The Practical Risk in the Fed and Treasury's 'Trickle Down" Approach

The 'trickle down' approach being taken by the Fed is in danger of not only failing to sustain the economy, but may precipitate a significant political crisis.

The current plan is to flood a few relatively large banks with public liquidity, without substantially changing their management, their charters, and their regulatory constraints.

What if these banks defer on lending to others as their primary objective, preferring instead to buy up valuable and productive non-financial assets on the cheap for their own speculative purposes? Or to provide the liquidity for their associated off-balance-sheet corporations to do the same, rather than funding organic growth?

Why would the banks limit themselves to commercial banking when they can still act like hedge funds buying assets and investing for their own tradebook and investment portfolios?

The short answer is that they always and everywhere have acted with their own interests first and foremost.

The obvious firms to watch are Goldman Sachs and Morgan Stanley. Why the Fed does not see this obvious moral hazard is astonishing. What is even more astonishing is that no one is calling out Paulson on this, who has a yawning conflict of interest with Goldman Sachs.

The inherent weakness in a centrally planned economy is that it invariably leads in distortion, corruption, and advantageous manipulation by insiders. To expect anything else is to ignore human nature and history.

The banks, our 'national champions,' must be constrained again as they were in the 1930's after their reckless speculation and credit expansion had financially decimated the nation's economy and the great majority of the public.

Gold, Oil, MZM, Credit and the Short Term Liquidity Contraction

MZM is the Fed's broadest measure of liquidity. Although gold is not as 'immediate' as cash due to the need to convert it to currency, nevertheless it is a liquid store of wealth in that there are no time constraints on it such as on Certificates of Deposit or other time constrained instruments.

Stocks are also a liquid store of wealth, but with a larger beta or 'riskier valuation' with respect to their expected growth and earnings. As an aside, some day we hope to see a return to the notion of a risk premium for equities versus debt.

As we have shown before, the correlation between the growth of MZM and the price of gold in dollars is remarkable. There are a few other factors in the regression we are tracking which are not shown here, such as fear-driven volatility as measured by VIX.



Note that in the chart below in the same time period M2, a broad money supply measure, but less liquid than MZM, has shown a sharp spike higher along with its associate, Total Bank Credit.
We think this is a clear indication that we are in a liquidity crunch, but not a deflationary contraction in the the broader money supply.

In other words, funds and individuals are raising 'cash' by selling liquid assets to meet margin calls and support investment assets and short term obligations.


On a cautionary note, the growth in a dollar of Bank Credit is showing less ability to produce a dollar of M2. Again, this is not deflation but the transfer of wealth from one asset class to another, with lags and amongst individuals, and the inefficiency of the ability of an economic system based on wealth transfers and specultation to produce incremental productive savings.


This is not to say that a true deflation is not possible. Quite to the contrary. Deflation is a policy decision, normally caused by an adherence to some non-synchronized external standard, such as gold or the US dollar, ignoring the short term needs of the domestic marketplace.

Does this mean that there is no manipulation in the gold market? No, the price manipulation there is obvious, and we will take the central banks at their word that they wish to discourage gold as an alternative store of liquid wealth, because it is beyond their control and a competitor to their desired fiat regimes. Statists dislike anything that provides competition to their power.

What we do wish to show is that the banks are not fighting the gold trend as much as some might think because of the short term liquidity contraction. When this changes, the move in gold will obtain explosive momentum from which a major rally leg will occur as the banks lose control.

We also believe the same set of conditions applies to Crude Oil based on our current data which we will not include here for the sake of brevity. The price declines in crude oil are not wholly related to a diminished demand or 'speculation' as some would contend. Rather, oil has been serving as a global store of liquid wealth against a declining dollar and increasing dollar inflation. Oil has many of the aspects of 'money' for global trade. Demand and supply for crude oil will prove to be much less elastic than many assume.



We do not hold the same view for all commodities because we have not looked closely at them, but not all have the same "monetary component" as gold and oil.

Interestingly enough, the eurodollar spread (TED) is artificially wide because of the eurodollar assets and liabilities as we have shown before. We wonder what this will do to the euro and its associated currencies in the longer term, since the artificial short squeeze in the dollar is causing some havoc short term with European money supply policy despite the central banks attempts to sterilize the effects.

We expect a sharp rally in gold, oil and the euro once the short term liquidity constraints are overcome with a corresponding sharp decline in the US dollar.

The Fed will likely have to raise interest rates, and perhaps sharply, to counteract this, unless they can rely on foreign central banks once again to 'bail them out.'

A Credit Bubble of Historic Proportions

"What is crooked cannot be made straight, and what is lacking cannot be counted." Ecclesiastes

Hmmm, let's see. How about injecting billions of capital in the banks crippled by reckless speculation and fraudulent lending, and obscenely high pay and bonuses to the people who ran them.

And then we can beg the banks to start making loans to us with our money to get the credit expansion back on the upswing.

That should fix the problem, right?

This is a Ponzi scheme reaching parabolic heights. It has to retrace at least fifty percent, and the US economy must get back into some sort of sustainable structure, period.

The alternative is for the majority of Americans and British to accept debt peonage or "go into service," and most of the world's economies to adopt the dollar and sign their people up for a neo-colonial, centrally-managed political structure.

Welcome to the new Anglo-American Empire, founded not on supremacy of the seas, but of the financial markets.

The most probable outcome is that the looting of the Treasury will continue until the current crew in Washington leaves town, and they dump the problem hard into 2009 which will be the year from hell. Then they will wind up their spin machine about low taxes and trickle down economics and blame it all on the new Administration.

Off Balance Sheet Lending Factors - Cumberland Advisors pdf