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Old 18-03-2009, 14:27   #1
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The Black Swan (part two)

Last July, I started a thread I called The Black Swan wherein I relayed the news that a hedge fund (Bridgewater Associates) had informed its clients that bank credit losses would be orders-of-magnitude greater than previously forecast. The attached commentary from Ambrose Evans-Pritchard in the Telegraph (London) posited that the enormous losses could well-lead to the nationalization of banks, inasmuch as governments, alone, had the wherewithal to save the financial system from such staggering losses.

I had considered adding this post onto that old thread, but it seems to me that it deserves to stand alone.

So what is The Black Swan (part two)?

Today, after the close of the futures markets in the New York session, the Fed announced that it would be "buying" an additional $1trillion in longer-term government debt ". . . in order to revive the economy." That this took the markets by surprise is an understatement. A quick glance at charts for Treasuries and Gold tell the story in an instant: The T-bond yield chart looks like it stepped into an open manhole, while the gold chart looks like a rocket launch.

Just as last July's item (combined with the news, then, of the effective nationalizations of Fannie Mae and Freddie Mac, the government-sponsored mortgage entities) was a very significant milestone on the journey into the financial unknown, today's news is no less stunning. Its significance cannot be over-stated.

It has been said that when a central bank opts to purchase its own country's debt, thereby monetizing it (incredibly inflationary), one could find certain similarities to a retailer buying his own inventory to make the sales reports look healthy - not exactly a brilliant business model. There is only one reason that it would be necessary for the Fed (the US central bank) to do this: All of the offshore buying of US government debt combined is insufficient to cover the current account deficit.

Here's a link to the New York Times report on this breaking story:

http://www.nytimes.com/2009/03/19/bu...d.html?_r=1&hp

So what? Well, the Fed has just told you that the purchasing power of the American dollar is going to shrink, probably significantly. It will take more and more American paper dollars to buy everything in future - food, energy, shelter and, yes, cruising vessels and the cruising lifestyle. The good news, if the Fed's intervention works, is that credit markets may thaw and people can once again yoke themselves to their "consumables."

TaoJones
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Old 18-03-2009, 15:33   #2
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I am posting an excerpt from Taipan Daily from Friday the 13th. The context is the gold market, but the analysis is spot on (pun intended). To continue with the analogy, Godzilla may be on his way...

The Fed Has Not Gone Crazy Yet
Most of you by now have seen the monetary chart that looks like a hockey stick, showing the huge quantity of reserves the Fed has pumped into the system. We’ve also talked about the multi-trillion-dollar expansion in Fed balance sheets, and everyone by now has heard about the big government stimulus plans.
But you know what? When it comes to inflation-producing efforts, everything so far is just a warm-up.
The big fear is that America winds up like Japan, so let’s use a Japanese analogy: the classic monster movie.
Picture deflation as a 200-foot-tall monster. Mothra, maybe. Except instead of attacking cities, this Mothra is laying waste to whole chunks of the U.S. economy.
What the Fed has done so far is equivalent to standard military response, albeit on a large scale. They’ve called in the tanks and the fighter planes. They’ve sent the bombers in to drop napalm on Mothra’s head. Next up for the Fed is the multi-trillion-dollar TALF lending facility. If that doesn’t work, they will have run out of options... except for one.
They can call in Godzilla.
If Mothra represents deflation, then Godzilla, by way of our little analogy, represents real inflation... stomping, screeching, fire-spewing, melt-your-eyeballs inflation.
If the Fed and Treasury were to truly go crazy and raise Godzilla up from the deep, what would that look like? Here are a few possibilities:
The government could announce a massive payroll tax holiday, at a cost that would blow everyone's mind, that would not have to be paid back.
The government could announce a one-fell-swoop effort to pay off tens of thousands or even hundreds of thousands of underwater mortgages.
The Federal Reserve could hit the banks with a draconian holding tax – sort of like the vigorish a loan shark charges except in reverse. Every day that goes by where bank ABC hasn’t lent out the $100 million in its reserves, a $50,000 holding penalty is assessed. Or something to that effect.
The Fed and Treasury could just say “You know what, screw it. We’re gonna write y’all some checks. Every American citizen age 18 or over with a social security number gets $10,000 – look for that in the mail.”
Why haven’t we seen anything like this already? Because, again, the above options are the equivalent of calling in Godzilla. Could Godzilla kick Mothra’s butt? Oh, most certainly. The problem is, after Mothra is dead you’ve got the little matter of dealing with Godzilla.
Ben Bernanke Knows All This... and So Do the Smart Players Buying Gold
Ben Bernanke knows the Fed can bring about inflation if it wants to. Heck, he openly bragged about it in his famous 2002 “helicopter” speech.
The thing is, gentle Ben really, really, really doesn’t want to let Godzilla loose unless he absolutely has to. Because the kind of inflation we could be looking at to blast our way out of this deflationary hole would be... well... monster-rific.
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Old 18-03-2009, 15:58   #3
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It sounds like the 21st century version of printing presses cranking up.
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Old 19-03-2009, 11:11   #4
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Over the past <24 hours since the Fed announcement, reaction is beginning to manifest. Here's a small sampling:

Stephen Roach is chairman for Asia at Morgan Stanley:

Video - CNBC.com

Martin Weiss is president of Weiss Research:

Video - CNBC.com

Puru Saxena is president of Puru Saxena Wealth Management:

Video - CNBC.com

And here's the latest on the effects of the Fed's announcement in the markets from The New York Times:

http://www.nytimes.com/2009/03/20/bu...s.html?_r=1&hp

Clearly, the Fed's announcement of its decision to purchase Treasury and agency debt for its own account is an act of desperation. For years it has been suspected that whenever the TIC flows (Treasury International Capital) were insufficient to cover the monthly deficit, and "Caribbean interests" stepped in to buy Treasuries (thus filling the gap), that these anonymous "Caribbean interests" were actually a cover for Fed buying.

That the Fed has chosen to dispense with the pretense that some offshore entity is always there to load up on US government debt is highly significant. It would be wise, IMO, not to underestimate the impact of this development.

TaoJones

PS: Lawrence Kudlow, the perennial dollar-bull, torched a dollar bill on CNBC this morning, demonstrating what the effect of the Fed's plan will be. See this tongue-in-cheek account:

http://www.cjr.org/the_audit/cnbcs_k...lawbreaker.php
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Old 19-03-2009, 12:15   #5
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Well then, the $64,000 question is " what other options are there?". Although I am not a big fan of Weiss or Saxena, I do respect Steve Roach's opinion and even he could not give an answer to the question "what should the fed do".
My whole problem with the "experts" is they are very quick to critisize but offer no constructive solutions.
IMHO I do think deflation will be with us for a while but the faster we can stabilize the credit markets, the faster we will get out of this mess.
Then again I am just a regular Joe, not a financial wiz, but after all the trouble those financial geniuses got us into I kinda think we may need more regular Joes making the decisions
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Old 19-03-2009, 13:00   #6
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Thanks again for the Tao Jones Report.

Rather than have decisions made by "regular joes", I think I'd prefer a sober analysis by an apolitical expert. In my experience, many of the so-called financial wizards are actually just political BS artists, or people who managed to do well in a bull market.
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Old 19-03-2009, 13:06   #7
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Slightly off-topic, but I'd be interested in TJ's opinion on executive pay and bonuses. To a financial outsider (myself) it sure looks much like looting akin to a third-world kleptocracy.
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Old 19-03-2009, 13:51   #8
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Tao, you are absolutely correct about how stunning this news is - and how sudden and significant the impact. The good news for me is that I will shortly be needing to buy more USD in order to complete my offshore project. Over the last day and a half the Canadian dollar has risen more than 2 cents against the greenback, and I am anticipating further gains as the dust settles (we have significantly less debt in relation to GDP): moreover, since Canada is still significantly a resource based economy, I suspect that our dollar will continue to rise with the rebound in oil prices towards a short-term peak during hurricane season.

Its the same old story - as you pointed out yesterday, what is decidedly bad news for some will always prove to be an opportunity for others.

Brad
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Old 19-03-2009, 14:35   #9
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My question would be, if we are in a peroid of deflation, and the fed is pumping money into the system, that should stimulate inflation. Isn't that what we want? I realize that will make the Chinese nervous, as well as the rest of the countries that purchase the dollar but it seems that if we do not do this we risk continuing deflation which makes all of our net worth less. please correct me if I am not seeing this correctly
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Old 19-03-2009, 16:02   #10
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Quote:
Originally Posted by johnmcntsh View Post
My question would be, if we are in a peroid of deflation, and the fed is pumping money into the system, that should stimulate inflation. Isn't that what we want? I realize that will make the Chinese nervous, as well as the rest of the countries that purchase the dollar but it seems that if we do not do this we risk continuing deflation which makes all of our net worth less. please correct me if I am not seeing this correctly
No, you're not seeing it incorrectly at all, John. This step by the Fed (which will very likely be followed by similar actions from other central banks around the globe) is, indeed, inflationary. Potentially, it is hyper-inflationary, as there is very little likelihood that it will be a one-time event. Hence, the instantaneous collapse in the $US and spike in gold and other tangibles mere minutes after the announcement.

If the Fed follows through on its announced plan to acquire longer-dated Treasuries, they will have effectively plunged a dagger right between the shoulder blades of everyone who has fled into the "safety" of US Treasuries. At the moment, that represents a huge number, and as entities start to move out of T-Notes and -Bonds in search of genuine safety, then whatever that capital floods into will soar (in price, not value - value is intrinsic, price is fluid).

The danger is that when this inflationary action manifests in rising prices, it may be impossible for the Fed to put the genie back in the bottle. The real risk is that we may be headed into a prolonged period of deflating asset values and, simultaneously, rising prices.

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Old 19-03-2009, 18:59   #11
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I think godzilla has already been set loose. He hasn't yet arrived but will be coming to a theater near you soon.
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Old 20-03-2009, 10:06   #12
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Thank you TAO!!!!!
One more question and and please remember I am not a rocket scientist when it comes to Finance
If a deflation spiral is really bad (ie. the great depression) and as the fed cannot really lower interest rates anymore, nor raise them, would not the only option to be to inject money into the system ( basically try to cause inflation?). And would not the fed be the first to see signs of a deflationary spiral? I somewhat see your point about the creation of hyper inflation, I just do not see where the fed has an alternative as they are the ones who would be the first to see the possibility of a spiral.
I appreciate your time!!!! I just have a small understanding of what is going on and looking at what the Fed did, I just do not see an alternative "IF" (and that is a big word) the Fed saw signs of a spiral.
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Old 20-03-2009, 10:29   #13
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Interesting reading from a speech in 2002. Do not have a good handle on what it all means but,
Speech, Bernanke --Deflation-- November 21, 2002
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Old 20-03-2009, 11:46   #14
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Just a reminder....the owners of the U.S. Federal Reserve Bank are NOT the U.S. government! Surprised? Most are. The ownership is actually secret, but it is likely a consortium including some entities not based in the U.S. Ponder the implications of it buying so much American debt....
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Old 20-03-2009, 12:11   #15
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That is true, somewhat. However,
The concept of "ownership" needs some explaining here, The member banks must by law invest 3 percent of their capital as stock in the Reserve Banks, and they cannot sell or trade their stock or even use that stock as collateral to borrow money. They do receive dividends of 6 percent per year from the Reserve Banks and get to elect each Reserve Bank's board of directors.

The private banks also have a voice in regulating the nation's money supply and setting targets for short-term interest rates, but it's a minority voice. Those decisions are made by the Federal Open Market Committee, which has a dozen voting members, only five of whom come from the banks. The remaining seven, a voting majority, are the Fed's Board of Governors who are appointed by the president.
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