Fed ups the ante but market calls

Its like watching a disaster movie in slow motion. To see the Fed so far on the back foot is disconcerting to say the least. The recent $40bln credit injection has just left the market needing more and stocks floundering.

For the first time I am asking myself whether we have a Japan style bank crisis developing. My immediate response is to say no because we haven’t had the screaming bubble of the equivalence they experienced in Japan but one could look back to the bubble of 2000/2001 and feel it was merely reinflated by the post 9/11 easing. This easing further invigorated the property bubble and took it to new heights along with financial practices that were dubious at best.

We have a situation where the banking system, in the wider sense, is stuck with a serious number of non-performing loans and this number could easily escalate if the recent liquidity measures don’t work. In Japan the policy response was to duck it and hope it would go away. The US has addressed it head on so far but will they allow banks to go under and house prices to tumble further. The maintenance of confidence is crucial in any fractional reserve fiat based money system and so far it seems like the US authorities are no taking any chances.

What if this doesn’t work? Then we will have a serious problem and global stock markets will take a 20-30% hit. I’m not making any predictions but cash still works for me.

Fed to freeze mortgage rates……another fiddle

So the Fed joins the Bank of England in changing the rules. The word is that certain sub prime mortgages will have their rates frozen for 5 years. This will ease the pain of borrowers who in some cases face rises of up to 30% on their mortgage bill.

Did i mention that mortgage means “deathgrip”?

Anyway this just shows that for all the hi’ fallutin’ nonsense about free markets we actually live in a system that is far from free. Bush doesn’t really want to hand the next election to the Democrats though he’s done his best to do so in recent years.

But what we are seeing now, as we saw post 1930, is that the financial system can be changed if required and that the fundamental right to create money resides with the people via their representatives. If i owned shares in a bank i would be worried.

Come to think of it if i had money in a bank i’d be worred but humping around gold coins is so 13th century.

I can’t quite work out if this is the beginning of the end or the end of the beginning. I fear its the latter.

Dark clouds gather over corpse of Northern Rock

Believe it or not Northern Rock is still up for sale. It’s hard to imagine it has any value in it though like Barings there is a chance of life after death. The real concern though is the financial responsibility assumed by the taxpayer. As previously reported the taxpayer has underwritten Northern Rock and by inference the entire banking system.

This week concerns have arisen that the taxpayer could actually be seriously under water from this guarantee. Cracks are appearing in the government establishment with the Bank of England under fire from the Treasury and the knives are being sharpened as the blame game starts.

The UK financial system is clearly still in trouble.

The first run on the Bank of England

No not today but back in 1696. But its useful to just retell the story as it has laid the foundation for the development of industrial societies all over the world but primarily the UK and the USA.

When the Bank of England was formed in 1694 it was not as a government agency but a joint stockholder company who then lent money to the government to wage war. Money and war go hand in hand really….sound familiar?

But the deal was interesting. Coin, in the form of gold and silver, had to be deposited and then was lent at a rate of interest which at the time was 8%. This is where the term “gilt edged” comes from.

So far so good. But at the same time new money in the form of paper bills was issued against the same deposit of coin. Therefore at a stroke the amount of money as measured by coin and paper was doubled. The paper money was exchangeable for coin so in fact there was only enough coin for half the supply of money.

I’ve seen more complicated magic tricks at a children’s birthday party!

Needless to say some bright spark decided to up the ante somewhat and the first run took place. Over time this settled down so that 4 to 6 times the gold on reserve could be lent out as paper money. This paper money became known as “good as gold”. Quite clearly it wasn’t but it became accepted.

This was taken to extreme by the Farmers Exchange Bank from Rhode Island which was found to have issued banknotes to the tune of $580m backed up by metal reserves of just $3m (note to Les Hunter for that information).

It never hurts to check the balance sheet of your bank to see exactly how much it does have in the way of equity but as we saw in the UK recently it doesn’t really matter since its all guaranteed by the authorities anyway!

Fed readies for another cut as markets hit and hope

As the Fed prepares for another rate cut, probably 25bps, possibly 50, markets are resilient in the face of what is still a horrendous credit meltdown. With Merrill Lynch reporting a monumental loss last week, it is clear that banks are still clearing away the debris of the last few months and the real impact may not be felt for some time.

Never mind the jokes (you can’t bail out anything with a siv)around the Super SIVs: the great $100bln bailout plan hatched by some genius to support the market. Similar to the rescue plan post LTCM crash, it basically involved the market coming in to buy its own distressed assets. Liquidity is the mantra but holding up the market is the reality.

Everything is under water so its a game of smoke and mirrors. As I’ve said before its a rational response to a difficult situation. The social impact of a complete financial crash is not something anyone wants to see but the longer we put off the necessary surgery the worse it will be.

The credit bubble of the last 15 years is over. The balloon has too many holes in it and its a waste of time pumping more air into it.  Satayjit Das, author of Traders, Guns and Money lays it all out in this paper. Its worth a read.

G7 get jiggy on the Yuan

The G7 communiques are out (i can’t find a link at the moment as i have it direct from a trading platform) and there is one clear story and several cloudy ones. The main thrust is that they would like to see the Yuan quicken its appreciation. Well looking at China’s trade surplus that’s pretty obvious. One only has to remember the famous Yen “endaka” from 1971 to 1995 when the $ fell from 360 to just below 80 Yen.

How far will the Yuan rise is anyone’s guess. The day it floats and becomes fully convertible will see a huge increase in volatility and speculative financial flows. However a floating Yuan would actually be beneficial in regulating global imbalances in trade and economic growth.

The Chinese are well aware of it and are probably not minded to open the doors to the Magic Kingdom just yet. They hold the balance of power at the moment and wont be pushed until they are ready. Still continued pressure will eventually tell.

However, it’s not just the Chinese getting a telling off. Some mention has been made of Asia as a whole and of course this refers to Japan. Whilst there was no specific mention of the Yen this will certainly not be lost on those with substantial short yen positions. There was mention of an improving economic situation in Japan and that exchange rates should reflect fundamentals.

The risk inherent in global carry trades was mentioned specifically by Juncker (Luxembourgs PM) saying they wanted the market to be aware of the risks of one way bets, specifically in the foreign exchange markets.

Paulson (US Treasury Sec) mentioned clearly and loudly that the US believed in a strong dollar. Added to that were moans from the ECB crew about the strength of the Euro and how they were bearing the brunt of $ weakness.

The Canadians jumped in on this wagon too noting the Loony is now 3% stronger than the Greenback. Strange times indeed.

So what does all this mean. Well for me it could means the $ depreciation is nearing an end or at least getting into the red zone. From a market perspective i would say NZ/Yen is due for more pounding (back below 80 again) given this is regarded as the major one way bet in the fx markets. The Euro may reverse back to 1.35, the C$ back above parity and the A$ probably could do with a small dusting (maybe down to 85cts).

Stocks could also get pounded this week. Who knows? It’s not a week to be hugely long and comfortable.

FX rates are elastic things and when they get stretched the bounceback (as we saw in August) can be pretty fierce.

P.S. Others may interpret the communique differently so feel free to give me some of your views.