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Forex Blog - By Any Means Necessary

By Any Means Necessary


Lenin and Trotsky agreed on a strategy for the socialist revolution in Russia – by any means necessary.  With developed capitalist economies running headstrong into nationalizing key industries starting but not ending with banking under the too big, too connected and too influential to fail principle, one can easily imagine Paulson and Bernanke are the modern day revolutionaries bringing socialist principles to banking under the strategy of by any means necessary.  


However, I am not making a case for a Darwinian outcome nor for a Soviet outcome.  Both are unacceptable and neither Paulson nor Bernanke are closet socialists.  But there actions to date speak of far greater fears over the health of the banking system and economy than I think many give them credit for.  Indeed the actions foretell a by-any-means-necessary response because they perceive the scale of the problem is so enormous that a revolutionary response is needed. 


Think for a minute about the ideologues in the White House who operated on the assumption that less government regulation and less government period in markets was best for everyone now leading the largest government intervention into the banking system in the nation’s history.  Things have to be really bad to allow this about face.  This brings me to the Fed Chairman’s appearance this week in Congress where in his prepared remarks he said a second stimulus package, which Democrats to that point had been advocating, would be helpful.  Well I’ll be a monkey’s uncle.  Now the White House is on board.   Is this a dream/nightmare?


My point is underestimating the power of the banking and economic crises and adverse feedback loop has been the main characteristic of markets for much of the last 14 months.  The Fed’s balance sheet has nearly quintupled this year and is approaching $2trln.  The Fed has cut 375bps since last September and will cut more October 29 (if not sooner with other central banks in light of the collapse in equity prices today).  The Treasury has committed $250bln into recapitalizing banks and has another $450bln earmarked for buying distressed ABS.  All arguably needed and yet still not sufficient. 


Why?  Because the problem is not static…it changes and it is compounded by, and compounds, the economic crisis.  Just when you thought things were cooling down wham and there is a run to dollars, bonds and out of stocks and EM...the anti-risk trade.  All this makes me think that there are large segments of capital mkts that are completely illiquid and fund managers are being forced to sell anything that is the least bit liquid to cover margin calls, redemptions, or collateral postings. 


So a partly nationalized banking system is not the ticket to normal capital mkts with liquid market segments.  Six years of leveraged investing and structured yield plays does not unwind in 13 months much less 4 weeks.  The tide is still rolling out and exposing new naked cards, corporate debt (see Bloomberg on the CDO mess brewing), corporate FX exposure (see WSJ article today on Latam corporate currency trading gone wild), Latam corporate local currency debt, leverage loans, convertibles, swaps, credit, commodities...nearly everything.  So policy response has closed gap on banking problem but the banking problem is not is morphing into new problems and non-bank corporate/household problems also proving a little underdressed as tide rolls out. 


I still out of the bunker but have not taken off the lacrosse helmet.  God bless Warren Buffet for buying for his country, but that is so not a successful strategy for this crisis.  Buying equities 10% from the lows two quarters from a bottom is rational.  And since the deeper recession scenario is now the favored one, equity bear market should last at least until halfway through the recession which makes next summer the earliest we should expect a bottom in stocks and frankly this may not happen until late 2009 if the 2-year recession is in our future.  As for the reflation trade – it is coming but will be much later than most expect…even with the Fed balance sheet exploding and the treasury dropping debt from helicopters…and yes with all that is wrong with the US banking system and economy the dollar collapse on reflation will be a very long wait. 


David Gilmore



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