In Hindsight Bernanke Was Prophetic in 2002

Thursday, December 18, 2008

Federal Reserve chairman Ben "Printing Press" Bernanke and his fellows around the FOMC oak table may appear being behind the curve since the onset of the debt crisis in August 2007. Its erratic rate policy rather followed loud calls from Wall Street pundits, establishing such nicknames like Nanny Benny or even Ben Dover.
But one has to wonder whether the Fed has really been all that clueless about the disastrous implications of a property market gone white hot, fuelled by cheap credit and next to no loan requirements.
Re-reading Bernanke's most infamous speech titled "Deflation: Making Sure 'It' Doesn't Happen Here" from November 2002 I am surprised that Bernanke had been actually quite prophetic about the future policy of the Fed.
Bernanke tabled already then the idea that the Fed could become a participant in the commercial paper market, buy long term US Treasuries and distribute government money willy-nilly (stimulus checks.)
At the same time he also touched the issue of zero interest rate policy (ZIRP), saying that the Fed could manipulate the long end of the market in order to keep financing costs low.
Bernanke has certainly made good on its promise to prevent deflation, continuing the easy money policy his predecessor Alan Greenspan had conducted in order to prevent all possible market meltdowns that came along. From the Black Monday '87, the mini crash '89, the Asian currency crisis in the mid 1990s, Long Term Capital Management in 1999, to the bubble in 2000 and the property bubble in this millennium the Fed has always thrown fresh credit at every problem that came along.
Read the following excerpts from Bernanke's speech that established his image of an inflationista and earned him the nicknames "Helicopter Bernanke" and "Ben electronic printing press Bernanke."
On deflation and zero interest rate policy:
...a deflationary recession may differ in one respect from "normal" recessions in which the inflation rate is at least modestly positive: Deflation of sufficient magnitude may result in the nominal interest rate declining to zero or very close to zero. Once the nominal interest rate is at zero, no further downward adjustment in the rate can occur, since lenders generally will not accept a negative nominal interest rate when it is possible instead to hold cash. At this point, the nominal interest rate is said to have hit the "zero bound."
...Beyond its adverse effects in financial markets and on borrowers, the zero bound on the nominal interest rate raises another concern--the limitation that it places on conventional monetary policy. Under normal conditions, the Fed and most other central banks implement policy by setting a target for a short-term interest rate--the overnight federal funds rate in the United States--and enforcing that target by buying and selling securities in open capital markets. When the short-term interest rate hits zero, the central bank can no longer ease policy by lowering its usual interest-rate target.
Running Out Of Ammunition
Bernanke then also admitted that a ZIRP diminishes the arsenal of weapons the Fed has. Now they boast of unspecified tools ready to direct interest rates.
Because central banks conventionally conduct monetary policy by manipulating the short-term nominal interest rate, some observers have concluded that when that key rate stands at or near zero, the central bank has "run out of ammunition"--that is, it no longer has the power to expand aggregate demand and hence economic activity. It is true that once the policy rate has been driven down to zero, a central bank can no longer use its traditional means of stimulating aggregate demand and thus will be operating in less familiar territory.
...However, a principal message of my talk today is that a central bank whose accustomed policy rate has been forced down to zero has most definitely not run out of ammunition. As I will discuss, a central bank, either alone or in cooperation with other parts of the government, retains considerable power to expand aggregate demand and economic activity even when its accustomed policy rate is at zero.
Preventing deflation:
Suffering from deflation phobia Bernanke then relied on the Fed's supervisionary powers in order to stabilize financial markets.
The Fed should and does use its regulatory and supervisory powers to ensure that the financial system will remain resilient if financial conditions change rapidly. And at times of extreme threat to financial stability, the Federal Reserve stands ready to use the discount window and other tools to protect the financial system, as it did during the 1987 stock market crash and the September 11, 2001, terrorist attacks.
Well, this obviously did not work in the current crisis where supervisors and authorities sat on their ears, eyes wide shut.
Curing Deflation:
Being by now the absolute high priest of ever expanding credit Bernanke sees his main task in growing debts to combat the ghosts of deflation.
...under a fiat (that is, paper) money system, a government (in practice, the central bank in cooperation with other agencies) should always be able to generate increased nominal spending and inflation, even when the short-term nominal interest rate is at zero.
In order to keep the party fuelled by spending going Bernanke mainly wants to push aggregate demand.
To stimulate aggregate spending when short-term interest rates have reached zero, the Fed must expand the scale of its asset purchases or, possibly, expand the menu of assets that it buys. Alternatively, the Fed could find other ways of injecting money into the system--for example, by making low-interest-rate loans to banks or cooperating with the fiscal authorities.
On fiat money and gold:
Ironically Ben's most immortal quotes about helicopters and the electronic printing press are linked in context with the virtue of gold, which is in contrast to Federal Reserve Notes (FRN).
Today an ounce of gold sells for $300, more or less. Now suppose that a modern alchemist solves his subject's oldest problem by finding a way to produce unlimited amounts of new gold at essentially no cost. Moreover, his invention is widely publicized and scientifically verified, and he announces his intention to begin massive production of gold within days. What would happen to the price of gold? Presumably, the potentially unlimited supply of cheap gold would cause the market price of gold to plummet. Indeed, if the market for gold is to any degree efficient, the price of gold would collapse immediately after the announcement of the invention, before the alchemist had produced and marketed a single ounce of yellow metal.
What has this got to do with monetary policy? Like gold, U.S. dollars have value only to the extent that they are strictly limited in supply. But the U.S. government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at essentially no cost. By increasing the number of U.S. dollars in circulation, or even by credibly threatening to do so, the U.S. government can also reduce the value of a dollar in terms of goods and services, which is equivalent to raising the prices in dollars of those goods and services. We conclude that, under a paper-money system, a determined government can always generate higher spending and hence positive inflation.
This may be the shortfall in Bernanke's thinking which is fixated on creating new credit. But growing government expenditures are certainly not the way to erode America's mountain of debt.
Oh, and for the record, here again Ben's helicopter quote, where he referred to Milton Friedman's helicopter drop in order to keep the economy going.
A money-financed tax cut is essentially equivalent to Milton Friedman's famous "helicopter drop" of money.
Still any doubts that Bernanke will ultimately be the death knell of the Fed, having created hyper inflation instead?

Plunging Energy Prices Lead European Inflation Sharply Lower in November

Wednesday, December 17, 2008

Sharply lower energy prices have resulted in a sharp decrease of European consumer prices. The headline annual inflation figure for the 15 Eurozone countries plunged from 3.2% in October to 2.1% in November, Eurostat reported. Transport fuels accounted for most of the improvement, registering a 4.9% MOM decline. Monthly inflation was -0.5% in November 2008.
Non-Euro members fare still worse.
EU3 annual inflation was 2.8% in November 2008, down from 3.7% in October. A year earlier the rate was 3.1%. Monthly inflation was -0.4% in November 2008.
East European countries are hit hardest. Relying on forex financing consumers are now stuck with higher installments for their Swiss Franc and Euro loans.
In November 2008, the lowest annual rates were observed in Germany and Portugal (both 1.4%), and France and the Netherlands (both 1.9%), and the highest in Latvia (11.6%), Lithuania (9.2%) and Bulgaria (8.8%).
Compared with October 2008, annual inflation fell in all Member States.
The lowest 12-month averages up to November 2008 were registered in the Netherlands (2.2%), Portugal (2.8%) and Germany (2.9%), and the highest in Latvia (15.6%), Bulgaria (12.3%) and Lithuania (11.1%).
In the Euro area
The main components with the highest annual rates in November 2008 were housing (4.5%), food (3.7%) and
alcohol & tobacco (3.5%.)
From all European countries Iceland recorded the highest inflation rate with an annual rate of 20%.
Find the complete table for all European countries here.
Eurostat now sports slightly easier access to information. For a long term inflation table click here. Eurostat is currently redesigning its website that will offer charts too. As of today the chart feature does not work, at least with a Mac and Safari browser.
As this slowdown in consumer price inflation is mostly based on plunging oil and gas prices whereas food is on the rise again, the HICP goods basket may not reflect current spending patterns of aging Europeans who are cutting back on more or less everything due to raising communal taxes and higher health spending.

Money For Nothin' And... - Fed Cuts Fed Funds Target To 0+

Share and bond markets rallied on Tuesday after the Federal Reserve announced that it will give away new money for almost free, lowering the Fed Funds target range to a historical low of 0% to 0.25%. The Fed had cut the Fed Funds rate in late October by 50 basis points. The new record low rate is a reaction to to the de facto status quo in treasury securities where short maturities of up to 6 months trade at yields below the upper end of the target range.
In a most unusual move the Fed provided publishable background on its decision, writes the WSJ blog, detailing it all here. The Fed has not held press briefings until now.
While markets welcomed the bold move, gold, the canary in the mine of inflation, advanced as well, piercing the important resistance at $850. Investors are obviously pricing in that all Treasuries yield less than the inflation rate of currently 3.7% YOY.
But the move to a zero interest rate policy will come at the cost of higher inflation in 2009 and 2010, it can be safely predicted. Chairman Ben Bernanke and his fellow Federal Open Market Committee (FOMC) members pulled out all stops in order to jumpstart the economy and assured market participants that the Fed would continue to engage in the dubious game of printing fresh money for collateral it does not want to talk about.
Once more proving their image of inflationistas par excellence the FOMC said the Fed can be expected to hold on to its free money policy for quite some time and use all tools to promote a return to growth.
The Federal Reserve will employ all available tools to promote the resumption of sustainable economic growth and to preserve price stability. In particular, the Committee anticipates that weak economic conditions are likely to warrant exceptionally low levels of the federal funds rate for some time.
But money for nothing alone will not help, the Fed reasoned, preparing markets for more growth in the Fed's balance sheet after it has exploded from $800 billion to $2.2 trillion since last summer. Expect the Fed to continue to buy more worthless MBS (mortgage backed securities) while substituting the banking sector in the commercial paper market.
The focus of the Committee's policy going forward will be to support the functioning of financial markets and stimulate the economy through open market operations and other measures that sustain the size of the Federal Reserve's balance sheet at a high level. As previously announced, over the next few quarters the Federal Reserve will purchase large quantities of agency debt and mortgage-backed securities to provide support to the mortgage and housing markets, and it stands ready to expand its purchases of agency debt and mortgage-backed securities as conditions warrant. The Committee is also evaluating the potential benefits of purchasing longer-term Treasury securities. Early next year, the Federal Reserve will also implement the Term Asset-Backed Securities Loan Facility to facilitate the extension of credit to households and small businesses. The Federal Reserve will continue to consider ways of using its balance sheet to further support credit markets and economic activity.
I translate this into "we will throw (fiat) money (that costs us next to nothing) on every problem as we did in the past 2 decades." See more worthless money created that will be exchanged for more MBS that are valued on a theoretical basis, i.e. not the market price which may be only a tiny fraction of the initial face value.
The announcement that the Fed is looking into buying longer term US Tresuries raises immediate fears that the Fed will be monetizing the federal debt again after a portfolio shift towards MBS in the recent past. Any talk about deflation misses the point of unprecedented monetary inflation that will show up in the real economy 2009/10.
Eric de Carbonnel argues at DollarDaze that monetary inflation does not even have to pump up money supply - my favorite theory - but that it is a loss of confidence that increases the velocity of money, resulting in the dange of hyper inflation.
The record low official Fed Funds rate may be elusive though. Jake at EconomPicData sees a disconnect between municipal bonds and Treasuries, reflecting the horrendous outlook for cash strapped communities which had invested heavily in property debt. Now they are broke.

GRAPH: The yield spread between Munis and 5-year Treasuries soared to a record high of 325 basis points. Graph courtesy of EconomPicData.

DollarDaze draws a historical comparison that shows deflation can be a hazy illusion.
As an example of deflation leading to hyperinflation, consider the case of the Weimar Republic. In 1920, Germany experienced a deflationary collapse, with the average citizen finding it harder and harder to get enough money for necessities. Banks, short of money, could not honor checks, and businesses were strapped for cash to buy materials and meet payroll. Fearing a collapse that would throw millions of workers out on the street, the German government desperately printed money in an attempt to re-inflate the economy. During this period, despite the government's money printing, the mark actually gained in value against foreign currencies, so that prices of imported goods fell by some 50%.
Eventually, as a result of the money supply's rapid expansion, the nation's massive foreign debt, and the shrinking economy, German citizens lost all confidence in their currency, and the Weimar Republic experienced one of the worst cases of hyperinflation in modern economic history.
Check out the time series of the Weimar hyper inflation - with the interim "correction" before it went parabolic - here.
The new policy to lend money to banks for free shows that the Fed is obviously willing to monetize all debt problems that come along. WIth its seven new financing tools introduced since the beginning of the crisis in August 2007 the Fed is already intervening in MBS markets and tries to keep the commercial paper market afloat.
But after all these attempts are nothing more than new fiat money with a different ribbon. The road to hyper inflation is clearly visible as were most problems already more than 3 years ago.
Time will show whether the Fed has been correct in its view of current conditions. Taking it from the past 15 months the Fed has been behind the curve despite its fast moves. It is to be doubted that the increasing readiness to prop up all markets with new money will mitigate the crisis. It will rather delay it but the point of no return comes closer with every day. Central banks have a bad record of containing inflation once they set the process into motion willingly.
But these facilities have not brought the liquefying effect the Fed had hoped for. So far all attempts to revive credit markets have failed, observes not only Bloomberg, which has all the details on Tuesday's rate decision.

Bush's Farewell in Iraq Ends With Ultimate Insult

Monday, December 15, 2008

In the fictitious series of "The popularity of president George W. Bush" historians can add another graphical milestone. During his last visit to Baghdad a reporter threw his shoes at Bush, missing the ducking commander in chief by only a hair's width.
Calling Bush a dog the reporter expressed his disgust with the person responsible for 100,000s dead civilians with two of the most serious insults in Arabic culture. Watch the 58-second clip to get an idea what legacy this president leaves behind.

US Treasuries - The Biggest Bubble Of All

Having seen most of the bubbles bursting I had listed in this post from 2005 the world may soon be in for the mother of all bubbles. With a size of $10 trillion the US government debt market has remained the world's #1, now that MBS have shed the better part of their initial values.
US treasuries have long been hailed as a safe haven for money fleeing from other overheated markets. Massive losses in more or less all other asset classes in the past 15 months have shown that investors followed Pavlov's reflexes, driving the 10-year yield to a record low of 2.55% last week.
CHART: The yield for 10-year US Treasury debt fell to a record low of 2.55% last week. This chart may see a sudden reversal based on the fundamentals.
It may be questioned whether this trust into the Federal Reserve's ability to contain long term inflation is justified, given the fact that chairman Ben Bernanke will enter history as the fastest money printer of all times.
While the Fed has reduced its federal debt holdings by $290 billion to $484 billion (buying doubtful MBS instead) in the last 12 months it was foreign investors TIC data and Treasury statistics show.
This has driven yields across the curve to record lows, leaving investors with a negative real yield when discounting inflation. US Inflation was 3.7% YOY as of October.
Institutional investors have been allocating more money into US treasuries recently, citing the safe haven status of American government bonds. But this era may be coming to an end as so many things do nowadays.
There appears to be a split of opinion. While European and American investors follow the old rule of buying US debt with a questionnable AAA rating their Asian counterparts see themselves trapped with US debt holdings they cannot sell in order to avoid a panicky stampede out of the biggest market of all.
The deficit outlook justifies a skeptical approach. Barack Obama will have to finance a budget deficit of an estimated $1 trillion in 2009, the biggest in American history. If Mr. Obama will not manage a U-turn in foreign policy which was mainly based on ignorance and arrogance under Bush, he could run into financing problems. China has urged other countries to replace Federal Reserve Notes with their own currencies in bilateral trade and voiced its concern about US fiscal policy repeatedly.
The global downturn may bring a different borrowing climate too. Losses in all asset classes across the board and record low yields will result in lower reinvestment amounts overall, it can be safely projected.
The borrowing needs will skyrocket as both the federal government and bankrupt local communities will scramble for funds to replace sudden drops in tax revenues.
Bets On A US Default Become More Expensive
While still being a mainstay for investors from all around the world, not everybody is confident about the future of a USA in the grip from the biggest financial crisis ever. Some wary souls are increasingly buying insurance against a default of the US government. According to a Reuters report from November 26, credit default swaps involving Treasuries reached a record high.
Ten-year U.S. Treasury CDS widened to 54.7 basis points from Tuesday's close of 50.0 basis points, credit data company CMA DataVision said.
Five-year Treasury CDS jumped to a record 52.0 basis points from Tuesday's close of 47.50 basis points, it said.
In plain language this means investors were willing to pay $54,700 to insure a portfolio of $10 million 10-year debt paper.
Summarizing the fundamentals such as no end to new debts, tax shortfalls, higher social and military expenditures, a central bank willing to monetize the debt and flooding the world with fresh Federal Reserve Notes, it can be safely bet that this bubble will end like all bubbles: In a gigantic burst that will unsettle everything we have learned about investing in the past.
A hat tip to Econbrowser who undug this paper by Stanford economics professor John Taylor on the failures of the Fed in the current crisis and why it all became worse this autumn.
I stand by my opinion that monetary inflation is in the early stages worldwide and will have seeped through into the real economy in 2009/10.

Main US Creditors Rubbing Shoulders Together

Sunday, December 14, 2008

Having been burned by premature investments in ailing US companies the three biggest creditors of America are teaming up in order to push their agenda for a new financial world order since most European and American banks are trending towards bankruptcy, only held alive by irresponsible government guarantees these days.

PHOTO: Chinese Premier Wen Jiabao (L), Japanese Prime Minister Taro Aso (C) and South Korean President Lee Myung-bak shake hands after signing a joint statement for Tripartite Partnership. Photo: Xinhua
According to official Chinese media,
The tripartite cooperation will not only contribute to create a peaceful, prosperous and sustainable future for the region and international community, but also be crucial to address the serious challenges in the global economy and the financial markets, said the statement.
The statement also said the tripartite meeting in Fukuoka will pave the way for a new era of tripartite partnership which will lead to the peace and sustainable development in the region.
The single biggest commonality between the 3 powers are their gigantic holdings of US debt and other US assets. Faced with the danger of exploding losses from these holdings because of America's nosedive into depression share a common problem they can only influence to a certain degree. As all other holders of US securities a stampede out of FRNs would wipe out a good part of these national savings.
Chinese Premier Jiabao said on Saturday that
China can not only maintain a steady and relatively fast economic growth through efforts and getting over difficulties, but also elevate its economy to a new level by overcoming the ongoing financial crisis.
China has repeatedly voiced its concerns with a dominant Western style financial system that is now failing on a wide scale. In the recent past China has tabled the future of the debt-ridden US economy, swinging widely between options.

One Of The Most Powerful Authorities In The World...

...and most European citizens could not say what they are exactly doing and so would I. In 2009 the European Parliament (EP), highest authority in the European Union, will be elected for the seventh time since 1975 in June 2009. The EU Parliament has raised its level of influence since the 1990s after starting out more or less as a talk shop with no legislative powers that was overridden by the appointed EU Commission. Its first act of significant resistance dates back to 1999 when it forced the EU Commission under Jaques Santer to resign over a budget affair.
With more than 320 million eligible voters it is the only EU wide election and voter turnout in 2004 was 45.6%.
The 732 seats are divided between Conservatives (269), Social Democrats (200), Liberals (88), Greens (42), Communists (41), Eurosceptics (37), Nationalists (27) and Independents (29.)
Despite its influence the EP is not anchored in the political conscience of most Europeans. In Austria there is a gut feeling that the EP is the scapegoat of national parliaments, pushing all discomforting political issues on a continent facing dramatically worsening demographics. This comes together with a general uneasiness about the loss of sovereignty of the EU member countries.
A good example for recent disconcert is the drive to enact a Europe wide restriction of smoking in public places and entertainment venues. While hailing a free market ideology that has become the stumbling block for a proposed EU constitution the supra-national behemoth in Brussels has a tendency to overregulation that interferes with regional customs, culture and individualities. Empty cafes all over Europe with shivering customers preferring the outside smoking areas are a good sign for the lack of connection between bureaucrats and citizens. Citing protective health rights of non-smokers and wanting a EU wide smoking prohibition the EU has not yet touched Europe's biggest drug problem, alcohol. The drug of choice is certainly the biggest burden on national health systems.
With legislative powers shifting to the EP, which affords two residences in Brussels and Strasbourg at the expense of EU taxpayers, this brings the problem of a lacking disability to protest effectively. How would you organize a 1000 km trek of 100,000 Austrians to Brussels?
Overcoming the general distrust between bloggers and the traditional mainstream media and sensing a lack of awareness about the EP the non-profit European Journalism Centre (ECJ) has initiated a blogging contest that will bring bloggers from the 27 EU members together. Th!nk About It will be a common effort of this group of bloggers to report on the EP elections and this blog will be part of it, covering mainly the socioeconomic aspects of EU legislature.

Fed Won't Tell Who Got The $2 Trillion

Friday, December 12, 2008

In a move not exactly designed to lower investors fears about rampant monetary inflation and other shady dealings without congressional oversight in the USA the Federal Reserve is battening down the hatches.
While money printing has become a fairly transparent business for central banks in the past 2 decades, the Fed acts like comical Ali in Baghdad, claiming there is no fire when everybody can see plumy smoke.
Going out of its way in order not to disclose documents related to the give-away of $2 trillion, the Fed rejected a Freedom of Information Act request by information provider Bloomberg that requested information about the recipients of this sizable addition to taxpayers burden.
Bloomberg filed suit Nov. 7 under the U.S. Freedom of Information Act requesting details about the terms of 11 Fed lending programs, most created during the deepest financial crisis since the Great Depression.
The Fed responded Dec. 8, saying it’s allowed to withhold internal memos as well as information about trade secrets and commercial information. The institution confirmed that a records search found 231 pages of documents pertaining to some of the requests.
A True Novelty In Journalism
Bloomberg's move to sue the Fed is a novelty in journalism. The former bond trader who built the leading financial information provider from scratch in 2 decades has opened a front against the secretive Fed, a privately owned organization that has never been audited and is constitutionally questionnable. Bloomberg must know what he is doing. The rule #1 for bond traders was always "never fight the Fed."
In the Fed's view, disclosing the recipients could obviously aggravate the financial crisis, taking it from their response to Bloomberg:
In response to Bloomberg’s request, the Fed said the U.S. is facing “an unprecedented crisis” in which “loss in confidence in and between financial institutions can occur with lightning speed and devastating effects.”
The Fed supplied copies of three e-mails in response to a request that it disclose the identities of those supplying data on collateral as well as their contracts.
While the senders and recipients of the messages were revealed, the contents were erased except for two phrases identifying a vendor as "IDC.” One of the e-mails’ subject lines refers to “Interactive Data -- Auction Rate Security Advisory May 1, 2008.”
Brian Willinsky, a spokesman for Bedford, Massachusetts- based Interactive Data Corp., a seller of fixed-income securities information, declined to comment.
"Notwithstanding calls for enhanced transparency, the Board must protect against the substantial, multiple harms that might result from disclosure," Jennifer J. Johnson, the secretary for the Fed’s Board of Governors, said in a letter e-mailed to Bloomberg News.
In its latest report on the matter Bloomberg quoted lawyers, journalists and market participants who share the desire to know more about the recipients of rapidly expanding Fed credit.
Accoding to the Wall Street Journal bank credit is on a runaway pace and could top $3 trillion next spring.
When all lending facilities are included, the Fed's balance sheet stood at over $2.26 trillion on Wednesday. Once recently announced programs to help consumer credit and mortgage markets are up and running, that figure should climb toward $3 trillion. The balance sheet was under $1 trillion as recently as mid-September. The U.S. commercial-paper market has expanded for seven consecutive weeks, jumping $48.6 billion in the latest week alone. Thursday's data suggest Fed purchases account for most of the growth in that sector.
Banks are refusing to release this information too as it would shed a light on their financial weakness.
Bloomberg is not alone in his fight. American lawmakers have demanded more transparency as recent as December 10.
Congress is demanding more transparency from the Fed and Treasury on bailout, most recently during Dec. 10 hearings by the House Financial Services committee when Representative David Scott, a Georgia Democrat, said Americans had “been bamboozled.
Right to Know
Media representatives tune into the choir for more transparency.
“There has to be something they can tell the public because we have a right to know what they are doing,” said Lucy Dalglish, executive director of the Arlington, Virginia-based Reporters Committee for Freedom of the Press.
“It would really be a shame if we have to find this out 10 years from now after some really nasty class-action suit and our financial system has completely collapsed,” she said.

It won't take 10 years to find out that an empire in decline has tried all dirty tricks to stay above the waterline.

Fed Plans The Next Layer Of Funny Fiat Money - WSJ

Wednesday, December 10, 2008

Ladies and gentleman, fasten your seat belts in anticipation of more monetary madness. In its drive to keep the helicopters above Wall Street (and certain privileged corporate headquarters) filled with colourful stacks of fiat money that can be showered onto everybody that is deemed too big to fail the Federal Reserve blueprints a new layer of debt, writes the Wall Street Journal on Wednesday.
According to the story based on sources "familiar with the matter" the Fed considers to issue its own debt. This would allow the Fed to circumvent banks as intermediaries, possibly leading to a recovery of capital markets. But it could also lead to a situation where the Fed would be a direct competitor to the US Treasury in debt issuance.
While the privately owned Fed's right to print unbacked fiat money is already constitutionally doubtful (see my sidebar) even the Federal Reserve Act does not explicitly permit the Fed to issue debt either.
As chairman Ben Bernanke religiously follows a policy of the easiest money ever in order to combat what will become a bigger depression than the 1930s Ben is looking into new ways to drop Federal Reserve Notes all over the world.
Always remember that chairman Ben Bernanke has become the biggest and fastest money printer in the history of mankind by now, doubling the monetary base within a week. It took 95 years for the first 750 billion. Ben added the same amount last November.
The WSJ reasons that the Fed has to make a move because of the explosive growth of its balance sheet and the questionnable quality of its collateral.
What the WSJ does not ask is whether the continuation of the game of unlimited funny money is another desperate attempt to keep the biggest Ponzi scheme of all times running a little longer. Without ever expanding credit the whole FRN scheme is destined to fail as did ALL other unbacked fiat currencies before.
From the WSJ:
The Federal Reserve is considering issuing its own debt for the first time, a move that would give the central bank additional flexibility as it tries to stabilize rocky financial markets.
...Fed officials have approached Congress about the concept, which could include issuing bills or some other form of debt, according to people familiar with the matter.
It isn't known whether these preliminary discussions will result in a formal proposal or Fed action. One hurdle: The Federal Reserve Act doesn't explicitly permit the Fed to issue notes beyond currency.
Just exploring the idea underscores many challenges the ongoing problems are creating for the Fed, as well as the lengths to which the central bank is going to come up with new ideas.
At the core of the deliberations is the Fed's balance sheet, which has grown from less than $900 billion to more than $2 trillion since August as it backstops new markets like commercial paper, money-market funds, mortgage-backed securities and ailing companies such as American International Group Inc.
The ballooning balance sheet is presenting complications for the Fed. In the early stages of the crisis, officials funded their programs by drawing down on holdings of Treasury bonds, using the proceeds to finance new programs. Officials don't want that stockpile to get too low. It now is about $476 billion, with some of that amount already tied up in other programs.
The Fed also has turned to the Treasury Department for cash. Treasury has issued debt, leaving the proceeds on deposit with the Fed for the central bank to use as it chose. But the Treasury said in November it was scaling back that effort. The Treasury is undertaking its own massive borrowing program and faces legal limits on how much it can borrow.
More recently, the Fed has funded programs by flooding the financial system with money it created itself -- known in central-banking circles as bank reserves -- and has used the money to make loans and purchase assets.
Some economists worry about the consequences of this approach. Fed officials could find it challenging to remove the cash from the system once markets stabilize and the economy improves. It's not a problem now, but if they're too slow to act later it can cause inflation.
Moreover, the flood of additional cash makes it harder for Fed officials to maintain interest rates at their desired level. The fed-funds rate, an overnight borrowing rate between banks, has fallen consistently below the Fed's 1% target. It is expected to reduce that target next week.
...There are also questions about the Fed's authority.
"I had always worked under the assumption that the Federal Reserve couldn't issue debt," said Vincent Reinhart, a former senior Fed staffer who is now an economist at the American Enterprise Institute. He says it is an action better suited to the Treasury Department, which has clear congressional authority to borrow on behalf of the government.
I conclude the Fed is looking for ways to fuel future monetary hyper inflation in truly creative ways. This move comes only 2 months after the Fed had announced unlimited FRN refinancing in collaboration with other major central banks.
Bernanke is of the stubborn opinion that the last depression was a result of too tight monetary policy. While this may be true to a certain extent we have no reality based example that a zero interest rate policy has helped averting an economic downturn that stemmed from too much easy money in the first place. It was the Fed that refused to recognize the unsustainable property bubble. It appears this was not their first mistake and it will not be their last one.

Austrian CB Projects Mild Recession In 2009

Tuesday, December 09, 2008

Eurozone member Austria is slipping into a recession these days that will last during 2009, the Austrian central bank said in a press release on Tuesday.
Austria has been hit especially hard by economic woes in Eastern Europe, the traditional backyard of Austrian companies and banks that have been expanding into this region since the fall of the iron curtain in 1990.
Thanks to a strong first half 2008 Austria will be able to record an overall GDP growth figure of 1.6% this year. The rapid economic contraction in Europe spells near term problems, though, leading to 0.3% lower GDP in 2009. 2010 should bring a reversal again with the Austrian central bank forecasting a 0.8% higher GDP again.
"Despite difficult circumstances Austria's economy has grown through Q3 2008", central bank governor Ewald Nowotny said, adding, "that the global downturn presents Austria with a very serious challenge."
Compared with the last projections from June 2008, the central bank has reduced its growth forecast for 2009 and 2010 by 2 and 1.6 percentage points. This is mainly based on lower private consumption growth and sinking gross investment expenditures. As most Eurozone countries the Austrian economy suffers from a rapid change in sentiment among both companies and consumers. Austria has not yet embarked on the irresponsible path of stimulus packages as they are currently being discussed in France, Germany and Spain. In the long term such stimulus packages are nothing else than an anticipation on future tax revenues with the additional burden of the interest to be paid for these loans.
Unemployment is expected to pick up to a 2009 rate of 4.2% after 3.7% this year.
Austria's federal debt will rise from a current 59.3% of GDP to 61.2% in 2009 and 63.1% in 2010.
Real wages are forecasted to rise 1.2% in 2009 after a 0.1% contraction in 2008.
The only bright spot is inflation which is forecast to drop to 1.4% in 2009 after a 2008 average of 3.3%. These figures are distorted by changes in the goods and services basket which has become unaligned with actual consumer needs by overweighting those goods that rose slowest in price while reducing the weightings of government and private services.
Austria's stellar savings quota of 12.7% of disposable income is expected to rise to 13.6% in 2009 and 13.7% in 2010. But this high savings rate distorts the real picture stemming from a continually growing gap between the wealthy and the growing class of the working poor.
My anecdotal evidence shows that both consumers and companies have been shelving plans for outlays due to a very cautious behavior of Austrians in the light of bad news being reported on a daily basis.
As in most European countries big ticket items are getting harder to sell with every new day, hitting especially consumer goods sales.

ECB Will Make Money Ever Cheaper - Governors

Monday, December 08, 2008

Reflecting on the sharp and sudden downturn in most Eurozone countries the European Central Bank (ECB) can be expected to lower the price of Euros for banks even further after the record rate cut from last Thursday that brought the main refinancing rate to 2.50%, the lowest in 2 1/2 years.
Lower inflation rates due to sinking commodity prices and a Eurozone wide recession make ECB council members sitting on the edge, Reuters reported in a wrap up on Monday.
ECB President Jean-Claude Trichet, in testimony on Monday to the European Parliament's economic committee, said unexpected further declines in commodity prices could put downward pressure on inflation, while upside risks to price stability could materialise if the fall in commodity prices were to reverse.
The ECB staff has lowered its inflation expectations for 2009 dramatically, forecasting an inflation rate of 1.1% to 1.7%.
Other governors said during the weekend that the ECB has not run out of ammunition to combat inflation while keeping monetary policy accommmodative to the needs of Eurozone banks who are currently hooked to a one trillion Euros lifeline that can be expected to grow more, taking recent history as a guidance for future policy moves.
Athanasios Orphanides, head of the Cyprus central bank and an ECB Governing Council member, said the euro zone economy was set for an extended downturn and inflation would keep falling.
"In light of the continuing improvement in the outlook for inflation, even following last week's interest rate action by the Governing Council there remains considerable room for monetary policy to manoeuvre," he told the Cyprus parliament's finance committee.
Orphanides's Greek counterpart, George Provopoulos, said on Monday that the ECB has enough monetary tools. "There is no issue when it comes to lack of ammunition. The ECB has ample monetary policy ammunition," he told the British-Hellenic Chamber of Commerce.
Austria's Ewald Nowotny told Bloomberg news agency that the ECB is keeping its options open on interest rates and does not want to be pressured by expectations.
"The situation is open," he said. "We'll observe how things are working, what's happening, and then we'll see. The ECB certainly doesn't want to be pressured by expectations."
"I favour a steady-hand policy. Having said that, one should always retain the flexibility to react to new developments. There's certainly room for manoeuvre if the future economic development is significantly weaker," he said.
Spain, one of the countries hit hardest by the property bust sees cheaper Euros in the future too.
The ECB does not exclude reducing the price of money again in the next few months, (spanish) Executive Board member Jose Manuel Gonzalez-Paramo said.
Gonzalez-Paramo said at a conference in Malaga which was reported by the Spanish newspaper La Opinion de Malaga, over the weekend, that the inflation outlook was improving.
"We don't rule out reducing the price of money again in the next few months," he was quoted as saying.
With the dramatic downturn of the Eurozone economy in mind that has led to a fully fledged recession accompanied by rising unemployment it appears that the ECB governing council is now more worried about GDP growth than its single mandate to fight inflation. Inflation may indeed sink below the 2% target in the light of receding commodity prices after plunging to 2.1% in November.
But this policy may have its pitfalls. These latest announcements show that the ECB is blind on monetary inflation which stems from an overly abundant supply of freshly digitized Euros. This way the ECB hopes to keep banks afloat that speculated with mortgage backed securities, forex loans and had in general too soft guidelines for new loans. The ECB's balance sheet roughly tripled within the first 10 years of the common currency that is under strain from the very different economic situation in the 15 Eurozone countries. With this kind of monetary expansion all talk of a possible deflationary development can be called bull.....

ECB Counters Faltering Economy With Record Rate Cut

Thursday, December 04, 2008

A multitude of recent bad economic data has lead to a record rate cut in the Eurozone. On Thursday the European Central Bank (ECB) cut its leading overnight interest rate 75 basis points to 2.50%, accelerating the downward spiral of interest rates after two 50 basis point cuts in October and November.
The strong move signals the willingness of the ECB to lend governments a helping hand in overcoming the current Eurozone recession that will become official in the next weeks. According to a first estimate by Eurostat the Eurozone economy continued on a downward path in Q3 2008, recording another quarterly contraction by 0.2% of Eurozone GDP.
It has to be seen yet that the aggressive loosening of monetary policy will bring another result than monetary inflation only. In the press conference following the rate setting meeting ECB president Jean-Claude Trichet warned not to mistake lower goods prices for a deflationary environment.
In his introductory statement, Trichet credited mainly sharply lower inflation - which has receded from a record 4% in July to 2.1%, remaining only a tick above the ECB's target rate of 2% or less - for the radical rate cut.
The significant decline in headline inflation since the summer mainly reflects the considerable easing in global commodity prices over the past few months, which more than offsets the impact of the sharp rise in unit labour costs in the first half of this year.
Looking forward, lower commodity prices and weakening demand lead us to conclude that inflationary pressures are diminishing further. The annual HICP inflation rate is expected to continue to decline in the coming months and to be in line with price stability over the policy-relevant horizon. Depending primarily on future developments in oil and other commodity prices, a faster decline in HICP inflation cannot be excluded around the middle of next year.
This outlook has also led to sharply lower inflation expectations, said Trichet.
Consistent with this assessment, the December 2008 Eurosystem staff projections foresee annual HICP inflation of between 3.2% and 3.4% for 2008 and declining to between 1.1% and 1.7% for 2009. For 2010, HICP inflation is projected to lie between 1.5% and 2.1%. The HICP inflation projections for 2008 and 2009 have been revised downwards substantially in relation to the September 2008 ECB staff projections, reflecting mainly the large declines in commodity prices and the impact of weakening demand on price developments.
In his monetary analysis Trichet pointed out that money supply growth, at 8.7% almost double the reference rate of 4.5%, continued to show signs of further depreciation, although at a high level. An intensification of the market turmoil since mid-September has not yet shown up in money supply due to shift in the M3 components itself, he said.
The most recent money and credit data indicate that this intensification has had a significant impact on the behaviour of market participants. Thus far, such developments have largely taken the form of substitution among components of the broad aggregate M3, rather than sharp changes in the evolution of M3 itself.
The latest available data, namely up to the end of October, reveal a continued moderation of the growth rate of loans to the non-financial private sector. At the same time, for the euro area as a whole, there were no significant indications of a drying up in the availability of loans. The annual growth rate of loans to households also moderated further, in line with the weakening of economic and housing market prospects and tighter financing conditions.
Summing it all up Trichet warned that risks to economic growth were sustaining. He saw the possibility that Eurozone growth could retract further while inflation shoukd remain below record levels due to diminishing demand.
In the view of the Governing Council, the economic outlook remains surrounded by an exceptionally high degree of uncertainty. Risks to economic growth lie on the downside. They relate mainly to the potential for a more significant impact on the real economy of the turmoil in financial markets, as well as concerns about protectionist pressures and possible disorderly developments owing to global imbalances...
To sum up, there is increased evidence that inflationary pressures are diminishing further and inflation rates are expected to be in line with price stability over the policy-relevant horizon, supporting the purchasing power of incomes and savings. The decline in inflation rates is due mainly to the fall in commodity prices and the significant slowdown in economic activity largely related to the global effects of the financial turmoil.

I would not buy Trichets complacency. The latest weekly financial statement of the ECB shows no structural improvement. Banks are still limping around with the help of more than one trillion Euros with bank credit. This monetary expansion will act as a strong counter force to efforts for lower inflation rates. Monetary inflation will begin to seep through into the real economy with a time lag of 6 to 15 months, menaing the Eurozone could be in for a bad price surprise next year.

Eurozone Banks Have Inadequate Stress Testing Methods

Saturday, November 29, 2008

A new report published by the European Central Bank (ECB) arrives at the conclusion that the stress testing methods of Eurozone banks are inadequate and have been introduced in some cases only after the beginning of the credit crisis in August 2007.
The report on "EU Banks' Liquidity Stress Testing and Contingency Funding Plans" carried out by the ECB's Banking Supervision Committee arrives at the sour conclusion,
that there is substantial room for improvement in both areas.
Surveying 84 Eurozone banks the ECB said that there was no common standard for the stress testing methods which were insufficient for the majority of banks.
The most common scenarios in liquidity stress tests are idiosyncratic scenarios and market scenarios, although not all banks run both types of scenario. Only a sizeable minority run integrated market and idiosyncratic scenarios.
Highlighting the shortcomings of most banks' stress tests the report points to a lack of different time frames.
Most banks run stress test scenarios that cover either short-term (e.g. four-week) or longer- term (e.g. 12-month) horizons, but only a few test market scenarios with both short and longer-term horizons. The BSC highlights the need for scenarios to be tested for all time horizons which are relevant to banks’ maturity proļ¬les and vulnerabilities.
Another major point for the ECB is the fact that almost all banks disregard cross-border flow problems. Admitting more than a year after beginning of the credit crisis that we are in a crisis situation, the ECB warns that such risks are particularly prevalent in these times.
... Banks do not always include potential barriers to the cross-border flow of liquidity in their stress tests, even though these can be particularly prevalent in crisis situations. In the face of potential barriers to the cross-border flow of liquidity and collateral, the BSC regards running stress tests at both the group and the entity level and accounting for these potential barriers in liquidity stress tests and contingency funding plans (CFPs) as improvements on current practice.
Shareholders Rights Are Secondary
Secretiveness on behalf of the banks is another problem that impedes a comparison of stress tests and their outcomes. The ECB proposes concerted stress tests for Eurozone banks. Proper information policy is not encouraged, though. The ECB recognizes the fact that early publication of banks' liquidity problems may aggravate the survival chances of a bank while paying only lip-service to shareholders information rights.
Banks are reluctant to disclose the results of their liquidity stress tests (apart from to supervisors, rating agencies and some key counterparties) because the results cannot be interpreted without a detailed understanding of the scenarios and the considerations underlying them. The results are therefore not comparable across banks. In addition, public disclosure could have negative repercussions on the liquidity situation of some banks under certain circumstances. While more disclosure, in particular on banks’ liquidity risk management, is generally to be encouraged, the BSC considers that, in the case of liquidity stress test results, the detrimental effects of mandatory public disclosure are likely to outweigh the benefits. Nevertheless, a majority of banks also regard public disclosure in this area as a tool for enhancing market discipline, subject to certain preconditions. In this respect, concerted rounds of common liquidity stress tests – which are conducted, for example, for supervisory/financial stability purposes without affecting banks’ routine liquidity stress tests for internal purposes – would help to increase the comparability of the output of internal models across banks.
The ECB did not find more encouraging practices concerning contingency fund plans (CFP.) As with stress tests there is no ideal CFP that would be applicable to all banks. But there is a lot of room for improvement, it noted.
The typology of EU banks’ CFPs is highly diverse, both in terms of their level of detail and their exact components. The typical CFP consists of a set of liquidity measures, internal procedures, responsibilities and lines of authority to be activated under liquidity stress. CFPs exist at the group level and/or the entity level, but many CFPs seem to cover only parts of the organisation, both in terms of geographic exposure and business areas.
... Given the diversity and complexity of practices, supervisors and central banks need to enhance their understanding of individual CFPs.
With banks being more equal than other corporations the ECB signals political willingness to support money centre banks in case of seizing money markets. This still leaves some other risks, though.
In the BSC’s opinion, it is also important that CFPs take into account potentially destabilising second-round effects on markets from liquidity-saving measures and/or asset sales, particularly in the case of large institutions.
No Quick Fix
Summarizing its survey results the ECB sees no quick fix although exactly that would be needed to mitigate the current crisis that is still on a steep downward path.
Although recent events indicate that CFPs have proved useful in establishing chains of command, a large number of banks failed to activate their CFPs. In some cases, this was blamed on the reputational costs of doing so.
The BSC considers it important that potential reputational challenges associated with the activation of CFPs be overcome, as otherwise they substantially reduce the usefulness of an important liquidity crisis management tool.
While most of the areas in need of improvement identified by the BSC could be addressed in the short term, it is likely that improvements addressing best-practice model developments (such as the inclusion of second-round effects or more integrated views of liquidity, credit and market risk) or the adoption of guidelines can be addressed only in the medium term.

Plans for contingency funding revolve around the all too well known phenomenon of creating more debt. While asset sales lead the list of instruments in an emergency all other options are debt based. I am not very confident that this will work in credit markets that are essentially seized up and show no sign of improvement.
While it is nice to read that the ECB finally acknowledges the sad reality that the crisis has not eased since its beginning 15 months earlier the spotlight is on the banks' inadequate preparedness for a major credit default that must be waiting around the corner given the continuing nervousness and distrust among lenders in the interbank market.

Eurozone Inflation Plummets to 2.1% - M3 Growth Unchanged at 8.7%

Friday, November 28, 2008

According to a flash estimate of Eurostat statistics office Eurozone inflation plummeted to 2.1% in November after 3.2% in October. While the flash estimate delivers no details on the price changes in the goods basket it can be safely assumed that plunging oil prices and receding commodity prices in general will have contributed prominently to the dramatic decline.
Eurozone inflation last held at this level in September 2007, piercing the ECB target rate of 2% for the first time in history and has since reached a record high of 3.7% in May 2008.
Find a table of long term Euro inflation here.
Money supply is still way above the reference rate of 4.5% with an unchanged reading of 8.7% in October. The three-month average of the annual growth rates of M3 over the period August 2008 - October 2008 declined to 8.7%, from 8.9% in the period July 2008 - September 2008, the ECB reported on Thursday.
Unemployment is on the way up, probably due to the contraction in the building industry. Eurostat records show a slight rise to 7.7% in October, compared to 7.6% in September. It was 7.3% in October 2007.
The EU27 unemployment rate was 7.1% in October 2008, compared with 7.0% in September. It was 6.9% in October 2007.
This data comes on the heels of declines in industrial orders a few days earlier.
In September 2008 compared with August 2008, the euro area1 (EA15) industrial new orders index fell by 3.9%.
In August the index decreased by 1.5%. In the EU27 new orders declined by 4.6% in September 2008, after dropping by 1.7% in August. Excluding ships, railway & aerospace equipment4, for which changes tend to be more volatile, industrial new orders decreased by 2.2% in the euro area and by 2.7% in the EU27.
With sentiment in the basement this data set delivers a mixed outlook for the European economy at best.

I Wanna Be a Bank

Thursday, November 27, 2008

Flirting with the Hindu theory of reincarnation I have decided to do my utmost that may give me a chance to be reborn as a bank.
Just imagine what life must be like. Compare it maybe to a video game where the drunk driver can crash into a wedding party, killing most attendees and wrecking the car. At that point Uncle Sam comes around, saying "no problem boy, never mind all the mangled corpses around you. Here's a bundle of cash so you can get a new car and mess around again."
No. Let's get serious. When being a bank, one does not need to draw on outdated analogies. Reality is already a paradise and this is a true story from cloud nine.
Let's begin with working hours. As the only industry in the world retaining a 5-day workweek, banks have an easy life. In contrast to all other businesses that have to stay open to fill the till banks have an enormous advantage. The money they lend out collects interest for at least 360 and in most cases 365 days. Not bad for working only 250 days. That's as close as one can get to "money for nothing and chicks for free," at least for the first part of this former Dire Straits hit.
Does a bad credit score hike your borrowing costs in real life? Again, better become a bank eligible for central bank refinancing. No matter what crap spoils a bank's asset portfolio, your central bank will be a most reliable buddy, lending you as much money as you want at negative real interest rates and far below what they charge for the risk associated with a client.
As a bank you are basically getting paid for borrowing.
Doesn't that sound like paradise? No, it is not paradise, this the very real world of banks these days, almost entirely free from any consequences for all its acting participants.

Are Banks Except From Common Sense Thinking?
This does not apply to the clerical workers level of course. A bank just needs to fire a couple of hundred secretaries etc. in order to keep its masters of the universe happy with gazillion bonuses. Sssshhhh, nobody wants to be reminded that the suipposed masters of the universe did nothing else than a herd of sheep: Staying together while stampeding in the same direction most times.
While mere mortal humans are told to save up for a nest-egg in case times turn to the worse, banks are again exempted from such profane common sense thinking.
Skimming the profits off shareholder's dividends in order to pay themselves bonuses in the good years banks apparently felt themselves expected from the need to create reserves for loans going bad. OK, they were not the first ones but only followed examples set by companies in many other industries where the aim to create shareholder value led to a short term oriented strategy that was dominated by the desire to raise the share price and not the strength of the company in the long term. Call the game by its true name: CEO compensation roulette.
The years in the casino with freely flowing champagne that came from selling increasingly risky products to clueless customers have created a resistance to change in the banking industry. While other drunks are thrown into the locker cell to sober up, a bank can instead stumble into its concerned parliament and tell a few horror stories about the importance of the credit industry. 
Incompetent politicians may feel like heroes when they throw billions after the banks they do not have in the first place. But this recipe for hyper inflation is so old that it has been long forgotten by today's caste of international leaders. They will find out together with revolting populations when Europe and the USA follow the nasty path of monetizing the debt that has reduced Zimbabwe from Africa's bread basket into a lawless impoverished society depending on food aid from abroad.
The common man meanwhile is told that banks deliver an important function to the public by guaranteeing the smooth and efficient flow of funds. What the public is not told is the sour reality that it will be them who will pick up the bailout bill of the banks with its future tax payments.
Decling property prices, the prime driver behind the global debt boom of this millennium, will chip away more of the prosperity the West has become used to in the past 2 decades of surging home values that have financed many luxuries people probably would not have bought had they had to use their savings.
A shrinking business base at least on the consumer level where a sudden change to frugality out of necessity means fewer loans may bring what politicians are so far eager to avoid with their donations to the banking sector: A resizing of the industry to the level needed to service other industries and consumers without dominating them. After all banks profits have seen a higher growth rate in the past 4 decades than all industries. 
All attempts to rein banks under stronger regulatory umbrellas were squashed in the past by them. Voicing their commitment to free market ideology it was argued that only self-regulation was sufficient and the state's hands would only hamper business. As the world now finds out that this was not the case, to be polite, banks have turned into super socialists at the same speed they saw their business model of taking on too much risk for lavish profits disappear because we cannot all get rich at the same time.
After all, it may still be most comfortable to be reborn as a bank in the near future. History shows a repeating pattern after bank crises. The bigger the excesses of the banks were the stronger the regulation they were relegated to.
It will not be different this time and for a while banking may become what it was for most of the time: A 3-6-3 business. Borrow at 3%, lend at 6% and be on the golf course at 3 PM. Life could be worse.

ECB Adopts New Collateral Guidelines, Leaves Public In Dark

Friday, November 21, 2008

The European Central Bank (ECB) has adopted new guidelines for collateral eligible in its refinancing operations. Having warned of a sinking quality of the ECB's balance sheet in January that were followed by an update of collateral guidelines in September, this move signals another milestone on the road to monetary hyper inflation.
According to the ECB,
"On 21 November 2008 the Governing Council adopted a Guideline on temporary changes to the rules relating to eligibility of collateral (ECB/2008/18). The Guideline will be published shortly in the Official Journal of the EU and on the ECB’s website."
This sparse bit of information may have added to today's explosive $50 move in gold. So far the public is left in the dark what kind of illiquid crap, ahem collateral, the ECB will "temporarily" accept. It certainly does not instill confidence in a crumbling financial system that is hollering along with more than one TRILLION Euros in bank credit while credit markets have essentially been ceasing to work for 15 months by now.
The monetary inflation, now aimed to salvage Eurozone cross-border banks, will soon begin to trickle into the real economy, creating a situation that will resemble the Weimar Republic or Zimbabwe if everything goes wrong, politically as economically. Give it a delay of 6 to 12 months until the effects will be felt.
Leaving the world in the dark about the changes in the collateral guidelines, one is left to speculations. Maybe the upcoming financial stability review will offer more clues on the real state of affairs within the Eurozone.
On 20 November 2008 the Governing Council authorised the publication of the “Financial Stability Review – December 2008”. The review provides a comprehensive assessment of the capacity of the euro area financial system to absorb adverse disturbances and examines the main sources of risks and vulnerability to financial system stability. The review will be published on the ECB’s website on 15 December 2008.
The sudden move on collateral guidelines may be the canary in the coal mine.
Given the dire outlook for overleveraged European banks still bleeding from gigantic derivatives losses I am most pessimistic that this financial crisis will find a happy end with a strong Euro.
The ECB has tripled its balance sheet since the inception of the common currency, leaving economic growth far behind.
A decade of monetary expansion will most likely end as it did in all comparable periods of panic before. Hyper inflation will help sovereigns to escape a default of nations, but all savings and investments will still be wiped out.
There will be no other cover than gold for what was last experienced by the now deceased generation of my grand parents. The system of floating currencies gets unmasked for what it truly is: A system of fiat currencies sinking at different speeds.
UPDATE: Find the new guidelines here.

Google Will Build Server Farm in Austria

Thursday, November 20, 2008

Internet giant Google will build a new server farm in Austria. According to Austrian media reports Google finalized the purchase of a 75 hectares (=185 acres) property in Kronstorf, Upper Austria. It is expected to build one of its 36 estimated data centres here. The server farm will need an investment upwards of €100 million and Google will employ roughly 100 people after two years of construction.
According to Austrian daily "Kurier" the property is ideally located, close to several hydropower plants that ensure power supply and the river Enns whose water can be used to cool the hardware. Kurier listed a link to, citing it as a source for its estimate that Google operates 36 server farms worldwide. The link was dead as of today.
Google has come under criticism in Europe for its attitude towards privacy laws while being secretive about its own data collection, gained from offering free services, like its famous search engine and Blogger, to users. Its critics say that Google evades local privacy laws by storing data out of reach of the respective jurisdictions.

China Considers US Treasuries Still the Best Option

A surprising change of course - that contradicts semi-official statements from only two months ago - in Chinese forex policy may bolster US treasury debt for a while. According to a front page report of Chinese economists recognize the dire state of US financial affairs that root in the reckless spending spree during the reign of George Bush.
But having become the biggest holder of US debt as of September 2008 China apparently also accepts the fact that a premature exit out of its $585 billion stash of Treasury paper would unsettle the shaken financial world to a degree nobody wants to ponder about. The report hints that China will remain a good bidder in future Treasury auctions, at these times certainly a more stabilizing act than what is coming from the US Treasury itself.
From Chinadaily:
China is likely to continue increasing holdings of US treasury bonds even after becoming the No 1 holder because it is the best way to deploy its $1.9 trillion foreign exchange reserves, economists say...
With a $43.6 billion increase in holdings of US treasury securities in September, China's overall holdings amounted to $585 billion. Japan cut its holdings to $573 billion from $586 billion in August.
Net foreign purchases of long-term US securities totaled $66.2 billion in September, up from $21 billion in August and $18.4 billion in July.
Treasury data suggests that foreign investors still regard the US as a relatively better place to invest when markets worldwide are crumbling, analysts said.
"That's why China has increased its holdings," said Dong Yuping, senior economist at the Institute of Finance and Banking affiliated to the Chinese Academy of Social Sciences.
Tough Times Ahead - But Not Many Options
Not all economists are of the opinion that China should help to blow up the US debt bubble. For the past decade China has increasingly bought US debt that helped finance its own Wirtschaftswunder based on enormous export growth that made it the biggest contributor to the US trade and current account deficit.
Once more in history the phrase "Federal Reserve Notes (FRNs) are the US currency, but a problem for the rest of the world" can be applied as the dollar still manages to hold on to its image of too big to fail. Still, China seems to be willing to lend the new president-elect Barack Obama a helping hand when he has the manage the biggest task of all politicians ever: To clean up the mess that Bush made. After all, the most populous country in the world and the so far most prosperous nation will share a fate that depends on each other,
As the US financial crisis worsens, Washington is in dire need of capital to fund its massive market rescue plan; but some domestic economists argue that China should not use its foreign exchange reserves to purchase US bonds for fear that it may incur huge losses.
"But China may not have many options," Dong said.
The US economy, though hemorrhaging from the crisis, remains the largest and strongest; and the EU and Japan are not yet a serious challenge to US pre-eminence. Investment in dollar assets, therefore, carries the least risk, he said.
If China reduces its holdings of US debt, others may follow suit, which will lead to a weakening of the dollar and depreciation of dollar-denominated assets, thus severely hurting China's interests.
"China and the US are in the same boat," he said.
"You may not like it, but China has to move along this path," said Yan Qifa, senior economist with the Export-Import Bank of China.
And now that many countries are increasing holdings of US treasury bonds, China's potential returns from the bonds will increase, said Chen Gong, chief economist and chairman of Anbound Group, a Beijing-based consulting firm.
"So China may continue to increase its holdings," he said.
However, some experts argue that Beijing use its considerable financial leverage to set conditions such as the US opening its financial markets more to Chinese funds, and allowing exports of high-tech products to China.
China faces the same problem every holder of US debt has: As the Bush regime has roughly doubled US debt to more than $11 TRILLION in a mere 8 years, more than all 42 previous presidents before in 224 years, the value of FRNs depends increasingly on the belief that America will somehow manage to escape a serious depression that is boldly written on the wall.
Right now the relative strength of FRNs stems to a good dose from even worse conditions for the Euro and the Pound. I think it is safe to say that all 3 will fail as all unbacked fiat currencies before. It is only a matter of time, as it has always been.
UPDATE: Find all current developments in the bond market over at Across The Curve.

Technical Problems Converge With a Berlin Trip

Thursday, November 13, 2008

Due to lasting technical problems with both my computers that converge with a trip to Berlin blogging will cease for a week. The situation again strengthens my belief that Microsoft is a long term short play.
After my MacBook - which survived the Indian monsoon, a crossing of the Sahara and my suicidal style of mountainbiking in Vancouver - suddenly went dead I turned on my Windows Vista equipped HP Pavilion for the first time in almost a year. It took me 14 hours to install all the Vista updates that had accumulated since. After this tiring job I was at least able to surf the web again, turned off the machine and went to sleep. Next morning I had a classical deja vu. Surfing the web, probably the most required task on any PC these days, again did not work although I had religiously followed all procedures to shut it down correctly.
Windows help is more or less useless in solving problems. One keyword leads to many others and in the end one is always advised "to contact the system administrator."
Haha, what a lousy joke. Thanks to a good friend who did not flee the scene when I told him my anger about this piece of crap called Windows Vista but took the laptop and said it would take him at least a day to set up the system again. So I can enjoy the 7 days a week party life while pondering whether to short Microsoft because its products always need a system expert just to keep it running.
The PC was always an unloved option for me, needed only to run some trading software while everything else is done on the Mac.
Turning the Mac in for repair became an entirely different experience. The power problem was solved for free and the replacement of the cracked top and bottom covers will be for free as well although the warranty haslong expired again.
Another indication that Apple computers are the future came up when I simultaneously ordered a new MacBook Pro. These laptops are selling like hot cake and even Vienna's biggest Apple shop had none in stock. They only took an order with an downpayment and were not able to guarantee a delivery date for 5 days.
I am actually relieved.Could I have a better excuse for not blogging a few days?

Fed Money Machine Gears Up - More Fed News - Short Microsoft

Tuesday, November 11, 2008

In its effort to alleviate the credit crunch the Fed today unloaded a few more $100 billion on money markets and therefore ultimately on the tax bills of generations to come.
At 6 AM local time the Fed came out with a statement on a restructuring of AIG's debt that will inject $40 billion in share capital. The sweet deal for AIG is the rate cur from Libor + 800 basis points to Libor + 300 basis points. Altogether the help was almost doubled to $150 billion. As the government is determined to keep AIG afloat the Fed will still make good money on it.
New money, money, money was the directive for the whole morning. At 10 AM the Fed money machine revved up. Looking forward to the new year the Fed will offer $150 in a 17-day repo that matures on January 8. 2009 and sports a minimum bid 0.528%. If one could only get that rate on credit cards.

It's a MMIFF Costing $600 Billion As Of Now
The Fed NY meanhwhile updated its information on the Money Market Investor Funding Facility (MMIFF). This new facility - that consists as all other liquidity facilities of nothing but new debt - has a current volume of $600 billion and I consider it a safe bet that we will see a TRILLION and more to come here soon as well.
After all, there appears to be not other strategy than to give away close to free. Aslong as you are a bank, GSE, or any other entity that has a good lobbyist at the Treasury. With Hank Paulson basically running the show by himself, chairman Ben Bernanke is degraded to an engineer who has to tune up the printing presses for the next couple of TRILLIONS we will see in the next few months only.

Bloomberg Presses Fed for More Transparency
Information provider Bloomberg, the only critical force among the major newswires, presses ahead in its crusade for more transparency of the Fed. Quoting several protagonists Bloomberg did not miss out that Treasury secretary Paulson said only 2 months earlier he too wanted more transparency. Check out the right sidebar of the link below for proof on video. Bernanke had pledged for more transparency on September 24, another video shows.
Here is the full article:

The Federal Reserve is refusing to identify the recipients of almost $2 trillion of emergency loans from American taxpayers or the troubled assets the central bank is accepting as collateral.

Fed Chairman Ben S. Bernanke and Treasury Secretary Henry Paulson said in September they would comply with congressional demands for transparency in a $700 billion bailout of the banking system. Two months later, as the Fed lends far more than that in separate rescue programs that didn't require approval by Congress, Americans have no idea where their money is going or what securities the banks are pledging in return.

"The collateral is not being adequately disclosed, and that's a big problem," said Dan Fuss, vice chairman of Boston- based Loomis Sayles & Co., where he co-manages $17 billion in bonds. "In a liquid market, this wouldn't matter, but we're not. The market is very nervous and very thin."

Bloomberg News has requested details of the Fed lending under the U.S. Freedom of Information Act and filed a federal lawsuit Nov. 7 seeking to force disclosure.

The Fed made the loans under terms of 11 programs, eight of them created in the past 15 months, in the midst of the biggest financial crisis since the Great Depression.

"It's your money; it's not the Fed's money,"
said billionaire Ted Forstmann, senior partner of Forstmann Little & Co. in New York. "Of course there should be transparency."

Treasury, Fed Remain Silent
Federal Reserve spokeswoman Michelle Smith declined to comment on the loans or the Bloomberg lawsuit. Treasury spokeswoman Michele Davis didn't respond to a phone call and an e-mail seeking comment.

President-elect Barack Obama's economic adviser, Jason Furman, also didn't respond to an e-mail and a phone call seeking comment from Obama. In a Sept. 22 campaign speech, Obama promised to "make our government open and transparent so that anyone can ensure that our business is the people's business."

The Fed's lending is significant because the central bank has stepped into a rescue role that was also the purpose of the $700 billion Troubled Asset Relief Program, or TARP, bailout plan -- without safeguards put into the TARP legislation by Congress.

Total Fed lending topped $2 trillion for the first time last week and has risen by 140 percent, or $1.172 trillion, in the seven weeks since Fed governors relaxed the collateral standards on Sept. 14. The difference includes a $788 billion increase in loans to banks through the Fed and $474 billion in other lending, mostly through the central bank's purchase of Fannie Mae and Freddie Mac bonds.

September 14 Decision
Before Sept. 14, the Fed accepted mostly top-rated government and asset-backed securities as collateral. After that date, the central bank widened standards to accept other kinds of securities, some with lower ratings. The Fed collects interest on all its loans.

The plan to purchase distressed securities through TARP called for buying at the "lowest price that the secretary (of the Treasury) determines to be consistent with the purposes of this Act," according to the Emergency Economic Stabilization Act of 2008, the law that covers TARP.

The legislation didn't require any specific method for the purchases beyond saying mechanisms such as auctions or reverse auctions should be used "when appropriate." In a reverse auction, bidders offer to sell securities at successively lower prices, helping to ensure that the Fed would pay less. The measure also included a five-member oversight board that includes Paulson and Bernanke.

At a Sept. 23 Senate Banking Committee hearing in Washington, Paulson called for transparency in the purchase of distressed assets under the TARP program.

Paulson on September 23, "We Need Transparency"
"We need oversight," Paulson told lawmakers. "We need protection. We need transparency. I want it. We all want it."
At a joint House-Senate hearing the next day, Bernanke also stressed the importance of openness in the program. "Transparency is a big issue," he said.

The Fed lent cash and government bonds to banks, which gave the Fed collateral in the form of equities and debt, including subprime and structured securities such as collateralized debt obligations, according to the Fed Web site. The borrowers have included the now-bankrupt Lehman Brothers Holdings Inc., Citigroup Inc. and JPMorgan Chase & Co.

Banks oppose any release of information because it might signal weakness and spur short-selling or a run by depositors, said Scott Talbott, senior vice president of government affairs for the Financial Services Roundtable, a Washington trade group.

"You have to balance the need for transparency with protecting the public interest," Talbott said. "Taxpayers have a right to know where their tax dollars are going, but one piece of information standing alone could undermine public confidence in the system."

The nation's biggest banks, Citigroup, Bank of America Corp., JPMorgan Chase, Wells Fargo & Co., Goldman Sachs Group Inc. and Morgan Stanley, declined to comment on whether they have borrowed money from the Fed. They received $120 billion in capital from the TARP, which was signed into law Oct. 3.

In an interview Nov. 6, House Financial Services Committee Chairman Barney Frank said the Fed's disclosure is sufficient and that the risk the central bank is taking on is appropriate in the current economic climate. Frank said he has discussed the program with Timothy F. Geithner, president and chief executive officer of the Federal Reserve Bank of New York and a possible candidate to succeed Paulson as Treasury secretary.

"I talk to Geithner and he was pretty sure that they're OK," said Frank, a Massachusetts Democrat. "If the risk is that the Fed takes a little bit of a haircut, well that's regrettable." Such losses would be acceptable, he said, if the program helps revive the economy.

`Unclog the Market'
Frank said the Fed shouldn't reveal the assets it holds or how it values them because of "delicacy with respect to pricing." He said such disclosure would "give people clues to what your pricing is and what they might be able to sell us and what your estimates are." He wouldn't say why he thought that information would be problematic.

Revealing how the Fed values collateral could help thaw frozen credit markets, said Ron D'Vari, chief executive officer of NewOak Capital LLC in New York and the former head of structured finance at BlackRock Inc.

"I'd love to hear the methodology, how the Fed priced the assets," D'Vari said. "That would unclog the market very quickly."

TARP's $700 billion so far is being used to buy preferred shares in banks to shore up their capital. The program was originally intended to hold banks' troubled assets while markets were frozen.

AIG Lending
The Bloomberg lawsuit argues that the collateral lists "are central to understanding and assessing the government's response to the most cataclysmic financial crisis in America since the Great Depression."
The Fed has lent at least $81 billion to American International Group Inc., the world's largest insurer, so that it can pay obligations to banks. AIG today said it received an expanded government rescue package valued at more than $150 billion.
The central bank is also responsible for losses on a $26.8 billion portfolio guaranteed after Bear Stearns Cos. was bought by JPMorgan.
"As a taxpayer, it is absolutely important that we know how they're lending money and who they're lending it to," said Lucy Dalglish, executive director of the Arlington, Virginia- based Reporters Committee for Freedom of the Press.

Ratings Cuts
Ultimately, the Fed will have to remove some securities held as collateral from some programs because the central bank's rules call for instruments rated below investment grade to be taken back by the borrower and marked down in value. Losses on those assets could then be written off, partly through the capital recently injected into those banks by the Treasury.
Moody's Investors Service alone has cut its ratings on 926 mortgage-backed securities worth $42 billion to junk from investment grade since Sept. 14, making them ineligible for collateral on some Fed loans.
The Fed's collateral "absolutely should be made public," said Mark Cuban, an activist investor, the owner of the Dallas Mavericks professional basketball team and the creator of the Web site, which focuses on the secrecy shrouding the Fed's moves.
The Bloomberg lawsuit is Bloomberg LP v. Board of Governors of the Federal Reserve System, 08-CV-9595, U.S. District Court, Southern District of New York (Manhattan).

When Will the $ Default?
Seeing that all dams have broken and the Fed is creating more money in a month than it did before in several years I am left with no other conclusion that Federal Reserve Notes - backed by nothing - will default in the future. The $100 trillion question is only when, not if.

Short Microsoft - What a Shoddy Product
Posting from a Windows Vista equipped notebook which has not been in use for several months it today took me 12 hours only to get Windows running at least the browser. I saw at least 3 dozen times the blue window of death, displaying some nerd gibberish that only a certified Windows developer may be able to encode in plain language. I had to upload at least 1 Gigabyte in updates only to get it to the point where it did not crash every 15 minutes, taking 3 more minutes to reboot every time.
Usually working on a Mac and having been forced to work with Windows in the last millennium in my perception nothing has changed. The whole thing is illogic, the help content only directs one to other computer jargon until it gives up and tells you to the contact the system administrator. What world is Microsoft living in? I am confident their next system will still lack the elegance of use that a Mac delivers. Currently the US automakers are on the way to the cemetery, Microsoft may follow in a couple of years.

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