The Fed Throws A Spit Ball

As the American Lost Decade(s) unfold, the Federal Reserve’s options to influence economic output dwindle. Today, the Fed confirmed the economic horizon will remain bleak. It also announced it would sell $400 billion of its near dated Treasuries and buy longer maturity ones. In a nut shell, Bernanke is trying to keep today’s free money and ‘bend’ the long term interest rates lower. The move (like earlier QE2) will have little impact in real economic output. The markets understandably aren’t impressed and fell on the grim forecast:

The Fed will replace some shorter-term debt in its portfolio with longer-term Treasuries in an effort to further reduce borrowing costs and keep the economy from relapsing into a recession, confirming market speculation that policy makers were planning an “Operation Twist” similar to a program in 1961.

“Markets took note of the Fed’s downward revision of the economic outlook and upgrading of downside financial risks,” Mohamed A. El-Erian, chief executive officer at Pacific Investment Management Co. in Newport Beach, California, wrote in an e-mail. Pimco is the world’s largest bond-fund manager. “While Fed purchases can influence Treasury and mortgage valuations, it is limited in its ability to deliver economic outcomesz” . . .

The Fed also said today it will reinvest maturing housing debt into mortgage-backed securities instead of Treasuries. “The mortgage story is the most important part,” said William Larkin, a fixed-income money manager who helps oversee $500 million at Cabot Money Management Inc. in Salem, Massachusetts. “This goes right to the source. This will create a wave of refinancings on the mortgage side.”

In short, the Fed’s move will not impact the real economy but might have some impact on artificial economic activity like re-financing, although that market segment is not infinitely elastic — i.e., many have already re-financed and now weigh the costs (aggravation as well as real) versus marginal benefit. Naked Capitalism also notes the flattening long term rate will undercut the basic business model of the banking system as a whole.

Dollar Daze

It’s only a matter of time before the U.S. loses the dollar as the global reserve currency. Inertia helps us. As do the tatters of the goodwill since Bretton Woods, the Nixon shocks and Reagan deficits notwithstanding. We should prepare for it. So far, we aren’t.

To call this weekend’s dollar slide an international conspiracy and attack is dramatic. But it did happen. And for the first time, finance ministers and markets are talking about a transition date, the admittedly nebulous 2018 summoned out of the air apparently in a thinly sourced column.

When it happens Americans will be stunned anyway. ‘How does it feeeeeeel’ indeed. For the new, less psychologically subservient Japanese government, the Chinese, Germans, and the Arabs, the time to wish for American fiscal sanity is long past. Russians and other emergent or disruptive powers are also interested in exploring this American weakness. Finessing a joint move from the dollar to either a new currency or so-called ‘basket’ we all know must be done gingerly. The U.S. today has our creditors in a mutual suicide pact. So today’s Asian move to shore the greenback makes sense. Have to keep the junkie afloat and calm to allow a graceful get away and freedom.

Dollar Daze Are Here Again, I Said It's Alright, You Know It's Alright

Chinese comments at G-20 and elsewhere make their strategy clear in long term goals while opaque in actual enactment. Contrary to Simon Johnson’s bald claim that a sliding dollar is Obama’s ‘Secret Weapon’ to keep the House in 2010, no one in or out of government believes that existing, locked-in U.S. federal and trade deficits can be addressed in even trivial terms by U.S.-led export growth. That’s part of the problem when a society gives up making things. But you can see why the Dali Lama got dumped on Nancy Pelosi this week in D.C.

Who could blame those holding either dollars or IOUs from the Treasury? When they look at the U.S. economy in basic input output terms and manner the U.S. addressed 2008 and budgets going forward, its pretty easy to conclude the U.S. political system will fall to the lowest common denominator/easy way out: inflate our way out of debt. In earlier years when U.S. capitalism was more than financial engineering the U.S. would make the same call – from our private sector leadership to government officials.

Whether it is 2018, who knows. Frankly, no one whether in Beijing, Moscow, Riyadh, Tokyo or Frankfurt can tell us when. But anyone there who tells you that they are committed to the dollar as international reserve currency also lies when they say ‘hello’.

The Oval Office Behind The Curtains

You have been talking to the Doctor !  Explain ! Explain !

The immediate granular reactions to Obama’s budget, such as its ‘honesty’, education, EPA, armed forces personnel expansion, tax cuts, etc. are all important. We agree with the Center Left that the stimulus and budget are unlikely to generate the economic growth underpinning the budget’s out year projections. They are not audacious enough.

Geithner’s tepid approach to the banking crisis is probably a more revealing insight into the Administration’s psyche than the budget. He’s an odd pollyanna. His ‘worst case’ scenario of a 3.3% economic decline this year and flat 2010 followed by growth can only be a political prism divorced from economic reality. 2008 Q4’s over 6% decline merely highlights this.

AIG is on the precipice of tripartite tear down. CitiGroup and Bank of America/Merrill Lynch are insolvent as we speak for all practical purposes. Paul Volker correctly observed recently ‘some banks are too big to fail exist.’ The Administration’s expected increased government position in Citi is best seen as a band aid.

The Obama Administration is not nearly as honest as it needs to be. The banking/financial situation is far more important for future national expenditure possibilities than a budget. Which makes Geithner’s dithering on bank capitalization, ‘to nationalize or not dare use that word’ etc. all the more bizarre.

Our macro take despite the stakes is meh. Assuming American historical luck holds and we navigate a soft landing for banks and Obama’s budget is even 20% close to reality we believe American capacity for subsequent austerity to sustain deficit reduction is zero. American debt service obligations will be crippling by any objective standard. If the depression takes hold speed things up.

Sound American strategic foreign policy planning should begin to anticipate the existing and soon to explode ends means gap and adjust accordingly. Obama’s success or failure will only attenuate the timeline a bit.

Savor The Moments

It’s maybe worth reminding ourselves that events in late 2008 prove there are more things in finance and geopolitics, Keith Olbermann, than are dreamt of in your ‘philosophy’. Paulson flings $600 billion more in fictional Fed money at the already sloppy financial wall this morning on top of Team Boy King’s unsubtle floating of a $500-700 billion ‘stimulus’ plan yesterday. The delusions continue apace.

The Boy King (perhaps wisely in the short term, but definitely foolishly in the medium) avoids two crushing truths. First, he and the American people are no longer masters in their own house. A future sustainable American standard of living based on a real economy will require a 25-30% reduction in consumption across the board. No matter what is said at a press conference. There is and will be no ‘return’ to a ‘stable’ economy as invoked circa 2003. That jenga block got knocked over by self absorbed boomers long ago.

Blue Screen Of Death

Second, hyper inflation is now all but unavoidable. The printing presses are running non stop. This is not the first time a Great Power debased its currency to paper over inconvenient truths. Yet history also teaches such expedient measures always fail and boomerang in the medium term. Already we see signs from erstwhile pillars of the dollar economy like the Bank of Japan balk at holding the giant hand grenade for Joe the Plumber let alone the Masters of the Universe. Imagine. They want the U.S. Treasury to issue bonds in foreign currency like, say the Yen. (This defeats the whole printing press thing, those fiendishly clever Japanese!)

Hyper inflation will not appear immediately. But will sooner than the voices whispering in Andrea Mitchell’s ear (at work *and* and home) can admit. The only immediate response Team Boy King can be expected to do for political – not economic reasons – is wage and price controls. You betcha.

Americans again forget history. Economies and sinews of economic productive activities do not sprout in a day, a quarter or even a year. Once the residue of the false, bubble and fraudulent finance economy is exposed and scraped away then what?

The quaint contempt Americans have for actual labor is on blatant display with the disparate reactions to and money poured on knowingly fraudulent banks versus millions of Americans who just happen to work for or depend on incompetent bosses in Detroit.

But let’s move past all that. What exactly are 20, 30 and 40 somethings with MBAs to do? They’ve known nothing but punching Excel spreadsheets and practicing their professional equivalent of phone sex on conference calls day after day swapping CDOs? What are they supposed to do the next day? Build cars? Bend steel in New York sewers? What do real estate brokers (ex house husbands or house wives) do now that they realize with a shock that $220,000 for doing literally nothing but driving people around to houses with a chipper smile is not a career? Pour concrete rebuilding I-95? This new reality is A Big Deal (and probably will not be recognized as such until Tom Friedman writes a book and gets it wrong again to boot). To quote Yul Brenner, ‘Et cetera, et cetera . . .’

Perhaps not days of wine and roses. But these few days should be savored nonetheless. A hard rain’s gonna fall.

Ashes In The Maelstrom

The IMF purports to be optimistic after the U.S. and U.K. acted to nationalize banks through direct capital injections. True, Paulson did not intend this even a week ago. But rather than excoriate him for improvising we applaud the flexibility. The question many might ask is why would a direct capitalization overcome fear of lending contra say Fed rate cuts and the open discount window.

Time outpaces ideology or statutes. We were skeptical Paulson could stand up and run auctions in ‘weeks’. We worked with the FCC and industry setting up and implementing the first ever spectrum auctions in the early 1990s and those that followed. Even skipping Reed Hundt and Blair Levin’s Gore-esque GOSPLAN regulatory mania for a down and dirty bare bones gig in 2008, those spectrum auctions each had a defined homogenous res (a specific band of frequencies) compared to current unknowable facility’s toxicity, etc. Even a reverse auction to function must have *some* kind of uniform or at least common baseline, however attenuated. That is simple auction theory 101.


Some comparable statistics of other economic declines are sobering and possibly reassuring:

The average downturn after recent banking crises in rich countries lasted four years as banks retrenched and debt-laden households and firms were forced to save more. This time firms are in relatively good shape, but households, particularly in Britain and America, have piled up unprecedented debts. And because the asset and credit bubbles formed in many countries simultaneously, the hangover this time may well be worse.

But history teaches an important lesson: that big banking crises are ultimately solved by throwing in large dollops of public money, and that early and decisive government action, whether to recapitalise banks or take on troubled debts, can minimise the cost to the taxpayer and the damage to the economy. For example, Sweden quickly took over its failed banks after a property bust in the early 1990s and recovered relatively fast. By contrast, Japan took a decade to recover from a financial bust that ultimately cost its taxpayers a sum equivalent to 24% of GDP.

All in all, America’s government has put some 7% of GDP on the line, a vast amount of money but well below the 16% of GDP that the average systemic banking crisis (if there is such a thing) ultimately costs the public purse. Just how America’s proposed Troubled Asset Relief Programme (TARP) will work is still unclear. The Treasury plans to buy huge amounts of distressed debt using a reverse auction process, where banks offer to sell at a price and the government buys from the lowest price upwards. The complexities of thousands of different mortgage-backed assets will make this hard. If direct bank recapitalisation is still needed, the Treasury can do that too. The main point is that America is prepared to act, and act decisively.

All of which leads to the real issue: What Comes After. As The Economist notes “If foreigners ever flee the dollar, America will face the twin nightmares that haunt emerging countries in a financial collapse: simultaneous banking and currency crises. America’s debts, unlike those in many emerging economies, are denominated in its own currency, but a collapse of the dollar would still be a catastrophe.”

The American ability to inflate our way out of our own stupidity is a short term Sword of Damocles over the IMF meeting this weekend in Washington and among the EU leadership. We agreed with Spengler before in an earlier post — Asian and European alternative capital architectures are not yet in place. It is, however, just a matter of time.

The Warlord destroyed the ‘American’ brand across the board. Centuries of brand equity squandered in front of a connected global audience. It will not be coming back by chanting ‘Yes we can’. Footsteps away with the whisper ‘Never again’ will dictate events.

In two debates both the Boy King and McCain avoided answering how this crisis constrained their options. Perhaps it is good politics to deny that the United States is a bankrupt hegemon. Even so, neither of them shows the necessary leadership to prepare the American people for the real hardship to come: life as a debtor nation in a post U.S. global financial system.

Over To You, Beijing, Riyadh, Kuwait And UAE (Updated)

Fine, who’s going to pay for it? We’re still skeptical the U.S. can sucker punch them yet again for a cash infusion. Particularly now since the Warlord’s tenure puts an exclamation point on “The Unipolar Power Has No Clothes” across all measures of influence, perceptions of power and status (even Scalia is not entertaining abroad).

International observers from Frankfurt to Tokyo observe that the U.S. on its own no longer can afford to pay for projects of this scale. Not anymore. Not without outside help.

Curmudgeon in the comments here noted a good point — T-bills paradoxically are more attractive now with the collapse of commercial paper. And at least verbiage from the Bank of Japan today confirms that they are holding so much in U.S. assets that they too are *in the short term* compelled to intervene and lend actual dollars. If Tokyo is in this position, one can only imagine the conversations in Beijing. Where the skepticism comes is after the short term measures are taken.

Save the Wall Streeters, Save the World (apologies NBC)

Whatever entity the Paulson Posse ™ creates (New Thing) will have to dispose of staggeringly huge, assumed toxic instruments or eat them. We remain in agreement with sentiments in Frankfurt and elsewhere that at this point, the U.S. simply no longer is in a position to do so on its own. Optimistic structural concepts for New Thing are thinking about tapping ‘only’ $250 billion in private money (which is unlikely if it couldn’t or wouldn’t save AIG or Lehman) or foreign sovereign funds. If only it were ‘only’.

We’re amused (in a sardonic way) to see how the campaigns flail about on this issue. McCain’s flip flops are already the stuff of immediate talking head legend. So too to see the Left rapturously pointing to the Boy King’s tete-a-tete avec Larry Summers, Bob Rubin and others who led the charge in the late 1990s to repeal the Depression Era’s Glass Steagall Act. As you know, dear reader, had the law remained intact, with its provision to separate banks, investment banks, etc. much of this cross-sector mutual pull down would not be happening. Observant commentators also note “Mr. Andrea Mitchell’s” finger prints, too. (Love that moniker).

Still, it’s nice to see that the Chairman of the Senate Banking Committee is taking notice:

As Senator Christopher J. Dodd, Democrat of Connecticut and chairman of the Banking, Housing and Urban Affairs Committee, put it Friday morning on the ABC program “Good Morning America,” the congressional leaders were told “that we’re literally maybe days away from a complete meltdown of our financial system, with all the implications here at home and globally.”

Mr. Schumer added, “History was sort of hanging over it, like this was a moment.”

When Mr. Schumer described the meeting as “somber,” Mr. Dodd cut in. “Somber doesn’t begin to justify the words,” he said. “We have never heard language like this.”

‘Somber’. They used to say the most dangerous place in Washington, D.C. was between Chuck Schumer and a microphone. Thank goodness Dodd heeded Dan Rather’s old sign off and showed ‘courage’ to step into that very harrowing gap.


And for your amusement, herewith a pen given to the Stiftung by the General Counsel of a major AIG component company — after we signed a joint venture agreement. (Assisted by a famous lawyer known to everyone from his White House Monica Lewinsky days).

It’s actually much nicer than a Bic. Not sure how many $85 billion will save. Maybe we will see if we can make a piece of toast with the AIG logo. And add the pen, too, for eBay . . .

How The Mighty Have . . .

Job No. 1 — Juxtapose

New York Crisis reveals real center of American power.

Interesting, no – even as juxtaposition. Although, like Shanghai, we too have always felt NYC was far more important to Amerikuh than the city built on a swamp. So when the City faces a full blown crisis, we take it seriously. U.S. strength despite the Military and History Channels’ (sometimes remarkably inaccurate) porn always has been our economic resources: today in tatters. What makes this case even more problematic than Bear Stearns is the government’s role in encouraging activities through the implicit non-guarantee guarantee.

We’re comforted tonight. The Man Child Who Will Bring Change agrees that “there is little doubt” the country is in a recession. How Clinton-esque, the parsing, so that the Crowned One can always fall back on the technical definitions of how many quarters of negative growth overall are required. Perhaps like re Iraq he can hold a second press conference. This time, big signs, a nice speech and a good grin won’t change “facts on the ground.” Or overcome mental whining.

No one can use the dreaded “b” word — bail out — yet, but it is exactly what is happening Monday, congressional approval a formality. After all, what are 435 members of a castrated Duma supposed to do when Reality drops its cloak and pulls its dagger? Midnight Rambler, indeed.

Don’t you feel like bystanders watching another slo mo accident? Is the American political system even capable anymore of strategic thought? Beyond lurching from crisis to crisis? Beyond tax cuts to this decimal place for this demographic. Beyond just energy. We can’t blame Neocons for our failure (and it is ours, collectively); Rumsfeld didn’t screw this up.

The U.S. Shanghai Two Step Crash And Burn

Easy for academics (including Bernanke) to criticize roundly the Japanese handling of their post 1989 bubble economy. Papers published, tenure locked in. Yet what exactly is learned? And its practical application?

Almost non-existent regulation of both Fannie Mae and Freddie Mac? Check. Almost non-existent regulation of derivatives and roll back of Wall Street ‘Chinese Walls’ between banking and investment banking? Check. Agit Prop from Movement types bleating to repeal the odious tedium of requiring exalted CEOs to sign declarations that they actually have read and understand company financials offered to the markets? Check. We even put eunuchs in at the SEC (Chris Cox) — and have no doubt, a Democrat Congress is as complicit now along with the Warlord’s feeble end.

The Prophet should not take all the skepticism. McCain is worse. We’ve only met Phil Gramm personally in his office a couple of times on the Hill. To us he is as out there as you guess. So we never did and never will take him personally seriously (in the Senate he was, however, a real “Force” by virtue of his mere presence and vote). We did find his wife intellectually interesting the few times we crossed paths. McCain’s problems go deeper. Did anyone else watch Carly Fiorina, Mcain’s other ‘economic advisor’ twitch on today’s moribund Press The Meat? How uncomfortable to watch someone alternate between stand up and pathos. (Someone needs to whisper in Carly’s ear that to express interest in the Veepship on national TV is a death knell). To all of them, we say “Well here is what you’re going to eat on Monday, Dearest Virginia”:

US taxpayers are about to find out what their long-standing and (strictly speaking) non-existent guarantee of Fannie Mae and Freddie Mac will cost them. One way to think of it is this: take the US national debt of roughly $9,000bn and add $5,000bn. Not bad for an obligation still officially denied.

In the end, that astounding prospect might be the outcome. Partial or outright nationalisation of the housing lenders – colossal pseudo-private entities that own and underwrite US housing loans – would add some or all of their $5,000bn (€3,144bn, £2,513bn) in liabilities to the government’s balance sheet. While it is true that the agencies (unlike the government) own housing-related assets that roughly match those liabilities, the still-collapsing housing market makes this a lot less reassuring than one could wish.

In some cosmic Jungian juxtapose, for 10 days next month we will see China proclaim her place on the global multimedia stage. Symbolism beyond mortal planning. True, Beijing is their Moscow to the Russian/Soviet Leningrad (see supra ). Also true that air there makes Los Angeles Aspen. But in the end, does it matter? What speaks louder today? LA smog or China’s staggering liquidity? The future is made real in their architecture, physical infrastructure and deft geopolitical expansion. Oh, and cash. By contrast, forget our crumbling infrastructure. We can’t even create a single building after 7 years (if you know what we mean).

What do the American crisis, Chinese Olympics and American analytical entrepreneurs have in common? Those still peddling Neocon conspiracies against Iran barely cling to an Israeli exercise and Photoshop. They should think about all of the above and take off their blinkers. A war with Iran? One must ask that famous question, paraphrased — “yeah you and whose finances [army]?” First, the U.S. military; it is no shape to wage war against Iran. Not going to happen. Absent a near term cataclysmic event. Beyond generational burnout of hardware in Iraq and personnel replenishment, the imminent procurement crisis still creeps up. Juggling those amazing costs, a new American president must then still manage an economy edging precariously close to a whirlpool. From that spring all national power flows. A tanking economy, two failing wars abroad *and* launch a third against Iran? Analytical shots of absinthe until the eyes bleed. But it makes good copy.

Imagine this scenario. The U.S. domestic situation somehow sua sponte “stabilizes”. We still won’t go to war against Iran. We can’t afford another unilateral expeditionary activity as they like to say. (We may not realize it yet, but it is true). Perhaps by 2015 — as the Marines wargamed — per earlier posts. Things may change human and real capital wise. But in the meantime? We are paper tigers to revive a Maoist slogan. At best we slink in as lowly mercenaries, fighting on another’s dime (Euro). The bottom of the barrel? Be like the Brits after 1940, fighting on charity. And who exactly has their wallets open?

We do concede one recent error. We thought human capital requirements would force major American troop drawdowns from Iraq around April-May. Recent announcements of larger returns to CONUS this Fall while late were inevitable. Even so, the idea that large portions of American troops simply will move to Afghanistan misses the point. Leaked studies estimating a drawdown to about 50,000 in Iraq makes sense for an initial — and only initial — bureaucratic ante. Iran? Puhlease.

Still, no reason for the Summertime Blues. Unlike some others we don’t have to take dog off the menu. Even our creditors are pre-occupied — building the future is not a stroll in the park, doncha know. How interesting in the background to watch breakthroughs as a EU Middle Eastern summit unfolds.

Strike a pose. There’s nothing to it. Juxtapose.