Thursday, October 30, 2008

The Obama Doctrine

A short essay concerning Mr. Obama and some implications assuming he is elected. (see "papers" section on this blog)


This essay seeks to outline some of likely implications and responses given an election victory by Barack Obama. The main conclusion derived here is an antipodean leaning towards U.S. foreign policy: an “Obama doctrine”, analogous to the Monroe Doctrine of the early 1800s, seeking influence in Africa and Latin America. It seeks to define the broad brush strokes, leaving specific investment strategies to later papers.

(update: the paper is only available via email contact)

Ben on his Hind...

(From an email conversation earlier today)

Back to the swap line problem.

The swap lines world wide are now over 522Bln. This is the ECB (and
now many others, like Brazil and Mexico) borrowing unsecured from the
U.S. in order to stave off deflation. Who knows what the process is
for granting these swap lines.

its the old-fashioned external debt problem and I don't expect some of
these funds to return (especially in ECB dollar funding to Eastern
European countries...plenty of room for outright fraud there as
regional banks give sweetheart loans to their future business

A massive transfer of wealth with no congressional approval, as I have
stated before. Forget lower interest rates, this is Ben Bernanke on a
Hind Helicopter, strafing the world with dollars. And why unlimited
lines for the Euro area alone, which in my mind now has the biggest
incentive to break up the Euro and simply keep the dollar wealth.

If/when, BHO takes office, I expect these types of facilities to be
extended to sub-saharan African banks, not with any "systemic risk to
the financial architecture" argument, but on any grounds the Executive
branch chooses.

Wednesday, October 29, 2008

K-T Boundary Event for Banks.

The "flailing around" by Congress and certain members of the Executive branch (namely, those who chair the Fed and head the Treasury) is producing some serious dislocation in the banking system. The promise of the TARP plan to inject equity in banks is going to produce winners and losers.

This is a K-T boundary type event for the banking ecosystem, and the corresponding meteorite is a wall of cash funded by the U.S. government. These organisms thought they lived on a different planet effected by things called "market forces". Now, the meteor has struck and they must obey "governmental largess". A very large change in ownership basis.

Proximity (and a good relationship) to governmental officials just became one of THE most significant source of profit and risk to all U.S. Banks for the immediate future.

For better or for worse, this is what government does best: destroy and force the organism to re-organize into different ecosystems. I believe that this, somewhat paradoxically, creates value. Anti-trust measures in the Sherman act are another similar event.

G20 goes under the knife once again...

Cut, cut and cut again. This is as much an exercise in placation as it is masterful economic policy.

As the FED has cut yet again, China lowers their own loan rates to a somewhat appropriate number given the proximity to the U.S. Halloween celebrations.

The world is digesting the events and policies of the past six months, and it it apparent that most G20 countries (ex the Anglo-American financial axis, which are executing Keynesian prescriptions at light speed with draconian lack of due process or a scintilla of understanding by our political leaders) have no idea how to stoke domestic demand even with an improving trade gap via the rapidly strengthening dollar.

However, lower rates are not necessarily "expansionary".

BEIJING, Oct 29 (Reuters) - China's central bank cut banks' benchmark lending and deposit rates by 0.27 percentage point on Wednesday, the third cut in six weeks.
The cost of one-year bank loans will fall to 6.66 percent from 6.93 percent, while the benchmark one-year deposit rate falls to 3.60 from 3.87 percent, the People's Bank of China (PBOC) said.
The cut in interest rates takes effect on Thursday, the central bank said on its website (www.
The PBOC gave no reason for the easing.

Friday, October 24, 2008

Populism as problem solving, cont.

This will be an open-ended string of posts. Again, expect all countries to re-trench and revisit old populist and mercantilist arguments to placate a populace faced with the decrease of wealth in nominal and real terms.

The French Version:

By James G. Neuger

Oct. 24 (Bloomberg) -- Since the era of Charles de Gaulle, France has rebelled against the American-style capitalism that put a ``Made in U.S.A.'' stamp on the world economy.

Now, as convulsions on Wall Street shake the global financial system, French President Nicolas Sarkozy is seizing the opportunity to remake the free-enterprise model along more state-managed Gaullist lines.

Emboldened by the U.S. pursuit of a European-style bailout, Sarkozy has packed his wish list for an upcoming international summit with calls for everything from stiffer bank supervision and limits on executive pay to state aid for hand-picked industries. While the moment is in his favor, history is working against him: throughout the postwar era, French attempts to subdue globalization and come up with an exportable economic model have misfired.

``There will be so much opposition against this grand idea of putting in more state control,'' says Paul de Grauwe, a professor at the Catholic University of Leuven in Belgium. Sarkozy is chasing ``a kind of French favorite dream that others do not perceive to be really necessary.''

As the financial crisis spiraled in early October, Sarkozy made a pilgrimage to De Gaulle's onetime country hideaway in eastern France, dedicating a memorial in the shadow of a double- barred Cross of Lorraine honoring the Free French in World War II. A prickly ally during the war, De Gaulle made a postwar reputation for defying the U.S.

`Mysterious Force'

``Gaullism is the spirit of rupture,'' Sarkozy said at the Oct. 11 ceremony attended by German Chancellor Angela Merkel. The general's legacy is a ``mysterious force,'' he said. It breaks with ``habits, routines, conventions,'' demanding ``exertion by all so that France may regain its rank among nations.''

The nominally pro-American Sarkozy, who ran as a pro- business candidate last year against Socialist Segolene Royal, is taking his crusade for a ``re-founding of global capitalism'' to Beijing today, when European leaders meet with the heads of 16 Asian countries including China, India and Japan. His next chance comes at the first in a series of global summits addressing financial markets slated for Nov. 15 in the Washington area.

``Nothing in the global economy will be the same as before,'' Sarkozy said yesterday in Annecy, France, as he announced plans to create a sovereign wealth fund to invest in French companies, protecting them from foreign ``predators'' after the global stock-market rout.

Populism as problem solving

Populist rhetoric...much more of this to come. This official obviously has no idea that its not just the global financial architecture that is a strategic asset to America, but also the global security environment. Everything is connected. Does China have the resources and the political will to police its own backyard? No. It outsources its security services for a fee to the world's top provider of those services.

U.S. has plundered world wealth with dlr -China paper
Fri Oct 24, 2008 1:59am EDT
BEIJING, Oct 24 (Reuters) - The United States has plundered global
wealth by exploiting the dollar's dominance, and the world urgently
needs other currencies to take its place, a leading Chinese state
newspaper said on Friday.

The front-page commentary in the overseas edition of the People's
Daily said that Asian and European countries should banish the U.S.
dollar from their direct trade relations for a start, relying only on
their own currencies.

A meeting between Asian and European leaders, starting on Friday in
Beijing, presented the perfect opportunity to begin building a new
international financial order, the newspaper said.

The People's Daily is the official newspaper of China's ruling
Communist Party. The Chinese-language overseas edition is a small
circulation offshoot of the main paper.

Its pronouncements do not necessarily directly voice leadership views.
But the commentary, as well as recent comments, amount to a growing
chorus of Chinese disdain for Washington's economic policies and
global financial dominance in the wake of the credit crisis.

"The grim reality has led people, amidst the panic, to realise that
the United States has used the U.S. dollar's hegemony to plunder the
world's wealth," said the commentator, Shi Jianxun, a professor at
Shanghai's Tongji University.

Thursday, October 23, 2008


Parabolas describe so many things. From markets to V2 rockets, events are shaped by unseen gravities that compel them to follow paths with varying degrees of predictability.

Nature abhors a void. Where there is a nutrient supply (even something as ubiquitous as sunlight) natural destructive forces only serve to test systems and create opportunities for new organisms to fill niches. Populations rise and fall in parabolic shapes.

The parabolic rise and fall of global stock markets also serves as a reminder that economics is "everything" when determining future human behavior.

So enough prattling and curve worship. What are some of the geo-political ramifications given the current circumstances, keeping in mind the LOCAL (present) position on our parabolic (sine) WAVE.

The European experiment is creaking along. Its (French at the moment) President is uttering populist rhetoric regarding the wholesale nationalization of economies and seems to advocate central control of banking systems. Of course, the central problem, and the assumptions that went with it, is not discussed. No "responsible" EU political figure has called for an open debate regarding the viability of the Union. A political fiction built by "elites" which the constituent people mistrust and which has no real economic power at the national country level. Can anyone think such a system will last? And then there is the problem to the East...

We are also seeing the fissures that create a capital route in "Emerging Markets". Foreign capital inflows manifest themselves in parabolic shapes which follow the unseen "gravity" of human fear and greed. I have said here on multiple occasions that "Latin America is next", this should be obvious by now and the vacuum thus created WILL be filled by other, more socialist/Marxist, niches of political leaders.

As for the Paper Dragon, I am slightly less pessimistic about its prospects given its return to earth. But only just. While it still has control over currency and debt issuance (unlike the Euro area), the political system is a horrid mess of cronyism and the ruling party is devolving into a USSR-type aristocracy, far more concerned with relative prosperity than the plight of the proles.

All of the above throws into stark relief what our current security position is now vs. what it will be in 10 years. Once Iraq is stabilized, I fully expect an antipodean emphasis in Africa and Latin America, with a steady eye on instability in all of Europe. This neo-Monroe Doctrine, pan African emphasis will allow the U.S. to achieve its strategic goals of cheap hydrocarbon fuel, cheap labor/gains from trade, and to capitalize on the plentiful natural resources in both continents.

Thus, I am positioning for the above to happen in the financial markets...and in some parabolic way may help strengthen the causational links to same. The irony is not lost.

But gravity is what it is.

Thursday, October 16, 2008

Achtung USA!

The ECB is now accepting all kinds of collateral for their U.S. dollar funding facilities. There is a non-zero risk that since the ECB's liabilities are denominated in foreign currency, they could engineer a default or engineer a massive depreciation of their own currency when the liabilities come due.

In other words, there is a danger that the U.S. will hold worthless Euros (as EU member countries revert back to national currencies) backed by substandard collateral.

This turn of events also invites fraud - the Euro banking system is basically getting cheap dollars that they have to pay back "someday". This invites national banks to give "sweetheart loans" (i.e., loans that do not have to be paid back) to their favored contacts. I don't think our politicians understand this risk.

15 October 2008 - Measures to further expand the collateral framework and enhance the provision of liquidity
The Governing Council of the European Central Bank (ECB) today decided, by means of a teleconference, on the following measures:

The list of assets eligible as collateral in Eurosystem credit operations will be expanded as set out below, with this expansion remaining into force until the end of 2009.

As from the operation settling on 30 October 2008 and until the end of the first quarter in 2009, the provision of longer-term refinancing by the Eurosystem will be enhanced as set out below.

The Eurosystem will start offering US dollar liquidity also through foreign exchange swaps.

Tuesday, October 14, 2008

The Florida Manatee and market thought processes.

Warning: this post is not so much about markets as it is the thought process that underpins my thinking.

Thinking about the markets is basically critical thinking. To wit:

When I was in Key West, Florida, I had a conversation (being Key West, this conversation was obviously held over cocktails) with some people who claimed the Florida Manatee has "no natural defense against predators".

I thought this curious. Every animal alive has "some" form of defense against predation or else they will not have prospered. So I immediately began thinking about what I know about this animal compared to what I do not know about it.

Choosing information sources is an important step. In this case, open source resources seemed objective enough given the non-technical aspects of identifying and characterizing this animal. Thus, I used Wikipedia to search for the animal, the relevant entry is as follows:

Duly armed with descriptive characteristics of the animal, I set about answering the question of "natural defense against predation".

The word "natural" always holds problems (as opposed to unnatural? supernatural?), but discarding that for the moment, let us focus on predation.

Again choosing open-source resources as the subject is non-technical and has enough participants to form a consensus opinion, I perused several on-line books to determine a useful way to define predation.

John Endler has broken down "predation" into various sub-stages. They are (in sequential order):

1. Encounter
2. Detection
3. Identification
4. Approach (attack)
5. Subjugation
6. Consumption

An animal can avoid predation at any one of these stages.

So let us apply this to the Manatee. Again, this derives from my interlocutors assertion that Manatees have "no natural defense against predators"

Avoiding the obvious question of "are there any predators?" Let us imagine a (very) large Alligator attempting predation upon the supposedly helpless Manatee.

Encounter, detection and identification all have their problems, but let us assume our hungry Alligator has focused on its prey and is attacking with extreme prejudice.

Getting its jaws in a position to subjugate is a problem. Manatees are bulbous creatures with a wide circumference and few angular features. Simply creating a wide enough angle to masticate a Manatee would be difficult for any creature not equipped with a truly gigantic maw.

Manatees are also incredibly powerful swimmers. In addition to their raw power, their very wide rear flipper creates tremendous amounts of turbulence. Think of the turbulence a 1000 pound animal makes when exhibiting explosive movement in anticipation or reaction to attack. This turbulence within its native habitat (rivers, etc.) creates a veritable explosion of sedimentary displacement resulting in a much more effective version of squid ink. Our Alligator would experience a great deal of confusion and blindness should the Manatee disagree with its putative subjugation.

Thus, the statement is false. No, a Manatee does not have armed torpedoes, but it certainly has defenses against at least 2 of the sub-stages (subjugation and consumption) of predation.

In conclusion, I realize this is mostly "critical thinking" 101 for most of you, but vigilance is required when dealing with conclusory statements that fly in the face of common sense...a statement like "no natural defense" must beg the question of "why is that important" and "are you sure you have not thought about ALL possible defenses?"

Such it is with must be acutely and obsessively aware of what you MIGHT not know. Again, the price of freedom is eternal vigilance.

Monday, October 13, 2008

Bretton Woods III?

As stated previously, new currency regimes will follow from the current (yet declining) credit crunch and market volatility. The Euro has been exposed as a deeply flawed Frankensteinian creation.

World needs new Bretton Woods, says Brown
1 hour ago

LONDON (AFP) — World leaders must meet to agree a new Bretton Woods system, Prime Minister Gordon Brown said on Monday, referring to the global financial architecture established at the end of World War II.

Speaking as the government announced its latest move to try to stabilise the creaking banking system, Brown said the current crisis should be seen as an opportunity to push through delayed reforms.

"Sometimes it takes a crisis for people to agree that what is obvious and should have been done years ago, can no longer be postponed," he said in a major speech on the fast-moving world financial crisis.

"We must create a new international financial architecture for the global age," adding: "We must have a new Bretton Woods -- building a new international financial architecture for the years ahead."

The Bretton Woods system was agreed at the end of World War II. It set in place the world's financial architecture, which remains in place today, based on the International Monetary Fund (IMF) and the World Bank.

Saturday, October 11, 2008

Austria's right grieves today...

...the ramifications for Europe are interesting. My initial guess is that his death will help to crystalize the right and pave way for a sympathy reaction to his policies. Conspiracy theorists will also find fertile soil here.,2144,3705734,00.html

Austrian politicians from all sides paid tribute to far right leader Joerg Haider, who was killed in a car crash on Saturday, describing him as a talented and charismatic yet highly controversial leader.

The accident occurred near Klagenfurt, capital of the province of Carinthia where 58-year-old Haider was governor -- around 2 am (0000 GMT), police official Meinhard Schiller told German news agency dpa.

Haider was driving by himself when his car veered off the road after passing another vehicle. It then hit several obstacles, including a concrete foundation of a fence, and flipped over several times.

Friday, October 10, 2008


Vertical moves in the VIX are "usually" (based on the relatively short history of the index, and minding the changes made to the composition of OTM options that comprise it) stamped out within 2 days of any 20% increase.

This chart looks like an advert for the market makers "look at how well it inversely correlates to market declines". Of course, making that conclusion by compiling option premia is dangerous...let's see how sustainable this is.


Just in time for earnings.

By Marine Cole
October 10, 2008 2:05 PM ET

The Financial Accounting Standards Board adopted new guidance on
fair-value accounting in illiquid markets today, giving financial
institutions more leeway to valueg financial instruments based on
internal inputs.

The board will release its final guidance Saturday, and it will be
effective upon issuance.

"I think it's safe to say when we wrote [Financial Accounting Standard
157 on fair-value accounting], we probably didn't contemplate exactly
the current situation that's developed in the credit and financial
markets," Robert Herz, chairman of FASB, said during today's meeting.

"Under such conditions, it's important to understand and apply both
the objective of 157 and the framework," Mr. Herz said. "By doing
that, it will require in some cases more analysis, more judgment."

In late September, FASB and the Securities and Exchange Commission
issued a joint clarification allowing companies to use more internal
inputs, related to future cash flow, for instance, when markets are
inactive and it is difficult to find trading prices.

FASB issued a proposed staff position on Oct. 3 clarifying the
application of FAS 157 on fair-value measurements in an inactive
market by providing an illustrative example.

Stability in Russia...

Its all economics. One should read this and think what likely ramifications are in store for a country with Russia's unique history and plan accordingly. Ironic that the one of the first countries to accept Marx's brilliant (yet terribly wrong) theory of eonomic determinism manifested as "dialectic materialism" will certainly not escape some of the more punitive conclusions from that theory.

Abramovich, Deripaska, Oligarchs Lose $230 Billion (Update1)

By Yuriy Humber, Greg Walters and Maria Kolesnikova

Oct. 10 (Bloomberg) -- Russian billionaires from aluminum magnate Oleg Deripaska to soccer-club owner Roman Abramovich lost more than $230 billion in five months during the nation's worst financial crisis since the 1998 default on its debt.

The combined wealth of Forbes magazine's 25 richest Russians tumbled 62 percent between May 19 and Oct. 6, based on the equity value of traded companies and analysts' estimates of closely held assets they own. The loss is four times larger than the fortune of the world's wealthiest man, Warren Buffett.

Moscow's benchmark Micex stock index declined 61 percent since its peak in May. The global credit seizure, war with Georgia and falling commodity prices led foreign investors to pull $74 billion out of Russia since the early August, according to BNP Paribas SA. While Russia's 1998 default and devaluation of the ruble eradicated savings for most of the population, this year's losses are wiping out its richest citizens' fortunes.

``There was a massive transfer of wealth into the hands of the oligarchs in 1998,'' said Mark Mobius, executive chairman of Templeton Asset Management Ltd., which has about $30 billion in emerging market stocks. ``Now it's going the other way.''

Thursday, October 09, 2008


Whatever credibility the ECB had is now gone. We will now see if the Euro remains a viable currency or becomes the latest casualty of a system of governance that had problems from the start. Divorcing fiscal and monetary policy is not advisable to any putative currencies.

Trichet Engineers ECB `Regime Change' as Banks Totter (Update2)

By John Fraher
Oct. 9 (Bloomberg) -- European Central Bank President Jean-
Claude Trichet is opening up the floodgates as the credit crisis
threatens to cripple the region's banking system.
Traditionally slower than its global counterparts to shift
policy, the ECB yesterday cut interest rates for the first time in
five years, joining in a global round of reductions. Trichet
declined to rule out further steps and today offered banks
unlimited cash to help them cope with frozen markets. The ECB also
gave banks a record $100 billion in overnight loans.
``This is a regime change,'' said Robin Marshall, director of
international fixed income at NCL Smith & Williamson, who oversees
about $20 billion in assets. ``This is a significant day in which
they've gotten real about the financial crisis.''
Trichet and other central banks are scrambling to restore
confidence in the global financial system after the credit crunch
spread from the U.S., pushing up borrowing costs to records. The
need for action is especially acute in Europe after governments
failed to agree on a rescue package acceptable across the region.
The ECB lowered its key lending rate by half a point to 3.75
percent, erasing a quarter-point increase in July, as the 15-
nation euro region teetered on the brink of a recession.
Historic Day

Wednesday, October 08, 2008

Down the drain

...a conversation over email today:

(answering the question: "How can a country drop the Euro and go back
to a national currency?

Makes it harder to go back, yes, but the incentive to default on the
ECB obligations is there...its an external currency debt problem that
we have seen a bunch of times. The incentive (and the risk) is there
to repudiate the ECB, the Euro, etc. and walk away.

It is likey some EU countries will realize that agreeing
to centralize monetary policy in a pan european institution is not as
favorable as issuing local currency backed by local tax collections.

Those countries that benefited from the euro will blame it for their
current predicament...and those that did not benefit as much are going to
suffer political and economic fallout.

Compression, continued

While today's actions are a good step in restoring confidence, the underlying problems will not be corrected with price adjustments on the time value of money.

Fiscal stimulus is sorely needed. Unfortunately the current institutional structure of Europe is not condusive to future growth.

The compression of G20 interest rates, something that has been forecasted here for some time, continues.

Oct. 8 (Bloomberg) -- The Federal Reserve, European Central Bank and four other central banks lowered interest rates in an unprecedented coordinated effort to ease the economic effects of the worst financial crisis since the Great Depression.

The Fed, ECB, Bank of England, Bank of Canada and Sweden's Riksbank each cut their benchmark rates by half a percentage point. The Bank of Japan, which didn't participate in the move, said it supported the action. Switzerland also took part. Separately, China's central bank lowered its key one-year lending rate by 0.27 percentage point.

Today's decision follows a global meltdown that sent U.S. stock indexes heading for their biggest annual decline since 1937; Japan's benchmark today had the worst drop in two decades. Policy makers are also aiming to unfreeze credit markets after the premium on the three-month London interbank offered rate over the Fed's main rate doubled in two weeks to a record.

Tuesday, October 07, 2008

Australia "Stuns" markets

But not readers here.

G20 countries are engaging in salvo after salvo of monetary warfare in an attempt to stave off the global contagion of capital flight and deposit withdrawal. It is ironic that the profits domestic banks saw as an opportunity to globalize their business has caused much more risk to their deposit base. If they experience capital flight in one jurisdiction, the entire world knows the bank is weak. Information technology has made markets able to panic much more "efficiently".

Australia slashes interest rate
By Peter Smith in Sydney

Published: October 7 2008 04:46 | Last updated: October 7 2008 07:25

Australia’s central bank stunned the market by cutting its benchmark rate by one percentage point, its largest reduction in 16 years, as evidence mounted the deepening financial crisis in the US and Europe could lead to a lengthy global downturn.

The severity of the cut, which takes the Reserve Bank of Australia’s cash rate to 6 per cent, wrong-footed economists who had predicted a 25 or 50 basis point reduction.

Monday, October 06, 2008

Compression, cont.

G20 interest rates cuts to near zero % is gaining "intellectual" steam now. A nice trial balloon. However, rate cuts alone will not stimulate aggregate demand enough. A Fiscal response is needed. Japan and especially the U.S. have the most license to accomplish this.

"So the case for interest rate cuts both in the euro area and the UK are strong indeed now, not because of any non-specific confidence effects or because this will help the solvency of their bankings sectors. While lower official policy rates do indeed permit banks to recapitalise themselves (provided the yield-curve is upward-sloping), the timing and scale of such official-policy-rate-led recapitalisation are such as to make it relevant to the resolution of the current crisis. Lower rates are required because an unexpected weakening of the real economy (caused by the collapse of the banking system) has increased the downside risks to inflation.

By how much and when should the Bank of England and the ECB cut their official policy rates? For both I would consider a 50 basis points immediate cut to be appropriate. When is immediately? For the Bank of England, this should be at the next regular rate setting meeting, on Thursday October 9. The ECB just met last week and decided to keep its official policy rate constant. A rate cut between the normal scheduled meetings of its Governing Council may well be more than the ECB can swallow, even though it would make sense."

Government policy summation, continued

The policies of this government, the flailing around of its agencies, and the wholesale effect of the United States congress in it zeal to be PERCEIVED as "doing something" and "taking action" has once again produced serious unintended consequences.

Intent: Curbing "speculation" that destroys value-adding financial firms.
Action: Banning short selling for a long list (who knows how one is added or deleted to the list) of financial firms.

Effect: Destroying support for share buy-backs as short-sellers close out positions. Destroying share-lending programs of financial institutions, limiting returns that would previously be inversely correlated with market declines.

Intent: Creating liquidity for MBS instruments and "toxic waste" financial assets
Action: TARP

Effect: Concentrating power in the Sec. of Treasury, no effect on Aggregate demand, creating general havoc for accounting treatment of the asset swap.

The equities markets have seen the breadth of the government's response and said a collective "whatever"...and went back to storming the doors for ANY safe or guaranteed asset.

Policy failures

This entire episode should be looked at as a demonstration of how overconfidence in knowledge leads to inherently bad decisions.

The "bailout" package was hailed by our political leaders as "action" in the face of a crises. Unfortunately, the market knows better and has said something like the following: "you should have studied how the bailout plan would effect aggregate demand and thus correct the underlying problems in this economy". A $700 Billion asset swap does not do that.

So the U.S. political leaders have been exposed as ordinary people on a sinking ship, panicking instead of thinking about the underlying problem and the best course of action to take in order to maximize surviveability. It also helps if one is prepared for this sort of outcome or has experience with same. It is truly unfortunate that Ben Bernanke, a celebrated student of the depression, does not see that the issue is a rapid decline of aggregate demand.

Deficit spending must happen statim. Tax breaks, infrastructure projects, etc. The markets are going to remain locked up until the only player left can get the wheels moving again. Remember, dear readers, the ability of the U.S. Government to expand the budget deficit (with fiat currency) is NOT CONSTRAINED by tax revenue. We should simply declare a moratorium on income taxes for an indefinite period. The Fed should do their part as well. Equity markets have lost trillions in (as yet unrealized) value. House prices have fallen by over 20% in some areas.

Stop treating symptoms as they arise and strike at the cause.


...of interest rates in developed (G20) countries.(especially those using the dollar as defacto reserve currency) is inevitable. Emerging markets will resist doing so as attracting capital in this environment needs special inducement.

Deflation has been the trajectory for this economy for some time, and it is interesting to note that the mainstream press has just now picked up on the meme.

Oct. 6 (Bloomberg) -- As Federal Reserve Chairman Ben S. Bernanke and his global colleagues fight the worst financial crisis since the 1930s, one danger is looming larger by the day: deflation.

With asset markets tumbling, commodity prices plunging the most in 50 years and banks keeping a tighter grip on credit, the ingredients for a sustained period of falling prices are coalescing. While inflation is still a concern for many policy makers only months after oil and food prices peaked, the risk is their patchwork of rescue and stimulus packages will fail, and prices will start to fall throughout the broader economy.

``The ghost of deflation could be dragged out of the closet again in coming months,'' says Joerg Kraemer, chief economist at Commerzbank AG in London.

A global recession is already looking more likely, with the credit freeze stirring memories of Japan's decade-long struggle with deflation in the 1990s. So European Central Bank President Jean-Claude Trichet and Bank of England Governor Mervyn King may be forced to follow Bernanke, whose Fed has chopped its benchmark rate by 3.25 percentage points since August 2007 to 2 percent -- its most aggressive round of easing in two decades.

Friday, October 03, 2008

The EU is Unraveling

As I said in a previous post, EU external debt is unraveling very quickly and it lacks the institutional mechanisms to deal with their funding crisis.

The only way to halt the decline is for EU members to offer deposit insurance for all members. This process, like everything in Brussels, will take time.

Unfortunately, time is not a luxury the EU has at the moment. This is the kind of thing that brings down governments.

Markets are responding. Peripheral members of the EU (I hesitate to use the acronym "PIGS" again) are suffering mass withdrawals from their banking systems.

And, since every other financial person is using a the patient-doctor analogy, I will weigh in with one of my own:

"The contagion is spreading, and amputation should not be ruled out at this point"

Clearly, policy formation in the EU has its first real trial by fire. We shall see if countries willingly cooperate at the EU level when it no longer benefits their populace.

Thursday, October 02, 2008

Trichet: Lets talk about throwing in the towel

Trichet and the ECB finally recognize the gravity of their predicament. My thesis of interest rate compression in developed countries has certainly not been refuted by the outcomes.

Oct. 2 (Bloomberg) -- European Central Bank President Jean- Claude Trichet's balancing act may be drawing to a close.

With the euro-region sliding toward its first recession since the single currency began trading in 1999, Trichet's ECB is finding it increasingly difficult to fight inflation and at the same time protect its 15-nation economy from the global credit crunch.

The result may be a move toward lower interest rates as financial turmoil damps growth and reduces inflation pressures. The crisis reached new heights in Europe this week, with governments forced to help bail out five banks and credit costs soaring to records as financial companies hoard cash.

``The ECB's Governing Council will have had a serious wake- up call in recent days,'' said Juergen Michels, a London-based economist at Citigroup Inc., who expects the bank to cut rates in December. ``The credit crunch has arrived on its doorstep.''

While the Frankfurt-based ECB left its benchmark rate at a seven-year high of 4.25 percent today, economists at Deutsche Bank AG, Goldman Sachs Group Inc. and JPMorgan Chase & Co. this week followed Citigroup in predicting a rate cut before the end of the year. Trichet is due to hold a press conference at 2:30 p.m.

Repatriation in Nippon

A veritable mountain of overseas cash could be repatriated in short order given these proposed taxation changes. However, one should be very careful deriving this conclusion from the below news article as the Japanese Ministry of Finance understands recursive systems very well. In this case, repatriation will lead to massive purchases of Yen to benefit from lower taxation. The demand for Yen will likely crowd out the inflationary effect of lower taxes. I am sure the MoF will wish to study the trade-off effects prior to rubber-stamping this measure.

Japan prefers a weaker Yen in order to prop up their export markets, and despite attempting to engineer controlled inflation for a decade, domestic demand remains weak. The U.S. remains the consumption engine for the world.

TOKYO (Nikkei)--Prime Minister Taro Aso told lower house lawmakers Wednesday that his government will consider including incentives for Japanese companies to repatriate profits earned abroad in a tax reform package for fiscal 2009.
"There's a wide range of tax issues we need to tackle, starting with creating an environment conducive to overseas subsidiaries' profits flowing back to Japan," Aso said in response to a question posed by ruling Liberal Democratic Party Secretary-General Hiroyuki Hosoda.

Japanese firms are increasingly leaving their profits abroad, where tax rates are often lower than at home. The Ministry of Economy, Trade and Industry has proposed exempting domestic companies from taxes on dividends from overseas affiliates in which they hold stakes of 25% or more, arguing that doing so would help boost domestic investment.
On other tax matters, Aso reiterated support for tax cuts during the current fiscal year and said that breaks for energy-saving technologies and other incentives will be considered. He also said that increasing the consumption tax is "unavoidable" but added that "it would be difficult in the current economic situation."
Lawmakers will begin debating fiscal 2009 tax reforms later this year.
As for economic stimulus measures, the prime minister stressed the need to pass the fiscal 2008 supplementary budget as soon as possible.

Wednesday, October 01, 2008

Brussels and Fiscal spending

Expect "revisions" to the Maastricht treaty. The markets will force their hand much as it forced the hand of our own politicans during this latest imbroglio. The "revisions" will be couched in terms of increased subsidiarity to the EU members, but will in reality seek to strip more economic sovereignity from its members. This will fail.

With individual countries having self imposed constraints on budget deficits, they cannot spend to address faltering domestic demand, and the PIGS certainly cannot issue more debt. Brussels has no fiscal authority among the several countries and does not insure bank deposits in the several countries. External debt can unwind VERY quickly.

We see that the Euro area is aping the U.S. "rescue package", and it has failed, at least initially. Recall that the Treaty has never been battle tested. We will see what it is made of.

And it is in serious trouble at the moment. The area needs US dollar funding more than their domestic currencies. The UK has also felt this lack of liquidity, but they of course can deficit spend as required to maintain aggregate demand.

The ECB is speaking strictly from a self-preservation standpoint (the reason detre of beurocrats) when it calls for order in the global markets.

My largest fear (longish term)is a return to conventional warfare. Europe has been at peace for 50+ years (not counting recent troubles in the Balkans). That is longest period of peace in over 1000 years. I am an Economic Determinist (Marx did have some good analytical tools, even if I think he came to some terrible conclusions) and when the chips are down, the Euro area does not exactly have the best record for picking themselves back up in a peaceful, collaborative manner.

Don't Panic.

Over the past several days, I have received all manner of dire predictions regarding this economy, the role of government leading up to and during this crisis, and the future of America.

My advice is always "Don't panic". Investment is as much an emotional pursuit as it is an analytical one.

During times like these, there are impassioned pleas of national solidarity - "we" must all get through this, etc. I have been told that the Democrats will benefit from this during the upcoming elections.

The Government is peforming its assigned role of chief meddler excellently...and they have succeeded in stopping some of the more pernicious recursions from which the economy suffers.

U.S. Equities are like a coiled spring.