Man the Pumps: Central Banks run up the white flag

With rumours continuing to circle around main street financial institutions in trouble, the Fed along with other central banks piled in another $200bln worth of liquidity in a vain hope to stem the tide. It certainly worked sparking a massive rally in the US market which was looking very weak indeed.

I wrote 6 weeks ago that the Fed would have no option other than to underwrite the whole financial system. This is exactly what they are doing. The worrying aspect of this approach is that it leads the market to depend on continuing liquidity to provide confidence and prevent what would be happening without intervention, namely a full scale rout with several institutions going under.

This creates extreme moral hazard. Even though many financial institutions have clearly acted irresponsibly and in some cases in other ways, they will not be allowed to fail unless a “deal” is worked out where they will be “acquired” quietly for a nominal sum and so the system stays solidly in place and the illusion is maintained.

F.William Engdahl lays out his thoughts on the origins of this mess. It’s focus is the US over the last 100 years and is interesting to read though he makes some strong accusations about the actions of certain people.  The extent to which small cliques have organised and run the financial system is open to questions but there is no doubt that the US prevailed at Bretton Woods on the strength of pure self-interest.

So what now? Well I would say more of the same. But gravity is a powerful force and its hard to imagine these markets not falling further and more de-leveraging taking place in credit and carry trades. I’ll discuss shortly what a new global currency system might look like because the current one is about to explode.

Agflation: Feeding the world

I’ve mentioned Agflation previously and we’re starting to see more concern expressed at the official level. The UK Government’s Chief Scientific Adviser, Professor John Beddington, has weighed into the debate calling food shortages a problem that was as immediate as climate change. The driver of agflation is two fold: increased demand driven by population growth and increasing development and supply shortages caused by deforestation to grow biofuels.

These two drivers are causing major price rises in all food groups. This creates what might be called “real” inflation, a price rise in the cost of real goods as opposed to asset inflation which is more of a monetary phenomenon.

This is a real problem because it can’t be solved by the hammer of monetary policy though the myopists in their central bank ivory towers seem to think so.

I can imagine their conversation: “let’s raise interest rates so people eat less”.

In many countries people are exhorted to have more children especially in developed economies where birth rates among the middle classes have fallen. So how can we stop the population expanding and how are we going to feed all these people and do it in a manner than the ecosystem can cope with.

It’s a tricky question. One could argue that food shortages, famine, disease and natural disasters regulate populations. That may still be the case. But can we rely on that and should we given we are more enlightened, well supposedly.

Population growth was for a long time a favourite topic for policymakers but has only recently come back onto the mainstream agenda. There is no doubt that the growth in biofuels has played a major part in this and that governments who have set targets for biofuel supply may well need to go back and think more carefully about how the unintended consequences of this feel good policy will play out.

National Security: $ on the verge of a nervous breakdown

It reads like a Tom Clancy plotline: The Senate Select Committee On Intelligence gets briefed on the national security implications of a collapse in the $. Suddenly there is a realisation that the US is very exposed not just economically but politically. Those who have read “Debt of Honour” will be familiar with the plot which involves a crashing of the US financial system using a coordinated attack on the $ and the Treasury market. Alas this is now not fiction but real time.

The $ is being abandoned wholesale and the US intelligence service is right to be focusing on what this could mean for national security just as the Pentagon did when they commissioned a report on the security implications of climate change back in 2004.

With Gold heading towards $1000/oz, Oil above $100/bl, the $ in freefall and the financial system in a mess, one could be forgiven for thinking that things couldn’t get much worse. Well stock prices still have plenty of room to fall and probably another 10-15% is about right. Property will continue to sag also.

But the main problem is the US getting the big fat raspberry from the rest of the world. It’s stretched militarily, politically it’s pretty much lost all credibility and now economically its kaputski, as its Russian pals would say.

Who caused this mess? Well according to some it was Sir Alan. No not Alan Sugar of Asmtrad and Spurs fame but Alan Greenspan. This little piece on his actions in 1987 paints an interesting picture.

Let’s hope someone with half a brain is in charge back in Washington otherwise this could get very messy.

Paper $ or Solid Gold?

Tough choice eh…..well not for jewelry lovers. The gold bugs have been enjoying the ride up in the price of gold as well as making fun of Gordon Brown who unloaded a huge brick of the UK gold reserves back in 2001 much to the chagrin of UK taxpayers.

But with the $ swift decline into obscurity the fans of something more solid than the US Treasurer’s signature on a piece of paper are clamoring fro the return of the Gold Standard as a way of preserving the value of paper and controlling the impulse of bankers to keep printing the stuff.

Well yes that does seem to be a problem. I’ve touched on this before when looking at how the Bank of England experienced several runs just after it was formed. Why? Because they printed way more paper than they had in reserves of gold. So gold or no gold, there is nothing to stop authorities or private banks printing paper or more accurately filling up spreadsheets with lots of numbers.

I’m ambivalent on this gold business. Storage issues, never mind the horrendous process of digging the stuff out of the ground, present problems as do the ability to carry it safely but really its a confidence thing.

Readers of this blog should hopefully know by now that money is an artificial construct. We can make it anyway we like. It’s created into existence in some form in order that we can exchange goods, services and labour in an efficient manner.

It is subject to the laws of supply and demand like any other product or service.

William Rees-Mogg makes some interesting points about it here but the reality is still the same gold or no gold. We must control the supply of money. 1:1 exchange for gold is a way to do that but its so last century. Surely we can come up with a smarter way of doing it.

My favoured approach is for a central monetary authority to issue interest free new money into the system directly. that supply of money (the only supply) could be controlled on an annual basis responding to set limits, constraints and changes in demand, population etc.

Goodbye interest, goodbye inflation and goodbye financial markets as we know them.

Gold bugs or not, we have to do something about the current system before it blows up and makes the 1930s depression look like an afternoon tea party.

Markets bomb: What’s next?

Well the 20% drop I predicted in December has happened pretty quickly but that’s coming off a big high. We’ve had liquidity injections, stimulus packages and now an emergency rate cut of 75bps.

So far so good but what happens next?  Well if this was a standard asset bubble/recession I would imagine a lowering of rates globally, a bond market rally, a rise in unemployment and so on. But this is different because its really a money crisis.

I say money instead of credit because to all extents and purposes money is credit. But whereas money is secured on confidence, credit is secured on assets. Those assets are now worth a lot less than previously imagined (another word for risk analysis!).

We’ve seen some major US banks bailed out, a major UK lender go bust and be bailed out and a complete collapse of the US sub-prime market. The stock market reaction is simply an inevitable response. But don’t let that distract us from the real crisis which is global financial insolvency.

So the next issue will be a major US (or other) financial institution going to the wall. I mean a big player simply collapsing. To prevent this the Fed and other central banks will have to underwrite the whole system of interbank credit. A major collapse simply cannot be allowed to happen.

We may not even hear much about it but right now credit lines are frozen solid and at some point that pressure will cause an explosion somewhere.

So I wouldn’t be getting too excited about cheap assets just yet

Holiday reflections

I’ve just spent some time up in the Abel Tasman National Park, one of my favourite places in New Zealand. It’s a stunning coastline Park with a lovely walking track and numerous bays and beaches to swim or kayak in. It also has a stunning eco-lodge for weary walkers to rest up in and relax.

As I walked, sam and lay on the beach I reflected on the past year and wondered where we were heading. Looking at the end of 2007 didn’t fill me with optimism: G7 financial system in a state of collapse, the biggest asset bubble since 1929, oil at record highs and conflicts continue in the middle east and africa.

And opening up 2008 with huge falls in global stock markets….why can’t they fall another 10-20%. No reason at all. Will the latest stimulus plan work? Who knows? There’s been so many I’ve lost count as well as interest.

A good film to watch now would be Paul Gringnon’s Money as Debt. You can also find it on Google video. I highly recommend it especially for the scene where the bankers try to re-inflate the economy for the umpteenth time.

There simply isn’t an answer to this.

It just has to play out.