Good summary of the market turmoil today from Marketwatch:

The Dow Jones Industrial Average (DOW:DJIA)  fell 103 points, or 0.9%, to 11,178, its lowest level since Nov. 2, the day of the U.S. congressional midterm elections. The Dow had surged nearly 220 points the following day, when the Federal Reserve announced its $600 billion bond-buying program.
The Dow has fallen 2.5% this week on worries about the consequences of the Federal Reserve’s quantitative-easing program. Renewed concentration on Europe’s sovereign-debt issues added to fears over the global economy.
“We’ve digested the third-quarter earnings and now we see the macroeconomic concerns come back to the fore,” said Benny Lorenzo, chairman and chief executive of Kaufman Brothers. On Friday, stocks slid as concerns were reignited that China could be moving toward further tightening of its monetary policy.
The Nasdaq Composite Index (NASDAQ:COMP)  fell 1.5% to 2,518. The S&P 500 Index (MARKET:SPX)  shed 1.3% to 1,198.
Materials and energy stocks led the measure’s decline as investors worried demand could slide if China, a big user of natural resources, cools its economy. Fertilizer producer CF Industries (NYSE:CF)  slid 5%, while Freeport-McMoRan Copper & Gold (NYSE:FCX)  sank 4.5% and metal processor Allegheny Technologies lost 3.2%. Aluminum maker Alcoa (NYSE:AA)  dropped 2.5%.
Crude-oil prices slid more than 3%, and gold futures dropped nearly 3%.

Stocks plummet in China

Why stocks in Shanghai plummeted more than 5% on Friday.
Asian markets tumbled on Friday as concerns resurfaced that the Chinese government would further tighten monetary policy to counter inflation. The benchmark Shanghai Composite Index fell 5.2%, erasing nearly a quarter of a three-month market upswing in one day. It was the index’s biggest drop in 14 months.
Not all investors fretted over potential tightening in China.
“They’re taking prudent measures to keep their inflation in check,” said Brian Peardon, wealth adviser at Harrison Financial Group. “It’s not going to kill their growth, it’s just going to keep it in control.”
Boeing (NYSE:BA) was the Dow’s worst performer on Friday, shedding 3% after Bernstein Research cut its investment rating on the company to market perform from outperform, citing “greater margin risk” on the 787 aircraft.
Walt Disney (NYSE:DIS)  was one bright spot for the Dow, surging 5.2% after its quarterly profit declined 6.7%, though some of the weakness was due to one-time events and its quarterly period included one less week than the same period in 2009. Disney’s movie studio swung to an operating income of $104 million, helped by “Toy Story 3.”
“The fundamentals are pretty strong when you take out the one-time items,” Lorenzo said.
Intel (NASDAQ:INTC)  rose 1.5% after its board approved a 15% dividend increase starting with the first quarter as the semiconductor maker said it continues to generate strong cash flows.
The U.S. dollar weakened against the euro, which was trading (REUTERS:USDEUR)  recently at $1.3679, up from $1.3659 late Thursday in New York.
Demand for Treasurys declined, sending the 10-year note’s yield (U.S.:UST10Y)  up to 2.73%.

G20 Says "No" to Obama

from AP:

SEOUL, South Korea – Leaders of 20 major economies on Friday refused to back a U.S. push to make China boost its currency's value, keeping alive a dispute that raises fears of a global trade war amid criticism that cheap Chinese exports are costing American jobs.
A joint statement issued by the leaders including President Barack Obama and China's Hu Jintao tried to recreate the unity that was evident when the Group of 20 rich and developing nations held its first summit two years ago during the global financial meltdown.
But deep divisions, especially over the U.S.-China currency dispute, left G-20 officials negotiating all night to draft a watered-down statement for the leaders to endorse.
"Instead of hitting home runs sometimes we're gonna hit singles. But they're really important singles," Obama told a news conference after the summit.
Other leaders also tried to portray the summit as a success, pointing to their pledges to fight protectionism and develop guidelines next year that will measure the imbalances between trade surplus and trade deficit countries.
The G-20's failure to adopt the U.S. stand has underlined Washington's reduced influence on the international stage, especially on economic matters. In another setback, Obama also failed to conclude a free trade agreement this week with South Korea.
The biggest disappointment for the United States was the pledge by the leaders to refrain from "competitive devaluation" of currencies. Such a statement is of little consequence since countries usually only devalue their currencies — making it less worth against the dollar — in extreme situations like a severe financial crisis.
The statement decided against using a slightly different wording favored by the U.S. — "competitive undervaluation," which would have shown the G-20 taking a stronger stance on China's currency policy.
The crux of the dispute is Washington's allegations that Beijing is artificially keeping its currency, the yuan, weak to gain a trade advantage.
U.S. business lobbies say that a cheaper yuan costs American jobs because production moves to China to take advantage of low labor costs and undervalued currency.
A stronger yuan would shrink the U.S. trade deficit with China, which is on track this year to match its 2008 record of $268 billion, and encourage Chinese companies to sell more to their own consumers rather than rely so much on the U.S. and others to buy low-priced Chinese goods.
But the U.S. position has been undermined by its own central bank's decision to print $600 billion to boost a sluggish economy, which is weakening the dollar.
Also, developing countries like Thailand and Indonesia fear that much of the "hot" money will flood their markets, where returns are higher. Such emerging markets could be left vulnerable to a crash if investors later decide to pull out and move their money elsewhere.
Obama said China's currency policy is an "irritant" not just for the United States but for many of its other trading partners. The G-20 countries — ranging from industrialized nations such as U.S. and Germany to developing ones like China, Brazil and India — account for 85 percent of the world's economic activity.
"China spends enormous amounts of money intervening in the market to keep it undervalued so what we have said is it is important for China in a gradual fashion to transition to a market based system," Obama said.
The dispute is threatening to resurrect destructive protectionist policies like those that worsened the Great Depression in the 1930s. The biggest fear is that trade barriers will send the global economy back into recession.
The possibility of a currency war "absolutely" remains, said Brazilian Finance Minister Guido Mantega.
Friday's statement is also unlikely to resolve the most vexing problem facing the G-20 members: how to fix a global economy that's long been marked by huge U.S. trade deficits with exporters like China, Germany and Japan.
Americans consume far more in foreign goods and services from these countries than they sell abroad.
The G-20 leaders said they will try to reduce the gaps between nations running large trade surpluses and those running deficits.
The "persistently large imbalances" in current accounts — a broad measure of a nation's trade and investment with the rest of the world — would be measured by what they called "indicative guidelines" to be determined later.
The leaders called for the guidelines to be developed by the G-20, along with help from the International Monetary Fund and other global organizations, and for finance ministers and central bank governors to meet in the first half of next year to discuss progress.
Analysts were not convinced.
"Leaders are putting the best face on matters by suggesting that it is the process that matters rather than results," said Stephen Lewis, chief economist for London-based Monument Securities.
"The only concrete agreement seems to be that they should go on measuring the size of the problem rather than doing something about it."

Walmart Survey Shows Inflation Is Real

There might not have been a second round of quantitative easing, if Federal Reserve Chairman Ben Bernanke shopped at Walmart.

A new pricing survey of products sold at the world’s largest retailer [WMT  54.06    -0.28  (-0.52%)   ] showed a 0.6 percent price increase in just the last two months, according to MKM Partners. At that rate, prices would be close to four percent higher a year from now, double the Fed’s mandate.
54.04     -0.30  (-0.55%%)

The “inaugural price survey shows a small, but meaningful increase on an 86-item grocery basket,” said Patrick McKeever, MKM Partners analyst, in a note. Most of the items McKeever chose to track were every day items like food and detergent and made by national brands.
On November 3, the Fed announced its much-anticipated purchase of $600 billion in Treasury securities. An effort to keep market rates low since the central bank’s benchmark rate is already at zero. The Federal Open Market Committee’s statement said, “Currently, the unemployment rate is elevated, and measures of underlying inflation are somewhat low, relative to levels that the Committee judges to be consistent, over the longer run, with its dual mandate.”
But since that statement, interest rates have actually gone up, backfiring on a Fed chief who wants his quantitative easing to spark inflation of 2 percent annually. A moderate amount of inflation would be considered good for the economy. The problem is that inflation is already running well above a healthy level, investors said, Bernanke is just not looking in the right place, like a Walmart.
“I suspect that when the Chairman thinks about reflation he has a difficult time seeing any other asset besides real estate,” said Jim Iuorio of TJM Institutional Services. “Somehow the Fed thinks that if its not ‘wage driven’ inflation that it is somehow unimportant. It’s not unimportant to people who see everything they own (homes) going down in value and everything they need (food and energy) going up in price.”
Next week, the government is expected to say its official measure of inflation, the Consumer Price Index, increased at a 0.3 percent annual rate, according to economists’ consensus estimate. Core CPI, excluding food and energy, is expected to climb just 0.1 percent.
The biggest dollar increase in McKeever’s survey was on a jug of Tide Original laundry detergent, manufactured by Procter & Gamble [PG  64.23    -0.13  (-0.2%)   ]. Both P&G and Kimberly-Clark [KMB  61.97    -0.18  (-0.29%)   ] gave tentative forecasts for this quarter on concern they won’t be able to pass rising input costs on to the consumer. They may have no choice.
Prices of cotton, silver wheat, soybeans, corn are all up big this year. Cotton futures are up the most, climbing 90 percent so far in 2010. The price of silver is up 63 percent.
The purpose of McKeever’s note was actually not to be a commentary on Fed policy. The retail analyst is just trying to find out if Walmart is subtlety-increasing prices without decreasing foot traffic. A process he would deem bullish the stock.
“If the pricing dynamic is shifting, as our survey suggests, this would lend some upside bias to our sales and earnings expectations,” said McKeever.
Bernanke keeping interest rates artificially low is sparking outrage among central bank chiefs around the world, who feel the U.S. is essentially exporting inflation.
China’s CPI surged 4.4% in October, according to figures released Thursday, higher than economists’ expected and up from a 3.6 percent annual reading in the month prior.
Said Founder Tim Seymour, “Bernanke definitely must not shop at WalMart in China.”

Failure At G20

SEOUL — President Obama’s hopes of emerging from his Asia trip with the twin victories of a free trade agreement with South Korea and a unified approach to spurring global economic growth ran into resistance on all fronts yesterday, putting Obama at odds with his key allies and largest trading partners.

The most concrete trophy expected to emerge from the trip eluded his grasp: a long-delayed free trade agreement with South Korea, first negotiated by the Bush administration and then reopened by Obama, to have greater protections for US workers.

And as officials frenetically tried to paper over differences among the Group of 20 members with a vaguely worded communiqué to be issued today, there was no way to avoid discussion of the fundamental differences of economic strategy. After five largely harmonious meetings in the past two years to deal with the most severe downturn since the Depression, major disputes broke out between Washington and China, Britain, Germany, and Brazil.
Each rejected core elements of Obama’s strategy of stimulating growth before focusing on deficit reduction. Several major nations continued to accuse the Federal Reserve of deliberately devaluing the dollar last week in an effort to put the costs of America’s competitive troubles on trading partners, rather than taking politically tough measures to rein in spending at home.
The result was that Obama repeatedly found himself on the defensive. He and the South Korean president, Lee Myung Bak, had vowed to complete the trade pact by the time they met here; while Obama insisted that it would be resolved “in a matter of weeks,’’ without the pressure of a summit meeting it was unclear how the hurdles on nontariff barriers to US cars and beef would be resolved.
Obama’s meeting with China’s president, Hu Jintao, appeared to do little to break down Chinese resistance to accepting even nonbinding numerical targets for limiting China’s trade surplus. While Lael Brainard, the undersecretary of the Treasury for international affairs, said that the United States and China “have gotten to a good place’’ on rebalancing their trade, Chinese officials later archly reminded the Americans that as the issuers of the dollar, the main global reserve currency, they should consider the interests of the “global economy’’ and their own “national circumstances.’’
The disputes were not limited to America’s foreign partners. Treasury Secretary Timothy F. Geithner got into a trans-Pacific argument with one of his former mentors, Alan Greenspan, the former chairman of the Federal Reserve, after Greenspan wrote that the United States was “pursuing a policy of currency weakening.’’ Geithner shot back on CNBC that while he had “enormous respect’’ for Greenspan, “that’s not an accurate description of either the Fed’s policies or our policies.’’
Much of the rest of the world seemed to share Greenspan’s assessment. Moreover, Obama seemed to be losing the broader debate over austerity. The president has insisted that at a moment of weak private demand, the best way to spur economic growth is to have the government prime the pump with cheap credit and government stimulus programs. He quickly found himself in an argument with Prime Minister David Cameron of Britain and Chancellor Angela Merkel of Germany.
“You do hear the argument made sometimes: If you have a deficit, put off the action to deal with it because taking money out of the economy will reduce your growth rate,’’ Cameron said at the meeting. “I simply don’t accept that.’’
Merkel, in a more traditional German view reflective of her country’s history of hyperinflation before World War II, was equally adamant.
“I am not one, and Germany is not one, who says growth and fiscal consolidation are contradictory,’’ she said during a lunchtime address in Seoul. “They can go together, and it is essential to return to a sustainable growth path.’’ She also suggested that it was the job of deficit countries — like the United States and Britain, although she diplomatically avoided citing them — to increase their competitiveness rather than put limits on countries that had figured out how to get the world to buy their goods.

Corn Limit Down Just Before Close

Meanwhile, the Humble Dollar Has Barely Moved!

Nassim Taleb Explains Bernanke's Ignorance of QE2 Risks!

Even Beans Are Limit Down!

Energy Commodities Tank Too!

Crude Oil drops $3

Natural Gas slides further!

Even Cotton Is Limit Down!

Coming Off a Sugar High!

Commodity Rout Too!

Gold sells heavily!

Corn sells heavily!

Commodity Index tells the story!

It's a QE2 Rout!

Stock futures -- heavy selling

Treasury futures -- just as heavy selling

Rice Limit Down

Fed Begins Monetization of the Debt Under QE2 Today

The Fed began with QE2 today by buying $7.2 billion of treasuries, while worries that China will raise interest rates seems to have overshadowed the Fed's move.

Oil May Soon Top $100/Barrel

from Bloomberg Businessweek:

Oil prices have hovered around $78 a barrel most of the year, providing little excitement as other commodities, including copper, gold, and cotton, have enjoyed record runups. Global economic growth has not been brisk enough to drive up oil demand substantially, U.S. inventories have been ample, and the Saudis have been pumping enough to guarantee a plentiful supply.
A change in the oil markets may now be upon us. Crude may climb past $100 next year as central banks pump cash into their economies to revive growth, predict JPMorgan Chase (JPM) and Bank of America Merrill Lynch (BC). The Federal Reserve's decision to buy $600 billion of Treasuries from commercial banks should lower U.S. interest rates and weaken the dollar further. Investors may turn increasingly to oil and other commodities to get a decent return.
The Federal Reserve's actions are "likely to push prices upwards," says Antoine M. Halff, head of energy research at Newedge USA in New York and former principal administrator at the International Energy Agency. "The past few years have shown that the more cheap money in the system, the more money flows into commodities, in particular energy." Since the start of September, oil prices have climbed 17 percent, to a recent $86.96.
Oil analysts are also watching OPEC for signs of its intent. Cartel members may seek a higher price as the depreciation of the greenback erodes the profitability of their dollar-denominated exports. Saudi Arabia's Oil Minister, Ali Al-Naimi, said in Singapore on Nov. 1 that a range of $70 to $90 a barrel should be satisfactory for consumers. The kingdom had previously indicated a target of $75 a barrel. "Al-Naimi spoke of a $70-to-$90 range for the first time," says Francisco Blanch, head of global commodity research at Bank of America Merrill Lynch Global Research in New York. "The next threshold is $90 if Al-Naimi says he won't be putting any more oil in the market until we get to that level." Later, however, OPEC's secretary-general said the group was satisfied with a range of $70 to $85.
Growth in emerging markets will help reduce stockpiles of crude oil in 2011, says David Greely, head of energy research at Goldman Sachs (GS) in New York. The Paris-based IEA figures global oil demand will climb from 86.9 million barrels a day this year to 88.2 million in 2011. Hedge funds and other large speculators are getting into the act: They increased their wagers on rising crude prices in late October, according to the Commodity Futures Trading Commission.
There are still skeptics about $100-a-barrel oil, such as Sarah A. Emerson, managing director of Energy Security Analysis in Wakefield, Mass. There's plenty of crude to satisfy world demand without spurring a dramatic climb in prices, says the energy analyst. "This is a well-supplied market, and that won't be changing anytime soon," Emerson says. "At the end of the day, fundamentals matter."
The bottom line: After several years in the doldrums, oil prices are creeping upward. Some analysts are projecting prices at $100 a barrel by next year.
Mark Shenk is a reporter for Bloomberg News. Smith is a reporter for Bloomberg News.

Thursday, November 11, 2010

Stocks Tumble Worldwide

Unusually heavy volume tonight, too!

The Fed Has Lit the Fuse With QE2

by Chris Martenson on his blog:

For a very long time I have been calling for, expecting and otherwise anticipating the day that the Federal Reserve would begin openly monetizing government debt. I knew the day would come intellectually, but in my heart I hoped it wouldn't. But with the Fed's recent decision to directly monetize the next 8 months of federal deficit spending, that day has finally arrived. I have to confess, while my prediction has proven accurate, I’m still stunned the Fed actually did it.
In this report I examine the risks that this new path presents, what match(es) may finally ignite the decades-old pile of dry fuel, what the outcomes are likely to be, and what we can and should be doing in preparation.

How is this Quantitative Easing (QE) different from the prior QE?

There are two main points of departure between the two QE programs:
  • The level of global support for such efforts
  • Where the money was/is targeted
Let's take the second point first.
QE I consisted of all sorts of liquidity efforts that went by various acronyms, but the main act was the accumulation of some $1.25 trillion in MBS and agency debt. Some might note that taking MBS paper off the hands of financial institutions, which then bought treasuries with the cash, is little different than the recently announced QE II program because at the end of the day, money was printed and Treasuries were bought. In this regard, they're right.
But let's be clear about something: the first QE effort had the specific aim of repairing damaged bank balance sheets. That is, banks and other financial institutions had made some colossally poor and risky financial moves that didn't work out for them and needed some help, and the Fed was more than happy to oblige by handing them free money to patch up their losses.
Of course they didn't do this outright by saying, "Here take this money!"; they did it somewhat sneakily. But when the Fed hands you huge piles of money (for your dodgy debt) and then let's you park that very same money in an interest bearing account at the Fed, there's really no difference between that and just handing banks free money. No difference at all. If the Fed ever offers you free money that you can then park in an interest bearing account with the Fed, you should take them up on it, and you should do it as much as they will allow.
Indeed, that's exactly what happened. These parked funds are called "excess reserves" and this chart clearly displays the massive program undertaken by the banks and the Fed:

Now, it's also true that the Fed does not pay a lot of interest on this money, just 0.25%, but on a trillion dollars that pencils out to some $2.5 billion a year, handed straight over to the banks. I call this program "stealth QE" because it is nothing more than printing money and handing it over to the banks with a slight bit of complexity thrown in just to put the dogs off the scent. A couple of billion may not sound like much these days, but I raise it to illustrate the many and creative ways that QE I was about getting the banks back to health, and not much else.
So QE I (and the ‘stealth QE’ program) was directly aimed at banks to help them repair their balance sheets and make them whole on their terrible decisions and losses. It turned out, though, that fixing the banks did absolutely nothing for Main Street. The rest of the economy remained mired in a rut, with banks either unable or unwilling to make additional loans. They kept their QE lotto winnings and parked them with the Fed.
QE II, then is about getting thin-air money to the government which, the Fed rightly assumes, will immediately spend that money and push it out into the economy. Here's how the head of the Dallas Fed, Richard Fisher put it in a recent talk he gave:
A Bridge to Fiscal Sanity?
The Federal Reserve will buy $110 billion a month in Treasuries, an amount that, annualized, represents the projected deficit of the federal government for next year. For the next eight months, the nation’s central bank will be monetizing the federal debt.
This is risky business. We know that history is littered with the economic carcasses of nations that incorporated this as a regular central bank practice.
There it is in black and white. You might want to read it a couple of times to let it sink in. The Fed is directly monetizing the next eight months of excess(ive) spending by the federal government and is doing it despite being perfectly aware of the extent to which history is littered with the economic carcasses of those who have traveled this path before.
Presumably we are supposed to console ourselves with the idea that the Fed will be successful where others have failed, and sometimes failed miserably. Yes, we are talking about the same Fed that fueled that last two destructive bubbles by keeping interest rates too low for too long, failed to see the housing bubble as late as 2007 for what it was, and which apparently entirely lacked the capability to foresee any of the current mess. That Fed.
The one run by the gentleman who said this to the House Budget Committee on June 3, 2009,
“Either cuts in spending or increases in taxes will be necessary to stabilize the fiscal situation…The Federal Reserve will not monetize the debt.”
~ Ben Bernanke
In summary, the difference between QE I and QE II is that QE I went primarily to the banks and QE II is going directly to the government. While this may be something of a semantic difference, it shows that the Fed is changing its strategy again. We might ask: why this shift and why now?

How is QE II being viewed outside of the US?

In a word, poorly.
The German finance minster called the Fed's application of US monetary policy "clueless" and argued that the Fed decision would "increase the insecurity in the world economy."
China was predictably unhappy too, but initially used more diplomatic language:
Xinhua: G-20 Should Set Up Mechanism To Monitor Reserve Currency Issuers
BEIJING (Dow Jones)--China's state-run Xinhua News Agency published a commentary on Tuesday calling for the Group of 20 industrial and developing economies to supervise the issuance of international reserve currencies, and harshly criticized the U.S. Federal Reserve's new round of quantitative easing.
The G-20 should "set up a new mechanism that effectively monitors the issuer of the international reserve currency, especially when it is not able to carry out responsible currency policies," Xinhua said, making an apparent reference to the U.S. as the issuer of the dominant reserve currency.
"Considering the influence of the policy moves in the major international reserve currencies on the global economy, it is necessary for the issuer of the international reserve currency to report to and communicate with the G-20 Group before it makes major policy shifts."
All of the above is loosely coded diplomatic speak for "The US really bummed us out here, they should have stuck to the agreements we thought we had after the Pittsburg meeting. Going off-script like this was really not appreciated. We think an intervention is needed here."
Later, an advisor to the Chinese central bank went further and called the US actions "absurd."
PBOC Academic Adviser Questions Dollar’s Global Role
Nov. 9 (Bloomberg) -- Li Daokui, an academic adviser to China’s central bank, said it could be seen as “absurd” that the dollar remains a reserve currency after the financial crisis.
Here are a few other selected expressions of dismay from around the world:
United States receive criticism from all sides because the decision to print money
U.S. decision to pump 600 billion dollars into the economy has sparked a wave of strong disapproval. World leaders, who are preparing for the G20 summit in Seoul this week, warns that the move will complicate U.S. global economic recovery.
G20 tensions rise over the future of the global economy
The US last week stoked the simmering tensions by unveiling plans for another $600bn (£370bn) of quantitative easing (QE), on top of the $1.7 trillion already in place. The dollar crashed in what is being seen as the latest round of competitive devaluations, as nations seek to debase their currencies to help domestic industry.
Brazil retaliated by buying dollars. Xia Bin, a member of the Chinese central bank's monetary policy committee, branded the US stimulus plan "abusive" and warned it could spark a new global downturn. German finance minister Wolfgang Schäuble accused the US of breaking the promise made at June's G20 in Toronto, saying he would "speak critically about this at the G20 summit in South Korea."
Just two weeks earlier, G20 finance ministers at the warm-up summit in Gyeongju, South Korea, had pledged to refrain from competitive devaluation and Tim Geithner, the US Treasury Secretary, had promised the US would retain its "strong dollar" policy. At Seoul, the US will be facing accusations of empty rhetoric.
The harmonious language of hope at the Pittsburgh summit has now given way to something brazenly belligerent. The Brazilian President, Luiz Inácio Lula da Silva, has said he will go to the G20 meeting in Seoul ready "to fight." For President Obama, who has just lost a bruising midterm election battle, it will mean another painful encounter.
Greece Hits Out At Money-Printing Nations
Speaking on Jeff Randall Live, George Papaconstantinou warned quantitative easing only serves to stoke up inflation.
"You get inflation. You get a situation that's out of control. People lose their purchasing power. It doesn't get you very far," he said.
In summary, QE II has been described by several major trading partners as "clueless," "abusive," "absurd," and even resulted in a lecture from Greece on the subject of printing. By the time you are getting lectured by Greece on monetary actions it might be time for a bit of self-reflection.
It is not too strong to suggest that something of a tipping point has been reached in regards to how the US is perceived as a leader on financial and monetary matters.

Why this is important

Okay, so the US's international friends are a little upset with the US for deciding to print up the better part of a trillion dollars out of thin air. What's the big deal?
The big deal here is that the OECD countries have a monster borrowing bill set for next year. There needs to be some level of cooperation and fair play is going to be required in order to pull this off:
$10.2 Trillion in Global Borrowing
Next year, fifteen major developed-country governments, including the U.S., Japan, the U.K., Spain and Greece, will have to raise some $10.2 trillion to repay maturing bonds and finance their budget deficits, according to estimates from the International Monetary Fund. That’s up 7% from this year, and equals 27% of their combined annual economic output.
Just ponder those numbers for a bit. The average borrowing across 15 major developed countries is 27 percent of GDP(!). Ask yourself how dependent the entire OECD world is on a smoothly operating financial system in order to merely function next year.
Having the perception out there that the US is being run by clueless (or 'abusive') individuals is not going to help the situation much.
In order for the requisite levels of borrowing to be pulled off in a smooth and uninterrupted fashion, there can't be any hits to confidence and no major disruptions can happen. Everything has to run with clockwork precision. It is against this backdrop that I view the profoundly undiplomatic statements directed at the US as quite a bit more serious than some other observers.


By choosing the path of money printing (instead of austerity like the UK), the Fed has decidedly placed the US on a very risky course. I see the outcomes are almost binary: either this works or it doesn't.
If this gamble works, business will pick up, unemployment will drop, tax revenues will flow again to the states and federal government, the sun will continue to rise in the east and roses will bloom in the spring.
If the gamble fails? There we can envision an enormous devaluation event for the US dollar and the Fed having to choose between defending the dollar (via rising interest rates) or preventing the federal government from a fiscal emergency brought about as a consequence of rising interest rates. And by "fiscal emergency" I mean being forced to slash expenditures by as much as 50% in order to service rapidly escalating interest carrying costs on the short term portion of the fiscal debt load. But that's a death spiral because cutting government spending is the same as cutting GDP (it's practically 1:1) and every cut to GDP leads to lower revenues which will necessitate more expenditure cutting, etc. and so forth until 'the bottom' is reached.
I wish there was some sort of middle ground on this one, but I can't quite see it. Either the Fed's efforts work or they don't. Let's hope for success.
In truth, I‘ve long predicted that the day would arrive when the Fed would monetize government debt, but I hoped that it would never come. Because hope alone is a terrible investment strategy, I prepared for this event years ago by accumulating gold and silver as the core of my portfolio.
But now the rules have changed again, we are on a slippery slope, and gold and silver were always meant to be my "transition elements" put there to help shepherd my wealth through the transition period as the world's fascination shifted from "paper" to "things."
Now that we're "almost there" in terms of the required shift in perception necessary to call an end to one period (the "king dollar" period) and mark the beginning of another, it's time to begin considering the places, timing and ways that these transition elements can be redeployed to take advantage of the second part of this story.
In particular, concerned minds are looking for answers to questions about what might happen next and how to insulate oneself from monetary madness.  These questions are explored in detail in Part 2 of this article (free executive summary, enrollment required to access).

To quickly review Part I, the US has embarked on a very dangerous strategy of trying to print its way to prosperity and various countries have, in exceptionally strong terms, indicated severe displeasure with the move. Essentially, they've determined that the US is trying to export its difficulties to them and this is not appreciated.
So what do we make of this and what might happen next?
I'll be honest with you here: I have been redoubling my efforts at personal preparation over the past few weeks (and they were already on set to "high" over the past 6 months). I now see a very high possibility that a fiscal and/or associated dollar crisis could happen in the next 12 months. How high? Right now it looks like 50/50 to me; it's a coin flip (or Russian roulette with three in the cylinder, if you prefer).
All that would be required to set match to dry tinder, would be a single failed Treasury auction. You may consider this unlikely due to the presence of the Fed backstopping all new government borrowing, and that's certainly a valid consideration, but the wildcard here is that the Fed is merely backstopping all the new Treasury issuances. As I indicated in part one, above, while the US might be floating roughly $1.2 - $1.5 trillion in new Treasuries in 2011, there's another $3 trillion or so of 'rollovers' that have to go off without a hitch as well.

Greenspan Calls Out U.S. Policy of Weakening Dollar


The US is pursuing a policy of weakening its currency which is driving up exchange rates in the rest of the world, according to Alan Greenspan, the former chairman of the Federal Reserve.
Writing in today’s Financial Times ahead of the G20 meeting in Seoul, Mr Greenspan argues that with China also holding down the renminbi, the upward pressure on currencies elsewhere risks a return to widespread trade protectionism. Mr Greenspan criticises China for continuing to prevent the renminbi strengthening, saying it reflects a misguided view that a weak currency is necessary for export growth and political stability. “China has become a major global economic force in recent years,” he writes. “But it has not yet chosen to take on the shared global obligations that its economic status requires.” More unexpectedly, Mr Greenspan adds: “America is also pursuing a policy of currency weakening.”

Fed Manipulating the Stock Market

"The Fed has spent the last 15, 20 years manipulating the stock market. I think they know what they do has no direct impact on the economy, the only weapon they have is the so-called wealth effect: if you can drive the market up 50%, people feel richer, they feel a little more confident, and the academics reckon they spend about 3% of that. The problem is they know very well how to stimulate the market, but they step away when the market gathers steam, and resign any responsibility for moderating a bull market that may get out of control, and I fear that the market will continue to rise, it will be continuously speculative. As a consequence you get a boom and bust... I think the Fed should settle for just controlling the money supply, not controlling the economy." -- Jeremy Grantham, Chairman of the Board of Grantham Mayo Van Otterloo (GMO).

Sorry, Soros! Dollar Continues to Rise on Europe's Woes

POMO Schedule Nov 12-Dec 9

Insider Selling Hits Record

"Insider selling at Standard & Poor’s 500 Index companies reached a record in the past week as executives took advantage of a two-year high in the stock-market to sell their shares." -- Bloomberg

Front-Running the Fed

Gifts! I'm trying to understand how this works. The Treasury sells at 11:00 am MST. Prices dip briefly, but only for less than 5 minutes. Then, after the Primary Dealers buy, they begin to rise again over the following four hours. Then, treasuries begin to sell off again at midnight! Ironically, at that point, the market sells off, with treasury prices lower for the day by 6 am MST the following morning. Thus, the short side of the trade can also be taken! This is being seen as "free money" in the markets. Buy, sell, rinse and repeat!

This article suggests that the next big Fed monetization (QE2) begins on Friday. It was my understanding that it began yesterday, shown on these charts. I have included the time scale at the bottom of each chart so that it can be seen.

The following charts show the progression of the trades on the 10-year treasuries. The charts for the 5-year treasuries were nearly identical! Also the 30-year! But the 10-year has at least twice, and up to five times the volume of the others!

Chart #1: 15 minute and 3 minute charts - note the time scale at the bottom
Chart #2: 50-tick chart - shows the selling at 11:00 am when the Treasury auction occurs, and the reversal at about 11:03 MST. Best to open large chart in a separate window.
Chart #3: 500-tick chart - This chart picks up where the 50-tick chart stops at about 11:08 MST. Note the steady rise until just after market close, even into the first few minutes when the market reopens at 4:30 pm MST, peaking out at 4:45 pm MST. This trade was worth $2000 per contract.
Chart #4: 150 tick chart - prices continue to fall for three hours before the Treasury auction, right up until the first few minutes of the auction

from Zero Hedge:

From Nic Lenoir of ICAP
A classic stop and squeeze...
Well at least the only trade left in town is working! In a classic old school alley-oop clinic that could make us forget Magic to Kareem, the Fed to dealers to Fed (remember the Fed runs the auctions) switcharoo was in full force today. Add to that the fact we have a mid-week bond holiday before the start of QE 2.0 on Friday, and really the set-up was perfect. A nice tail at the auction stopped out the day traders and the weak longs into the hands of the dealers who turned around and bought, even more so in the 5y to 10Y sector, so they can deliver to the Fed on Friday. We happily tried to help our clients collect on the round trip as this kind of day is clearly a sign of what's to come in the Fixed Income space.

The Fed can claim all it wants it is making money on its portfolio, when the Treasury sells 30Y bonds at 92-16 and they settle at 93-24 before the Fed starts buying (Fed buys shorter maturities which actually outperformed the bond on the rally), the government is not really making money on that trade. Today was a nice $170mm handout to the market. Hopefully that money is spent and leveraged into millions of subprime mortgage loans that revive the housing market... NOT!

Good luck trading,


Wednesday, November 10, 2010

Atlantic Rift Forms Over Irresponsible U.S. Policy

We have learned nothing from the mistakes of Europe! Nothing!

BERLIN (Reuters) - Germany's undiplomatic outbursts against U.S. policy, calling it "clueless" before a G20 summit, show growing estrangement on economics as America's focus shifts away from transatlantic ties to domestic challenges and Asia.
"The Atlantic is getting wider," said Anton Boerner, head of Germany's Foreign Trade Association, who spoke of a "creeping alienation" between America and Europe, which has been exacerbated by the global financial crisis.
Germany and the United States often criticize each other's approaches to aiding economic recovery, with U.S. calls for more expansive policy falling on deaf ears in fiscally disciplined Germany. But Berlin has taken the rhetoric to a new level.
Finance Minister Wolfgang Schaeuble, 68, said last week that the U.S. Federal Reserve decision to buy $600 billion of government bonds undermined U.S. credibility and was "clueless." There was no point, he said, in pumping money into the markets.
China and Brazil were among those echoing his comments but U.S. officials were particularly stung by Schaeuble and German Economy Minister Rainer Bruederle saying the Fed move amounted to "indirect manipulation" of the dollar to boost exports; this at a time when Washington is criticizing China for exactly the same kind of strategy.
"It's not acceptable for the Americans to criticize China for currency manipulation then slyly help the dollar by printing at the Federal Reserve," Schaeuble told Der Spiegel magazine.
Coming ahead of a G20 summit in Seoul where nerves about trade and currency imbalances will top the agenda, the comments were strong even compared to the frank tone that U.S. Treasury Secretary Timothy Geithner uses with the Germans and others.
"The harsh tones betray major nervousness among top decision makers," said Boerner. "The effects of the financial crisis have made them insecure and afraid."
Fed Chairman Ben Bernanke says buying government debt to boost the U.S. economy is important for global growth.
But Chancellor Angela Merkel and her minister "think pretty much alike" even if her language is more moderate, said a German government source. She refrained from using names, for example, when she criticized policy keeping currencies artificially low to boost exports as short-sighted.
Simon Green, a history professor at Aston University in Britain, said the Americans' quantitative easing was a "red flag" to the Germans with their historic fear of inflation.
Germany has made a painful effort to get competitive in the past decade of slow growth and stagnant wages and is unhappy to see "the Americans saying 'let's throw on the press, print money and get competitive that way,'" said Green.
One regional German paper, the Hannoversche Allgemeine, came to the conclusion that "never before has the Merkel government had such a direct confrontation with the United States."
Merkel's center-left predecessor Gerhard Schroeder came into conflict with President George W. Bush for criticizing the war in Iraq. The arrival of conservative Merkel raised great hopes in Washington and she got on well personally with Bush.
But the chancellor and Bush's successor Barack Obama have always had a difficult time communicating, said William Drozdiak of the American Council on Germany.
While they broadly agree on many geopolitical issues like Iran and Afghanistan, there are differences in the approach to security and, most significantly, Merkel has doggedly refused U.S. overtures to fire up domestic economic demand in Germany.
"On economic policy there is no dissonance with Europe as a whole, but rather with successful EU states like Germany," said Hans-Ulrich Klose, head of German cooperation with Washington and deputy head of parliament's foreign affairs committee.
After his mid-term election defeat, Obama's priority is to boost jobs via exports by whatever means, said Klose, who while stressing the shared values and Obama's popularity in Germany, sees Washington with "a quietly protectionist frame of mind."
U.S. diplomats are trying to convince Germany "Europeans are the best partner the U.S. could have," as Assistant Secretary of State Philip Gordon said on a recent visit to Berlin.
"But the danger is that anti-American sentiment in Germany could grow," said Klose.
At the Center for American Progress in Washington, Michael Werz said U.S.-German tensions reflect difficulties adjusting as Asia and other developing areas outstrip Europe and America in economic and demographic growth and divert their attention.
"The census shows the U.S. population's center of gravity is shifting 20 meters a day away from the north-east toward the south-west due to immigration from Asia and the South," he said.
On top of that, Obama lacks the instinctive European focus of some of his predecessors like Bill Clinton, said Green. But it is also "part of a mature bilateral relationship to recognize the fact that they are not exclusively focused on each other."

Tuesday, November 9, 2010

Mark Fisher Says QE2 Will Make Dollar "Worthless Paper"

"QE2 can't end right. Worthless paper after endless paper.... What's good for the equity markets is not necessarily good for the economy. The equity markets are not going to create jobs. If you have a paper bag full of money are you going to go out and hire workers and take risk with healthcare and all these other regulatory restrictions? No, you are going to go ahead and buy high yield, you will buy equities, you will buy risk assets. The fallacy in the whole thing is that you are not going to go ahead and create jobs just by pushing up the market by 20%, 15%. In fact, to some degree by pushing up commodity price to levels that are going to be obscene, which is what is going to happen, you are hurting everybody in mainstream America... If you have all this money coming into the system, and this money stays in the equity and commodity markets, when at some point you take this money out of the system, where is this money going to come out of? Parabolic moves have Parabolic corrections. This is going to end bad. It is not a matter of if, just a matter of when. This is going to be the ultimate bubble, this is going to make 2000 look like a cakewalk. This is going to be the bubble of all bubbles."

Soybeans Open Limit Up, Back Off Somewhat

Is Fed's QE2 Unconstitutional?

by Elizabeth McDonald on Fox Business:

Is the Federal Reserve violating the U.S. Constitution’s separation of powers in its new purchases of $600 billion worth of U.S. Treasuries? Is the Fed engaging in an unconstitutional monetization of the   U.S. Congress’ out of control spending spree that is really a bridge loan to fiscal insanity?
At minimum, should the Fed be avoiding these purchases until the fiscally debauched U.S. Congress, packed to the ceiling with fiscal dipsomaniacs, follows Great Britain’s lead in its fiscal abstinence that may "out Thatcher" even Margaret Thatcher?
Isn’t the problem fiscal incontinence and regulatory misfeasance, and business uncertainty about all of that, which is creating joblessness? Not a lack of liquidity and not deflation, which is not a clear and present danger, as instead inflation is still with us?
And isn’t the Fed dangerously habituating the stock, bond and commodities markets to a “new normal” of constant quantitative easing?
Open Revolt
Germany, China, Russia and Brazil are attacking the Fed’s move. President Barack Obama is now defending the Fed in his overseas trip to India. Former Republican vice presidential candidate Sarah Palin demanded that the Fed "cease and desist" on its bond purchases. Wall Street experts are now starting to call the Fed's moves an end run around the legislature.
And even Fed chairman Bernanke has criticized such extracurricular activity on the part of central banks in the past.
Watching closely in the wings are the Congressmen who want a full-fledged audit of the Fed, including Rep. Ron Paul (R-Texas), who said he will push to examine the Federal Reserve’s monetary policy decisions if he takes control of the Congressional subcommittee that oversees the central bank, as expected, in January.
Last week, the Federal Reserve announced it plans to buy more U.S. Treasury notes and bonds at a massive clip, $600 billion, between now and the end of June in a bid to spur economic demand, lower the jobless rate and resuscitate a still fragile U.S. economy.
Already, from December 2008 through this past March, the Federal Reserve bought about $1.6 trillion of government debt and mortgage-backed securities to stem the economy’s free fall.
Federal Reserve Act Sanctions Such Purchases
Although Article I of the Constitution specifically gives Congress the power to "borrow," "coin" and "regulate" money, a little understood section of the Federal Reserve Act, section 14(b)(1), does let the Fed buy Treasuries in the open market — and under the Act the central bank can buy foreign debt, too. But that act, put in place in the early part of the 20th century, was meant for smaller bore purchases to help the government build bridges and roads--not the massive intervention planned now. Fed historians fear the central bank is now pushing the envelope of the Federal Reserve Act. For more on the section, click here.
Why the Fed Intervention?
The banks say there is still a lack of demand, at the consumer and business levels. Banks are being criticized for not lending more, even though the Fed has kept interest rates at nearly zero, and even though they hold more than $1 trillion in excess reserves. Loans as a percentage of assets are declining, notes the Dallas Federal Reserve, although it sees a pickup in bank corporate lending.
The central bank hopes to lower the 10-year note even more, helping homeowners teetering on the brink to refinance their mortgages and businesses to obtain cheaper credit.
The Heart of the Problem
The problem is, businesses say they face hyper-taxation and hyper-regulation at the federal, state and local, and that is what is helping to create joblessness. Fed officials agree.
“The remedy for what ails the economy is, in my view, in the hands of the fiscal and regulatory authorities, not the Fed," said Richard Fisher, president and CEO of the Federal Reserve Bank of Dallas in a speech to members of the Association of Financial Professional that was critical of the central bank’s debt purchases.
Uncertainty rightfully abounds in the business community because businesses do not know what else will pop up in the health and financial reform bills that many in Congress have not read that could hurt their businesses.
The problem is the Fed is buying much of next year’s fiscal deficit spending at a time when fiscal austerity is nowhere to be found in Congress. The problem is the Fed won’t stop buying Treasuries unless the government fixes a jobless rate stuck at 9.6%, the goals of “maximum employment” being part of the Fed’s mandate.
The problem is this vicious circle: the Fed’s dollar printing could undo the government’s stimulus deficit spending because it will cause the dollar to drop and it will trigger inflation, as already food and gas prices have risen, hurting the U.S. consumer.
The danger is monetary policy acts with a lag. “I liken it to a good single malt whiskey or perhaps truly great tequila: It takes time before you feel its full effect,” says the Dallas Federal Reserve’s Fisher.
So the Fed’s moves could take effect when the economy is already healing — igniting inflation, which the U.S. already sees in food and energy prices.
The Markets Cheer
The stock markets have cheered, and the Dow Jones Industrial Average has risen 12% higher as the dollar has dropped about 10% versus the euro since Federal Reserve chairman Ben Bernanke first hinted at more purchases in his Jackson Hole, Wyoming speech last August.
U.S. Federal Reserve Chairman Ben Bernanke (Source: Reuters)
Investors have seen an estimated $1.4 trillion in paper gains in their portfolios since then, the wealth effect Bernanke had hoped for to revive consumer confidence and spending.
However, market watchers now fear a trifecta of bubbles is forming in stocks, bonds and commodities — and foreign governments, notably in Asia, are hollering that this flood of money is ending up on their shores creating bubbles there, too.
Already, as the dollar drops, oil is trading at two-year highs, and gold has hit a nominal high of $1,400, still off its inflation adjusted high of $2,314 reached in 1980.
“Right now, the world is faced with the unprecedented consequence of demand-pull inflationary forces fueled by the voracious consumption of oil, wheat, corn, iron ore, steel and copper, and all other kinds of commodities and inputs, including labor, among the three billion new participants in the global economy,” says Fisher.
But instead of what former Fed chairman William McChesney Martin once famously said -- that the job of a good central banker is to take away the punchbowl just as the party gets going -- Bernanke is spiking the bowl even more.
Fed’s Scary Exit Strategy
And another gargantuan problem looming is the Fed’s exit strategy out of its dollar printing, which involves selling those exact same Treasuries it is buying to remove the excess liquidity the central bank is creating.
All of those bonds seeking a finite pool of investors could cause a bond market crack up, because higher yields would have to be offered to lure investors in.
The Fed’s exit strategy could cause bond yields and borrowing rates to spike way higher.
Controversy Stretches Back Decades
Since the Federal Reserve Act of 1913 created the Fed, scholars have argued the Fed itself as an entity is unconstitutional. Texas Republican Rep. Ron Paul and his newly elected son Rand have made similar arguments.
FOX Business' top legal analyst, Judge Andrew Napolitano, notes that “the Supreme Court has never ruled on the constitutionality of the Federal Reserve, believe it or not. But the lower federal courts that have addressed the issue have found it to be constitutional by employing the argument that Congress can enter into a contract with private entities to perform governmental services; and that is what it has done with the private bankers who own and operate and profit greatly from the Fed.”
Fox Business news director Ray Hennessey notes that in 1952, Rep. John Wright Patman of Texas, who was head of what was then called the House Committee on Banking and Currency, crystallized the argument, saying, “In the United States we have, in effect, two governments. We have the duly constituted Government. Then we have an independent, uncontrolled and uncoordinated government in the Federal Reserve System, operating the money powers which are reserved to Congress by the Constitution."
The U.S. central bank grudgingly bought U.S. debt during the Great Depression under pressure from Congress to battle deflation—a playbook Bernanke is following now.
Between 1926 and 1929, the Fed bought $1.7 billion in US debt, but then ramped that up from $729 million to $1.8 billion in 1933, averaging $2.4 billion in purchases every year after that until 1941.
While these moves helped lower interest costs corporate debt “and appeared to arrest the decline in prices and economic activity,” Bernanke said. “Fed officials remained ambivalent about their policy of monetary expansion. Some viewed the Depression as the necessary purging of financial excesses built up during the 1920s..slowing the economic collapse by easing monetary policy only delayed the inevitable adjustment.”
The Fed also bought U.S. debt in the 1940s to keep interest rates low after World War II, a move some economists say helped usher in the post-war economic boom.
And back in the 1970s, it was Congress that pressured the Fed into adding Fannie Mae and Freddie Mac securities to its portfolio in order to help develop the market for those mortgage-backed securities. That was unpopular with the Fed at the time too.
Bernanke Uncomfortable
Fed chairman Bernanke himself said he was nervous about such extracurricular moves by any central bank in a 1999 speech, where he discussed the Bank of Japan’s monetary easing to help fix the country’s banking collapse that led to its lost decade of the ‘90s, now two decades running.
Bernanke said that if the BOJ outright bought nonperforming bank loans, such purchases would be “correctly viewed as an end run around the authority of the legislature, and so are better left in the realm of theoretical curiosities.”
But the Fed effectively did make such a monetary gift to Fannie Mae and Freddie Mac when it bought its rotten mortgage-backed securities, notes John Hussman of Hussman Funds.
Hussman says: “It is doubtful that when Congress drafted the Federal Reserve Act to allow the use of mortgage-backed securities, it ever dreamed that the Fed would purchase these securities outright when the issuer was insolvent. Until this issue is clarified in legislation, Bernanke will continue to see it as “perfectly sensible” for the Fed to make ‘money financed gifts’ that substitute his own personal discretion for those of a democracy.”
Quantitative easing simply lets the Fed to not just buy Treasuries, but also other assets that may not be allowed by the Constitution, Hussman says.
“Creating government liabilities to acquire goods and assets, unless those assets are other government liabilities, is fiscal policy, pure and simple” and “that fiscal authority is enumerated by the Constitution as the sole right of Congress,” Hussman notes.
And “nowhere in the Federal Reserve Act did Congress provide authority for the Fed to create subsidiary corporate entities as it did with the Maiden Lane vehicles,” to take on rotten assets from Bear Stearns and AIG, says Chad Emerson of the William & Mary Business Law Review. “The Fed cannot simply establish off-the-books shadow companies to avoid its restrictions under the Act. The legislative power of Congress cannot be circumvented by merely creating a LLC.”
When Bernanke Acted
Bernanke first raised the idea of purchasing Treasuries in a Dec. 1, 2008 speech, which the Federal Open Market Committee later reaffirmed in a statement on Jan. 28, 2009. But when the Bank of England later that year succeeded in dropping long-term rates by buying U.K. gilts, that’s when the Fed took notice. The 10-year gilt yield slid to the lowest level in at least 20 years after the BOE’s purchases began.
But Great Britain became abstemious with its deficit spending. The U.S. has not.

Monday, November 8, 2010

Fed Governor Expresses QE2 Buyer's Remorse

from Bloomberg:

In a speech Monday, Federal Reserve Governor Kevin Warsh questioned whether the government's decision to spend $600 billion on bonds would have lasting positive effects on the economy, the Associated Press reported. The comments are somewhat surprising considering that Walsh, an ally of Chairman Ben Bernanke, voted for the plan.

Speaking at the annual meeting of the Securities Industry and Financial Markets Association in New York, Warsh said government bond buying could cause longer term inflation because of a weakening dollar and higher commodity prices. The government may be better off reforming the tax code to incentivize companies to boost investment, he added. "Additional monetary policy measures are, at best, poor substitutes for more powerful pro-growth policies," he said.

EU Enters New Era of Crisis

from Bloomberg:

The life-support system for Greece, Ireland, Portugal and Spain is now under threat. The highly indebted nations of the euro area can’t survive the deficit crisis without access to central-bank credit.
Last month’s Franco-German agreement at Deauville, France, and the statement of European leaders on Oct. 29 have changed the ground rules for euro-area debt.
All 27 member states have now signed up to the need for a revision of the Lisbon Treaty in exchange for a permanent crisis-resolution mechanism. The key new element is that Europe’s leaders have specifically said that future rescues might involve private creditors.

Fed Admits It IS Monetizing the Debt

"For the next eight months, the nation’s central bank will be monetizing the federal debt." Dallas Fed President Richard Fisher

Mortgage Delinquencies Edged Higher

The number of new foreclosure notices fell 5.5% but a slightly larger proportion of mortgages became delinquent in the third quarter of 2010, according to a New York Federal Reserve Bank survey released on Monday.
About 2.7% of current mortgage balances fell into delinquency between June and September, compared to 2.6% in the second quarter, marking the first rise in this figure since last year.

Gold Blasts Through $1400

G20 Fireworks


Germany has put itself on a collision course with the US over the global economy, after its finance minister launched an extraordinary attack on policies being pursued in Washington.
Wolfgang Schäuble accused the US of undermining its policymaking credibility, increasing global economic uncertainty and of hypocrisy over exchange rates. The US economic growth model was in a “deep crisis,” he also warned over the weekend.

from Reuters:

NEW DELHI, Nov 8 (Reuters) - U.S. President Barack Obama defended the Federal Reserve's policy of printing dollars on Monday after China and Russia stepped up criticism ahead of this week's Group of 20 meeting.
The G20 summit has been pitched as a chance for leaders of the countries that account for 85 percent of world output to prevent a currency row escalating into a rush to protectionism that could imperil the global recovery.
But there is little sign of consensus.
The summit has been overshadowed by disagreements over the U.S. Federal Reserve's quantitative easing (QE) policy under which it will print money to buy $600 billion of government bonds, a move that could depress the dollar and cause a potentially destabilising flow of money into emerging economies.

Robert Zoellick Says We Should "Go for the Gold"!

 HONG KONG (MarketWatch) –- The president of the World Bank said in a newspaper editorial Monday that the Group of 20 leading economies should consider adopting a global reserve currency based on gold as part of structural reforms to the world’s foreign-exchange regime.
World Bank chief Robert Zoellick said in an article the Financial Times that leading economies should consider “employing gold as an international reference point of market expectations about inflation, deflation and future currency values.” 
Zoellick made the proposal as part of reforms to be considered at this week’s G-20 meeting in Seoul.
“Although textbooks may view gold as the old money, markets are using gold as an alternative monetary asset today,” said Zoellick.
He said such a reform would reflect economic realities and should be considered as a successor to the existing global currency paradigm known as “Bretton Woods II.”
Bretton Woods II refers to the system which began in 1971, when U.S. President Nixon ended the dollar’s link to gold as established under the Bretton Woods agreement.
Zoellick said a return to some sort of currency link to gold would be “practical and feasible, not radical.”
“This new system is likely to need to involve the dollar, the euro, the yen, the pound and a renminbi that moves towards internationalization and then an open capital account,” he said.

Sunday, November 7, 2010

Hussman: QE2 Just More Bubble and Crash Economics

"Stock prices rose and long-term interest rates fell when investors began to anticipate the most recent action. Easier financial conditions will promote economic growth. For example, lower mortgage rates will make housing more affordable and allow more homeowners to refinance. Lower corporate bond rates will encourage investment. And higher stock prices will boost consumer wealth and help increase confidence, which can also spur spending. Increased spending will lead to higher incomes and profits that, in a virtuous circle, will further support economic expansion."

Federal Reserve Chairman Ben Bernanke, Washington Post 11/4/2010
Last week, the Federal Reserve confirmed its intention to engage in a second round of "quantitative easing" - purchasing about $600 billion of U.S. Treasury debt over the coming months, in addition to about $250 billion that it already planned to purchase to replace various Fannie Mae and Freddie Mac securities as they mature.
While the announcement of QE2 itself was met with a rather mixed market reaction on Wednesday, the markets launched into a speculative rampage in response to an Op-Ed piece by Bernanke that was published Thursday morning in the Washington Post. In it, Bernanke suggested that QE2 would help the economy essentially by propping up the stock market, corporate bonds, and other types of risky securities, resulting in a "virtuous circle" of economic activity. Conspicuously absent was any suggestion that the banking system was even an object of the Fed's policy at all. Indeed, Bernanke observed "Our earlier use of this policy approach had little effect on the amount of currency in circulation or on other broad measures of the money supply, such as bank deposits."
Given that interest rates are already quite depressed, Bernanke seems to be grasping at straws in justifying QE2 on the basis further slight reductions in yields. As for Bernanke's case for creating wealth effects via the stock market, one might look at this logic and conclude that while it may or may not be valid, the argument is at least the subject of reasonable debate. But that would not be true. Rather, these are undoubtedly among the most ignorant remarks ever made by a central banker.
Let's do the math.
Historically, a 1% increase in the S&P 500 has been associated with a corresponding change in GDP of 0.042% in the same year, 0.035% the next year, and has negative correlations with GDP growth thereafter (sufficient to eliminate any effect on the long-run level of GDP). Now, even if one assumes - counter to reasonable analysis - that the GDP changes are caused by the stock market changes (rather than stocks responding to the economy), the potential benefit to the economy of even a 10% market advance would be to increment GDP growth by less than half of one percent for a two year period.
Now, as of last week, the total capitalization of the U.S. stock market was at about the same as the level as nominal GDP ($14.7 trillion). So a market advance of say, 10% - again, even assuming that stock prices cause GDP - would result in $1.47 trillion of market value, and a cumulative but temporary increment to GDP that works out to $11.3 billion dollars divided over two years. Moreover, even if profits as a share of GDP were to hold at a record high of 8%, and these profits were entirely deliverable to shareholders, the resulting one-time benefit to corporate shareholders would amount to a lump sum of $904 million dollars. In effect, Ben Bernanke is arguing that investors should value a one-time payout of $904 million dollars at $1.47 trillion. Virtuous circle indeed.
One of the main reasons that stock market fluctuations have such a limited impact on real output is because investors correctly perceive these fluctuations as impermanent - particularly when they are detached from proportional changes in long-term fundamentals. Recall that the primary source of the recent financial crisis was excessive debt expansion, consumption, and speculative housing investment. Consumers observed persistently rising home prices, and inferred that they were "wealthy" enough to shift their consumption forward by borrowing against that perceived "wealth." A key to this dynamic was the fact that U.S. home prices had never experienced a sustained decline during the post-war period, so the increases in housing wealth were indeed viewed as permanent. As Milton Friedman and Franco Modigliani demonstrated decades ago, consumers consider their "permanent income" - not transitory year-to-year fluctuations - when they make their consumption decisions.
Rising home prices were further promoted by a combination of lax credit standards, perverse incentives for loan origination, a weak regulatory environment, and a Federal Reserve that sat so firmly on short-term interest rates that investors felt forced to reach for yield by purchasing whatever form of slice-and-dice mortgage obligation the financial engineers could dream up. Rising home values provoked more debt origination, and even higher prices. What seemed like a "virtuous circle" was ultimately nothing but an overpriced speculative bubble with devastating consequences.
Bubble, Crash, Bubble, Crash, Bubble ...
We will continue this cycle until we catch on. The problem isn't only that the Fed is treating the symptoms instead of the disease. Rather, by irresponsibly promoting reckless speculation, misallocation of capital, moral hazard (careless lending without repercussions), and illusory "wealth effects," the Fed has become the disease.
Alan Greenspan contributed to the late-1990's market bubble by his embrace of the notion that 100 million lemmings leaping off of a cliff into the ocean can't be wrong. Beyond a single bit of rhetorical lip service to the effect of "how do we know when irrational exuberance has unduly escalated asset values," Greenspan aggressively accommodated that bubble. Once it crashed, the Fed sat on short-term interest rates in a way that directly contributed to the housing bubble. Back in July, 2003, I published a perspective called Freight Trains and Steep Curves, which is a reminder that that the recent credit crisis did not emerge out of the blue:
"What is not so obvious is the extent to which the U.S. economy and financial markets are betting on the continuation of unusually low short-term interest rates and a steep yield curve. This doesn't necessarily resolve into immediate risks, but it could profoundly affect the path that the economy and financial markets take during the next few years, by making the unwinding of debt much more abrupt... So the real question is this: why is anybody willing to hold this low interest rate paper if the borrowers issuing it are so vulnerable to default risk? That's the secret. The borrowers don't actually issue it directly. Instead, much of the worst credit risk in the U.S. financial system is actually swapped into instruments that end up being partially backed by the U.S. government . These are held by investors precisely because they piggyback on the good faith and credit of Uncle Sam... tolerated by the financial system because the debt has been swapped out through financial intermediaries, so investors get to hold relatively safe instruments like bank deposits and Fannie Mae securities. This mountain of debt in the U.S. financial system - tied to short-term interest rates - is ultimately and perhaps somewhat inadvertently backed by the U.S. government."
It is difficult to interpret Bernanke's defense of QE2 as anything else but an attempt to replace the recent bubble with yet another - to drive already overvalued risky assets to further overvaluation in hopes that consumers will view the "wealth" as permanent. The problem here is that unlike housing, which consumers had viewed as immune from major price declines, investors have observed two separate stock market plunges of over 50% each, within the past decade alone. While investors have obviously demonstrated an aptitude for ignoring risk over short periods of time, it is a simple fact that raising the price of a risky asset comes at the sacrifice of lower long-term returns, except when there is a proportional increase in the long-term stream cash flows that can be expected from the security.
As a result of Bernanke's actions, investors now own higher priced securities that can be expected to deliver commensurately lower long-term returns, leaving their lifetime "wealth" unaffected, but exposing them to enormous risk of price declines over the intermediate (2-5 year) horizon. This is not a basis on which consumers are likely to shift their spending patterns. What Bernanke doesn't seem to absorb is that stocks are nothing but a claim on a long-term stream of cash flows that investors expect to be delivered over time. Propping up the price of stocks changes the distribution of long-term investment returns, but it doesn't materially affect the cash flows. This reckless policy has done nothing but to promote further overvaluation of already overvalued assets. The current Shiller P/E above 22 has historically been associated with subsequent total returns in the S&P 500 of less than 5% annually, on average, over every investment horizon shorter than a decade.
With no permanent effect on wealth, and no ability to materially shift incentives for productive investment, research, development or infrastructure (as fiscal policy might), the economic impact of QE2 is likely to be weak or even counterproductive, because it doesn't relax any constraints that are binding in the first place. Interest rates are already low. There is already well over a trillion in idle reserves in the banking system. Businesses and consumers, rationally, are trying to reduce their indebtedness rather than expand it, because the basis for their previous borrowing (the expectation of ever rising home prices and the hope of raising return on equity indefinitely through leverage) turned out to be misguided. The Fed can't fix that, although Bernanke is clearly trying to promote a similarly misguided assessment of consumer "wealth."
To a large extent, the Fed has assumed the role of creating financial bubbles because we have allowed it. The proper role of the Federal Reserve, and where its actions can be clearly effective, is to provide liquidity to the banking system in periods of financial stress or constraint, by replacing Treasury bonds held by the public with currency and bank reserves. But to expect the Fed to somehow bring about full employment is misguided. To believe that changing the mix of government liabilities in the economy (monetary policy) is a more important determinant of inflation than the total quantity of those liabilities (fiscal policy) is equally misguided. Historically, and across the world, the primary driver of inflation has always been expansion in unproductive government spending (think of Germany paying striking workers in the early 1920s, or the massive increase in Federal spending in the 1960s that resulted in large deficits and eventually inflation in the 1970s). But unproductive fiscal policies are long-run inflationary regardless of how they are financed, because they distort the tradeoff between growing government liabilities and scarce goods and services.
We are betting on the wrong horse. When the Fed acts outside of the role of liquidity provision, it does more harm than good. Worse, we have somehow accepted a situation where the Fed's actions are increasingly independent of our democratically elected government. Bernanke's unsound leadership has placed the nation's economic stability on two pillars: inflated asset prices, and actions that - in Bernanke's own words - should be "correctly viewed as an end run around the authority of the legislature" (see below).
The right horse is ourselves, and the ability of our elected representatives to create an economic environment that encourages productive investment, research, development, infrastructure, and education, while avoiding policies that promote speculation, discourage work, or defend reckless lenders from experiencing losses on bad investments.
Out of control: The distinction between monetary policy and fiscal policy
A decade ago, Bernanke gave a speech titled “Japanese Monetary Policy – A Case of Self-Induced Paralysis?” where he encouraged the Bank of Japan to pursue “substantial currency depreciation,” “maintaining the zero interest rate policy for the indefinite future,” “stating an inflation target of, say, 3-4 percent,” and if necessary, that “the BOJ expand its open market operations to a wider range of assets, such as long-term government bonds or corporate bonds.” Bernanke is essentially operating from this playbook, despite the fact that it has done Japan no good at all.
Some may argue that the first round of QE in the U.S. was effective, but to the extent it had an effect on the economy, that effect had nothing to do with monetary policy. What the Fed really accomplished during the first round of QE was the unlegislated grant of the government's full faith and credit to Fannie Mae and Freddie Mac. As I noted last week, the public would have viewed Fannie and Freddie securities as indistinguishable from Treasury debt if Congress had explicitly guaranteed them, but Bernanke decided to substitute his own will for that of the public.
Bernanke's 1999 speech included a very disturbing paragraph, particularly in light of what the Fed did by purchasing $1.5 trillion of these agency securities.
“In thinking about nonstandard open-market operations, it is useful to separate those that have some fiscal component from those that do not. By a fiscal component I mean some implicit subsidy, which would arise, for example, if the BOJ purchased nonperforming bank loans at face value (this is of course equivalent to a fiscal bailout of the banks, financed by the central bank). This sort of money-financed “gift” to the private sector would expand aggregate demand for the same reasons that any  money-financed transfer does. Although such operations are perfectly sensible from the standpoint of economic theory, I doubt very much that we will see anything like this in Japan, if only because it is more straightforward for the Diet to vote subsidies or tax cuts directly. Nonstandard open-market operations with a fiscal component, even if legal, would be correctly viewed as an end run around the authority of the legislature, and so are better left in the realm of theoretical curiosities.”
Yet this is precisely what the Fed did with Fannie Mae and Freddie Mac a year ago. Bernanke understands this. He simply does not want the public or Congress to recognize it.
Given that fiscal authority is enumerated by the Constitution as the sole right of Congress, and spending is prohibited by the Constitution without explicit appropriation, it seems clear - regardless of how the Federal Reserve Act is written - that monetary operations involving anything but Treasury securities contain unconstitutional “fiscal component,” unless they involve repurchase agreements that would make the Fed whole even if the underlying securities were to fail. It is doubtful that when Congress drafted the Federal Reserve Act to allow the use of mortgage-backed securities, it ever dreamed that the Fed would purchase these securities outright when the issuer was insolvent. Until this issue is clarified in legislation, Bernanke will continue to see it as “perfectly sensible” for the Fed to make “money financed gifts” that substitute his own personal discretion for those of a democracy.
Equally disturbing is that Bernanke apparently has no problem confusing fiscal policy with monetary policy when it suits him. In the same paper, Bernanke purports to explain why the central bank always has the ability to increase aggregate demand, even in a liquidity trap:
"The general argument that the monetary authorities can increase aggregate demand and prices, even if the nominal interest rate is zero, is as follows: Money, unlike other forms of government debt, pays zero interest and has infinite maturity. The monetary authorities can issue as much money as they like. Hence, if the price level were truly independent of money issuance, then the monetary authorities could use the money they create to acquire indefinite quantities of goods and assets. This is manifestly impossible in equilibrium. Therefore money issuance must ultimately raise the price level, even if nominal interest rates are bounded at zero. This is an elementary argument, but, as we will see, it is quite corrosive of claims of monetary impotence."
The only thing that is corroded here is Bernanke's economic reasoning. In this example, the central bank is not engaging in monetary policy, but fiscal policy. Creating government liabilities to acquire goods and assets, unless those assets are other government liabilities, is fiscal policy, pure and simple.