|
Now that Bailout I voted down,
bailout II comes up next. Surely some new bailout manifestation will emerge
this week and pass. We suspected in our Sunday newsletter Bailout I would
fail to pass. But, Congress, shell shocked by fast moving events, will do
something.
But it won’t work.
Ultimately, even if they came up with a $1 trillion program, all it would do
is buy time. I mentioned that there is $1000 trillion of various leveraged
markets deleveraging, and putting up 1 trillion against that just won’t
work.
I remember a year ago, when the
credit crisis started in Aug 07, a banker said ‘the deleveraging will
not be denied.’ How true that has proved to be.
Using some basic math, I count
total US and ECB temporary lending injections at $3 trillion so far. It’s
failing to stop deleveraging. It’s simple math really, $3 trillion
thrown against a deleveraging $1000 trillion is not much. The central banks can
lend money to banks, even taking bad assets as collateral, but it does not
force lenders to lend to one another. They all know that, the truth be told,
no one is admitting the extent of the bad paper they hold. So, they
won’t lend in interbank lending markets, and Libor rates skyrocket. That
effectively negates interest rate cuts by the central banks.
Borrowed short, but can’t
roll over
In effect, that means that
banks/any borrowers cannot roll over short term financing, and that means
that the commercial paper markets (short term business credit) does not roll
forward, and that means that companies can’t make payrolls, buy
inventory, or do whatever. Since everyone from central banks, to businesses,
to even people (ARMs) are borrowing short term money, and have to roll
forward each term/month; the entire world credit market is being forced to
deleverage since banks are refusing to roll forward new short term credit. This
specific problem of not being able to roll forward short term credit is a
system wide problem.
The math of this is simply
called debt deflation. And when it results in actual defaults, banks fail,
people and businesses go insolvent, economic activity stops cold
incrementally. And that is what is happening. The next phase for the
remaining months of 08 will be the hundreds of thousands of layoff notices
each month. It’s called a deflationary spiral.
Doomed to fail
So, even as the Fed injects an
incredible $600 billion of currency swaps (lending USD to central banks in
trade for their currency as people sell out of foreign markets and go to cash
and repatriate money to the US) to EU banks Monday, a failure to pass Bailout
I – the TARP, causes a 777 point fall in the Dow. And more importantly,
the credit markets continue to contract. The central banks are trapped. All
they can do is single handedly try to replace all the gazillions of
vaporizing short term credit that is not rolling over everywhere. And that is
simply doomed to fail.
“The interbank market has
collapsed," said Hans Redeker, currency chief at BNP Paribas."
"We're now seeing a domino
effect as the credit multiplier goes into reverse and forces banks to cut
back lending to clients," he said.
Mr Redeker said the latest
alarming twist is a move by banks to deposit €28bn in funds at the
European Central Bank in a panic flight to safety. This has jammed the
mechanism used by the authorities to shore up the financial system in a
crisis.
"The ECB is no longer able
to inject liquidity because the money is just coming back to them again. This
is extremely serious. If monetary policy is no longer working, there is a
risk that the whole system will blow up in days," he said.
The euro plunged on Monday as
the wave of bank failures hit the newswires, dropping 2pc to $1.43 against
the dollar. It recovered slightly as the US Federal Reserve flooded the
markets with $630bn of dollar funding with fellow central banks in the
biggest liquidity blitz in history…”(Telegraph.co.uk)
As we said, Congress will pass
something. But, even though that will cause a relief rally, credit
contraction will not be halted. And that means the world is now in the
beginning of debt deflation. So, really, all that will happen in the next two
weeks will be a relief rally followed by more and more bank crises, as they
find they cannot roll forward short term paper, and short term credit of all
types, ARMs, corporate paper, and pretty much any kind of credit you can
imagine out there just sort of disappears from the world economies like
smoke.
What’s next
This week the US Congress will
likely pass something. But as we said, these efforts are doomed to fail. All
that a new TARP will do is buy some time and a short relief rally, but it
will not stop the relentless deleveraging, and the ongoing disappearance of
short term credit and economic disintegration in the West right now, and
it’s now spreading to Asia. This is a world debt deflation.
The relief rally will give the
astute a chance to do some more liquidating. The only real solution to this
mess is for interbank lending to begin again, and businesses and consumers to
get access to credit to roll forward their expiring short term credit. And
that is not happening either. So the economies will continue to deteriorate
rapidly. And layoffs are coming big time.
This economic demand destruction
does not bode well for general commodities. See the oil prices falling $10
Monday, and commodity bellwethers like Freeport McMoran falling to new lows.
Old Hat
In the beginning of 08, as inflation
raged worldwide but economic growth was slowing, it appeared we were headed
for stagflation. In that environment, gold and oil did really well. But
toward the middle of 08 it started to become clear there was some real
economic slowing, and demand destruction. This was a leading indicator of a
more serious problem, relentless world deleveraging and debt deflation, which
we are now seeing. And the new prospects are debt deflation and not
stagflation.
Stagflation is commodity
bullish, but deflation is not.
Even so, the flight to cash in
general and the credit crisis has proven a potent combination for gold. You
can track all the major movements in the gold market since August 07 with
developments in the credit crisis. Most recently, the failure of the TARP and
the debate over TARP for the last week caused gold to rally strongly, even as
oil fell drastically because of expected demand destruction. Why is this?
That is because gold is cash par
excellence. Even though gold has an exasperating $100 price volatility week
to week, it’s the final place of safety for cash worldwide. So, flight
to cash and liquidity finds its way to gold ultimately. People know that,
despite a rallying USD, gold ultimately will be the safest place for cash.
The investing mantra, that the
world economy will drive basic commodities relentlessly up, is what we heard
for the last 5 years, but the markets are saying that is old hat. What’s
new hat is a contracting world economy and debt deflation. But it’s
typical for the economic commentary and thinking to be 6 months behind seeing
the obvious, that the investing climate has now changed decidedly away
from the general ‘economic growth to infinity’ paradigm we heard
for the last 5 years. Hence we see bell weather Freeport McMoran (base
commodities like copper and some gold) falling.
Real problem
The real problem now is what to
do about the deleveraging and progressively evaporating short term credit and
interbank lending. For the moment, there is no viable solution. That
ultimately means severe economic contraction going into 09, something that
scares the hell out of every economy in the world. But the central banks are
proving totally impotent to stop it and are merely accumulating all the
illiquid assets on their balance sheets, and are only buying time with their
ever increasing short term lending to financial institutions, which is NOT
finding its way to businesses and the economy now.
Unless this dilemma of
relentlessly contracting short term credit is resolved, we will have a severe
world depression and big upcoming layoffs. I don’t see any way around
this.
So, for the moment, the USD and
gold rise together. There is flight to cash generally. We might have a hiatus
of this as we pass quarter end after September. But then we enter the cash
crunch of end of year. So the USD will still likely rally, and gold will
continue rather strong too as it’s the ultimate cash, and the credit
crisis continues to plague the planet’s economies and banks.
Oil’s prospects are down
going forward too, as people realize the ‘growth to infinity’
paradigm is crashing on the reef of the credit crisis. Deleveraging is
forcing economies to contract violently.
I can imagine what will happen
to stock markets, after the upcoming new TARP the US congress will pass. There
will be a relief rally, and possibly in oil too. But toward the end of 08,
the markets will finally realize their growth to infinity paradigm is dead,
and the world entering a relentless debt deflation. And that means stocks
going into 09 are down down down.
Flight to cash is the order of
the day, and gold ultimately is a beneficiary, albeit with infuriating bouts
of $100 price swings.
There is one more problem worth
noting. We are just entering a stage of bank runs. What happened with the 5
EU banks bailed out this week, and then the failures of all the investment
banks and banks/institutions in the US in the last two weeks were bank runs. I
am quite concerned that a wave of these in the US and the EU can lead to a
failure or interruption of credit cards and ATMs and debit cards.
So, not only do people have to
accumulate cash in general and sell investments, but also they will start to
need actual cash in hand. I think everyone should be stocking a month or so
of cash, just in case they need to pay some bills, buy gas (have you noticed
big gas stations not accepting credit or plastic money?).
The Prudent Squirrel newsletter
is our financial and gold commentary. Subscribers get 44 newsletters a year
on Sundays, and also mid week email alerts as needed. We alerted our
subscribers April 20 that the USD was bottoming. The USD has strengthened
significantly since. The alerts include quick notification of important
financial news developments by email. Subscribers tell us that the alerts
alone are worth subscribing for.
I had one potential subscriber
ask me if the newsletter has much more content than these public articles,
ie, if it was worth subscribing. The answer is that the public articles have
less than 10% of our research and conclusions that subscribers see, not to
mention the subscriber email alerts of important breaking financial news. We
have anticipated many significant market moves in the last year, such as
imminent drops in world stock markets within days of them happening, and big
swings in the gold markets within days of them occurring. We have also made a
number of good calls on big currency swings, such as with the USD, the Euro
and the Yen.
Chris
Laird
Prudent
Squirrel
Chris Laird has been an Oracle
systems engineer, database administrator, and math teacher. He has a BS in
mathematics from UCLA and is a certified Oracle database administrator. He
has been an avid follower of financial news since childhood. His father is
Jere Laird, former business editor of KNX news AM 1070, Los Angeles (ret). He
has grown up immersed in financial news. His Grandmother was Alice Widener,
publisher of USA magazine in the 60?s to 80?s, a newsletter that covered many
of the topics you find today at the preeminent gold sites. Chris is the
publisher of the Prudent
Squirrel
newsletter, an economic and
gold commentary.
| 
