Tuesday, March 30, 2010

Leftovers -- Radio Show 3/20/2010

Edward Harrison of Credit Writedowns observed there has been no credible reform of the financial system while monetary and fiscal normalization is taking place.  He remains concerned that several pitfalls remain in the global economy with respect to protectionism, unemployment in the United States, sovereign debt crisis, and commercial real estate.  In his opinion, any renewed economic weakness could be viewed as a double dip and he gives the probability at even odds.  Last week Roubini gave the odds at 20%, Roach at 40%, and three months ago Hussman gave the odds at 60% but now sees the market as irrationally sustained despite its overvaluation.  The banking analyst Meredith Whitney said the housing market in the United States will go through another double dip while mortgage backed securities and Treasuries will surely retreat.

In his weekly commentary, John Hussman observed that the financial crisis was not an unpredictable surprise but an ordinary outcome of extraordinary recklessness as observed by problems in the market beginning in 2005.  Adjustable rate mortgages are just now hitting their 5 year reset dates and this will require payments of interest plus principal replacing payments less than interest on loans well above current market values of the homes.  Any analysis which alludes to data prior to now are reflective of a reset lull and the real time frame to watch is the three months following July-September 2010 which may start showing delinquency increases which will peak in the second half of 2011,  With hundreds of billions of dollars in resets in the coming months, it would be reasonable to expect 40% to become delinquent.  He believes it will be interesting to observe to what extent 30 day delinquencies spike in February-March 2010 as the result of the small number of resets in November 2009 and expects the delinquencies to increase through 2010, back off in the first half of 2011, and reach a final peak in late 2011.  He is doubly concerned, because "...the only points between the pre-Depression period and the late-1990's when the market has been so richly valued were November-December 1972 (before a 2-year market loss of about 50%), and August-September 1987."

The Federal Reserve will close the Term Asset-backed Securities Loan Facility on June 30 for loans backed by new issue commercial mortgage-backed securities and on March 31 close loans backed by other types of collateral.  They reaffirmed with one dissent that interest rates will remain zero to 25 basis points for an extended period of time.  This has some economic observers questioning what effect these actions will have on liquidity in the market.

The Baseline Scenario commented on the Irish economy as an example of why the United States should limit the size of risk taking banks and force them to hold more capital.  Exports are down 9%.  Its GDP was down 7.3% through Q3 2009.  Housing prices continue to fall.  Its euro currency exchange rate cannot move relative to its major trading partners and, therefore, cannot improve competitiveness without drastic wage cuts.  It is perceived by some to be a success story for its EU imposed austerity program with draconian fiscal cuts with lower wages and higher taxes, because its bond yields imply just a 1% chance of default greater than Germany.  The whole fiscal austerity program is a gamble that GDP will recover to over 4% in 2012, while planning further cuts through 2013.  Its budget deficit will still be 12.5% of GDP in 2010.

According to The Baseline Scenario, the difficulties in Ireland began with a massive property boom financed by cheap credit from Irish banks with the three largest banks building up loan and investment portfolios 2 1/2 times GDP.  With the financial crisis, housing prices fell 50% and today approximately 1/3 of loans on the banks balance sheets are essentially non-performing which means potential bad debts are 80% of GDP.  As the result of strong lobby by real estate developers, bond investors, and politicians with links to developers and the banks, the Irish government guaranteed all of the liabilities of the banks and injected funds into the banks.  It is now planning to buy the most worthless assets in exchange for government bonds.  In doing so, they have converted private liabilities into public (sovereign) debt, while creditors remain free and clear of the results of their reckless behavior.

Deutsche Bank, J.P. Morgan Chase, UBS, and Hypo Real estate were charged with fraud in the sale of derivatives to the City of Milan.

Ernst & Young ignored a whistleblower on the Lehman Repo 105 transactions, which materially misstated Lehman's balance sheet, ignored questions from audit staff, and became "comfortable" with the Lehman's use of the Repo 105 transactions.

Tyler Durden ventured the opinion that the decline in purchases of US Treasury securities by China and Japan have been offset by increased purchases by the UK, as a proxy of China, oil exporting countries, and Caribbean banking centers, as a proxy for hedge funds.

The Financial Accounting Standards Board may be preparing to propose banks expand the use of market values for financial assets, such as loans.  The banks have been exempted from mark-to-market rules, which means their financial statements and income statements are not accurate and cannot be relied upon.  40% of the total assets ($2.8 trillion of loans) of the four largest banks (J. P. Morgan Chase, Bank of America, Citigroup, and Wells Fargo) could be affected.  The impact could be even larger on smaller banks.  While the banks will fight any proposal, the FASB proposals are actually fairly limited to balance sheet and income statement disclosure of historical cost and loan-loss reserves and market values, of financial holdings divided between those they trade and those they hold with trading assets affecting profit and non-trading assets being marked-to-market as a portion of shareholder equity called other comprehensive income, and income statements would show more than just net profit by adding an "other comprehensive income" category reflecting market value changes of loans and securities.  The "other comprehensive income" would be added to net income for a new bottom-line figure called comprehensive income, while earnings per share would still be based on net profit.  Whatever happened to the concept of fair market value?

While markets are becoming slightly more bullish on Greek debt, the resolute desire by member nations against any "stronger" political union to resolve the structural problem of the euro means the EU must consider a European Monetary Fund funded by member countries with excessive deficits and debt levels, as proposed by Gros and Mayer, and the creation of Euro Bonds with the interest rate of each participating country dependent on the interest rate it pays when it issues its own bonds.  In my opinion, if the competitiveness gap refelct in current account balances resulting from the structural problems of the euro are to be addressed sufficiently, any EMF would have to be funded by countries with excessive deficits and excessive surpluses.

Germany insists that every country eliminate its excess fiscal deficit quickly, but that can only happen is current account balances improve or private balances deteriorate,  If private balances are to deteriorate, then private debt financed spending must surge.  If current account balances must improve, then they must deteriorate elsewhere in the Eurozone resulting in a move to smaller private surpluses in countries like Germany or the Eurozone must shift towards surplus.  The most likely outcome of a fiscal retrenchment would be a continued, long lasting economic slump in those countries forced to implement austerity programs.  Why should their populations endure and accept this imposition?  Martin Wolf has said "Germany's structural private sector and current account surpluses make it virtually impossible for its neighbors to eliminate their deficits, unless the latter are willing to live with lengthy slumps.  The problem could be resolved by a eurozone move into external surpluses." Germany wants its neighbors to be like itself, but they do not have Germany's deficient internal demand.  What is required is for Germany to become less German and increase internal demand.

In Spain the central government is hobbled by 17 regional governments which control 17% of the public spending as well as regulate the banks within their regions.  The political problem is the regions have been given control over spending, such as health and education, without the need to go to the taxpayer and ask for the money.  The only real control the central government has is that it must sign off on region's debt issuance.  Yet, it is dependent on these regions for political support in maintaining parliamentary control.  The Spanish banks regulated by the regions have significant mortgage loans which have never been marked to market and may pose a systemic risk to Europe and, perhaps, globally.

While it is obvious that China uses trade and currency rules to boost exports, any attempts to take protectionist actions against the Chinese currency rate would be self-defeating. China's use of the WTO to file more complaints than any other country on other country's trade practices is an example of how China would react.  It is entirely possible they view any pressure to appreciate the yuan as economic warfare just as their pegging the yuan to the dollar may be a form of economic warfare.  Yet, Paul Krugman has indicated that the Treasury Department should declare China a currency manipulator in its April 15 semi-annual report.  Krugman asserts we have nothing to fear from China with respect to selling US assets and we must act forcefully with a large 25% surcharge on imports.  This would be trade war on a truly global scale, not just nation against nation.  Krugman has also maintained that the US does not need China to continue buying US debt for the US to keep interest rates down, because they would be selling US dollars which would be expansionary for the US.  Krugman totally dismisses the consequences of a global trade war asserting the US and Europe can get what they want elsewhere and the real issues are Chinese currency intervention which increases their exports, elastic pessimism which would support foreign exchange controls do not apply because China is in the process of rapid economic transformation and a real exchange rate has to change to reflect the significant changes in the economy internally, and China's outlandish mercantilist policies must be stopped if the acute damage from their currency policy is to be abated. The Chinese premier strongly argued that the Chinese currency  policy needs to be maintained to control Chinese inflation and social stability and that its exit policies need to be deliberate in order to avoid a global double dip.  Wen Jiabao warned against protectionism and strongly defended free trade, while expressing concern about the US dollar.  The Chinese central bank recently did some stress testing of the effect of appreciating the yuan on selected exporting industries and found that every 1% appreciation would likely result in a 1% drop in profit margin.

Michael Kleist, who lives in Shanghai, has written that China's real estate bubble is overrated, because the Chinese government has the power to exert any fiscal control it needs whenever it needs and it needs to maintain a strong housing market which does not appear to be credit driven.  He, however, is not addressing the significant speculation in vacant real estate and vacant buildings and the use of leverage in that speculation.  While the Chinese government has taken some small monetary tightening policies to control this bank lending and speculation, the question is can it control the credit bubble from bursting and prices falling as defaults mount.

James Rickards has joined Chanos, Faber, and Rogoff in warning of a potential crash in the China's economy.  He said the Chinese central bank's balance sheet resembles a hedge fund buying US dollars and selling the yuan and characterizes the economy as a giant bubble with a massive misallocation of wealth.  He also asserted that China would incur massive losses if it tried to dump US debt.

There has been a recent paper by Rogoff and Reinhart citing evidence that bad things happen when debt goes above 90% of GDP, but as Krugman observes it is really "...that bad things happen to debt when growth is low."  William Mitchell has criticized the paper for mixing data from countries which had debt issued in foreign currencies and with faulty research with respect to sovereign defaults and that no nation with non-convertible currencies and flexible exchange rates has ever defaulted.

Former Goldman Sachs traders reacted to the Lehman Repo 105 transactions, as reported by Felix Salmon, disclosed in the Valukas report to the Lehman Bankruptcy court as if it was no big deal; it was just business and no big deal with one saying, "like, whatever."  If people do not go to jail, why should they care what the peons think?

Bank of japan doubled to $221 billion funds available to Japanese banks for 3 month loans on a split 5-2 vote.

The US "jobs" bill is basically providing tax credits to small businesses for new hires through December, if they have been unemployed for at least 60 days, by forgiving 6.2% sales tax payments through December and a $1000 tax credit if new hire on job one year and approximately $20 billion for highway funds.  This will have little effect.

IMF says Chinese yuan is undervalued.

I have consistently warned about financial reporting in China and Fuqi International (Jeweller) fell 37% on March 17th when they disclosed accounting errors will cause the last 9 months of 2009 to be restated.

Chicago Fed Midwest Manufacturing Index was up 1.9% in January with automobiles up 4.5%.

Eurozone trade deficit is down 26% to $12.2 billion in January; exports were up 5% vs year ago and imports were up 1%.

US home prices were down .7% in January vs year ago and down 1.9% from December.

US trade current account deficit was up 12.9% to $115.6 billion in Q4.  The 2009 deficit was down 40.5% to $419.9 billion (8 year low) and only 2.9% of GDP (smallest in 11 years).

Indias's central bank raised its interest rate to banks to 5%.  They are experiencing wholesale price inflation which rose to 9.9% annualized in February primarily on food.

The EU is drawing up a plan for banks to pay into a fund to unwind failed banks.

The Federal Reserve reported industrial output was up one-tenth percent in February (was up .9 in January); capacity utilization was up to 72.7 from 72.5 and is still 7.9 points below the average.

NY Fed manufacturing was up to 18.9 from 17.6.

Producer Price Index (PPI) was down .6% in February with energy down 2.9%; core prices were up .1% and up 1% for last 12 months.

US wholesale prices were down .6% in February (biggest drop since July) and, excluding food and fuel, it was up .1%.

Capital One credit card defaults fell to 10.19% in February; Bnak of America's were up to 13.51% from 13.25%.

Geithner, Orzag, and Romer all said they do not expect further declines in unemployment this years.

AIG will withhold $21 million in bonuses --- retention bonuses for former and current employees and is paying out $46 million to 70 people mostly former employees.  This will help AIG to meet its $45 million give back target to the US Treasury.  It was due to pay $195 million in bonuses on 3/15, but many, including almost all current employees, took $20 million cut for early payment.

After bankruptcy proceedings, Lehman will re-emerge as LAMCO.

Banks failing to make TARP dividend payments was up to 82.

US Appeals Court said Fed must release loan information as public information.  The Fed is expected to appeal.

The ECB's Trichet said he will "push" for more transparency on CDS trades by establishing a central counter party facilities.

IMF's Strauss-Kahn said he was against the Tobin Tax concept, which would tax risky financial transactions in order to discourage them.

Greece tells EU help us  or we are going to the IMF for help.  Sarkozy (France) opposes the IMF alternative despite Germany's turnaround (from Chancellor Merkel) in support of the IMF possibility although internal dissension (Finance Minister Schaeuble) remains.  Sarkozy sees Strauss-Kahn pf the IMF as a potential political opponent in the next election.

Latvia's coalition government collapsed in a dispute over how to handle the economic crisis with the largest of the five coalition parties --- People's Party --- wanting a more "populist" action plan.

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Friday, March 19, 2010

Leftovers -- Radio Show -- 3/13/2010

With calls during the radio show, we have a lot of leftover information.  We have already posted on the Valukas report on Lehman and we discussed it in a cursory fashion on the show.  There are several key points in that report, but the knowledge which the New York Fed had and its failure to act under Geithner deserves a spotlight and is much dismissed or ignored in the main stream media. We also discussed that the continuing low volume in the market combined with overvaluation of the market and pressure on bond yields often precede a negative turn in the market, as John Hussman pointed out in his weekly commentary.  We also noted the large monthly mystery buyer of S&P futures which has been putting a lot of liquidity into the market as well as high frequency computer trades by one or more large banks in which they are purchasing the SPY ETF multiple times a minute, minute after minute, and, rather than seeking the best price,they are always purchasing at a higher price with each purchase.

The SEC has asked Congress to provide transparent regulation of credit default swaps, because they are often used in place of securities and directly impact the market.

Sheila Bair of the FDIC supported the Fed's low interest rate policy to get credit flowing but said regulators should not force banks to lend.  She also said Fannie and Freddie should either be privatized or nationalized.  She also said a resolution mechanism to unwind financial companies and shadow banks would also require aligning economic incentives with regulation.

Christina Romer, who heads the Council of Economic Advisers, said the deficit is a cause for concern but it would be foolish to derail the recovery.  Controlling the deficit is directly related to lowering unemployment.

Prudential of America is facing a nation-wide class action lawsuit on behalf of long-term care disability claimants who are appealing denied disability income benefits for the second time since November 2005.

While credit card debt has been falling for 16 months, consumers are not paying debt down as much as walking away from the debt.  Some credit card issuers are writing off as much as 90% of the reported drop.

Paul Krugman looked at the similarities in the Irish financial crisis and the United States and found irrational exuberance, a huge inflow of cheap money, the financial players had huge incentives to take big risks, and the people charges with regulating the banks just did not do their jobs.  For Krugman this means we need to focus on the regulators and we need an independent consumer financial protection agency.

Spain has the economic means to weather this financial crisis if it starts taking action to combat the property bubble that burst and exposed the illusion of some public finances and the need to restructure their financial system with banks far more exposed to real estate mortgages  than is publicly reported, which may be double.  The banks have been allowed to apparently under report non-performing loans and continuing to carry toxic assets at inflated values, because the central bank and the central government has been unable to force the regional cajas which control the banks in their regions to act.  This has some people concerned that the Spanish banks may be systemically dangerous and more financially weak than publicly perceived.

We have published articles and discussed the growing wage inequality in China between the urban-coastal workers and the rural workers, but the problem is actually more serious, because China does not allow rural citizens working in urban settings to legally register as urban residents, which forces them to be eligible for rural wages only.

The EU is discussing forming an internal IMF-like lender but the discussions are divided even within member countries.  The formation of such a European Monetary Fund is well advanced but still sticky in acceptance.  However, the EU appears firm in its determination to regulate derivatives and curb their use in making bets against sovereign debt. 

We have talked in the past of the the CDS investigations in Italy involving sales to municipalities which appears to be expanding very fast.  The overall notional figure may be 35.5 billion euro or one-third of local government debt.

Portugal intends  a fiscal consolidation by generating a decline in real wages of public workers by capping pay increases below inflation, postpone infrastructure investments, and step up its privatization efforts.  Portuguese 10 year bonds are almost half the premium they were a month ago.  Their 5 year CDS are third behind Greece, and Ireland.

As we have proposed may be necessary, the EU is discussing whether EU bonds should be issued to assist EU countries, like Greece.  All 27 EU countries would have to agree.

China, in order to control its housing bubble, is raising down payments required to 40% and requiring higher interest rates for purchasers of existing mortgage property to discourage speculators.

While China is under increasing pressure to appreciate the yuan, it remains adamant that the yuan must remain stable.  Concerns that inflationary pressures may build has the government reviewing monetary policies and curtailing debt issuance internally.  Its current account balance can be readjusted without readjustment by other exporting countries such as Germany and Japan.  Foreign exchange reserves are approximately $2.4 trillion.  China has reaffirmed its commitment to US Treasuries and said it is wary of gold.  Still many economists still expect China to move gradually away from pegging its currency to the US dollar.  China's shrinking trade surplus may allow China to argue the currency appreciation is not necessary.  The trade surplus fell $6 billion to $8 billion from January to February.  There is some speculation China may slowly appreciate its currency 4% in the next 12 months.  Nouriel Roubini thinks China will raise its currency 2% in the 2nd Quarter and let it strengthen another 1-2% in 12 months.

China plans to nullify all guarantees local governments have provided for loans taken by financing vehicles.  It will also ban all future guarantees by local governments.  These were used to circumvent regulations preventing them from borrowing directly.  This crackdown is estimated to involve $3.5 trillion and could trigger a wave of bad loans as projects are left without funding.

The Fed announced it will expand reverse repo counterparties when the Fed begins to reduce its balance sheet.  It has already drained $990 million in five trials in December.

Chicago Fed President Evans said policy makers may be accepting a higher level of unemployment in the future.  While he thinks the Fed has taken its asset purchases to the extent it has been helpful, he left the door open for further purchases if the economic conditions change.

William White, a former BIS economist, who in February 2008 slammed the Fed for blowing bubbles and then "using gimmicks and palliatives" to only make things worse, is again lecturing Bernanke in a December-January OECD Observer article in which he says the current financial crisis has focused on the underlying systemic questions which expose the vulnerability of financial stability.  Since financial stability is necessary, the US may be facing a similar challenge as did Japan in the 1990's in reducing the debt created by booms fueled by excess credit and it will take a significant amount of time.

Unemployment is up in 30 states in the US with Illinois at 11.3% in January or 8th highest.

US wholesale inventory was down .2% in January (Down 1% in December), inventory ratio was down to 1.10 months, and sales were up 1.3%.

US regulators sent a letter to banks in December telling them to avoid dividends or stock buybacks or face a stress test to get permission.

US trade gap shrank 6.6% to $37.3 billion despite lower exports, because oil imports fell to the lowest since February 1999.  There is a significant oversupply of oil and the refineries are not buying at current prices and cutting back refining oil for gasoline.  Consequently, you can expect gasoline to rise to $3.50 per gallon this summer.

The Congressional TARP Oversight Panel issued a critical report on the special treatment given GMAC and expressed the opinion that it is not convinced bankruptcy was not a viable option in 2008.  The US has spent $17.2 billion and owns 56.3% and the OMB estimates $6.3 billion may never be paid back.  Treasury has never required a clear business plan to viability from GMAC.  It has a large portfolio of real estate mortgages.

February retail sales were up .3% (expected .2%) but January was revised down from .5% to only .1%, excluding autos February was up .8%.

US manufacturing and trade inventories are at 1.25 months and may continue down, although inventory adjustments may be over.  However, that would remove the largest driver of GDP growth in Q4.

Greek strikes shut down hospitals, schools, airports, bus systems, and subways as drivers, doctors, journalists, and teachers protested wage cuts and tax increases as the Greek government expands its austerity program to reduce debt to please the EU.  The Greek austerity program will contract the Greek economy at least 2.0% in 2010 (same contraction as in 2009).

San Fransisco Fed President Janet Yellin is rumored as a potential replacement for Kohn as Fed Vice-Chairman.

US Treasury auctions:
3 year Treasury, $40 billion, yield 1.437%, bid-to-cover 3.13, foreign 51.8%, direct 10.3%.

10 year Treasury, $21 billion, yield 3.735%, bid-to-cover3..45 (new record), foreign 35.1% (low), direct 17.5% (record).

30 year Treasury, $13 billion, yield 4.679%, bid-to-cover 2.897, foreign 23.9% (low), direct 29.6% (new record).

Bank lending in Japan fell 1.5% in February vs year ago for 3rd straight month.  The Bank of Japan and the government disagree on deflation moves with the government exerting pressure for the Bank to take action to boost prices.

Paul Volcker called IMF study papers suggesting central banks raise their core inflation targets to 4% "nonsense".  Those papers argued that the Central banks would have had more room to lower interest rates without encountering the monetary policy problems of very low or zero interest rates and one paper used modeling of pre-Volcker and post-Volcker time periods to demonstrate it would have provided increased flexibility.

Chicago Fed President Evans indicated there would be zero interest rates and loose monetary policy for at least the next 6 months.

US January exports were down 6.9%, which is the biggest decline since July 2006.

France's trade deficit went down 13% in January.

Japan's Q4 GDP was 3.8% (estimate was 4.6%) with less capital spending.

The Swiss National Bank left interest rates at near zero.

AIG will sell Alico to MetLife for $15.5 billion and use the money to repay Fed loan.

The FDIC is trying to encourage large pension funds ($3 trillion or more) to directly invest in the securitized assets of failed banks the FDIC is offering.  63% of these assets involve other lender participation who might have to take writedowns after auction.

Barney Frank asked the largest banks to writedown 2nd liens.

Besides tariff disputes with China, the US now faces retaliation for US cotton subsidies from Brazil with the support of the WTO, which is allowing Brazil to raise tariffs on 102 US products in what is the second largest # of retaliatory tariffs allowed by the WTO.

Fannie 30 year fixed rate mortgage bonds and 10 year Treasury spread is at .63%, which is the smallest since 1984.

According to a Spectrum survey, in 2009 the number of millionaires increased 16% to 7.8 million from 6.7 million (shrank 27%) in 2008 from 9.2 million in 2007.  Those with a net worth of at least $5 million is up 17% to 980,000.

February Chinese exports jumped 45.7% vs year ago (21% in January) with imports up 44.7% (85.5% in January) and was perhaps skewed by the long lunar New Year.

Chinese inflation for the year to February was 2.7% (1.5% in January) from a low base in last year's slump and holiday spending from last months extended lunar New Year as well as bad weather pushing the price of food up.  This means the inflation rate is above the 2.25% interest rate for 12 month CD's in China.

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Tuesday, March 16, 2010

Are All the Large Banks Insolvent?

Last Thursday, the Lehman bankruptcy court's examiner report was filed.  It was undertaken by Anton Valukas of Jenner and Block; it took a year, is over 2200 pages, and cost 38 million well spent dollars.  The Baseline Scenario has since posted an excellent, brief synopsis of the more relevant sections.  Yves Smith of naked capitalism was one of the first to respond with emphasis on the collaboration of the New York Fed under Geithner, which allowed a series of lowered criteria stress tests to be performed on Lehman and ignored they failed.

Washington'sblog concentrated on the fraudulent aspects of the cooking of the books and the failure of the Fed and the accounting firm, Ernst & Young to sufficiently act on what they knew.  Karl Denninger of MarketTicker espoused the judgment that this proves all large banks are insolvent as the result of fraudulent accounting and government cover up and he was according liquidating all of his long positional trades as a direct result.

We briefly discussed the above on last Saturday's radio show, but did not have the time we would have liked for this subject, because this report shows serious, deep failures of the financial and regulatory system to curtail blatantly fraudulent activities much less systemically dangerous.  How fraudulent?  Can you say ":Enron"?  With Enron, their independent auditor, Arthur Anderson, went out of business, although it was ultimately found they were not as liable as originally alleged.  Unfortunately, it is not uncommon for auditors, particularly if a very large and prominent or otherwise important client is involved, to not press issues or dig deep enough if the client is adamant in their position and the issue involves a technical call decision on facts which are not black-and-white caught in the spot light.  But Ernst & Young had information from a whistleblower, had questioned the transactions, kicked the issue up their own organizational ladder, and ended up going along with it.

Some people are calling for Fuld as the Lehman CEO and Lehman financial officers to be charged with fraud.  Fuld has already denied any knowledge of how the Repo 105 transactions happened improperly.  Basically, they took a financing transaction which should have been reported on both sides of the balance sheet and recorded it as a sale taking it completely off the balance sheet.  Authorities should not only be looking at former Lehman officers but the Board of Directors also.  If members of the New York Fed knew of these transactions, they are complicit.

The Valukas report also questions if JP Morgan Chase, whose CEO, Jaime Dimon, sits on the Board of the New York Fed, made collateral claims in the days just prior to the Lehman failure which put it in an over collateralized position and may have contributed to the failure.  We already know that Joseph Stiglitz believes the Fed district banks are working conflicts of interest with bankers regulating bankers.  How much did Jaime Dimon know about Lehman from his position as a Director of the New York Fed. and did he use it to protect JP Morgan Chase?

Frank Partnoy has questioned whether Lehman was too complex to do anything but fail, because the Valukas report cites numerous valuation problems.  To Partnoy this implies Lehman did not know how to value its trades, assets, and liabilities.  To me, I find it impossible to believe that the Lehman employees and officers did not understand exactly what they were doing.  It was done extensively and repeatedly to such an extent that the Board of Directors had to know enough, at the very least, to not ask.

We have repeatedly discussed the role of Treasury and the Fed in getting regulatory authorities to allow the banks to fraudulently represent their balance sheets while they rebuild their capitalization with new stock and debt issuances.  They have enjoyed the "legal" deferral of proper accounting of assets and transactions which, if practiced by any other business entity would result in terminal fraud charges.  They have been allowed to carry toxic assets on their books at exaggerated valuation.  Repo 105 transactions are not the only type of financial transaction that could have been utilized by any bank to misrepresent value and hide leverage in any of the gray areas of FASB 140 or other financial transactions and trades utilizing off balance sheet entities or other willing companies desiring to make a few basis points quick profit.

The brush fire which has ensued from the Valukas report has started to encircle Tim Geithner and all of the poisoned apples collected in his financial rescue basket.  What did he know and when did he know it or is he just a dupe of the bankers?  If all the banks are using or have used similar financial chicanery much less been allowed to carry toxic assets at inflated values, are any of the large banks not insolvent?

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Friday, March 12, 2010

Leftovers -- Radio Show 3/6/2010

 We emphasized the euro is here to stay and Greece is not going to default, but the EU austerity program includes tax increases, public job cuts, wage cuts, and lower pension payments to current retirees.  The problems in Greece cannot be solved until the mirror problems in Germany are solved: more internal demand and more productive labor wages.  The trade account competitiveness gaps between the southern Eurozone countries and the northern Eurozone countries are a direct result of the structure of the euro and even the primary author of the Stability and Growth Pact has publicly said it was not designed to be applied and create economic harm.

China's hidden debt may push government debt to 96% of GDP in 2011 or about $5.8 trillion, because surging local government borrowing is not counted in official estimates of China's debt to GDP.  China's banking regulator has begun an investigation and review of loans to local government's financing vehicles which were created as investment companies to circumvent regulations against local government direct borrowing.  This crackdown could create a wave of bad loans as projects are left without funding.  This debt could hamper China's ability to maintain growth and control inflation.

Kenneth Rogoff said China may be different, but that does not mean it will not have a financial crisis particularly since it is mired in debt and needs to spend to maintain growth.  The global financial crisis is still filtering its way through China, which is the world's largest economy, and China sees itself as standing alone in a hostile global environment.

A Deputy Governor of the Bank of China said his biggest fear for 2010 is the risks of the dollar carry trade, which China estimates at $1.5 trillion.  If the size of the Fed balance sheet is maintaining equilibrium in currency markets, which the 20 week correlation of .7 to .9 between the Fed balance sheet and value of the dollar appears to support, then any steps by the Fed to normalize rates or reduce its balance sheet (below $1.9-2.o trillion) too fast will tip the dollar into a deflationary rally.

US consumer credit in January went up $5 billion or 2.4% annualized.  It was expected to go down $4.5 billion but December was revised up $4.6 billion.  Credit card debt is down for 16th month in January, while auto and non-revolving debt is up $6.6 billion.

GM February sales up 11.5% vs year ago; Ford up 43.1% (and now has a 17% marketplace share); Toyota down 8.7%.

Pending home sales were down 7.6% in January.

US factory orders were up 1.7% in January (below 1.8 expected) propelled by aircraft sales which were up 118.6%; excluding transportation, orders were only up one-tenth percent.

10 Vanguard sector index funds, which were previously too concentrated for IRS favorable treatment, changed their MSCI benchmarks as did Fidelity previously.

On last Friday, Barney Frank agreed with the Administration that Fannie and Freddie debt should be backed by the US.  He said he supports the earlier Treasury statement that it stands fully behind their debt.  Earlier in the week Treasury testified before the financial investigatory commission that the US never guaranteed TBTF.

GM will reinstate 661 dealers of 1100 who sought arbitration over their terminations.

Stiglitz said the Fed structure is rife with conflicts of interest, because banks sit on the board of directors of each Fed district bank, which means the bankers are governing themselves.  He said that when he ran the World Bank he would have denied assistance to any country which created a central bank with the Fed's governance system.

FDIC will auction $38 billion of securities backed by residential mortgage assets of failed banks in 3 tranches managed by Barclays.

On 2/28, 1.2 million people lost unemployment benefits.  A temporary one month extension to April 5th was signed into law last week, but it does not effect those who have exhausted benefits or exhausted the final tier of extended benefits.  It only extends the deadline for one month allowing the opportunity to qualify for emergency unemployment compensation or extended benefits to continue.  The one month extension will cost $10 billion.

US consumer spending was up .5% in January; income was up .1% but disposable income was down .4%.

Construction (residential) spending was up 1.1% in January, but non-residential was down 1.4% for a total decline of .6%.  Residential is down 6.4% vs year ago and non-residential is down 19.9%.

ISM manufacturing index was down to 56.5 in February from 58.4; new orders were down 6.4 points' employment was up 2.8 points; inventory was up .8.

Outstanding bank credit fell $3.3 billion during the week of 2/17.  This is a 7 week cumulative decline of $150 billion.  Lending to households fell at 12% annualized over the lst 13 weeks.

Pension funds hold 68% of commercial real estate equity.

ISM service sector index was up to 53.0 (highest since 12/07) in February from 50.6; employment up to 48.6 from 44.6; prices paid down to 60.4 from 61.2.

US productivity Q4 up 6.5%; labor costs down 5.9%.  People are working harder for less.  Some economists are speculating that temporary and part-time employment may be coming permanent.

Fed President Rosengren (Boston) like Lockhart (Atlanta) favors keeping rates low and Rosengren said low interest rates were not "solely" to blame for the housing bubble.

Italy 2009 GDP contracted 5% and is estimating a positive .7% for 2010.  Unemployment was 8.6% in January.  The deficit is up to 5.3% of GDP from 2.7% a year ago.

Average wages in Germany for 2009 were down .4%.

French unemployment was up .5% to 10.0% in Q4.

German factory orders were up 4.3% in January (most since 6/07) with input prices up 6.9% (7.7% in January), but economists expect weak economy will not sustain inflation.

The Chinese Premier at their National Party Conference said they need to address the inequality of wages (urban-coastal vs rural) by boosting public welfare in rural areas, by maintaining easy monetary policies, and by holding the yuan steady to support economic recovery.

Bank of England held its interest rate at .5%; ECB held its rate to 1%.

16 country Eurozone Q4 GDP was .1% and contracted 2.7% vs year ago.

Australian central bank raised its interest rate 25 basis points to 4% (4th raise in 5 meeting - did not raise in last meeting).  Unemployment is 5.3% in January (5.8% in October).  Q3 GDP was up .3% and Q4 was up .9% for 2.4% 2009 and 2.7% vs year ago.  GDP is expected to grow 3.0% in 2010.  Public spending was up 3.8% in Q4.

Sweden fell back into recession with Q4 GDP down .6% and Q3 revised to <.1%> from up .2%.

Copper prices are up as the result of the earthquake in Chile.

HSBS profits were down unexpectedly to $7.1 billion in 2009 from $9.3 billion in 2008.  There was a $6.5 billion accounting loss on value of its debt (expected $5 billion loss).  It is paying 3 investment bankers over 9 million pounds each in mostly shares over 3 years.

China manufacturing (PMI) fell to 52.0 in February from 55.8.

AIG will sell its Asian life insurance subsidiary to UK's Pru for $35.5 billion.

Fed vice-chair Kohn (67 years old) is quitting at the end of his term in June.

Fed President Hoenig (Kansas City) said Fed should not be guaranteeing markets zero interest rate for extended period and should raise rates sooner than later but very gradually.  Plosser (Philadelphia) said the Fed must not lose regulatory powers and other bureaucracies are not needed.  He also want TBTF concept to end and be replaced with orderly bankruptcy process.  Fisher (Dallas) said let risky banks fail.  Bullard (St. Louis) wants Fed to treat QE in the same manner as adjusting interest rate policy.

US Treasury auctioned $272.17 million of Bank of America warrants and got in excess of $1.5 billion with A warrants fetching $8.35/warrant ($7 minimum) and B warrants selling for $2.55/warrant ($1.50 minimum).

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Wednesday, March 10, 2010

State/Local Governments: Dupes or Incompetent?

The impact of derivative swaps by state and local governments to insure against interest rate swings is again surfacing in this continuing Fed policy of zero interest rates (ZIRP).  The most recent story has been Los Angeles, which bought interest rate swaps from the Bank of New York Mellon to protect it from higher interest rates and in this zero interest Fed environment now finds itself paying the Bank of New York Mellon $10 million annually until either interest rates go up or until 2028.

The heart of the issue is were these governmental entities the victims of fraud or incompetent?  They were convinced by sales presentations to convert 10 year bonds that could be retired or restructured into 30 derivatives contracts which did not allow call or retirement, without penalty, if interest rates fell.  Some in the investment world have argued that it is buyer beware, although the governmental entities are often characterized as greedy, and, now, with lower interest rates they are whining.  Some commentators have focused on a New York Times writer who cannot grasp the different types of derivatives and swaps despite repeated criticism.  Was there a reliance upon the presentations of the securities brokers and investment bankers and were those presentations too optimistic and not forthcoming in the possible negatives?  In Italy, as we have previously reported, Bank of America has become the focus of a national fraud investigation with respect to its advice and sales of swaps to municipalities.  In Jefferson County, Alabama, the fraud was in the favorable placement of bonds and purchase of swaps with a securities broker.  In that case the former mayor of Birmingham took bribes and got 15 years in prison, the broker got only 52 months, and the broker's consultant-intermediary got 4 years in prison.  Notice the securities broker who wanted the business and made the bribe payments only got 52 months.  JP Morgan Chase, Bear Stearns, and Goldman Sachs paid the broker to secure the business.  While SEC fines have been paid the banks are demanding dismissal of fraud charges.  Several states have found themselves stuck with swaps, such as New York which paid $103 million to terminate $2 billion of swaps and still had $3.74 billion of swaps as of 11/30/2009.

Obvious, world-wide, governmental entities have been taken by fast talking investment salesmen.  As Felix salmon observes in this last link, interest rate swaps are sold rather than bought.  He points out that if the governmental entities had known enough to design the swap they wanted and asked for bids, there would have been less problems.  My experience is that governmental entities do not understand the counter party risks, the downsides, and the constraints and penalties, because they focus on the "savings" in the future of increasing interest rates.  In doing so, they fail to cost out the different scenarios and options before being sold.

We have discussed how auction rate securities were sold as liquid investments when, in fact, there was no guarantee by the issuing banks that the auctions would be held or the securities bought back if the market froze.  When the market did freeze, the cry of individual investors caused state and US regulators to force the banks to settle with these individual investors, but the governmental entities have had to fend for their selves.

Hawaii has lost $250 million in writedowns of $1 billion in auction rate securities bought from one securities broker, who had lobbied the Legislature to approve the investments, working for Citigroup.  While the State was limited to no more than 20% of auction rate securities to cash assets, the investments may have actually approached 29%.  Hawaii has rejected an unspecified offer from Citigroup to settle.  Maui County is suing Merrill Lynch over a similar investment.  There have been mixed judicial outcomes of governmental entities suing, because those which have tried to recoup 3 times the losses by alleging anti-trust violations have run afoul of SEC law and regulatory power over multiple participants preempting anti-trust law.  The proper way to proceed is to allege fraudulent, unfair, and misleading practices.

The same is true with respect to the interest rate swaps bought by governmental entities.  They should be repudiated and told to take the deceptive and misleading contracts back.  If they will not make a reasonable offer to settle, they should be sued for felony fraud.  However, one needs to be very careful in selecting an appropriately experienced attorney without conflicts of interest with the OTC dealer community.

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Sunday, March 7, 2010

Credit Card Robbery

Both Karl Denninger of Market Ticker and Yves Smith of naked capitalist have commented on the new credit card user agreements that have been sent out in preparation for the new credit card law, which Citigroup wrote for the Administration, which has just recently taken effect.  We have previously commented on several areas which will bear watching and will undoubtedly have negative effects on consumers.  We commented on the radio show yesterday about the comments of Smith and Denninger, but it is serious enough that it deserves its own post rather than being lumped in with the Leftovers.

Using the JP Morgan Chase new user agreement as an example, both Smith and Denninger exposed the wording that would allow the bank to demand immediate and full payment of the credit card balance if they have any reason to "believe" the account holder may be unwilling or unable to pay as the result of "information" they may receive without regard to your account being current and no payments late or missed.  Universal default was to be illegal, but the banks have used legal language to circumvent the prohibition and make make a "maybe if" rather than a specific act reason for immediate and full payment.  This is not just a continuation of complex contract abuse; it is a direct threat to human liberty and due process.

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The Global Gambit vs. Regulatory Reform

In February, IMF managing director Dominique Strauss-Kahn at Davos, warned the US and European countries should not attempt financial regulatory reform nationally and urged governments pursue a multilateral, global approach.  His concern is that different national reforms will be inconsistent.    He is echoing concerns of international regulators and bank executives who do not want the "closely coordinated" efforts during the financial crisis in 2008-2009 giving why to concrete national initiatives providing reform regulation.  These are the same bankers who tell countries proposing regulatory reforms that banks will just move to other countries.

They are reacting to the proposed "Volcker" rules in the United States, which, as we have discussed previously, would actually leave the big banks as is while imposing a ban on proprietary trading.  The EU finance ministers publicly opposed this limitation on bank size and risk taking as inconsistent with the current European universal banking system.

Yet, when it is discovered that Greece, and other Eurozone countries, used legal currency swaps in 2002 to help hide debt, the EU wants to divert its attention from the real euro crisis to its current manifestation in the pan-European debt crisis to how international large banks made money legally but in a way which is fundamentally systemically dangerous.  Even while we have a demonstration of systemically dangerous investment banking by large international banks, a German economist has written that the re-instatement of Glass-Steagall type laws as the "Volcker" rules imply are unnecessary, because the US "... system of bank separation remained fairly intact up to the outbreak of the crisis."  He argues the US is actually trying to undo the Paulson-Geithner conversion of Goldman Sachs and Morgan Stanley into investment-commercial banks and reassert the legacy of separate commercial and investment banking which, in his opinion, made the crisis worse.  According to this German economist, the cavalier risk taking that led to the crisis was actually "...due to their inadequate capital reserves."

While the need for better capital reserves is obviously necessary, the German economist is actually arguing for a continuation of the current universal European banking system, which the separation of commercial and investment banking would directly challenge.  This raises the question of how systemically dangerous the universal European banking system is even if currently bureaucratic regulatory proposals are adopted and capital reserves increased.

The Baseline Scenario succinctly summed up the illusion of international governmental cooperation.  The WTO and the IMF have no authority and the EU Financial Stability Board is a "paper tiger".  The FSB is merely a forum for regulators and bankers to talk shop.  The big international banks have known this and use it to keep the process "international" and going no where meaningful.

Paul Volcker in a recent speech in Europe argued that commercial banks will become more like hedge funds unless limits on proprietary trading are not imposed.  He asserted that it is not in the public interest to have banks take deposits and use that money to engage in risky trading.  ECB President Jean-Claude Trichet, in defense of the current universal European banking system, expressed concern this would just push regulated activities into the unregulated hedge fund sector.

Who said hedge funds, and other shadow banks, should be left unregulated?

It all comes down to Joseph Stiglitz's early February opinion piece that differing opinions and priorities make global coordination difficult, if not a prescription for paralysis, which would only benefit the bankers. The only way to stimulate effective global cooperation is for individual nations to establish what they believe is a good regulatory structure for their nation.  This would force the bankers to fight multiple regulatory fires here and there and expose their attempts to prefer little regulation.  It is in the best interests of self-protection for each country to deal with its own regulatory needs and the leave the subterfuge of global intertwining behind to enable global regulatory coordination to be addressed later as self-protected countries seek coordination from positions of strength.

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Friday, March 5, 2010

Leftovers -- Radio Show 2/27/2010

Tyler Cowan and Felix Salmon both commented on Gary Gorton's new paper, "Questions and Answers about the Financial Crisis", with regard to the use of repos creating fragilities in the banking system.  Banks no longer just use deposits as funding sources.  The use of repos as funding sources creates a systemic risk, because the bond market depends on the denial of risk and when risk becomes questioned, the bond market comes to a grinding halt.  We should not try to guarantee repos as we guarantee deposits, but all systemic risks should be regulated and decisions made on how commercial banks function and investment/trading banks function.

China's banking regulator told commercial banks to restrict new lending to local governments and stop lending to those projects backed only by expected fiscal revenues.

China has performed some stress tests of potential yuan appreciation.  The tests which concentrated on the textile, shoe, garment, and toy exporters found that every percentage point of yuan appreciation would erode one percentage point of their profit.

While derivatives traders are still betting the euro will continue to slump, any speculation that the euro is doomed or will fade away is misplaced.  It is here to stay, although the EMU needs to restructure its trade and monetary policies, as well as how it applies the Stability and Growth Pact.

The Greek central bank governor said the Greek balance of payments gap is unsustainable.  As we have been saying, a crucial part of the current problem is the fixed trade exchange rates between the Eurozone countries, which create competitiveness gaps.  The Greek central bank governor said, "The balance of payments deficit is not sustainable. A policy mix which will bring back the macroeconomic and microeconomic imbalance and improve the economy's competitiveness and productivity is needed to restore sustainability."

The economist, Carlo Bastasin, has written that the IMF cannot help Greece, because it is less able to address the problem of restoring equilibrium  in the current account balances within the Eurozone.  The Greek fiscal deficit and the loss of competitiveness are connected, because a current account deficit (imports over exports) will make it more difficult for the Greek government to raise taxes to cover the public deficit.  "...If Greece's growth prospects are more limited, its existing debt burden is more onerous."  To avoid this, the domestic demand of Greece's trade partners needs to increase.  "In other words, the Greek problem is the mirror image of the 'hidden' German problem", which needs to increase domestic demand and lower labor costs.  You cannot solve the Greek imbalances without correcting the German imbalances.

The role of large banks and hedge funds in threatening the survival of Greece and the value of the euro in order to make short term derivative trading profits is drawing the attention of other European countries and there is a growing consensus that regulatory action may be necessary as the credit default swaps are increasing systemic risk. 

The ECB refuses to release information as to how many Greek bonds are on its balance sheet as the results of its repo operations.  It is speculated that many of the Greek bonds, of which there are approximately 270 billion euro total, which were held by European banks are now in the possession of the ECB and 37 billion held by Greek banks.

After the EU commission visit, the Greek prime minister said that the worst fears of the Greek economy had been confirmed and the Greece would miss its deficit reduction efforts if it did not carry out more spending cuts which have already sparked demonstrations.  The EU commission indicated that Greece may be able to cut its deficit by 2% rather than the 4% goal. There is increased antipathy between Germany and Greece, which will hinder Greece's ability to obtain EU support for its deficit reduction program.

Portugal has said it is under no pressure to speed up bond sales as 20% of its financing needs have been met for the year.  Portuguese bonds are the worst performing in the region.

The Bank of Spain is considering raising the minimum amount banks must hold in provisions of potential losses in property assets.  Many experts believe Spanish banks will face a new housing crisis in the coming months.  They may have to absorb between 100,000 and 150,000 homes immersed in foreclosure cases.

The Irish government is being forced by the EU to take a 15.7% stake in the Bank of Ireland PLC in lieu of a 250 million euro cash dividend due the government despite the need to contain government deficits.  The government holds 25% preference shares in both the Bank of Ireland PLC and Allied Irish Banks.

Italy has the second largest debt and is considered to the economy of the Eurozone according to the economist Robert Mundell, who won the Nobel prize in 1999 for research which lead to the creation of the euro.  Italy's economy contracted .2% in Q4 and risks falling back into recession.  It has 1.8 trillion euro in debt, which is five times that of Greece and one-quarter of the Eurozone debt.

US Treasury auctions: 
30 year TIPS, $8 billion, yield 2.229%, bid-to-cover 3.33, foreign 42.4%, direct 15.1 in what was seen as a weak, soft demand.
2 year Treasury, $44 billion, yield .895%, bid-to-cover 3.33, foreign 53.6% (high) and 100% filled, direct 8.2%.
5 year Treasury, $42 billion, yield 2.395, bid-to-cover 2.75, foreign 40.3%, direct 12.8%.
7 year Treasury, $32 billion, yield 3.078%, bid-to-cover 2.98%, foreign 40.3%, direct 17.2%.

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Argentina, Oh, Argentina: Playing With Fire

While the world watches Greece, Argentina is burning.  Because both countries have debt problems and endemic private and public corruption, some commentators have tried to draw parallels between the two.  In fact they are two very different situations.  In 2002, Argentina defaulted on $95 billion of debt internationally.  Greece is not in jeopardy of default and will not default.  While both countries are still emerging from dictatorship, the level of private (including tax evasion), public, and political corruption is far more invasive in Argentina with its peronista culture.  While Greece has a competitiveness problem within the Eurozone as the result of fixed trade exchange rates, the euro is not a pegged currency.  The Argentine peso maintained a fixed peg with the US dollar for 11 years until 2002 which increased its dependence on US dollars and foreign debt leading to the 2002 default.  Beginning in 2002 with the rescinding of the currency peg, inflation broke out and has continued to the present as a virtual way of life and may approach 20% this year.

In 2001, de la Rua resigned the presidency and Duhalde, an economically center left Peronist, became interim president with unemployment at 25% and capital fleeing the country.  Despite intense social protests, the country used the currency devaluation to re-industrialize, increase internal demand and exports leading to fiscal and trade surpluses.  In 2003, Kirchner, a social democratic Peronist, was elected president and Argentina paid off its IMF loans, restructured its defaulted debt at a 66% discount, renegotiated utility contracts, began nationalizing privatized businesses, applied price controls, and engaged in a sweeping public works investment program.  Kirchner's approach to inflation was to remove those in charge of studying and issuing inflation statistics with his own people; consequently, "official" inflation statistics are less than one-half of reality.  In 2007, Kirchner "stepped" aside to let his wife run and be elected president and she has continued his policies, which aggravate and continue the inflation.  In 2009, the Kirchner's political party lost control of the Argentine Senate, which is leading to a potential political confrontation.  The emergence of major bribery and corruption scandals from Nestor Kirchner's administration are continuing and will not die away.

In 2008, Fernandez de Kirchner had a law passed allowing the government to seize all private pension funds allowing the government to invest the pension funds in government bonds, which were used to make international debt payments.  If Argentina is going to be able to borrow internationally, it must continue to repay its re-structured default debt.  Despite the Argentine central bank being a political extension of the government, Fernandez de Kirchner fired its president Redrado, when he refused to transfer central bank foreign currency reserves to the Treasury, and replaced him with a political ally, Mercedes Marco del Pont, who will guide the central bank consistent with the economic policies of the government and who transferred $4.2 billion to the Treasury without the necessary legislative approval.  These foreign currency reserves will be used to pay international debt.

The transportation monopolies, which accept only coins, are so corrupt that the country as a whole has a shortage of coins as these companies hoard the coins and charge exorbitant fees for paper currency exchanges.  Regular businesses and individuals would rather give excess change in paper currency than part with a coin.  Beef prices, as the result of production and export taxes (which effect supply) as well as inflation, are up 25% in this beef eating country.  Argentina's budget deficit to GDP will double this and the country faces an inflation-wage price spiral as Fernandez de Kirchner aggressively seeks to appropriate money from whatever sources to pay international debt and continue an aggressive public works program in defiance of Argentina's Congress.

Is Argentina so systematically corrupt that its citizenry cannot demand a free society and have grown to expect the choices to be one type of corruption or another?  At what point does this out of control inflation, which has been accompanied by growth, become socially intolerable?  Is the massive public works program keeping enough people employed and fueling enough future growth?  Will increased political confrontation require public diversions?  Oil has been discovered in the Falkland Islands (Malvinas) and Argentina and the United Kingdom are butting heads.  Both countries have economic difficulties, with Greece debt problems focusing a lot of analytical attention on the United Kingdom, and both could politically benefit internally from an international confrontation involving sovereignty and oil.  Posturing rather than actual military confrontation is the most likely scenario, particularly since Argentina has cut military spending by 50%.  Argentina has gone to the UN and the United States is not supporting the United Kingdom.  The United States Supreme Court also allowed Argentina private pension money in the United States to be turned over to Argentina.  While trying to mitigate Venezuela's, and its allies Iran and Russia, influence as well as China, the United States may be playing into their hands if the UK redeploys troops from Afghanistan to the Falklands in a demonstration of strength that could bolster Gordon Brown.  The current situation could strengthen the Rio Group at the expense of the Organization of American States as well as the commercial-strategic position of China, Russia, and Iran in Central and South America.

Argentina's central bank has consistently failed to promote price stability and monetary policy and has been unable or unwilling to divorce itself from fiscal policy.  It is a perfect example of the failure of a corrupt central banking system tied to a corrupt political system.  Unfortunately, Argentina's inflation problem has geopolitical consequences.

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Tuesday, March 2, 2010

Economic Warfare: China & the United States

A book, "The China Dream", written by a senior Chinese Army officer, Liu Mingfu, who is a professor at their National Defense University, has recently been published.  This is the second book recently published by senior Chinese Army officers on China's relationship with the United States, as Colonel Dai Xu also published a book in which he argues that China is surrounded by countries largely influenced by the United States.  Senior Colonel Liu Mingfu argues that China will become the number 1 economic power in the world within the next few years and this will involve economic warfare with the United States which could escalate into military warfare in ten to twenty years.

While the Chinese Army has been upset over military sales to the Taiwan government and the reception of the Dalai Lama by President Obama to the extent the Chinese Army has suggested China should start selling US debt, the Chinese government does have significant global economic power which is growing.  Economic warfare is not new.  The CIA has had an active economic warfare operation from almost the beginning of its existence.

A 2007 paper published by the United States Army School of Advanced Military Studies very conservatively predicted China would become the number 1 economic power by 2025 and argues that America's economic assets must be utilized in economic warfare strategy.  It quotes extensively from the 2002 book "Unrestricted Warfare: China's Master Plan to Destroy America" written by Chinese Army Colonels Qiao Liang and Wang Xiangsui.  Unrestricted Warfare concentrated on economic warfare, the use of trade, and the effect of revaluation and devaluation of currency and its effect on target countries.

While the United States needs China to buy US treasuries, China does not publish a breakdown of its foreign asset holdings and there has been recent controversy whether Japan has displaced China as the largest holder of US debt.  This could easily be just a temporary re-balancing of China's central bank's foreign investments and currency holdings.  There has been some speculation that China may be buying IMF gold, but this does make a lot of sense unless China is using the carry trade on the US dollar to divest itself of US dollars as one can presently obtain more value by buying gold with the euro.

The United States has repeatedly indicated China needs to appreciate the value of the renminbi which is tightly pegged by the Chinese government to the US dollar.  The United States has also predicated its economic recovery on export growth and has advocated an unrealistic doubling of exports within five years.  This can only be done at the expense of other countries, such as China.

We have seen oil used by the Arab countries in the 1970's as a form of limited economic warfare.  While it has been obvious from 2007 to the present that oil futures prices are driven by speculators with futures contracts far exceeding actual delivery, to the point where oil prices make the refining of oil unprofitable in the United States despite a staggering over supply of oil.  In James Norman's book, "The Oil Card", he argues that oil could be used as economic warfare against China by keeping the price high.  The problem with keeping oil prices high is that it significantly impairs economic recovery in the United States and globally.

In 2009, the Pentagon held a war game which involved economic warfare only among five teams: China, Russia, United States, East Asia, and All Others.  China won.  The United States was second.

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