Thursday, June 15, 2006


'Floating On The Crest Of Cheap Credit'

The New York Times has this opinion piece titled, 'The Mark of the Bust.' "What may be the most important number in the American panoply of economic statistics appears every Thursday night as an appendix to the weekly statement of the condition of the Federal Reserve System. This generally ignored number, few, if any, newspapers cover its release, has the unusual virtue of accuracy, for it is a simple financial statement derived from an adding machine, not from a computer or a formula."

"What the number announces is the quantity of government and agency securities held 'for foreign official and international accounts', that is, for foreign central banks and finance ministries, by the federal reserve banks. It is important because over time it measures the demand for American assets by private enterprise in the world's creditor nations. It is important also because it is very large, last week, about $1.63 trillion. Three years ago it was about $900 billion. The week George W. Bush took office, it was $693 billion."

"Our appetite for imported goods throws some $600 billion to $700 billion a year into the hands of foreign suppliers. The businesses that receive these dollars have two fundamental choices about what to do with them: spend or invest them in the United States, or convert them into their own local currency. Exporters to America who keep the dollars and use them for American purchases and investments create what economists call an autonomous flow of funds back to the United States, financing the American trade deficit with an American investment surplus."

"This produces the argument most closely associated with the new Federal Reserve chairman, Ben Bernanke (though Alan Greenspan believed it, too), that our trade deficit is caused by a surplus of savings that can't be profitably invested in the home countries of our trading partners. Financing for our trade deficit comes before, and actually causes, the deficit itself."

"If instead of investing their dollars in the United States, foreign exporters want to take the proceeds of their sales in their own currency, their central banks will in effect sell them that currency for their dollars. Back in the late 1960's, when Great Society deficits and the Vietnam War prompted the first serious sell-off of dollars (and forced the United States to abandon the gold standard because too many holders of dollars, led by President Charles de Gaulle of France, wanted gold), those central banks lent those dollars into the new Eurodollar market, where they traded somewhat separately from domestic dollars."

"This created a nightmarish prospect of the United States losing control of its own currency, and in 1971 the Fed chairman, Arthur Burns, negotiated a deal with the European and Japanese central banks. The deal was that they would return to America the dollars they acquired in their own economies, and the Fed would invest the money on their behalf, in absolutely safe government securities, without charge and at the best rates."

"Today, the Fed continues as custodian of the 'foreign official holdings' of such government obligations. During the Clinton administration, the Fed agreed to invest in federally guaranteed housing securities for those foreign central banks that wanted a better yield on their dollar reserves than they would get from government bonds, and now more than half a trillion dollars of the total official holdings are invested in agency paper."

"Foreign official holdings of government paper is a miner's canary number. It tells you if there is big trouble ahead. The most common worry is that the number will shrink suddenly, with foreign governments dumping their dollar holdings, driving down the dollar's value and driving up American interest rates, but that's not a real danger."

"What we have to watch out for is a sudden and drastic increase in foreign official holdings. Rapid growth in this number in the late 1960's and 1970's forecast the recessions of the early 1970's and 1980's, and it could happen again."

"Recent large increases in foreign official holdings indicate that foreign private investors see fewer attractive places to put their money in the American economy. They could presage a significant fall in the price of American assets, stocks (witness the recent drops in American stock markets) and bonds and real estate and all, and a hard landing for a world economy still floating on the crest of cheap credit."

The Times and this think tank fellow can say things like this without being called a conspiracy nut. This revolving paper 'deal' the central banks run will work until it doesn't. The question we should be asking is, why can't we have a sound currency instead of these back-room agreements?
because a sound currency means you have to make tough choices.

plus, the banks love their fiat money/fractional reserve system that to create money out of thin air and charge interest on it. if they fail, it's heads I the banks win and tails the banks win. they won't give up a free ride like that willingly.

there are a few good books on this topic, I'll try and find them.
In answer to Ben's question, I'd say because (unfortunately) a sound currency is a currency that can't be stretched. And such a currency would require fiscal responsibility -- something sadly, no government in history has been capable of for an extended period of time.

This seems like a very pivotal moment, where capital is being held and not invested. With US debt levels at an all time high and the real possibility of a downgrade in the ratings for US bonds, appetite for US dollar assets is likely waning. US consumer demand is clearly looking over the edge of the precipice. Emerging markets are looking shaky as ever, and gold is (IMHO) looking increasingly downwardly manipulated by the powers that be. I think the big question is, where is the capital going to go then? Or are gold and silver the answer (again)?
A related link:

'The US dollar lost ground for a second session as portfolio inflows into the US disappointed and rising interest rate expectations appeared to lose their ability to support the greenback.'

'The US Treasury reported that net inflows into US assets of more than one-year duration totalled just $46.7bn in April, the lowest figure for a year. This was not only below March inflows of $70.4bn and consensus forecasts for a reading of $60bn plus, it was also insufficient to cover April's trade deficit of $63.4bn.'

'At a time when global imbalances have taken on greater importance in the market psyche the decline in inflows will come as a blow to the dollar,' said Mitul Kotecha, head of global FX research at Calyon.'

'Elsewhere the Swiss franc fell 0.2 per cent to SFr1.5541 to the euro as the Swiss National Bank raised rates by a quarter of a point to 1.5 per cent, scotching minority expectations for a half-point rise.'
"The most common worry is that the number will shrink suddenly, with foreign governments dumping their dollar holdings, driving down the dollar's value and driving up American interest rates, but that's not a real danger."

I have to say, I wouldn't dismiss this possibility quite as quickly. There's an awful lot of foreign competition to usurp the dollar's reserve currency status. I don't think we'll see a clear winner any time soon, but the net result won't be pretty for the dollar.
the new currency is commodities. think about it. hasn't china said they were considering or were going to invest their dollars in a petroleum reserve? and we've all heard about CBs investing in gold and rumors that others will invest in gold.

where you really see this is in pension funds.
I think Benny is just about to run out of options. He will raise .25
and pause...We have overdosed on easy money. With the flippers and
helocs and the housing related
jobs gone, the economy should go in to a funk...Once there are serious cracks showing, ole Bennie
will have to find the crash cart and try to revive the economy... The big adrenaline needle in the heart will be the printing press.
Our creditors will not approve.
I've said the same before, except there will be serious chaos in the banking industry. Those folks with money in "safe" places will be in for a surprise. You mention the printing press. Do folks not realize that bailing out the massive defaults on bad loans is exactly that? Do we think the creditors with trillions at stake won't notice bailing out the banks when we are already in debt about 9 trillion or so? The piece I keep hearing from folks (I'm sure repeated from what they hear on TV) is that China needs us to buy their goods. Oh really? So you're saying they need to send us their resources, labor, etc so we can send them the pieces of paper, IOUs, dollars that they just have to have? Right. I can't believe folks believe that for one second.

Booze is booze all by itself. It doesn't need the alcoholic. One is dependent on the other, period. Same with China. They can take someone else's paper, especially when that paper will buy oil.

If our economy hits a soft spot,
I am not sure any other economy will be able to pick up the slack.
I think China will be in for some
serious pain too. It should be interesting to see how they fare.
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