Which Way The Wind Blows

Americans by and large long ago ceased understanding the economic underpinnings of their soft empire and its benefits. The most committed generally followed the Dow Jones number as an overall barometer while working out or eating dinner (not realizing that for that insufficient purpose the S&P is better but still limited). The Dow is a Delphic utterance from the vague auguries of ‘Wall Street’ across the land because it just branded itself more successfully.

When Cheney said defiantly “Deficits don’t matter!” he may have well been speaking for NASCAR Dads, Safety Moms, Firearm Uncles and Waterboarding Aunts everywhere. Yet even Americans cocooned within their mammoth, dry walled Great Rooms watching re-runs on Chinese consumer electronics know that something is wrong. Beyond the writers’ strike. Oil near $100. That, they get is bad. The big heads on TV tell them that much. The ARM resets on their mortgages they know are very bad — they get the bill. And while they wait for the popcorn to come out of the microwave before the commercial break ends for “Dancing With The Stars”, they also sorta kinda get that a lower dollar didn’t result in more American manufacturing and manufacturing exports. Even they dimly understand that Americans as a people no longer make things. We are well on the way to becoming the direct-mail society — sending each other direct-mail (or email, or social invites to web pages) for a fee.

All of which is to say that this item in the Financial Times is perhaps a wake up call. If Citicorp and Merrill Lynch are estimating that Wall Street will have to write off an additional $64 billion in bad money, we could be seeing the beginning of a massive asset self off. The $64 billion write off by itself essentially means the end of the so-called private sector rescue fund that was the talk of the Street just last month. The commercial and investment banks simply won’t have the dough to do it. (Citi says now it itself may have write off almost $11 bn, and Merrill’s write off will reach $10.2 bn). You remember the heady days of October 2007, just last month? Then the confident predictions were that the private sector could handle the ‘soft landing’ by joining together and pooling reserve funds. And that was just one of two proposed pools — for the large institutional investors. Another fund would be set up to take care of the smaller player, including the Man on the Street.

Not gonna happen now. The banks’ problems will soon become the American people’s problem. Moreover, this may still be the tip of the iceberg. As the initial meltdown at Merrill makes clear, the investment in derivative facilities 2007 remains what it was in 1998 when Long Term Capital Management collapsed. Even now, such instruments are largely so arcane and contingent on so many inputs that even the physicists who design them still have difficulty fully understanding all the permutations. Let alone, say, Stanley O’Neil, the CEO of Merrill Lynch — and he just resigned before the losses were said to now reach over $10 billion. We mentioned shades of 1998 once again. To be fair, it is somewhat different — here it is reckless forays into subprime lending via so-called collateralized debt obligations (CDOs), combined with oil shocks and dollar depreciation. All creating a perfect storm.

The Stiftung expects continued (and ineffective) interest rate cuts by the Fed. Accordingly, the dollar depreciation will continue, creating an increasingly intolerable overhang abroad. Absent a clear and immediate U.S. plan to address the situation, it is almost inevitable that the dollar will cease to be the global reserve currency and we will witness a growing flight to other currencies, not only the Euro. The impact on American standard of living will be fairly immediate. A significant (and rapid) asset sell off would also undermine the American global strategic position as well. Thus would the Warlord’s calamitous tenure see not only the collapse of the American 1945-2001 soft empire, but his preening and hollow ‘self righteous Empire’ as well. His ultimate legacy? A mistrust of government, incompetence, erosion of Rule of Law, and a devastated American economy under the gray cloud of stagflation. The good news? For his Rangers and his newly bloated Plutocratic elite? They may escape with a minor flesh wound. ‘Tis but a scratch.’

They used to say that us humans would do well to watch the nature around us for signs of disaster. Birds, animals and the shoreline all send us signals if we would only listen. So it is now. Gisele Bundschen, famous runway artist, wants her contract in Euros.

It doesn’t have to end this way, of course. And rarely do complex probability waves collapse into such a narrowly contrived certainty. Yet we can not help but think that without a captain until 2009, those probability waves are going to wreak havoc on this rudderless ship.