Tuesday, August 19, 2008

The Debts of the Spenders: Cost of De-Leveraging

We are experiencing a period of temporary - but noticeable -deflation. This is being triggered by the sell-off in the pound andEuro. The pound broke the 200 WEEK moving average on a downwardslide! Their sub-prime problems are just beginning. If the BritishCentral Bank cuts rates (as many expect them to), expect the pound tostagger and the dollar to rally.

Euro-land isn't really affected by the sub-prime related problems(w/the exception of Ireland and Spain which had extremely speculativehousing markets). Their main devil is inflation and a high euro that hurt exporters. The ECB is unlikely to cut rates as they don't have enough room to maneuver. Labor unions are against it as it will biteinto their workers' spending power (labor unions DOMINATE socialistWestern Europe).

Don't confuse the criteria to go to the discount window with any requirements to unload the commodity. Separate things. The only people who are allowed to go to the discount window are commercial and investment banks - not hedgies (although some hedgies could be run byinvestment banks their accounts are supposedly kept separate).

With that being said, both the investment banks and hedgies are desperately trying to re-capitalize. They don't have to unload commodities but many are choosing to do so. The CFTC raised the margin requirements for many commodities this summer - especially in agriculture and oil (they have no control over currencies as there is no exchange floor). Combine the new margin requirements with theFed's increase in collateral requirements and you have a perfect storm.


The IB banks are forced to do this since the traditional revenuestream: (M+A, IPOs, etc.) have dried up in this economy. Many of them are now heavily involved in the debt markets (Lehman and Bear springsto mind). As for hedgies, they are involved in all kinds of complex derivative transactions ( I can't speak for sure since their books are not open). When the IBs start to sell, it causes a chain reaction as hedgies try to cut their losses on overly-exposed derivative transactions.

Please remember these guys use system trading. That means theircomputers will automatically sell when a certain price is reached.


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