Why Gold is Not in a Bubble

A nicely done analysis by Paul Krugman, economist of Princeton, in The New York Times.

What Paul does fail to mention is the significant decline of the dollar tends to inflate the prices of all commodities and products not produced in domestic US or sold openly in world markets, and that commodities are significantly and increasingly the case, a triumph of the service economy. Further, the inputs to costs of extracting/producing those commodities are soaring because of the general inflation of energy products.

So even if the price had increased while the supply remained steady, or even increased, a case could be made for commodities priced in dollars that they are still not in a bubble because the US dollar is in a bubble of supply.

However, this brings us to the interesting anomaly. Why is metals production not increasing with the dramatic increases in prices?

Some say that gold and silver were actively priced suppressed by the paper markets in NY and Chicago for many years, with huge short positions keeping the benefits of adding sources of supply artificially low. So now we are paying the price, since it takes years to bring new supply, new mines, into production.

But that's Moral Hazard and Unintended Consequences, and we are told to ignore them, as Josef Goebbels told the German people to disregard the bombs falling on Berlin. And for now, we listen, and go forward into the night.

Moral Hazard: A dilemma that arises when government officials take steps to bail out countries or businesses that are in serious financial trouble. Although the action may help prevent widespread financial turmoil, thereby protecting innocent parties, it creates an expectation that governments will always come to the aid of failing countries and companies, potentially increasing risky behavior because there is no penalty. Webster's Dictionary

Since free markets and capitalism are based on the principle of discovering price and managing risk, the greatest hazard ultimately is that we will lose our free markets, and essentially lose that which we think we have based our market economy upon, until of course we hit the wall and collapse, in our markets or as a republic.

Commodities and speculation: metallic (and other) evidence
by Paul Krugman
April 20, 2008, 9:49 am
The NY Times

We’ve had a huge runup in commodity prices — fuels, food, metals. But why? Broadly, the debate is between those who see it as a speculative phenomenon, driven by some combination of low interest rates and irrational exuberance, and those who see it as a collision of rapidly growing demand with constrained supply.

My problem with the speculative stories is that they all depend on something that holds production — or at least potential production — off the market. The key point is that the spot price equalizes the demand and supply of a commodity; speculation can drive up the futures price, but the spot price will only follow if the higher futures prices somehow reduces the quantity available for final consumers. The usual channel for this is an increase in inventories, as investors hoard the stuff in expectation of a higher price down the road. If this doesn’t happen — if the spot price doesn’t follow the futures price — then futures will presumably come down, as it turns out that buying futures produces losses.

Which brings me to this chart, from the IMF’s World Economic Outlook:



Bubble, bubble, where’ the bubble?

As far as I can see, this creates real problems for any claim that high metal prices are speculatively driven. Food inventories are also historically low. I just don’t see how a low-interest-rate or bubble story works here.

Paul Krugman in the NY Times

US Dollar Crisis Gathers Pace: One Night in Bangkok Makes a Hard Man Humble

Ironic to hear about the worsening global financial crisis triggered by the US dollar from The Nation, Bangkok's business daily.

We're trying to obtain a copy of this "authoritative report" which Thailand's Largest Business Daily reference. Odd they never mention the title or author.

The irony of hearing about the dollar crisis from the home of the Thai baht, the currency that brought low the careers of many a trader including Victor Niederhoffer, is just too ironic. And now is it the dollar's turn? And will the poor unsuspecting US public finally hear about the source of their pricing problems from Thailand? No word in the US media. Its a mystery.

"Oh how are the mighty fallen..." 2 Samuel 1:27

"One night in Bangkok makes a hard man humble
Not much between despair and ecstasy
One night in Bangkok and the tough guys tumble
Can't be too careful with your company
I can feel the devil walking next to me."

FINANCIAL TURMOIL
Breakdown of dollar system ' gathers pace'
Full-blown US balance of payments crisis also looms
April 18, 2008
The Nation - Thailand's Business Daily

The US is experiencing a breakdown of the dollar system that is similar to the 1971 breakdown of the Bretton Woods system of international monetary management, says an authoritative US financial report.

"The breakdown of the US-dollar system has gone from slow to moderate in pace, and there is a significant risk of an acceleration in the coming months," said the report which was released earlier this month.

With extreme provisions of liquidity [by the Fed] investors are now extremely bearish for the dollar, which still has ample room to fall further.

"While the global nature of financial markets means that financial problems are affecting every major developed economy, the US consumer is at the centre of this current crisis," it said.

"The change from having extremely easy access to credit to almost none has been most extreme in the US. All the entities that rely on the US consumer, from smaller US businesses to US commercial real estate to municipalities, are under significant strain. In aggregate, the amount of US-dollar-denominated debt that is trading at historically high spreads is huge, and it is likely that the Fed (and the US government) will have a lot more heavy lifting to do to keep the financial system and the economy from a severe contraction.

"The implications for the balance of payments are very negative as well, and the US is at the edge of a full-blown balance-of-payments crisis."

Despite the magnitude of the financial crisis, the US faces the daunting prospect of attracting foreign capital with its economy contracting.

Last year, foreign and sovereign funds were quick to snap up distressed US assets at bargain value, but they may have moved in too quickly.

"Ultimately, the US balance-of-payments situation means that either a combination of a deep contraction in US consumption and a much larger decline in the dollar will occur or American households will keep going deeper into debt. But American households can't keep going into debt, because they can't handle the debts they [already] have, and lenders don't want to continue to aggressively lend to them," the report said.

It concluded that either an intolerable economic contraction or a deep decline in the dollar would have to occur and speculated that the economic contraction could be 6-8 per cent. The dollar's decline would have to be mostly against the currencies of emerging markets.

The report said the gap in incomes between workers in the US (and other mature industrialised countries) and those in emerging countries, now about 15 to 1, would have to narrow.

The nominal value of the dollar has declined about 27 per cent since 2002, and those who save their money in dollars have lost their savings.

"It is not hard to question the US dollar as a [means of storing] wealth when you have lost 25 per cent or more of that wealth in as little as six years," it said.

An implication of the US dollar breakdown is that there are opportunities in emerging market currencies. Thailand and other emerging-market countries have been maintaining relatively weak currencies in order to boost export competitiveness. But the US conditions are forcing these countries to readjust their currencies toward the upside.

As for the baht, the Bank of Thailand has been intervening in the foreign-exchange market to keep the nominal effective exchange rate (NEER) of the currency stable. The NEER is calculated from a trade-weighted exchange rate between the baht and 25 major currencies, mainly those of Thailand's export markets and its export competitors.

Supavud Saicheua of Phatra Securities wrote in a report last Friday that Thailand's NEER was relatively stable.

"The baht is nominally 21 per cent weaker today than it was prior to the economic crisis in 1997. "However, the real effective exchange rate (REER) is drifting upwards and now only 13 per cent below the precrisis level (the REER is the same as the NEER, except it incorporates inflation differences between Thailand and the other 25 trading partners)," he wrote.

"In short, the REER suggests the Thai economy has been inflating at a faster rate than these countries over the past several years," Supavud added.

US Dollar Crisis Gather's Pace

Our Financial Sickness - First, Do No Harm

Today we present an excerpt from Doug Noland's weekly Credit Bubble Bulletin. This week Doug is responding to an op-ed piece by Marty Feldstein which suggests that the Fed ought to stop decreasing interest rates now.

We agreed with Feldstein's proposal for what we 'think' are the same reasons, and had come to the same conclusion some time ago. By lowering interest rates so precipitously, the Fed has taken a broad brush to solve a problem that might better have been addressed by a more selective remedy, which in some ways the Fed undertook with the opening of the Discount Window and the bailout Bear Stearns, although we disagree with specifics as we have already related.

The overall lowering of rates 'helps' the real economy which is also in a recession. The additional collapse of the credit Ponzi scheme by the banks is a significant complicating factor. We believe the recession we are entering is the child of past Fed actions in attempting to ameliorate prior financial slumps.

Clearly the Fed had a policy decision to make, and their decision was to throw the long term concerns and principles to the wind, and give a full force effort to holding the banking system together, inflation be damned. Anyone who suggests they have been conservative would probably like to see our economy run more like an Old West card game called Faro.

Doug suggests one step in addition to Marty's and that is that the Fed should increase interest rates now presumably to fight inflation and to strengthen the dollar, lowering commodity prices.

We've included Doug's entire argument because we wanted to make sure we had it right, since we're operating on short timeframes this weekend. What Doug is prescribing is to take the patient, which was brought in with an acute appendicitis, and after the Fed has removed it with a garden shovel, to take a cattle prod and try to get the patient back on its feet.

Nothing could more closely fulfill Jefferson's warning of 'first through inflation and then through deflation' the money controlling powers would destroy the middle class, making it serfs in the nation their forefathers created out of wilderness. Now that the speculative class have gained the bulk of the wealth, let's allow them to keep it, and make it all the more valuable through deflation, putting the middle class into early graves, for really little or no gain for the country. What good is a strong dollar when the real economy is in deep depression, and only a privileged few have them?

We are going to suggest, carefully we hope since Doug is a friend and a highly respected analyst, that raising rates now is the just counterpart, the flip side of the coin, to the mistake the Fed has made.

Using interest rates, the public money supply, to address a problem specific to the banking sector, a massive and pervasive case of credit fraud and at best the unintended consequence of irrational regulation and almost sociopathic venality, just once again uses the public as a bludgeon to try and hammer down the problem like a nightmarish game of whack-a-bubble. There needs to be an effort to specifically 'fix' the bank system, not by repair by through reform. Any remedy just keeps the game going is making the patient more feeble and imbalanced, requiring a more stringent and risky remedy at the end.

Put simply, anything that does not reform the banking system as part of the program, even in the near term, just compounds the problem through unintended consequences, with the larger public taking it right in the neck.

We thought the Naked Capitalist made a well thought proposal even better and more specific than the one which we had put forward some weeks ago.

1. Force as much OTC activity as has reasonable trading volume onto exchanges. That means at a minimum interest rate swaps, currency swaps, and credit default swaps. Yes, this will require standardization and some buyers will lose access to variants they might have liked. Too bad. Protecting the economy and the taxpayer is more important than indulging every investor’s pet need.

This of course will also considerably lower the profitability of the industry. Again, too bad. They screwed up and cost the populace a ton of dough. There are consequences for mistakes of that magnitude. They should consider themselves lucky not to have been subject to public beheadings.

Lower profits for banks has positive consequences. It means less talent and other resources are sucked into the FIRE economy (and remember, the FI in that equation are at best service providers to the real economy, and worse, when they become too large, parasites).

2. Prohibit off balance sheet vehicles.

3. Prohibit Level 3 assets; allow only Level 1 and strictly defined and audited Level 2 assets. This means regulators will not have anything overly arcane to assess; they ought to be able to get a clear picture of risks, processes, and exposures if they are dogged.

4. Prohibit these regulated institutions from lending, providing other funding, or investing in concerns that have Level 3 assets.

Hedge funds would continue to be unregulated. I might also prohibit any unregulated entity from going public. Speculators playing with investors’ money is tempting enough; having them have even less skin in the game via a public floatation makes it easier for them to get so large as to pose a danger. Yes, this can create problems of succession, but Wall Street dealt with it for a hundred years or so. These guys ought to be smart enough to figure it out.

I’d also have pretty draconian penalties for breaking the rules, the sort that can have individuals involved and their supervisors forfeit a lot of dough and go to jail.

Thus I’m not as pessimistic about the ability to leash and collar the industry, perhaps because I lived in it briefly when it was more heavily regulated and it functioned much better for society as a whole than it does now. And the bankers still made a very nice living, although nowhere near as egregious as the pay scales of late. The real constraint is political will, and I don’t think things have gotten bad enough yet for the public to demand an end to rule by finance. But that attitude will change if real estate prices fall another 10%.

We would go a step or two further, but this would be a great start. We need to separate the capital allocation system from the speculation system. We need to place strong accountability in the speculation system, in a sense firewalling off the real economy from the excesses of easy money speculation.

Is it really all that simple? Yes, it is. But it will be made to seem complex and dangerous because the banks fought against Glass-Steagall for years, and spent hundreds of millions doing it, to have the type of system exactly which we have today. They wish to be able to tap Other People's Money (OPM) in order to socialize their losses, while keeping inordinate gains and accumulate fabulous wealth when they are right.

And they will continue to corrupt the country as collateral damage to the national intellect by distorting reality and buying the best minds, until the republic is a shell of itself. Such is the work of parasites, which is exactly the type of unproductive and madly inefficient financial system which we have today.


Setting the Backdrop for Stage Two
by Doug Noland

Martin Feldstein, Harvard professor and former chairman of the President’s Council of Economic Advisors, wrote an op-ed piece in Wednesday’s Wall Street Journal – “Enough with Interest Rate Cuts” – worthy of comment.

“It’s time for the Federal Reserve to stop reducing the federal funds rate, because the likely benefit is small compared to the potential damage. Lower interest rates could raise the already high prices of energy and food, which are already triggering riots in developing countries. In order to offset the inflationary impact of higher imported commodity prices, central banks in those countries may raise interest rates. Such contractionary policies would reduce real incomes and exacerbate political instability.

The impact of low interest rates on commodity-price inflation is different from the traditional inflationary effect of easy money. The usual concern is that lowering interest rates stimulates economic activity to a point at which labor and product markets cause wages and prices to rise. That is unlikely to happen in the U.S. in the coming year. The general weakness of the economy will keep most wages and prices from rising more rapidly. But high unemployment and low capacity utilization would not prevent lower interest rates from driving up commodity prices.

Many factors have contributed to the recent rise in the prices of oil and food, especially the increased demand from China, India and other rapidly growing countries. Lower interest rates also add to the upward pressure on these commodity prices – by making it less costly for commodity investors and commodity speculators to hold larger inventories of oil and food grains. Lower interest rates induce investors to add commodities to their portfolios. When rates are low, portfolio investors will bid up the prices of oil and other commodities to levels at which the expected future returns are in line with the lower rates. An interest rate-induced rise in the price of oil also contributes indirectly to higher prices of food grains. It does so by making it profitable for farmers to devote more farm land to growing corn for ethanol.”

While I concur with the basic premise of the article (stop the cuts!), the substance of Mr. Feldstein’s analysis leaves much to be desired. First of all, I find it strange than he would address the issues of overly accommodative Federal Reserve policy, commodity price risk, and inflationary pressures without so much as a cursory mention of our weak currency. The word “dollar” is nowhere to be found – not a mention of our Current Account Deficits. The focus is only on interest rates - and such one-dimensional analysis just doesn’t pass muster in our complex world.

Most remain comfortably oblivious to today’s inflation dynamics. Mr. Feldstein mentions increased demand from China and India. He seems to imply, however, that portfolio buying (financed by low interest rates) by “commodity investors and speculators” is providing the major impetus to rising inflationary pressures generally. Perhaps price gains could have something to do with the $2.5 TN increase in global official reserve positions over the past two years (85% growth). I would also counter that destabilizing speculative activity is an inevitable consequence – rather than a cause - of an alarmingly inflationary global backdrop.

I’ll remind readers that we live in a unique world of unregulated Credit. Excess has evolved to the point of being endemic to an apparatus that operates without any mechanism for adjustment or self-correction. There is, of course, no gold reserve system to restrain domestic monetary expansions. Some years back the dollar-based Bretton Woods global monetary regime lost its relevance.

And, importantly, the market-based disciplining mechanism (“king dollar”) that emerged at times to ruthlessly punish financial profligacy around the globe throughout the nineties has morphed into a dysfunctional dynamic that these days nurtures self-reinforcing excesses. The “recycling” of our “Bubble dollars” (in the process inflating local Credit systems, asset markets, commodities and economies across the globe) directly back into our securities markets rests at the epicenter of Global Monetary Dysfunction.

A historic inflation in dollar financial claims was the undoing of anything resembling a global monetary system, and now this anchorless “system” of wildcat finance is the bane of financial and economic stability. To be sure, massive and unrelenting U.S. Current Account Deficits and resulting dollar impairment have unleashed domestic Credit systems around the globe to expand uncontrollably. Today, virtually any major Credit system can and does inflate domestic Credit to create the purchasing power to procure inflating global food, energy, and commodities prices.

The long-overdue U.S. Credit contraction and economic adjustment could change this dynamic. But for now there are reasons to expect this uninhibited Global Credit Bubble to instead run to precarious extremes - and for resulting Monetary Disorder to become increasingly problematic. Destabilizing price movements and myriad inflationary effects are poised to worsen. The specter of yet another year of near-$800bn Current Account Deficits coupled with huge speculative flows out of dollars is just too much for an acutely overheated and unstable global currency and economic “system” to cope with.

I hear pundits still referring to a “deflationary Credit collapse.” Well, the U.S. Credit system implosion was largely stopped in its tracks last month. The Fed bailed out Bear Stearns; opened wide its discount window to Wall Street; and implemented unprecedented liquidity facilities for the benefit of the marketplace overall. Central banks around the globe executed unparalleled concerted market liquidity operations. Here at home, the GSEs’ regulator spoke publicly about Fannie and Freddie having the capacity to add $200 billion of mortgages to their balances sheets, with the possibility of increasing their guarantee business as much as $2 TN this year (certainly including “jumbo” mortgages). The Federal Home Loan Bank system was given the ok to continue aggressive liquidity injections and balloon its balance sheet in the process. And now (see “GSE Watch” above) we see that the Federal Housing Administration (with its new mandate and $729,550 loan limit) is likely to increase federal government mortgage insurance by as much as $200bn this year, while Washington’s Ginnie Mae is in the midst of a securitization boom.

Together, the Fed and Washington have effectively nationalized a large portion of both mortgage and market liquidity risk. It is, as well, worth noting that JPMorgan Chase expanded assets by $80.7bn during the first quarter (20.7% annualized) to $1.642 TN, with six-month growth of $163.3bn (22.1% annualized). Goldman Sachs expanded its balance sheets by $69.2bn during Q1 (24.7% annualized) to $1.189 TN, with half-year growth of $143.2bn (27.4%). Even Wells Fargo grew assets at an almost 14% pace this past quarter. And we know that Bank Credit overall has expanded at a 12.6% rate over the past 38 weeks. Meanwhile, GSE MBS issuance has been ramped up to a record pace. And let’s not forget the Credit intermediation function now being carried out by the money fund complex – with assets having increased an unprecedented $371bn y-t-d (41.3% annualized) and $900bn over the past 38 weeks (47.7% annualized). It is also worth noting the $184bn y-t-d increase (29% annualized) in foreign “custody” holdings held at the Fed. Sure, the Credit system remains under significant stress, with additional mortgage and corporate Credit deterioration in the offing. But, at least for now, policymakers have successfully stemmed systemic deleveraging. The Credit system is simply not in deflationary collapse mode.

I could not be more pessimistic with regard to our economy’s prognosis. And certainly much more severe Credit problems lay ahead. I could argue further that recent Credit system developments are indeed consistent with the unfolding “worst-case scenario”. Yet I tend this evening to see benefits from analyzing the current backdrop in terms of the conclusion of the first Stage of the Crisis. The key aspect of this “first Stage” was a breakdown in Wall Street’s highly leveraged risk intermediation and securities speculation markets. The speed and force of the unwind was extraordinary and in notable contrast to traditional banking crises that track real economy developments. “Resolution” came only through the Federal Reserve and federal government assuming unprecedented risk – and at a cost of a policymaking mix of interest-rate cuts, marketplace interventions, and government guarantees. It is worth pondering some of the near-term ramifications.

First of all – and as the market recognized this week – yields have been driven to excessively low levels. Fed funds are today ridiculously priced in comparison both to the inflationary backdrop and to global rates. Mr. Feldstein is calling for a halt to rate cuts when it would be more appropriate for the Fed to move immediately to return rates to a more reasonable level. They, of course, would not contemplate as much. So I will presume that today’s non-imploding Credit system – replete with government-backed mortgage securitizations, government-guaranteed bank Credit, presumed government-backstopped money funds and a recovering debt issuance apparatus – will suffice in the near-term in generating Credit sufficient to perpetuate our enormous Current Account Deficits. This is no minor point.

I have in past Bulletins made the case that U.S. Credit and Economic Bubbles had become untenable – the scope of Credit and risk intermediation necessary to support the maladjusted economy had become too large. Extraordinary measures to effectively “nationalize” mortgage and market liquidity risk change somewhat the direction of the analysis. I would today argue that the risk of a precipitous economic downturn has been reduced in the near-term. As a consequence, U.S. Credit growth could surprise on the upside with risks to global Price Instability increasing markedly.

I would argue firmly that – in the face of a rapidly weakening economic backdrop - global inflation dynamics coupled with our highly maladjusted economy ensure intractable trade deficits. I would further argue that the current inflationary backdrop will prove an impetus to Credit creation – that then begets only more heightened inflationary pressures. There are certainly indications that the over-liquefied global “system” is not well situated today to handle more dollar liquidity (akin to throwing gas on a fire). Inflation and its consequences have quickly become major issues around the world.

With crude hitting a record $117 today, there is every reason to expect that newly created global liquidity will further inflate energy, food, and commodity prices generally. The Goldman Sachs Commodities index has gained 21% already this year. But when it comes to Monetary Instability, our financial markets might just prove the unappreciated wildcard. When the Fed and Washington radically altered the rules of U.S. finance last month, they placed in jeopardy huge positions that had been put in place to hedge against and profit from systemic crisis. With the end of “Stage one” arises a major short squeeze in the Credit, equities, and derivatives markets. And when it comes to contemplating the scope and ramifications of today’s “hedging” activities, we’re clearly in Uncharted Waters. It is not beyond reason that a disorderly unwind of “bearish” Credit market positions could incite a mini bout of liquidity, speculation, and Credit excess that exacerbates Global Monetary Instability - while Setting the Backdrop for Stage Two of the Crisis.

Doug Noland's Credit Bubble Bulletin

Russia Buys Deliverable Gold and the Madness of Bankers

Here's an odd little story we have come across. Russia has purchased gold for its reserves directly from the gold producers, not from the interbank market, the central bank boys' club. This is the first time they have had to do this.

Significant?

Perhaps, if Russia found that there was not enough deliverable gold on the central interbank market to fill its needs, and had to find fresher sources of the physical metal at today's prices, rather than interbank IOU's.

As you recall, the G7 central banks have been selling their gold slowly but surely for quite a few years now, with some having sold most of their reserves. Apparently they do this to raise cash when their printing presses are trés fatigué.

Sometimes they have done it quite noisily and a little stupidly, as in the case of the Bank of England. A seller generally does not crush the price with clumsy announcements before they intend to sell. At least not the seller who seeks a fair price and a reasonable profit, especially when selling on consignment.

The IMF has pledged to sell the same 400 tonnes of gold about twenty times if memory serves. If they were paid for announcements of sale rather than actual sales, they would be simply rolling.

But some central banks have been buying, and building up their reserves, and strengthening their currencies for the future.

Perhaps this is nothing, and not even close to a significant development.

But it strikes a chord. The US has sold off its entire official store of silver which was enormous, and now must scramble in the open markets to buy actual silver for the Mint.

Spain has sold off its gold reserves entirely we hear. They are content to have a claim on Germany's gold. Even the frugal Swiss have been releasing their national savings of the barbarous relic. Einer für alle, alle für nichts.

Such are the changing fashions in the haute couture of bank reserves and monetary taste. Most of the banks in the US are already fashionably insolvent, with paper claims on paper claims, although we hear London is also vying for title to the financial grande dame (pun intended as 'grand lady' or 'big hurt') for the world.

La moneta è mobile, qual piuma al vento, muta d'accento — e di pensiero.

Its an interesting theme, the world of financial speculation diverging from the natural world, into a realm of self-absorbed arbitrariness. Almost like a form of collective madness among the bankers, with their mountains of derivatives and paper bets and claims on the same set of things over and over, coming up short in fits and starts, shakes and shudders, slips and the occasional stumbles.

Nearly had a nasty spill the other week when the dice came up unfavorably for one of the largest banks at the table. Some think this will frighten them into more conservative behaviour, eliminating the need for reform. We predict they will be back at the tables as though nothing had happened.

Sempre un'amabile, furtivo banca, in pianto o in riso, — è menzognero.

Who is mad, the savers and builders or those who gamble and consume into hopeless indebtedness? Who is mad, conservative banks or the massively-leveraged English-speaking banks? As Churchill would say, "KBO." For none dare call the Emperor naked.

Russia. The new hard money currency. Possible candidate for the world's reserve currency? Oh the irony!

Russia & CIS
11:23 GMT, Apr 18, 2008 Latest Headlines...

For first time, Central Bank buys gold from producers - source

MOSCOW. April 18 (Interfax) - For the first time, the Central Bank
of Russia purchased gold for its international reserves from gold
producers, a source in banking circles told Interfax.

Previously the Central Bank had always purchased gold on the
interbank market.

jh (Our editorial staff can be reached at eng.editors@interfax.ru)

Interfax - Russia Goes to the Producers to Buy Its Gold

Libretto
Rigoletto, Verdi

La donna è mobile
Qual piuma al vento,
Muta d'accento — e di pensiero.
Sempre un amabile,
Leggiadro viso,
In pianto o in riso, — è menzognero.

Woman is variable
Like a feather in the wind,
Changing her tone — and her mind.
Always sweet,
Pretty face,
In tears or in laughter, — always lying

US Dollar (DX) Commitments of Traders as of April 15

Demystifying the TED Spread

TED is an acronym for Treasury and EuroDollar.

A Spread is just the difference or 'distance' between one thing and another.

Eurodollars are bank deposits denominated in U.S. dollars but held at locations outside of the U.S. Initially, the term only referred to dollar deposits in London but has been expanded to include dollar deposits at any offshore location. The deposits may be held by the foreign branches of U.S. banks or by non-U.S. banks. Eurodollar deposits may be Eurodollar certificates of deposit or simply Eurodollar time deposits.

T bills are US Treasury debt of short duration are considered to be risk free.

TED Spread = Yield on Eurodollar deposits - Yield on T Bills

The TED Spread is the difference between U.S. Treasury bill yields and yields for Euro dollar deposit contracts of the same maturity, generally three months, from the London Interbank Overnight Rate (LIBOR) market.

The theory is that US dollars held in offshore accounts are not subject to short term market activity and regulations by the Fed. They are a slightly better measure of the short term risk associated with holding dollars that are not US Treasuries.

The TED spread is used as a measure of investor confidence. Remember, for the individual components (T bills and Eurodollar deposits) the higher the yield the higher the perceived risk, the lower the yield the lower the perceived risk.

When the spread is small, investors are not requiring a large amount of additional compensation for the additional risk of deposits. This means the Eurodollar yield is lower, and closer to that of the T Bills.

When the spread is large, investors are demanding a higher yield on Eurodollars as compared to the higher quality of U.S. Treasury bills.

A sudden widening of the TED spread is indicative of a flight to quality and a perception of risk in corporate credit markets.

A rising TED spread at the extreme is thought to foretell a downturn in the U.S. stock market as liquidity is withdrawn from the equity markets. We think this is more of a confirming indication than a bellwether since analysis of the SP after extreme readings using TED alone is mixed. In that sense we would use it much as we would use VIX to indicate a period of high or low volatility and elevated or quiescent risk. Spreads by definition are indicators of risk.

TED Spread Chart on Bloomberg

US Crackdown on Credit Card Fees Coming

Good news in general although our skeptical sense is that the Fed is trying to stall the Democrats' effort in this area which is likely to be a little more rigorous.

No wonder the Wall Street Banks were so anxious to get that Visa IPO out the door come hell or high water or another wave of credit defaults.

The tide seems to be receding for the credit vultures.


US crackdown on credit card fees seen by year-end
18 Apr, 2008, 0016 hrs
The Economic Times

WASHINGTON: The Federal Reserve will soon unveil a broader plan to protect consumers from abusive credit card practices than a proposal it issued last year, a Fed official told lawmakers on Thursday.

The Fed's new plan, which it hopes to finalize by December, would restrict retroactive rate increases and other fees that consumer groups and lawmakers have criticized as exorbitant. In February, U.S. House of Representatives Democrats introduced a bill to stop arbitrary interest rate increases, penalties for consumers who pay only a portion of their balances on time, and excessive fees charged by credit card issuers.

Sandra Braunstein, director of consumer affairs at the Fed, acknowledged that a Fed proposal last June did not go far enough to help consumers. (How unusual. Let's give the Fed more power to do nothing effectual. - Jesse)

That plan would have required plain-English disclosures by credit card issuers to help consumers understand fees and rates. (What a draconian reform! The industry proposal was for the disclosures to be in an obscure dialect of the Anasazi Indians. PLAIN English! Wait! The Fed didn't specify what kind of English. How about plain MIDDLE English? The language of Chaucer. Ah! - Jesse)

"Careful measures that would restrict credit card terms or practices may, in some instances, be more effective than disclosure to prevent particular consumer injuries," Braunstein told a House Financial Services subcommittee hearing. (No shit Sandy, really? I've heard the State Police are going to stand on the edge of the highway and chastise reckless drivers with stern glares as they speed by. Did you design that reform too? - Jesse)

Chairing the hearing was Rep.Carolyn Maloney, a New York Democrat who wants Congress to adopt a credit card holder's bill of rights. Some lawmakers expressed concern that the regulators' efforts could conflict with congressional efforts to revamp credit card rules. "I'm very concerned about how we are doing this," said Rep. Mike Castle, a Republican from Delaware. (I am sure Mike is primarily concerned about the large contributions he receives from credit card companies operating out of his state. - Jesse)

Banks that offer credit cards, such as Bank of America Corp and Capital One Financial Corp, oppose the legislation. They have warned it could raise fees and reduce the amount of credit available to consumers. John Carey, chief administrative officer of Citigroup Inc unit Citi Cards, said new restrictions would penalize responsible customers. (How about a national usury law? We'll know its good if the CEOs of Capital One, BAC, and Citi blow chunks when they read it. - Jesse)

"The financial burdens associated with the higher-risk customers will be spread across all customers," Carey said in testimony prepared for the subcommittee. The Fed is aware that proposed restrictions could have unintended negative consequences, such as reduced credit availability and raised costs, Braunstein said. (Oh yeah but when it comes to bubbles the Fed can't find its own ass with both hands. - Jesse)

Also working on the proposed regulations to crack down on abusive practices are the U.S. Office of Thrift Supervision (OTS) and National Credit Union Administration, she said. (Oh great idea. If they ever write reforms for organized labor abuses can we conjure the ghost of Jimmy Hoffa to help? - Jesse)

OTS Deputy Director John Bowman said his agency shared lawmakers' concerns about the practice of increasing the annual percentage rate on an outstanding balance for reasons other than cardholder behavior directly related to the account.

"In our ... proposal we expect to place restrictions on some of these types of practices," Bowman said. Bowman called the practice of computing finance charges based on account balances in billing cycles preceding the most recent billing cycle "troubling." (Criminal and obscene were the ones that first came to mind. - Jesse)

For example, when a consumer makes a payment on a portion of his bill, the credit card company may still charge interest on the full amount, even though part has been repaid. (Gee, how could anyone object to that? I think we should start doing the same thing with corporate income tax payments, retroactive to the beginning of the Bush Administration. - Jesse)

"It is very difficult for consumers to avoid the increased costs associated with double-cycle billing because most consumers simply can't understand it," Bowman said. "This is another area that we address in our proposal." (I think they understand it all right. Its just that they can't do anything about it. - Jesse)

The OTS supervises credit card activities of thrift institutions. The agency is "at the beginning "stage of crafting tougher rules and will soon issue a notice of proposed rule making, Bowman said. But Braunstein said the Fed may use its unique authority to impose stricter regulations on the credit card industry. (These guys make FEMA look like Delta Force - Jesse)

How Phil Gramm and the Banks Helped to Destroy the US Financial System - An Insider's Perspective

A well-informed explanation of how we got to where we are. Relevant even more now perhaps since Mr. Gramm, among other things, is John McCain's economic advisor.

Fresh Air from WHYY, April 3, 2008 · Perplexed by the U.S. economy? You're not alone. Law professor Michael Greenberger joins Fresh Air to explain the sub-prime mortgage crisis, credit defaults, the shaky future of other types of loans and what we can expect from the U.S. financial markets.

Michael Greenberger Our Confusing Economy - Explained (Audio)


Michael Greenberger is the Director of the Center for Health and Homeland Security (CHHS) at the University of Maryland and a professor at the School of Law. In 1997 Professor Greenberger left private practice to become the Director of the Division of Trading and Markets at the Commodity Futures Trading Commission. In that capacity, he was responsible for supervising exchange traded futures and derivatives. He also served on the Steering Committee of the President's Working Group on Financial Markets, and as a member of the International Organization of Securities Commissions' Hedge Fund Task Force. He has frequently been asked to speak both in the media and at academic gatherings about issues pertaining to financial regulation, and has appeared on the ABC Evening News, The Jim Lehrer News Hour, and C-Span to discuss financial issues arising out of the Enron, Arthur Anderson, and WorldCom, and Refco failures.

Bankers Ask: Are the Bankers Rigging the Markets?

This is a particularly timely article. In essence, banks are raising the alarm that the LIBOR rates might be 'fixed' by large global banks providing false information. The banks are concerned because as a widely followed interest rate benchmark, LIBOR affects a signficant amount of financial activity in the real economy. And its bad for the banks' business, which is why it made the front pages of the WSJ and several leading economic blogs.

Categorize this under the title "Lack of Genuine Price Discovery in Manipulated Markets Leads to a Moral Hazard and Economic Distortion in the Real Economy."

The tricksters at Enron were able to manipulate the market for energy prices to the extent that they almost brought down the state of California, which is the size of most countries. Were the markets reformed? No, let's just move on.

The government has been manipulating key interest rate benchmarks pretty brazenly for years, such as CPI, through some of the most tortured and ridiculous of rationales imaginable. Some might say that this stealing from pensioners sets a rather poor example for the rest of the financial marketplace.

Just this morning the action in the S&P500 futures market was comparable to water running uphill. A recent ex-Treasury Secretary maintained its easier to fix "the problem" by manipulating the futures markets than cleaning it up afterwards. Not only was this NOT condemned, it was embraced by many academic financial types as clever and practical and cool.

Apparently some financial thinkers failed to learn the basic lessons of the schoolyard such as honesty and reputation and trust, because they were obviously hiding in the cloakrooms or library most of the time. Once you cheat or steal or lie, 'just this one time,' you often start doing it more and more for convenience until you do it all the time as a reflex. You parse the world into clever boys like yourself and stupid honest fools to be cheated. You become known as a cheat and a thief and a liar, and you hit the wall and fall from grace, and find yourself on the bottom.

(To the ex-Treasury Secretary's credit he did not use the word "manipulate," he used a more palatable euphemism which we cannot recall. But he is also not alone. Can you believe that there are some financial thinkers who maintain that by controlling the prices of key commodities and benchmarks the government can actually mask the impact of their reckless money printing? They call it 'managing the perception of inflation.' Take all this behaviour and put it on the schoolgrounds. What do you think about these boys now? Amoral little monsters. Yikes! - Jesse)

When the government gives a 'wink and a nod' to market manipulation, and either turns a blind eye and fails to prosecute, or bails out the miscreants using public money when they stumble and fall, or provides wristslaps without admitting guilt to the offending corporations when they get caught red-handed engaging in obviously illegal acts in the markets----

THAT IS MORAL HAZARD you fatheaded prunes.

There has been a lot of fuzzy thinking lately from economists who somehow have taken the posture that financial utilitarianism is the 'scientific approach' and that whatever 'fixes the problem' most quickly and cleanly is the optimum economic approach. Well, you might be able to build a career out of cheating, beating the system, invoking private privilege, and fundamental amoral lowness, but its a rough way to try and approach the problem of creating a sustainable, productive economy. It always and everywhere results in some form of totalitarianism.

"The President's Secret Working Group on Financial Markets" indeed. Future generations will think we were simply hypocrites or mad or deluded or all of it. Let's make reality a certain way by merely saying and acting as though it is.

What these fellows don't realize is that economic decisions almost always rest on the assumption of a moral judgement. There is no escaping it. It is better to cheat and break the rules one way and punish this group (usually of weaker innocents), than to hold some other more powerful group to account.

One has to do certain things when one is in a position of power. No, it when one is under stress in a position of power that they hold their whole selves in their hands, and their character is tested, and if they let go, they are lost.

Well, this is where that sort of thinking has brought us. We urge all economic students to take note of the slippery slope of moral retardation for the sake of expediency, and to start preparing now for the new wave of economic thinking that will come out of this period of economic vacuousness and lifeless neo-liberal madness.

Oh, and when this whole rats nest of dishonesty blows up in our faces, don't say you haven't been warned.


LIBOR FOG
Bankers Cast Doubt On Key Rate Amid Crisis
By CARRICK MOLLENKAMP
April 16, 2008
The Wall Street Journal

LONDON -- One of the most important barometers of the world's financial health could be sending false signals.

In a development that has implications for borrowers everywhere, from Russian oil producers to homeowners in Detroit, bankers and traders are expressing concerns that the London inter-bank offered rate, known as Libor, is becoming unreliable.

Libor plays a crucial role in the global financial system. Calculated every morning in London from information supplied by banks all over the world, it's a measure of the average interest rate at which banks make short-term loans to one another. Libor provides a key indicator of their health, rising when banks are in trouble. Its influence extends far beyond banking: The interest rates on trillions of dollars in corporate debt, home mortgages and financial contracts reset according to Libor.

In recent months, the financial crisis sparked by subprime-mortgage problems has jolted banks and sent Libor sharply upward. The growing suspicions about Libor's veracity suggest that banks' troubles could be worse than they're willing to admit.

The concern: Some banks don't want to report the high rates they're paying for short-term loans because they don't want to tip off the market that they're desperate for cash. The Libor system depends on banks to tell the truth about their borrowing rates. Fibbing by banks could mean that millions of borrowers around the world are paying artificially low rates on their loans. That's good for borrowers, but could be very bad for the banks and other financial institutions that lend to them.

True Borrowing Costs

No specific evidence has emerged that banks have provided false information about borrowing rates, and it's possible that declines in lending volumes are making some Libor averages less reliable. But bankers and other market participants have quietly expressed concerns to the British Bankers' Association, which oversees Libor, about whether banks are reporting rates that reflect their true borrowing costs, according to a person familiar with the matter and to government documents. The BBA is now investigating to identify potential problems, the person says.

Questions about Libor were raised as far back as November, at a Bank of England meeting in which United Kingdom banks, the firms that process bank trades and central bank officials discussed the recent financial turmoil. According to minutes of the meeting, "several group members thought that Libor fixings had been lower than actual traded interbank rates through the period of stress." In a recent report, two economists at the Bank for International Settlements, a sort of central bank for central bankers, also expressed concerns that banks might report inaccurate rate quotes.

ARMA spokesman for the BBA, John Ewan, said the trade group is monitoring the situation. "We want to ensure that our rates are as accurate as possible, so we are closely watching the rates banks contribute," Mr. Ewan said. "If it is deemed necessary, we will take action to preserve the reputation and standing in the market of our rates." Libor is expected to be on the agenda of a bankers' association board meeting on Wednesday.

In a recent research report on potential problems with Libor, Scott Peng, an interest-rate strategist at Citigroup Inc. in New York, wrote that "the long-term psychological and economic impacts this could have on the financial market are incalculable." Mr. Peng estimates that if banks provided accurate data about their borrowing costs, three-month Libor would be higher by as much as 0.3 percentage points.

A small increase in Libor can make a big difference for borrowers. For example, an extra 0.3 percentage points would add about $100 to the monthly payment on a $500,000 adjustable-rate mortgage, or $300,000 in annual interest costs for a company with $100 million in floating-rate debt. On Tuesday, the Libor rate for three-month dollar loans stood at 2.716%.

Libor has become such a fixture in credit markets that many people trust it implicitly. Concerns about its reliability are "actually kind of frightening if you really sit and think about it," says Chris Freemott, a Naperville, Ill., mortgage banker who depends on Libor to tell him how much his firm, All America Mortgage Corp., owes First Tennessee bank for a credit line that he uses to make loans.

The Libor system was developed in the 1980s. Banks were looking for a benchmark that would allow them to set rates on syndicated debt -- corporate loans that typically carry interest rates that adjust according to prevailing short-term rates. By pegging lending rates to Libor, which is supposed to represent the rate banks charge each other for loans, banks sought to guarantee that the interest rates their clients pay never fall too far below their own cost of borrowing.

Banks typically set their lending rates at a certain "spread" above Libor: A company with decent credit, for example, might pay an interest rate of Libor plus one-half percentage point. A risky "subprime" mortgage loan might carry an interest rate of Libor plus more than six percentage points.

Today, Libor rates are set for 15 different loan durations -- from overnight to one year -- and in 10 currencies, including the pound, the dollar, the euro and the Swedish krona. They serve as the basis for payments on trillions of dollars in corporate loans, mortgages and student loans. Libor rates are also used to set the terms of more than $500 trillion in "derivatives" contracts such as interest-rate swaps, which companies all over the world, including U.S. mortgage guarantors Fannie Mae and Freddie Mac, use to protect themselves against sudden shifts in the difference between long-term and short-term interest rates.

When banks want to borrow money, they contact banks directly or phone a loan broker, such as ICAP PLC in London. Much of the interbank lending takes place between 7 a.m. and 11 a.m. London time. In broker speak, a bank might ask for a "yard" -- one billion in a designated currency. Brokers communicate with bank clients by phone or through desktop voice boxes, which are faster. At ICAP, brokers track bids and offers by looking up at a big whiteboard above the trading floor, where a "board boy" posts information. The actual rates at which banks borrow from each other are known only to the lenders and borrowers, and possibly to their brokers.

Every morning by 11:10 London time, "panels" of banks send data to Reuters Group PLC, a London-based business-data and news company, on what it would cost them to borrow a "reasonable amount" in a designated currency. The dollar Libor panel, for example, consists of 16 banks, including U.S. banks Bank of America Corp. and J.P. Morgan Chase & Co. and U.K. banks HBOS PLC and HSBC Holdings PLC. Reuters uses the reported borrowing rates to calculate Libor "fixings." To reduce the possibility that any bank could manipulate an average by reporting a false number, Reuters throws out the highest and lowest groups of quotes before calculating averages.

Justin Abel, global head of data operations for Reuters, said in a statement that his company's role is solely to calculate fixings based on the information provided by banks. "It is their data alone we distribute. Reuters is purely the facilitator," he said.

Wary of Lending

The global financial crisis that began last summer has made it more difficult for banks to package and sell all kinds of loans as securities, as well as to issue bonds and short-term IOUs to investors. Increasingly, banks have turned to the interbank market to borrow cash. But their mounting losses on mortgage securities and other investments have raised fears that a major institution could go bust.

That's made banks increasingly wary of lending to one another.

Such jitters have made many banks unwilling to extend loans to each other for more than one week. As a result, the rates they quote for loans of three months or more are often speculative, because there's little to no actual lending for that time period, brokers say. "It amounts to an average best guess," says Don Smith, an economist at ICAP, the London broker of interbank loans and derivatives.

These bank problems are proving costly to other kinds of borrowers around the world. One way to measure the rough cost is by comparing the three-month Libor rate with an interest rate that doesn't reflect worries about banks' financial health -- such as the yield on a three-month Treasury bill, which is backed by the U.S. government. The gap between the two stood at 1.58 percentage points Tuesday, and has averaged 1.39 percentage points since the crisis began in August. In the five years before the financial crisis started, it averaged only 0.28 percentage points.

(This is a decent example of the problem of lack of true price discovery in rigged markets. - Jesse)

Citigroup's Mr. Peng believes banks could be understating even those abnormally high Libor rates. He notes that the Federal Reserve recently auctioned off $50 billion in one-month loans to banks for an average annualized interest rate of 2.82% -- 0.1 percentage point higher than the comparable Libor rate. Because banks put up securities as collateral for the Fed loans, they should get them for a lower rate than Libor, which is riskier because it involves no collateral. By comparing Libor with that indicator and others -- such as the rate on three-month bank deposits known as the Eurodollar rate -- Mr. Peng estimates Libor may be understated by 0.2 to 0.3 percentage points.

Other Benchmarks

In one sign of increasing concern about Libor, traders and banks are considering using other benchmarks to calculate interest rates, according to several traders. Among the candidates: rates set by central banks for loans, and rates on so-called repurchase agreements, under which borrowers provide banks with securities as collateral for short-term loans.

In a report published in March by the Bank for International Settlements, economists Jacob Gyntelberg and Philip Wooldridge raised concerns that banks might report incorrect rate information. The report said that banks might have an incentive to provide false rates to profit from derivatives transactions. The report said that although the practice of throwing out the lowest and highest groups of quotes is likely to curb manipulation, Libor rates can still "be manipulated if contributor banks collude or if a sufficient number change their behaviour."