Unfortunately, we Americans now realize that the decision by Ben Bernanke to slash the Fed Funds rate to 2% (a three hundred twenty five basis point reduction) was just the opening act in this Republican administration's socialism play. At the time some wondered why the government didn't just allow home prices fall to historical averages rather than seeking to lower the value of the U.S. dollar and send inflation to a 17-year high. Now we have learned just this past weekend that the Department of the Treasury has come up with a plan for conservatorship of the GSEs, enacting the largest bailout in the history of the United States.
What does the conservatorship plan mean? It means the government will take over the GSEs for the purpose of continuing their operation rather than putting them into receivership, which would seek to sell off their assets and shut down future business. In contrast, the Paulson plan will actually increase the holdings of (NYSE: FNM ) & (NYSE: FRE) by $144 billion. The total of mortgage backed securities held by the GSEs will be allowed to increase to $850 billion each by December 2009.
My Libertarian heart sank when I witnessed Republicans and Democrats slap each other on the back as they congratulated themselves from saving us from the natural workings of the free market. The Republicans reek of hypocrisy, claiming the bailout of FNM & FRE was necessary for the health of the real estate market and the economy. I guess government intervention in the free market is only mandatory if you're a bank, insurance company, foreign government or a pension fund that owns GSE debt.
It was especially telling when Hank Paulson's was asked in a CNBC interview how much his bailout plan will cost taxpayers. He responded that he "did not use a calculator" when putting together this scheme. The essence of his response was that he did not care what the bill to taxpayers would be, his main concern was to recapitalize banks and stop home prices from falling.
The big problem with this plan is that the government does not have a plausible exit strategy. After Treasury has taken the companies into conservatorship and then expands their operations, it will not be easy to reduce the size of the GSEs. Their intention is to wind down the agencies' balance sheets beginning in 2010 at a rate of 10% per annum until they reach just $250 billion each. So let me get this straight, after the real estate market has become more reliant on FNM & FRE to securitize the mortgage market, we will then be able to allow market forces to take hold? That view becomes especially dubious in light of the fact that we will have a new administration in charge when this scale-down is supposed to be taking place.
Just as the U.S. has become addicted to artificially low interest rates-unable to raise them without seriously hurting the economy-- we now have most likely permanently socialized a good portion of the real estate market and the economy. Does the administration really believe that it is better to debase our currency and greatly expand the obligations of our government rather than letting home prices fall to a level that can be supported by the market? This move has long-term ramifications on the dollar and the national debt. Thanks to a stimulus package and reckless spending from the administration, annual deficits are already skyrocketing to nearly $500 billion. Now with the Paulson bailout plan, debt could increase even faster. This may torpedo the recent move higher in the dollar and makes its long-term picture even more bearish.
Perhaps it will fall even further in coming weeks, but the need to own honest money-gold-has never been more apparent.
www.deltaga.com
WHAT IS THE RISK FOR THE ECB?
In yesterday's Daily Currency Focus, we said that the 1.45 level was significant support in the EUR/USD.A break below that level would have opened the door for a move down to 1.42. Even though the EUR/USD did take out the support to hit an intraday low of 1.4385, what was more impressive was the currency pair's reversal. The close back near today's high reflects strength rather than weakness.
The bearish losses in the international markets will make investors wince... if they aren't wincing already. They may even make some folks crumble in despair.
The benchmarks across the globe are daunting:
Things are about to get really bad. Rotating bubbles are now becoming rotating sector recessions as the positive feedback loops, created as money and credit growth ballooned over the last 25 years, have reversed and are now becoming negative feedback loops. I expect to see those 25 years of excesses to dramatically unwind over the course of the next few years. The evaporation of paper wealth will be breathtaking. A "buy on the dips" mentality has been replaced by "sell on the rallies." Declining house values will further hinder the finance sector which will impede the real economy, causing asset prices to further plunge. The tipping point for debt creation's positive impact has been reached and we can expect economic convulsions similar to what a drug addict experiences after kicking the habit "cold turkey."
"The credit crunch is morphing from an American-centered financial crisis into a global economic crisis," according to David Bowers of Absolutely Strategy. The policy of creating more money than could be put to productive use in the real economy that allowed rising asset prices would more than compensate for a lack of ‘real' wage gains in the real economy and for consumers to continue to borrow and spend more than they earn at an accelerating pace failed once the excess money began to flow to commodities rather than to real estate or stock prices.
Growth is now demonstrably slowing in all parts of the world. Central Banks around the world will be embarking on a campaign of lowering their interest rates. Participants in the US stock market, fresh off an artificially trumped up GDP restatement (trumped up due to the stimulus package and severe understatement of the GDP deflator), will take a while to realize that gains in the dollar are due to relative underperformance of other currencies and a massive liquidity contraction. The gains will be short-lived and will result in pain and agony as those investors are lured into another bear trap that will reveal itself once much of the sidelined money comes back into the market.
The fall in commodity prices will be wrongly interpreted as a reason for the economy to rebound and for stocks to rally. While the dollar will likely continue to rise over the short term it is ultimately destined to suffer the same disastrous fate as the other fiat currencies of the world. After the sucker's rally has run its course over the next few weeks or so, the reality of an unserviceable and un-payable debt overhang will set in and the second wave of financial calamity will ensue. This time around it will be the result of the effects emanating from the negative feedback loop coming from the real economy.
Scott Bugie of Standard & Poor's writes that the second phase of credit crunch could be severe: "The credit crunch is entering a second, 'post-subprime' phase where banks' loan books deteriorate more rapidly and capital-raising efforts might become harder, says Scott Bugie, credit analyst at Standard & Poor's. Loan book deterioration is starting to hit a wider array of financial institutions, as credit losses migrate from subprime into other sectors of household finance, such as credit cards, Alt-A and prime mortgages, and auto loans well into 2009,' he says.
Other mainstream economists are have also been sounding the warning trumpets: "The US is not out of the woods. I think the financial crisis is at the halfway point, perhaps. I would even go further to say the worst is to come," according to Professor Ken Rogoff who was chief economist at the IMF from 2001 to 2004 and who now teaches at Harvard. He goes on to say, "We're not just going to see mid-sized banks go under in the next few months, we're going to see a whopper, we're going to see a big one - one of the big investment banks or big banks."
In 2002 Dr. Marc Faber, author of the GloomBoomDoom Report and highly-sought guest for CNBC and Bloomberg TV, wrote a book titled, Tomorrow's Gold-Asia's Age of Discovery. Those who read the book and followed Faber's investment advice to invest in commodities and Asian and other emerging market equities have significantly outperformed those who primarily invested in US stocks (tech, consumer and financials). But Faber had recently cautioned against this "short dollar trade" as it had become stretched and crowded. He presciently warned investors late last year. More recently, referring to commodities, he said "Prices have made a peak...Whether that is a final peak or an intermediate peak followed by higher prices, we don't know yet. It could go lower."
He echoed similar sentiments in a Bloomberg TV interview this morning. I found his most recent market commentary, issued on August 20, 2008 titled, "Contracting Global Liquidity," quite compelling. He uses several charts to demonstrate how liquidity is contracting, the dollar is strengthening, commodities are declining, and what the relationships that exist between them predict for the future. He writes:
"In sum, credit growth and liquidity are contracting, a vicious economic downturn is about to unfold (China could surprise on the downside and put additional pressure on commodity prices) and asset markets are still high by historical standards and, therefore, remain vulnerable. I would use equity rallies as a selling opportunity and further weakness in gold as a buying opportunity for long term holders with significant cash and cash flows."
Faber has an enviable track record over the long, intermediate and shorter term. Not many investment strategists can boast of getting the market right over these three terms. He is an open-minded contrarian who is not afraid to change his views. He was way in front of the investment community predicting the rise of China and commodity prices six years ago. He correctly wrote that the US currency and stock markets would relatively outperform others last year. And he got the April-May S&P 500 rally to 1440 right also.
The one longer-term trend Faber appears to have the most confidence in is the "long gold/short the DJIA" trade that has been working, despite the recent pullback, since 2001. Over the intermediate term he is a looking for what can be described as nothing less than a US stock market crash, perhaps by the end of this year.
Rather than the US markets leading the rest of the world higher, the evidence points toward the rest of the world leading US markets lower. The global slowdown had begun in earnest. The US is now more dependent on world growth than the world is reliant upon the US. This is especially true since the US consumer is seeing his credit cut off and US banks and financial institutions suffer the effects of the second wave of the credit crunch. Once the relief rally has run its course and investors see that the US economic rebound has not staying power and only worn out consumers trying to pay off 25 years of accumulated debt, the dollar will rejoin the ranks of the other fiat currencies and resume its decline versus the price of gold.
Excerpted from the 9/2/08 Global MegaTrends Portofolio's Newsletter:
To learn more about Kurt's Kasun's Global MegaTrends Portfolio, click here.
Anything is possible but very little is probable.
This is the thought I have as I look at the many price distortions that abound in commodities, stocks related to commodities and currencies related to commodities. Over the last month and a half there has been a big one way decline in this area, at the same time the greenback has skyrocketed. The size and velocity of these declines have drawn all sorts of commentary that extrapolates these declines further into the future.
With Hurricane Gustav being downgraded to a tropical depression, the Hurricane Premium is off the table. Oil prices have plunged more than $10 a barrel since Friday with $100 a barrel now within striking distance. The rally in the US dollar is a direct result of the fall in oil prices. Since the beginning of the year, we have seen a 70 percent correlation in the price of the EUR/USD and crude.
The US dollar has been quietly trending higher since the European trading session.The EUR/USD hit a high of 1.4768 shortly after the London open but ended the US session near its daily lows.Although this strength was also seen against many of the other major currencies, the dollar failed to rally against the Japanese Yen.This weakness was primarily due to the move in US equities which dropped over 170 points in the US session.Oil also reversed sharply, ending the day slightly under $116 a barrel, after having hit an intraday high of 118.76.
While Thursday’s gains in stocks appear to be impressive, they do little in terms of making an impact on longer-term trends. We do not need any complicated technical indicators to discern the long-term trends on the following charts. Thursday’s rally in stocks cannot even be seen on the six-year chart of the S&P 500 Index below.
Earlier today on The Network they had a chap on (whom I seem to recall his being wrong a lot during this bear market) who suggested getting out of or reducing foreign equity exposure due in part to the recent rally in the dollar. Presumably he thinks this trend will continue.
The call may or may not be right but it raises several dilemmas for investors. The issues include commission dollars spent, taxes (depending on the account type), where to invest the proceeds and the risk that the dollar rally is a short term snapback in a downtrend.
It’s another occasion to post Thomas Lorimer’s print that reflects current conditions. Without a firm buyout/bailout of Lehman or any concrete rescue proposals for Freddie Mac and Fannie Mae, despite a successful debt sale, stocks quickly gave back all Friday’s gains and then some. So the financials induced cloud over the market from Thursday’s post dumped rain today on extraordinarily light late summer volume. Breadth was as poor as you might expect.
