The Debts of the Lenders: China Speaks On Davos and the West's Bad Bank Plan

Actions - not words - are the ultimate decider.

Beijing has ultimate authority over any US bailout package - indeed
any Western bailout package. The Chinese could care less about the
Western stock market. All they want is preservation of jobs back at
home and their Treasuries to be worth something.

The Chinese just sent a shot across our bow. The Davos conference is
a collection of Western bankers and politicians who still think they
are in control. Meanwhile, China issued this statement:

"Whether we will continue to buy U.S. Treasuries, how much we will
buy, depends on our own need for maintaining the value of our foreign
reserve investments and keeping them secure."

http://www.forbes.com/feeds/reuters/2009/01/31/2009-01-31T170129Z_01_LAL002149_RTRIDST_0_CHINA-TREASURIES-URGENT.html

We also heard from the Chinese on Thursday when the 30 year long bond dropped 4 or 5
points and finally closed on Friday at 3.6%.

To be sure the Chinese did not suggest that they would liquidate treasuries but traders interpreted it that way. Chinese comments also set the tone for the big oversupply of bonds on Thursday's treasury auction on the 5 year note. This encouraged bond shorts to call Bernanke's bluff about monetizing the 30 year long bond and allowed them to ride it 4-5 points lower.

BUT we remain in deflation. This is evidenced by:

1) UUP - strong dollar; AND
2) USD/JPY - (relatively) strong yen; AND
3) General Macro-economic environment

The Debts of the Lenders: The Irony of the West

Irony. Definition - incongruity between the actual result of a sequence of events and the normal or expected result (Merriam-Webster's Online Dictionary).

10-11 years ago the IMF went to the emerging markets (East Asia, Eastern Europe, and Latin America) to demand the following fiscal austerity measures:

1) Don't bailout bad banks
2) Raise Interest rates
3) Cut Government spending

These measures actually worked! And sometime during the intervening decade the emerging markets became net savers/lenders to the net spenders/borrowers of the West. Emerging markets were so successful that the emerging markets largely repaid their IMF debts on time (Argentina being a notable exception).

Today, when the shoe is on the other foot, the West has done the EXACT OPPOSITE.

1) Bailout not just bad banks but ALL sectors of the private sector
2) Lower interest rates to 0
3) Spend vast amounts of money and even resort to inflationary measures like monetizing debt.

In addition, the West is also DEMANDING the emerging markets CONTINUE to lend them more money.

Am I the only one detecting a double standard here? That the Western dominated IMF
is somehow above taking its own medicine? Hypocrisy or a double standard. You decide.

The Debts of the Spenders: EU Hawkish On Inflation

Can the EU contain inflation? The bond markets don't think so. Since all their attention is focused on the "big boys" (US, UK, Japan, and ARGUABLY Germany) who are engaged in quantitative easing programs of some sort, this naturally leaves the smaller players struggling for the table scraps left behind by bond bulls.

Case in pt: Trichet remains scared of the diverging bond yields in the Eurozone. This is why he has strongly hinted that he will NOT cut rates next week. Then again the EU interest rate decision is made BY COMMITTEE - a 22 member committe that is. Can these fools do anything right?

Not when their self interest conflicts w/others. Interest rate cuts would PENALIZE the peripheral members - those w/the biggest public debt exposure and weakest capital markets (such as Spain, Greece, Portugal, Ireland, and Italy ). At the same time, lower rates would reward those core states w/sufficient access to capital markets and (relatively) lower public deficits (such as France and Germany). I say "relatively" because all of the socialist EU member states have heavy exposure to public debt but the economic "core" of France and Germany are more integrated w/global capital markets.

The Debts of the Spenders: It's the Clearinghouse Stupid!

Consolidation is happening in the OTC derivative markets for CDS products.

WATCH THE EUROPEAN FRONT. Eurex and Clearstream are working on ways to handle the EU crisis (and it is a crisis by any stretch of the imagination).

In America we have the SWIFT standard soon to be integrated w/the Chicago traders - CME/CBOT (they merged) handling the products.

Remember when traders were asking if the LEH and FRE/FNM trades had settled last November? Well, they did successfully.

THEORETICALLY, these trades cancel each other out so we don't have the LEH problem from last fall. So, if AIG has $50 billion liability and Deutsche Bank has $50 billion trades they are supposed to cancel each other out. Central banks act as the guarantor of risk w/taxpayers as the ultimate guarantors.

The important thing in having a central clearinghouse instead of OTC derivatives is that there will no longer be counter party uncertainty. Therefore I do NOT think ETFs are going away anytime soon. Quite the opposite in fact.

Short ETFs are another story as their future looks uncertain from the relative lack of volatility going forward. Constant leverage will eat into them. On the other hand the bullish ETFs should fare well.The futures casinos (err... I mean exchanges) have been itching for a chance to get the big money. This is a 0 sum game where financiers are poaching each other's business.

After last fall's debacle, politicians and regulators are ready and willing to listen to the CME and Clearstream lobbyists.

The Debts of the Spenders: The Death of Graham Bleach Bliley

Pay close attention to the date this was written and the names in the article. *(Special credit to Temo1051 from Stockstop.org for poitning this article out)

http://findarticles.com/p/articles/mi_m0EIN/is_1999_Oct_22/ai_56749404

Citigroup Statement on Financial Services Modernization Act
Business Wire, Oct 22, 1999

NEW YORK--(BUSINESS WIRE)--Oct. 22, 1999--

Chairmen and Co-Chief Executive Officers Sandy Weill and John Reed said: "We congratulate the leaders of our country for their efforts in hammering out a successful agreement on the last remaining issues surrounding the Financial Services Modernization Act. In particular, we congratulate President Clinton, Treasury Secretary Larry Summers, NEC Chairman Gene Sperling, Under Secretary of the Treasury Gary Gensler, Assistant Treasury Secretaries Linda Robertson and Greg Baer, Senators Gramm, Dodd, Schumer, Johnson, Edwards, and Members of Congress Leach, Bliley, Dingell and La Falce and the Congressional Leadership including Senators Daschle and Lott and Speaker Hastert and Democratic Leader Gephardt."

"By liberating our financial companies from an antiquated regulatory structure, this legislation will unleash the creativity of our industry and ensure our global competitiveness. As a result, all Americans - investors, savers, insureds -- will be better served."

Citigroup (NYSE: C), the most global financial services company, provides some 100 million consumers, corporations, governments and institutions in 100 countries with a broad range of financial products and services, including consumer banking and credit, corporate and investment banking, insurance, securities brokerage and asset management. The 1998 merger of Citicorp and Travelers Group brought together such brand names as Citibank, Travelers, Salomon Smith Barney, Commercial Credit (now named CitiFinancial) and Primerica under Citigroup's trademark red umbrella. Additional information can be found at: www.citigroup.com.

COPYRIGHT 1999 Business Wire
COPYRIGHT 2008 Gale, Cengage Learning

The Debts of the Spenders: Watch the UK and Italy for Signs of Hyper-Inflation

The UK and Italy will be leading indicators of hyper-inflation among the G7.

The UK's Gordon Brown and Mervyn King are idiots. They are trying to imitate Bernanke
and Paulson. Unfortunately for them, they are operating on an accelerated schedule. The FSA's short ban expired on January 16 and this week is going to be all BAD data for the UK.

Also, the fundamental problem with the UK is its smaller population which is roughly 20% of the US. Smaller demographics ensure that there will also be smaller tax revenues. The UK authorities' only other alternative is to raise taxes in the corporate sector. However, this measure will also serve to drive away all the hedgies and banks that made London the "City of Finance" over the past 10 years. Such actions will lead to further job losses in the sector and additions to the ranks of unemployed.

Brown and King could not have picked a WORSE time to nationalize the UK banking system. The system was already bending under the strain of prior banking bailouts. Their actions amount to nothing more than desperate attempts to lift up FTSE share prices. Politicians can "jawbone" lenders all they want but how can you entice people to borrow after the worst credit bubble in history is just beginning to implode?

FTSE 3k w/in 6 months. And then pound-dollar parity w/in a year.

As for Italy, their problems stem not from over exposure to capital markets but in a more perverse way from under exposure. Milan has never been able to match New York, London, or even Frankfurt as a viable economic powerhouse. Capital flows have never been a particularly strong suit in Italian hands.

Instead, the Italian economy has relied on the seeming "allure" of its Old World craft industries to sell overpriced fashion and home furnishings to gullible consumers in status climbing, luxury obsessed Japan and the US. These social climbers were the same fools who lived beyond their means - flipping multiple McMansions w/marble kitchen countertops and buying the latest Gucci fashion to compete for status among their peers. The market for such luxurious indulgences has waned signficantly in recent months even as the ECB stubbornly refuses to cut rates to match the competitive devaluation favored by other world governments.

Moreover, the Italian government has never been able to reign in state spending and is chronically over budget in its wasteful public works programs. The problem is compounded by its rapidly aging demographic and relative dearth of younger workers. Put bluntly, Italians are simply not having enough babies and are also racking up extreme numbers of elderly. This problem has been growing for years but recent developments are showing just how widespread the cracks in the system have grown (and will continue to grow). Whereas the UK and US at least have the hope of increasing immigration to offset the decline in birthrates common to all developed nations, the Italians (for reasons of ethnic, cultural, or political pride) have stubbornly resisted the integration of foreigners into the social and economic fabric of their nation.

Are the Chinese, Japanese, and Arabs as willing to buy gilts as they are Treasuries? Will there be any more oil left in the North Sea w/in the next 10 years? The sun set on the British Empire a long time ago but the UK is still in denial.

Are the Chinese, Japanese, and Arabs as willing to buy Italian bonds as they are gilts or treasuries? Do they even have a strategic economic stake in Italy that can match the scale of their investments in America or the UK?

The bond markets have already spoken. But they will really roar in the latter parts of 2009-2010.

The Debts of the Spenders: The Bad Bank Idea

US government officials are now considering a "bad bank" to hold the bad assets of bank balance sheets. UK officials are also reportedly researching similar proposals.

This new credit that world governments are pumping into the banking system can THEORETICALLY offset the deflation in the private sector without triggering inflation...as long as it is contained w/in the banking matrix.

This is accomplished through electronic swaps and transfers between governments and large institutions (corporations, ngos, quasi-govt bodies, etc.). In the past, bodies like the Resolution Trust Corporation, or RTC were established to handle credit failures. But now the problem is complicated by the existence of derivatives whose notional value FAR outstrips any real
economic value by orders of staggering magnitude:

40x-50x the ENTIRE GDP of the world by common measures.

We can enter a discussion about the different kinds of derivative packaged instruments - CDOs, CDS, CMBS, etc. - and how much value is retained within these "assets" (and I use that label very loosely). But the talking points will always return to the focal point of marketability - if private buyers are unwilling to buy then just how much value is really there? I don't have a specific answer because the books have been sealed by the Treasury and authorities by judicial order.

These derivative pools are a ponzi scheme where the banks relied upon new borrowers to pay interest to existing holders. The banks even had mathematicians who ran complex equations to manage the money pools and decided who gets what payment. Once the last sucker was in, there is no more new money to payout the previous investors their interest.

Madoff, the hedge fund con artist, is a minor blip on the radar screen compared to the utter levels of fraud being concealed by the authorities.

Governments can backstop existing debt obligations ...but can central banks print more money than has ever existed in the world?

Remember, the modern financial system is built on trust in the government, trust in social order, and trust in debt.

And what happens when there is a need for REAL currency to circulate throughout the economy? Case in point - America's auto bailout which I have discussed previously. Workers, sub-contractors, suppliers, small businesses, and other economic actors that had NOTHING to do with Wall Street gamblers are going to have to take money out of the system eventually.

The results will not be pretty.