Commentary from the Privateer's 'subscription' letter ... just posted as a freebie
(snip)"A Potential Disaster - March 18, 2008
If you are any type of a (US) "Fed watcher", the above date will be familiar to you. It is the date of the next meeting of the Federal Open Market Committee - more widely known as the FOMC. To use the jargon so beloved of economists, on the one hand, the Fed is looking across a widening swathe of fiscal and financial chaos and devastation as it surveys the economy it claims to be trying to help. On the other hand, it is looking at what are already runaway price increases throughout the "real" economy, the one which Mr Bernanke was so insistent would NOT be affected by the financial market "hiccups" which began last northern summer. And in the middle of all this, the Fed cannot ignore its "Federal Reserve Note" (aka the US Dollar), a currency which is in all but free fall, having now slumped almost 40 percent against a basket of the currencies of its major trading partners since the beginning of 2002.
Out there in the paper economy which the Fed under Alan Greenspan administered with such panache for so many years, the fear is growing daily. As yields on Treasury paper continue to fall, the rates charged for borrowing by anyone except the US federal government continue to rise. Even fixed US mortgage rates are UP since the Fed starting cutting its rates so agressively in January. The reason for this was given by Mr Paul Miller, an analyst at Friedman, Billings, Ramsey on March 7. It is very simple. The mortgage market is short of CAPITAL to the tune of (at least) $US 1 TRILLION.
The principal financiers of mortgages in the US (and everywhere else) make use of HUGE amounts of leverage when they obtain the funding needed. Mr Miller points out that in the US, $US 11 TRILLION of mortgage debt is "supported" by a little under $US 600 Billion of equity. That is a ratio of about 19 to 1. As the concept of risk has re-entered the markets for debt paper, the amount of leverage available has declined sharply. In some markets, it has disappeared entirely. Hence margin calls and hence calls on the tiny capital base which is supporting this mountain of debt.
The Fed knows how bad this situation is getting. And it is by no means confined to mortgage paper. Consumer debt of all descriptions, auto loans, credit card and personal debt is all getting much more expensive at ever increasing speeds. The banks and financial institutions which originated the paper and the derivatives on the paper have absurdly inadequate amounts of capital "backing" this paper blizzard.
Hence, the Fed has just announced that they are once again increasing the amounts they offer at their bi-monthly "auctions" to the banking system. This procedure only began in January, after the Fed decided that they had to find a way to allow distressed banks to borrow money directly from them using a means other than the discount window. The problem with the discount window was that the banks couldn't obtain funds there anonymously. Hence the auctions, at which the banks can "bid" for funds anonymously.
There are two auctions a month. When first instituted in January, the amount on offer at each auction was $US 20 Billion. In February, it was upped to $US 30 Billion. Now, in March, it is being increased once again to $US 50 Billion. Hence, in two months, the amount on offer at each "auction" has increased by 150 percent. Nor is this all. The Fed has stated that they will keep increasing the amounts on offer "if needed". And as proof that it WILL be needed, the Fed also announced that they will be making an additional $US 100 Billion available "to a broad range of financial players" through a series of transactions separate to the auctions. These transactions are to begin on March 14.
In sum, never in its history has the Fed piled so many new schemes for getting newly created money out into the system at the speed it is doing so at present. Never in its history has the Fed resorted to such outright inflation. This is a "virtual" fleet exercise in Mr Bernanke's famous "helicopter money". The only difference is it is not - yet - raining $100 bills.
Finally, the last feeble pretense that the US economy was not already IN recession was exploded on March 7 when the US Labor Department reported that the economy lost 63,000 jobs in February. This is the second straight month of overall job LOSSES in the US, the figure for January was a loss of 22,000 jobs. Fear enveloped Wall Street on this news, as it drives another nail into the coffin of what was the biggest contributor to US economic "growth" during the various bubbles - consumer spending.
So, Wall Street and the US paper markets in general have only one slim thread of hope remaining. That is that the Fed will go on cutting their official rates and that one of these cuts will do what they have always done before, it will re-ignite borrowing and spending. The universal expectation is that the Fed will cut another 0.50 percent (many want 0.75 percent) at their meeting on March 18. If that one doesn't work, then the FOMC will have to cut again on April 30. If that one doesn't work, they'll have to cut yet again on June 25. And so on.
Apart from the potentially fatal absurdity of the Fed funds rate already being a negative REAL interest rate at present levels, there are two big problems with futher rate cuts. The first one is the refusal of most of the rest of the world's central banks to join the Fed on this road. This week, the Australian central bank RAISED their rates - for the second time in a month. And the Central Banks of Britain and the European Union stood pat.
The second problem is the Federal Reserve Note (aka US Dollar). On a trade weighted basis as measured by the USDX, the US Dollar dropped to post 1973 lows nearly five months ago and has been setting new lows since late last year. This huge $US fall (and even bigger $US Gold rise) has coincided almost exactly with the beginning of the Fed's series of cuts to its Fed Funds rate on September 18, 2007. At present, the USDX stands at 73.04. It has never before been this low. It has no support whatsoever. A rate cut on March 18 could easily lead to a $US bloodbath. But what else can the Fed do, besides giving up and getting out of the way?"(snip)



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