Four Scenarios for the US Dollar and Equity Rallies

As you may have noticed we have been experiencing a powerful counter-trend rally in the US dollar and financials assets including stocks, especially the financials and the broader indices like the Russell, and the US Bonds. Certain commodities like oil, gold and silver have gotten beaten like a rented mule. Why has this occurred with such sudden power?

Here are several scenarios worth considering.

1. Short Squeeze and Forced Liquidation: The "sell dollar and buy energy and metals" trade had become vastly overdone, the big players noticed this, and are using their Wall Street ways to force out the funds and specs that were holding this trade. We consider this a high probability because of the sharpness and violence of the move which has all the hallmarks of a forced liquidation and short covering. Considering that this move has been progressing on low summer volumes during the Olympics in China lends credibility to a calculated trading gambit.
   
   There may also be some government intervention involved over the short term as a 'spark.' There is a disinformation effort tied to specific objectives, such as option expiration and unloading 'dog stocks' along with the usual mindless optimism of the prompter readers. The banks may be intentionally crowding out the hedge funds from short term liquidity for a trade, since they don't have many other sources of income and they require the capital anyway. 'Betraying your customer when the chips are down' is a time honored tradition on the Street, face-ripping-wise. And most importantly so far the moves are well within the parameters of corrective rallies on most of the charts, especially the dollar, stocks and gold.



2. Government Sponsored Reflation: In contrast to a simpler government intervention, a government sponsored reflation is a longer term effort to lift the markets against the tide through the judicious application of liquidity in repetitive tranches of less than three months overlapping. On our long term Dow chart we have identified a couple periods after the 2000-2002 tech bust that we consider reflationary attempts by the US Treasury and the Fed that inflated bubbles in various markets including stocks and housing. This is a medium probability.
   
   It will increase in probability if the market continues to rally with liquidity efforts and new asset bubbles begin to appear. The rallies coincidence with the operation in Georgia which had the marks of a Bushco calculated event lends some credibility to this as well as the first scenario.



3. Goldilocks is back in town: The US economy is ahead of the rest of the world in getting past its credit crisis and restoring soundness to its financial system. The recession will be mild and short lived. The markets are anticipating the US advantage of grossly distorting its economic statistics versus Europe's relative honest reporting. This is a low probability.
   
   The data just does not support an improving economy in the forseeable future. Ben and Hank will botch the rescue effort required for this scenario and activate scenario 2, handing the next president a serious problem. If its McCain we'll just go to war to take our minds off our problems. If its Obama, we'll have a lot of fireside chats to keep us warm in the winter winds that blow through our ruined economy.



4. Prelude to a Crash: It is a little premature to discuss this scenario further with charts and examples unless the stock market reverses hard in a 'rally that fails.' We're keeping a close eye on it. The probability may move very quickly from low to high if we see the 'right moves.' It has a nice cynical irony of betrayal of the public trust once again by the financial sector as well. But it is unlikely as of now. But we wanted to make you aware of it, because the elements for this to form are all there, despite the oncoming Presidential election.
   

We'll have to see what happens to assess the situation further. But it is apparent that the US financial system is badly in need of reform and responsible adult supervision. Truth, accountability, and vigilant justice are among the commodities in the shortest supply.

Who Holds the Most US Dollars?

The People's Bank of China now holds the most dollars on the asset side of its balance sheet, more than even the US Federal Reserve Bank.

Now THAT's a global imbalance.

The full essay from Brad Setser is available at this link which is a bit slow in responding at times. It is a discussion of how a monetary authority can influence policy by acquiring certain types of debt rather than others.

Its a bit of a moot point, since China holds US debt in aggregate, excepting any Fannie and Fred agencies of course. Since the Treasury and Fed are busily monetizing nearly everything, China may only have a single lever to pull: to buy or not to buy.

But it does strike us as a nice example of the imbalances in the world's financial structure, and yet another reason why a true monetary deflation in the US dollar is most likely a fantasy.

"The Capitalists will sell us the rope with which we will hang them." V.I. Lenin


Follow The Money
Quaint
Brad Setser

...The PBoC now has a larger dollar balance sheet (on the asset size) than the Fed. It holds around a trillion dollars of Treasuries and Agencies (over $950b can be identified using the TIC data, and the TIC data understates China’s holdings … ). The Fed has around $900 billion in assets — $940 billion, to be precise....

Most US Companies Pay No Federal Income Tax

We like to read the non-US newspapers to get a better idea of what is happening in North America.

It does appear that change might be in the wind. But we're not optimistic.

Most people are still thinking in slogans, headlines, and cartoons of reality, shaped by what is given by the media, the professional story-tellers, and character assassins. One has to only look at the chain emails they receive, uncritically passed around from person to person, to see how pathetically misinformed the majority seem to be.

So many Americans say "Good!" when they hear that many corporations and the abundantly wealthy few are paying less taxes, without realizing that they and their children are paying for this instead, since government spending is increasing dramatically. They are paying for the billions being created by the Treasury and Fed to subsidize the reckless banks and the huge war profits of the corporations.

We are no better nor different than any other people that have been deluded and misled by propaganda, no matter how ridiculous it might have sounded to others. We asked, "How could they have believed that nonsense, right up to the point of their own destruction?" Now we know.

Its not that we are any less intelligent than others. We are more complacent, self-absorbed, conceited and naive, with our senses dulled by excess. And before you smile too smugly about the Americans, it is a high probability that your own country and central bank have deeply involved you in this financial scheme. Its just that their propaganda has a different tone and flavor.

"It also gives us a special, secret pleasure to see how unaware the people are around us of what is really happening to them." Adolf Hitler


Most Companies in US avoid Federal income taxes
12 Aug, 2008, 0955 hrs IST
The Economic Times (India)

WASHINGTON: Unlike the typical American citizen, most U.S. corporations and foreign companies doing business in the United States pay no federal income tax, according to a new report from Congress.

The study by the Government Accountability Office, expected to be released Tuesday, said two-thirds of U.S. corporations paid no federal income taxes between 1998 and 2005, and about 68 percent of foreign companies doing business in the U.S. avoided corporate taxes over the same period.

Collectively, the companies reported trillions of dollars in sales, according to GAO's estimate.

``It's shameful that so many corporations make big profits and pay nothing to support our country,'' said Sen. Byron Dorgan, who asked for the GAO study with fellow Democratic Sen. Carl Levin.

An outside tax expert, Chris Edwards of the libertarian Cato Institute in Washington, said increasing numbers of limited liability corporations and so-called ``S'' corporations pay taxes under individual tax codes.

``Half of all business income in the United States now ends up going through the individual tax code,'' Edwards said.

The GAO study did not investigate why corporations were not paying federal income taxes or corporate taxes and it did not identify any corporations by name. It said companies may escape paying such taxes due to operating losses or because of tax credits.

More than 38,000 foreign corporations had no tax liability in 2005 and 1.2 million U.S. companies paid no income tax, the GAO said. Combined, the companies had $2.5 trillion in sales. About 25 percent of the U.S. corporations not paying corporate taxes were considered large corporations, meaning they had at least $250 million in assets or $50 million in receipts.

The GAO said it analyzed data from the Internal Revenue Service, examining samples of corporate returns for the years 1998 through 2005. For 2005, for example, it reviewed 110,003 tax returns from among more than 1.2 million corporations doing business in the U.S.

Dorgan and Levin have complained about companies abusing transfer prices _ amounts charged on transactions between companies in a group, such as a parent and subsidiary. In some cases, multinational companies can manipulate transfer prices to shift income from higher to lower tax jurisdictions, cutting their tax liabilities. The GAO did not suggest which companies might be doing this.

``It's time for the big corporations to pay their fair share,'' Dorgan said.

Consumer Inflation Comes in Smoking Hot

Tomorrow is the August stock options expiry and the Wall Street wiseguys are gaming the system aggressively to skin the public, so don't let the short term market reactions to any news we get influence your own thoughts. Think for yourself.

August 15, 2008
Inflation Hits Annual Pace Not Seen Since 1991
By MICHAEL M. GRYNBAUM
NY Times

Inflation reached a 17-year high last month, fueled by high gasoline and food prices, all but assuring that the Federal Reserve will keep interest rates on hold for the time being.

Consumer prices were 5.6 percent higher last month than they were in July 2007, a brisker pace than economists had expected, the Labor Department said on Thursday.

That was the sharpest annual increase since January 1991, as Americans paid more for clothing, food, transportation and recreational products.

The news was distressing for investors and the stock markets initially fell on the report. The major exchanges recovered, however, and the Dow Jones industrials up more than 100 points in early afternoon trading.

Investors returned to buying financial stocks, taking advantage of a sector that has fared poorly in recent sessions. The broader S.&P. 500-stock index was up 0.61 percent. Wal-Mart also reported a better-than-expected rise in quarterly profits, but the discount retail giant also issued a gloomy sales forecast for the rest of the year. In addition, crude oil prices continued to fall, dropping below $113 a barrel.

The overall Consumer Price Index, considered the benchmark gauge of domestic inflation, rose 0.8 percent in July. Economists had forecast a rise of half that rate. In June, prices rose 1.1 percent, the second highest monthly pace in 26 years.

The C.P.I. surveys prices of a basket of common consumer goods, measuring everything from toothpaste and prescription drugs to airline fares and restaurant menus.

Because food and energy prices can be highly volatile from month to month, the Labor Department also calculates a so-called “core” price index, which strips out those costs. In July, core C.P.I. rose 0.3 percent, reaching a 2.5 percent annual rate.

That is higher than the Federal Reserve and other economic policy makers would prefer. Central bankers use core C.P.I. to see whether price increases are becoming entrenched in the broader economy; Fed officials are said to prefer a ceiling of 2 percent annual increases.

The Fed has signaled repeatedly that it has no plans to lower interest rates, given the threat inflation poses to the economy. Lowering rates could stimulate more economic activity, but such a move would risk inflating prices further. Thursday’s C.P.I. report cements that view, and suggests that a rate increase could come sooner rather than later. (They will only raise rates under extreme duress - Jesse)

Still, central bankers face a difficult set of possibilities. The American economy continues to deteriorate: consumer spending is bad and likely to get worse; home prices continue to fall; and Wall Street has been unable to shake a credit crisis that keeps hurting big institutions. Stock prices are down too, further eroding household wealth.

The C.P.I. provided further evidence about the price pressures facing Americans this summer. Energy prices were up 4 percent in July; transportation costs increased 1.7 percent on a sharp rise in airline fares; and the price of clothing soared 1.2 percent after falling or staying steady for most of the year.

Food and beverages also cost more, with prices rising 0.9 percent last month. Since July 2007, food prices have risen 5.8 percent.