Replies to post #157933 on Zeev's Turnips Patch-No Politics (ZEEV)

[Public Heel]

They can't unload them. To do so would man the U.S. would have to pay higher interest rates to finance its debt, which would crash its economy, which would cripple its ability to buy Japanese goods.

They are stuck with financing our overspending and underproducing. We've got them just where we want them.

I would guess, though, that they are hoping to help engineer a gradual decline in the $US, meaning a gradual decline in our ability to buy from them, which would give them time to find other markets.

[Joe Stocks]

>>There's an article floating around recently on the web about an interview with someone (a fed gov I think). He used the old expression "If you borrow a lot of money from a bank, and you can't pay it back, the bank has got a problem" <<

Doug Noland commented on that this week.
>>President of the Dallas Fed Robert McTeer responding to a question after his speech Wednesday at the Kanaly Trust Company Distinguished Lecture reception:



“What is my opinion of the current account deficit? Just to define the terms a little bit, the trade deficit is the excess of our imports of goods over our exports of goods. The current account deficit adds services and some other things in the balance of payments. It’s a better measure of our trading relationship with the rest of the world. In college in the 1960s when you studied things like that the answer was that a fairly large and sustained current account deficit – if you have a floating exchange rate – will cause the exchange rate to decline until it brings about equilibrium.



The U.S. is a little bit of an exception to that, in that its dollar is used all over the world as a currency by a lot of people and it’s held by central banks all over the world as a reserve currency. To some extent, the world has long been willing to hold the excess dollars that we put out by buying more than we sell to the rest of the world. And we get sort of a free ride. Sort of like we’re in a poker game and we never have to cash in our chips. In the late nineties, when we were doing so, we had such a dynamic economy, particularly compared to the Eurosclerosis in Europe, there was a lot of funds floating to the United States from Europe that sort of artificially held up our dollar and made the current account deficit larger. In the 1960s you learned that trade was independent and capital flows were the financing mechanism – they were sort of passive.



But these days capital flows are kind of independent too, and one could almost argue, not that our capital inflow is financing our current account deficit, one could almost argue that our current account deficit is financing our capital inflows. So long as that is happening, and as long as we are regarded as the dynamic economy and the best place in the world to invest, our large current account deficit is not going to cause us any problem. The problem will come when people change their mind about all that and they’ve decided, maybe suddenly, that the world has too many excess dollars and they’d like to sell a lot of them all at once in the foreign exchange market. If they did that all at once, we would experience an exchange rate crisis. We’d do no telling what to react to it. I don’t know exactly what would happen, but it wouldn’t be good. But we’ve had the potential for that to happen for several years now and it hasn’t. Most of the countries that own a lot of the dollar balances don’t have any real incentive to trigger a crisis like that. They would perhaps be hurt as much as anybody else by such a crisis. What is it they say: 'If you owe the bank a little money, you’ve got a problem. If you owe it a lot of money, the bank’s got a problem.' We might be in that situation.”



This was an unusually candid discussion from one of our prominent central bankers. I would furthermore argue that it is curiously germane. Mr. McTeer - with comments such as late-nineties flows “artificially held up the dollar;” that “suddenly” it may be a case that “the world has too many excess dollars;” and that “If you owe (the bank) a lot of money, the bank’s got a problem” – is a man after our own analytical hearts. With his above comments in mind, let’s take a step back and try to make a little sense out of an extraordinarily challenging environment.



I have argued that the Death of King Dollar “changes everything.” The late nineties presented an atypical environment conducive to a major Dollar Bubble. A dysfunctional dollar reserve global financial system had wreaked liquidity-induced boom/bust havoc around the world. Yet here at home, an historic stock market Bubble was running out of control. With major real economy and financial effects, an historic boom was running rampant throughout the U.S. technology sector. The U.S. economy was dramatically outperforming the global economy, with foreign investors clamoring for U.S. assets and direct investment to play the U.S. “miracle economy.” It was an amazing confluence of factors that came together. Importantly, many Credit systems around the globe were in tatters after a spectacular domino collapse. Southeast Asia had been decimated, along with scores of emerging market financial systems including Russia, Turkey and throughout Latin America. Strong demand for dollar assets (real and financial) reinforced American economic and market relative out-performance and exacerbated (over)demand for U.S. assets. Internationally, there really was only one game working: King Dollar.



Along with our King Currency, we also enjoyed the fruits from our benefactor Master Central Banker. No other central bank in the world could basically guarantee vibrant and liquid financial markets. No other central bank had the capacity/audacity to collapse interest rates and flood their domestic financial systems with liquidity to stem any unfolding crisis. Certainly, there was at that point no other central bank with the immense power to mitigate the negative consequences of bursting Bubbles by fueling larger ones. And although the bursting of a rather conspicuous stock market Bubble posed systemic risk, Fed chairman Greenspan was brazenly signaling that the Fed would aggressively cut rates in the event of significant stock market weakness. The enticement dangled in front of the speculators and dollar holders was a distinct possibility for a once-in-a-lifetime bond market play. Especially after being burned in so many other markets, the global leveraged speculating community came to appreciate that there was only One Game in Town: King Dollar financial assets. The Fed enjoyed credibility with the speculator community like no central bank in history and was pleased by it all.



Unbeknown to most, the linchpin to Federal Reserve “credibility” was located with the government-sponsored enterprises. Fannie Mae, Freddie Mac and The Federal Home Loan Bank system -- with the market readily assenting to implicit government backing on GSE debt -- enjoyed the phenomenal capacity to expand their liabilities (increase Credit), virtually without limit and virtually on demand. The GSEs -- and Wall Street “Structured Finance” to a lesser degree -- garnered their immense power from their extraordinary capacity to create endless perceived safe liabilities – a capability historically enjoyed only by the government monetary “printing press.” The GSEs and Wall Street had evolved to the point of creating a mechanism for generating systemic liquidity on demand and they were not bashful about employing it.



It was this capacity for aggressively expanding U.S. financial sector balance sheets (ballooning assets) during a crisis that provided the cornerstone to the market’s perception that the Fed could so easily reliquefy the system to mitigate financial tumult. The 1994 and 1998 episodes, in particular, had emboldened the leveraged speculating community. They learned that if the markets moved decisively against them -- Credit market liquidity began to wane -- an aggressive buyer (happy to pay top dollar) was only a phone call to Fannie or Freddie’s trading desk away. Why would anyone not believe this would fuel unprecedented excess?



So market psychology and profound financial innovation combined to nurture the Great U.S. Credit Bubble. Yet as fast as our ballooning trade deficits spewed dollar liquidity throughout the global financial system, these Bubble Dollars were recycled right back into U.S. financial assets and the real economy. Perceptions solidified that King Dollar was a permanent fixture of the global financial landscape and that trade deficits no longer mattered. We had to spend the "money" that was (and would always be) thrown our way.



But things always change, and manic delusions inevitably disenchant. With everyone zealously playing King Dollar and caution thrown to the wind, the game was at its end. To be sure, Credit and speculative excess always sow the seeds of their own destruction. On the one hand, there are resulting real economy effects (distortions to pricing, investment, the nature of demand, etc.) On the other, financial excess nurtures financial fragility. Both deleterious effects were all of the sudden conspicuous. Last year’s accounting scandals didn’t help, nor the near dislocation in the U.S. corporate bond market. The unfolding crisis quickly had its sights set on the vulnerable indebted consumer sector. The Fed responded by cutting rates to 1% and intimated “unconventional” measures to preserve the Credit Bubble. This incited a massive, leveraged speculation-induced reliquefication. This inflation, however, sealed King Dollar’s fate. Quietly, but importantly, Non-dollar asset began outperforming as dollar claims inflation accelerated.



Considering the degree of unrelenting excess pervading the U.S. Credit system (and consequent internal and external imbalances), an immediate dollar crisis would have been expected. But this is not your grandfather’s financial system, domestically or internationally. The GSEs have evolved to assume the crucial role of Buyers of First and Last Resort – assuring excessive and unending liquidity for the U.S. financial system. And, to this point, they have been able to accomplish this feat more successfully than any central bank in history. In the same vein, foreign central banks (largely Asian) have evolved as Bubble Dollar Buyers of First and Last Resort, assuring unending liquidity for dollar sellers, along with resulting excess liquidity globally. They lap up the liquidity created in such gross excess by the GSE-led U.S. financial sector, assuring Bubble perpetuation.



Global central bank actions gave the U.S. Credit Bubble free rein and fostered recent blow-off excesses. The prospering and ballooning speculators, with one eye on the GSEs and the other on the foreign central banks, have operated confidently and aggressively. Uncontrolled excesses -- Credit, speculative and economic -- have gone to truly astonishing extremes. All the while, the eager optimists have been emboldened. As analysts, it is today critical to appreciate the unparalleled financial and economic landscape that has evolved with GSEs as domestic financial backstop and foreign central banks as GSE and global financial backstop.



With Credit excess going to new extremes concurrently with waning demand for U.S. assets, foreign central banks are accumulating dollar securities like never before. The Bank of Japan has purchase in the ballpark of $100 billion over the past year, with the Chinese and other Asian banks not all that far behind. Ominously, this has accomplished only an orderly general dollar decline. Yet, central bank purchases have played a pivotal role in sustaining artificially low U.S. interest rates. It is one more irony of this aberrant environment that a weak dollar today supports the U.S. bond market (and Credit Bubble!). This is, as well, one more anomaly that repudiates the economic laws of market price-based self-regulation. And striving to front run the central banks, we have now reached the point where dollar weakness fosters speculative buying of U.S. Credit instruments (while the dynamically trading derivative players try to stay ahead of the speculators). As constructive as these central bank Treasury and agency purchases may appear on the surface, the upshot of this huge artificial support is that it only bolsters GSE and speculative finance-led domestic Credit excess (and resulting financial fragility and economic maladjustments).



There are myriad serious issues with this increasingly symbiotic GSE/foreign central bank “alliance.” For one, from deep domestic and international structural weaknesses/imbalances/distortions has emerged a (manic and uncontrollable) liquidity-induced expansionary environment. Second, the GSE and central bank financing mechanisms have all seductive appearances of being rock solid and sustainable. Third, this financial backdrop exacerbates already unprecedented leveraged speculation and untenable derivative expansion. Fourth, the GSE/foreign central bank “alliance” combines for the most powerful liquidity creation mechanism ever known to global finance. Surely, speculative excesses have never been as endemic to the global financial system, never – encompassing developed markets, emerging markets, equities, Credit market instruments and interest rates, Credit insurance and Credit default swaps, real estate, commodities, a derivative Bubble and so on. That such excess runs out of control in a global environment so susceptible to severe structural frailties recalls the seductively catastrophic environment of the closing years of the Roaring Twenties.



The truly frightening aspect of these circumstances is that both the GSEs and central banks have succumbed to Bubble dynamics. Individually and in concert, it is Inflate or Die. With the parlous mortgage finance Bubble, an incredibly leveraged Credit system, and a hopelessly distorted Bubble economy requiring massive and unrelenting Credit inflation/currency debasement, it is a safe assumption that dollar vulnerability is here to stay. Moreover, the out-performance of non-dollar assets (real investment and economies, financial markets and assets, and basic commodities) will augment dollar liquidation. And just as King Dollar foreign inflows were self-reinforcing during the late-nineties, there is evidence that non-dollar flows (investment and speculative) are now increasingly fueling self-reinforcing expansions overseas. This is especially the case throughout Asia (including India), Russia, Eastern Europe, Australia and elsewhere. This is the essence of my now weekly “Global Reflation Watch” and keen focus on foreign economies and markets. Global reflation is a dollar problem and central bank problem.



I do see relative strong performance sufficient to sustain major non-dollar flows. Foreign central banks, then, will continue to have no attractive alternative other than further dollar “Buyers of Last Resort” accumulation. We “owe (them) a lot of money, the banks’ got a problem;” a huge and ballooning problem. In reality, foreign central banks can’t turn off the Credit/liquidity spigot any more than the GSEs can turn it off. It’s out of control domestically and internationally. The speculative marketplace fully appreciates this dangerous dynamic, as the perception of endless global liquidity solidifies.



Mr. McTeer provided an additional candid and pertinent comment Wednesday night:

“One of the great things about moving to Texas after the banking crisis was that Texans are willing to talk about their bank failures, their own failures, and there’s no embarrassment about it whatsoever. It’s a very entrepreneurial country and we’re in the center of the entrepreneurial part of the country. And we’ll survive whatever they throw at us. I don’t know what the next external shock might be. It might just be that the current account deficit finally reaches a Tipping Point.”



Current account deficit reaching a Tipping Point? Are such thoughts even allowed at the Federal Reserve? Well, there is absolutely no doubt we are heading toward a major dollar crisis. The issue is only when. There is no doubt in my mind that the GSE Bubble will burst, and there are certainly enough issues unfolding to keep our analytical interest. These institutions and the marketplace are seemingly doing everything possible to ensure that this inevitable financial dislocation will be historic. I also have no doubt that the foreign central bank dollar Bubble will come to a most unpleasant end. That the interplay of these two ultra-powerful financing mechanisms has evolved to foster unprecedented Credit and speculative excess throughout the world is a deeply despairing worst-case-scenario unfolding right before our eyes.



To wrap this up, it appears we have entered what will be a wildly unstable environment, as we meander towards some type of financial “resolution.” Yet there is today an atypically fine line between financial dislocation (likely related to the dollar) and abundant global liquidity unlike anything seen in our lifetimes. There is a fine line between a “Tipping Point” break in dollar confidence and desperate foreign central bank dollar purchases (unprecedented global liquidity injections). There is similarly a thin line between endless liquidity supporting our leveraged Credit system and consequences of incessant liquidity excess at some point terrorizing it. And it does today appear reasonable to presuppose that things may look absolutely wonderful to most right up until the proverbial “wheels come flying off.” Most financial crises develop as liquidity disappears over a period of time. But the nature of the runaway GSE/central bank financial Bubbles may dictate that enormous over-liquidity works its seductive magic until it abruptly doesn’t work anymore: a systemic crisis of confidence.



In the meantime, there is this massive speculative community placing leveraged bets on stocks, bonds, currencies, commodities, Credit, spreads, and God knows what else. Additionally, there will be an unfolding Battle Royal as bets are placed as to how this all plays out, only ensuring greater chaos in the markets. An incredibly unstable environment has been nurtured, and we are today forced to be on guard for extreme price movements across the spectrum of now highly interrelated markets. This week had the “feel” of a commencement of some type of systemic dislocation, with an initial convulsion to the upside, at least for stocks. I wonder what Larry Kudlow would think of this week’s Bulletin? <<<<<<<<<<<<<<<

http://www.prudentbear.com/creditbubblebulletin.asp

[Newly2b]

I think the problem revolves around what else can they do with their access dollars received in exchange for exported goods. They can't just sell those dollars without affecting the exchange rate unfavorably, so they reinvest them in our bonds. But what if they suddenly decide to shift their reserve dollars into PMs instead?

Newly

[Ace Hanlon]

To be sure policymakers will be VERY reluctant to take actions that risk global recession. But in the final analysis they may have no choice if (when) the current credit bubble leads to surging inflation and a dollar/ bond market collapse.