Friends and Foes

France was Germany's #1 trading partner before World War II.

Riots out of nowhere, invectives against reserve currencies and trade regimes, internet attacks, missile tests... the insiders are dumping their shares, so to speak.

Condoms in Combat

Often in war, soldiers are issued condoms. The naive ones become excited, thinking they can use it in the conventional sense with some dusky, nubile native.

Unfortunately, the vets know that the condoms are issued to protect their rifle, not their "gun".

Likewise, greenies are all excited about Obama's energy conservation plan: they think it's about saving the world.

In fact, it's a strategy to prepare the US for a severe energy shock when the dollar gets properly devalued. Part of the reason the 70's proved so brutal was the sensitivity of the energy-intensive US economy to the price of oil. By taxing carbon and creating a mandate to reduce energy consumption, the US can lessen the blow upon J6P's purchasing power after the necessary monetary stimulus keeps the Republic from imploding.

Namely, a house that uses half the energy to heat during HDD's and cars that get 45 mpg will make $100 oil tolerable. With poorly insulated homes and crappy GM clunkers getting 12 mpg, J6P is reduced to an even more pathetic state of penury than he already endures.

At least, that's how a jaded cynic like I am look at it...

Back to North Korea...

This will be a flaky post, but since the US is officially a banana republic, I see no reason to sweat economics anymore.

I told all of you to watch North Korea a few months ago: it's the perfect Sino-US tension indicator.

That indicator is flashing, "red" now.

As someone who personally invests in projects that are often bought-out by the Chinese, I can confidently say that someone very powerful has decided that Obama will NOT defend the purchasing power of the USD. Note that I said, "Obama", not Bernanke: Bernanke is clearly being maligned and pressured to play along with .gov's Printing Push.

I never considered Bernanke an "inflationary" fella: he's actually quite stingy with the punch. This doesn't comport well with a socialist administration that has to appeal to an insolvent and savings-free electorate (you see where I'm going with this?)

I know the Fed Giveth and Taketh Liquidity, but with the Messiah, the alternative may be a putsch at the FRBNY...

Shop till you drop

“So far, purchases of Treasuries have not resulted in lower rates, and it may be likely that the volume of purchases to accomplish that would be sufficiently large that the balance sheet might have to explode even more, further exacerbating the exit-strategy problem,” said Robert Eisenbeis, chief monetary economist at Cumberland Advisors Inc. and a former research director at the Atlanta Fed.

Once again, the Fed has dissimulated its intention by feigning incompetence or impotence: I claim that the Fed sought, through the Treasury buy-back, to merely buy time for greater fools to suck the beta out of key DI's and the Fed itself.

I am pretty lazy, but I think it's time to defer to some data to substantiate this:










































Last I checked, losing $40B in liquidity is... deflationary. Are we then surprised at all that commodities this week were under pressure? The Fed is going long duration/credit and offloading risky assets, with substantial progress to make in meeting its supposed Agency purchase commitments.

In other words, the Fed is reloading. The interim periods between Fed pumps and the attendent tankage of Treasuries are known as, "rallies". Without a Fed pump to prime liquidity, we should see a quick bout of healthy deflation before Obama's stimulus comes to fore, helping purge some of the speculative excesses from the market that ultimately tax the economy (ahem, oil speculators) and move capital into markets that help restore the consumer's wealth (cheaper mortgages).

However, you can not allow a deflation, however brief, without creating another Minsky moment unless DI's, especially key DI's, are understood to be well-capitalized and clear of crap... a bank holding crap into a deflation is a disaster, but a bank holding treasuries into a deflation...

A very Clever Article, and on the Virtues of Poverty

As we speak, the yield curve is getting savaged(many smart folks figure the 10yr yielding 4% is irrelevant: I tend to agree there, so long as NIM persists), and many are fretting about the State's ability to finance huge deficits into a recession. Of course, there is plenty of wealth to redistribute, but to do declare a crusade without a mandate from the Church is just bad cricket.

This clever article gave reminded me that, yes folks, this is just another, "managed crisis":

Sorry, Larry Summers. It’s looking more and more likely that you’re going to be stuck in the West Wing for the duration.

See, if your boss fails to reappoint Ben Bernanke as Federal Reserve chairman come January, it would be a public betrayal worthy of the television reality show “Survivor.” For President Obama has no greater ally: Bernanke is truly the gift that keeps on giving.

The latest evidence came on Wednesday during Bernanke’s testimony before the House Budget Committee. The Fed chairman offered a stern warning about America’s huge budget deficits.

“Maintaining the confidence of the financial markets requires that we, as a nation, begin planning now for the restoration of fiscal balance,” Bernanke said.

Tough, but hardly atypical Fedspeak.

Then Bernanke went a step further. He gave significant credence to the view that the recent rise in long-term Treasury yields and mortgage rates was caused by deficit jitters:

“These increases appear to reflect concerns about large federal deficits but also other causes, including greater optimism about the economic outlook, a reversal of flight-to-quality flows, and technical factors related to the hedging of mortgage holdings.”

Bingo! We have Fed confirmation: those inflation-hating “bond vigilantes” have time warped to 2009 from 1994 and are hot on the hunt for countries that can’t manage their finances.

Now when talk about the return of the bond vigilantes got louder last week, some were quick to declare it bad news for Obamanomics.

Rising rates, the theory goes, could force the White House to trim its future spending plans and return more quickly to a sustainable fiscal path. So long, universal healthcare. Bye-bye, green investments. And Bernanke playing deficit hawk only adds to that momentum, right?

Not really. Chatter about budget deficits and fiscal responsibility is exactly what Team Obama needs right now.

Here’s why: If you buy the theory of bond vigilantism — that credit markets will force interest rates higher in reaction to unsustainable national budget deficits — then you also have believe the White House needs to raise taxes sharply to pay for all its spending programs or risk a bond revolt.

Indeed, plenty of White House staffers, particularly if they worked for Bill Clinton, probably do believe in the theory. It was Clinton, after all, who chucked his investment agenda in favor of a “bond market strategy” to boost growth by persuading credit markets that the administration would balance the books.

As Clinton nicely boiled it down, “You mean to tell me that the success of the program and my re-election hinges on the Federal Reserve and a bunch of [expletive] bond traders?”

Now Obama has no intention of following a Clintonesque bond market strategy. Rates are already low. He just needs them to stay there until the economy recovers. And he also needs more tax revenue to pay for healthcare reform, alternative energy investments and his other investment priorities.

Maybe even a carbon tax to keep gas prices high enough so consumers will want to buy General Motors’ pricey electric vehicle, Volt.

Unfortunately for the White House, there are few signs that Americans want to pay higher taxes, especially during a recession that has eviscerated their net worth even if they have stayed employed. California voters, for instance, just voted down their state’s efforts to raise taxes to close a yawning budget deficit.

Yet the recent experience on the national level is that gigantic budget deficits often lead to higher taxes. That was true in 1982, 1990 and 1993. So if Team Obama wants a value-added tax, higher payroll taxes to fix Social Security or higher incomes taxes on wealthier American, it needs Americans to start fretting more about America’s fiscal condition.

Bernanke’s sharp warning contributed to that effort. So not only has Bernanke’s unprecedented monetary stimulus allowed Obama to focus on pushing forward his policy agenda rather than a pure stimulus effort (such as a temporary suspension of payroll taxes), but the weight of his authority is now being used to help persuade Americans that the budget deficit is the Next Scary Problem.

In short, Bernanke is effectively preparing the battlefield for Obama tax initiatives to pay for Obamacare and who knows what else. What more could a Fed chairman do for a president?

http://blogs.reuters.com/great-debate/2009/06/04/bernankes-deficit-warning-he lps-obama/#comments


Now, onto the Virtues of Poverty:

Because the US is such a dire debtor, it only makes sense that she needs to retrench hard and dig herself out of her hole. There are 4 ways to sort this out:

1) Higher taxes: no inflation, no debt
2) bond sales: no inlation, but debt
3) fiat money: inflation, no debt
4) bank credit: inflation, debt

The above are the main tools in the Fed's/.gov's arsenal. So far, we have used #2 and #3 extensively, and their sustainability has been questioned. Now, it is time for #1, to allow for further stimulus spending to, inshallah, permit #4, often associated with "economic growth".

The truth is, US consumers will have to export more than they import, and this implies US consumers will pay more for a given good than their export market would. Thus, by suppressing US demand by impoverishing its consumers, the US government can slowly rebuild the foreign exchange reserves in the country, just like china did after Deng Xiaoping's reforms. The process, though, requires free access to markets, and here's the sticky wicket for all the rosy prognostications for the future.

2010 is going to be grim.

general update

I've been out for a while, looking for a job for myself. Needless to say, while I've seen some "green shoots" with respect to interview interest from prospective employers, closing the deal has proven elusive.

In any case, here we are: a grossly over-valued market, hyper speculation in commodities, and a suitably positive yet most likely ephemeral reaction to higher price levels and a papered-over credit market.

The key issue remains, and still remains, trade. Inflation, deflation, credit markets: these are academic issues now. The real, solid, blood and guts is in TRADE.

What, then are the general trade themes we can see going forward? Many countries still have huge agricultural deficits: Iran, for example, could be crushed if the US or other wheat exporter decided to withhold a few million tons. China's agriculture is notoriously compromised after 3k years of deforestation and freshly polluted water. China continues to cultivate a strategic relationship with Brazil, not only for oil, but for food.

The problem is, ultimately, all these countries are competitors, not peers. They enjoy domestic wealth when they can import for less and export for more, and they hoard other people's wealth when they import for more and export for less. The real question, then, is how will these buckets of wealth and debt balance out through 2009 and into 2010? 2010 will clearly be a... grim year for the global economy, as nations continue to churn through bad debt and rising cost of funds.

Resolving the trade issue is key, now. This dictates not only whether or not global trade completely seizes-up, but also how sustainable the recent injection of capital into the US remains.

So far, the tea leaves do not look very promising. I hope readers can share anecdotes of the horse-trading going on at the IMF/WTO etc.

Price levels, stock markets, and All That

Anyone who's seen the recent market rally, be it credit, equity, or in the commodity space, must appreciate that they are on the receiving end the Fed's QE bat.

The argument from the Fed is simple: imbue people with inflation expectations, and they will pull demand from the future, stimulating production now: You buy the car today if you know it'll cost more tomorrow, etc.

However, nothing in Fedland is ever simple: while they seek to pull demand, they also can't compromise the treasury market. The US gov is facing record deficits, and huge interest payments under the magic of continuously compounding interest will only exacerbate the economic crisis.

And so we are torn: the real downside for pulling future demand is an exorbitant cost of capital for the US government. Considering the need for stimulus, wars, and entitlement programs, it stands to reason that inflation expectations will be necessarily curbed by government finances. Furthermore, the recent market rally has allowed key players to raise necessary capital to cover their short-term obligations, and so near-term solvency has been established.

Here's a theory on what will happen: the Fed will actually start pulling liquidity from the market, correcting the equity market and giving strength to Treasuries again. The media will blame unemployment, but the wise amongst us realize it's because the money tap will have been turned off - for a moment. Once .gov has filled her coffers with relatively cheap debt, the Fed can QE accordingly to keep the market plodding along, all the while propping up inflation and hence growth expectations.

I would not be surprised at all to see positive Q4 GDP numbers... especially if price levels rise substantially!