Page 2 of 2 US Fed's move is the bigger problem
By Julian Delasantellis
The issue of who loosed the shadow banking/CDS financial system onto the world
is mostly uninvestigated. There was the Commodity Futures Modernization Act of
2000, pushed through the Congress with no debate in either chamber, mostly by
Republicans such as Phil Gramm of Texas, and signed into law by president Bill
Clinton a month before the end of his term. It removed private party
derivatives from regulation by the US Commodity Futures Trading Commission; as
applied to CDS, that was what allowed one to hold so many of them without
posting a margin.
On April 28, 2004, the US Securities and Exchange Commission approved a rule
that permitted major investment banks to operate
with much higher leverage ratios, allowing for up to $40 in loans for each
dollar in capital. Explaining his vote for the change, SEC commissioner Rod
Campos is heard on the tape of the meeting saying that "I keep my fingers
crossed for the future".
We now see that more in terms of prudent regulation was needed than just what
could be provided for by commissioner Campos' digits.
Asking how the shadow banking system grew these past years is like asking why
plants grow in highly fertile soil; no one in authority had to take a lot of
positive action - it just did.
Specifically, the conception of government as a negative, inhibiting force, and
the freedom of private finance to dream up and create just any financial
product they could think of, led to this circumstance. Those who knew, like the
Greenspan Fed, and the bankers themselves, were either profiting from the
experience or expected to profit from it once they left government service. If
you knew what was going on and objected, you were a veritable spoilsport at the
orgy; if you came all this way to understand what was going on, why not go one
more penultimate step, take off your clothes and morals, join the fun?
AIG used to be a pure insurance company. General Electric used to sell good
toasters, Sears clothed the backs of Middle America. In one way or the other,
all three staid-and-true American commercial names have recently allowed
themselves to roll down the road to ruin and turn their companies into hedge
funds.
That, the recent obsession over manipulating leveraged finance instead of
actually producing something to be successfully sold in the markets of
commerce, is something that aches for a public debate it will never see.
(Consider Sears:
majesty to hedge fund dust, Asia Times Online, May 14, 2008.)
But if the public is getting the AIG story wrong, it's also now getting an even
bigger story wrong.
An addicted cigarette smoker might deny that his nagging cough and scratchy
throat was the onset of the lung cancer or emphysema he was so often warned
about; "It's just a cold or allergy, right, Doc?" So seems to be happening with
America's addiction to foreign capital.
The first article I ever wrote for Asia Times Online, (US
living on borrowed time - and money" March 28, 2006), introduced
readers to the US Treasury's monthly Treasury International Capital (TIC)
report, a compendium of how much investment or short-term capital the US
receives from foreign sources every month. Back then, the US was quite the
popular parking spot for foreign capital, frequently drawing in over $100
billion a month.
That worm has certainly turned; the US in January, the last month data is
available, was actually net drained of foreign capital, to the tune of $150
billion. On his blog at the Council of Foreign Relations, economist Brad Setser
interpreted the data this way.
Today's TIC January data was a disaster.
$150 billion in (net) capital outflows (negative $148.9 billion to be precise)
cannot sustain even a $40 billion trade deficit.
Obviously, the
concern is that those with still the capital to lend to the US, primarily
China, seeing the huge increase in US government demand for borrowed funds with
its now huge and ever-burgeoning budget deficits being used to finance the
economic crisis recovery programs, will fear that the US dollars they use to
buy US debt will depreciate in value, devastating the value of their
investments.
Previously, China has tried to give messages that slowly pulling out of its
dollar positions was exactly what it wanted to do, but America's cherished
habit of ignoring anything that foreigners say to it had it lending a
stone-deaf ear to the warnings.
Last week, as detailed on this site with W Joseph Stroupe's three-part series
(see Dollar
crisis in the making Asia Times Online, March 14-18, 2009) and by
Olivia Chung's article on Chinese Premier Wen Jiabao's warning to the US to
maintain the value of its currency as a matter of national honor, (see
Wen puts US honor on the debt line Asia Times Online, March 14, 2009)
the message seemed to be being sent as loudly and clearly as possible. Still,
the US stockmarket ran true to form - it ignored Wen's warnings, and continued
its recent bounce off the lows.
So Ben Bernanke decided to give America's Chinese and other foreign investors a
good swift kick in the keyster as they headed out the door.
Meetings of the US Federal Reserve's interest-rate setting Open Markets
Committee used to be a lot more interesting back when there were actually
interest rates to set. Now, with rates at zero, the Fed has to work extra hard
to get the markets to take notice. At Wednesday's meeting, they did.
After committing another $750 billion for purchases of mortgage-backed
securities as part of its program of adding liquidity to the system through
"quantitative easing", the Fed had this for those foreigners who apparently
think that they can put America over a barrel by refusing to buy its debt.
To
help improve conditions in private credit markets, the committee decided to
purchase up to $300 billion of longer-term Treasury securities over the next
six months.
In other words - foreigners, we don't need your
money; we'll print our own! That's what's essentially been done with the short
end of the Treasury yield curve since the Fed's rescue operations from last
September; it was probably only a matter of time before they would attempt the
same with longer-term securities.
What will this do to the Fed's balance sheet? It will cause it to grow - a lot.
From being virtually non-existent a few years ago, the Fed has it soon growing
to almost $4 trillion - more than 25% of the country's gross domestic product.
That's supposed to inspire confidence?
The potential drawbacks to this approach are obvious. Does Bernanke really
think he can convince foreign investors to make new investments in US
government securities by threatening the dollar value of their existing
securities? The last thing the recovery effort needs is long-term interest
rates in an uncontrolled rise.
A key factor currently holding down inflation in the face of the incredible
monetary expansion recently has been a decline in what is called monetary
velocity, the rate of which money circulates in the economy. Nothing will ramp
up velocity faster than a falling dollar; people will want to get rid of that
accursed green thing as soon as possible, before it falls even further.
In the markets, the effect of the Fed announcement has been entirely
predictable. Although yields on 10-year US government securities fell to 2.5%
from near 3% before the announcement (entirely expected, what with $300 billion
of new buying to hit this market) they were back on the rise by late Thursday.
With the US dollar, there's been no such ambiguity of effect. The euro rose
from 1.31 against the dollar to 1.37 immediately after the announcement, its
highest level against the greenback since early January. The dollar also fell
five cents against the yen, to under 0.93 cents/yen. Other inflation-sensitive
markets also fell in line: crude oil broke above $50 per barrel for the first
time since the New Year; gold takes the cake for sounding the alarm bell, up
over $77 per ounce just since the announcement.
But this collective 5% impoverishment of America drew no notice on Capitol
Hill. The House of Representatives, in the very rare mode of considering
themselves and acting as servants of the plebeians, overwhelmingly voted to
seize the AIG bonuses through confiscatory taxation; to have a similar
beneficial effect with the currency markets might require a repeal of the laws
of gravity.
I almost get the impression that, like a child with too many toys and who has
become bored with his most recent one, the public is tiring of AIG rage. Will
they now turn their focus to an actually important public issue?
Doubtful.
"Next, on PowerCableNews, we'll have the experts debating President Barack
Obama's NCAA basketball picks!"
Julian Delasantellis is a management consultant, private investor and
educator in international business in the US state of Washington. He can be
reached at juliandelasantellis@yahoo.com.
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