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Thursday January 29, 2009 - 23:05:06 GMT
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Forex Blog - Beyond Repair

When the TARP was patched together last fall I said it was a down payment on the banking problem and more would be forthcoming.  Well here we are a quarter later and the new President and his advisers are trying to find a way to finance another $1-2trln in bank bailout – presumably funding a bad bank aggregator along the lines of the RTC and the S&L crisis of the 1980’s. 


The problem is the problem.  The banking crisis is not stagnant.  It grows faster than the policy response and it infects more “healthy” segments of the real economy that our banking system is heavily exposed to.   It seems to me that officials have approached the crisis as stochastic points in time and treatable and arrestable while ignoring dynamic nature of the problem.  And despite paying lip service to adverse feedback loops.  Hello, the adverse feedback loop started in Q4 2007 and went asymptotic in Q4 2008. 


No one really knows how much cash is needed to recapitalize banks…US or any other national banking system.  But showing up with a few vials of morphine at Normandy Beach is no way to boost moral among the soldiers face down in sand.  And if psychology is a key component in the feedback loop than it is shock and awe – over gunned – that can turn the tide in the war.  Sadly few governments have the ability to marshal the kind of resources needed to turn psychology and stop the bleeding.  Obama can’t go back to Congress for $1-2trln for the banks in the next few months for new rounds of bank capitalization (there are no private investors willing to pony up for shares in banks) or for a pool of funds to buy illiquid toxic assets at some artificial price.  The public won’t stand for it (why the House Republicans said no to the stimulus plan) no matter what the majority votes the Democrats have in Congress.    


And it is very likely that the $815bln (got rid of contraception funding) stimulus bill that the House has passed and the Senate will rework and both chambers are sure to pass is equally a down payment on economic growth much as TARP was for bank capital.  It is more than any single stimulus package that has been seen in generations if ever.  But it impacts the economy with long lags (debate rages over how long) and the problem changes (worsens).  So by the time the government is spending and taxing its way out of the recession, the recession is significantly worse.  In other words, like TARP, more pothole filling. 


Anyone that thinks the worst is behind us only has to look at the layoff announcements this week from top US firms spanning the range of industries from technology to pharmaceuticals.  Retail sector has joined the pileup of the auto sector and the firestorm in housing.  Banking employment is particularly at risk of going retail.  Until states are bailed out government is going retail, auto and housing. 


GOP leadership in the House stress the need to cut taxes for corporations and small businesses (read income tax as small businesses pay tax on income for partnerships, proprietorships, S-corps and LLCs) and the latter is where the bulk of new jobs are created.  Well anyone with a small business does not have much of a business left if what is up the food chain of companies is utterly under water or in the bomb shelter in a fetal position.  In our little office complex in Essex, CT the occupancy rate has plummeted (all 1-20 people firms).  Moreover, what company will take a tax cut and use it to expand capacity in this economy?  Unless the government requires firms to use tax breaks to invest or hire this is a pure < 1 fiscal impact (which I think personal tax cuts would prove to be as happened in the 2008 tax cut…pay down debt or save and < 1 impact).  And how better off is the economy if corporate tax breaks were indeed used to increase capacity (more capital and labor)?  Sounds like a fast way of piling on to the inventory overhang problem.


Housing, despite Pollyanna bloviators on the airwaves, is still in a nosedive and why shouldn’t it be in light of the soaring unemployment rate?  Foreclosures are running rampant and now impacting prime jumbo mortgages not simply subprime and Alt-A loans…conforming prime mortgages are showing stress too.  Many have confused banks selling homes out of foreclosure in places like California as indicative of a turn in the housing sector.  I would view this activity as a bear market rally…those who think the real economy will not threaten income and wealth more ahead are buying “bottoms”.


And international trade and strong emerging economies, the lifeline that so many economists said would cushion the downside in the developed world and make for a shallow and short recession, have disappeared faster than bank assets.  Exports are collapsing globally.  China can only import what it will export.  China’s government can spend trillions of USD to keep the economy growing, but this is unlikely to end up driving imports higher – slow pace of decline at best – as China’s government has no incentive for expanding capacity and city build-outs that are driven by international trade.  China’s fiscal stimulus will pay for basic sustenance for the hoards of poor and few newly minted middle class.  I don’t see China’s fiscal policy offering much of a backstop to weak domestic economies in the region or world.  And many emerging nations do not have the luxury of China’s vast savings (government and private).  What do they do?  IMF and WB are severely underfunded for the crisis washing over the emerging and poor nations of the world where defaults, failed states, war and famine are real risks.     


I think we moved from recession to deflation/depression in Q4 2008...we will see a hint of it in Q4 US GDP Friday with a 5-7% SAAR contraction.  I don’t think the policy response in the US where arguably it is most developed and largest proportionately is adequate to achieve much more than filling potholes and falls short of even the basic objective of freezing the problem or buying time.  Which reminds me of Paulson and Bernanke claiming TARP successfully stabilized the banking system…you have to be kidding me.


My opinion for what it is worth is that much more of everything is needed and more government not less (with public ownership of upside not just downside – go Nordic).  But I also am aware of the impossibility politically and ideologically of having a policy response that can stop the decay, stop a depression.  A year ago TARP and a bad bank aggregator might have done it.  But they came later in the game when the virus had spread throughout the host. 


Increasingly the Fed and its balance sheet, not Congress or the White House, will be where future financing of policy fixes come from.  Unfortunately the response is so late and the problem is so much bigger that the end end game of hyperinflation seems unavoidable.


I still hate stocks, like gold (will never love gold) and think emerging currencies collapse.  Bonds and the dollar do okay until the Kool-Aid runs out.


David Gilmore




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