The Monetary Base During the Great Depression and Today

Economic commentator Marty Weiss has put out this chart with the somewhat florid headline, Bernanke Running Amuck

"Fed Chairman Bernanke is running amok, and for the first time since the birth of the U.S. dollar, our government is egregiously abusing its power to print money.

Specifically, from September 10, 2008 to March 10 of this year, he has increased the nation’s monetary base from $850 billion to $2.1 trillion — an irresponsible, irrational and insane increase of 2.5 times in just 18 months.

It is, by far, the greatest monetary expansion in U.S. history. And you must not underestimate its sweeping historical significance."

This chart with its editorial commentary are from Marty Weiss.



Here is a closer look at this monetary expansion, without the editorial comment



Is it without historical precedent? I wondered.

Let's take a look again at a prior period of dollar devaluation and monetary expansion in a period of deep recession, the period in the 1930's in which the US departed from specie currency to facilitate the radical expansion of the monetary base.



As you can see, the Federal Reserve increased the monetary base in several steps, resulting in an aggregate increase of about 155% in four years. In this chart above one can also nicely see the contraction in the monetary base, the tightening, that caused a dip again into recession in 1937.

It is also good to note that the recession ended and the economy was in recovery prior to the start of WW II, which I would tend to mark from Hitler's invasion of Poland in August, 1939. There was a military buildup in Britain before then, but I believe that the common assumption that only the World War could have ended the Great Depression was mistaken.

If real GDP is any indication, the recovery of the economy was underway, but somewhat anemic compared to its prior levels, reflected in a slow decline in unemployment. It is absolutely essential to remember that the US had become a major exporting power in the aftermath of the first World War. The decline therefore of world trade with the onset of the Depression hit the US particularly hard. But the recovery was underway, until the Fed dampened it with a premature monetary contraction that brought the country back into recession, a full eight years after the great crash. Such is the power of economic bubbles to distort the productive economy and foster pernicious malinvestment.



What prolonged the Depression in the US was the Federal Reserve's preoccupation with inflation that caused it to prematurely contract the money supply. In addition, the Supreme Court overturned most of the New Deal employment programs before the economy had fully recovered from the shock of the Crash of 1929, and the severe damage inflicted by liquidationism on the financial system and the real economy. One can hardly appreciate today the impact of repeated banking failures, with no recourse or insurance, on the public confidence.

It is instructive to look at the Consumer Price Index for that period of time to see what was motivating the Fed.



It is fair to say that the Fed made several policy errors out of a fear of inflation. Keep in mind that it was only 1933 that the Fed had been freed of the gold standard, and there was tremendous pressure from the monied interests to maintain a strong currency, as we can see, to a fault. The public interest was sacrificed to protect the pre-Crash gains of the wealthy.

The US economy had a more difficult time adjusting to the collapse and the Depression because it had been a net exporting nation in the 1920's. The decline in markets for its exports, and the constrictions in international trade symbolized in the US by the Smoot-Hawley tariffs, affected it much more than other nations that had been net importers, and which exited the Depression earlier.

With the collapse of its export business, the US would have been well-advised to stimulate its domestic markets, to help take up the slack and help to rebalance its productive capacity. In this case, domestic liquidationism was exactly the wrong thing to do. This, by the way, is why the Wall Street money men starting looking at foreign direct investments in the domestic production of recovering economies such as Germany and Italy in the late 1930's. Indeed, the search for profit was so compelling that several of the money houses, and famous men, did not stop investing with the Nazis until they were prosecuted under the Trading with the Enemy laws.

This provides an instructive example to the exporters German and China in this modern crisis perhaps. Now is the time for them to stimulate domestic markets. China must create internal markets, and Germany best try and hold the EU together and keep it healthy.

Japan is in a much more difficult circumstance because of its particular demographics and cultural homogeneity. I see no way out for them in the short term.

Here is what the monetary base did during World War II. As one can easily see, war is bad for people but good for industrial output and monetary expansion.



Expansion of the monetary base during the war was nothing short of astonishing, if one forgets that there was a significant monetization of war debts occurring, and there was less opportunity for inflation because of rationing and wage and price controls. But inflation there was, and it gained a significant leg up after the War.



Here is our real GDP chart extended through the War so one can more easily see the build up and then the flattening of growth post War.



Where Do We Go From Here?

The status quo has failed in its own imbalances and artificial distortions. But while avoiding bubbles in the first place through fiscal responsibility and restraint is certainly the right thing to do, plunging a country which is in the aftermath of a bubble collapse into a hard regime, such as the liquidationists might prescribe, is somewhat like taking a patient which has just had a heart attack and throwing them on a rigorous treadmill regimen. After all, running is good for them and if they had run in the first place they might not have had a heart attack, so let's have them run off that heart disease right now. Seems like common sense, but common sense does not apply to dogmatically inclined schools of thought.

What the US needs to do now is reform its financial system and balance its economy, which means shrinking the financial sector significantly as compared to its real productive economy. This is going to be difficult to do because it will require rebuilding the industrial base and repairing infrastructure, and increasing the median wage.

The US needs to relinquish the greater part of its 720 military bases overseas, which are a tremendous cash drain. It needs to turn its vision inward, to its own people, who have been sorely neglected. This is not a call to isolationism, but rather the need to rethink and reorder ones priorities after a serious setback. Continuing on as before, which is what the US has been trying to so since the tech bubble crash, obviously is not working.

The oligarchies and corporate trusts must be broken down to restore competition in a number of areas from production to finance to the media, and some more even measure of wealth distribution to provide a sustainable equilibrium. A nation cannot endure, half slave and half free. And it surely cannot endure with two percent of the people monopolizing fifty percent of the capital. I am not saying it is good or bad. What I am saying is that historically it leads to abuse, repression, stagnation, reaction, revolution, renewal or collapse. All very painful and disruptive to progress. Societies are complex and interdependent, seeking their own balance in an ebb and flow of centralization and decentralization of power, the rise and fall of the individual. Some societies rise to great heights, and suffer great falls, never to return. Where is the glory that was Greece, the grandeur that was Rome?

The lesser concern for the US now is globalization, new trade agreements, and its debt, which is largely held by foreigners who have provided vendor financing while using exports to build their own economies. The mercantilists are addicted to exports because it provides them the means to bring in national wealth for the benefit of a narrow elite, without empowering the masses and allowing them a greater measure of say in their government, with only a modestly improved standard of living.

This Will Not Be Your Father's Inflation

Why is this important? Because as I think is apparent in the stunning chart contained in Debt Saturation in the US Dollar Economy, the US dollar is already entering an inflationary spiral that will lead to its destruction and reissuance.



Although as you know I always allow that deflation and inflation are policy decisions, at some point a threshold can be passed, and the likelihood of one event or the other becomes more compelling. The US is at that crossroads wherein it must change, or go down the painful path of selective monetary default, of a degree different than a hyperinflation, more similar to that which was seen in the former Soviet Union, than the monetary implosion of a Weimar.

One can watch the growth of the traditional or even innovative money supply figures, and be reassured at their nominal levels, only to misunderstand that money has a character and quantity of backing, that can erode as surely as the supply of money can increase, to produce a type of inflation that comes upon a nation quickly, like a thief in the night. It will bear the appearance of stagflation, because it is caused by a degeneration of the productive economy coupled with a disproportionately increasing money supply.

A transactional economy can have all the appearance of vital growth and activity, when in fact it may be an increasingly hollow shell, a Ponzi scheme, and prone to unexpected collapse. Such a systemic collapse was almost witnessed when the US financial system was threatened by the fall of Lehman Brothers. That event was averted. But the system still remains in a precarious, unreformed state of imbalance.

What does a country have to providing a backing to its money, except its natural resources, its productive labor, and the ability to create products of value? Some countries, or more properly empires, may provide the backing for their currency through force and fraud, and a sort of indirect or de facto taxation on the many. These types of arrangements can last many years, but can disappear quickly, based as they are on conditional situations, subject to relatively sudden change.

Cutting expenses to reduce deficits is a weak attempt to reform. One does not starve themselves back to health. What is needed is growth, savings and investment, the reallocation of capital and true valuation of goods and services. The productive economy must come back into balance with the administrative sectors, those being finance and government.

At the end of the day, some of the greatest impediments to economic recovery reside in the selfish and fearful desire for control and power in rather narrow oligarchies, both in the East and the West. They were the primary beneficiaries of the status quo, and they will seek to maintain and even recreate it, even though it has proven to be unsustainable.

Curtain of Tragedy Will Be Raised Soon Enough, But Perhaps Not Next in Japan

"Ninety-five percent of Japan's debt is domestically owned. Fickle foreigners have almost no sway. Indeed, Japan's problem is still an excess of savings ." (at abormally low rates of return that serve to subsidize government mismanagement and malinvestment.)

An interesting piece from the Japan Times below, raising the issue of a hyperinflationary collapse of their economy and the yen. As you know, I forecast in 2005 that a new school of economic thought is likely to rise out of the financial crisis which the world is in today. The crisis is certainly not over, despite the government propaganda and economic window dressing that is being applied. Quite likely we have only seen the end of the first Act in what is going to be a three part drama lasting about nine more years.

In particular, the understanding of money and monetary theory is still in its infancy, having been sidetracked by the ideologues in the service of corporatism and big government. In fairness, economics is difficult because there are an enormous amount of variables, and the time lags are highly significant and varied. The fact that economics is a social science with a profound impact on public policy decisions does not help advance academic research. It does seem that the field has a surfeit of economists for hire who often seem to produce studies in order to support pre-ordained conclusions and biases. The average person can only mouth the opinions given to them by television and these studies as 'proofs' of the opinions they hold so dear. Their judgement is easily led in this, since it has no depth.

Economics is a subject rarely taught in the general curriculum. A person reads a few articles by supposedly learned men, and thinks themselves in a position to pronounce broad judgements for or against anything. Those who would appear informed enjoy repeating slogans and cartoons of thought to support their biases, which they themselves do not really understand, but draw emotional comfort from them. The irony is that they are so often arguing nonsense, and against their own best interests. Such is the power of propaganda to hold up caricatures and denounce them, and energize the public to enslave themselves.

Most discussions which I read get the Japanese economic experience all wrong. There is a complete misunderstanding of the roots of their deflation, the bubble as it was occurring, their long deflation and national stagnation, the single party political system and oligarchic economic structure, and the tremendous psychological impact which defeat had on the Japanese national psyche at the end of World War II.

As I have pointed out before, deflation and inflation are part of a policy decision in a purely fiat regime. The bias is to expansion as it is in all Ponzi schemes. People constantly create artificial rules regarding the inability to expand the money supply at will. Their minds cannot accept that something which they value so highly is created out of thin air by the monied interests.

The assumptions one makes when engaging in economic analysis are all important. Data is often sketchy and selective. People take naive examples and extrapolate them into real-life scenarios, crushing their complexity. This is due to the weakness of their model.

I think the field will progress more quickly once some new insights are made, and a new model, or skeleton if you will, is struck that allows the mathematicians to begin to flesh it out again.

For now, at least in my opinion, most economic thought is impoverished since the revolutionary insights of Keynes and so many others in response to the world depression of the 1930's. The jargon that currently passes for knowledge is a sign of decadence. I find all of the schools to offer little more than caricatures of what is a highly complex and richly interactive system.

My personal opinion is that Japan will not collapse until its export mercantilism collapses, or the average age of the overly homogeneous population strangles its ability to maintain a high savings rate and a ready market for government debt at artificially low prices.

I expect the UK and a portion of the european region to founder first, and then perhaps China, which appears to be an enormous bubble, an accident waiting to happen. Its collapse may be a precipitant to collapses in the developed world. The US dollar will have its day to devalue into a reissuance, but perhaps not until Europe and the UK are sorted out first. But the dollar is a doomed currency, the vanity of vanities. All fiat currencies are doomed; they are invariably the victims of human willfulness.

The adulation which the media and financiers had showered on Mussolini and Hitler and their economic recoveries in the 1930's was widespread, as it was for Japan Inc. in the 1980's, and for China today. The crowd always gets it wrong, but it is surprising how often the monied interests and the professionals get it wrong as well, and remain stubborn in their misjudgement until they are overwhelmed by its consequences. Or perhaps that is their intention. Who can say, who can truly 'think like a criminal.' You are a prisoner of reason, balance, and natural restraint. These are creatures of their own appetites, with a hole in their being which one can barely appreciate.

The Bankers will make the world an offer which they think it will not be able to refuse. One currency, and then one government. People being irrational are not likely to take that deal, once again.

There are those who say that they very sure what is coming, what will happen, what the future will bring. For the most part they are speaking out of fear and false pride. The only certainty is that if they really knew what is going to happen, they would cast themselves down from high places in despair.

Grab something solid and hang on to it, and to the faith that sustains you. Do not be distressed if it feels as though the world has lost its reason, and is made blind, and all is deception and trial, for this is part of the process which has begun. If a war comes, then the world will lose its ability to reason in its temporary madness. We are in for a rough ride, and revelations of what is life and what is nothingness, what is true and what is false.

“When pride comes, then comes disgrace. But with disgrace comes humility, and with humility comes wisdom. The humility of the righteous will guide them, but the sly illusions of the proud will destroy them." Prov 11

People will ask, and I can only say that I do not know if this is the end time, as no one can know this. What does it matter, since surely we are all heading towards the last things and a judgement, at our own pace. But it may certainly feel like it is something more general, more momentous, at some point before our blasphemous generation puts itself back into balance with God and nature again, and the crisis has past.

As the song says, "You ain't seen nothing yet."

How to Live Before You Die by Steve Jobs

Japan Times
Government Debt Crisis: Bubble prophet fears new disaster
By REIJI YOSHIDA
March 19, 2010

Economist Noguchi warns soaring public debt may bankrupt Japan, bring back hyperinflation

Prominent economist Yukio Noguchi is one of the few who correctly predicted the collapse of Japan's bubble economy in 1987, warning the preceding euphoria was based on a major distortion in land prices.

Now the doomsday prophet is making another terrifying prediction: Japan is likely to be devastated by a snowballing public debt that will bankrupt its government and trigger catastrophic hyperinflation.

"There is little hope," Noguchi said in an interview with The Japan Times at Waseda University's Graduate School of Finance in Tokyo. "Japan's fiscal conditions are so bad, it can no longer be fixed without causing inflation. I'm very pessimistic."

Noguchi is not the only one deeply fretting the debt.

They may still be a minority, but an increasing number of economists and market players are voicing deep concerns about Japan's fiscal sustainability and fear catastrophe may strike in the near future.

Compared with Greece, Japan's gross government debt is far worse, at 181 percent of gross domestic product — the highest among the developed countries. Greece's debt-to-GDP ratio is 115 percent.

Japan's present debt-to-GDP ratio is only comparable with what it was at the end of World War II. At that time, the only way the government could reduce the debt was through hyperinflation, which wiped out much of the people's wealth with skyrocketing prices.

"I can't tell exactly what will happen (this time), but what actually happened after the war was that the price level surged 60 times in just over four years," Noguchi said.

"If the same thing happens again, a ¥10 million bank account will have the same net value of just ¥100,000 today. It's actually possible," he warned.

The alarmists even include Ikuo Hirata, chief editorial writer of the Nikkei business daily.

Hirata predicts the huge debt will eventually force the Bank of Japan to purchase Japanese government bonds on a massive scale, eroding market confidence and pushing up long-term interest rates.

A rise in long-term interest rates of even a few percentage points would sharply increase debt-servicing costs on the bonds and critically damage the government's already precarious finances.

"The curtain of the tragedy will be raised next year," Hirata warned in a Nikkei article on Dec. 21.

Pessimists like Noguchi and Hirata are still in the minority — at least for now. The yield on 10-year JGBs, their barometer, hasn't indicated any trouble yet.

"Talk of a massive JGB bubble — let alone default — is far-fetched," the Financial Times said in its Feb. 8 editorial titled "Japan's debt woes are overstated."

The editorial pointed out that, for a long time, JGB yields have been effectively fixed at the ultralow level of around 1.3 percent — compared with the 3.6 percent yield on 10-year U.S. Treasury bonds and the 4 percent for its counterpart in Britain as of Thursday.

"Ninety-five percent of Japan's debt is domestically owned. Fickle foreigners have almost no sway. Indeed, Japan's problem is still an excess of savings," the FT said.

"For some time yet, the government will not find it hard to secure buyers for JGBs. Japan's debt problem will be worked out in the family."

But most experts, including those at the International Monetary Fund, agreed that Japan's midterm future is shaky, and that the government could face difficulty financing its public debt in around 10 years.

In a July report, the IMF warned that Japan may find it "difficult" to finance its debt domestically toward 2020 because household savings are expected to keep falling in line with its rapidly graying population and declining birthrate.

Households maintained an average savings rate of more than 10 percent in the 1990s, much higher than in other developed countries. But as the aging workforce started tapping their assets to support retirement life, the savings rate — which supports Japan's fiscal deficit — fell to 2.2 percent in fiscal 2007, according to IMF figures.

Households directly and indirectly account for the financing of at least 50 percent of all outstanding JGBs, mainly through accounts and other assets at banks, Japan Post Bank and pension funds, the IMF said.

The IMF simulation indicates gross public debt could exceed household financial assets as early as 2019, which would likely force the government to seek more JGB buyers abroad, probably with a higher interest rate, since foreign investors in general demand a higher return on bonds than the ultralow 1.3 percent offered by Japan.

"The results indicate that domestic financing will likely become more difficult toward 2020, while other sources of fundings are available, including from overseas," the report said.

Masaya Sakuragawa, professor of finance at Keio University in Tokyo, recently conducted a simulation on the sustainability of the nation's public debt. His conclusion is that the only way to save Japan from bankruptcy is to drastically raise the politically unpopular consumption tax to at least 15 percent — a level he describes as "a rather optimistic scenario."

"If the debts keep increasing at the current pace, there is a possibility that (Japan) will face big trouble in around 10 years," Sakuragawa said.

The simulation examined two scenarios. The first hikes theconsumption tax to 10 percent by raising it a point a year from fiscal 2014 to 2018. The second hikes it to 15 percent, raising it over a longer period, from fiscal 2014 to 2023.

Under the 10 percent tax scenario, the debt expands forever, making sovereign bankruptcy inevitable. But the 15 percent scenario starts bringing the debt to heel in 2025.

Sakuragawa admitted the simulations weren't that realistic because they are based on some optimistic assumptions: that the social security budget won't drastically expand, interest rates will remain low, and the economy will keep growing at an annual pace of 1.5 percent.

The professor argued that a more drastic increase in tax revenues will be needed to save Japan from going insolvent, a crisis he says would wipe out much of the value of JGBs and trigger a domestic financial panic.

"The possibility is high that panic like a run on banks would break out. People would try to withdraw their money, but banks would go insolvent because they wouldn't have enough assets anymore," Sakuragawa said.

According to Sakuragawa, a dramatic rise in the consumption tax is the only viable option. Economists agree that, compared with other taxes, the sales tax would have the least impact on potential economic growth because the burden would be thinly spread to all taxpayers, he said.

Tax hikes, especially in the sales levy, are always a political taboo. When the former ruling Liberal Democratic Party introduced and then later hiked the consumption tax, it took a drubbing at election time. Even the LDP's Junichiro Koizumi — the most popular prime minister in recent memory — pledged not to touch the sales tax for fear of triggering a voter backlash.

"Koizumi should have raised the consumption tax. He had such high popularity, but he still did not want to raise the tax," said a former senior government official who was one of his closest aides.

"Japan's finances are in a stalemate. There will be no way out," he said.

Prime Minister Yukio Hatoyama, head of the ruling Democratic Partyof Japan, has pledged not to raise the consumption tax for at least four years, although key politicians in both the ruling and opposition camps have started discussing the urgency of fiscal reconstruction.

Deputy Prime Minister and Finance Minister Naoto Kan surprised the public last month by floating the idea of starting discussions as early as this month on a sales tax hike.

Kan has pledged to adopt a midterm fiscal policy framework by June and reach a conclusion on "fundamental tax reforms" by the end of March 2012. Market players are keen to see what strategy the government maps out for fiscal reconstruction.

Kan, however, told the Upper House Budget Committee on March 4 that he will stick with an expansionary budget to prop up the economy for at least "one or a few more years." He also said it is still too early in the global slump to start talking of an "exit strategy" to mop up liquidity.

"If we shift to an exit strategy too early, the results will be much worse," Kan told NHK on March 8, signaling that an immediate switch to fiscal austerity could throw cold water on the economy and reducetax revenues even further.

Keio University's Sakuragawa and many other fiscal experts remain skeptical about the government's financial future. He said the public and politicians will avoid taking bold action on government finances until a shock hits the JGB market and starts pushing up long-term interest rates.

"So the scenario that I hope will happen is that Japan will face a minor crisis first, and the people will finally realize that a government bankruptcy will have a catastrophic impact on them," he said.

"Basically, Japanese people are good (at grasping situations). So they will eventually be willing to accept a rise in the tax," Sakuragawa said.

Debt Saturation in the US Dollar Economy

The debt must be liquidated and income in the form of real wages must increase to bring this relationship back into balance.

This is going to be a dangerous path for the US monetary authority to tread, because a misstep will lead to an inflationary spiral that will surprise most economists as did the stagflation of the 1970's, which up until that point was considered to be almost impossible according to the prevailing theory of that day.

The financial engineers will keep at this until they hit they wall. If we were not in the car with them it might be a more interesting exercise to observe. The answer of course is to get out of the car as best you can.

Think of debt as a surrogate for the creation of money, in its various forms, for that is what it is. What this chart is showing is that money being creating is aenemic, and a trend that looks very much like the 'law of diminishing returns.'

This is the well spring of monetary inflation, that is, the power of money to create some substance to back it. The more dollars that are printed, the weaker their backing, without an economic vitality created by savings, investment, and labor.

This is why I would say that the US dollar is an obvious death spiral. I would not say that its demise is inevitable, merely likely.



Chart from Nathan's Economic Edge

Canaccord Sets PALM Target Price at *Zero*

Buy that dip, Chip. Traders who are buying now are hoping (betting) that Palm becomes a takeover candidate.

In the 1990s I was actively involved in M&A in the tech sector, primarily around Boston and Silicon Valley. Boston's 128 corridor was absolutely the worst place to try and make a decent acquisition, and few of them I witnessed worked out for the buyers.

In Silicon Valley things were a little more straightforward, but one had to watch their back with the omnivorous acquisitor, Cisco. The flippers were reasonably well known to the cognoscenti and a quick visit to the premises often was an easy 'tell.' The Sand Hill Road crowd and the other denizens of the Lion and Compass were always a treat to work with. Personally I preferred sushi in town followed by The Compass Rose at The Saint Francis, but I was an east coaster, and almost looking for light meal and a drink to take the edge off the jet lag.

I priced mature companies and start-ups, largely based on the potential of their technology and engineering talent, much more so than existing cash flows which were often negative and a key factor in playing the game.

Personally I think zero is too low a price for Palm. Maybe two dollars, with their float of 168 million shares. Maybe even four dollars if it catches a bid soon from more than one interested buyer who wishes to jump start into their space. One would have to look at their portfolio of technology and patents, and franchise players in the engineering group, and the value of your own currency, your stock, and its prospects.

Cash deals generally are a strong indicator of pure intent, and are therefore rare. One positive is that the tech market in the US is so bad that retention bonuses ought not to be such an issue, except for a handful of key engineering talent.

The problem with companies like this is that new money, particularly the venture capitalists and white knights, like to come in and obliterate the existing common shareholders. This is the 'last man standing' phenomenon.

If someone makes a play for Palm, it could turn into a bit of a bidding match. But for now the vultures will prefer to circle and hover. And it would not shock me if a certain broker wasn't hammering the price with their most recent target, for any variety of purposes and headlines.

TickerSpy
Canaccord Leaves Palm Hanging With $0 Target
by Owen Vater
March 19th

Investors who went bargain hunting with Palm (PALM) after its brutal late-February guidance are getting hammered.

Palm shares are off by -18% today after reporting an adjusted fiscal third-quarter loss of -61 cents per share, missing analyst consensus by -19 cents. The company beat on revenue after giving analysts a warning last month. Chairman and CEO Jon Rubinstein said, “the potential for

Palm remains strong,” but Canaccord Adams isn’t buying it, nailing the stock with a $0 price target, down from $4, and reiterating its Sell rating. The analyst noted that Palm has about 12 months of cash on hand with an accelerating burn rate, and the company could start to lose suppliers as its solvency comes into question.

The Palm selloff is dragging the Personal Computer and Smartphone Stocks Index by -3.7%. The Index is now trailing the S&P 500 by -13.7% over the last month, despite every other component gaining more than 2% for the period.

Quad Witching Expiration and a Pullback from the Back-Kiss on the Long Term Trend

The front month on the SP futures has now switched from March to June as a part of the Quad Witching Expiration. (Technically it switched last week, but for charting purposes I made the switch last night.) The June Futures have essentially the same formations as did March, its just that the earlier months have few trades to mark them.

This is the first serious test for US equities since mid-February, as it has been on a spectacular rally streak, no doubt fueled by excess liquidity applied to a selling exhaustion in the funds. Curiously not among corporate insiders who were selling at a rate of 57 to 1 in this latest rally, no doubt for diversification purposes

The extent of this correction will be determined on the amount of actual selling that starts to occur. For now what we are seeing is more of a trading correction in response to an outsized rise in price, or as the Street likes to say, the market was getting ahead of itself.

Key levels to watch are 1135 and 1120. If we break those I would look for a consolidation around the 1080-1100 level.

This news is weighing on US stocks today, but they were overripe for a correction at least.

Bloomberg
U.S. Stocks Erase Advance as India Unexpectedly Raises Rates
By Rita Nazareth

March 19 (Bloomberg) -- U.S. stocks erased their advance after India’s central bank unexpectedly raised interest rates for the first time since July 2008 after inflation accelerated to a 16-month high.

The Standard & Poor’s 500 Index fell less than 0.1 percent to 1,165.46 at 9:46 a.m. in New York. It had advanced 0.3 percent before India’s decision.

“Keep an eye on the punch bowl,” Larry Kantor, head of research at Barclays Plc, told Bloomberg Radio. “The major risk going forward for markets is not budget deficits, it’s the fact that policy makers have put so much into the economy to get things going that they’re going to be withdrawing that stimulus. That’s actually the big risk.”

“Everybody knows that the dice are loaded
Everybody rolls with their fingers crossed
Everybody knows that the war is over
Everybody knows the good guys lost
Everybody knows the fight was fixed
The poor stay poor, the rich get rich
That's how it goes
Everybody knows”

Leonard Cohen, “Everybody Knows”

Rumours of an Unexpected Fed Discount Rate Hike Dampen Stocks

Bloomberg reports that rumours of a surprise Fed Discount Rate hike circulated trading desks earlier today, helping to depress stock prices in the land of lotus eaters, almost darkening the colour of the biggest winning streak since August 2009.

The rumour reportedly originated with traders in Chicago. It was so ludicrous that one has to believe that it was indeed started there. You expected something original on the day after St. Patrick's Day? The Fed just raised the discount rate, symbolically I should add, at a regularly scheduled meeting.

Oh that's right, it is options expiration and a quad-witch nonetheless. Is the Chicago Board Option Exchange trying to whistle up some action? Are traders struggling to find an easy trade with the forces of the High Frequency Terminators so ably thinning the herds of small specs?

Why is Wall Street like the Planet of the Apes? Because the gorillas have all the weapons, nets, and horses, and ride around all day shooting the human beings.

There are those of us who remember the disrepute and revulsion in which the US markets were held by the public back in the dark days of the 1970's in the aftermath of the 72-74 bear market. The pit crawlers spent the day throwing paper airplanes at one another, the Dow languished sub-1000, and the brokers talked about the 'return of the small investor to the markets.'

It took the bull market of the 1980's and Reagan's voodoo economics and laws about IRAs and 401K's to bring the public back in for a wash and rinse by the Street.

Just another day in the Pax Dollarous.

Boehner Tells Bankers to Stand Up to Those Senate Punks

"O heaven,...put in every honest hand a whip to lash the rascals naked through the world." William Shakespeare, Othello

Senate Minority Leader John Boehner told the American Bankers Association to 'stand up to those punks' in the Senate who want to regulate them. He said 'staffers' but that is because professional courtesy prohibited him from saying 'Senators.'

Perhaps Mr. Boehner feels a burst of confidence since Timmy and Ben and Larry have his back. And of course the bankers to whom he was speaking already have 25 lobbyists fighting against reform for every Congressman in Washington, and buckets of cash to spread around.

Actually, the only ones who seem to be underrepresented and in trouble in Washington these days are the American people.

The Dodd bill has its good points, but contains some bizarre twists. The ruling that the Fed would only supervise banks of over 50 billion seems particularly bizarre. Mr. Hoenig of the Kansas City Fed objected to this today. As well he might, since his district contains NO banks worth more than $50 billions, and he would be presumably out of a job.

This is classic Democrat blundering. Spend many months negotiating and seeking partnership with people who would just as soon place their hands in a meat grinder as make any reasonable compromise, and then toss off some bizarre legislation seemingly out of nowhere, after having made a big deal out of wishing to be 'bipartisan.' The Democratic party seems leaderless.

One thing for which I will give credit. Mr. Obama has certainly united his country -- in believing that he is one part corrupt Chicago politician and two parts a rather ineffective waffler who mistakes campaign-style speaking for leadership and timidity for consensus building.

Leadership in the real world is measured by getting the job done, and being recognized as effective by your own people and your key stakeholders, inspiring them with confidence and the ability to do even more than they might have imagined.

The American President reminds me of a corporate executive at a company which had recently acquired mine who was clearly over his head in his current position. When asked why he did not meet his commitments, he replied without hesitation, "My people are incompetent." What was particularly galling is that he had been allowed to assemble his own team, and been given adequate time to build his plan and objectives. He missed most of them, badly but did manage to exceed his expenses.

Mr. Obama inspires most people with disappointment, dismay, confusion and despair. He has managed to alienate a good chunk of his electoral base while gaining nothing. To win is not to be elected; to win is to succeed in your goals and the expectations which you have set with your constituents.

Still, as unattractive as the Democratic leadership may be, there is nothing uglier than a politician soliciting money from fat cat businessmen, and few can be as smarmy as a Republican in heat for cash.

Dealbook
Boehner to Bankers: Stand Up to ‘Punk’ Staffers
March 18, 2010, 9:18 am

Opponents of Senator Christopher J. Dodd’s financial regulation overhaul bill are talking tough, telling bankers how displeased they are without mincing words.

Representative John A. Boehner, the Republican House minority leader, told members of the American Bankers Association on Wednesday that they need to be unafraid to stand up to whom he called “punk” Senate staffers, according to MarketWatch.

And even the head of the Office of the Comptroller of Currency took a swipe at the consumer protection aspects of the bill, according to The Financial Times.

Mr. Dodd, the chairman of the Senate Banking Committee has already been hearing from Republican senators who are unhappy with his decision to forge ahead without first reaching bipartisan consensus. Now House Republicans, according to Mr. Boehner, are arguing that Mr. Dodd’s proposal is too far apart from the financial regulation overhaul bill the House passed in December.

Here’s what Mr. Boehner said, according to MarketWatch:

“Don’t let those little punk staffers take advantage of you and stand up for
yourselves,” Boehner said. “All of us are hearing from our friends and
constituents on lack of credit, you can’t get a loan, the more your government
takes and taxes, the more regulations you have to comply with the more cost you
have there and less amount you are going to have available to loan to
customers....”

And remember, 36% of American Congressmen are also lawyers.

Dodd's Chief Counsel Was Trading In Financial Stocks During Financial Crisis

Wall Street Banks Using Geithner and the NY Fed to Stifle FDIC Reforms

The President's Working Group on Financial Markets, aka the 'plunge protection team,' is apparently acting to block financial reforms being proposed by Sheila Bair's FDIC, according to the attached piece from Chris Whalen of Institutional Risk Analytics, an authoritative source on US Banking.

The President's Working Group on Financial Markets consists of:

Time Geither, The Secretary of the Treasury, as Chairman of the Working Group;
Ben Bernanke, The Chairman of the Board of Governors of the Federal Reserve System,
Mary Shapiro, The Chairman of the Securities and Exchange Commission; and
Gary Gensler, The Chairman of the Commodity Futures Trading Commission.

This is reminiscent of the actions of Larry Summers, Robert Rubin, and Alan Greenspan to block attempts by Brooksley Born, then head of the CFTC, to head off the derivatives crisis back the 1990's, the very crisis which brought the US to the brink of disaster last year.

Obama has no credibility as a reformer, not with Tim Geithner and Larry Summers as the key members of his financial team. And the Fed is proving itself again to be little more than a mouthpiece and servant to the Wall Street Banks, completely unworthy of any additional supervisory powers.

Personally, I thought Chairman Bernanke's testimony in front of Congress yesterday to be both embarrassing and disgraceful.

It is more than disappointing, it is an outrage, if this is true. The actions of the President's Working Group on Financial Markets is a sore point with many, as it is repeatedly linked to secret dealings with the Wall Street banks, and efforts to manipulate US markets to support government policy.

If this is true, then we would hope that the Congress will be motivated, at least after the November elections when many new members will be joining, to launch a thorough investigation of Mr. Geithner and his activities both at the NY Fed and the Treasury, and the actions of the President's Working Group on Markets.

"We hear that the FDIC rule making process could start as soon as next month, but more likely will wait till the FDIC's board meeting in May. We also hear that the President's Working Group (PWG) on Financial Services is preparing a "white paper," in cooperation with the Federal Reserve Board and the Office of the Comptroller, to block the FDIC reform effort. This campaign, which apparently was orchestrated by the largest dealer banks, is intended to derail the new rules proposed by the FDIC mandating greater transparency and disclosure for bank sponsored residential mortgage securitization deals.

The President's Working Group, in case you don't know, is an informal group created in 1988 by President Ronald Reagan that allows the executives of the biggest banks to influence public policy in Washington, but without going through the trouble of registering as lobbyists or other public disclosure. Sometimes referred to the "plunge protection team," the PWG is part of the invisible government of Washington," an agency which operates within the government, but at the behest of private interests.

Barry Ritholtz has a nice summary on the PWG in his book, Bailout Nation, and also in his Blog, "The Big Picture." As Barry notes, the PWG is every bit as incompetent as most other people in Washington, but they do have one special skill: pushing the banking industry's agenda in Washington via informal "guidance" and white papers that are written by and for compliant regulators. The PWG essentially acts as a super-lobbying channel for the largest banks focused right at regulators. Only "team players" need apply.

The Federal Reserve Bank of New York and the OCC in Washington are reportedly drafting the "guidance" on reform of bank securitizations and at the request of the PWG. No clue whether the White House is involved directly yet or if this is merely a Tim Geithner operation. These PWG white papers are never released to the public even though the Treasury acts as the de facto public affairs organ for this corporate influence group.

We called out former Wachovia Bank CEO and Goldman Sachs (GS) banker Robert Steel on the subject of the PWG last year at the Chicago Fed's international banking conference. He was unapologetic and more than a little offended, or so he claimed. The PWG acts with impunity in Washington, in part because the members of Congress understand their subordinate role. We hear that Senator John Warner (D-VA) is now competing with Judd Gregg (R-NH) to be the next "Senator from Wall Street" and specifically seems to be angling to join a private equity firm. Gregg's tastes seem to run more along the lines of a large OTC derivative dealer bank.

The fact that the PWG is in league with the Fed and Treasury against the FDIC board is all you need to know about the politics of reforming private label mortgage securitization.

If Barack Obama were really interested in reforming Washington, he would rescind President Reagan's executive order and disband the PWG for good. Allowing the big banks which participate in the PWG to lobby financial regulators and members of Congress without any public disclosure is a national scandal and makes a mockery of any claim by Barrack Obama to be changing the business of Washington.

We noted in our comment last Tuesday in American Banker, "Viewpoint: Stop Blocking FDIC Securitization Effort," that "the practical policy issue is the losses observed in failed banks over the past two years, averaging over 30% of total assets, versus just 11% on average in the S&L crisis. The common factor in failed banks with high loss rates is unsafe and unsound securitizations practices, thus the FDIC initiative on securitization."

It is very telling to us that the FDIC is advocating greater openness and transparency in bank sales of mortgage loans to securitizations, but the Fed and OCC are standing with the larger dealer banks that arguably caused the financial crisis in complex structured assets. Hopefully these federal agencies and the industry groups they seem to be allied with will realize that the FDIC's rule making process holds the potential to revive private label mortgage finance and that they can influence the outcome - but only if they participate constructively.

One mortgage market veteran who ran risk for one of the largest private conduits in the business put the situation succinctly last week: "You can argue against the FDIC securitization proposals, looking at them in a bundle, as perhaps being overkill, but each piece of their proposal, taken separately, is pretty compelling. The other bank regulators and industry groups could easily negotiate a better, more streamlined deal that would help the market if they bothered to push back and participate constructively, instead of simply attacking the FDIC."

Chris Whalen, Institutional Risk Analytics, March 15, 2010

The Fed's View of American Banking: No Restraints for the Katzenjammer Kids

Through the mills of God grind slowly, yet they grind exceeding small;
Though with patience He stands waiting, with exactness grinds He all.
- Baron Friedrich von Logau, Sinngedichte

Mr. George Washington has a guest post over at Naked Capitalism that makes some points worth emphasizing. More Evidence That Banks Create Credit Out of Thin Air I find his work to be quite interesting, and a good companion to the work of Yves and Ed Harrison.

First, as we all know, banks do create money as credit 'out of thin air' in the current version of fractional reserve banking in the US. The Fed exercises some potential restraints on their ability to do so in the form of reserve requirements and Fed Funds target rates. One might think of the reserve requirement as a leash, and the Fed Funds as the price of exceeding the reach of the leash.

I had not been aware of the Fed's recent moves to eliminate the reserve requirement altogether. So, in keeping with the analogy, the Fed wishes to unleash the US banks to create money at will. One needs to realize that reserve requirements have already been significantly relaxed with the ruling on the use of sweeps to alter a bank's reserve profile on an overnight basis.

This is not quite as severe or outlandish as one might suspect, since there are examples in the rest of the world where reserve requirements are not used, such as in Canada and Mexico, and the voluntary system in the UK for example. The difference of course is that these countries have other traditions, customs, and laws in place. There is no comparison between the Canadian bankers for example, and the Katzenjammer Kids of Wall Street, although Canada may be heading for a fall of its own making as well. Their real estate is looking a bit frothy, and the instances of corruption on their equity exchanges I have witnessed is something to behold, and certainly a tip of some sort of iceberg that manifests elsewhere.

What is concerning about this in the particular perhaps is that the recent crisis in the US was precipitated by a solvency crisis caused in large part by excess leverage and rampant fraud, which then triggered a liquidity crisis, and a run on the banks. The similarites between this crisis and the Panic of 1907 seem more pronounced the more that is revealed. The difference of course is that Mr. J. P. Morgan and his bankers took strong steps to prevent such an event from reoccurring for their own good. How ironic that his own bank remains at the center of the problem at this turn of the cycle, but not as a remedial influence.

As we have seen with the New York mobs with the rise of Messrs. Luciano and Lansky, the syndication of abuse and manipulation of the law and the enforcement agencies is a paradigm shift that can transform even traditional small time thuggery into seriously organized crime that can overwhelm conventional safeguards and restraints.

The purpose of reserve requirements is to uphold some Capital Adequacy Ratio, meaning that a bank would have liquid assets adequate to support the normal demands of their customers. There are obviously other ways to do this, but a reserve requirement is a quite common method of controlling what is essentially a leverage and prudence issue. CAR is a bit of an anachronism when we have Frankenstein banks such as Goldman Sachs and Morgan Stanley, the Max und Moritz of American banking, that are less bank than hedge funds with little regard for depositors and traditional function of banks. The issue there is leverage and the adequacy of collateral. Is this where the Fed wishes to take American banking?

In the case of the US, the most recent crisis was precipitated by the rampant fraud in the assets held and sold by the banks in the form of collateralized debt obligations. The assets were not of a quality or a liquidity to support the bank's balance sheet.

The most recent revelations regarding Lehman Brothers in particular are quite pointed. The bank was using swaps to hide its true capital structure and leverage, and its vulnerability to a financial shock. When push came to shove, the company crumbled with losses much larger than anyone had estimated. The laxity at the New York Fed was an issue. It shows the weakness of what is essentially self-regulation of the banks by the banks, for the NY Fed is a creature of the banks. As Lehman says, "Everyone was doing it." It is just that Lehman were the ones that fell down, as the others were 'saved' at significant public cost.

By eliminating the reserve requirement the Fed is seeking to relax the constraints of its need and ability to 'save' banks when shocks occur. If there is no reserve requirement, then the Fed need only address itself to a run on the bank. As Mr. Washington states, the Fed stands ready to provide any and all capital required. They just do not wish to do it under constraints beyond their control.

What are seeing is the natural progression of a debilitation. The financial engineers keep creating problems with their tinkering, and the solution is to keep relaxing the constraints on their actions. As the comedian used to use, what we need is "MORE POWER!"

The Fed is the last place that should receive additional power over the banking system, showing itself to be a bureaucracy incapable of exercising the kind of occasionally stern judgement, the tough love, that wayward bankers require. And the mere thought of putting Consumer Protection under their purview makes one's skin crawl with fear and the gall of injustice.

They may get it, this more power, not because it is deserved, but because politicians themselves wish to have more power and money, and this is one way to obtain it.

The next time the financial system crashes, the torches and pitchforks will come out of the barns and there will be a serious reform, and some tar and feathering in congressional committees, and a few virtual lynchings. The damage to the people of the middle class will be an American tragedy. But this too shall pass.

Kurz, im ganzen Ort herum
Ging ein freudiges Gebrumm:
"Gott sei Dank! Nun ist's vorbei
Mit der Übeltäterei!"
Max und Moritz

Among the people quickly went
a joyful sigh of deep content:
"God be praised! at last we're free
From da boyz' insanity!

P.S. My grandmother (mein Grösi) told me the stories of Max und Moritz when I was a very little boy on her lap. It is my earliest childhood memory.