Tuesday, August 7, 2012

Tuesday, August 7, 2012 - Stay Dry My Friends!

Stay Dry My Friends!
-by Sinclair Noe

DOW + 51 = 13,168
SPX + 7 = 1401
NAS + 25 = 3015
10 YR YLD  +.07 = 1.63%
OIL - .22 = 95.23
GOLD + .70 = 1613.30
SILV + .22 = 28.20
PLAT + 6.00 = 1413.00

The head of the Federal Reserve Bank of Boston, Eric Rosengren, wants the Fed to undertake "an aggressive, open-ended bond buying program" that would stop only when the economy's growth rate accelerates and unemployment begins dropping. Last week, following the FOMC meeting, the Fed said it would "closely monitor incoming information on economic and financial developments and will provide additional accommodation as needed to promote a stronger economic recovery and sustained improvement in labor market conditions in a context of price stability.

So, that means the Fed will do something we just don't know what or when, but things would have to get much much better, otherwise the Fed is somewhat obligated to do something. The Fed's counterpart in Europe, the ECB is obligated to do “whatever it takes”. Mario Draghi, former Goldman man and now head of the European Central Bank, promised to do “whatever it takes” to save Euroland.

Whatever it takes, Mario Draghi didn’t seem to have it. Or maybe he did. The situation in Europe is so complicated it’s hard to tell. So, investors have been fearful one day and cheerful the next. At the beginning of last week they thought all was lost. Then, by the end of the week, stocks were rallying again. Draghi has secured a mandate for “unlimited open-market operations”, a far cry from the half-hearted and self-defeating bond purchases of the last two years. The ECB at last has a license to act with overwhelming force, like the US Federal Reserve. “Overwelming force” is what Ben Bernanke has; I think it means Bernanke has a printing press and he will use it. Draghi has finally figured out, he too has a printing press and maybe he understands the only way you can hold off a default is by promising to print an infinite quantity of cash. And you have to mean it. If speculators see you haven't printed enough, they sell your bonds, fearing that you will default. Then, other speculators buy them at low prices, betting that you will print more of whatever it takes. Then, when you do print more, prices soar and the speculator sells the bonds back into the market, and the whole process repeats itself, until you finally default.

No sooner had some astute Euro commentators noted that Draghi might have found a path to keep the Euro-crisis patched up long enough to impose austerity on the periphery and drive the Euro-zone into an outright depression, various elements of his plan look as if they were coming unglued.

The German press suggests the commitments to bond buying, both from German pols and from northern central banks ex the Bundesbank, are qualified: only near term maturities (less than two years) and only in limited amounts (“limited” has not been translated into a particular number, it appears). Yet the media seems to think quite the reverse; that Draghi is going to engage in unlimited bond buying. After denying for months that Spain will require anything resembling a sovereign bailout, Madrid hinted that it could take up Draghi’s conditional offer of buying short-term debt. Unlimited bond buying by the ECB would surely soon follow, or so the Financial Times seems to think, but unlimited bond buying might lead to a revolt by the northern bloc. Unless the Euro melts down completely, it does not look like they will give the ECB what it wants quickly or easily. Draghi may be a victim of his own success in jawboning. He’s driven down short term yields enough that Spain feels less anxious about access to markets, plus its next bond sale isn’t until October. Italy has already said that it won’t ask for funds before Spain. That was what Draghi wanted, to keep everything on hold until at least Sept. 12, when the treaty allowing the establishment of the ESM will presumably be signed by the German president, German constitutional court willing, but too much complacency on the part of Spain and Italy is not seen as desirable because it won't push the northern bloc to act. Too much complacency and the Germans won't be snookered into the deal; for a deal to take place, there must be a sense of desperation, the stench of fear must fill the air. 

Bill Gross, the head of the bond giant Pimco writes, “Investors get distracted by the hundreds of billions of euros in sovereign policy checks, promises that make for media headlines but forget it’s their trillions that are the real objective. Even Mr Hollande in left-leaning France recognizes that the private sector is critical for future growth in the EU. He knows that, without its partnership, a one-sided funding via state-controlled banks and central banks will inevitably lead to high debt-to-GDP ratios and a downhill vicious cycle of recession.” I think what Gross is saying is:“Psst…investors: Stay dry my friends!” 

Yesterday I told you about Standard Chartered, the old British bank that has been playing with the Iranians despite sanctions that say they can't do that. The head of New York State's Department of Financial Services accused the bank of hiding 60,000 secret transactions worth $250 billion over nearly a decade. Shares in Standard Chartered closed down 16.4 percent at 12.28 pounds, taking their losses to 24 percent since the news surfaced; they've lost about $17 billion in market value. 

According to New York authorities, one of StanChart’s group executive directors, when warned by a colleague of potential criminal liability, responded: “You f—ing Americans. Who are you to tell us, the rest of the world, that we’re not going to deal with Iranians.”

What makes this especially rich is the 2010 advertising campaign aired by Standard Chartered; this was during a time when the New York regulators say SCB was making the US  financial system vulnerable to terrorists, weapons dealers, drug kingpins and corrupt regimes – while SCB was wheeling and dealing with the ayatollahs, here is the text of their commercial:
Can a bank really stand for something?
Can it balance its ambition with its conscience?
To do what it must. Not what it can.
As not everything in life that counts can be counted.
Can it look not only at the profit it makes but how it makes that profit?
And stand beside people, not above them.
Where every solution depends on each person.
Simply by doing good, can a bank in fact be great?
In the many places we call home, our purpose remains the same.
To be here for people. Here for progress. Here for the long run.
Here for good.

Last week, Standard Chartered PLC Chief Executive Peter Sands told analysts that “our culture and values are our first and last line of defense.”  If their values were their last defense, then their goose is clearly cooked. 

Last week we had the harmonic convergence of Central Bankers: the European Central Bank, the Bank of England and the Federal Reserve Board all held their policy meetings nearly simultaneously. The Euro-zone and the UK are in a depression; the US never really got out of the depression. The central bankers all decided to do nothing, at least for the moment. They all restated their unbreakable resolution to do “whatever it takes” – to prevent a breakup of the euro, in the case of the ECB, or, for the Fed and the BoE, to achieve the more limited goal of economic recovery. But what exactly is there left for the central bankers to do?

They have essentially two options. They could do even more of what the Fed has been doing since late 2008 – creating new money and spending it on government bonds, in the policy known as “Quantitative Easing.” Or they could admit the policies of the past three years were not working, at least not well enough. And try something different.

There is, admittedly, a third option – to do nothing, on the grounds that public bodies should stop interfering with the private economy and instead leave financial markets to restore economic prosperity and full employment of their own accord. This third idea is based on the economic theory that if governments and central bankers leave well enough alone, “efficient” and “rational” financial markets will keep a capitalist economy growing and automatically return it to a prosperous equilibrium after occasional hiccups. This theory, though still taught in graduate schools and embedded in economic models, is implausible, to put it mildly, especially after the experience of the past decade. It is based in part on the flawed notion that markets are free, when the reality is that free markets are as prevalent as pink unicorns  In any case, experience shows that the option of government doing nothing in deep economic slumps simply doesn’t exist in modern democracies.

So, back to the drawing board; Plan A, Quantitative Easing.  Maybe QE might still help in the euro zone, since the ECB is the only entity that can guarantee that Italy, Spain and France will not go into a Greek-style default. QE has had limited success.

So far the Fed has created $2 trillion or maybe more and the money that was created out of thin air has vanished into thin air. Where has all this new money gone? It has certainly not appeared in my wallet or bank account – nor has it fattened yours,  unless you happen to be a bond trader or banker. The fact is that all the new money has been spent on buying bonds. QE has inflated bond prices and boosted bank profits, but achieved little else. Mortgages are cheaper but harder to get; CD's pay nothing for savers. 

The one economic benefit of QE has been to help governments finance the huge deficits without having to raise taxes or to cut public spending. Yes, it might have been worse without QE but QE has failed to stimulate employment or economic growth. Think Japan. New rounds of QE would likely just stagnate, while discouraging other, potentially more  more effective stimulus measures.

Instead of giving newly created money to bond traders, central banks could distribute it directly to the public. Technically such cash handouts could be described as tax rebates or citizens’ dividends, and they would contribute to government deficits in national accounting. But these accounting deficits would not increase national debt burdens, since they would be financed by issuing new money, at zero cost to government or to future generations, instead of selling interest-bearing government bonds.

Giving away free money may sound too good to be true or wildly irresponsible, but it is exactly what the Fed and the BoE have been doing for bond traders and bankers since 2009. Directing QE to the general public would not only be much fairer but also more effective.

Suppose the new money created since 2009, instead of propping up bond prices, had simply been added to the bank accounts of all citizens; $2 trillion of QE could have financed a cash windfall of $6,500 for every man, woman and child, or $26,000 for a family of four. 

Distributing money to the general public was the one solution that united Milton Friedman and John Maynard Keynes. Their main difference was that Friedman proposed dropping dollar bills out of helicopters, while Keynes suggested burying pound notes in chests that unemployed workers could dig up. I know that passing out money directly to citizens sounds crazy, but then no economists have seriously suggested distributing money exclusively to bond traders and bankers – that would be insane, it clearly would not work,  but that is exactly what we have been doing. 

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