Wednesday, November 26, 2008

Volker's remarks from a speech last week at Drew University

Volker's comments and my remarks in blue.

Ex-Fed chief Volcker at Drew: 'There is no magic bullet' for economy
Obama adviser says a plan is needed at start of presidency
by laura bruno • daily record • November 21, 2008

"No magic bullet" comment means that he does not believe in the Keynesian approach that utilizes large doses of government spending to restore aggregate demand.

MADISON -- Former Federal Reserve Chairman Paul Volcker, one of President-elect Barack Obama's top financial advisors, didn't let slip any of his secret advice Thursday when he addressed a room of some 40 Drew University students, professors and trustees.

He did tell them that while it's easy to get cynical and discouraged about public service after nearly a decade in Washington, (he served from 1979 to 1987), he said there is a chance that under Obama some of the excitement that was felt in the 1960's with President John F. Kennedy could see a resurgence.

Kennedy's chief economic advisor was John Kenneth Galbraith--a fervent Keynesian. Quite different from the team that Obama has assembled. There is not one Keynesian on it, so it's weird that Volker does not recognize that distinction.

He also said Obama needs to be prepared with an economic plan on inauguration day or the day after, because with General Motors and the other American auto makers on the brink of bankruptcy, Obama may have his hand forced before he has a chance to make his own choices, Volcker said.

"Forced" to do what? Let them fail? Bail them out? No specifics.

Volcker answered questions posed by former New Jersey Gov. Brendan Byrne, a fellow 1949 Princeton University graduate, who is teaching a course on politics and the media at Drew.

When Byrne asked what options there are for solving the economic crisis, Volcker had a short answer:

"Time," he said. "There is no magic bullet."

Again, this comment displays a complete mistrust of the Keynesian approach. Implies shared suffering and sacrifice by the electorate. A muddling through at best.

Sharing the stage with Volcker was former New Jersey Gov. Thomas Kean.

Volcker joked that his true mission at Drew was to offer Kean the Secretary of Treasury position on behalf of the President-elect.

Volcker has been on the short list of possible candidates for the position.

In dishing about the press, Volcker was kinder than Kean, who said the press acts in a "herd mentality" on a major story and most reporting on a complicated story is not sensible.

On this characterization of the press, Gov Kean is absolutely correct. As an aside, I lived in Jersey when Kean was governor and he was an excellent chief executive!

In contrast, Volcker said today's financial press is far more sophisticated than it was 20 years ago.

Is he joking? I find this remark to be incredible. The financial press is still pretty much clueless; views everything through the paradigm of a gold standard. But then again, so does Volker, so you can see why he lauds them.

"I have a feeling the press hasn't done such a bad job," Volcker said of the media's reporting on the financial crisis. "It's a pretty complicated story to tell."

"Press hasn't done a bad job." Unreal! No understanding of gov't finance, monetary operations, floating exchange rates, promoting the likes of Peter Schiff, Jim Rogers. Little or no perspective when it comes to economic data, deficits, debt, etc. Incessant cheerleading, entrenched ideology. Sheesh, what's Volker smoking?

And Volcker acknowledged that public relations can have a powerful effect on the powers of a new president.

"It's not all p.r., but you have to get it pretty right otherwise you can't do what you want to do."

What is he saying? That the press has more power than the policymakers? More power than the Fed? More power than the Federal Gov't? Should we pander to what the press thinks we should do? Is THAT leadership???

Fiscal conservatism is dead! Long live fiscal conservatism!

Fiscal conservatives are beside themselves with delight as they now have an have an absolute vice grip on policy. They’ve had it for years. The hard money crowd has seen their leader resurrected and installed back in his throne with Volker.

Under this team I am skeptical that we will get the kind of demand stimulus that is needed. Obama's first term will likely fail to achieve its economic goals. As a result, he will be blamed–not because of the fiscal conservative policies of his administration–but simply because he is a Democrat. Thus, you will see the “tax and spend” rote criticisms being hurled at him.

Paving the way for even a more extreme version of fiscal conservatism.

Fiscal conservatism is dead! Long live fiscal conservatism!!

P.S. Argentina proposes infrastructure spending equal to 10% of GDP

Obama addresses "recycled" appointees

Obama addressed concerns that many of his economic appointees have been "recycled," meaning they were in the Clinton Administration.

"The American people would be troubled if I selected a treasury secretary or a chairman of the National Economic Council at one of the most critical economic times in our history who had no experience in government whatsoever," Obama said.

You mean like electing a president who has no experience either?

Anyway, isn't that what "change" is supposed to be all about?

Obama to name Volcker to head economic group

Fiscal conservatives everywhere are cheering!

Any chance of a Keynesian response to this crisis is dead.

Tuesday, November 25, 2008

Obama won't save us...his glow is already fading

Since election day each time Obama spoke the markets responded positively. That was a welcome contrast to the devastatingly negative effects seen after any Hank Paulson or President Bush comments.

However, Obama's press conference today was met with market selling for the first time and probably for good reason. Rather than aggressively reiterating the need for a big stimulus without any conditions or without any regard over deficits, Obama sounded a more cautious tone. He talked about crafting an "efficient and responsible" budget. (Code words for fiscal responsibility.)

He spoke about how his OMB appointee, Peter Orszag and his debuty, Rob Nabors, would be "charged with going through the federal budget “page by page, line by line” to develop a budget that would eliminate waste and increase government efficiency."

Obama also said, “If we are going to make the investments we need, we also have to be willing to shed the spending that we don't need.”

Again, the thinking there seems to suggest that he believes the government is somehow constrained in what it can do. Only by "scouring the budget, line by line," is the way he believes he can come up with the money.

Obama's team is filled with deficit hawks, suggesting that bold and aggressive measures to revive demand will fall far short.


This professor mainly suggests that the cause for the breakup of America is debt. On that score he has it wrong, however, gold standard thinking is pervasive and the one thing that may imede or block our abililty to turn this economic crisis around.

"Millions of citizens there have lost their savings. Prices and unemployment are on the rise. General Motors and Ford are on the verge of collapse, and this means that whole cities will be left without work. Governors are already insistently demanding money from the federal center. Dissatisfaction is growing, and at the moment it is only being held back by the elections and the hope that Obama can work miracles. But by spring, it will be clear that there are no miracles."

He also cited the "vulnerable political setup", "lack of unified national laws", and "divisions among the elite, which have become clear in these crisis conditions."

He predicted that the U.S. will break up into six parts - the Pacific coast, with its growing Chinese population; the South, with its Hispanics; Texas, where independence movements are on the rise; the Atlantic coast, with its distinct and separate mentality; five of the poorer central states with their large Native American populations; and the northern states, where the influence from Canada is strong.

There are large racial, ethnic, religious undertones in the American society that can become a source of tension and strife if economic conditions become very bad. I believe that.

Is Britain Going Bankrupt?

Another ridiculous article by a journalist who doesn't understand floating exchange rates and the difference between currency issuing nations that spend by crediting bank accounts (and Britain is one). There can never be a payments crisis or bankruptcy.

If this guy Ambrose Evans-Pritchard wanted to write about such a possibility he should focus on Germany or any nation within the Eurozone. These countries are no longer currency issuers and are completely constrained by the total amount of savings of their citizens and the nations' ability to borrow. They can go bankrupt. Britain, U.S. Japan, etc. can't!

Christina Romer: Obama's choice for Chair of the Council of Economic Advisors

In case you were wondering. Talking points below taken from Brad DeLong website:

Talking Points on the Designation of Christina D. Romer as the Candidate to Be Nominated to the Senate for the Post of Chair of the Council of Economic Advisers

World-class expert on the Great Depression: if you want to avoid any of the mistakes made during the Great Depression, she is the one to hire.

World-class expert on monetary and fiscal policy: encyclopedic knowledge of their history--since we need a CEA chair who knows more about stabilization policy than about tax or labor or industrial organization policy.

Very good at explaining economics: great similarities between teaching Econ 1 and teaching the White House staff about economics.

Very good at making people believe that relatively complicated ideas about economics are simple facts of nature.

Bush moved the CEA staff out of the Eisenhower Executive Office Building:

A very bad thing because the CEA staff can no longer look over the shoulders of the White House staff and offer advice.

CDR should demand, as a condition of appointment, that at least her two deputies have offices in the White House complex.

A center-left moderate:
But these are not moderate times. To be moderate now is to be radical. To be radical is to be moderate.

The dollar's rally is over

The Fed has effectively killed it with massive dollar selling of the past two months.

The good news is, they will have a huge profit on their foreign currency position.

The bad news is, it translates into a decline in Americans' purchasing power.

But, hey, at least taxpayers are getting "payback," right?

Maybe they'll divvy up the Fed's trading profit and send us all a check!

Don't hold your breath.

Riots in Iceland as economy darkens

Look at events playing out in Iceland, where an economic collapse is now bringing riots in the streets...violence!

As Americans rail against bailouts and increased government spending; as our leaders preach constraints, sacrifice and shared pain, we impede our ability to get us out of this crisis.

This is no time for fiscal restraint, yet that is what the Obama team is proposing: new spending balanced with new spending cuts. Where is the stimulus? States and local governments face severe cash shortages and looming cutbacks in services.

We risk bringing on a broader and more long-lasting downturn under this sort of approach. Look at Iceland and don't think that America is immune to this type of social diorder and chaos.

Obama promotes fiscal restraint as counterpoint to spending plans

The economy's problems are tied to a large decline in aggregate demand, which means that more demand is needed, not less or the same. While Obama's spending plans are good, his perceived need to balance that out with spending cuts will likely not produce sufficient new demand to turn things around. His appointment of Peter Orszag to OMB was a dead giveaway. Orszag is a deficit hawk as are other members of the Obama economic team. Obama and his team are operating under the notion that the government is fiscally constrained, when in fact it is not. This is gold standard thinking.

Monday, November 24, 2008

Money supply starting to grow more rapidly

M2 (y-o-y % change)

Growth in this aggregate is starting to accelerate. Sign that things may be stabilizing.

Weekly reserves and monetary base update

Reserve balances with Federal Reserve banks

Now up to $634 billion. This is the money that will be used to buy Treasury securities. It has already been put into the banking system as a result of Fed actions and Gov't spending.

Monetary Base

Up by $700 billion since September. Where did this money come from? Answer: Federal reserve credits and gov't spending.

Friday, November 21, 2008

Six Myths about the Big Three

Good article covering some of the misconceptions about the Big 3 automakers on Seeking Alpha.

"Memo to CEOs: Ask for a bailout, and your company will be reduced to a caricature.

Recent congressional hearings on the plight of GM (GM), Ford (F), and Chrysler have illuminated a few important issues - like how the Detroit executives travel when on business. Populist politicians and gotcha journalists delighted at the prospect of rich CEOs riding corporate jets to ask for taxpayer money. There was a little talk about jobs and cars and the foundering economy, too. But you might have missed that part, or gotten confused by a welter of misperceptions that emerged from the spectacle of supplicant CEOs trying last-ditch tactics to save their companies."

As the automakers careen toward bankruptcy, here are some of the myths complicating the debate over the future of the Detroit Three:

Go here.

Did the $600 billion in loans the Fed made to foreign Central Banks go to foreign automakers?

Congress denied our automakers a $25 billion loan despite the prospect of bankruptcy and the massive, negative, economic ramifications of that.

Yet over the past several months the Fed has lent over $600 billion to foreign central banks, including, the ECB, Bank of England, Bank of Japan, Swiss National Bank, Banco Central do Brasil, the Bank of Korea, Banco de Mexico and the Monetary Authority of Singapore.

Here's what the Fed had to say about those loans in its minutes:

" address the sizable demand for dollar funding in foreign jurisdictions"

What does this mean?

It means that the Fed gave over $600 billion to foreign CBs and that money will be lent to individual institutions and companies within those respective countries.

Wouldn't it be ironic, then, if some of the recipients of those dollar loans turned out to be foreign automakers like Daimler, BMW, Hundai, Mazda and even Nissan and Toyota?

Could very well be.

There is no U.S. Government regulatory oversight when it comes to how the central banks of other nations dole out OUR money.

Did Congress say anything about this? Of course not.

The most egregious thing is that the Fed did not have to do this. If foreign central banks needed to help companies within their jurisdiction that had dollar liabilities, they could have bought dollars in the open market and supplied those dollar loans directly. Our Fed didn't have to supply them. However, as a consequence of giving those dollar loans the Fed has stopped the dollar's rally. That hurts Americans.

Where's the outcry over the $8.6 billion the Fed lost on currency swaps?

There was huge public outcry when the Fed arranged the "bailout" of Bear Stearns. Back in July the Fed created the Maiden Lane Portfolio to assume the $28.8 billion of Bear Stearns' assets. The value of that portfolio as of 11/20 was $26.9 billion. So, over the course of four months the Fed has "lost" about $2 billion based on current, mark-to-market value of the Bear Stearns assets.

Yet in the past week the Fed's foreign currency holdings have lost $8.6 billion in value--more than four times what it lost on the Bear Stearns deal. (View the Fed's weekly statement here.)

At least with Bear Stearns the Fed acted to help an American institution and U.S. financial markets, as opposed to giving money to foreigners.

So, where is the public outcry? Where are the Congressional hearings?


Thursday, November 20, 2008

Fed's forex swaps decline by $8.6 billion in the latest week

Total outstanding value of foreign currency on the Fed's balance sheet as of November 20th is $606.4 billion. That is down $8.6 billion from the previous week.

Access the Fed's weekly statement here.

Peter Orszag: Obama's pick for OMB

”Peter Orszag, the head of the Congressional Budget Office, was picked to head Obama’s Office of Management and Budget, a top Democratic source told CNN on Tuesday. Orszag worked at the Clinton White House as special assistant to the president at the National Economic Council and served on the Council of Economic Advisers.”

Orszag has written on the dangers of rising deficits for interest rates, and on the government’s fiscal “gap” into the infinite horizon, to head OMB.

Change we can believe in?

Wednesday, November 19, 2008

Finger-pointing begins as Senate nixes auto vote

WASHINGTON – A Democratic Congress, unwilling or unable to approve a $25 billion bailout for Detroit's Big Three, appears ready to punt the automakers' fate to a lame-duck Republican president. Caught in the middle of a who-blinks-first standoff are legions of manufacturing firms and auto dealers — and millions of Americans' jobs — after Senate Democrats canceled a showdown vote that had been expected Thursday. President George W. Bush has "no appetite" to act on his own.

Then he oughta force himself to have one.

U.S. auto companies employ nearly a quarter-million workers, and more than 730,000 other people have jobs producing the materials and parts that go into cars. About 1 million on top of that work in dealerships nationwide. If just one of the auto giants were to go belly up, some estimates put U.S. job losses next year as high as 2.5 million.

"If GM is telling us the truth, they go into bankruptcy and you see a cascade like you have never seen," said Sen. George V. Voinovich, R-Ohio, who was working on one rescue plan Wednesday. "If people want to go home and not do anything, I think that they're going to have that on their hands."

The automakers — hobbled by lackluster sales and choked credit — are burning through money at an alarming and accelerating rate: about $18 billion in the last quarter alone. General Motors Corp. has said it could collapse within weeks, and there are indications that Chrysler LLC might not be far behind. Ford Motor Co. has said it could get through the end of 2008, but it's unclear how much longer.

For now, however, with the federal emergency loan plan stalled in the Senate, lawmakers in both parties are engaged in a high-stakes game of chicken, positioning themselves to blame each other for the failure.

Senate Majority Leader Harry Reid, D-Nev., scrapped plans Wednesday for a vote on a bill to carve $25 billion in new auto industry loans out of the $700 billion Wall Street rescue fund.

It's really up to Bush's team to act, he said.

"I don't believe we need the legislation," Reid said. Treasury Secretary Henry Paulson can tap the financial industry bailout money to help auto companies, Reid said, but "he just doesn't want to do it."

Paulson says he "doesn't think that was the intention of the legislation." It's not up to him, it's up to Congress. Who made Paulson God? He should be held in contempt of Congress.

Not our responsibility, countered the White House.

The president is Commander in Chief. Ultimately, if the fate of the nation's economy is at stake, it is his responsibility. He has walked out on the American people.

"If Congress leaves for a two-month vacation without having addressed this important issue ... then the Congress will bear responsibility for anything that happens in the next couple of months during their long vacation," said Dana Perino, the White House press secretary.

The president is ultimately in charge. He can do it by executive order and anyway, it is the Republicans in Congress who are being obstructionist.

She said there was "no appetite" in the administration for using the financial industry bailout money to help auto companies.

"No appetite???" She must be kidding. As the economy prepares to crater that's the lame excuse they come up with???

The White House and congressional Republicans instead called on Democrats to sign on to a GOP plan to divert a $25 billion loan program created by Congress in September — designed to help the companies develop more fuel-efficient vehicles — to meet the auto giants' immediate financial needs.

Voinovich and Sen. Kit Bond, R-Mo., along with Democratic Sen. Carl Levin of Michigan, were at work on that measure Wednesday, trying to placate skeptical Democrats by including a guarantee that the fuel-efficiency loan fund would ultimately be replenished.

"It is the only proposal now being considered that has a chance of actually becoming law," said Republican leader Mitch McConnell of Kentucky.

If an acceptable deal emerges, Reid said it could be passed as part of a measure to extend jobless aid to unemployed workers whose benefits have run out. A vote on that bill is likely on Thursday. Negotiators were discussing a scaled-down aid package of $5 billion to $8 billion to help the automakers survive through year's end.

But there was little sign that Democratic leaders would go along.

"We have to face reality," Reid said.

They are vehemently opposed to letting the car companies tap the fuel-efficiency money — set aside to help switch to vehicles that burn less gasoline — for short-term cash-flow needs.

All of which leaves the Big Three bracing for a bleak winter without government help.

GM CEO Rick Wagoner told a House committee Wednesday that the downfall of his industry would ripple through communities around the nation. Pressed by lawmakers, Wagoner wouldn't say precisely when GM would run out of money without a government lifeline, but he disclosed that the company now was burning through $5 billion a month.

Still, with the $25 billion emergency package, "we think we have a good shot to make it through this," Wagoner said.

Many lawmakers in both parties are now openly discussing whether bankruptcy might be a better option for auto firms they regard as lumbering industrial dinosaurs that have done too little to adjust their products and work forces for the 21st century.

Will make Lehman bankruptcy look like a walk in the park.

The carmakers argue that bankruptcy would devastate their companies, but proponents say it would give them a chance to reorganize and emerge stronger and more competitive.

It's unclear, though, whether Democrats controlling Congress are willing to risk being blamed for letting one of the Big Three — symbols of the nation's once-mighty manufacturing sector — go under.

Bailout-shy lawmakers got an earful from jittery constituents last month when the House let an early version of the Wall Street rescue fail, sending the Dow Jones industrials tumbling and erasing more than a trillion dollars in retirement savings and other investments. Congress took a deep breath and reconsidered, passing the plan a few days later.

Faced with a similar collapse in the auto industry, the Bush administration might yet decide to step in to help the auto companies, or the Federal Reserve could step in — though both have steadfastly refused to do so.

If not, lawmakers have left themselves a contingency plan: Come back to Washington in December for yet another postelection session where they might be able to strike the deal that now seems beyond reach.

Democratic leaders are planning to gather for an economic conference the week of Dec. 8, noted House Majority Leader Steny H. Hoyer, D-Md.

"That is available," Hoyer said this week. "The year has not ended."

Consumer prices drop the most in 61 years

This shows the futility of raising interest rates to address demand driven increases in commodity prices. The Fed's long march to a 5.25% fed funds rate, from 1%, was part of what caused the housing market to peak. The Fed did this because it caved in to pressure that we there was rising inflation, yet, the rise in commodity prices simply were a reflection of a global boom (and speculation--they could have addressed that, but chose not to). Moreover, there was little or no wage inflation throughout the course of the gains in commodities.

Even the ECB has reversed course.

Eventually, commodity prices would have stabilized at some higher plateau and that element of inflation would have abated. Instead, the Fed chose to fight it with higher rates, and support a weak dollar (also caving into concerns about the dollar's exchange value). That's a good part of what burst the bubble.

Ironically, the Fed has had a wonderful opportunity to allow the dollar to rise dramatically, but opted to engage in massive forex swaps that put a cap on the dollar. This selling of the buck by the Fed will turn the dollar's trend down again. It may already be starting.

I.O.U.S.A. Makes Oscar Shortlist For Best Documentary

The propaganda film, I.O.U.S.A has been nominated for an Oscar. This is no surprise.

The film totally miscontrues and distorts the financial position of the United States. It routinely takes things out of context and fails to understand the concept of debt as money in a modern economy or the world under a regime of floating exchange rates.

This is a well-crafted propaganda film designed to scare people, and it has done jus that. Like Al Gore's, "An Inconvenient Truth," this film could launch policy shifts designed to address the so-called "debt timebomb."

If these policy shifts occur (like forced saving and/or transformation of the U.S. economy from a consumer to exporter), it will lead to a substantial decline in the standard of living of all Americans.

Tuesday, November 18, 2008

More bad thinking: WSJ Op-Ed, "Why Spending Stimulus Plans Fail"

The Wall Street Journal published this Op-Ed piece today. It is mired with myths and erroneous thinking.

Read article here.

By the way, I will have the author on my radio show tomorrow (Wednesday, November 19, 10:20am Eastern Time). Please feel free to listen by going to You can also call in, toll-free, by dialing, (877) 777-7713.

An excerpt:

"Congressional Democrats are now demanding another economic stimulus package to "inject" as much as $300 billion into the economy. The package will fail -- just like last year's $333 billion in emergency spending and $150 billion in tax rebates failed. There's a simple reason why.

Government stimulus bills are based on the idea that feeding new money into the economy will increase demand, and thus production. But where does government get this money? Congress doesn't have its own stash. Every dollar it injects into the economy must first be taxed or borrowed out of the economy. No new spending power is created. It's merely redistributed from one group of people to another."

My comments:

The stimulus and spending didn't fail. Last year's $330 billion added 2.4% to GDP and this year's $150 billion in rebates added, at a minimum, 1.7% to GDP.

Government doesn't tax and borrow first and then turn around and spend after the fact. On the contrary, the government spends first (by crediting bank accounts), then collects taxes and sells securities after the spending has already occurred.

Simple deductive reasoning can prove this.

If government first needed to collect money via taxes and through the sale of securites before it could spend, a deficit could never exist. It would be operating under a system of pay-go.

However, deficits do exist. We know that for a fact. And they exist precisely because the government spends more than it recovers in taxes and the sale of securities.

How, then, could that be possible under your scenario, where the government first had to collect "one dollar for every dollar it injected into the economy?" Under that mode of operating there would never be any deficits.

Consider this: In the past two months reserves in the banking system have increased by nearly $600 billion. How did this happen? Under your paradigm the government would have had to collect that money somehow--either through a levy of taxes or the sale of new securities in the amount needed.

However, in looking at the recent, $700 billion bailout, or the rebate checks that were sent out earlier in the year, no new tax levies had been imposed, nor was the total dollar amount of securities sold by Treasury in the period prior to the spending, anywhere near $600 billion (or $150 billion in the case of the rebate checks).

So where did the money come from?

Again, these are credits to the banking system. If you'd like to see an accounting of this simply go to the first line item on the Fed's weekly Statement. It reads: "Reserve Bank Credit.

Furthermore, it is important to understand that if the Fed did indeed collect taxes first, and/or sold bonds, notes and bills to "get this money out of the economy," bank reserves would have decreased by an equivalent amount because the money would actually have been "taken out of the economy" just as you stated. Yet that didn't happen. In fact, as far as I can tell, not a single American taxpayer reported sudden and unanticipated withdrawals from their checking accounts (earmarked to the "U.S. Treasury") prior to that spending.

Last year the government collected $2.5 trillion in total receipts (taxes plus proceeds from the sale of securities), yet it spent $3 trillion. Now, I'm no math genius but just looking at those two figures tells me that somehow the government managed to pump $500 billion more into the economy than it took in. That's the deficit. And that's why the non-governmental sector (you, me, the private sector), is $500 billion richer, not poorer.

Paulson acts unilaterally, against Congress' intent

Who made Hank Paulson God?

Paulson repeatedly stated the actions that HE believed appropriate for the $700 billion bailout, even though Barney Frank pointed out numerous and specific instances in the bill's language where Treasury had been INSTRUCTED BY CONGRESS to spend, as in the case of mortgage relief.

Paulson basically said that he thought that was not appropriate use of the money.

CONGRESS decides what the money is to be used for, NOT PAULSON!

Paulson has hijacked the money for his Wall Street friends and he has even limited the amount that he will distribute. (Just giving relief to the likes of Goldman, Citi, JP Morgan, Morgan Stanley and a handful of others, but far below the $700 billion authorized.)

Who made Paulson God?

He should be held in contempt of Congress!!

Monday, November 17, 2008

Kansas City Fed President Hoenig's comments on the current situation and Fed's actions

Fed `Has Done About as Much as It Can,' Hoenig Says (Update1) 

By Vivien Lou Chen and Craig Torres

Nov. 17 (Bloomberg) -- Federal Reserve Bank of Kansas City President Thomas Hoenig said the central bank has ``done about as much as it can do'' to revive the economy, which has worsened faster than he expected. 

He's got to be kidding. There is a lot more the Fed
can do. He just doesn't understand. As an example: from 2002-2004 the Bank of
Japan bought stocks to stabilize the market and it worked. The Fed could do the
same here, even if it were just bank stocks.

``Interest rates are extremely low,'' Hoenig said today in an interview with PBS's Nightly Business Report. ``The fact that we have the recession now is a little bit more than what I had anticipated,'' he said in a transcript of an interview provided by the show prior to a scheduled broadcast tonight. 

Obviously doesn't understand the connection between
the Fed's target rate and its effect on reserves. Until recently, actions
designed to maintain target rate led to "sterilization" of liquidity

The Fed has tried to mitigate the worst credit crisis in seven decades by reducing the benchmark interest rate to 1 percent and channeling more than $1 trillion in loans to banks and other financial institutions. Some central bank credit has gone to non-banks, such as insurer American International Group Inc., and U.S. automakers are also seeking federal assistance. 

Fed authorized under Section 13 Paragraph 3 of
Federal Reserve Act, to discount loans to anybody against any collateral it
deems satisfactory. That's why we have a Fed and Congress gave it that authority
for this exact purpose.

Policy makers should provide emergency lending programs only to financial institutions that create credit and handle payments, Hoenig said earlier today in a speech in New York. 

Again, there are no limits to whom the Fed can lend
to under the Act.

``The focus should be on protecting the intermediation process and payments mechanism,'' he said. ``I would argue for at least drawing a sharp line between banking and commerce, with our discount window only used to fund institutions and markets that play strictly a financial role.'' 

Protect unregulated intermediaries? The very entities
that got us into this trouble?

President-elect Barack Obama said yesterday the government needs to provide a ``bridge loan'' or other help to auto companies on condition that management, labor and lenders come up with a plan to make the industry ``sustainable.'' 

Obama's policies will work on the demand side.
That's what is currently needed.

``For the auto industry to completely collapse would be a disaster,'' he said in an interview broadcast on CBS News's ``60 Minutes.'' 


Federal Aid 

General Motors Corp., Ford Motor Co. and Chrysler LLC need federal aid before Obama takes office Jan. 20, United Auto Workers President Ron Gettelfinger told reporters on Nov. 15. 

Democratic lawmakers would like to use part of $700 billion in bank rescue money approved this year to help automakers, a move opposed by U.S. Treasury Secretary Henry Paulson and President George W. Bush. An impasse in Congress may put more pressure on the Fed to provide temporary assistance. 

Paulson's not even using all the money. Moreover,
his judgment has been extremely poor: letting Lehman fail, the ill-conceived
bailout and flip-flop. Yet we are to trust him when he says that helping the
automakers is going down the "wrong route?" Bizarre.

Loans and other assistance from the Fed and the Treasury have brought several unintended consequences because the U.S. lacks a framework for aiding troubled non-bank financial institutions, Hoenig said. 

Unintended consequences? Such as?

``Many of the steps taken have raised important issues with regard to moral hazard and the subversion of market discipline, equitable treatment of different institutions and segments of the market, and public interference in credit allocation,'' he said at an Institute of International Bankers conference. 

There's market discipline and there's market
discipline. If he is advocating economic depression as a form of market
discipline that's not the best course of action, it would seem.

Emergency Credit 

Hoenig, Richmond Fed President Jeffrey Lacker and Philadelphia Fed President Charles Plosser have called for a framework limiting emergency central bank credit. 

Again, this goes against the intent of the Federal
Reserve Act. Who gives these Fed governors the power to do this? Only Congress
can. Who made them God all of a sudden? Audacity!

``An expanded role for the discount window may bring central banks more directly into allocating credit as collateral requirements are selectively relaxed, and lending is used to support specific segments of the market,'' Hoenig said. 

All conforming to the letter and spirit of the law.

The Kansas City Fed president said he was ``especially concerned'' that loans to institutions beyond banks put the Fed in the position of ``mixing banking and commerce.'' 

See comment above.

``Such assistance could put public authorities into the process of allocating credit and selecting the winners and losers,'' he said. ``A long-standing concern is that central-bank lending should not be used to prop up insolvent institutions.'' 

What about letting solvent institutions fail, as in
Lehman, Wachovia, etc? The Fed stood by and watched while that happened.

The U.S. Treasury has set aside $250 billion of a $700 billion taxpayer-funded bailout package for direct capital injections into banks. Changes to the program have created ``confusion out there,'' he said.

You can thank Hank Paulson for that.

Lehman II, The Redux (Only much, much bigger.)

Senate Republicans oppose help to the automakers and the Bush Administration has decided not to ask for the remaining $350 billion of the bailout money. This means it is almost a certainty that GM and the other American automakers will fail.

With one out of ten jobs in the American economy tied to the auto industry, the result will be catastrophic. It will make Lehman's failure look like a walk in the park.

Paulson's actions throughout this crisis have been beyond incomprehensible: Letting Lehman fail, his ill-conceived bailout plan then the flip-flop. His staunch resistance to helping the auto industry despite its huge economic influence on the economy. His ignorant and lame "confessions" to the American public that the government is powerless on its own to help. And let's not forget his threats to China on the question of their currency, etc.

A total disaster.

Weekly update on Monetary Base and Reserves

Reserves on deposit at the Fed

Reserve balances now $600 billion even with recent sales of securities. These are the funds that will be used to buy more securities as the Treasury sells them.

Monetary Base

Bush Administration Said to Not Seek Remaining Bailout Funds

Story came off of

Bush Administration and Republicans essentially walking away from the economy's problems. Unbelievable!

Access here.

Friday, November 14, 2008

Bush continues pushing "free market" approach to crisis

President Bush continues to push the same tired, old, free market mantra at the G20 meeting in New York:

The greater threat to prosperity is "not too little government involvement, it is too much government involvement in the market," Bush said.

Even Brazil's president gets it:

Brazilian President Luiz Inacio Lula da Silva said last weekend in Sao Paulo, where G20 finance ministers met, that the world economic order "collapsed like a house of cards" because of a "dogmatic faith in non-intervention in markets."

Thursday, November 13, 2008

Fed's forex swap lines increase another $41 billion in latest week. Total now stands at $615 billion.

Fed continues to dole out dollars to foreign central banks (to be used by foreign financial institutions). Another $41 billion was handed out in the week ended November 13. The grand total so far is $615 billion. This now comprises nearly 30 percent of the Fed's balance sheet. These loans are uncollateralized and non-recourse. We let our guys fail but we are supporting foreign financial institutions and keeping the dollar weaker than where it would be if these dollar handouts were not happening. It is a ripoff to American taxpayers.

Access the Fed's weekly statement here.

"Liar's Poker" author chronicles the End of Wall Street

Good article by the author of "Liar's Poker," Michael Lewis.

Here is an excerpt:

"I’d never taken an accounting course, never run a business, never even had savings of my own to manage. I stumbled into a job at Salomon Brothers in 1985 and stumbled out much richer three years later, and even though I wrote a book about the experience, the whole thing still strikes me as preposterous—which is one of the reasons the money was so easy to walk away from. I figured the situation was unsustainable. Sooner rather than later, someone was going to identify me, along with a lot of people more or less like me, as a fraud. Sooner rather than later, there would come a Great Reckoning when Wall Street would wake up and hundreds if not thousands of young people like me, who had no business making huge bets with other people’s money, would be expelled from finance."

Full article here.

Chicago Mayor Daley: Prepare For Mass Layoffs

"This is going to be all year, so it's going to be a very frightening economy," Mayor Daley said. "Each one tells me what they're laying off, and they're going to double that next year. We're talking huge numbers of permanent layoffs for people in the economy. It's going to have a huge effect on all businesses."

The mayor said the gravity of the situation cannot be underestimated.

"We never experienced anything like this except people who came from the Depression," Mayor Daley said. "When you have that many layoffs early – and they're telling me this is only the beginning of their layoffs – that is very frightening."

Mayor Daley also warned that local governments will be in jeopardy and may not have enough money to meet payroll, although he is not worried about paying City of Chicago employees.

Full article here.

More awful advice from a former Goldman chairman

By Joseph A. Giannone

NEW YORK (Reuters) - The economy faces a slump deeper than the Great Depression and a growing deficit threatens the credit of the United States itself, former Goldman Sachs chairman John Whitehead, said at the Reuters Global Finance Summit on Wednesday.

This guy was former Chairman of Goldman Sachs, so you can see why Paulson’s thinking is the same as his. This is where Paulson essentially got his “schooling” about the way the world works. (Or at least, the way gov’t finance works.)

Whitehead, 86, said the prospect of worsening consumer credit woes combined with an overtaxed federal government make him fear that the current slump is far from over.

Nothing that massive governments spending cannot cure. But there is no modern day Keynes, unfortunately. We need him more than ever.

"I think it would be worse than the depression," Whitehead said. "We're talking about reducing the credit of the United States of America, which is the backbone of the economic system." Whitehead encountered plenty of crises during his 38 years at the investment banking firm and was a young boy during the 1930s.

Sovereign, currency issuing nations that spend by crediting bank accounts do not need, “credit.” The only potential downside to this spending, if done in sufficient degree and left unchecked, is a decline in the foreign exchange value of the nation’s currency.

Whitehead warned the country's financial strength is at risk due to the sweeping demand for tax relief and a long list of major government spending plans.

The country’s financial strength is at risk precisely because we don’t engage the government to a greater degree (as in, more deficit spending, not less).

"I see nothing but large increases in the deficit, all of which are serving to decrease the credit standing of America," said Whitehead, who served as chairman of the Lower Manhattan Development Corp after the World Trade Center was destroyed during the September 11, 2001 attacks.

The deficit during WWII went to 40% of GDP. With the terrible mess we are facing now in the economy, the deficit is still under 4% of GDP. However, people like Whitehead will cause us to suffer far longer than if we were to address this with aggressive spending.

Whitehead, who helped make Goldman a top-tier Wall Street firm and led its international expansion, left in 1984 to become a deputy secretary of state under Ronald Reagan.

His old boss, Reagan, ran the biggest deficits in post WWII history. That’s why the economy boomed. This guy has selective memory, it appears.

He warned that the country's record deficit is poised to balloon as the public calls on government for more support.

Again, as a percent of GDP smaller than in the 1982-83,1990-91, 2001, recessions.

"Before I go to sleep at night, I wonder if tomorrow is the day Moody's and S&P will announce a downgrade of U.S. government bonds," he said. "Eventually U.S. government bonds would no longer be the triple-A credit that they've always been."

They will. But only because the rating agencies are clueless. They rated toxic subprime debt AAA. They downgraded Japan to the status of Botswana. Nothing to lose sleep over.

There are at least ten "trillion dollar problems," facing the United States, he said, including social security, expanding health insurance, rebuilding infrastructure and increased spending on green energy. At the same time, the public does not want to pay for it.

The public can only “pay for it” with funds provided to it by government spending. That’s the only thing the government accepts for the payment of taxes.

"The public is not prepared to increase taxes. Both parties were for reducing taxes, reducing income to government, and both parties favored a number of new programs -- all very costly and all done by the government," he said.

Government doesn’t need “income.” It spends by crediting bank accounts. The sale of securities and the collection of taxes function merely to maintain a certain level of reserves and that’s tied to the Fed’s targeting of an interest rate. That’s it. End of story.

Large deficits can weaken the country's credit and increase its borrowing costs, which already constitute a significant part of funding to cover expenses. Whitehead said it could take "several years" for the current problems to be resolved.

Japan has a public sector debt twice as large as the U.S. and official interest rates are near zero. No correlation.

Whitehead said he is speaking out on this topic because he is concerned no lawmakers are against these new spending programs and none will stand up and call for higher taxes.

Higher taxes will reduce aggregate demand in the economy even further.

"I just want to get people thinking about this, and to realize this is a road to disaster," said Whitehead. "I've always been a positive person and optimistic, but I don't see a solution here."

It’s a road to disaster if we follow his misguided prescriptions.

Dollar libor spreads widening again after 23 days of decline

Remember,some of the Forex swaps that the Fed recently engaged in had 28 day terms. Could there already be a problem with some European institutions in paying back some of these loans? Are these debtors on the hook, bidding for dollars to close these swap positions?

City Council: Detroit needs $10-billion bailout

It's getting worse. Money must be made available to states and municipalities now. Too much time has been spent trying to prop up much of what is worthless in the financial sector. Very few non-bank entities really have any reason to still be around. The entire thing was an artificial construct born out of excessive deregulation. It added little benefit but brought enormous risk.

Paulson abandons his troubled asset purchase plan for what appears to be a "Whack the mole" strategy. Curiously, it is worth noting, that the troubled asset wharehousing scheme did get us out of the S&L mess. Paulson appears to be reeling, not knowing which way to turn. Bad. Really bad!

Bloomberg: Boehner Demands Fed Identify Recipients of Loans

It was only a matter of time before this happened. You can blame that terrible Bloomberg column of a couple of days ago. More of the same misinformed reporting today:

House Republican leader John Boehner called for the Federal Reserve to disclose the recipients of almost $2 trillion of emergency loans from American taxpayers and the troubled assets the central bank is accepting as collateral.

Boehner, in a prepared statement, also asked the Federal Reserve to comply with a Freedom of Information Act request seeking details about the loans.

The Fed ``should comply with this Freedom of Information Act request, and in the interest of full and fair disclosure, they must begin providing lawmakers and taxpayers all information about how they are using federal tax dollars,'' Boehner said.

My email to the Bloomberg journalist (Laura Litvan) who wrote this tripe.

These were not "emergency loans from American taxpayers." The Fed has infinite ability to create money in our system and does so by simply crediting bank reserve accounts.

If indeed the $2 trillion in credits were loans from American taxpayers then it would stand to reason that personal savings of Americans would decline by that amount. Yet this has not happened.

Furthermore, banks are regulated by the Fed, FDIC and Office of the Controller of the Currency as to what assets they are allowed to own. They are constantly monitored and scrutinized and must conform to minimum capital requirements. The need to post collateral is redundant under this institutional structure.

The assets that banks own are all government approved and marginable at the Fed's Discount Window. This list is available to the public, free of charge, at

Your article is steeped in misinformation and displays a horrible lack of understanding of monetary operations and how the Fed functions. It is misleading and ignorant.

-Mike Norman

Wednesday, November 12, 2008

Paulson highlights the drawbacks of having a businessman in government

Government exists for the public purpose; businesses exist to make profits. Governments should not be run as profit seeking enterprises. If they are, they immediately crowd out private enterprise. (Because they can tax and often issue the "chips" with which we play the game, at least the Federal Gov't does. So they have a huge advantage and by applying this advantage they can quickly own all the means of production.)

The Federal Government is never spending constrained, but even the biggest corporations sometimes can be.

Businessmen like Paulson have been honed to think in terms of profits and constraints. Their view of what can and cannot be done is always colored by that.

This is why you hear him say, "There is nothing the Government can do by itself." Or, "We need the help of other countries." Or, "This is going to be a long and difficult road back."

Statements like the ones above can be true for businesses and even for state governments or nations that are not sovereign currency issuers. They are NOT true for governments that issue non-convertible currency and that spend by crediting bank accounts.

Paulson does not understand this, nor, unfortunately, do many members of Congress. As a result we will continue to operate under these self-imposed constraints. The road back will be long and difficult, because we will make it long and difficult by adhering to misconception and myth.

It doesn't need to be this way.

Obscene Wall Street pay

If there was ever any question in your mind as to how ridiculously overvalued Wall Street was, and how its compensation structure was beyond obscene, just look at the useless flailings of our vaunted Treasury Secretary. He made hundreds of millions as a Master of the Universe at Goldman, but is clueless on helping save the economy. Worse...his ineptness is rapidly destroying it.

Paulson is clueless

Paulson should be fired immediately. Back in September he let Lehman fail, for no apparent reason and that touched off the systemic nature of the current crisis. Look at a chart of any market—stocks, bonds, commodities, the dollar—and you’ll see that all hell broke loose when Paulson decided to let Lehman go under.

Today he admits his bailout plan stinks. So, instead of going with his first idea, which was buying troubled assets, he wants to support the very institutions that created those troubled assets in the first place.

On the suggestion of using some of the money to help GM and the other U.S. automakers, he states confidently, “That would be the wrong way to go.” If recent history is any guide, we ought to get very worried when Paulson confidently states what we ought to be doing. This guy should be given the boot immediately.

Paulson to markets: "My plan stinks"

The vaunted chief of Goldman Sachs (the firm itself is nothing less than a Pantheon of the Gods when it comes to Wall Street) brought in to save the day as Secretary of the Treasury, now says his plan was bad and he knew it the moment he signed off on it.


What's even more unreal is that many people are praising him for "having the guts to admit he was wrong."

He's lucky to keep his job at Treasury. President Bush, in one of his last acts as president, should fire Paulson on the spot after that lame admission. If he did that his approval ratings would soar and he could at least go out on a somewhat positive note.

How dare he!! After imploring Congress to pass this package and after insisting his plan was the right one to save the financial system, he now says it was a bad plan??

Paulson got paid hundreds of millions while at Goldman, for what? Creating, packaging and selling the very instruments of mass destruction that now has our economy tanking. Whose bright idea was it to put him at Treasury? Why do we worship these Goldman people so? Why is that firm so admired?

In the end it had to run to the Fed to save its hide. Paulson will never have to worry. He's set for life, as are most of the Goldman bankers and traders.

It's just most everyone else in the economy that must now suffer. And we suffer doubly as a nation by having this idiot running Treasury. He tells us that the U.S. needs the help of other nations to right its economy. Nonsense! He tells us it was the "imbalances" that brought this on (you mean imbalances like other nations desiring to save in our currency, to the point that they were willing to suppress the standard of living of their own citizens in order to do that?). Nonsense!

Paulson is clueless. We should have let Goldman fail!

The really sad part is that Obama has an entire crew ready to come in and "help." Warren Buffet, a member of his economic "team" has put his money in sorry state Goldman. (Obama should jettison Buffet poste-haste, or this should at least raise some eyebrows regarding Buffet's "acumen.")

Americans beware! Obama's "experts" are all of the same creed as Paulson.

Tuesday, November 11, 2008

China stimulus doubters don't understand soft currency economics

On Barry Ritholtz's blog a story appeared that claimed, "China's stimulus is no such thing."

It states:

"Compare China — a country with a centrally planned economy, carefully managed by a communist regime — with the United States. The US has a $14 trillion economy, of which about $3 trillion is government spending (military, entitlements, discretionary). Any new stimulus plan — be it tax rebates, direct spending on public works programs, or aid to the auto industry — is essentially new spending that didn’t previously exist.

When $3 trillion becomes $3.17 trillion, it is significant. It is as if the US is adding more pieces to the economic chess board.

China, on the other hand, is merely moving resources from one region to another. They are not creating more economic activity, putting cash in the hands of consumers, or even increasing their infrastructure plans."

What the author misses is that the the Chinese Government can spend all it wants of its own currency and the People's Bank of China can credit bank accounts just like the Fed can in the U.S. The stimulus is as valid there as it is here. The fact that China has a centrally planned economy is irrelevant.

Workable solutions, along with things we must come to accept

The problem, it seems, is weak demand in the economy. Lending money to banks and other firms that are not seeing strong customer demand for their products and services on the other side does very little. Therefore, these loans return little bang for the buck.

There are myriad ways for the government to address the lack of demand. Some suggestions are, as follows:

• Increase the level of government spending on infrastructure, money to states and localities, extension and increase in unemployment benefits, health care payments, etc.

• Raise income and/or disposable incomes by doubling the minimum wage, income tax cuts (including suspension of the payroll tax), or money sent directly to households.

• Provide low interest or zero interest loans directly to consumers and households to be used for auto purchase and/or purchase of durable goods (appliances, large ticket items, etc.)

• End the forex swaps to foreign central banks. This is keeping the dollar lower than it otherwise would be if these swaps were not occurring. A weaker dollar hurts U.S. consumers’ purchasing power at a time when more, not less, purchasing power is needed.

• Back off on threats to foreign countries that they are manipulating their currencies to gain export advantage. Let them keep their currencies weak and export; let us have the strong currency and higher standard of living.

Things we must come to accept

Accept that Fannie Mae and Freddie Mac were designed for a public purpose—to foster home ownership—and consider their lending in that regard to be a public subsidy to achieve the stated goal. End their existence as publicly traded companies and the charade that they must remain profitable enterprises in a competitive environment. Either that, or declare that large-scale home ownership is not a worthy public goal and close them down altogether.

Accept that a large and growing function of the military is to provide social spending and support. For an increasing segment of the population the military provides health care, education, family services and employment. It is terribly inefficient to have it done this way. The government should invest directly in these services through existing administrations and departments or set up a new department and relieve the Department of Defense from acting in this role.

Accept that much government research and development (R&D) funding is channeled through the military and NASA. Many commercial applications of this R&D effort eventually hit the free market, but again, it is a very inefficient way to go about it. Create a new department--the Homeland Department of Technology--that directly funds research and development for civilian applications. This department could also fund R&D alternative energy projects. Its budget should be pretty substantial.

Any and all of these things are feasible, the only constraint is political. The Government deficit will rise no matter what we do and we shouldn’t be concerned with that. What we should be concerned with is whether or not the growing deficit reflects wise choices—choices that will restore economic health and vitality. Lending or investing money in institutions that are experiencing weak and deteriorating demand in their ongoing businesses is not very useful.

Monday, November 10, 2008

Here is a list of all the regulated collateral that the Fed is lending against

Lame brained journalists at like Mark Pittman, Bob Ivry and Alison Fitzgerald could have looked this up before they wrote their horribly irresponsible article on the Fed's lending.

Collarteral Margins Table.

Everything on that list is regulated collateral. Banks can pledge any of those things as collateral for loans.

Moreover, as Warren Mosler states:

"...the Fed asking for collateral from US member banks is ‘redundant’ in that FDIC/OCC regulation/supervision already requires all bank collateral be ‘bank legal’ and that required capital be sustained."

Bloomberg journalists stir needless concerns about Fed actions. Could harm Fed's ability to help financial sector.

An article on suggested that the Fed has been hiding behind a lack of transparency. The Bloomberg journalists do not understand that Fed lending is to banks with regulated collateral and all of that is publicly available information.

Here is the article.

The misinformation in the Bloomberg article could put pressure on the Fed that might result in hurting its ability to help the financial markets. We must try to stop journalistic ignorance and complicity in this time of crisis.

Please cut and paste the following letter and send it to the following Bloomberg journalists:

It is clearly stated under Section 13 Paragraph 3 of the Federal Reserve Act that in exigent and unusual circumstances the Fed is allowed to lend to whomever it pleases against any collateral that it deems satisfactory.

Moreover, all banks come under regulatory scrutiny by the Fed and Office of the Controller of the Currency and can only have bank-regulated collateral. The list can be found at the Fed’s Discount Window of Marginable Collateral.

The Fed is not limiting transparency in its actions. All this information is publicly available. Your research and assertions are incorrect and misleading and you should publish a retraction with the proper information.

Sunday, November 9, 2008

John Mauldin needs an education on government finance

John Mauldin is a widely followed market analyst. Every week he sends out his popular e-letter, "Thoughts From the Frontline." I receive it, but hardly read it anymore because I find it is too wordy. A listener of my radio show sent me his comments and highlighted the following paragraph:

"...a lower trade deficit means there will be fewer dollars to buy US debt, just at a time when US debt will explode. That means that US citizens must save and buy that debt, or the Fed will have to monetize it, or rates will have to rise to attract capital. These are somewhat counterintuitive concepts and need explaining. But not this week. It is time to hit the send button." -John Mauldin

What Mauldin and many like him don't seem to understand is that actions taken by the government and the Fed over the past two months have already boosted bank reserves to nearly $500 billion. That's the money that will be used to buy the bills, notes and bonds when they are sold. Bank reserves pay very little interest so reserves will be happily swapped for Treasury securities that yield more.

The claim that, "US citizens must save and buy the debt, or the Fed will have to monetize it, or rates will have to rise to attract capital," displays a monumental lack of understanding of government finance and monetary operations. Government spending has already put the money in the banking system to buy the securities. Moreover, the government doesn't even have to sell the bills, notes and bonds, it does so merely to adjust the level of reserves (bring them down).

Conservatives fear Rahm Emanuel...the ballet dancer

Conservatives like Rush Limbaugh and House Minority Leader, John Boehner (R-OH) fear White House Chief of Staff, Rahm Emanuel. Do they know that Emanuel is a ballet dancer? So, they're afraid of a ballet dancer?

Here's Limbaugh:

"...he is good a old-fashioned Chicago thug just like Obama is a good old-fashioned Chicago thug. On the night of the Clinton election, Rahm Emanuel was so angry at the president’s enemies that he stood up at a celebratory dinner with colleagues from the campaign; Rahm Emanuel grabbed a steak knife and he began rattling off a list of betrayers.

As he listed their names, he shouted, “Dead! Dead! Dead!” and he plunged the steak knife into the table after every name." -Rush Limbaugh on Rahm Emanuel

Emanuel is a former ballet dancer.

Letter to Stuart Varney, Fox Business anchor

November 9, 2008

Stuart Varney
Fox Business
1211 Avenue of the Americas
New York, NY 10036

Dear Stuart,

I heard you say on the O’Reilly Factor the other night that the Government was getting ready to borrow $900 billion over the coming months.

The selling of securities by the Treasury is often characterized as borrowing, but in reality it is simply the management of reserves in the system.

Actions taken by the Federal Reserve and Treasury over the past two months to address the credit crunch and help firms like AIG and a number of banks have caused reserves in the system to swell to $500 billion. (The average level of reserves in the system over the past 20 years has only been around $20 billion.)

In other words, the Government has already put the money in the banking system that will be used to “buy” the bills, notes and bonds that it sells over the next several months.

Remember that reserve balances at the Fed get paid a very low rate of interest (and even that has only been a recent phenomenon—reserves up until last month got paid zero interest), so it is quite normal for those reserves balances to be exchanged for higher yielding bills, notes and bonds that the government sells.

The key point—and the point that the media often misunderstands—is that the money to buy Government securities and pay taxes comes from government spending itself. The government spends first by crediting bank accounts (causing the level of reserves to rise) and then it sells securities and collects taxes, which brings down the level of reserves. If it didn’t do this we’d quickly see a hyperinflation.

The idea that the government must “raise the money” in some fashion, is rooted in gold-standard thinking. When nations were on a gold standard, the amount of gold it held determined its ability to create money. If a nation wanted to spend more it would have to get more gold.

We are no longer on a system like that. The only thing that constrains how much the Government can spend is the degree to which it creates inflation and that is a political constraint, not an operational constraint.

I hope this clarifies this for you.


Mike Norman

China Announces 4 Trillion Yuan Economic Stimulus

As the U.S. proposes stimulus measures that equal a measely 1-percent or less of GDP, China goes for the big numbers. Its 4 trillion yuan ($586 billion) fiscal package is 20 percent of the nation's GDP. That would be like the U.S. implementing a $3 trillion stimulus package!

Here's the full article.

Weekly update on Monetary Base and Reserves

Monetary Base

Monetary Base (y-o-y % change)

Reserve balances at the Fed

Note that reserve balances at Federal Reserve banks is now about $500 billion. The average over the past 20 years has been about $19 billion. The Government has already put most of the money in the system that will be used to buy the securities it sells. DO NOT LISTEN TO PEOPLE WHO SAY, "The Government will have to raise the moeny in order to fund the bailouts." The money is already in the banking system and most of those resereve balances--that pay very little interest--will be happily swapped for the securities the Treasury will sell.

Saturday, November 8, 2008

Obama makes 'no commitment' on missile shield

He doesn't seem to be about much "change" when it comes to economic policy, given those 17 economic advisors we saw on Friday.

However, he DOES seem to be about change when it comes to our commitments to our allies.

Read article below:

Barack Obama has made no commitment that a missile defense shield in eastern Europe will go ahead, an advisor to the president-elect said Saturday, in apparent contradiction of statements by Poland.

Earlier, a statement from Polish President Lech Kaczynski after the two men spoke by telephone said Obama had said he would go ahead with plans to build a missile defense shield in eastern Europe despite threats from Russia.

But Obama had given no such clear cut undertaking on the controversial program, his senior foreign policy advisor Denis McDonough said in a statement.

(The) "president-elect had a good conversation with the Polish President and the Polish Prime Minister about the important US-Poland alliance," McDonough said in a statement.

"President Kaczynski raised missile defense but President-elect Obama made no commitment on it.

"His position is as it was throughout the campaign, that he supports deploying a missile defense system when the technology is proved to be workable."

The statement by President Kaczynski appeared to put a different spin on the conversation between the two men.

"Barack Obama has underlined the importance of the strategic partnership between Poland and the United States, he expressed his hope of continuing the political and military cooperation between our two countries," the statement read.

"He also said the anti-missile shield project would go ahead," said a statement said.

Warsaw and Washington signed a deal on August 14 to base part of a US missile shield in Poland, despite Moscow's opposition and mounting East-West tensions over Georgia.

The United States wants to base 10 interceptor missiles in Poland plus a radar facility in the neighboring Czech Republic by 2011-2013 to complete a system already in place in the United States, Greenland and Britain.

Washington says the shield -- endorsed by NATO in February -- is aimed at fending off potential attacks by so-called "rogue states" such as Iran, and is in no way aimed at Russia.

The United States warns that Iran could develop long-range missiles capable of carrying nuclear warheads by 2015-2017.

The plan has enraged Moscow and the Kremlin has threatened to aim its own missiles at the planned US installations.

Just hours after Obama's historic election victory on Tuesday, Russian President Dmitry Medvedev said Moscow would station short-range missile systems in its Kaliningrad enclave wedged between Poland and fellow EU member Lithuania.

US negotiator John Rood said Thursday that Washington had given Russia fresh proposals to try to ease its concerns and hoped the row could still be resolved.

He said the offer was sent "earlier this week," before Medvedev announced his plans to deploy missiles in Kaliningrad.

Medvedev's remarks on Wednesday amounted to a warning shot to Obama and Washington's allies in central Europe.

The European Union and NATO also expressed strong concern over Russia's decision to deploy missiles on the EU's doorstep.

Polish lawmakers have yet to ratify the US missile defense deal while the Czech government has called for a delay in a final vote on its radar agreements until the inauguration of President George W. Bush's successor in January.

Thursday, November 6, 2008

Fed forex swaps increase by $28 billion in the latest week

In the Fed's weekly release of "Factors Affecting Reserve Balances", shows that the level of foreign currency holdings rose by $27.9 billion for a total of $573.9 billion as of November 5. So the Fed continues to supply dollars to foreign institutions (through a number of central banks). If this were not happening the dollar would be much higher. The Fed let Lehman fail, but it has helped foreign financial institutions to the tune of nearly $600 billion since June. That's nearly the size of the Treasury's bailout package. Unbelievable!

Commercial paper holdings rose to $226 billion, up $185 billion from the prior week. This is why the commercial paper market is "unfreezing." It's all Fed. Like I said in an earlier post, the financial sector is not necessary. The Fed can do it alone and the economy will do just fine, without the redundancy or ever present danger of these freeze ups.

Get rid of the financial sector. It serves no real purpose.

As the Fed continues to step up to do the work that a large segment of the financial sector can no longer do (as a result of terrible, failed and misguided investments), expect to see its balance sheet grow. At the same time, the balance sheet of the private financial sector will shrink and we should be happy about that. What has become plainly evident is that the financial sector contributed pretty much nothing to the real economy (the Fed is doing all the work now), but increased the risks substantially.

The financial sector went on an unbridled, giddy, nonsensical spree of malinvestment the likes of which we’ve never seen before. Most of this was conducted by unregulated, non-bank financial entities—hedge funds, financial intermediaries, mortgage brokers, etc—that at its peak provided more than 80 percent of all credit to the economy. Yet there was no support net or backstop should something fail. (By the way, commercial banks were not innocent bystanders. They were involved in this too, but since they were regulated and had lifelines to the Fed, most of them will likely survive).

Who builds a structure like this? What critical system—an airplane, a hospital’s power source, a nuclear reactor—does not have multiple backups and constant supervision? How could we have allowed a system where nearly all the credit to the economy went through, in many cases, shadowy, unregulated entities run by greedy “cowboys” whose big stakes games of dice ended by coming up craps? When they were forced to stop playing as a result of their greed and recklessness, the rest of the economy was held hostage.

After many long months the Fed has finally stepped up to act in its most important capacity, as lender of last resort. It took a while for this to happen, because all along, the Fed, Treasury, the Administration and many members of Congress were hoping, praying, that they could get the cowboys to come back to the crap table. Finally, I think they saw, reluctantly, that it’s not going to happen. Nor should it be desired. (Although they have been giving some of the players new “stakes,” which, perhaps is a little disappointing.)

The system as it existed before was inherently unstable, prone to failure and as we are now finding out, lethal. My hope is that we give up the impractical goal of trying to reconstruct it, at least in the form it was. If it comes back at all it should be a fraction of what it was and highly regulated, with many of the now familiar institutional structures like hedge funds, financial intermediaries and finance companies, done away with permanently. They contribute nothing of real value, but add a high element of risk and in many cases, siphon off brainpower that can be used elsewhere in the real economy.

The most preferable solution, I think, is to simply have the Fed continue the credit provider role that it has assumed. Maybe we’d want to keep some commercial banks around to provide the public with its credit needs (the banks can be considered, after all, as agents of the government; they have charters, come under regulatory oversight and have direct access to the Fed in times of need) although the Fed can provide that function as well. With the Fed providing the credit function there would be no risk of systemic failure. The system would be stable and fail safe. The real economy could continue to be productive and grow without the risk of being shut down.

Another example of the ignorance of the financial media

The following story appeared on and highlights how clueless the media is:

BOJ Helpless as Yen Rises on Carry, UBS, Barclays Say

"Once the market realizes that we're now in a global recession, there's further deleveraging to come," said Geoff Kendrick, a senior currency strategist in London at UBS

That's a fallacy. While a central bank may be helpless at times in being able to support its currency, it can sell limitless quantities of its own currency if it wants. Any entity standing in the way of a central bank wanting to destroy its currency will be decimated.

At the present time, the Bank of Japan is allowing the yen to appreciate in an orderly fashion. Japanese policymakers probably do not like this and the BOJ can put an end to it any time if it wants, but probably risk incurring the wrath of Hank Paulson and the Bush Administration, who view a weak dollar as a good thing.

Wednesday, November 5, 2008

Dollar weaker, even as fear returns to stock markets

I've heard a lot of people commenting in the last two days that the reason the dollar has fallen back is because the so-called, "flight to safety" element has been removed. In other words, now that stock markets have stabilized and credit market spreads are narrowing, the dollar's decline was merely the markets' way of sending an "all-clear" sign.

I didn't see it that way.

With all the problems in Europe and elswhere, the dollar should have kept rallying. The world was short of dollars and still is, in a big way.

The reason the dollar has stopped falling is simple: Forex participants now understand that the Fed will provide dollars to any European institution (or Brazilian, Taiwanese, S. Korean, Mexican...) with dollar liabilities through the ECB or respective central bank, rather than see asset sales and/or the purchase of dollars in the open market. Therefore, for now, further dollar appreciation appears to be a low probability or even out of the question.

Down the road, however, it is possible that portfolio investors favor the dollar over the euro if they see U.S. conditions improving and Eurozone conditions worsening. However, it’s hard to assign a probability to that.

The Fed has missed a golden opportunity to let the dollar appreciate, with little or no policy adjustment. It would have brought important benefits on the inflation front, in terms of trade to U.S. consumers, and with respect to the asset holdings of central banks around the world like China, that hold lots of dollar denominated assets.

Instead, they put a cap on the dollar’s rise.

Personally, I find this hard to understand. The benefits of letting the dollar rise because of a technical “condition” rather than having to implement a major policy shift seem to outweigh the risks. Perhaps they felt that asset sales by foreign institutions would have some contagion or systemic impact? But even that doesn’t make sense because if they’re worried about contagion and systemic impact, why did they let Lehman fail?

I am baffled. Absolutely baffled.

It's official!

Yesterday's election results made official what most people pretty much expected--an Obama Presidency. There's not likely to be any huge market reaction.

Over the next week or so events the first of several events will take place. First, who will be on Obama's transition team. Those members, particularly in areas of economics, will be crucial in determining the nature of policy and the economy for the near term. After that will come his cabinet selections. That may take some time, but the posts of Defense, Health and Human Services, Labor, Education, Commerce and of course, Treasury, will be highly important to investors.

Tuesday, November 4, 2008

Porsche executes a brilliant short squeeze of the hedge funds

I've always loved Porsche. I've owned the cars. Now I think the company belongs in a corporate hall of fame thanks to its execution of a brilliant short squeeze on hedge funds. Read the fascinating account of how Porsche fleeced the short sellers. (Other firms should study this!)

Squeezy money

Oct 30th 2008
From The Economist print edition

How Porsche fleeced hedge funds and roiled the world’s financial markets

GREAT cornering and eye-popping acceleration make Porsche’s cars popular among thrill-seeking bankers and hedge-fund managers. Now its clients are discovering that the carmaker itself has an unexpected talent for cornering markets. In a few tumultuous days it is thought to have made a cool €6 billion-12 billion ($7.5 billion-15 billion) on the share price of Volkswagen (VW)—a coup that has roiled the world’s financial markets.

Porsche’s gambit was as old as finance itself. For about three years it had been steadily increasing its stake in VW, a much larger yet less profitable carmaker with which it shares a little production. Its buying had driven up the price of VW’s shares to above the level at which it would make any economic sense for Porsche to buy VW. Seeing this, hedge funds sold shares in VW that they did not own. One strategy was a bet that VW’s share price would fall. Some also bought shares in Porsche, in a wager that shares of both would converge.

The risks of short selling should have been apparent to the brightest hedge-fund managers in Mayfair and Greenwich because of widespread suspicion that Porsche, a dab hand in currency-derivatives markets, was also mucking about with options on VW stock. Adam Jonas of Morgan Stanley warned clients on October 8th of the danger of playing “billionaire’s poker” by betting against Porsche. Max Warburton of Alliance Bernstein said Porsche could make billions by squeezing short-sellers of VW’s shares.

At the time Porsche dismissed these musings as a “fairy-tale”. But on October 26th it executed a handbrake turn, saying that it owned nearly 43% of VW’s shares outright and had derivative contracts on nearly 32% more. That meant it had tied up almost all of the freely available shares (the rest are held by the state government and index funds). Hedge funds quickly did the maths, concluding that they could be caught in an “infinite squeeze” in which they were forced to buy shares at any price.

Their frenzied buying sent VW’s share price soaring (see chart). After languishing below €200 last year, it jumped to more than €1,005 at one point on October 28th, briefly making VW the world’s most valuable company. Porsche may have made paper gains of €30 billion-40 billion in what one analyst described as “one of the most brilliantly conceived wealth transfers ever.” Porsche says it never intended to make money on derivatives and only bought them to protect its planned purchases of VW stock. On October 29th it said that it would settle up to 5% of its VW options, freeing up a similar portion of stock and sending the price down again.

Hedge funds that take bad bets may garner little sympathy, but the VW saga does more than punish a few “locusts”. On October 28th shares in Morgan Stanley, Goldman Sachs and Société Générale wobbled on worries (denied by all) that they might also be exposed to VW. If the losses are big enough to cause the failure of even a few hedge funds, that would spell more pain for the battered banking system. Other casualties include buyers of passive funds that track the German market who will end up with a disproportionate stake in VW within their portfolios. With VW’s share price falling again, those who sell now will lock in a loss.

The greatest damage is to the reputation of Germany’s capital markets, where regulators are now belatedly investigating what went on. Allowing acquirers to build large secret stakes in bid targets does nothing for confidence. Even Porsche may come to rue its coup. “They may struggle to sell 911s to hedge-fund managers for years and years to come,” says one investor.

The new, nonsensical term in the media: "Pre-Finance"

On a blog written by CNBC commentator, Paul Kedrosky, he writes:

Treasury Trying to Pre-Finance TARP, etc.?

"While the U.S. Treasury’s current capital needs are undeniable, its just-announced Q4 fund-raising plans are epochal. Is it trying to fully pre-finance current plans, knowing full well that yields are going to rise as struggling U.S. creditors find other, higher uses for the same capital over the coming months?"

This statement, once again, displays a complete lack of understanding of government spending, monetary operations, etc. The inferrence on the part of Mr. Kedrosky is that the government is now trying to raise the money needed for bailouts and other measures. Hence the term, "Pre-Finance."

The risk, according to Kedrosky, is that the government, cup in hand, might be turned away by investors who prefer to find, "other, higher uses for the same capital."

Mr. Kedroskly clearly does not understand that more than half of the $700 billion bailout has already been put in the banking system (the result of simply, magically, crediting reserve accounts), so "selling" $100 billion or so of securities is no problem at all. Indeed, with interest on reserve balances currently paying a paltry, 0.65% rate, it won't be difficult at all finding investors willing to swap a low-yielding reserve balance for a higher yielding Treasury.

Lesson to Mr. Kedrosky: The government spends first (by crediting bank accounts) then sells securities later. The "sale" of securities is nothing more than a reserve maintenance operation.

U.S. Commercial Paper Rates Decline to Lowest in Four Years

More evidence conditions are improving, but it has all been due to the Fed. Makes you wonder why we need an interbank market and CP market dependent on private institutions if it can stop functioning just like that and jeopardize the entire economy. True, the Fed's balance sheet would have to expand much more if it continues in this capacity, however, the financial sector's balance sheet would shrink by the same amount. The non-financial sector would keep on functioning as usual. I guess this also illustrates why the financial sector, in its current form, is redundant.

Monday, November 3, 2008

Obama on the dollar

But when asked about the dollar, Obama reveals just how inept he is when it comes to economics. His answer is ridiculous and displays a level of cluelessness that is mind boggling!

Obama victory may bring dollar spike

Don't be surprised to see a dollar spike if Obama wins the election. His team may quietly make their desires for a stronger buck known to Treasury and Fed officials. They could then point to that as a global vote of confidence in his new presidency. Watch Fed forex swap amounts for an indication.

What's wrong with this headline?

A article yesterday had the following headline:

"Bonds pressured by cost of bailout"

The article starts off by informing readers that the Treasury will need to "finance" $1 trillion in new programs by the end of the year, which we are told, "will bring a great deal more supply to the market."

First of all, the Treasury does not "finance" new programs. It simply credits bank accounts for whatever amount it needs to spend. The money is put into the economy first. That's why there's never any problem with selling any new "supply." In reality the "selling of that supply" is merely the Treasury swapping a reserve balance at banks for an interest bearing asset (a Treasury bill, note or bond), which in most cases returns a higher yield than the 0.65% interest rate the Fed currently pays on reserve balances.

The author of the article unwittingly points to the lack of difficulty in carrying out this operation when he states, "But demand for Treasurys remains, even with expanding supply."


How hard could it be for the Treasury to get investors to fork over a reserve balance paying a paltry 0.65% interest rate for a higher rate Treasury? And particularly since the Fed has recently added over $400 billion in reserves?

But the author, like most people (and nearly all Wall Street economists) just don't understand monetary operations. (If only the Fed and the Treasury would just explain!)

Last week, despite the auction of this "huge supply" of $85 billion of new bills, notes and bonds, rates were unchanged. No surprise. Only a surprise to the media and Wall Street economists who will always be worrying about issues of "supply."

Total bank credit rebounding

Total bank credit fell sharply from April through September, but it is now growing at more normal rates. The nominal level of bank credit is at an all-time record high, however, it's good to see that the rate of growth is rising as well. This is good news for the economy; shows the Fed's actions are working and it should be good news for bank earnings going forward. Banks are incredibly cheap.