IOU's with Handcuffs |
By Bill Bonner |
Published
03/21/2008
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Currency , Futures , Options , Stocks
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Unrated
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IOU's with Handcuffs
Yesterday brought much conflicting, confusing news.
The Dow rose 262...bouncing back from Wednesday’s drop. Oil held just over $100. Gold dropped hard...and came to rest at $920. And the dollar rose strongly against the euro. Now, you can buy a euro for only $1.54.
What to make of all this?
“Central banks pour on the cash,” is the central headline in today’s International Herald Tribune . The European Central Bank is getting in the act – with a $15 billion infusion of cash. The Bank of England came in with $10 billion.
When central banks put in extra cash it sounds vaguely inflationary. In fact, it is a sign of just the opposite – at least at first. Banks in the euro-zone have reacted to the crisis just like those in Britain and America – they’ve become reluctant to part with money. The interest rate on three-month loans has risen to 4.67% as “system crisis shows no sign of ending.”
It shows no sign of ending because it’s impossible to say where the end of the losses will be...even when you’re looking right at them.
Gretchen Morgensen in the New York Times :
“As of last Nov. 30, Bear Stearns had on its books approximately $46 billion of mortgages, mortgage-backed and asset-backed securities. Jettisoning such a portfolio onto a mortgage market that is not operative would, it is plain to see, be a disaster.
“But who knows what those mortgages are really worth? According to Bear Stearns’ annual report, $29 billion of them were valued using computer models ‘derived from’ or ‘supported by’ some kind of observable market data. The value of the remaining $17 billion is an estimate based on ‘internally developed models or methodologies utilizing significant inputs that are generally less readily observable.’
“In other words, your guess is as good as mine.”
Our guess is that there are more surprises to come. But this is the first day of spring, so we’re determined to look at things in a positive way...even if we have to stand on our head.
Fannie Mae and Freddie Mac have been authorized to buy up more mortgages. The Fed has made available another $200 billion. Rates have been cut to barely half the rate of consumer price inflation.
The banks are trying to avoid a “liquidity crisis,” something that happens when there’s no money or credit readily available. But liquidity is not the real problem; the real problem is solvency.
There’s plenty of money around. But it’s scared money...fearful money...timid money. It’s now rushing to cover – into short-term Treasury bills. So much money has gone into 3-mo. T-bills that the yield has fallen to only half of one percent. And so much money has sought the additional safety of TIPS – indexed against inflation – that the yield has actually gone negative.
The TIPS are favored by investors who want the certainty of the full faith and credit of the U.S. government...but who are also certain that they can’t put too much faith in the U.S. government’s money. The TIPS are not merely IOUs from the government, but IOUs with handcuffs.
It is a bit like a second marriage – to the same person. ‘Yes,” say the feds, in the pre-nup redux, ‘we admit that we’ve cheated on you...but we promise not to do it again.” (As a measure of how much hankey pank has been going on, a silver dollar – once worth a dollar – now has silver content alone worth $15.20.)
And so, the TIPS are to be adjusted to the rate of consumer price inflation. If this worked as well in practice as it does in theory, an investor could put money confidently into TIPs, knowing that he was protected not only against the risk of default, but the risk of inflation too.
But there’s a catch. The same people who issue the IOUs also figure out how much inflation has gone up. ‘No, we won’t cheat again,’ say the Feds, ‘and just to make sure...we promise to tell you if we do.’
Conveniently, for them, they also changed the way they calculated changes in consumer price inflation. Previously, if the price of say, butter, rose 10 cents a pound, they figured the cost of living had risen accordingly. Now, if the price of butter goes up 10 cents, they figure you will switch to margarine, which is 20 cents a pound cheaper. Hey, fella – your cost of living just went down!
*** Yesterday’s big news was the downturn in commodities and gold. We’ve been waiting for it...it now seems to have arrived.
The softs are going down – not surprising, considering all the wheat and corn that is being planted.
The hards are going down too – also not surprising considering how much they’ve run up...and what will happen to demand as the credit crisis evolves into an economic crisis.
Ah...that’s the point, isn’t it, dear reader? At the debut of the housing bubble, we argued that speculation in housing would evolve from a purely financial matter into an economic one. That is, people would gradually change their spending and saving habits as they believed they were getting rich. The economy itself – not just the financial markets – would be affected. That is just what happened. Girls went wild. Boys too. And soon, the whole economy was giddy.
Now, there are those who believe that the credit crisis – which is the debut of the deflation phase of the bubble – will be merely a financial phenomenon, with little impact on the real economy. It that were true, the damage would be limited to a few banks and investment firms...and a fringe of lunatic homebuyers. The great mass of consumers, and the lumpeninvestoriat, on the other hand, should be spared.
But it is obvious – to us at least – that the same delusions of wealth that led people to overdo it on the upside will surely lead them to overdo it coming down the other side.
That is what we are beginning to see – not just in U.S. retail spending...but in the world’s commodity markets too.
Yesterday, commodities continued their meltdown. In dollar terms, they were almost all down. As mentioned above, the dollar rose against the euro and just about everything else – save stocks and bonds.
Unemployment rose.
In the United States, according to a Bloomberg report, California leads the nation – in defaults, falling house prices, and a slumping economy.
And the automakers report that they have given up expecting a rebound in sales in the second half of the year.
Bill Bonner is the President of Agora Publishing. For more on Bill Bonner, visit The Daily Reckoning.
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