Monetary Policy

Following weeks and months of lies that Portugal does not need a bailout, that is is not Ireland, Greece, Algeria, Tunisia, Egypt, Middle Earth, Uranus, etc, the country finally realized it is bankrupt, unless it comes, hat in hand, bagging for a bailout from Jean Claude Trichet (who now is scratching his head how to spin this latest sovereign default as bullish ahead of tomorrow's rate hike). Which it just did. Reuters has compiled the reactions by those who felt like sharing their views on this foregone conclusion.

Congress, you need to wake up. The people who are acting as your financial advisors are lying to you about the economy and our financial system. They’re also lying to you about the effectiveness of their policies. You are supposed to represent us. You are supposed to defend us against threats both internal and external. Bernanke is lying to you and all of us. He is an internal threat to our financial wellbeing.

DO SOMETHING ABOUT IT.

The REAL Crisis (of which 2008 was the warm-up) is fast approaching. When I say REAL Crisis I mean full-scale systemic meltdown, a situation in which the market accomplishes what the Fed, regulators, and US Government at large have failed to do: clean house. The plain facts are right in front of us. The US is broke on every level: Federal, State, Local, and individual/ consumer. We all know this, but we don’t want to admit it because doing so would likely mean wiping out at minimum 30% of what we have today.

Following our expose on the unwind in the repo (O/N GC) - reserve (IOER) carry trade yesterday, the FDIC induced compaction in the "free money" rate arb continues with GC sliding again to a jaw dropping 0.03%. And with this source of free money now shut down for good, and creating all sorts of havoc for short-term rates and further headaches for the Fed as it has one more black swan to deal with in extracting liquidity, all the free money trades have firmly shifted to FX carry, where the Yen is now the recipient of the wrath of every single Mrs Watanabe known to man. If and when Yen repatriation resumes in earnest (considering Japan GDP has to surge following its rebuilding effort as pundits claim), the outcome will be quite hilarious.

Marc Chandler, head of currency strategy at Brown Brothers, shares Zero Hedge's healthy dose of skepticism over two things: the pace of tightening in Europe, which the market is now taking for granted (the EURUSD hit 1.4315 earlier following rumors of Petrodollars now being recycled by purchasing European currency, not dollars: deja vu 2005 anyone?), and Fed tightening following a purported QE2 end. Summarizing: "our argument is two-fold. First, in Europe, we suspect the market is ahead of itself on the likely pace of ECB tightening. The market appears ripe for buy (the euro) on the “rumor” of an ECB rate hike and sells on the fact type of action. Second, similarly, the market appears too aggressive in pricing in Fed tightening after QEII is finished. The pendulum of market sentiment has swung too hard and we expect it to adjust in the weeks ahead." The problem is how to trade this: if the market is expecting too much tightening in both the EUR and USD, shouldn't the two offset? Then again, with the Yen carry trade now being put on en masse by everyone in the aftermath of the reserve-repo carry end, what happens with the two currencies may be quite irrelevant as everyone rushes to short the Yen. That said, there appears to be further EUR upside before the strong Europe trade finally fizzles: "Prudent investors should also consider what is potentially on the euro’s upside. An initial barrier is seen in the $1.4280-$1.4300 area. A break could signal another 1-2% euro rise to the $1.4450 and possibly $1.4600. To be sure, we suspect further euro appreciation in the face of tightening of monetary and fiscal policies will exacerbate the pressure in the periphery and act as further headwinds to European growth."

In trading in London this morning, gold reached a new record nominal high ($1,459.07) and silver a new 31 year nominal high ($39.50) as investors bought the precious metals to hedge deepening sovereign debt risk (in the EU but also in the US with the threat of a federal budget shutdown), geopolitical risk and deepening inflation. Brent crude reached $123.00 a barrel this morning and looks set to challenge the high seen in July 2008 of $145.49. Anemic economic growth, extremely loose monetary policies, sovereign debt risk, geopolitical risk and surging oil and commodity prices is a recipe for stagflation which would see the precious metals replicate their performance of the 1970’s when gold rose 24 times in value (from $35 to $850) and silver by over 32 times (from $1.55 to $50). Silver over $100/oz is not as outlandish as once thought with dealers in Hong Kong mooting that possibility. Strong demand for silver is being seen in Asia (see news). Inflation has taken hold in much of the developing world and is taking hold in developed world markets now. Despite very significant price increases in vital commodities, particularly the essentials of food and energy, there remains much denial about the threat of inflation and indeed the threat of stagflation.

The Congressional Budget Office has chimed in with a 30 page summary comparing the proposed Ryan budget and two previously analyzed scenarios: scenarios—an extended-baseline scenario based on June 2010-current law and an alternative fiscal scenario that incorporated several changes to then-current law that were widely expected to occur or that would modify some provisions of law that might be difficult to sustain for a long period. In essence these are merely variation on the theme of an Obama budget. Needless to say, the divergences are quite dramatic. Since the Ryan budget is focused on fiscal solvency, it achieves that: indeed, comparing projected 2050 Debt/GDP in the Ryan proposal, the CBO reaches a number of 10%, compared to 90% and 344% for the extended-baseline and the alternative fiscal scenarios. On the other hand, the credibility of the assumptions used to goalseek this outcome remain very much in doubt (much more on these in the CBO analysis below). The massive amount of spending cuts, coupled with some very aggressive revenue postulates, will certainly bring the critics out of the woodwork. It will also mean that with fiscal stimulus essentially curtailed, the only source of incremental economic boosting will be monetary policy, read - the Fed, which is an outcome that Bernanke has vocally warned against, due to his concern of Fed "politicization." Then again, with no other choice, it means that the debauchery of the dollar, since the economy is nowhere near the stage where the morphine can be removed, is about to kick into hyperdrive. In the meantime, here are the CBO summary observations.

Time is running out for a decision on Q/E but there is simply not enough evidence to make an informed judgement on the state of the economy and how it would react to a withdrawal of liquidity. Most analysts just look at the ISM and other supply data but Bernanke has got to make sure the economy can survive without his daily liquidity gift. In addition, if as some suggest, Q/E2 has done its job by ramping up equity markets, it still falls far short of his mandates. Unemployment is still massive (the real level is nearer 12-13%) and the participation rate continues to fall. Today there are 44.2 million Americans on food stamps, or 14.3% of the US population! Analysts also seem to forget the massive mountain of issuance coming from the Treasury this year and next. Consumer debt and confidence also matter more to Bernanke than it does to main stream analysts and housing is not helping at all and looks set fall further causing havoc at the banks again.

Looking through the Federal Reserve’s newly released Discount Window data fills in some missing pieces surrounding the credit crunch in 2008. We now know why Senator Chuck Schumer was so concerned about IndyMac. In the three business days after June 19, 2008, IndyMac had to double its discount window borrowings from $200 million to $400 million. Four short days later, Schumer’s leaked letter forced IndyMac to ask the Fed for $1 billion. Beyond some of these little details that end up providing granularity to the whole picture, there is still one piece of data that stands out as a singularity. Although it had become public knowledge over a year ago, the Lehman Brothers activity on September 15, 2008, still flashes a deepening warning as our economy and markets depend more and more on central banks. On the surface, Lehman’s use of the Primary Dealer Credit Facility (PDCF, the investment banker’s discount window) seems to be insignificant. It was a momentous day, after all, with turmoil in every corner of the global marketplace. Why shouldn’t Lehman borrow $28 billion from the Fed on that Monday? It had filed for bankruptcy at about 1:30am that morning, so clearly it was in need of financing. A lot has been published already about that volatile week. However, I still believe there is a hole in the “official” story as it relates to overall monetary policy. What is truly striking is not that Lehman used the Fed that Monday; rather the significance was that it was Lehman’s first use of the PDCF since April 16, 2008. Lehman Brothers did not use the Fed’s liquidity until after it had declared bankruptcy.

Since it is now obvious to even the back office that Jan Hatzius makes monetary policy in the US (just note the spike in QE3 anticipating factors following his weak assessment of the weak Services ISM earlier), it probably makes sense to present his response to the policy that he through his predecessor Bill Dudley, helped enact. Below is the Goldman take on the FOMC minutes. Ignore the house of mirrors effect.

Key Highlights:

• GDP revised modestly lower from January meeting on surging commodity prices
• FOMC sees stronger recovery, higher inflation
• Fed officials divided over tighter policy
• Almost all Fed officials saw no need to taper QE2 buying

"So Rick Ackerman posted a piece that I spotted on Zero Hedge—which surprised the hell out of me. Either Tyler and his gang of merry pranksters are losing their nerve about the downward trajectory they think the U.S. economy and monetary policy is headed in—or they ran the piece for shits and giggles. Ackerman’s piece said, in effect, that dollar hyperinflation was impossible. His post was titled “Big Gap in Logic Weakens Hyperinflation Argument”. The cause of hyperinflation is always the same: Spiralling prices that cannot be reigned in with traditional monetary policies of interest rate hikes. But Ackerman doesn’t see this: In his piece, it’s clear he doesn’t realize hyperinflation is an effect of rising prices. Eventually people realize the money itself is to blame—but only eventually, at the end. That’s why Ackerman’s first sentence sort-of makes sense, but not really. But although Ackerman is partly right in the first sentence, his second sentence? That it’s “highly unlikely that this will happen in the United States”? Brother, a panic in the dollar that leads people to exit it for commodities has happened already—and not that long ago: In 1979-’80, when inflation crossed the double digits but before Volcker slammed the brakes via interest rate hikes, people were beginning to get out of the dollar and into anything else, especially commodities, especially gold and silver." Gonzalo Lira

Time for some more theater: at 10:30 am Eastern Paul Ryan will reveal his budget proposal which sees the US government cutting $650 billion each year over the next 10 years. This simply means that even more stimulus will reside with the Fed, and with monetary policy, which also means that not only is QE3 guaranteed, but so is QE33. Watch Ryan live at the below C-Span link.

Atlanta Fed's Lockhart is the first Fed talking head on the wires today advising the general public to, gasp, spend: "A less consumption-dependent economy will help rebalance the country's external accounts—the trade and current accounts. It's unlikely and even undesirable that there be a drastic shift away from consumption, so less American consumption will not fix the global imbalances.[sic]" In other words: 1) max out your credit card 2) .... 3) profit.

At this point it is certain: the Fed is determined to baffle them with bullshit.