Friday, May 12, 2006


Is Bernanke Losing Control?

This Market Watch article sizes up the Feds' performance. "All eyes are on the Fed, and one respected institutional service thinks there are reasons to dislike what they're seeing. It's nearly eight years since the Long-Term Capital Management hedge fund cratered. At that time, the Federal Reserve engineered an extraordinary bailout on the (highly debatable) theory that the financial markets would otherwise be fatally disrupted. What would happen if there was another LTCM today?"

"The Connecticut-based institutional service Bridgewater Daily Observations, which itself manages over $150 billion, has been asking this disturbing question and getting a fairly disturbing answer. In recent issues, Bridgewater pointed out that money invested in hedge funds is now five times higher than in 1998, when the LTCM debacle occurred."

"Bridgewater also tried to show that hedge funds are vulnerable to the same things: 'tight credit, widening credit spreads, and falling equity markets.'"

"Bridgewater's summary: 'We estimate that an unfavorable environment, in degrees comparable to 1994, 1998, and 2000/01 will cost..equally to about 2/3 of the S&L crisis and twice the size of the Mexican default in 1994, i.e. it is material, but not system threatening.'"

"That's the good news. The bad news: 'the system can withstand a moderate economic crisis (like those that occurred post-1993) but not a major one (like 1974).' Bridgewater estimates that losses with the current hedge fund regime would have been $80-$100 billion in the post-1993 crises, $300-$350 billion in 1974 (and $500-$600 billion in 1929)."

"And then there's the REALLY bad news: Bridgewater also expects a major international system crunch exactly like the collapse of the fixed exchange rate Bretton Woods system, which lead directly to the inflationary crisis of 1974."

"Wednesday morning, Bridgewater's Daily Letter was headlined, 'The Tremors Before the Big One' and concluded: 'We believe the odds of a dollar/ U.S. debt crisis in the next twelve months are elevated (say 50 percent).' A week earlier, Bridgewater pointed squarely at China's manipulation of its exchange rate and at new Fed Chairman Ben Bernanke's handling of the situation."

"In an issue titled 'Bernanke's Test begins,' Bridgewater wrote: 'Today's imbalances are much larger and global in scale. They have been sustained for a longer time because China, and many other countries, are not defending a declining currency with shrinking reserves. Instead, they are resisting rising currencies with increasing reserves, a much more sustainable action.'"

"The result, according to Bridgewater: 'bigger imbalances that have taken longer to build, have been sewn deeper into the economic fabric, and will take much longer to unwind, with dramatically larger financial consequences.'"

"Bridgewater's savage summary: 'Now you've got a new, academic, waffling Fed chairman, a falling dollar, a falling bond market, rising gold and commodities prices, and an underperforming stock market all with a giant current account deficit.'"

"Its caustic conclusion: 'Bernanke is rapidly losing control.'"

As someone has already asked, if you were Ben Bernanke what would you do? He only has a few options, raise rates, lower rates, hold rates. Increase the money supply, decrease the money supply. I still contend after all these years of dollar devaluation the FED has painted itself into a corner. Inflate or die! Deflation will occur ultimately. Damn shame the Federal Reserve was ever established in the first place,IMO. All fiat paper ends up in the same place, in due course!
With 80% of GDP tied with export, China doesn't afford to raise exchange rates dramatically. What I see will happen is they will put up small percentages from time to time to placate Western pressure.

China is only a conduit to the world from commodities to consumption. The problems starts with the US.

Greenspan deliberately inflated with Bush's mindless tax cuts, which resulted in the unsustainable debtload we are having now. Senate just extended the tax cuts for capital gains. All the forces are still in the system.

Short of raising rates like Volcker, Bernanke is not going to reverse the course. Bernanke is a dove. That's what he is.

Long bonds will go up with inflation and gold. Housing and consumption will be dive with high gas prices.

We are reliving the 70s, folks. Only there is no Volcker to save us.
At least we're not reliving the '60's, like the other half of our political class wishes were true.
Personally, I think we're in uncharted territory here. I can't imagine how BB copes.
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