Shot across the bow from the Fed

Well, well, well, for all those who thought the Fed was going to eat those losses? Remember what I said, "The Fed is not a charity and serves only itself!"

NEW YORK (Reuters) - An agreement with the U.S. Treasury to swap Treasury bonds for non-government debt on the Federal Reserve's balance sheet could help the central bank unwind its extraordinary credit-easing policies, a top Fed official said on Friday.

The move would also help draw a clearer distinction between monetary and fiscal policy to ensure the Fed's independence does not come under attack, Philadelphia Federal Reserve Bank President Charles Plosser said in remarks prepared for delivery to a forum on monetary policy.

"The current crisis and the Fed's interventions have dramatically altered the composition of the assets on our balance sheet and created confusion in the minds of many as to the respective roles of the central bank and the fiscal authority," Plosser said.

The U.S. central bank's balance sheet has more than doubled to around $2 trillion as it pumped hundreds of billions of dollars into key credit markets. It has bought assets that it would not usually hold on its balance sheet, including agency debt and agency mortgage-backed securities.

An agreement with the Treasury to switch U.S. government bonds for these less-liquid non-traditional assets on the Fed's balance sheet would help the central bank focus on conducting traditional monetary policy.

"With Treasuries back on the balance sheet, the Fed will be able to drain reserves in a timely fashion with minimal concerns about disrupting particular credit allocations or the pressures from special interests," said Plosser, who is not a voting member on the Fed's policy-setting committee this year.

He said such an agreement would transfer funding of the credit programs to the Treasury, "thus ensuring that credit policies that place taxpayer funds at risks are under oversight of the fiscal authority.

"Second, it would return control of the Fed's balance sheet to the Fed, so that we can continue to conduct independent monetary policy," he said.

Plosser said it is important for the Fed to articulate a clear exit strategy from its credit policies and anticipate that political pressures could make it more difficult to shrink its balance sheet quickly enough when the time comes.

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Ahh ha! The Fed will now pass the garbage can onto J6P shoulder's directly! This announcement is not only a reminder that almost everyone in the US is basically a serf, but also that soon, and i mean SOON, the Fed will start retrenching.

You think the Fed will let the dollar get destroyed? I've been waiting VERY patiently for something like this to come out, and NOW is the time to begin timing a 10 year treasury short. As a TOTAL amateur in treasury trading, I will admit I'm out of my league, but the MOMENT the Fed starts retrenching its B/S, it means that credit spreads will begin to widen again.

aka a market crash

And then, my friends, we reach maximum fear, and this is where the "insurance" premiums of treasury will reach their maximum.

You think the Fed is your friend? The Fed had to keep the Ox alive another day to plow the field, but this tired beast will get the flesh flayed off of it in the process. Oxen have very low standards and are content with watching the possums mate in the evening. Buddha would be impressed.

Think of the Fed as your medieval overlord: Obscurantist, intractable, and utterly obdurate.

Bank Recapitalization plan and North Korea

This post will concern two things: recapitalizing US banks and the recent agitation by NK against their southern cousins.

First, let's start with the banks.

It's important to realize that the current plan supposedly considered consists of the government drawing a fat, black line across the capital structure of every afflicted American bank and saying, "We do not retreat past this point." The mechanics, I suspect, will be a massive investment in convertible preferred stock that will, upon loss milestones, convert into common shares.

For those expecting significant common equity upside in the big banks from this plan, I'm afraid this plan won't bring it: the beneficiary will be senior and sub debt holders, who happen to be other banks. That means the random bank that isn't totally underwater and owns a lot of C and BAC sen/sub debt will get a huge capital gains kick if this plan goes into action.

Think about it: common shareholders are jerks like you and I and crappy funds. Those are all zeros, and we know it. The government must, if it's serious about this plan, protect bondholders at all cost. This inevitable creates massive dilution potential, and so even though TECHNICALLY there isn't another 80% of shares O/S after the government deal, the analysts will realize that given the risk of a seemingly inevitable dilution, common equity shares demand a far lower bid than the currently seek, even now.

HOWEVER, there is some potential for upside: if sen/sub debt is protected, all other banks that own sen/sub debt of other banks will get CAPITAL GAINS on the holdings of other bank debt. To expect these capital gains to countervail portfolio losses and suspended dividends is naive, but that's not the point: the point is to get the banks on life-support.

PROTECT THE DEBT: That's the objective here: forestall further deterioration of the portfolios of those institutions owning bank debt. If we don't backstop bank debt, then we have to recapitalize entirely NEW AND DISTINCT DI's, which means losses in DI's ramifying across the globe. Perhaps it's too odious for us to imagine the pain that would cause, hence .gov's reluctance, or perhaps it's just cronyism as usual... I do not know.

Topic 2: North Korea

North Korea is one thing and one thing only: a release valve for China. Hillary is trying to strong-arm the Chinese into buying more crappy US debt, and so China unleashed the hounds to chase her away. Perhaps the threats are a cover for an otherwise humiliating deal made by the Chinese, but North Korea is definitely in a tough spot, and I would not put anything past them, especially if the US is squeezing the current regime quite hard.

North Korea allows China to, in a true crisis, punish the US severely by attacking South Korea and Japan, which would compel the US to react and further stretch her already straitened resources, especially the US national debt.

It's a dangerous game of chicken. Keep an eye out for North Korea!

Emerging markets and capital

All you need to do is look at the FX tables: every currency is falling against the dollar, and even the yen is starting to budge (after much intervention). This is, of course, the usual deleveraging coupled with sovereign debt credit downgrades.

The Fed now has $389B of swap lines established around the world. This is a great benefit to those nations friendly with the Fed that need dollars. It also shackles the Fed to various corpses around the world, and imbues the Fed with an interest in reviving global economic growth - at any cost.

The Fed would not issue swap lines without some help from its old friend, the BoJ. What, then, is the BoJ doing to make sure the Fed doesn't totally lose its ass? The BoJ lends to the IMF, of course!

Quote:

"This loan of $100 billion is the biggest loan ever in the history of mankind," he said, adding that he hopes other countries will follow suit by contributing to the IMF.

Nakagawa said, "I hope this can be put to good use very quickly." He said that given the global crisis, it is important that the IMF play a major role in dealing with it.

The loan, announced by Prime Minister Taro Aso in November, will help the IMF shore up its financial standing and help continue lending.

The IMF has been trying to double its lending ability to about $500 billion to boost confidence so it can handle any future borrowers amid the deepening financial crisis, in addition to recent borrowers, such as Pakistan, Iceland and some Eastern European countries.

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While China commits reserves to secure natual resources, Japan seeks to move capital (cheaply) to emerging markets so Japan can EXPORT to someone.

Japan's economic model demands exports. Capital deployed to emerging markets can quickly affect local markets, as they're thinner and less liquid than mature markets, and so the RoC improves. However, then one has a new problem: whom does the emerging market export to? Japan? US? Trade deficits? Other LDC's?

This is the tricky part, and you have to manage both capital (IMF) and trade (WTO) between the G-7(8) . History shows that in every case of an economic prisoner's dilemma, all players cheat. Hence, in order for an order to maintain, some player has to create a unilateral order in the game.

I personally think Japan is trying to front-run the Chinese in securing markets: in exchange for IMF financing, perhaps the receiving nation will abide a trade policy that excludes chinese products or favors Japanese products more.

In any case, this is far, far from charity. It may also be a model for future interventions, in which case, equity indices in emerging markets will prove an extremely lucrative investment(just keep out of russia!).

China and Medicare

The stimulus bill has a provision for a new, national medical database. Ostensibly, the purpose of this database is to reduce "waste" in the medical industry.

The real objective is obvious: to cut benefits to those on public health insurance. Since the expected number of people on medicare is expected to explode and costs already imperil the national budget, any meaningful injection of foreign capital will require retrenchment of US domestic "pork", and the fattest pig in the room is the bloated government-subsidized medical industry.

This is an important datum, though, and here's why: it indicates that the government DOES intend to make the US more credit-worthy in the future. While the US will be afflicted by the cost of recapitalizing its DI's, foreign creditors may find that meaningful cuts in entitlement spending and, eventually, military spending will satisfy them.

It all goes back to cost of funds - the cost of sovereign debt percolates throughout the economy, and if it is not contained, the US will drive away both investment and trade. Expect further cuts to be announced in the future.

Thought nursing homes were a safe haven? Consider them warehouses for the dying, now: we have mortgages to cramdown!

TALF

Let's talk about TALF:

TALF is a band-aid. TALF is a substitute for DI's. TALF is the secondary market.

The reason TALF exists should make ANYONE long common bank stocks shit themselves: TALF exists because banks CAN NOT lend at reasonable rates AND maintain reserves for deposit liabilities. The term for this situation is, "insolvent".

TALF incentives private capital to buy risky assets with minimal risk and high leverage, allowing an almost risk-free RoC of 6-14%. There is fine print, though, to contend with, and I will delve into that in a later post.

What I think is important to understand is that the very EXISTENCE of TALF implies that the money markets and banking system as a whole IS BROKEN! TALF seeks to turn hedge funds into banks rather than speculative pools of capital. TALF seeks to reduce cost of funds for businesses etc and even bid up the value of ABX/CMBX securities.

Finally, TALF will let assets sit SOMEWHERE OTHER THAN THE FED so when the banks are recapitalized, the Fed doesn't have to take the risk of auctioning off assets that may have deterioriated even more in value.

Never forget that the Fed is not a charity. The Fed is also not your friend - it serves itself.

Deglobalisation

In a previous entry, I tried to explain in detail the myth of globalisation, and how this globalisation was nothing else than a cheat for extracting unsustainable corporate profits and hide the inefficiencies and losses behind distorted trade imbalances.

It seems the system is now in agony, and like in the Madoff investment scheme the losses cannot be hidden anymore.

There is an excellent piece in FT, written by Gideon Rachman on the subject of Globalisation-in-Reverse at Davos. Here is a short quote:

But this year the forum has had to confront a new phenomenon – deglobalisation. The world that Davos Man created is slipping into reverse. International trade and investment is falling and protectionist barriers are on the rise. Economies are shrinking and unemployment is growing.

The symptoms of deglobalisation are all around us. Last week, it was reported that global air cargo traffic in December 2008 was down 22.6 per cent compared with December 2007. Abhisit Vejjajiva, prime minister of Thailand, told the forum that tourist receipts in his country had fallen by about 20 per cent year-on-year, in line with the general decline in international travel (and stripping out the effects of the temporary closure of Bangkok airport). In the US and Europe, governments are scrambling to bail out not just banks but also car companies. But, as the European Union has long acknowledged, “state aid” to national industrial champions is a form of protectionism.

Then there is “financial mercantilism”, the talk of this year’s Davos. This is the growing pressure on banks and financial institutions to retreat from international business and concentrate on domestic markets. Trevor Manuel, South Africa’s finance minister, captured the fears of many when he warned that his country and other emerging markets were in danger of being crowded out of international capital markets and of “decoupling, derailment and abandonment”.

Financial protectionism is driven by the logic of the market and political pressure. Banks that have lost confidence and capital in the credit crunch are retreating to the home markets they know best. And because so many banks have been bailed out by national taxpayers, they are also coming under political pressure to lend at home rather than abroad

In the context of deglobalisation it is really funny to watch the blame game of who was at fault: the developed deficit countries which engaged in creative financial engineering or the surplus emerging market economies which engaged in creative protectionist and monetary engineering?

My answer is that it always take two to tango and as in any game there are always winners and losers. This time the losers are countries and the winners are corporations.

The next stage will be the surprise of learning how much each country lost in this deceiving economic game of musical chairs and who was swimming naked. For that we just need a change of tide.

Adam Yamaguchi made an interesting little documentary about the economy of Tinian. I believe the clip is foretelling. This what mercantilist emerging economies will face when the false competitive advantages offered by globalisation are gone.

http://current.com/users/Adam_Yamaguchi/all/0.htm

I believe Adam Yamaguchi is wrong with his conclusion that Saipan represents the future of US. I believe it represents a time compressed version of what will happen with China's manufacturing provinces.

The big question is how will we get out of this post-globalisation crisis....

Will it be through a global financial Coup de Grace?

Coup de Grace

We all feel it coming... the Fed's "slosh" tightens, the trade indices continue to collapse. Riots emerging in non-indebted countries: Russia, China, Iran.

Putin knew that the preserve sovereignty, he had to extinguish Russia's foreign debt, and he did that successfully. Putin tragically overlooked the flaw in his method: he depended entirely on foreign consumption... consumption created by fractional reserve banking where 90% of the money was backed by loans made into bubble, both foreign and domestic.

The Chinese, likewise, fell exactly into the same trap. Ditto Iran, which barely merits mentioning since Iran is an utterly emasculated state.


What I am trying to emphasize here is that the situation right now is actually quite simple, contrary to the obfuscation declaimed by various academics and other tortoise-mutilating analysts: we are witnessing an epic contraction in credit, and without NEW credit from a NEW issuer, there is NO way the current economic order will avoid collapse.

China and Russia are the two key sovereigns outside The Club. Why are they outside The Club? Because they have pretensions of sovereignty! The labor of China and the resources of Russia are still not under the control of the Fed nor the IMF. Why did Obama have a "buy american" clause in his infrastructure bill? Well, of course, it was meant to punish the Chinese! The US will starve China of markets and become highly mercantalist SO LONG as it suits the interests of the Fed and IMF to further weaken the Chinese economy and foment a dependency on foreign credit to finance domestic consumption.

Russia and China suffer the same problem, and neither really have any prospects for autarky or financing without going through the NY Fed or the IMF. The Chinese still continue to grope for a larger stake in the IMF, but this protracted battle will only exacerbate the depression.

The options are clear:

1) a global bank issues new debt to every nation, approtioned according to its "expected" GNP and power, and reignites the flow of capital flows.

2) War, and I am not being glib here. We are on a path to war, and it will happen with metaphysical certainty if China and Russia resist subordinating themselves to the new debt-issuing authority that will soon be contrived.

There's no need to waste time on esoteric economics: this is all about power, and so let's focus on the politics at hand: can the Chinese and Russians find a way to forestall #1? The answer, I think, is not without #2.