Archive for the ‘inflation’ Category

Regular finance-focused readers have probably noticed that I’ve neglected economic commentary recently. That’s because 1) there hasn’t been much net marginal information recently to clarify what I see right now (monstrous reflation in the West, looming monstrous deflation in the East, looming war in the Mid-East, commodities as The Big Thing through late July). 2) the geopolitics of Lebanon is probably the single most influential thing going on (for commodities markets, anyway) with such a corresponding lack of true public analysis.

Anyway, as I have scrolled through my lonnnnnng list of finance blogs and gotten more and more bored, one wasteful meme in particular has infected more and more online financial discourse. (Which is still way ahead of the NYT and WSJ, who are probably wondering how best to appeal to the estrogenated millenials, i.e. the yuppie female/ gay demographic,  with more front-page fashion coverage.) Let’s call it the Complex Systems Meme.

The Complex System Meme is what all the Smart Guys In The Room, the quants, talk about these days. CSM exhibits a predictable life-cycle.

  1. Quant adds long, verbose, high-syllable-per-word, hypertechnical, and thus unfalsifiable comment to a mainstream financial blog.
  2. Blogger, realizing he’s in the presence of a Smartest Guy In The Room, gracefully and tacitly hands over the reins of discussion to Quant.
  3. Many, many jargon-intensive paragraphs ensue. Frequently sighted examples of jargon intensity include “information latency,” “Knightian uncertainty,” “systems architecture,” “the financial transmission mechanism,” “the securitization process is driven by nonlinear systemic processes,” “counterproductive proliferation of systemic dependencies,” “constructive ambiguity” (Greenspan’s fave), and “reflexivity.” The liquidity of discussion within the broader discursive framework of the weblog, if you will, exhibits a six-sigma nonlinear growth trajectory.
  4. At this point, 100.00% of common sense has been scared the hell out of the room. Only certified high priests of quantology, and their most zealous qualitative admirers, remain.
  5. After paragraph count has vaulted into the upper two digit range, absolutely nothing has been said that couldn’t have been stated much more simply.
  6. However, Quant’s intellectual stature has been established beyond all dispute. If anything, the transaction cost of challenging him (requiring at least as many ubersyllabic paragraphs as were just hemorrhaged) has become prohibitive.

Verbose commentary wastes everybody’s time.

I don’t blame quants for crappy writing, just as I don’t blame myself for crappy quantification. The problem is that carpet-bombing a discussion with unnecessary technical verbiage excites a majestic awe in influential qualitatives least able to challenge — but best able to disseminate — quants’ “solutions” to the “problem,” which are at least as benighted as everybody else’s, yet treated with greater credibility.

Everything in life is nonlinear.

Just because liquidity is an economy of scale, doesn’t make it a national imperative of the federal government. In the long run, economic surplus of even the largest economies of scale is captured by the operators of that system. For example, mass transit seems like a great idea on paper, and it is — in the medium run. However, the workers and conductors of any mass transit system quickly realize that society is capturing much more surplus from their activity than they are. So their rational best choice is to unionize, and go on strike, holding the broader economy hostage until they capture (in the form of higher salaries, pensions, etc) the entire social surplus of that activity. Such is the case with the French railway workers’ union.

Liquidity isn’t nearly that nonlinear — I’m just using a more dramatic example to make the point.

Every commodity, whether it’s oil, debt, or whatever, has a parabolic marginal cost/marginal benefit curve. “Scale economies'” MB/MC curves currently seem to offer higher rates of return with greater investment, until some point farther off in the future, than those of corresponding industries. Over time,  scale economies become identical to those of non-economies of scale, except that the production side has fewer participants. Fewer producers relative to consumers means that consumers’ bargaining power asymptotes to zero. Consumers get mad, and government steps in and regulates producers. Leveraging of producers’ superior bargaining power ends. In the long long long run, both producers and consumers enjoy more surplus. In theory.

The market for lending, ostensibly a sacrosanct economy of scale, obviously went into negative territory on that curve. Now it’s snapping back. Government interventions to maintain the current level of debt are only going to cause a snapback much more “nonlinear” than whatever nonlinear correction we would otherwise have undergone.

Getting wrapped up in “the nonlinear nature of liquidity” only obfuscates the discussion for everyone. Every process is nonlinear relative to itself at the distribution of previous moments in time. But processes tend to be much more linear relative to all other processes. Since we’re talking about subsidizing one somewhat nonlinear process (debt-funded liquidity) at the expense of all other nonlinear processes, why bring nonlinearity into the discussion at all.

If smart people spent their time weighing on other Smart People to solve simple problems, instead of taking themselves so seriously and flaunting their technical knowledge, maybe we would actually get somewhere in terms of stopping BS Bernanke & Co. from butchering the financial credibility of the United States, and actually get some return on all this talking/typing time investment.

When that starts happening, and private parties are barred from free-riding off of AAA government bond ratings courtesy of taxpayer sweat, I will crawl out of my dollar-bearish, euro- and “safe” fixed income-uberbearish hibernation. And maybe the future of finance will become an interesting topic to blog about again. It’s just that with Fannie Mae et al. going $400bn-$1.1trn in debt, in addition to the Fed ~$400bn of Treasuries exchanged for worthless MBS, AND $500 billion in FY09 debt, the medium term US bond rating is already staring at either much higher taxes or an epochal downgrade. Capital is already leaving in anticipation of necessarily higher taxes, which will mean still higher taxes on whatever capital is left. Prescriptions of “solutions” to the current “credit crisis,” as if we can outsmart mean reversions of debt if we just think hard enough, are as stale as they are futile.

And in case you were wondering what the point of all that bloviation was … it was just a rant. It’s frustrating, waiting and wishing for a better alternative to capital flight.

[*] unless the abbreviation damages rhythm too much

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I’m not sure Felix Salmon is as dumb as he thinks.

May 6 2008 6:49PM EDT

Fannie Mae’s Weird Rally

I’ve seen a lot of financial institutions see their stock soar on the day they release atrocious quarterly results, and in fact I had them in mind this morning when I kicked off a blog entry with the words “Fannie Mae’s stock is certain to tank today”.

Ahem. FNM closed up 8.9% at $30.81 per share, for no obvious reason. Which is not to say that journalists didn’t try to find one: both Reuters and Fortune seem to have decided that it was the conference call which did it.

Really? This conference call? I skimmed the whole thing, and couldn’t see anything particularly upbeat in there, even after realizing that when the Seeking Alpha transcribers had CEO Daniel Mudd saying that “we will feed stock this book business that we are putting on for many years to come,” in fact he was saying “feast on this book of business”.

Of course, the reason that Fannie Mae is doing such great business is that at the moment it’s pretty much the only game in town. As house prices continue to fall, Fannie Mae continues to lose money – and if house prices ever recover, then it will have competitors again. Yes, the mortgages it’s buying now might well be profitable long into the future, but I don’t see any of Fannie Mae’s management making the case that the profits from its present business will ultimately exceed the losses being suffered in the markets.

Even Mudd himself seemed pretty downbeat at times. “The summary is, we still believe that ’08 and ’09 will be tough years as home prices return to the trend line,” he said. “No news there, but an updated forecast there.”

And on any call where an executive starts talking about “creating a significant long-term shareholder value as we ramp everything up to serve our mission,” you have to wonder if there’s really any substantive good news. There’s certainly bad news:

Florida is very over built. It will take a long time to correct. Values continue to fall and delinquencies continue to increase hitting 232 basis points in March up from about hardly 60 basis points in December and up from 49 basis point a year ago.

Still, all that said, I was very wrong: I said the stock was going down, and it went up. Yet more reason, if any is needed, never to listen to me on the subject of stock prices.

Any theories on this, other than the default conspiracy theory (that the Fed is propping it up)?

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I can barely find anything about the Muslim Brotherhood’s May 4 strike in Egypt so I assume that Mubarak’s measures to jack up wages 30 percent fizzled the strike.

And what do you know, the *next day* Mubarak proposes a 35 percent increase in fuel prices.

The Egyptian parliament’s ruling party proposed May 5 large increases on Monday in fuel and cigarette prices and in vehicle licence fees as a means of paying for the costs of President Hosni Mubarak’s recent proposal for public-sector pay raises, Reuters reported. In the proposal, the price of 90 octane fuel would rise 35 percent.

This story isn’t over … Egypt is going to spawn a lot of problems for us in the next few years.

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Right-wing hedge fund legend Bruce Kovner, responding to the standard “How do you make all of your money?” question, supposedly said, “From stupid governments.” Speaking of which:

Asian Ministers Agree to Pool $80 Billion of Reserves (Update1)

By Keiko Ujikane and Seyoon Kim

May 4 (Bloomberg) — Finance ministers from 13 Asian nations agreed to create a pool at least $80 billion in foreign- exchange reserves to be tapped by nations in case they need to protect currencies.

Contributions from Japan, China and South Korea will total 80 percent of the pool, while the 10-member Association of Southeast Asian Nations will make up the rest, the ministers said in a statement after talks in Madrid, where the Asian Development Bank is holding its annual meeting.

Asian governments are trying to avoid relying on institutions like the International Monetary Fund, which forced them to adopt harsh economic policies in return for bailouts during the financial crisis a decade ago. Pooling of foreign reserves may help prevent a repeat of the region’s turmoil.

All 13 nations will contribute to the fund, and they will still manage their own reserves under the arrangement. Exact contributions have yet to be decided. Today’s talks involved Japanese Finance Minister Fukushiro Nukaga, China’s Xie Xuren, South Korea’s Kang Man Soo and their counterparts from Brunei, Cambodia, Indonesia, Laos, Malaysia, Myanmar, Philippines, Singapore, Thailand and Vietnam.

Ministers last year agreed to set aside part of their $3.4 trillion of foreign reserves for emergencies, without deciding the size of the pool and when they would start the fund. The nations decided to accelerate discussions on the details of borrowing conditions, the statement said.

`Appropriate Actions’

On the economy, Asian governments “confirmed the importance of taking appropriate actions” to sustain economic activity, the statement said.

“The regional economy has continued its strong growth and is forecast to remain robust although somewhat weaker,” the statement said. “Nonetheless, several risks remain such as further worsening of the growth prospects, vulnerability of financial markets, and continued inflationary pressures from rising oil and non-oil commodity prices.”

Crude oil has soared, and rice prices have more than doubled since Asian finance ministers met a year ago in Kyoto, Japan. The increases have stoked social tensions and led to wider fiscal deficits as governments subsidize food and energy costs for their people.

The reserve pool is an expansion of a current arrangement that only allows for bilateral currency swaps. It is designed to ensure central banks have enough to shield their currencies from speculative attacks like those that depleted the reserves of some countries during the Asian financial crisis in 1997 and 1998.

During that crisis, Indonesia, Thailand and South Korea spent most of their foreign reserves to prop up their currencies. The three nations had to turn to the IMF for more than $100 billion of loans to shore up their finances when investors sold their currencies. The IMF forced governments to cut spending, raise interest rates and sell state-owned companies.

In other words, they will dump their forex reserves to defend their currency pegs, for the privilege of subsidizing American consumption even more than they have for the past six years. Damn it (occasionally) feels good to be American!

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Yeah, he “caved in” already.

Action taken by the Federal Reserve on Friday targeting the global credit crisis, in concert with European central banks, included an injection of cash into the stricken student loan market through a special lending operation.

Lawmakers and the student loan industry have been pressing for such action by the central bank for weeks, as distress in the credit markets has caused more than 60 lenders to stop making federally guaranteed student loans, either temporarily or permanently.

The exiting lenders, which include college loan agencies in several states, account for an estimated 15 percent of the federally backed student loan market. Their departure comes at the time when students headed to college next year must lock in their loans.

In the move, the Fed is allowing investment firms and banks to use bonds backed by federally guaranteed student loans as collateral for the loans of safe Treasury securities that the central bank is making available.

“The Fed’s decision…will help inject much-needed liquidity into the student loan market,” Sen. Christopher Dodd, D-Conn., chairman of the Senate Banking Committee, said in a statement.

More than two dozen lawmakers of both parties earlier this spring asked the Fed to inject cash into the student loan market by taking that action. But Fed Chairman Ben Bernanke responded in a letter that it wasn’t the central bank’s intention to do so at that point.

“I am pleased that the Federal Reserve Board has changed its policy,” Dodd said in his statement.

He said the move, coupled with legislation passed by Congress this week giving the Education Department temporary authority to buy loans from student lenders to ensure their access to capital “represents a timely response to funding concerns in the student loan market and should allow lenders to continue to make loans to students who need them.”

President Bush is expected to sign the legislation, which also would let the education secretary advance federal money to designated companies that would operate as “lenders of last resort” if they run out of capital to make new federally backed loans.

The Fed said Friday it was boosting the amount of emergency reserves it supplies to U.S. banks to $150 billion in May, from the $100 billion it supplied in April. The Fed took this action and several other moves to boost credit in coordination with the European Central Bank and the Swiss National Bank.

This is such an obvious shell game. I guess the amount of private money sitting in Treasuries just goes to show you how much dumb money’s out there. Treasury notes (rates) have nowhere to go but down (up).

I expect the number of students requesting loans will significantly exceed expectations. There are already indications, in fact, that a disproportionate number of graduating college seniors are going on to law school or med school, because the part of the white-collar job market that so many college students geared themselves towards four years ago (ie finance) is so bad.

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May 2 (Bloomberg) — A month after the Federal Reserve rescued Bear Stearns Cos. from bankruptcy, Chairman Ben S. Bernanke got an S.O.S. from Congress.

There is “a potential crisis in the student-loan market” requiring “similar bold action,” Chairman Christopher Dodd of Connecticut and six other Democrats wrote Bernanke. They want the Fed to swap Treasury notes for bonds backed by student loans. In a separate letter, Pennsylvania Democratic Representative Paul Kanjorski and 31 House members said they want Bernanke to channel money directly to education-finance firms.

The Fed’s loans to Bear Stearns were “a rogue operation,” said Anna Schwartz, who co-wrote “A Monetary History of the United States” with the late Nobel laureate Milton Friedman.

`No Business’

“To me, it is an open and shut case,” she said in an interview from her office in New York. “The Fed had no business intervening there.”

There are already indications that investors perceive the safety net to be widening as a result of the actions by Bernanke, 54, and New York Fed President Timothy Geithner. The Bear Stearns bailout and an emergency facility to loan directly to government bond dealers triggered a decline in measures of credit risk for investment banks and for Fannie Mae, the Washington-based, government-chartered company that is the nation’s largest source of funds for home mortgages.

Yield differences between Fannie Mae’s five-year debt and five-year U.S. Treasuries have fallen to 0.55 percentage point, from 1.15 percentage points on March 14, the day the Fed’s Board of Governors invoked an emergency rule to lend $13 billion to Bear Stearns.

“The market understood that this is the method by which Fannie Mae and Freddie Mac could be bailed out if necessary,” Poole said.

Wall Street Impact

The cost of default protection on Merrill Lynch & Co. debt fell to 1.4 percentage point by April 30 from 3.3 percentage points on March 14, CMA Datavision’s credit-default swaps prices show. The cost of protection on Lehman Brothers Holdings Inc. securities has fallen to 1.5 percentage points from 4.5 percentage points over the same period.

Fed Board spokeswoman Michelle Smith declined to comment, as did New York Fed spokesman Calvin Mitchell.

On March 16, two days after the Fed provided its Bear loan, it agreed to finance $30 billion of the firm’s illiquid assets to secure its takeover by JPMorgan Chase & Co.

The Standard & Poor’s 500 Financials Index had lost 12 percent in the three weeks prior to March 14; Geithner defended the loans before the Senate Banking Committee on April 3, saying that the Fed needed to offset risks posed to the entire financial system.

A systemic collapse on Wall Street would also mean “higher borrowing costs for housing, education, and the expenses of everyday life,” Geithner, 46, said.

While the Fed must by law withdraw its financing backstop for investment banks once the credit crisis passes, investors will probably still bet on its readiness to intervene. …


The Fed also influenced market incentives last month when it introduced the so-called Term Securities Lending Facility. The program is designed to lend up to $200 billion of Treasury securities from the Fed’s holdings to Wall Street bond dealers in return for commercial and residential mortgage bonds among other collateral. Congress has noticed the program favors mortgage credits, and Dodd has asked the Fed to swap some of its $548 billion in Treasury holdings for bonds backed by student loans.

Back to Congress

Bernanke rejected Dodd’s request in an April 25 letter, saying it’s up to Congress and the Bush administration to address diminishing profits on the loans. He didn’t explain why the Fed is reluctant to swap Treasuries for bonds backed by student loans.

“If there is a public purpose in lending to investment banks, and taking dodgy mortgage securities as collateral, then it is a question of degree about other potential lending,” Vincent Reinhart, former director of the Fed board’s Division of Monetary Affairs, said in an interview. “That’s the consequence of crossing a line that had been well established for three- quarters of a century.”

Having extended welfare to Wall Street Republicans, the Fed cannot now refuse Democratic client industries, such as government-sponsored enterprises, education financiers, etc.

Additionally, the Fed will be on the hook for the “containment” bailouts it arranged in the first stage of the credit crunch. The Bank of America acquisition of Countrywide, for example, was widely seen as a Fed “containment” move. CFC owed at least $51 billion of debt to the FHLBs, and $38 billion is the latest figure Bloomberg is bandying around. Bank of America appears poised to take every BofA asset it can and shovel the debts to the government into a bogus holding company, which will go bankrupt. It will be entertaining to watch the FHLBs make good on a $38 billion hole in their balance sheet. Ambrose Evans-Pritchard said that at one point, Citigroup owed $98 billion to the FHLBs. Assume that has been cut 25 percent by a combination of a slight credit recovery and the Fed taking a lot of what can’t be sold; that still leaves $75bn. The FHLBs are going to have to start calling in loans. There will be another deleveraging frenzy. What’s the Fed going to do then, since it’s already forked over $400 billion of its $950bn in Treasury “bullets” to the banks? Putting bad debt in different buckets doesn’t change the fact that it’s bad debt, especially when the new bucket is owned by the government.

S&P estimated a couple of weeks ago that Fannie and Freddie alone would require a bailout of between $420 billion and $1.1 trillion – enough to jeopardize the United States’ AAA bond rating. Presumably that didn’t include Sallie Mae, the student loan originator.

At any rate, the renewed sense of optimism on equities among “the big boys” ™ has been palpable for at least a week. Wall Street is once again cranking up the leverage. Hence the shift out of commodities and into equities effected by the tacticals (hedge funds) at the expense of the dinosaur pension funds and endowments, which piled into commodities very late.

The data junkies tell me that broad money (MZM) strongly leads narrow money (BASE). The deflation-will-be-the-end-of-us-all crowd (eg, Mish Shedlock, John Mauldin, coming from somewhat different angles) has generally pointed to BASE as at least a quasi-justification of what Bernanke is doing. Bond vigilantes have pointed to MZM as a portent of severe future inflation. Obviously, I think the bond vigilantes are correct.

For now, the “inflationary bull market” classes (leveraged equities and base raw materials) have won the argument against the stagflation asset classes (eg precious metals). As long as the Fed dilutes Treasuries by swapping them for MBS, precious metals will still woefully underperform. Gold has been hammered for the past few weeks and although I am still quite bullish about it in the 6-24 month time horizon, the past four weeks have obviously been very unkind to that thesis.

Short Treasuries; long equities and precious metals.

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Forget about NYC ever recapturing London’s financial crown. What sane hedge fund manager would de-privatize all his information, and submit to “surveillance” by the very Praetorians who have exacerbated every shock of the last 20 years?

Treasury eyes stronger powers for Fed

By Gillian Tett in London and Krishna Guha in Washington

Published: April 29 2008 23:23 | Last updated: April 29 2008 23:23

Meanwhile, data showed accelerating US house price declines and further declines in consumer confidence.

The Federal Reserve could use proposed new regulatory powers to try to stop credit and asset market excesses from reaching the point where they threaten economic stability, the US Treasury said on Tuesday.

David Nason, assistant secretary for financial institutions, said the Fed could even use its proposed “macro-prudential” authority to order banks, hedge funds and other entities to curtail strategies that put financial stability at risk.

By “leaning against the wind” in this way, the US central bank could “attempt to prevent broad economic dislocations caused by potential excesses”, he said.

His comments come amid debate inside the Fed as to whether it should try to do more to contain asset price bubbles, following the housing and dotcom busts. Some see enhanced regulatory powers as a better tool for this than interest rates.

The proposed new powers – outlined in a Treasury blueprint published last month – require legislation and may never be authorised. But policymakers see the plan as offering a template for future regulation.

The blueprint envisages giving the Fed roving authority to collect, analyse and publish market data from a wide range of institutions, from banks to hedge funds.

“The market stability regulator must have access to detailed information about all types of financial institutions,” said Mr Nason.

Hedge funds are uneasy about this proposal. However, many European central bankers are eager to acquire the kind of macro-prudential powers the Treasury would like to give to the Fed.

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The Bank of England has imposed a permanent news blackout on its £50bn-plus plan to ease the credit crunch.

Ferocious and unprecedented secrecy means taxpayers will never know the names of the banks that have been supported through the special liquidity scheme, which was unveiled by Bank Governor Mervyn King last week.

Requests under the Freedom of Information Act are to be denied. Details will be kept secret even after 30 years – the period after which all but the most sensitive state documents are released.

Any Bank of England employee leaking the names of institutions involved will face court action for breach of contract.

Even a figure for the overall amount advanced will not be published until October. Meanwhile the Bank is expected to issue at least £50bn of Treasury bills to banks in exchange for their mortgages – entirely in secret.

This hypersensitive official stance is thought to be a response to the events of last year when a huge stigma was attached to any lender suspected of going to the Bank for cash help.

The scheme is intended to steady the markets, but it is feared that reports of banks making widespread use of the facility could trigger further instability.

Barclays and HBoS have both confirmed they will use the Bank of England scheme. ‘We welcome the Bank facility and we will participate in it,’ confirmed Andy Hornby, chief executive of HBoS.

Other banks declined to comment, but it is expected that this week all of the leading banks, with the exception of Lloyds TSB, will tender some of their mortgages to the Bank of England.

HBoS confirmed last week it had packaged up £9bn of mortgages ready either for securitisation – in effect, selling them on in the wholesale financial markets – or to be offered to the Bank in return for Treasury bills.

The scheme, drawn up by King and approved by Chancellor Alistair Darling, aims to improve banks’ liquidity by temporarily swapping bundles of mortgages and credit card debt for Treasury bills, which are short-dated Government debt that matures within nine months.

The scheme will run for three years so these bills will be replaced by new ones when required.

Under the plan, bills will be exchanged only for securities rated triple-A – the highest possible grade of security – by at least two of the three big ratings agencies, Fitch, Moody’s and Standard & Poor’s.

It would not normally be considered acceptable for big companies to arrange billions of pounds of financial support without telling their shareholders.

But one source close to major institutional investors said: ‘I can see why there may be a case for secrecy.

‘It may be the lesser of two evils.’

The £50bn or more of Treasury bills involved will dwarf the £17.6bn currently in issue, but the authorities are adamant this will not destabilise the Government debt market.

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What would happen when non-government T-bill chumps figure out that they’re getting between negative 5 percent and negative 9 percent real interest on a 2-year Treasury note?

… In March, consumer prices rose 0.34 percent, for an annualized rate of more than 4 percent, according to the U.S. Department of Labor. That’s only slightly lower than the 2007 annual rate of 4.1 percent – which was the highest inflation rate this decade.

On the other hand, so-called core inflation – which excludes energy and food prices because they are considered volatile – rose only 0.15 percent, or 2.4 percent over the past year, which is close to the Federal Reserve’s 2 percent comfort zone.

For the Federal Reserve, the core inflation rate amounts to a green light to continue its policy of lowering interest rates in order to keep the economy from falling into a deep recession. A higher inflation rate could conceivably make the central bank freeze or raise interest rates.

But many economists say the core rate does not show how inflation is affecting the typical consumer. Because salary raises for most people are not keeping pace with the rising cost of living, people are using a greater percentage of their wages to buy a smaller amount of goods.

“Food prices and the price of gas are really eroding the purchasing power not just of the working class, but people in the middle class, who are already beginning to have a hard time making ends meet,” said business-trend consultant Joel Kotkin.

John Williams, who spent more than two decades as an economic consultant to Fortune 500 companies, said the government figures understate the true rate of inflation. …

I am getting a little tired of hearing about food inflation, by the way. I bet that a hedge fund got about 100 people to buy massive amounts of food at bulk wholesalers around the country, loaded them on a container for China, and sold the rice for a gigantic profit. The food inflation meme is getting deafening.

Having said that, there’s no doubt that the Fed’s inflation statistics are dripping with phoniness. “Core inflation” is a joke and everyone knows it.

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Gold stocks, more so.

This morning’s commercial EURUSD models showed a major dollar bias, which largely corrected itself today, greased by some more “we don’t like currency volatility!” hot air from ECB honcho Jean-Claude Juncker.

Meanwhile, the Treasury yield curve has steepened again. The difference between 30-year and 3-month Treasury rates widened by 9 bips today, to a very high 327 bps.

Private equity has $1 trillion of dry powder. China’s trade surplus, particularly the euro-denominated part, is still dilating. There is a lot of money sitting around that wants to move — into (credible) US equities, raw materials, and precious metals.

The P/E of Barrick has dropped to 33 (Goldcorp is at 60 ! — bad 1Q earnings for major miners from over-hedging).

Until there’s a run on the Chinese banking system, flow of funds from “funny money” (Treasuries, paper cash) isn’t going to slow down.

Before I lose myself in bullish pronouncements, how credible is official CPI when, after oil’s “real” adjusted high of $102, oil is kissing $120/barrel today — despite

  1. no second oil embargo (1979);
  2. no revolution in Iran (1979);
  3. no massive, public unrest quaking the foundations of the Saudi state (Grand Mosque of Mecca seizure, 1979); and
  4. no massive slowdown in Asia/ end to the commodities bull run is looming; therefore, the peak this time will probably well exceed even its $120 peak so far.

Yeah, there was no China then, but on the other hand, Russia also didn’t produce as much oil, world economies in general were much less oil-efficient, there were not as many viable substitutes for oil then as now, etc.

I think going short paper cash (Treasuries and eurobonds) and long inflation-protected cash (gold and silver) is the great one-way trade of the next five years, as I have said for months. Global savings glut in the East, global inflation glut for the West.

By the way, Ambrose Evans-Pritchard’s latest is mandatory reading.

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PARIS (MNI) – With eurozone HICP at a record high and inflation
risks on the horizon as far as the eye can see, the European Central
Bank’s Governing Council is stiffening its resolve as the defender of
price stability, even at a time of great uncertainty about economic
growth, well-informed monetary sources have told Market News

The ECB is still piloting the monetary aircraft in a thick fog as
inflation rises well above the bank’s comfort level and ongoing market
turmoil, accompanied by a sharp slowdown or recession in the United
States, clouds the view, these sources said.

But the thinking in Eurosystem monetary circles appears to have
shifted recently, as oil continues its steady rise and workers in
Germany win bigger-than-usual pay increases.

In recent months, as unabated turbulence roiled markets and the
U.S. economy slipped towards the abyss, many eurozone monetary
policy-makers saw price risks as an obstacle to cutting rates. Now, the
ascending view is that a lack of clarity over how sharply growth will
slow is what’s keeping the ECB from putting up rates.

“Nobody talks about an interest rate cut anymore,” said one source.
“It’s a wait-and-see policy, as it has been for awhile, but the bias has

That is not to say the ECB has formally returned to a tightening
bias. But there is an awareness that unless inflation behaves, the next
move could very conceivably be a rate hike — in contrast to market
expectations, albeit receding ones, for a cut.

“With inflation running at 3.6%, the ECB could be forced to tighten
monetary policy,” said one senior Eurosystem official. “This will depend
on whether inflationary pressures from oil and food price hikes create a
second round of increases in wages and consumer products.”

Another official put it more bluntly: “The fact is that if the
money markets can be stabilized, then rate hikes would have to be put
back on the agenda,” he said.

But such a move, if it comes at all, may still be a long way off.

The official who observed that “the bias has moved” also said,
“It’s difficult to see rates going up at the moment, with the financial
sector still weak and the U.S. maybe in recession. Higher rates here
will make it worse for financial institutions. They are still

He also noted that “there is already some tightening effect in the
markets,” given the strong euro and the rise in three- and six-month
rates, which are now well above 4.8% — more than 80 basis points north
of the ECB’s main policy rate.

The senior Eurosystem source made it clear that while perceptions
may have hardened with regard to inflation, no imminent action by the
ECB is likely because the economic picture is just too cloudy for now.

“The markets should not expect monetary policy changes during the
coming months, despite market and political pressures,” he said. “We are
in no position to make a medium-term assessment, since we are not fully
aware of the banking sector’s exposure to the financial market crisis.”

Therefore, policy is still finely balanced for now between two
conflicting pressures, he said. “The one is an interest rate increase
and the other is a rate cut. As a result, the Council has decided to
freeze any action and continue to inject the market with liquidity.”

Nonetheless, the more hawkish comments by MNI’s sources —
including that senior official — jibe with recent public remarks by
some members of the ECB Governing Council, who have resurrected the idea
of hiking rates in the face of what they see as an extremely worrisome
inflation picture.

In a newspaper interview published today, Luxembourg Central Bank
Governor Yves Mersch said the ECB staff would probably revise upward its
inflation forecasts for 2008 and 2009. Asked if this implied the ECB
would have to hike interest rates, he said the question was “entirely

Bundesbank President Axel Weber, expressing great alarm about
inflation developments, said Monday that the ECB must “decide whether
the current level of interest rates ensures the fulfillment of our
mission.” And Bank of Greece Governor Nicholas Garganas pointedly noted
on Friday that he had not ruled out a rate hike.

The only way the ECB can reconcile higher interest rates *and* pacify the hyperleveraged, debt-glutted Club Med, would be by swapping quality debt, Bernanke-style, for the banks’ asset-backed garbage, and subsidizing the Club Med/ Ireland banking sector commensurate with the size of those countries’ gargantuan trade deficits.

Italy will be the one to watch. We will soon see whether the fulcrum of Berlusconi’s coalition, Umberto Bossi’s anti-euro Lega Nord, can be bought off or not.

But at least the ECB is trying.

On another note, Bernanke is said to be heavily influenced by the work of Athanasios Orphanides, the chairman of the Bank of Cyprus, whose philosophy can be summarized as, “When there’s a recession, cut interest rates until interest-rate expectations begin to become unmoored.” By every indicator, including the laggardly consumer surveys, inflation expectations have become significantly unmoored. If there is any time for Bernanke to stun Wall St. and the commodities markets with a 25 basis-point rate hike, it would be on April 29-30. (Not that I think Bernanke will.)

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The Age (Aus.):

Justin Norrie, Tokyo

April 21, 2008

A 130% rise in the global cost of wheat in the past year, caused partly by surging demand from China and India and a huge injection of speculative funds into wheat futures, has forced the Government to hit flour millers with three rounds of stiff mark-ups. The latest — a 30% increase this month — has given rise to speculation that Japan, which relies on imports for 90% of its annual wheat consumption, is no longer on the brink of a food crisis, but has fallen off the cliff.

MARIKO Watanabe admits she could have chosen a better time to take up baking. This week, when the Tokyo housewife visited her local Ito-Yokado supermarket to buy butter to make a cake, she found the shelves bare.

“I went to another supermarket, and then another, and there was no butter at those either. Everywhere I went there were notices saying Japan has run out of butter. I couldn’t believe it — this is the first time in my life I’ve wanted to try baking cakes and I can’t get any butter,” said the frustrated cook.

Japan’s acute butter shortage, which has confounded bakeries, restaurants and now families across the country, is the latest unforeseen result of the global agricultural commodities crisis.

A sharp increase in the cost of imported cattle feed and a decline in milk imports, both of which are typically provided in large part by Australia, have prevented dairy farmers from keeping pace with demand.

While soaring food prices have triggered rioting among the starving millions of the third world, in wealthy Japan they have forced a pampered population to contemplate the shocking possibility of a long-term — perhaps permanent — reduction in the quality and quantity of its food. …

… Last week, as the prices of wheat and barley continued their relentless climb, the Japanese Government discovered it had exhausted its ¥230 billion ($A2.37 billion) budget for the grains with two months remaining. It was forced to call on an emergency ¥55 billion reserve to ensure it could continue feeding the nation.

“This was the first time the Government has had to take such drastic action since the war,” said Akio Shibata, an expert on food imports …

Biofuels companies are going to be destroyed by this. Agribusiness — especially anything having to do with genetically-modified food — will blast off. This isn’t going away in 2 quarters.

Thailand, one of the world’s biggest rice exporters, is only the latest country to be mauled by a massive drought.

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I have always thought that there’s something uniquely soporifying about DC that makes most who live there especially complacent and/or ignorant, kind of like the lead plumbing of many “established” Roman cities poisoned most urban dwellers into senility by age 55.

George Will, though, gets it. He has just enough of a flicker of cynicism for him to ask, “Hey, wait a second … what the hell is everybody doing, trusting the Federal Reserve?

What the Fed’s Job Isn’t

By George Will

Some say the world will end in fire,
Some say in ice. …

— Robert Frost

WASHINGTON — And some say it will end because of subprime mortgages. But for those who cultivate fears of catastrophes as excuses for expanding government supervision of other people’s lives, the bad news is that the world is not going to end — not from global warming or economic cooling or anything else. Today’s untethered Federal Reserve will, however, make the muddle-through interesting.

The late Sen. William Proxmire, a populist Democrat who represented Wisconsin for 32 years, wanted all members of Congress to write on their bathroom mirrors, so it is the first thing they read each day, this: “The Fed is a creature of Congress.” Congress created the Federal Reserve pursuant to its constitutional power “to coin money” and “regulate the value thereof.” Fortunately, Congress has left the Fed free to go about its business.

But suddenly the Fed is undergoing radical “mission creep.” The description of the Fed as the “lender of last resort” is accurate without being informative. Lender to whom? For what purposes? Last resort before what? Did the bank “lend” $29 billion to Bear Stearns, or did it, in effect, buy some of the most problematic securities owned by Bear? If so, was this faux “loan” actually to J.P. Morgan Chase? The purpose of the money was to give Morgan an incentive to buy Bear — at a price so low that an incentive should have been superfluous.

In 1979, when the government undertook to rescue Chrysler, conservatives worried not that the bailout would fail but that it would work, thereby inflaming government’s interventionist proclivities and lowering public resistance to future flights of Wall Street socialism. It “worked”: Chrysler has survived to endure its current crisis. The fallacious argument in 1979 was that Chrysler was then “too big to be allowed to fail.”

Today’s argument is that Bear Stearns was so connected to the financial system in opaque ways that no one could guess the radiating consequences of its failure — the financial consequences or, which sometimes is much the same thing, psychological.

But what is now the principle by which other distressed firms will elicit Fed interventions in future uncertainties? By what criteria does Washington henceforth determine whether a large entity is “too connected to fail”?

The Fed has no mandate to be the dealmaker for Wall Street socialism. The Fed’s mission is to preserve the currency as a store of value by preventing inflation. Its duty is not to avoid a recession at all costs; the way to get a big recession is to engage in frenzied improvisations because a small recession, aka a correction, is deemed intolerable. The Fed should not try to produce this or that rate of economic growth or unemployment.

After the tech bubble burst in 2000, the Fed opened the money spigot to lower interest rates and keep the economy humming. And since the bursting of the housing bubble, which was partly caused by that opened spigot, the Fed has again lowered interest rates, which for now are negative — lower than the inflation rate, which the open spigot will aggravate.

A surge of inflation might mean the end of the world as we have known it. Twenty-six percent of the $9.4 trillion of U.S. debt is held by foreigners. Suppose they construe Fed policy as serving an unspoken (and unspeakable) U.S. interest in increasing inflation, which would amount to the slow devaluation — partial repudiation — of the nation’s debts. If foreign holders of U.S. Treasury notes start to sell them, interest rates will have to spike to attract the foreign money that enables Americans to consume more than they produce.

Having maxed out many of their 1.4 billion credit cards, between 2001 and 2006 Americans tapped $1.2 trillion of their housing equity. Business Week reports that the middle-class debt-to-income ratio is now 141 percent, double that of 1983. Because anxiety is epidemic, bipartisanship has reared its supposedly pretty head.

Republicans and Democrats promise cooperation, compromise and general niceness using other people’s money. If Congress cannot suppress its itch to “do something” while markets are correcting the prices of housing and money, Congress could pass a law saying: No company benefiting from a substantial federal subvention (which would now include Morgan) may pay any executive more than the highest pay of a federal civil servant ($124,010). That would dampen Wall Street’s enthusiasm for measures that socialize losses while keeping profits private.

Too little too late.
I thought the figure was higher than twenty-six percent. The People’s Bank of China alone holds over $1.7 trillion, although a large and growing fraction of that is actually euros (I’d guess that about 80 percent of China’s stash — $$1.35trn or so — is in dollars.) Dubai’s aggregate holdings are also enormous, over $900bn. Japan holds over $900 billion. Russia holds over $500bn, although again a lot of that is euro-denominated. Vietnam holds $50bn. Taiwan holds, I think, $450bn. South Korea’s is about $250bn, going from a spotty memory. India, Germany and Brazil are surging.
There are other exporters like Singapore and HK batting above a quarter trillion in forex reserves, but their assets are significantly more diversified.
All in all, 26 percent of $9.4trn (about $2.3trn) sounds way too low.

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It’s almost as if the ECB wants Italy to quit the euro.

BERLIN (Reuters) – Wage and fiscal policy in the euro zone could buoy inflation and the European Central Bank may need to act, ECB Governing Council member Axel Weber said in a newspaper interview released on Saturday.

“I am concerned that, with regard to the conduct of wage and fiscal policy, the recent temporary heightened inflation rate could be consolidated for longer than is necessary above the tolerance level of the Eurosystem,” Weber said.

“Should indications of this increase, we must react with interest rate policy,” he added in an interview with Germany’s Welt am Sonntag. “We are therefore observing the current wage agreements and finance policy decisions very closely.”

The ECB has kept interest rates at 4 percent for the last 10 months while the U.S. Federal Reserve, the Bank of England and the Bank of Canada have cut their benchmark rates in the face of accelerating inflation and uncertainty about the impact of a global credit crisis on the world economy.

Another ECB Governing Council member, Austria’s Klaus Liebscher, told Reuters on Friday that no room exists to cut euro zone interest rates and rate rises could not be ruled out.

Weber told Welt am Sonntag: “Our primary goal is price stability.”

Surging energy and food prices pushed euro zone inflation to a new high of 3.6 percent in March, well above the ECB’s target of just below 2 percent.

“We must make sure that inflation expectations remain stable, and that the higher prices now do not lead to higher wages and salaries. Because that would inevitably start off a wage-price spiral,” Weber said.

Cultural attitudes towards default — and its stepchild, inflation — are deep-seated. Whenever the liquidity party runs out, currency unions in the past have erupted over differing attitudes towards debt. I believe the eurozone will see such a rupture.

Fundamentally Italy has too much debt, and too high a proportion of old people. France’s problems aren’t quite as acute, but Sarkozy has been agitating in the same direction.

In Europe, the only meaningful difference that I can tell between left and right lies in euro attitudes. Internationalist “leftists” are pro-euro, and nationalist/subsidiarist “rightists” despise it.

Most of Europe is now under nationalist control. Spain and Ireland are still ruled by “leftist” (pro-euro) parties, and their attitudes are viable only because Spain’s banks, and probably Ireland’s as well, are able to swap their mortgage-backed garbage for government bonds en masse.

ECB aid to Spanish banks matches Rock rescue

By Ambrose Evans-Pritchard, International Business Editor

Spanish banks are issuing mortgage securities and asset-backed bonds on a massive scale to park at the European Central Bank, using them as collateral to raise money at favourable rates from the official credit window in Frankfurt.

The rating agency Moody’s said lenders had issued a record €53bn (£39bn) in the fourth quarter, yet almost none of the securities have actually been placed on the open market. Most have been sent directly to the ECB for use in “repo” operations.

Eurozone CPI is not abating, despite a slowdown across much of the region, because the ECB is inflating via a mechanism separate from interest rates. As such, most eurozone economies are experiencing the early stages of stagflation, despite “high” nominal interest rates.

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More on JPMC

from Institutional Risk Analytics:

… On that same note, author Martin Mayer makes an interesting comment on the BSC debacle and leverage generally in this week’s issue of Barrons:

“In the OTC derivatives market, people who want to get out of their previous trades have to offset the obligations of that trade by creating a new instrument with a new counterparty. Take a credit-default swap, by which each party guarantees to accept the payout on a debt instrument held by the other party. It’s an insurance instrument, with some differences: The holder of the insured instrument can sell it, and the new owner becomes the beneficiary of the insurance. And the insurer may find someone who will accept a lower premium to take the burden of the insurance, allowing him to lay off his risk at an immediate profit. The one trade thus generates two new instruments, with four new counterparties, and as the daisy chain of reinsurance expands, the numbers become ridiculous: $41 trillion face value of credit-default swaps… Once you begin to remove individual flower girls from the daisy chain of credit swaps, you don’t know who will wind up with obligations they thought they had insured against and they can’t meet.”

For some months now, we’ve been pondering what happens to all of those net short credit default swap portfolios at dozens upon dozens of hedge funds that will be going out of business this year due to the Great Unwind. Hedge funds have no permanent capital, thus there are no assets available to support the defeasance of a book of net-short OTC derivatives positions should the fund be forced into involuntary liquidation.

In such a scenario, you can forget about netting; won’t be nothing left to net, in or out of bankruptcy. And since the old habit of simply writing more CDS contracts is not available once the fund starts liquidating, we wonder if leading CDS dealers like JPMorgan (NYSE:JPM) won’t be forced to take these trades back as hedge funds expire. What’s the “fair value” of a book of short OTC derivative positions taken by a dealer in payment of other debts?

Indeed, if you think of BSC not as a broker dealer, but instead as a clearing customer of JPM, then the logic of the acquisition makes perfect sense. JPM could not let BSC go into Chapter 11 because doing so might have started a chain reaction among the OTC derivative counterparties of both firms.

Between JPM, BSC and BSC’s customers there were three levels of leverage, making the ratio of Economic Capital to Tier One Risk Based Capital computed by The IRA Bank Monitor (4.7:1) for JPM at the top of the leverage pyramid seem entirely too generous! If you impute even a fraction of the downstream leverage residing with clearing customers to JPM, the giant bank’s capital shortfall becomes alarming.

A bank holding company, after all, is thinly capitalized and in many ways was the precursor of the hedge fund model. On a parent-only basis, JPM’s $314 billion asset balance sheet includes $200 billion representing investments in its subsidiary banks and non-bank units, supported by half as much equity and more than $200 billion in debt.

And remember that JPM’s on-balance sheet capital does not even partially support the counterparty risk of its vast OTC derivatives businesses, thus the BSC acquisition was a “must do” deal for Mr. Dimon. Think of it this way: JPM is essentially an uncapitalized, $76 trillion OTC derivatives exchange with a $1.3 trillion asset bank appendage. By the way, we are working to include factors for OBS securitizations in the next iteration of our Economic Capital simulation in The IRA Bank Monitor.

But you understand that Fed officials still believe, even today, that the US markets are not over-leveraged.

The story goes that shortly after Ben Bernanke was confirmed as Fed Chairman, he attended a dinner in New York attended by the heads of the major banks. All the big banksters were there. After dinner, Chairman Bernanke gave a speech and he at one point reportedly commented that the financial markets were “not very leveraged,” causing audible laughter from the audience.

According to one attendee, Lehman Brothers (NYSE:LEH) CEO Dick Fuld eventually spoke up and, while declaiming any intention to disagree with Chairman Bernanke publicly, told the newly minted Fed chief that his comments about the degree of leverage in the financial markets were mistaken. JPM CEO Jamie Dimon, who also attended the dinner, was reported to second Fuld’s comments.

I don’t agree with the larger points of the article at all (a long-winded argument against mark-to-market accounting). If an asset is “too illiquid” to mark to market, then it has no business being traded on a public market, and can only be traded in a “dark market” transaction (off-market, basically). What the hell is the point of having a public market if you can’t accept the posted numbers?

It’s only now, ex post, that the broker dealers think this is so unfair; yet they implicitly accepted the complexities of pricing when they traded these securities in public markets for years.

All that has been said ad nauseam by many people smarter than me. The question now is, we do have a huge collective inventory of product, which is now impossible to value since mutual trust between financial institutions has collapsed, as it should after an orgy of absurd over-valuations.

Should we maintain the old prices (which we know are too high), or let the chips fall where they may? There is no middle option, because any intervention will, by definition, err on the side of propping up inflated prices.

The answer is obvious.

We will never know whether or not Armageddon would have occurred, had the Fed not stepped in and bailed out JPMC/BSC.

What we do know is that Bear Stearns and JPMC were bailed out; the mortgage origination industry has been effectively nationalized via the FHLBs; the dollar demolished; the risk-free rate, defined as the rate on US Treasuries, has been permanently raised by MBS-Treasury convertibility. Finally, the nerve center of the credit default swaps market — financials CDS — have been effectively nationalized, defrauding everyone who prudently insured against catastrophe, so that a favored clique of broker-dealers who have already made these same mistakes many times before, could be bailed out yet again.

And this is some kind of capitalist country?

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The bailout of Bear Stearns was, in effect, a bailout of JPMorgan Chase.

Chase wrote the most credit default swaps of anyone. They also had by far the largest number of open but uncleared swaps (i.e., JPMC sells one side of the swap to a counterparty, but cannot spin off its own side — overwhelmingly, the “BSC will not default” side of the default-swap bet — because no market participants *wanted* credit default swaps). In other words they were a huge risk for JPMC.

Of course, (I think) nobody knows the exact distribution of swaps JPMC had regarding Bear Stearns. However, it’s almost certain that a preponderance of the credit default swaps were Bear Stearns swaps, considering how few people there were who would bet that Bear wouldn’t default.

And everyone on the other side of JPMC’s open, uncleared BSC credit default swaps was defrauded. They paid for default protection, and the unprecedented, extralegal, Fed-brokered absorption of BSC by JPMC defrauded all of those people.

Indirectly, everyone who purchased financial default swaps has been defrauded, because the Fed now accepts garbage for whatever you say its value is — as long as you’re one of the “sweet 16” broker dealers. None of the banks will ever go bankrupt, which means that all the private sector actors who saw BSC coming were defrauded, while JPM, the primary market maker of credit default swaps which greased the wheels with merry abandon, gets bailed out.

And the Fed’s “bailout,” in the form of exchanging AAA Treasuries for “AAA” (garbage) mortgage-backed securities, is a tax on everybody who was stupid enough to trust the “full faith and credit of the United States Treasury.”

The credit default swap market — the venue for private buying and selling of insurance against default — has been inflated out of existence, because its largest (financials) segment has been rendered too big to fail by a moronic/compliant Fed. What is all that default protection worth now? Nothing.

This dose of regulatory fascism (the invalidation of a tens of trillions of dollar market), has, by the way, been brought to you by the Republicans.

It’s always good to put the Greenspan – Rubin – Bernanke free-base, free-lunch, free market brand of capitalism in perspective: it’s a fraud.

Let’s just say that if Paulson or Bernanke or Jamie Dimon happened to be black, and walking out of a bank, he’d be shot dead on sight or handed 25 years in the slammer, for robbery (as well as aggravated assault with an assault weapon, etc).

(TOH to “mystery” for that lesson …)

Oh, by the way, this isn’t the first type of “screw the intelligent bears” move Bernanke has pulled. Remember the bogus “discount rate” cut that Bernanke announced half an hour before close of business last Friday? All those options purchased by all the intelligently bearish people were rendered worthless.

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Silvio Berlusconi’s election victory, a landslide by Italian standards, has major ramifications for the euro, warns Ambrose Evans-Pritchard:

Silvio Berlusconi’s return to power in Italy is a nightmare come true for the European Central Bank, opening the way for a Rome-Paris axis with the political muscle to force a change in monetary policy.

The billionaire politician has pledged an alliance with France’s Nicolas Sarkozy aimed at humbling the bank and asserting the primacy of elected leaders over interest rates and the currency.

“A very strong euro is hurting Italy’s economy. I will discuss intervening with the ECB with Sarkozy,” he said.

The threat brought a sharp retort yesterday from the ECB’s German governor and chief economist Jurgen Stark. “I would recommend to political leaders in Europe, newly elected and re-elected, to read the European law on the ECB,” he said.

Mr Berlusconi – who is setting up a temporary office in Naples to tackle the city’s long-running rubbish crisis – inherits an economy trapped in near slump conditions. The country has lost 40pc in unit labour cost competitiveness against Germany since 1995, largely due to anaemic productivity gains and an inflationary wage-bargaining culture. Yet it cannot use the old method of devaluation to claw back parity.

The International Monetary Fund forecasts growth of just 0.3pc in both 2008 and 2009, levels that are certain to cause a renewed rise in the country’s national debt. Italian car sales plunged 18.8pc in March, and the Alpine lender Credito Valtellinese has just become the first European bank in living memory to miss a redemption on a callable bond – raising concerns of deeper troubles brewing in Italy’s financial system.

Mr Sarkozy has repeatedly attacked the ECB’s tight money policies, blaming it for causing the euro to surge 27pc in two years to a record $1.59 against the dollar. He says the ECB risks bankrupting Airbus and driving much of Europe’s industry off-shore. Until now he has lacked the allies needed to impose his will.

“Politics is everything in EMU, and the re-election of Berlusconi represents a big shift in the political balance of power,” said Bernard Connolly, global strategist at Banque AIG. “Spain will probably join France and Italy before too long, so you will have three of the big four eurozone countries in the same camp.

They can set ‘broad guidelines’ for the ECB. It is a total misperception that the ECB should not be subject to political influence.”

Article 111 of the Nice Treaty gives politicians power to set a fixed exchange rate for the euro (by unanimous vote), or to shape the exchange rate (by qualified majority vote). This power gives EU ministers an indirect means to force the ECB to cut interest rates. The treaty article has never been invoked but it hovers in EU affairs like Banquo’s Ghost.

Mr Berlusconi does not share the EU-loyalities of the outgoing government. Ex-premier Romano Prodi was once the president of the European Commission, the public face of the euro. His finance minster Tommaso Padoa-Schioppa was a founder of Europe’s monetary union.

The last time Mr Berlusconi was in power, two ministers from his coalition partner ‘La Lega Nord’ called for a return to the lira to escape the constraints of the euro system. While he did not endorse the comments, he appeared to relish their effect on his enemies in Brussels and Frankfurt.

Berlusconi’s ally, Lega Nord (Northern League), gained about 8.6 points out of about 46 percent, meaning that they have approximately 20 percent of the votes in Berlusconi’s coalition, and hold the balance of power. Lega Nord is vociferously anti-euro.

I have said for months that the euro is incapable of absorbing global savings, and exporting its manufacturing base, to the extent that the United States has.

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“More, faster, please.” I don’t agree with every single sentence here, but by far the most important issue is Bernanke’s inflationist fundamentalism. Without further ado–

How Greenspan & Bernanke Invalidated Friedman
Monday, April 14, 2008 | 03:01 PM
in Credit | Derivatives | Economy | Politics

Hedge fund manager Scott Frew is a friend and occasional fishing partner. He had a few words to say about this morning’s discussion re: Volcker and Bernanke:

I wanted to flesh out some of what Barry wrote earlier about former and current Fed Chairs Volcker and Bernake. We must begin with Bernake’s now infamous Deflation speech. It is certainly “The Speech.” And I think in many ways it’s a terrifying document.

I am, by the way, in total agreement that Greenspan’s the guy who’s responsible for all of this; the particularly insidious quality of bubbles is that once you’re in one, the future is more or less pre-ordained.

An ironic corollary of that thought is that it pretty much invalidates the entire, mainstream (most certainly including Bernanke and Greeenspan), Milton Friedman-inspired critique/view of the Great Depression as having resulted from bad monetary policy on the part of the Fed as the bubble burst. They needed, according to that critique, to be much looser than they were, and all the problems would have been avoided.

So, in a sense, Bernanke’s an acolyte of that same church (recall him saying to Friedman, at some dinner or something honoring him, Never again; i.e., as a result of the lessons learned, taught by Friedman, the central bank would never repeat those Depression errors,), can’t fall back himself on a “It’s Greenspan’s fault” defense, because that’s antithetical to their whole view of history.

I see The Speech itself as a terrifying document, although it’s also an absolute blueprint for what’s going on today — you’ve got to give Ben credit for foresight; he’s running down the checklist he provided there, item by item, line by line. Too bad none of it’s working, at least to date, but instead is exacerbating the problems.

The other thing to do is to look at the steps along the way, including that represented by this speech, incidentally, by which Ben provided intellectual cover and backdrop for Greenspan’s moves.

The latter task is pretty simple. Let’s first note that Bernanke moved from the Fed, to become Chairman of the Bush’s Council of Economic Advisors, and then back to succeed Greenspan as Fed Chairman. There’s been lots of criticism of the Bush administration, on lots of fronts, for its politicization of many different policy arms. Certainly Greenspan has been criticized, and not just recently, for being an overly political creature, shifting his public statements about fiscal policy and taxation to fit the views of his changing political masters. And there’s been recent criticism that the Fed has come to view itself more as an adjunct member of the Bush cabinet, than in its traditional and prescribed role as an independent policy-making body. Bernanke’s career path exemplifies that sort of politicization, which ought to raise alarms on all sorts of level. Getting to more fundamental issues, he was at all moments a willing and eager accomplice to Greenspan’s rate-cutting efforts and asymmetrical policy responses, all of which engendered moral hazard in the DNA of the markets, and told speculators at every level not to worry, that the Fed had their collective backs. The “global savings glut” answer to Greenspan’s “conundrum” as to the explanation for low long term interest rates is a perfect example of Bernanke playing the geeky intellectual to Greenspan’s smoove political animal, providing an ingenious, and plausible, explanation for a phenomenon that had equally plausible, and far simpler, yet less convenient, explanations. Occam’s razor doesn’t always rule.

Back to the speech, early on Bernanke signals the asymmetrical policy response which characterized the Greenspan Fed from early on, and which has continued under Bernanke. The Congress has given the Fed the responsibility of preserving price stability (among other objectives), which most definitely implies avoiding deflation as well as inflation. I am confident that the Fed would take whatever means necessary to prevent significant deflation in the United States. Do you have any recollection of Ben suggesting, at any point, as the prices of a wide variety of goods and services, that middle class Americans purchase on a day to day basis, has skyrocketed, invoking Malcolm X in his willingness to use any means necessary to keep inflation under control? I sure don’t.

Then in the speech he starts talking about how to prevent deflation. The famous “technology, called a printing press” statement is a not-veiled at all threat to simply drive down the value of the dollar. Certainly one way to get people spending is to let them know in no uncertain terms that tomorrow their savings will be worth half of what they’re worth today. Ask any citizen of Harrar — it works for them. By increasing the number of U.S. dollars in circulation, or even by credibly threatening to do so, the U.S. government can also reduce the value of a dollar in terms of goods and services, which is equivalent to raising the prices in dollars of those goods and services. Bernanke’s been incredibly successful in this endeavor — just look at the price of oil, gold, wheat, milk, rice — the list goes on and on.

The speech runs through all of the other gambits that Bernanke’s been attempting over the last six or so months. At the end, he discusses the case of Japan, and why despite all these theoretical weapons in the Fed’s toolbox, Japan was unable to stave off deflationary forces. He starts that section of the speech by noting significant differences between Japan and the United States — recall that this was November, 2002:

“As you know, Japan’s economy faces some significant barriers to growth besides deflation, including massive financial problems in the banking and corporate sectors and a large overhang of government debt. Plausibly, private-sector financial problems have muted the effects of the monetary policies that have been tried in Japan, even as the heavy overhang of government debt has made Japanese policymakers more reluctant to use aggressive fiscal policies (for evidence see, for example, Posen, 1998). Fortunately, the U.S. economy does not share these problems, at least not to anything like the same degree, suggesting that anti-deflationary monetary and fiscal policies would be more potent here than they have been in Japan.”

Uh, Dr. Bernanke, I’m not sure you had that quite right, or that the conditions than applicable pertain today. In fact, it appears that our situation today is worse than Japan’s in those respects. The one factor in our favor is that exorbitant privilege of having the reserve currency, of being able to pay off our debt in a currency which only we can print. As Jim Grant said in a recent essay, there’s only one nation that has that ability, and it’s national pastime is baseball. But the advantage of owning the reserve currency is a blessing easily abused. In terms of what our national balance sheet looks like, it seems easy to describe it as more curse than blessing. Bernanke has often seemed blind to the fact that our monetary policy has far-reaching implications, that riots over inflation in the Gulf Cooperative Countries, over food in Egypt and the Philippines, might be connected to our interest rates and the value of the dollar.

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I will let the idiocy speak for itself.

The Inflation Solution to the Housing Mess

April 14, 2008; Page A15

The policy alternatives in the post-housing-bubble world are painfully unpleasant. In my view, the least bad option is for the Federal Reserve to print money to help stabilize housing prices and financial markets. Yes, use reflation to soften the pain for Main Street and Wall Street. If instead we let housing prices fall another 25%-30% – as predicted by the Case-Shiller Home Price Index – it’s almost certain that Washington will end up nationalizing the mortgage business.

So far, the Fed’s lending programs have not provided adequate liquidity to financial markets: Reserves supplied to the banking system have grown at a tiny 0.6% annual rate since December. That’s because the reserves the Fed is injecting by lending are effectively pulled out or “sterilized” by its sales of Treasury securities. The Fed has been selling these securities to keep the fed funds rate at the level targeted by its Federal Open Market Committee directives.

Congress and the Treasury have proposed voluntary measures to help mortgage borrowers, but the impact on mortgage availability has been nil. As average house prices plummet – declining at a 23% annual rate over the three months ending in January – lenders are sharply curtailing access to mortgage-based, home-equity loans. The 15% of U.S. mortgage holders with negative equity in their homes have no access to credit, and 20% with marginal equity have limited access at best. Overall access to credit is contracting: Ask Americans trying to utilize home-equity lines or arrange student loans.

Meanwhile, the collapse of house prices and the attendant damage to credit markets have become so severe that the Fed has been forced to create new policy measures at a fast clip, including the radical decision to take $30 billion worth of Bear Stearns’ risky mortgages onto its own balance sheet, and to open the discount window to investment banks.

The bottom line is this: The Fed could have watched a run on investment banks quickly turn into a run on commercial banks, or protected the creditors of investment banks (like the depositors of commercial banks) at the expense of Bear Stearns’ shareholders. The Fed wisely chose the second alternative.

Still, the Fed’s intervention has done no more than buy a respite from the crisis in the financial markets. The monetary easing I’m recommending can occur by having the Fed print money to purchase mortgages directly, or purchase Treasury securities directly. The latter is probably more desirable because it adds higher-quality assets to the Fed’s balance sheet. The Bank of Japan was also forced to reflate by printing money in 2001, after two years of a zero interest-rate policy failed to lift the economy out of a prolonged recession that had moved Japan to the brink of a deflationary crisis.

Fed reflation – to slow the fall in home prices and alleviate the distress for households and lenders – carries many risks. But the alternative is to struggle with a patchwork of inadequate efforts to shore up mortgage markets, while the Fed sticks to its current tactic of pegging the fed funds rate without increasing the money supply. This, I would submit, is even more risky. It risks a severe recession that will only intensify the drive for reregulation of financial and mortgage markets after the election.

Printing money is a radical step that enables the Fed to stop pegging the federal-funds rate and start increasing market liquidity directly. In any event, there is substantial evidence that the fed funds rate has been well above the equilibrium level. One piece of evidence is the accelerating deterioration in credit markets and the real economy that ensued even while the Fed cut the rate. Even more compelling, consider the sharp widening of the gap between the fed funds rate and the yield on three-month Treasury bills.

That gap, usually close to zero, measures the intensity of demand for riskless assets relative to the Fed’s target rate in the interbank market. At the time of the Bear Stearns crisis on March 16, the fed funds rate was an extraordinary 250 basis points above yields on three-month Treasurys. This corresponded to a “10 sigma,” or ten-times-the-typical deviation from the mean event. Statistically, 2 or 3 sigma is a very unusual event suggesting, in this case, an unusually strong preference for riskless T-bills. Four or 5 sigma represents a serious risky event, and 10 sigma is an outright panic. Based on this gap criterion, the August 2007 crisis onset was a 5-sigma event, while the October 1998 LTCM crisis and the 1987 stock market crash were each 4-sigma events. This suggests that even at those earlier times of crisis there was less fear as expressed by a run into riskless Treasurys. Ominously, after dipping close to 5 sigma after the Bear Stearns crisis, the gap has crept back above 6 sigma.

The Fed should announce its intention to add to its holding of Treasury securities in order to provide additional liquidity. It should cease pegging the fed funds rate while this policy is in effect. While there is no guarantee, direct injection of money holds some promise of alleviating the worst of the credit crisis. This means that, after the election, Congress will not feel justified in nationalizing mortgage markets.

While there is a substantial risk that inflation may rise for a time – this would be the policy goal – monetization is more easily reversible than nationalization of the mortgage market. Meanwhile, Fed officials concerned about inflation should rethink their view that it is impossible to identify an asset bubble before it bursts.

The postbubble period has yielded some very unattractive policy alternatives. They clearly underscore the rationale for having the Fed target asset prices – in a world where asset markets affect the real economy more than the real economy affects asset markets.

Mr. Makin is a visiting scholar at the American Enterprise Institute.

The fact that the so-called conservatives (really, Bruce Kovner and KKR shills) at AEI are the chief advocates of quantitative easing, and the demolition of the dollar, is 75% of the explanation for why so many die-hard, cynical, pasty-white conservatives will be sitting out November.

What could be worse than validating the policy of the Bernanke/Paulson regime.

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As reported by The Wall Street Journal, one of the more remote contingencies the Federal Reserve has considered is a mirror image of the Term Securities Lending Facility: it would take the mortgage backed securities pledged to it by dealers in return for Treasurys; then repledge them to other dealers, taking Treasurys back. Since the Fed is highly unlikely to fail, dealers might be more comfortable accepting MBS as collateral from the Fed than from other parties. But this might be complicated to do if the MBS are held by a custodial bank as is typical in a triparty repo.

Lou Crandall of Wrightson Associates thinks it’s cool idea. His thoughts:

I’ve been discounting the inflated Treasury borrowing option a little bit because the traditional legal view at Treasury has been that the Secretary’s borrowing authority only extends to financing Congressional appropriations. (They cited legal objections last summer when they were urged to pump up their borrowing and put the money back into the [Treasury Tax and Loan] system last summer as a way of providing support.) Running a banking business is frowned upon. I don’t doubt that [Treasury Secretary Henry] Paulson could persuade the Treasury’s lawyers to rethink their position if absolutely necessary, but it would be a lot cleaner to go to Congress for authority to create a larger warehouse for financial instruments.

The reverse swap is intriguing because it is sufficiently exotic that it might sidestep some of the traditional legal issues. My hat is off to whoever thought of it. That is one option that hadn’t occurred to me.

After a quick first reading, it sounds to me as if the idea would be to take the triparty collateral and put it back into the market with a Fed seal of approval. The curious thing about recent repo market disruptions is that counterparties have started caring more about the counterparty than the collateral because nobody wants to be caught up in the uncertainty of a bankruptcy. If the Fed were on the other side, the counterparty risk component would fade away in an MBS repo. [LOL, no sh*t–ed] That’s so creative/outside-the-box that I hesitate to simply assume that’s what the Fed is talking about.

The Fed could provide guarantees in the financing market that would substantially expand its balance sheet resources through the equivalent of a matched-book operation. With sufficient leverage, they could revalidate a huge range of privately-financed mortgage debt. I’m not sure they should or could legally, but it is really interesting and worth chewing over.

For what it’s worth, I really do think this is an idea that would be worth pursuing if the Fed were faced with an emergency need to provide funding through the discount window. …

Conclusion one: Never hire “Wrightston Associates” for anything. This guy is a complete moron.

Conclusion two: The Fed believes that the best way to “solve” this mess is to do the exact same thing that the banks did — put its own name behind an obligation that is fundamentally worthless.

That’s what got us into this mess into the first place.

The only reason the Fed’s guarantee is any better than a private bank’s is that the Fed has the power to create money.

So it will be perceived to be committing to create money in the future, even if no actual money-creating takes place in terms of the Treasuries and MBS on the balance sheet.

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