Wednesday, 16 July 2008

It's the US$ stupid! [Part 1: The Super-shear]

Posted by: Ash Khanna

The recently revealed troubles of the 'BIG DADDIES' of the US mortgage system (Freddie Mac & Fannie Mae) and the subsequent support initiated by both the US Treasury & Fed can threaten the stability of global commerce!

Don’t believe me? Then look at the evidence:

In an extra-ordinary set of actions the US Treasury & Fed worked out a mechanism, over a weekend. Further, Henry M. Paulson, Jr., announced the ‘bail-out’ package on a Sunday to try and prevent further erosion of the market-value, of these over leveraged institutions, before equity markets opened for business on Monday the 14th of July.

On the 15th of July, 2008, for the first time in US history both the Chairman of the US Federal Reserve and the US Treasury Secretary are called by the US Senate House Select Committee on Banking to explain the state of affairs under their executive charge. Further, their boss the ‘chief’ executive, the US President is, in parallel, addressing the press, to infuse confidence into the ‘system’ on their “psychological” assessment of the US economy. There is more, all the ‘global’ news channels were covering this ‘choreography’, live! This is an unprecedented event, three most powerful men in the world, desperately selling to the world - “We are doing ‘exactly what we did and has been done by our predecessors,’ so calm down, PLEASE” – in unison!

The ‘ailment’ is VERY serious!

[Action(s) plan by US Fed & Fisc]
- The US Fed opens the discount window to mitigate liquidity risk.
- The US Treasury pumps in capital ($15 billion(+) each) in exchange for equity to shore up the Capital Adequacy, of these ‘”share-holder” (!?!) owned institutions
- The Treasury lines up $300 billion(+) of ‘available’ credit to mitigate ‘solvency’ risk!
- Still further, the Treasury creates a ‘temporary’ regulatory institution to further guarantee (government protection/‘stamp’) quality of collateral – in effect any paper emerging from these institutions will be like government bonds!

-US M3 money supply increases, further…..
-US fiscal deficit increases, further….
-Dollar slides further...
-Oil and commodities experience the 'predicted' "super-spike", as they tactically become the value investments…..
-“Inflation” soars, further…..
(If I was an oil or commodities trader, I'd be laughing my way to the bank!)
Doesn’t all this sound familiar? US sub-prime crisis, bail-out, and effect!

BUT the real story is going to be about those investment banks that are 'lucky' enough to still have an operational mortgage trading desk:

[Effect continued…..]
-The US Treasury is going to 'stamp' the mortgages held by Freedie Mac & Fannie Mae, hence making them tradable paper, again (the ‘perception of risk’ is in effect lowered)
-Structuring / collateralizing back in - like a tidal surge [any % of $5.3 trillion is massive volumes!]
-These new avatars of CMOs will HAVE TO BE SOLD at HUGE DISCOUNTS to maintain 'cash-flow' of Freddie Mac & Fannie Mae for them to try and stay above water and their executives to still have a job and decent bonuses ;-)!
(The mortgage securities traders are in for a windfall!)

The US Mortgage market is, still, the largest capital market in the world, by far! In effect it is the largest engine of credit production for the world. So the resultant effect of the ‘bail-out’ package(s) will be to add fuel to the US$-credit engine!

Another bail-out cycle, in less than 4 months! The scary bit is that relative to Fannie Mae & Freddie Mac, Bear & Sterns seems so long ago and so insignificant in size. Further, IndyMac Bank’s collapse (the third largest financial disaster in the US) has gotten relegated to a footnote so quickly!

The frequency of these crises is increasing and the size of potential destruction is increasing exponentially – predicted as early as 2002 in the documentary “Commanding Heights” based on a book by Daniel Yergin and Joseph Stanislaw. [ ]

I acknowledge that the troubles of Freddie Mac & Fannie Mae are only served as ‘circumstantial evidence’ of the under-water ‘super-shear’ that the global economic system is undergoing. But it should provoke policy planners and executives to have the courage to be bold and encourage fresh thinking. They have repeated past-practice too often and for far too long.

The starting point like I have said in my previous blog-post is not purely economic; the starting point is of a political nature:

Does a value reserve system, which permits the monopolistic position of the US$, serve the needs of an increasingly globalizing and inter-dependant economic environment that we are already witnessing at the start of the 21st century?
How do we introduce competition in the value reserve system?

The biggest immediate threat to global commerce is the collapse of the US$, the only truly international value reserve currency.

Do we have a “Plan B”?

(To be continued…..)

No comments: