Gold Daily and Silver Weekly Charts - Le Douleur

Once again the dollar was weak, and metals rallied, while stocks wallowed.

I am once again long metals, short stocks. Options Expiration on the Comex tomorrow. If they cannot bring prices down watch for a secondary bear raid into the weekend. This is how they played the last one.

Of course it is possible that the paper bears will be broken in their attempts to take on the bullion demand, and will be forced to retreat and attempt to defend a higher price level. This has also happened around an expiration.

The US is heading towards a crisis that very few understand, whether out of ignorance or arrogance. I have been a little surprised by this, but it is only to be expected, and is the hallmark of the really 'big events' in which God let's us have our way, if only to teach us that our ways are not His, and bear the taint of death.

"In this world there's room for everyone, and the good earth is rich and can provide for everyone. The way of life can be free and beautiful, but we have lost the way. Greed has poisoned men's souls, has barricaded the world with hate, has goosestepped us into misery and bloodshed."

Charlie Chaplin

They'll never learn, it seems, except the hard way.

Gold Daily and Silver Weekly Charts

"Our government...teaches the whole people by its example. If the government becomes the lawbreaker, it breeds contempt for law; it invites every man to become a law unto himself; it invites anarchy." Supreme Court Justice Louis D. Brandeis

This morning I added a lengthy intraday commentary here.

A fifth margin increase in silver is baked into the cake for Monday May 9th. Let it not be said that the CME does not care about its biggest customers.

There was a bounce today, and sighs of relief from the beleaguered metals bulls. My own portfolio was exhibiting some fairly impressive G forces today, that made up for the faux pas of coming back in a day early. Adjustments have been made, and thank God for hedges.

So what next. Nothing goes straight up or down, and silver certainly had gotten far ahead of itself. But as noted yesterday, I do not think that we are seeing an analog of the 1980 Hunt Brothers market corner rally which was fairly specific.

But who can say what will happen? Certainly not most of the commentators whom I have read, or the people who took the time to write in and tell me what a dope I am, and how silver is going to $22.

I cannot say it enough. It is not about predicting and making one way bets. It is all about managing risk in the short term, and paying attention to the market. I signalled my own sell within a day of the top, and came back in a day and a half before the bounce, for a trade.  I would have preferred to have waited longer, but the CME surprised me with the extra margin requirements.  And so I adjusted my strategy and came out without taking 'the big hit.' 

I think what bothers some people who write in is that I am still a long term holder of the metals. They send the oddest messages, feigning personal omniscience, and assuming some sort of undeserved pride in finally not being as wrong as they have been for a long time.

Well, sorry, but until the fundamentals change I don't change that long term portfolio, and certainly not in response to big moves either down or up, that are here and gone like flashes in the pan.  That is for the short term trading portfolio.

It bothers me a bit that the Comex does not seem to be addressing the very low levels of deliverable silver in their warehouse, and the incredibly large short position held by a few of the TBTF banks who are playing with public monies as far as I can tell.  That remains a potential problem even if they raise margins to 100%. And lower prices through rules changes do not help supply problems, the last time I checked.  It tends to dampen supply and make the problems even worse given enough time.

I have a bias to gold, I admit. But if you want to flee a manipulated market, I am not so sure that gold is so much different than silver, but certainly quite a bit less volatile, and more widely held as a a form of wealth by sovereign nations. 

I still cannot get over the fellow blogger who claimed that gold cannot be money because its value fluctuates, and some people hold it using leverage. I don't suppose the forex market is familiar territory to someone who could say this.  Everything is subject to speculation.  The crux of the matter is counter party risk and the ability, or lack thereof to manipulate supply in the long term.

Bart Chilton has indicated that the CFTC should look into the recent market action. To what end? They never release any of the pertinent data, and certainly don't do anything about it. And I suspect they won't until the aftermath of this latest banking fraud, after something breaks and a crisis ensues. I like Bart, and think he wants to do the right thing. I have also been in management situations that I think are similar to the one he is in now, so he has all my sympathy and good feelings as a lonely voice for truth, a pillar in the stream.

Greece is threatening to leave the EU, and I am sure that many of ther others in the EU will say, "Well let them." And yet it is not quite that simple, because the reason for leaving would be to default on their debts. Perhaps of benefit for Greece, but very bad for their creditors.

Would this extinction of euro debt result in a stronger euro as in the model of the monetary deflationists? Sometimes it is instructive to take your assumptions and apply them to someone else, to see if they are self-serving.

Greece's euro debts are held to a large degree by German banks. And a Greek default would encourage Ireland to do the same, and its debt is largely held by English banks. And in turn these banks are highly interconnected to the multinational banks. The financial market is still a mine field of counter party risk, and the Anglo-Americans and the rest are in a currency war.

The banks and their servants in office are fighting and gutting regulation every day, and there is little doubt in my mind that there will be a new financial crisis, worse than the last, that will shake the dollar denominated debt to its very foundations. But that's just my opinion, and I cannot tell what the time frames might be. However, I think I know what to look for. I also still believe that the UK will lead the way in the downward spiral of the western financial oligarchy.

The Banks must be restrained, and the financial system reformed, with balance restored to the economy, before there can be any sustained recovery.

"The extreme volatility seen in the price of silver—exacerbated by tightened margin requirements—and the la large swings in the price of gold, price of oil and in certain U.S. dollar exchange rates, do not in any way change the long-term outlooks for the U.S. dollar or for the long-term hedges against a collapse in U.S. dollar purchasing power. The current markets leave open the potential for near-term jawboning (official or through market intermediaries) and government intervention (overt or covert) to encourage relative U.S. dollar strength.

Despite whatever volatility there may be, the U.S. dollar remains on track for an eventual complete collapse in a hyperinflation, and the roots of that hyperinflation remain embedded in the system. The primary hedge against losing U.S. dollar purchasing power remains physical gold (and silver), with some funds outside the U.S. dollar. As discussed in the Hyperinflation Special Report (2011), I still like the Swiss franc, Canadian dollar and Australian dollar."

John Williams, 6 May 2011

The US Dollar Rally of 2008: The Consequence of a Bull Market in Fraud

The theory of a short squeeze in Eurodollars which we had first put forward last year "The Dollar Rally and Deflationary Imbalances in the US Dollar Holdings of Overseas Banks" seems to be confirmed by this paper from the NY Federal Reserve bank, and the latest figures on cross border currency transactions from the BIS.

"Highlighting the international dimensions of the financial crisis that began in the fall of 2007, authors Niall Coffey, Warren B. Hrung, Hoai-Luu Nguyen and Asani Sarkar examine the difficulties international firms encountered obtaining U.S. dollars and the ensuing effects on the foreign exchange (FX) swap market. Analysis shows that as firms increasingly turned to the FX swap market to obtain funding, the dollar “basis”—the premium paid for dollar funding—became persistently large and positive, primarily as a result of higher funding costs paid by smaller firms and non-U.S. banks." The Global Financial Crisis and Offshore Dollar Markets

Further, the latest data from BIS shows that the dollar rally tracked the acquisition of eurodollars with a significant correlation. This is shown on the chart at the right.

After the Federal Reserve alleviated the short squeeze through dollar forex swaps "The Fed's Currency Swaps" with the central banks in the affected regions, the dollar squeeze dissipated and the dollar fairly quickly resumed its downward trend. There is a case to be made that some of the big US money center banks were using the dollar shortage to reap windfall profits, but this could have also been a side effect of the seizing in the short term credit markets.

But much of the European outrage, as least, was in feeling that they had been 'set up' by the very banks that had sold them the foully rated instruments in the first place. A classic face ripping, as they say at Wall and Broad. And this similar to the reason is why the Chinese government declared that its own institutions could walk away from derivatives arrangements that had been sold to them by the Wall Street wiseguys under false pretenses. US towns and states are not so fortunate it appears.

What does this mean? It implies rather strongly that those looking for a repeat of the sharp dollar rally from last year are very likely to be sadly disappointed.

This was no flight to safety; this was the consequence of a massive fraud in dollar denominated financial assets having been sold to gullible foreign investors and their banks. Note too that the eurodollar positions do NOT account for the dollar rally in 2006. This is what was expected, because there was no corresponding spike in LIBOR to indicate a squeeze. Rather, that earlier dollar rally was due to foreign investment in US equities and financial assets at the height of the post tech crash Dollar Assets Bubble.

Here is a brief piece on The Backwardation in LIBOR and Its Divergence from Effective Fed Funds which shows the signs of the 'eurodollar squeeze' as opposed to net foreign investment in financial assets.

The foreign banks have now unwound a significant amount of the dodgy US dollar financial assets that caused the short squeeze through their fraudulent valuations.

Yes, there will be more rallies in the ongoing decline in the US dollar. There always are countertrends in every long term trend. This is how traders make and lose their gains, as the market makers skin them slowly but surely. We can only wonder for now how much money has come into the US equity and bond bubble in the past six months, and how much is leveraged via the dollar carry trade.

But we ought not to see such a large rally in the dollar again unless there is a precipitous decline in stocks that forces a painful unwinding of the dollar carry trade. Foreign banks ought to be on the lookout for this development, because it is in their regions that the short squeezes have most of their effect. The Fed is awash in dollars and does own a printing press, and is not afraid to use it.

And for those desperately waiting for a free ride and easy money from a synthetic dollar short on debt, they should be reminded that the chief monetarist himself, Milton Friedman, also reminded that "There Ain't No Such Thing As a Free Lunch."

Or more civilly perhaps, "even fraud has its limits in conferring more value upon that which has less."

Why the Federal Government Seized the Monetary Gold in 1933

The question of confication reappears every time gold rallies, from those with enough history to be able to throw out a few facts and sound plausible, but not enough grounding in history and the law to actually place them in any sort of reasonable context.

Below is a 'reprise' of a blog entry we posted early this year on the topic.

The Feds acted on gold because at the time it WAS the currency of the country, and the government had some proper claims on it. When the US left the gold standard it relinquished all such claims, as gold became purely private property. Except perhaps if you are holding gold American eagles, which bear the patina of 'currency.'

It should also be noted that the sole action of the government was to ask for the gold, to withdraw convertibility of gold notes from the domestic public, and to monitor the activity of safe deposit boxes taking certain categories of gold, and essentially nothing else. There were no investigations, searches, or even active prosecutions for non-compliance.

The purpose of the confiscation was to prepare the way for a formal devaluation of the dollar while it was still on the gold standard.

Could the government try to confiscate the gold from private citizens again? Certainly. Although unless it is part of a return to the gold standard with adequate recompense, it would be little more than the theft of private property.

The government can also ask you to place an RFID chip in your head before you can buy anything or drive a car, ask for your children and place them in youth camps, bind you over to your creditors in indentured servitude, ask you to house homeland security troops in your home with no payment, and request your presence on a freight train for relocation to New Mexico.

There is a wide difference between what *could* be done, what is likely to be done, and what people might consider to be unreasonable enough to resist.

Talk of confiscation invariably occurs when gold rallies because it is a way for those who rode the rally to climb the wall of worry and those who missed the rally to feel better about their lost opportunity.


The Last Time the Feds Devalued the Dollar to Save the Banks
14 January 2009

We dipped once again into the Federal Reserve Bulletin Publication from June, 1934 to take a closer look at the growth of the monetary base, and found an interesting graphic that shows the accounting for the January 1934 devaluation of the dollar and the subsequent result on Bank Reserves in the Federal Reserve System.

As you will recall, the Gold Act, or more properly Executive Order 6102 of April 5, 1933, required Americans to surrender their gold coinage and certificates to the Federal Reserve Banks by May 1, 1933. There were no prosecutions for non-compliance except one benchmark case which was brought voluntarily by a person who wished to challenge the act in court.

After a substantial portion of the gold was turned in by US citizens and taken from their bank based safe deposit boxes, the government officially devalued the dollar from 20.67 to 35.00 per ounce in the Gold Reserve Act of January 31, 1934.

The proceeds from this devaluation were used to provide a significant boost to the Federal Reserve member bank positions as shown in the first chart below.

The inflation visited on the American people because of this action helped to take the CPI as it was then measured up 1200 basis points from about -8% to +4% by the end of 1933. To somewhat offset the monetary inflation the Fed also contracted the Monetary Base which served the nascent recovery in the real economy rather poorly and is viewed widely as one of a series of policy errors.

Considering that the actions did little for the employment situation this was painful medicine indeed to those who were dependent on wages.



Fortunately at the same time FDR was initiating the New Deal programs which, despite continual opposition from a Republican minority in Congress, managed to provide a small measure of relief for the 20+% public that was suffering from unemployment and wage stagnation.

People ask frequently "Will the government seize gold again?"

While there is no certainty involved in anything if a government begins to overturn the law and seize private property, one has to ask for the context and details first to understand what happened and why, to understand the precedent.

Technically, the government did not engage in a pure seize of private property, since at that time the US was on the gold standard, and much of the gold holdings of US citizens were in the form of gold coinage and certificates.

Governments always make the case that the currency is their property and that the user is merely holding it as a medium of exchange. The foundation of the argument was that the government required to recall its gold to strengthen the backing of the US dollar against the net outflows of gold for international trade. The devaluation helped with this as well, since dollars brought less gold for trade balances.

People also ask, "Why didn't the government just revalue the dollar without trying to recall all the gold from the American public?"

The answer would seem to be that this would have been more just, more equitable recompense for the public. The Treasury could have purchased gold from the public to support its foreign trade needs.

But it would have left much less liquidity for the banks.

One can make a better case that the recall of the gold, with the subsequent revaluation to benefit a small segment of the population in the Banks, was a form of seizure of wealth without due compensation. Hence the lack of active prosecutions.

So, will the government take back gold again to save the banks by devaluing the dollar?

Highly unlikely, because they not only do not need to this, since the dollar is no longer backed by gold, and is a form of secular property except perhaps for gold eagles, but they do not have to, because they are devaluing the dollar already to save the banks.

This time the confiscation of wealth to save the banks is called TARP.

If one thinks about it, US Dollars are being created and provided directly to the banks to boost their free reserves significantly, at a scale comparable and beyond to 1933-34.

The confiscation of wealth is being spread among all holders of US dollars and dollar assets, foreign and domestic, in the more subtle form of monetary inflation.

Granted, the government must be more opaque to mask their actions in order to sustain confidence in the dollar while the devaluation occurs, but this is exactly what is happening, and all that is required to happen in a fiat regime.

There is no need to seize widely held exogenous commodities like gold and oil, but merely dampen any bellwether signals that a significant devaluation of the dollar is once gain being perpetrated on the American people in order to save the banks.

Its fascinating to look carefully at this next chart below.



First, notice the big drop in gold in circulation of 9.8 million ounces, or roughly 36% of the measured inventory at the end of 1932. Think someone was front-running the dollar devaluation? We suspect that the order went out to start pulling in the gold stock to the banks.

The reduction in gold in circulation AFTER the announcement of the Gold Act in April would be about 3.9 million ounces, or roughly 22% of the gold remaining in circulation in March 1933.

Considering that all gold coinage held by banks in the vaults was automatically seized, the voluntary compliance rate is not all that impressive. We are not sure how much of this was being held in overseas hands by non-US entities.

But beyond a doubt, there was a unjust, if not illegal, seizure of wealth by requiring citizen to turn in their gold to the banks, which was then revalued at the beginning of 1934 by 69% from 20.67 to 35 dollars.

It would have been much more equitable to devalue the dollar and to change the basis for dollar/gold first, before requiring private citizens to surrender their holdings. But of course, this would have lessened the liquidity available for direct infusion into the Federal Reserve banks.

US Dollar Seasonality

Rough seas ahead for Uncle Buck.



Chart Courtesy of ContraryInvestor.com

A Stronger Dollar: After Many a Summer Dies the Swan

This is the kind of situation that tends to wobble forward from momentum until it hits a crack in the pavement, some trigger event, then topples into a ditch and a full blown crisis, often when we least expect it.

I have not been reading many other financial blogs lately, giving more time to family and preparing for what is to come. I wonder if the more strident true believers in a stronger dollar through deflation have relaxed belief in the improbable yet, or if they are still flogging the data to support a mistaken theory.

Its one thing to be wrong. Everyone is, at one time or another, including yours truly. But its especially costly, sometimes fatally so, to be stubborn after your time has come and gone.

If equities take another leg down, as we suspect they will, then the dollar will strengthen once again, perhaps impressively. But it is just a shifting in allocations in a dollar universe that is changing, often slowly, into something that will likely be quite different, as in a black swan event.

As you know the position we took on this question was to make the case that in a fiat currency regime a range of outcomes are technically possible (and still are). But the probability of inflation was overwhelming when the facts were considered dispassionately.

As a general rule, the louder the rhetoric, the weaker the case to be made for a viewpoint.

Look at the data and be guided by it in all other things of this world.


Bloomberg
Dollar Declines as Slump Prompts Nations to Mull Alternative
By Oliver Biggadike and Matthew Brown

June 2 (Bloomberg) -- The dollar dropped to its lowest level against the euro this year on speculation record U.S. borrowing will undermine the greenback, prompting nations to consider alternatives to the world’s main reserve currency.

The 16-nation euro gained for a fourth day versus the dollar as the Russian government said emerging-market leaders may discuss the idea of a supranational currency. The pound strengthened to $1.65 for the first time since October.

“There’s been a lot of talk out of Russia about a new global currency, and that’s contributing toward this latest bout of dollar weakness,” said Henrik Gullberg, a currency strategist at Deutsche Bank AG in London. “These latest comments are just adding to the general dollar weakness we’ve seen recently...”

Russian Proposal

Russian President Dmitry Medvedev may discuss his proposal to create a new world currency when he meets counterparts from Brazil, India and China this month, Natalya Timakova, a spokeswoman for the president, told reporters by phone today. Medvedev first proposed seeking alternatives to the U.S. dollar as a reserve currency in March.

The dollar also declined on speculation “smaller” central banks started today’s selling of the greenback, said Sebastien Galy, a currency strategist at BNP Paribas SA in New York.

“If people believe that there is official pressure behind it, then obviously it puts pressure on euro-dollar on the upside,” Galy said. Galy predicted the 16-nation currency may reach $1.4360 today, a peak last reached in December.

There will be demand for the record amount of debt the U.S. is selling, Treasury Secretary Timothy Geithner said in an interview earlier today with state media outlets in China.

China’s ‘Understanding’

China has a “very sophisticated understanding” of why the U.S. is running up budget deficits, Geithner said in Beijing, pledging to rein in borrowing later.

“Despite the more comforting words we’ve had from the Chinese to the U.S. overnight, it does seem that the world’s reserve managers are still concerned about exposure to the dollar,” said Ian Stannard, a foreign-exchange strategist in London at BNP Paribas SA...

‘Last Stage’

The euro’s rally against the dollar may be entering its “last stage,” and investors would likely benefit from selling the 16-nation currency against the greenback, UBS AG said.

Europe’s currency is poised to weaken toward $1.30, analysts led by Mansoor Mohi-uddin, Zurich-based chief currency strategist at the world’s second-biggest foreign-exchange trader, wrote in a note to clients yesterday. The analysts reiterated forecasts for the euro to trade at $1.40 in one month’s time and weaken to $1.30 in three months.

“We remain positive on the U.S. dollar and think that the greenback is likely in its final stage of weakness,” the analysts wrote. “Equity and bond flows have the potential to surprise and could lend support to the dollar.”

To contact the reporters on this story: Oliver Biggadike in New York at obiggadike@bloomberg.net; Matthew Brown in London at mbrown42@bloomberg.net

Ladies and Gentlemen: the United States Is Insolvent

"We are out of money." Barack Obama May 23, 2009

Obama openly says what anyone with common sense has known for quite some time: the US is broke, and will not be able to honor its financial and fiduciary obligations.

The question remains how the US restructures that debt and how big a haircut the debt holders will take.

20%? 30%? More like upwards of 50% at least in real terms.

And who are these debt holders?

Anyone who hold Treasury debt obligations and financial assets, from the Long Bond to the US Dollar, and assets guaranteed by the Federal Reserve and the Treasury.

Technically the debt will be serviced and the interest paid according to the terms of the agreements, with devalued US dollars.

The process will continue until the debt is restructured and the dollar is replaced with a new dollar. This may take some years.

The Incontrovertible Truth About Debt, Deleveraging, Devaluation and Recovery

Why the US Has Gone Broke: Chalmers Johnson

Marc Faber Sees Bankruptcy for the US

In 2009 the US Will Be Forced to Selectively Default and Devalue Its Debt

A Credit Bubble of Historic Proportion

Shhhhhh.... Here is a Secret Worth Remembering

Didn't you just know they would spill it over a long holiday weekend?

Don't be too concerned, there will be more spin and denials after this trial balloon has been floated, and life will go on.

"Oh, that's not what Obama meant. He means we have a problem but there are the means and the time to address and repair it before it becomes too great."

People have an enormous capacity for delusion bordering on selective amnesia. Go back and read the posts on this blog starting in September 2008. Then reflect on what has been said recently on Wall Street and you will see what we mean.

We are now in the endgame of an historic credit bubble that will result in a currency crisis of epic proportions.


DrudgeReport
'WE'RE OUT OF MONEY'
Sat May 23 2009 10:32:18 ET

In a sobering holiday interview with C-SPAN, President Obama boldly told Americans: "We are out of money."

C-SPAN host Steve Scully broke from a meek Washington press corps with probing questions for the new president.

SCULLY: You know the numbers, $1.7 trillion debt, a national deficit of $11 trillion. At what point do we run out of money?

OBAMA: Well, we are out of money now. We are operating in deep deficits, not caused by any decisions we've made on health care so far. This is a consequence of the crisis that we've seen and in fact our failure to make some good decisions on health care over the last several decades.

So we've got a short-term problem, which is we had to spend a lot of money to salvage our financial system, we had to deal with the auto companies, a huge recession which drains tax revenue at the same time it's putting more pressure on governments to provide unemployment insurance or make sure that food stamps are available for people who have been laid off.

So we have a short-term problem and we also have a long-term problem. The short-term problem is dwarfed by the long-term problem. And the long-term problem is Medicaid and Medicare. If we don't reduce long-term health care inflation substantially, we can't get control of the deficit.

So, one option is just to do nothing. We say, well, it's too expensive for us to make some short-term investments in health care. We can't afford it. We've got this big deficit. Let's just keep the health care system that we've got now.

Along that trajectory, we will see health care cost as an overall share of our federal spending grow and grow and grow and grow until essentially it consumes everything"...

The US Dollar and a Paradigm Shift in the Markets

From Warren Pollock:

A simple grid shows how the USD and the Stock Market have moved together in different ways during different economic times. Today we saw the USD down in a huge way with the Stock Market Weak.. Are we seeing the pendulum shift once again as the stress of derivatives and Insolvent municipalities hatch out. Are we a bailout nation? And Will the world bail us out?

Bernanke's Gamble on the Dollar

There are several things of interest this week. The first and foremost is the Fed's FOMC two day meeting with their announcement on Wednesday at 2:15.

It is important despite the fact that rates are effectively at zero, and the Fed has declared for 'quantitative easing.'

How does the Fed intend to implement this quantitative easing? Another way to ask this is to say, "What is the next bubble?"

Quantitative easing implies market distortion, and traders will be keen to understand where and how that distortion will play, because they are still geared for supercharged returns in an environment where fewer and fewer opportunities exist.

The Treasuries seem like a safer place, because lower interest rates are to the economy's benefit. Foreign entities may not like the monetization aspect, but we wonder how many real 'investors' are left in the bonds? Most in there are domestic parties seeking safe havens with any sort of return, and foreign central banks supporting political and industrial agendas.

So the focus will be on the wording of the Fed's statement once again, looking for clues with regard to the Fed's easing implementation and potential distortions that provide market inefficiencies.


Bloomberg
Bernanke Risks "Very Unstable" Markets as He Weighs Buying Bonds
By Rich Miller
January 25, 2009 19:01 EST

Jan. 26 (Bloomberg) -- Federal Reserve Chairman Ben S. Bernanke and his colleagues may try once again to cure the aftermath of a bubble in one kind of asset by overheating the market for another.

Fed policy makers meeting tomorrow and the day after are exploring the purchase of longer-dated Treasury securities in an effort to push up their price and bring down their yield. Behind the potential move: a desire to reduce long-term borrowing costs at a time when the Fed can’t lower short-term interest rates any further because they are effectively at zero.

The risk is that central bankers will end up distorting the Treasury market, triggering wild swings in prices -- and long-term interest rates -- as investors react to what they say and do. “It sets forth a speculative dynamic that is very unstable,” says William Poole, former president of the Federal Reserve Bank of St. Louis and now a senior fellow at the Cato Institute in Washington....

Inflated Prices

Recent history shows the economic danger of inflating asset prices. After a stock-market bubble burst in 2000, the Fed slashed interest rates to as low as 1 percent and in the process helped inflate the housing market. The collapse of that bubble is what eventually helped drive the U.S. into the current recession, the worst in a generation.

Faced with the danger of a deflationary decline in output, prices and wages, the Fed is considering steps to revive the moribund economy. On the table besides bond purchases: firming up a pledge to keep short-term interest rates low for an extended period and adopting some type of inflation target to underscore the Fed’s determination to avoid deflation.

The central bank has been buying long-term Treasury debt off and on for years as part of its day-to-day management of reserves in the banking system. Yet it has always gone out of its way to avoid influencing prices. What it’s discussing now, says former Fed Governor Laurence Meyer, is deliberately trying to push long rates below where they otherwise might be.

Fed Purchases

Bernanke raised this possibility in a speech on Dec. 1. While he didn’t specify what maturities the Fed might buy, in the past he has suggested that purchases might include securities with three- to six-year terms. (This is around the sweet spot for foreign Central Banks - Jesse)

Investors immediately took notice, with the yield on the 10-year note falling to 2.73 percent from 2.92 percent the day before. Yields fell further on Dec. 16, dropping to 2.26 percent from 2.51 percent the previous day, after the central bank’s policy-making Federal Open Market Committee said it was studying the issue....

Yields have since risen, with the 10-year note ending last week at 2.62 percent. Behind the reversal: expectations of massive fresh supplies of Treasuries as the government is forced to finance an $825 billion economic-stimulus package and a possible new bank-bailout plan. This week alone, the Treasury is scheduled to auction $135 billion worth of securities.

Jump in Yields

David Rosenberg, chief North American economist for Merrill Lynch in New York, says the jump in yields may prompt the Fed to go ahead with Treasury purchases.

This isn’t the first time Bernanke and the Fed have discussed buying longer-dated securities and ended up roiling the market. Bernanke touted the idea as a tool to fight deflation in speeches in November 2002 and May 2003.

Egged on by his comments -- and later remarks by then-Fed Chairman Alan Greenspan that the central bank needed to build a “firewall” against deflation -- many investors became convinced the central bank was poised to buy bonds. The yield on the 10-year Treasury note fell to 3.11 percent in June 2003 from 3.81 percent at the start of the year.

Traders quickly reversed course as it became clear the Fed had no such intentions, sending the 10-year Treasury yield soaring to 4.6 percent just three months later, on Sept. 2.

‘Miscommunication’

Poole, who was then at the St. Louis Fed, was critical at the time of what he called the central bank’s “miscommunication.” He now sees the Fed making the same mistake with its latest suggestions that it might buy longer- dated securities.

“If they do it, it’s going to be disruptive to the market,” says Poole, who is a contributor to Bloomberg News. “If they don’t do it, it will impair the Fed’s credibility and erode the confidence the market has in the statements that the Fed makes.”

Meyer, now vice chairman of St. Louis-based Macroeconomic Advisers, says the Fed should, and probably will, go ahead with purchases as a way to lower borrowing costs. “The story is stop talking and start buying,” he says.

Still, he notes that not everyone at the Fed is enthusiastic about the idea. One concern: Foreign central banks and sovereign-wealth funds, which are big holders of Treasuries, might cool to buying many more if they believe prices are artificially high. (The buyers of our debt now are supporting their own industrial policy we would hope. Any other reason borders on mismanagement of funds while anyone in their country is hungry or unemployed - Jesse)

Undermine the Dollar

That may undermine the dollar. “There’s no guarantee that international investors would switch to other dollar- denominated debt if flushed from the Treasury market,” says Lou Crandall, chief economist at Wrightson ICAP LLC in Jersey City, New Jersey.

Tony Crescenzi, chief bond-market strategist at Miller Tabak & Co. in New York, says foreign investors might also get spooked if they conclude that the Fed is monetizing the government’s debt -- in effect, printing money -- by buying Treasuries. (They already are, and they already are - Jesse)

Bernanke himself, in his 2003 speech, said monetization of the debt risked faster inflation -- something bond investors, foreign or domestic, wouldn’t like.

Some economists argue the Fed would help the economy more if it bought other types of debt. (Such as corporate bond - Jesse) Even after their recent rise, 10-year Treasury yields are still well below the 4.02 percent level at the start of last year....

Hawks at the Fed wouldn’t welcome such purchases. They are already uneasy that some of the central bank’s programs are effectively allocating credit to one part of the economy rather than others. Case in point: the Fed’s ongoing program to buy $500 billion of mortgage-backed securities, which Jeffrey Lacker, president of the Federal Reserve Bank of Richmond, has called “credit policy” rather than monetary policy. (Its nice to see that someone else is noticing that the Fed has crossed the Rubicon from central bank to central economic planner in the worst sense of the description - Jesse)

Strong Gold, Strong Dollar

"Because the Dollar Index (DX) is an outmoded and artificial measure of dollar strength, containing nothing to account for the Chinese renminbi for example, it may not be a true reflection of the progress of this inflation."
The Fed Is Monetizing Debt and Inflating the Money Supply

A number of people have remarked about the strong dollar and strong upmove in gold today. It does seem counterintuitive.

The euro is weak because of the solvency situtations in Ireland and Spain. This is taking the euro down and the dollar higher.

At the same time there is a flight to safety occurring into gold, but not into commodities in general.

It is not a flight from inflation, it is a flight from risk to relative safety. At least for today.

But by the way, keep an eye on the Treasuries, particularly the longer end of the curve, as we have previously advised.

There is 'the tell.'

The Fed is Monetizing Debt and Inflating the Money Supply

Here are the latest figures on the growth of the various money supply measures.

See Money Supply: A Primer for a review of measures and their differences.

The charts indicate that the growth in the money supply is due to a significant monetization of debt by the Fed in expanding its balance sheet and deficit spending by the Treasury, rather than organic growth from credit expansion from commercial sources and economic activity. The negative GDP figures confirm this.

You could imagine this as a tug of war if you wish. On one side is the deflationary force of bad debt and falling aggregate demand. On the other is the Treasury, the Fed, and the Congress, using the triple threat of deficit spending, monetization of debt, and stimulus programs. The limits of the power of the Feds are the value of the dollar and the acceptability of Treasury debt.

There is no lack of debt that can be monetized. To think otherwise is fantasy. But there are limitations about how much the dollar can bear, which is why the banks and moneyed interests have shoved their way to the front of the line, and are gorging themselves now with a little help from their friends in the Treasury and the Fed. When the time comes they intend to throw the public agenda under the bus. Its an old script, many times performed with minor enhancements.

If the current trend continues, it will have an inflationary effect on certain financial assets and commodities, and a negative impact on the dollar. There are lags in the appearance of this, but it will come.

Because the Dollar Index (DX) is an outmoded and artificial measure of dollar strength, containing nothing to account for the Chinese renminbi for example, it may not be a true reflection of the progress of this inflation. Time will tell.

A similar case might be made for certain strategic commodities, gold and oil, which are the instrument of government policy. Although it is much less important, silver may be one of the first commodities to break out because the government maintains no significant physical inventory of it as it does for gold and oil.

The huge short interest in silver may be an ignored scandal on the order of the Madoff Ponzi fund, not in dollar magnitude, but likely in terms of regulatory lapse and deep capture.



M1 has become a much less useful measure of the money supply these days because of changes in banking rules and technology. However, M1 is a good intermediate measure of the impact of the growth in the Fed's balance sheet as it feeds through the system.





Growth in MZM frequently results in financial asset expansion once it gains traction.



The US Dollar does not generally react well to aggressive growth in MZM.



The growth of credit, organic growth from economic activity, is sluggish.



The growth in the Monetary Base due to Fed inflationary activity has been nothing short of spectacular, without equal in US monetary history. This makes all Money Multiplier measures that use the AMB in the denominator meaningless for now.



The spike in Treasury settlement failures is one measure of the stress in the financial system. It seems to be quieter now, after spiking in response to seizures in the bonds trading. We will maintain a watch on this.

Willem Buiter Warns of a US Dollar Collapse While China Makes a Move

This UK Telegraph story below is a bit florid in its reporting based on selective quotations from an otherwise phlegmatic column by the Maverecon, Willem Buiter in the Financial Times titled Can the US Economy Afford a Keynesian Stimulus?

Its an interesting essay, and it is hard to argue with his thesis, since it has been the recurrent theme of this blogwriter since 2000. He is directionally correct.

But M. Buiter seems to miss the key placement of pieces in this stage of the game, seeing only one aspect of the play. He sees the weakness of the US, and the corruption and mismanagement of the US financial system, which, somewhat ironically, describes that of Europe as well (and Russia and China). The European banking system has been a house of cards for some time.

He believes that the rest of the world will shun US financial investments based on the broken myth of US financial efficiency. It was an illusion, and it has been dispelled. And we do not think that it was ever really the linchpin of the dollar hegemony.

Many private parties have already fled US financial investments, and in turn a great deal of money has come back to the US from the developing nations. So here we are.

The question is not whether the US can afford a Keynesian stimulus package.

The real question can the rest of the world afford a US Keynesian stimulus package? And if not, what will the world do about replacing the US dollar as the world's reserve currency and the basis for most international trade?

More specifically, how will China, Japan and Saudi Arabia migrate to an industrial policy that is independent of the need to export goods to the United States while maintaining low wages and domestic consumption, and relatively low defense spending?

China, not depending on the US military as a shield, will likely make the first moves, as they are reported to be making tentative steps in this direction, as in this overstated report from AsiaNews.it Chinese Yuan Set to Replace US Dollar. The odds are high that China will play into a US geopolieconomic strategy by attempting to do the obvious, in an obvious way.

This is not to say that there will be no change, ever. There will, since the dollar has not always been the faux gold standard, and will not always be.

But there is a decided lack of original thinking on the matter, and a definite lack of will to do much about it, in the rest of the world.

So until then, it is status quo, and the US can afford anything it wishes. Because it can, and it will.
That is the current position of the pieces on the board.


UK Telegraph
Willem Buiter warns of massive dollar collapse
By Edmund Conway, Economics Editor
05 Jan 2009

Americans must prepare themselves for a massive collapse in the dollar as investors around the world dump their US assets, a former Bank of England policymaker has warned.

The long-held assumption that US assets - particularly government bonds - are a safe haven will soon be overturned as investors lose their patience with the world's biggest economy, according to Willem Buiter.

Professor Buiter, a former Monetary Policy Committee member who is now at the London School of Economics, said this increasing disenchantment would result in an exodus of foreign cash from the US.

The warning comes despite the dollar having strengthened significantly against other major currencies, including sterling and the euro, after hitting historic lows last year. It will reignite fears about the currency's prospects, as well as sparking fears about the sustainability of President-Elect Barack Obama's mooted plans for a Keynesian-style increase in public spending to pull the US out of recession.

Writing on his blog, Prof Buiter said: "There will, before long (my best guess is between two and five years from now) be a global dumping of US dollar assets, including US government assets. Old habits die hard. The US dollar and US Treasury bills and bonds are still viewed as a safe haven by many. But learning takes place."

He said that the dollar had been kept elevated in recent years by what some called "dark matter" or "American alpha" - an assumption that the US could earn more on its overseas investments than foreign investors could make on their American assets. However, this notion had been gradually dismantled in recent years, before being dealt a fatal blow by the current financial crisis, he said.

"The past eight years of imperial overstretch, hubris and domestic and international abuse of power on the part of the Bush administration has left the US materially weakened financially, economically, politically and morally," he said. "Even the most hard-nosed, Guantanamo Bay-indifferent potential foreign investor in the US must recognise that its financial system has collapsed."

He said investors would, rightly, suspect that the US would have to generate major inflation to whittle away its debt and this dollar collapse means that the US has less leeway for major spending plans than politicians realise.

Dollar Assets and Liabilities in the International Banking System Update

On 2 October 2008 in The Dollar Rally and Imbalances in the US Dollar Holdings of Overseas Banks we said that:

When a multinational company deposits US dollar receipts from an export business in their domestic banks those deposits are frequently held in dollars... If those dollar assets decline because of a financial event as we are seeing today, the depositors may choose to withdraw their dollar deposit from the bank as they mature. This places the bank in an awkward position since the corresponding assets have deteriorated in value, but the nominal value of the certificate of deposit liability remains the same with the requisite interest accrual. As a result, a demand for dollars can be generated in the foreign country that is artificial but very real in terms of day to day banking operations. This is the 'artificial dollar short'

In the chart below we have updated the data from the BIS report to June of 2008, and the DX dollar index to today. In our October blog entry we forecasted that:

The resulting sharp rally in the US dollar is therefore likely to be an anomaly which will correct, and perhaps quite sharply, once the effect of the short term imbalances dissipates.

Although it is too early to say with certainty, it does appear that the hypothesis may be valid, and that the correlation is significant. The recent dollar rally was as the result of an artificial short squeeze resulting in an anomalous demand for dollars primarily in Europe.

The actions by the Federal Reserve and the foreign central banks to open their swap lines to relieve the dollar liquidity short squeeze appears to have been successful. We will see in the next series of BIS data how effective that effort has been, and if it will need to be continued as the imbalances are worked out of the system. As the ECB announced on September 13:

In order to facilitate the functioning of financial markets and provide liquidity in dollars, the Federal Reserve and the European Central Bank (ECB) have agreed on a swap arrangement. Under the agreement, the ECB would be eligible to draw up to $50 billion, receiving dollar deposits at the Federal Reserve Bank of New York; in exchange, the Federal Reserve Bank of New York will receive euro deposits of an equivalent amount at the ECB. The ECB will make these dollar deposits available to national central banks of the Eurosystem, which will use them to help meet dollar liquidity needs of European banks, whose operations have been affected by the recent disturbances in the United States.

We assume that at some point the ECB and BIS will take steps to modernize the international currency system to remove its exposure to the fluctuations of a single currency and the need for ad hoc arrangements to facilitate the proper functioning of international trade. Although a crisis has apparently been averted for now, it serves to expose the artificiality of the existing currency regime which may exist but not be as noticeable or measurable under more common conditions.

Dancing on a Precipice: The Tenuous Balance in Global Finance

“If you owe the bank $100 that's your problem. If you owe the bank $100 million, that's the bank's problem.” Jean Paul Getty

We imagine J. Paul Getty would probably like to update that quotation to billions if he were still alive. We knew some people who subscribed to this notion that you keep borrowing until you gain a measure of control over your banks, since your default would be so painful to them. It is a tool of financial engineering roughly related to a passive form of extortion, a long con.

Here is an extended quote from a 29 December 2008 essay by Brad Setser titled The collapse of financial globalization...

"Both private capital inflows to the US and private capital outflows from the US have fallen sharply. They have gone from a peak of around 15% of US GDP to around zero in a remarkably short period of time …

Direct investment flows have continued. Other financial flows though have largely gone in reverse, with investors selling what they previously bought. In the third quarter foreign investors sold about $90b of US securities (excluding Treasuries) and Americans sold about $85 billion of foreign securities. And the reversal in bank flows on both sides (as past loans have been called) has been absolutely brutal.

This sharp fall has bearing on the bigger debate over the role global capital, global savings and foreign central banks played in helping to to create the conditions that allowed US households to sustain a large deficit for so long — and whether American and other policy makers should have paid more attention to the risks that came with the surge in foreign demand for US financial assets earlier this decade...

I think we now more or less know that the strong increase in gross capital inflows and outflows after 2004 (gross inflows and outflows basically doubled from late 2004 to mid 2007) was tied to the expansion of the shadow banking system.



It was a largely unregulated system. And it was largely offshore, at least legally. SIVs and the like were set up in London. They borrowed short-term from US banks and money market funds to buyer longer-term assets, generating a lot of cross border flows but little net financing. European banks that had a large dollar book seem to have been doing much the same thing. The growth of the shadow banking system consequently resulted in a big increase in gross private capital outflows and gross private capital inflows... (Hence the subsequent spike in the value of the dollar from the eurodollar short squeeze we have recently seen - Jesse)

Why didn’t the total collapse in private flows lead financing for the US current account deficit to dry up? That, after all, is what happened in places like Iceland — and Ukraine.

My explanation is pretty straightforward.

Central banks were the main source of financing for the US deficit all along. Setting Japan aside, the big current account surplus countries were all building up their official reserves and sovereign funds — and they were the key vector providing financing to the deficit countries."

The implications of this are rather profound. The much touted notion that the US is the preferred destination for private wealth, thus sustaining an out of balance trade deficit through a financial services economy, is rubbish at best, and propaganda at worst. It is rooted in the Dick Cheney nostrum that "Reagan proved that deficits don't matter."

What we have today is a very lopsided vendor financing arrangement, wherein the US is largely supported by China and Japan whose industrial policy currently recommends their support of a US debt that is increasingly unpayable.

If and when China and Japan are no longer able to support the continued growth of US deficit financing, the dollar and the bonds will contract (decrease) in value, and perhaps precipitously, like a house of cards. It is much worse than we had imagined, and more concentrated on these two countries, along with Saudi Arabia, than we had thought.

For now the balance is maintained because of self-interest and fear. But we cannot stress enough the highly artificial nature of the arrangement, and its inherent instability, now that the charade of sustained private investment flow is shown for what it is. There is no economic theory to support this model other than a distorted form of neo-colonial parasitism. Substitute US paper dollars for opium and you get the idea.

Japan and Saudi Arabia are understandable as virtual client states under US military protection, but we struggle with how China was taken into this arrangement which is so potentially destabilizing of their internal political and economic stability.

This is why the world has not developed a sound replacement for the dollar hegemony. It is because if they do, they must navigate around the probability, not possibility, of a collapse of their dollar reserves, and a dislocation of their own export driven economies, much worse than we might have imagined. It is not a matter of economic inventiveness; it has become a matter of will.

Who will be the first to flinch? History shows it is rarely a conscious decision, but rather some incident, an accident, some trigger event, even one so small, that it creates astonishment at the size of the avalanche it unleashes.

To make it clear and simple, this is the first evidence we have seen to suggest that hyperinflation is in fact possible in the US. As you know, we have been strongly adverse to the extremes in outcomes, both in terms of a sustained deflation and a significant hyperinflation.

That has now changed. The dollar is a Ponzi scheme, the waters of debt are overflowing the dam of artificial support, and only a few countries, two of them somewhat unstable, are holding back the deluge.

A Question Worth Considering for the New Year...

What is at the heart of the US financial crisis?

Is it that the US has been precipitously cut off from some foreign source of funding? Has there been an oil embargo, a supply shock imposed such as the one that triggered the financial crisis of the 1970's? Are the problems caused by some external change, some actor outside the system?

I think most will say the answer is 'no.' The problems are internal to the US, to its financial system.

So, how would you fix a system that has broken from an internal flaw in this way? Try more of the same, business as usual, apply fresh debt to a failed system based on a growing pyramid of debt without making any substantial changes?

The US financial system, the housing, equity and Treasury markets, are all Ponzi schemes, with the need for a constantly increasing source of fresh money to keep going. That funding is new debt, new dollars based on nothing produced, just the trust and confidence of the participants.

Would you fix the Madoff Ponzi scheme by giving Bernie more money, public money, to keep his payments flowing to his 'investors?'

I think most of us would say, no, no more money.

But what is the difference between that and what Paulson and Bernanke are doing today? Is there a graceful exit strategy? Have any serious reforms or changes been made or even proposed? Has there even been a frank disclosure and discussion of exactly what happened, and what is continuing to happen, beyond blaming the victims, or cynically hiding behind 'well that's how things are?'

No. The key participants in the Ponzi scheme are continuing to take their gains out, in dividends and bonuses, front running the final collapse and admission that "its all gone; we're bankrupt."

Think about it.

What would you do if it is a Ponzi scheme, teetering on the edge?

Black Swan Dive: Life On the Tails

The worst case scenario is if the Dollar, Bond, and Equities start going down together as the world repudiates the US Dollar Reserve Currency and Credit Bubble.

This is not a probable scenario.

The last time it happened was in 1933 in the trough of the Great Depression.

But we may have the opportunity to see something as once-in-a-lifetime and memorable as John Law's Banque Générale and the Mississipi Bubble.

Let's hope the Federal Reserve can reach deeper in its pockets for a better class of tricks than just front running the dollar and the bonds until they fall over.

Certainly anything is possible, but it does appear as though the US Long Bond is hitting a 'high note' of improbable valuation unless the world accepts a single currency dollar regime.

Too Big to Fail, Too Well-Connected to Jail: The Economic Underworld of Bankruptcy for Profit

In her brilliant essay, NY Times Pulls Punches on Wall Street Bubble Era Pay, Yves Smith at Naked Capitalism quotes a 1993 research paper from the Brookings Institution titled Looting: The Economic Underworld of Bankruptcy for Profit.

"Our theoretical analysis shows that an economic underground can come to life if firms have an incentive to go broke for profit at society's expense (to loot) instead of to go for broke (to gamble on success). Bankruptcy for profit will occur if poor accounting, lax regulation, or low penalties for abuse give owners an incentive to pay themselves more than their firms are worth and then default on their debt obligations.

Bankruptcy for profit occurs most commonly when a government guarantees a firm's debt obligations. The most obvious such guarantee is deposit insurance, but governments also implicitly or explicitly guarantee the policies of insurance companies, the pension obligations of private firms, virtually all the obligations of large or influential firms. These arrangements can create a web of companies that operate under soft budget constraints.

To enforce discipline and to limit opportunism by shareholders, governments make continued access to the guarantees contingent on meeting specific targets for an accounting measure of net worth. However, because net worth is typically a small fraction of total assets for the insured institutions (this, after all, is why they demand and receive the government guarantees), bankruptcy for profit can easily become a more attractive strategy for the owners than maximizing true economic values...

Unfortunately, firms covered by government guarantees are not the only ones that face severely distorted incentives. Looting can spread symbiotically to other markets, bringing to life a whole economic underworld with perverse incentives. The looters in the sector covered by the government guarantees will make trades with unaffiliated firms outside this sector, (such as Enron, and even the 'deep capture' of agencies like the SEC, and the placement of your people in key government positions - J) causing them to produce in a way that helps maximize the looters' current extractions with no regard for future losses...."

We wonder if the authors Akerlof and Romer realized that their paper of appropriate warning would become a prophetic, virtual guidebook for an historic looting of the United States economy by a few financial institutions under the government guarantee of 'too big to fail' and 'too well-connected to jail.'

Impossible? Who would have believed that a paper from a neo-conservative think-tank, The Project for the New American Century titled Rebuilding America's Defences: Strategies, Forces And Resources For A New Century would become a blueprint for a program of deception and invasion?

The conclusions and the title of this blog are our own. Yves is one of the most level-headed of economic commentators. Her site is a 'must read' for the serious every day. We do not wish to put words in her mouth.

Having said that, the solution for non-US investors is simple. Do not hold US dollars or dollar assets to any significant degree until it proves itself to be responsible again. Bring your money back to your home economy. Build something useful for yourself and your children. Do not be a renter in your own house. If you are not for yourselves, who will be?

Do not allow your own bureaucracies to enforce an industrial policy of domestic deprivation and low wages to support an aggressive expansion of exports in return for increasingly worthless paper. When will the benefits come if not when times are good?

If your country is large enough you may become self-sufficient. If not, you can join one of the regional trade associations such as the European Union.

Commodities such as oil and industrial raw materials will continue to be pivotal, highly manipulated and disputed, for quite some time until the world regains its economic and political balance. Why would you allow one country to essentially set all the prices with its own paper?

For US investors the solution is not as easy. The dollar is an essential component of any portfolio and almost all day to day transactions.

There is promise in the new administration, despite early disappointment in some of the appointments to date. Let's give them time to show progress and programs. One needs capable individuals in place to act quickly. How can we forget the stumbling missteps of the Jimmy Carter administration?

However, too many of the appointments are cyncial verging on the outrageous for a government with a mandate to reform. Actions will speak much louder than words.

Excessive secrecy is incompatible with a democracy. More transparency in government is a reform of the first order.

It took years to lose our integrity, and to regain it is the work of a generation, one day at a time. There has been an ongoing program of overturning all the reforms and regulations of the 1930's, one by one, to discredit and repeal them, and to ultimately put the country under the control of an oligopoly. The pattern is unmistakable.

If you would like to give your children and grandchildren something worthwhile and lasting at this holiday season, then resolve to reform and replenish the Republic that your parents and grandparents gave to you, and not trade it away for some short term security and profit.

Citadel Suspends Withdrawals to Halt the Run on Two Funds

Are the hedge fund runs the modern day equivalent of the bank runs of the 1930's or even the Panic of 1907?

That is not as glib an observation as you might think at first. The hedge funds like Citadel and Fortress resemble the private banks of New York in the early 1900's in many ways.

As in the case of Bernie Maddow, as a type of Richard Whitney, we're seeing echoes of certain periods in the past in many of the events today.

This is clearly not your father's recession, but we are not quite sure what it will be yet, and are often unpersuaded by those who think they do.

"Why can't you just accept that this is deflation?" It is clearly a deflation in terms of aggregate demand, no question. All one has to do is look at GDP. But we do not see it as a true straightforward money deflation with a sustainable increase in the value of the dollar. The dollar is a financial asset and not a store of value. It is an artifice.

Something is going to replace the dollar, but we cannot tell what it will be yet.

The Fed and Treasury have given away three trillion dollars at least so far, with commitments to give away five more. It only seems to be a deflation if you are not on the list of the chosen few, and take a shower before leaving for work instead of after. In the short term deleveraged cash is king, no doubt about it. Risk is still high, and we have much further to do to the downside. Stocks are poison and debt is unstable.

The dollar is decoupled from reality, far from the conventional mechanisms of savings and investment. Its all policy now in the short term, and then the next phase of this transformation will begin, and it will contain a surprisingly large portion of the unexpected, the unanticipated, on the order of the stagflation of the 1970's that left so many economists with their mouths gaping open.

The natural question is "But Jesse, this is all well and good, and it makes my head hurt. What is the endgame? Where should I put my money now?"

Cash. The safer stores of value of wealth. Its no coincidence that short term Treasuries have spiked to negative returns, and manageable forms of gold and silver bullion are in scarce supply. And then we wait and see what happens next. Take risks if you must, but only with a very small percentage of your portfolio, and sit on the rest, get out of debt, cut consumption, and wait.

There is no way to adequately measure and assess risk in a system in which the price discovery mechanisms are broken, and the standards of value are changing to something radically different, and success and failure can rely on the somewhat arbitrary policy decisions of a few politicians and bankers and the decisions of foreign governments.


Citadel Suspends Withdrawals in Two Hedge Funds After 50% Drop
By Saijel Kishan and Katherine Burton

Dec. 12 (Bloomberg) -- Citadel Investment Group LLC, the Chicago-based hedge-fund firm run by Kenneth Griffin, halted year- end withdrawals from its two biggest funds after investors sought to take out $1.2 billion, according to a letter sent to clients.

The Kensington and Wellington funds, which together manage about $10 billion, have lost 49.5 percent of their value this year through Dec. 5. Withdrawals may resume as early as March 31, said the letter, signed by Griffin and sent to investors today.

“We have not made this decision lightly,” Griffin wrote. “We recognize how a suspension impacts our investors, especially those with current financial obligations of their own to meet.”

Citadel joins hedge funds including Fortress Investment Group LLC and Tudor Investment Corp. in limiting withdrawals as hedge funds head for their biggest annual losses since at least 1990. Hedge funds have declined 18 percent, on average, this year through Nov. 30, according to Chicago-based Hedge Fund Research Inc.

As of October, 18 percent of hedge-fund assets, or about $300 billion, managed by 5 percent of hedge funds, were subject to some sort of restriction on withdrawals, according to Peter Douglas, principal of Singapore-based hedge-fund consulting firm GFIA Pte.

Citadel normally allows clients to withdraw up to 1/16th of their assets quarterly. If total withdrawals exceed 3 percent of the fund, investors must pay a fee back into the fund ranging from 5 percent to 9 percent. Redemptions have never before surpassed the limit.

Citadel will also absorb “a substantial portion” of the funds’ expenses this year, the letter said. Citadel clients usually pay these charges, which have traditionally amounted to about 3 percent to 4 percent of assets.

The fund is holding between 25 percent and 30 percent of its assets in cash.

Katie Spring, a spokeswoman for Chicago-based Citadel, declined to comment.

Before 2008, Citadel had posted just one losing year since Griffin started the firm in 1990, dropping 4 percent in 1994. Three Citadel funds, whose returns are tied to the firm’s market- making business, have climbed about 40 percent this year. Those funds manage about $3 billion.

Is the Fed Taking the First Steps to Selective Default and Devaluation?

We have been looking for an out-of-the-box move from the Fed, but this was not what we had expected.

The obvious game changing move would have been for the Treasury and the Fed to make an arrangement in which the Fed is able to purchase Treasury debt directly without subjecting it to an auction in the public market first. This is known as 'a money machine' and is prohibited by statute.

But as usual the Fed surprises us all with their lack of transparency. They are asking Congress about permission to issue their own debt directly, not tied to Treasuries.

This is known in central banking circles as 'cutting out the middleman.' Not only does the Treasury no longer issue the currency, but they also no longer have any control over how much debt backed currency the Fed can now issue directly.

If the Fed were able to issue its own debt, which is currently limited to Federal Reserve Notes backed by Treasuries under the Federal Reserve Act, it would provide Bernanke the ability to present a different class of debt to the investing public and foreign central banks.

The question is whether it would be backed with the same force as Treasuries, or is subordinated, or superior.

There will not be any lack of new Treasury debt issuance upon which to base new Fed balance sheet expansion. The notion that there might be a debt generation lag out of Washington in comparison with what the Fed issues as currency is almost frightening in its hyperinflationary implications.

This makes little sense unless the Fed wishes to be able to set different rates for their debt, and make it a different class, and whore out our currency, the Federal Reserve notes, without impacting the sovereign Treasury debt itself, leaving the door open for the issuance of a New Dollar.

What an image. The NY Fed as a GSE, the new and improved Fannie and Freddie. Zimbabwe Ben can simply print a new class of Federal Reserve Notes with no backing from Treasuries. BenBucks. Federal Reserve Thingies.

Perhaps we're missing something, but this looks like a step in anticipation of an eventual partial default or devaluation of US debt and the dollar.


Wall Street Journal
Fed Weighs Debt Sales of Its Own
By JON HILSENRATH and DAMIAN PALETTA
DECEMBER 10, 2008

Move Presents Challenges: 'Very Close Cousins to Existing Treasury Bills'

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.

Government debt issuance is largely the province of the Treasury Department, and the Fed already can print as much money as it wants. But as the credit crisis drags on and the economy suffers from recession, Fed officials are looking broadly for new financial tools.

The Federal Reserve drained $25 billion in temporary reserves from the banking system when it arranged overnight reverse repurchase agreements.

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.

Louis Crandall, an economist with Wrightson ICAP LLC, a Wall Street money-market broker, says the Fed's interventions also have the potential to clog up the balance sheets of banks, its main intermediaries.

"Finding alternative funding vehicles that bypass the banking system would be a more effective way to support the U.S. credit system," he says.

Some private economists worry that Fed-issued bonds could create new problems. Marvin Goodfriend, an economist at Carnegie Mellon University's Tepper School of Business and a former senior staffer at the Federal Reserve Bank of Richmond, said that issuing debt could put the Fed at odds with the Treasury at a time when it is already issuing mountains of debt itself.

"It creates problems in coordinating the issuance of government debt," Mr. Goodfriend said. "These would be very close cousins to existing Treasury bills. They would be competing in the same market to federal debt."

With Treasury-bill rates now near zero, it seems unlikely that Fed debt would push Treasury rates much higher, but it could some day become an issue.

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.

The Dollar Trap Part II: Mutually Assured Financial Destruction

The current structure of the remnants of the Bretton Woods agreement with the US dollar as the dominant reserve currency is not sustainable unless the rest of the world is willing to accept a form of neo-colonialism.

The developed nations are holding approximately 70% of their reserves in US dollars.

The rest of the world knows it must find an acceptable substitute for the dollar as the reserve currency.

The US does not wish to change the status quo for several reasons.

First, it provides an automatic funding mechanism for incredibly large budget deficits that would collapse without this mechanism.

Additionally, the US economy has become badly distorted, with an outsized financial sector as a percent of GDP created to manage its artificial reserve construct.

Change will be painful for all. Yet change must and will come, even as the US resists that change and uses a type of Mutually Assured Financial Destruction policy to maintain its hegemony.

No one wishes to make the 'first move' to the exit, since it will cause a severe depreciation of their dollar reserves, and possibly provoke clandestine and military action by the world's sole superpower.

And yet, the inching to the exits is underway, and the world holds its breath in case a shift occurs that will precipitously unravel 37 years of financial imbalance in a global economic earthquake.

The dollar will either be saved with a new formal structure, with more fiscal and political overtones to support an otherwise unstable monetary regime, or it will be decimated.

It would be naive to think that the US financial planners do not see this and are not using it to their advantage.

One can always count on a reversion to the mean. We just cannot know when it will happen, or how, or in what period of time.

When it comes it will come quickly like a lightning strike, with a terrific thunderclap heard around the world.

US Debt has grown to be about ten percent of World GDP (excluding the US) which is without historic precedent.



Approximately thirty percent of US debt is being held by non-US entities, in particular foreign central banks.



The Developed Countries are holding approximately 70% of their reserves in US Dollars. The Developing Nations have less exposure on a percentage basis.

Above Charts from "Is the US Too Big to Fail?" by the Reinharts at VoxEU


Total US Dollar Credit Market Debt Now Stands at 350% of GDP. This cannot be sustained. Certainly a certain portion of credit will be written off in defaults. But notice that the strategy of the US is not to make structural reforms but to try and restart the debt creation engine. This will require continued subsidies from foreign sources with waning appetites for US debt that can never be repaid.



Above chart courtesy of Ned Davis Research.