Who’s going to pick up the tab?

http://www.tradingfloor.com/posts/steen-jakobsen/steens-chronicle-whos-going-to-pick-up-the-tab-3512

29 April 2011

Steen's Chronicle: Who's going to pick up the tab?

Steen Jakobsen, Chief Economist
America is a country that doesn't know where it's going but is determined to set the speed record getting there - Laurence J. Peter
Last night I had the pleasure of speaking at a Saxo EBANK seminar in Copenhagen with the world famous blogger Mike "Mish" Shedlock -he of the Mish's Global Economic Trend Analysis blog.

First, I must note that it was a novel experience for me in my twelve years of speaking engagements to be out-gunned on the negative side on my investment outlook. In the past, so many have asked me after my presentations: 'Steen, you are always selling everything – what are we supposed to BUY?  Clearly, I need to bring Mish along on more of these speaking gigs and play off his gloom to make my views appear a bit more cheery.

Mish raised several critical themes and issues in the current financial environment, but the most interesting was the often forgotten focus on leverage in the US – which we all know is high, but  do we really understand exactly how high?
 
Financial leverage in the United States
Fed Balance Assets – white line, MZM – broad money – Yellow, Public Debt – Green and finally Credit Market Debt  - Red line


Source: Bloomberg

The US Fed has more than tripled its balance sheet since 2008, and US public debt has followed suit. Meanwhile, the broader money measure, as a benchmark for baseline money in the economy, has remained stable. The point here is not rehash the well publicized fact that the Fed has printed money, but more to point out that when you have this kind of leverage, even small policy errors can have major implications.

I will never forget how in the pre-Financial crisis day, I listened in on a Lehman CFO analyst call in which she boasted that they had brought down their balance sheet leverage from 40 times to less than 30! In retrospect, it's so easy to point out that this means it only takes a 3.34% move in the wrong direction in underlying assets to wipe you out rather than a 2.5% move – not a huge difference.

My piece yesterday on the possibility of an upcoming US dollar crisis drew some attention, but I must say the more I think about the main issue: How the Fed and to some extent the ECB continue to write off any material changes in the economic reality as "noise" or "transitory effects", the more I believe that all economists, a.k.a. dismalists need to own up to the fact that all models in economics are flawed – They are all fair-weather models that work when we have a tailwind and clear visibility, but as soon as things start going down the drain, the model continues to see clear skies ahead instead of a thunderstorm of uncertainty.

Here's what you get when you compound the erroneous assumption that these economic models work with the scary cherry of financial leverage on top: Main Street suffering, Wall Street celebrating, a lack of real traction in the economy, whether investment or job creation, spiking inflation expectations, US dollar weakness, and a flight to tangible assets and other seemingly tangible assets like stock. This paradigm can gain and has gained incredible inertia over a certain period of time – but we are now entering the part of the party where someone needs to go to the bar and cough up some cash to pay for the drinks. I fail to see anyone at the party willing or even able to do so. The two or three giants: Asia (China+ India), the Middle East, and to some extent Germany have domestic issues that are too pressing for them to continue to bail-out everyone. And while on the one hand the political establishment does know it needs to strike a deal, on the other hand, a wait-and-see mentality seems to have no downside risk in the meantime and hence we will continue to see plenty of non-solutions and decision-making delays on offer. Meanwhile, silver, gold, and stocks continue their upward spiral and the US dollar keeps dropping.

The current market environment seems relaxed about it probably being too easy and therefore very dangerous. Please realise that high leverage always means high risk and if nothing else that is probably the best advice I can give anyone, not that anyone asked for it. This was also the bottom line of Mish's presentation yesterday. Yes, it is appealing to join the crowd, but sometimes it is also better risk-reward to say like Groucho Marx: " I don't care to belong to any club that will have me as a member".

Fed distances itself from high oil price

Excellent balanced comment from FT editor – and the conclusion is simply: Scary!

Anyone who does not believe in debasing?

Nice week-end

http://view.ed4.net/v/8P1R88/S3E9NO/EXCYA0X/0GTGP/

Note from the editor

Fed distances itself from high oil price

By Javier Blas The US Federal Reserve has a message for the commodities markets: it was not us and we plan to ignore you. Let me explain. Over the past few days, the US central bank has published a number of research pieces about monetary policy and commodities prices in which it argues that its loose monetary policy is not behind – as some critics claim – the spike in commodities prices. The research also concludes that the Fed should ignore the impact of high commodities prices on inflation – again, something that critics dispute vehemently – and focus instead on core inflation. The research by the Federal Reserve Bank of San Francisco and the Federal Reserve Bank of Chicago shows, in any case, the growing importance that commodities play in monetary policy nowadays. As the Chicago Fed puts it: "The recent run-ups in oil and other commodity prices and their implications for inflation and monetary policy have grabbed the attention of many commentators in the media." Yes indeed, they have: over the past few weeks, oil has hit $125 a barrel, copper a record of more than $10,000 a tonne and corn an all-time high of almost $8 a bushel. Difficult to ignore this stuff, even if the Fed would prefer that the media – and the market – looked elsewhere. The San Francisco Fed, which published the paper on the impact of US monetary policy and commodities prices, says that its analysis does not provide evidence that large-scale asset purchases, better known as quantitative easing, fuelled the rise in commodity prices. "It shows that, despite the fall in long-term interest rates and the depreciation of the dollar, commodity prices fell on average on days of large-scale asset purchases announcements," the research paper concludes. "Some critics argue that Federal Reserve purchases of long-term assets are fuelling this rise by maintaining an excessively expansionary monetary stance. However, daily data indicate that Federal Reserve announcements of large-scale asset purchases tended to lower commodity prices even as long-term interest rates and the value of the dollar declined," the San Francisco Fed's research paper adds. The analysis, however, ignores the impact pre- and post-announcements of large-scale assets purchases. The Fed communicated well its intentions to the market, so it is hardly surprising that investors bought the rumour and sold the news. Hence, the findings of the Fed. Once the San Francisco Fed has felt reassured that the US central bank has nothing to do with high commodities prices, the Chicago Fed has looked at how it should react to them. The Chicago Fed has concluded in a research paper – signed by its own president Charles Evans – that it could ignore them. The study says that "sharp increases and decreases in commodity prices have had little, if any, impact on core inflation", the preferred measure of inflation of the Fed. The bank argues that the share of commodities in the US economy is decreasing and adds that, in the case of oil, the price increases do not need to force the central bank to tighten its monetary policy as oil price "increases tend to slow the economy even without any policy rate increases". The bank further argues that it would need to act only if high commodities prices spill over to core inflation. But it concludes that is an unlikely case: "Assuming there is a generally high degree of central bank credibility, there is no reason for such expectations to develop – in fact, in the post-Volcker period, there have been no signs that they typically do." The Fed has a point here, particularly on the fact that high commodities prices are self-correcting to the economy slowing economic growth. The main problem is that some other central banks – particularly in emerging countries – are taking home the message of the Fed. For them, however, high commodities prices are a problem: the share of raw materials consumption per unit of gross domestic product is higher and the credibility of other central banks is usually less than the Fed.

Steinhardt talks the trust - amazingly honest interview - must see..

http://video.cnbc.com/gallery/?video=3000014541