Monday, October 31, 2005


Is Copper Leading A Commodities Bubble?

While not precious, this copper story is relevant to the inflation question. "Copper has doubled in price since 2003 and is up 40 percent this year alone, thanks to the housing boom in the United States and increased demand from China and India. But after hitting record highs two weeks ago, copper prices have bounced wildly in recent trading, kindling fears that a commodity price bubble is about to burst, even as mainstream investors keep piling into the markets."

"Copper prices 'will fall at least 25 percent by the end of the year,' said Maqsood Ahmed. Speculative buyers have pumped copper up beyond what the fundamentals justify, he said."

"When copper prices start to fall, 'it could be a dramatic affair rather than a slow burn,' added Nick Moore, director of global commodity analysis at ABN AMRO. He predicted that prices would drop 40 percent in 2006."

"New inflows of capital in the market from investors like hedge funds and pension funds, which often make bets that the market's current momentum will continue, have exacerbated price increases."

"'If one tries to gauge the commodity bubble over all, copper is the place to look,' said Henry To. He maintains that prices have been over inflated by emotion, not fundamentals, just as they are in oil, and could fall. 'People are just scared, because they think we'll run out of copper in the warehouse,' To said."


US Economy On The Brink Of Recession

CNN reports the US consumer is pulling way back. "Hurricanes can bury a lot of things, but don't let them bury a very important nugget in Monday's personal income and spending report: the consumer fell off a spending cliff in August and September!"

"Personal spending rose 0.5 percent last month, but when the effect of soaring oil and gas prices is removed to get a 'real' view of spending, then the number looks pretty anemic: real spending fell 0.4 percent in September after falling by 1 percent in August."

"The economy's growth rate could actually turn negative in the fourth quarter if the consumer doesn't perk up quickly. 'Coming on the heels of a 1 percent drop in August, the two-month decline was the biggest in nearly 19 years and leaves the spending level at quarter-end well below the Q3 average,' wrote economist Dave Resler."

"For spending to match the third-quarter level, thereby avoiding a decline, real spending must grow at a 3.6 percent annual rate (about 0.3 percent each month). With car sales reportedly quite weak in October, this could prove to be a rather tall order' he said."

"'Unless spending (primarily ex-autos) stages a rather convincing recovery in the next few weeks, the prospect of the first quarterly decline in consumer spending in 15 years could factor into the December 13 FOMC decision,' Resler wrote."

"'The U.S. consumer is quite vulnerable to rising market rates...the home ATM machine gets gummed up if rising mortgage rates lead to a correction in the U.S. housing market,' Dave Gilmore said."

"A possible assist for the consumer could be shaping up in the steady drop in gas prices at the pump. The problem is, in the view of Gilmore, that the Fed is raising interest rates, bond yields are rising finally as a result, and if energy prices keep falling and give the consumer some relief, and the economy a bounce, that could encourage even more rate hikes."

"'If bond yields keep rising which I think they will, then not even stocks are safe from a welcome decline in energy prices,' observes Gilmore. 'In this case lower energy prices could prove to be a Trojan horse unleashing a problematic rise in market rates.'"


No Alternatives To Deflation: Prechter

The Elliott Wave crew review a year old interview with Robert Prechter. "Let's look back one year in time to Bob Prechter's Theorist of October 2004. In it, he published an interesting interview he did with Chris Oliver, of The South China Post."

"Q: Can the Federal Reserve prevent deflation? Bob Prechter: No. We have a huge bond market of $30 trillion, which is debt already created. If bond investors came to believe that the Fed would begin printing money and throwing it around, what would they do? They would sell every bond they’ve got, which would lead to a decrease in the supply of credit because bond prices would fall and interest rates would rise. So there aren’t any alternatives to deflation."

"Q: What will be the outcome of deflation? Bob Prechter: The ultimate result is going to be a worldwide depression. There were deep depressions in the 1790s, the 1840s and the 1930s, and I think the next one is already under way. It started in 2001."

"Q: But doesn’t the gold rally predict inflation? Bob Prechter: Think about this: Gold is trading exactly where it was in 1996 despite massive credit inflation over the past eight years. Why is that? I think the gold market understands the difference between credit inflation and currency inflation. A reversal in credit expansion, which is inevitable, will crush prices for everything, and the gold market knows it. The gold bugs’ theory is that an increasing money, actually credit, supply should be bullish for gold and silver. But it hasn’t been bullish for 24 years, so why is it bullish now?..People have a psychological imperative to come up with reasons to be bullish at tops and bearish at bottoms."

"Q: If the forces of inflation in real estate and consumer prices have been going on for decades, why should we believe they are now about to reverse? Bob Prechter: The bull market of the 1990s was a period of high confidence. Many people were willing to extend credit, and many others were willing to borrow. As soon as the trend turned down, it told you that people were becoming more defensive, more protective of what they have, more conservative financially. In the long run, it means a trend towards less extension of credit and less assumption of debt. It will eventually mean the net retirement of debt."


Japan Longs For Inflation

Bloomberg has the latest on the situation in Japan. "Japan's central bank said a seven- year bout of deflation will end in the year to March, increasing the chances the board will raise interest rates from almost zero. The chances of a reduction in the amount of cash pumped into the economy and higher rates 'will increase over the course' of next fiscal year, the bank said in a statement."

"A return of inflation will support growth in the world's second-largest economy, which has had four recessions since 1991, by allowing companies to raise prices, boost earnings and increase wages."

"Deflation in Japan is a legacy of the bursting of asset price bubbles in the early 1990s, which dragged down equity and real estate prices by about 75 percent. The bubble lifted the Nikkei 225 Stock Average up to a record 38,957.44 on Dec. 29, 1989."

"'Just as land price declines are easing, the end of deflation will help cut bad loans and that's going to feed into the entire economy,' said Youichi Yanai, chief fund manager who oversees the $28 billion at the Bank of Tokyo-Mitsubishi Ltd."

"The central bank first adopted the zero rate policy in March 1999. It raised rates in August 2000 in the face of government opposition, saying the economy had recovered sufficiently to cope with higher borrowing costs. Seven months later it was forced to cut rates again and adopt the quantitative easing policy following the slump in global growth that accompanied the bursting of the Internet technology bubble."

"'The Bank of Japan would never, ever want to repeat the same mistake,' said Hiroaki Muto, a senior economist at Sumitomo Mitsui Asset Management Co. 'They want to avoid by all costs being blamed again for a deterioration resulting from a policy change.'"

Sunday, October 30, 2005


The Fed Isn't Your Friend

This editorial examines what the Federal Reserve means to US citizens. "We all like to believe that there's an all-knowing, all-powerful force looking after us. I'm talking about the widespread belief that an all-powerful Federal Reserve Board controls interest rates and inflation, and is looking out for each and every one of us."

"You've got to remember two things about the Fed. First, it's not looking after your personal interests—it's looking after the financial system, which isn't the same thing. A for-instance: in the early 1990s, when many major banks were effectively insolvent, the Fed bailed them out by lowering short rates, handing them huge profits at the expense of people who depended on CD income for food money."

"The Fed is far from all powerful. In fact, it's considerably less powerful than it was when Greenspan took the helm in 1987. Since then, the United States has become dependent on the rest of the world—especially the central banks of Japan and China and other Asian countries—to finance our budget and trade deficits. If Asia grows less eager to hold dollars, U.S. interest rates will rise, regardless of the Fed's wishes."

"The fact that Bernanke isn't perfect shouldn't be cause for alarm. Neither is Greenspan. The stock bubble grew and burst on his watch, and we've now got a housing bubble that will inevitably burst. Last year, Greenspan talked about how foolish home buyers had been to get fixed-rate mortgages rather than variable-rate ones—but given the sharp rise in short rates, anyone who switched to a floating-rate loan is wailing the blues today."

"We won't know how effective a Fed chairman Cousin Ben is until after his first crisis. But one thing we know already: a divinity, he's not."

Friday, October 28, 2005


US Uses 70% Of Worlds Capital

The IMF is worried about the US financial situation. "Massive U.S. deficits, red-hot housing prices, and volatile energy markets could soon dampen American consumption and darken world growth forecasts, the International Monetary Fund's chief economist said in remarks released on Friday."

"'The central concern has to be about consumption growth in the United States, which has been holding up the world economy,' Rajan said. He warned high energy prices, if they feed inflation and inflationary expectations, could cause the U.S. Federal Reserve to raise rates faster and further than now expected and lead to an abrupt fall in consumer spending."

"'My greatest worry is not that U.S consumption will slow; it has to, because it is being fueled by unsustainable forces,; Rajan said. 'My worry is that it will slow abruptly, taking away a major support from world growth before other supports are in place.'"

"Rajan cited the U.S. current account deficit, approaching 6.25 percent of gross domestic product and more than 1.5 percent of world GDP this year, as another key source of global instability. To finance it, the United States needs to pull in 70 percent of all global capital flows, he said, adding oil producing Middle Eastern countries were increasingly filling the gap as their surpluses eclipse emerging Asia's."

Thursday, October 27, 2005


'Government Malfeasance' Hurts Currency

Market Watch sees implications for the US currency out of the political scandals in Washington. "The U.S. dollar, Treasurys and American stocks could sell off if top White House aides are indicted on charges they leaked the identity of a CIA employee, analysts said Thursday. Any charges could create 'political paralysis' at the White House, said Brian Dolan, head of currency research at New Jersey-based trading firm Gain Capital."

"Charges would be 'detrimental to the dollar, a psychological blow,' said Alex Beuzelin. They would distract Bush from important economic issues like high energy prices, patches of slower growth and deficit reduction, he said. The dollar's year-to-date run may be in jeopardy should confidence in Bush's ability to steer the economy be shaken."

"A weaker dollar could raise inflation risks at a time that the Federal Reserve is working furiously to stamp out its spread from high energy prices. U.S. bond yields could rise further if foreigners become less willing to hold so much U.S. debt, raising borrowing costs. Stocks, too, might suffer, but the damage would likely be less than in the 'emotional' currency market that tends to be more politically sensitive, said Dolan."

"'If corporate malfeasance is bad for a firm's stock where senior executives run amuck, it should follow that government malfeasance should impact negatively a country's debt and currency,' said David Gilmore. 'If it were only so easy, exceptions are the rule not the exception.'"

"The best historical reference for investors may be the fallout of the Watergate scandal, which was limited to Nixon aides, although did ultimately lead to the president's resignation, said Dolan. But the U.S. was just coming off the gold standard at that time, so currency markets behaved differently than they do today."

"More recent memory reminds that the dollar was hammered leading up to and in the immediate wake of the impeachment of President Bill Clinton on perjury and obstruction of justice charges tied to the cover up of his affair with intern Monica Lewinsky. Over a five-day period in January 1998 that followed the first mention of Lewinsky, the dollar shed a swift 3.3% against the German mark, the pre-euro proxy for European currencies. The dollar reclaimed that decline during the following week."

"The greenback fell over several days to a four-month low against the Japanese yen during December 1998, when the House approved two articles of impeachment against Clinton."


Mistake To Protect Dollar: Bernanke

The Washington Post had this in a story on the new Fed nominee. "Ben S. Bernanke does not think the national housing boom is a bubble that is about to burst, he indicated to Congress last week, just a few days before President Bush nominated him to become the next chairman of the Federal Reserve."

"After Bernanke joined the Fed board in 2002, as the economic recovery remained sluggish and job cuts continued, he vocally supported Greenspan's strategy of lowering the benchmark rate further and holding it very low until mid-2004, when it was clear that both job growth and the economic expansion were solid."

"Bernanke also warned in a November 2002 speech that the Fed would act aggressively to prevent deflation, which had devastated the economy during the Great Depression that followed the 1929 stock market crash. Bernanke earned academic renown for his research on the Fed's role in causing the Depression."

"After the 1929 crash, the Fed mistakenly raised interest rates to protect the value of the dollar, which was then pegged to the price of gold, Bernanke wrote in an October 2000 article in Foreign Policy. The higher rates contributed to surging unemployment and severe price deflation. The Fed then made things worse by not acting to counter the credit crunch that resulted from the collapse of the banking system in the early 1930s."

"'Without these policy blunders by the Federal Reserve, there is little reason to believe that the 1929 crash would have been followed by more than a moderate dip in U.S. economic activity,' Bernanke wrote."

"In late 2000, looking ahead to the possibility of a sharp fall in then-lofty stock prices, Bernanke concluded, 'history proves..that a smart central bank can protect the economy and the financial sector from the nastier side effects of a stock market collapse.'"

"And in words that might come to mind if housing tanks, he said the economic effects of falling asset prices 'depend less on the severity of the crash itself than on the response of economic policymakers, particularly central bankers.'"

Wednesday, October 26, 2005


Jim Grant On Bernanke And The Fed

The New York Times has this editorial by Jim Grant. "President Bush's choice to succeed Alan Greenspan as chairman of the Federal Reserve Board has raised a roar of approval. But there is one rub. The man..professes to believe the impossible. He insists that the Fed can keep the economy chugging and prices stable just by pushing a single interest rate (the so-called federal funds rate) up and down."

"If Mr. Bernanke then ventured a long-term oil-price forecast, would anyone even bother to write it down? Would anyone expect him, once confirmed, to actually fix the price? Those who did would have to call the idea by its discredited name, price controls, and would have to explain why the secretary-designate knew better than the market at which price the supply of oil would meet the demand for oil. They would also have to explain why this episode in price controls would turn out better than the long series of flops that preceded it. The world would laugh."

"Yet we seem to accept, and even desire, exactly such ludicrous claims of foresight from a Fed chairman. It follows that anyone who is willing to take the job as Fed chief is, by that reason, unqualified to hold it."

"Now Mr. Bernanke stands to inherit what Mr. Greenspan and he, among others at the Fed, wrought. Certainly they have whipped deflation. But by pressing down interest rates to the floor, they have pushed housing prices to the sky. And they are the uneasy witnesses to an unscripted climb in the Consumer Price Index, which, in September, registered a 4.7 percent increase over last year."

"Don't worry, many counsel. The seemingly alarming inflation data are the statistical tracks of a boom in energy prices caused by the Iraq war and the Gulf Coast hurricanes. It will pass."

"But what if it doesn't? What if a new cycle of rising prices has already begun - as I happen to believe it has? Mr. Bernanke, as sure of himself as he is of the future, won't soon be changing the way the Fed operates. Rather, it will be the world's dollar holders who will change the way they operate."

"If America's creditors sense that inflation is robbing them of their wealth and that the Bernanke Fed is too slow to raise its interest rate, they will sell their dollars and dollar-denominated securities. Such an exodus would, among other things, tend to increase the costs of imported goods and drive up dollar-denominated interest rates. In other words, events would control the Fed."

"Since each of the world's major currencies is a scrap of paper of no intrinsic value, some of these disaffected dollar investors may buy gold. Mr. Bernanke doesn't talk much about that barbarous relic. What would he make of a flight from a rationally managed currency into an inert precious metal? I will guess that it would astonish him."


New Zealand Makes 'US Look Frugal'

This Forex Asia site has the latest on the Kiwi. "The New Zealand dollar this month reached an eight-year high against the Japanese yen but the gains aren't sustainable. Signs that New Zealand's monetary tightening cycle is nearing an end, worries about the country's bulging current account deficit and an economic slowdown are set to drag the New Zealand currency lower."

"A fall in the kiwi, as the currency is known, could signal that other high-yielding currencies, including the Australian dollar and Canadian dollar, are also overvalued against the yen, some say. As Japan leaves deflation behind and the Bank of Japan looks to tighten monetary policy possibly in 2006, the wide gap between ultra-low interest rates in Japan and elsewhere is unlikely to widen any further, some analysts say. It is this interest-rate gap that has supported high-yielding currencies against the yen."

"At 0834 GMT, the kiwi was quoted at Y81.25, just below an eight-year high set earlier Wednesday of Y81.47. Analysts say that by early next year the New Zealand currency could fall as low as Y70."

"Hefty short-term interest rates of 6.75% have supported the kiwi by encouraging a steady flow of new uridashi bonds denominated in New Zealand dollars. Uridashi are non-yen denominated bonds sold to Japanese retail investors. These investors like the high yields offered by kiwi-denominated uridashi."

"RBNZ Governor Alan Bollard and New Zealand's Finance Minister Michael Cullen have already warned that the New Zealand dollar's exchange rate is unsustainable and analysts agree. 'There's a good case for the kiwi/yen to fall precipitously, and when it comes it could be nasty,' said Sean Callow, senior currency strategist at Westpac in Singapore. 'The current account deficit is a concern, because it can't be sustained and makes the U.S. look frugal by comparison,' he said."

Tuesday, October 25, 2005


Fed Using Inflation Scare To Move Long Rates Up?

The Resource Investor explains what it sees as an 'inflation scare.' "With the US Dollar Index at 89, it seems fairly clear that gold as illustrated by its recent performance has decoupled from the dollar, and is rising in all currencies. But the major move in gold in the last quarter seems to have come from what many perceive to be an inflation threat, which has come completely out of the blue."

"With many funds playing momentum and trends in these modern capital markets, and with the fourth estate ready to cheerlead and/or scaremonger about the latest threat or cognoscenti theory, the inflation story has gone from barely receiving mention a month ago, to substantial column inches today."

"The catalyst for all of this seems to have been Katrina..Greenspan was using this as a way to get the move he wanted at the long end of the curve. Stephen Roach seemed to concur, as he was quoted as saying 'The Fed seems determined to set interest rates high enough to ensure it has regained traction with the real economy and asset markets. If it needs the excuse of an inflation scare to pull off the policy normalization, so be it.'"

"The National Post reported that Roach didn’t believe inflation was going to be a problem, calling current numbers 'hardly a major breakout from the disinflationary channel of the past 10 years.'"

"The question is, if gold breaks the $500 mark on the back of what would appear to be an engineered inflation scare, and if nearly all of the new money coming into gold is from players seeking protection from said inflation, what will happen when it is shown to have been 'tamed'?"

"Gold will do equally well in a deflationary environment, as in an inflationary one, and we are still in the early going. If and when the danger of inflation subsides and the hot money flees the sector and the metal, it doesn’t mean that the game is over, it may be just beginning."


Bernanke, Confidence Numbers Hit US Dollar

Reuters has an update on the US dollar. "The dollar fell on Tuesday after weaker-than-expected U.S consumer confidence data hinted that the impact of hurricanes and soaring energy prices could slow the economy's momentum and the pace of interest rate rises."

"'The confidence numbers and component numbers were a little weaker than even the weakest projections, so the dollar is getting hit a bit here across the board,' said Ed Stapleton, head of foreign exchange at Fortis Bank in New York."

"The euro rose to session highs around $1.2115 according to Reuters data, steeply up from around $1.2065 shortly before the consumer confidence report. Around noon in New York, the euro was trading at $1.2091 , up about 0.9 percent from late on Monday in New York. Against the yen the dollar was trading lower at 114.85 yen, compared with around 115.17 yen shortly before the consumer confidence report and down about 0.5 percent."

"Sterling was trading up 0.9 percent at $1.7848. The dollar was trading down 0.8 percent at 1.2770 Swiss francs."

"The dollar has been boosted for much of 2005 by Fed rate hikes and rising yields, which have burnished the appeal of dollar-deposits to foreign investors. But if softer economic growth caused the Fed to raise interest rates less steeply than expected, that could weigh on the dollar."

"Gold futures climbed almost as $8 an ounce Tuesday to close at a one-week high as uncertainty surrounding Ben Bernanke's nomination as the next chairman of the Federal Reserve put pressure the dollar. Gold for December delivery climbed as high as $475.80 an ounce on the New York Mercantile Exchange, a level not seen since Oct. 18."

"'The foreign-exchange markets apparently think he is less concerned with budget deficits, and that could be why the dollar has sagged and in turn yielded some minor support to gold,' Nell Sloane said."

"Indeed, 'once the world, particularly the foreigners who have been supporting our massive current-account deficit, becomes more and more familiar with many of Mr. Bernanke's past remarks, they will become increasingly less inclined to be 'long' the U.S. dollar,' said Richard Sacks, a managing partner at Brick Capital Partners LP."

"December silver closed up 11.7 cents to end at $7.825 an ounce after tapping a one-week high of $7.87. December palladium closed at $221.55 an ounce, up $7.75. Sister metal October platinum climbed $12.80, or 1.4%, to close at $945.60 an ounce."


A Return Of Stagflation?

Forex News has this overview of the global economy. Highlights, "We believe there is another story behind the low rates of longer securities that is all too obvious: the US economy is slowing down. An economy that must offer 'employee discounts' to sell cars is in trouble. We had one airline after another declare bankruptcy; now the world’s largest automotive supplier, Delphi, has declared bankruptcy."

"General Motors and Ford are likely bankruptcy candidates. What is happening is that corporations cannot pass costs on to consumers. The Greenspan conundrum unplugged means: Our low long-term interest rates suggest that we are going to lose entire industries in the looming economic downturn. Industries that cannot adapt quickly enough to our global economy will be wiped no developed country can compete with the cost of labor in Asia."

"Asia believes that it must generate economic growth at all cost to provide jobs and political stability. The result is a surge in world commodity prices (we had high commodity prices before the hurricanes) and low consumer goods. In addition, take a US consumer that is heavily in debt, and you end up with very little pricing power."

"This is not the place to discuss whether an economy can survive long-term if it entirely dismantles its manufacturing base and exclusively focuses on services. What we do know, though, is that the accommodating policies have created inflationary pressures in just about all sectors of the economy where we cannot import goods from Asia. And while we are at it, we also created a phenomenal housing bubble that has allowed the US consumer to increase its spending (by taking out home equity loans and refinancing) while real hourly wages have been on the decline."

"We do not see a conflict in low long-term rates and high gold prices, at least not for now. What about inflation and economic growth going forward? The Fed has been steadily raising rates. Bill Seidman..says Federal Funds rates would need to move to 5.5% just to have a neutral impact on economic growth. We agree: even with the many small increases in rates, we still have an accommodating monetary policy, one that fosters growth and inflation. At the same time, the economy is clearly slowing down."

"Corporate America has reasonable looking balance sheets, but we cannot rely on them to bail this economy out. The reason corporate America has not invested much of its cash, because it sees the shakiness of the American consumer and is reluctant to invest."

"We believe Asia will continue its path as long as it can afford it. We also believe that we cannot assume Asian countries will react rationally when US consumption slows. It is unclear whether Asian countries will try to devalue their currencies even further in a desperate attempt to continue to sell to the United States, even at a loss. Governments in Asia may be more interested in political stability."

"What does this all mean for the dollar? We believe the dollar continues to be at serious risk as the balance of payments between the United States and the rest of the world is unsustainable and further escalating..As countries look for alternatives to the US dollar as a reserve currency, gold and the euro are gaining a higher profile."

"The United States next year will pay more to foreigners in interest charges on its own debt than it receives in interest. With US debt growing rapidly, interest rates rising and much of US debt in short-term securities, this will have a negative impact on the balance of payments. Also, if US consumption slows just as the housing market enters a more serious decline, foreigners may be less willing to invest in US assets. We do not believe the fundamental pressure on the dollar will go away unless and until policies will be put in place to foster savings and investment rather than consumption. For now, consumers continue to believe that their real earnings will grow and have refused to cope with reality."

Monday, October 24, 2005


Gold Traders Remember 'Helicopter Bernake'

Market Watch talks to traders about the Fed nominee. "'In a longer-term context, the selection of Ben Bernanke has positive implications for gold,' said Richard Sacks, a managing partner at Brick Capital Partners L.P. 'Remember that in the midst of deflation fears 12-18 months back Ben Bernanke was quoted as saying 'we will drop money from helicopters, if necessary,' said Au.

"Gold futures closed lower Monday after a brief stint above $470 an ounce, giving back less than half of the nearly $6-an-ounce gain scored during the previous session. 'Gold has been pretty volatile lately, which makes sense given the uncertain inflation picture out there,' said Michael Cuggino, chief executive at Pacific Heights Management LLC."

"Indexes tracking equities in the metals-mining sector defied weakness in gold to trade broadly higher to start the week, rebounding from losses of about 3% last week."


Tangled Financials Hid Refco Fraud

As details of the Refco scandal emerge, the behind the scenes action is even more unbelievable. "Peter F. James had been working at Refco less than two months when he noticed something this summer that teams of accountants had apparently missed for years. Mr. James, a recently hired employee in the controller's office, wondered why a larger-than-normal interest payment had been made to Refco on an outstanding loan made by the company."

"In August he started to ask questions, eventually taking his concerns to the chief financial officer, Gerald M. Sherer. The answers would lead to the departure of the chief executive and the rapid unraveling of the company that prompted its filing for bankruptcy protection last week."

"The oversize interest payment that Mr. James noticed had its roots in a bad receivable, money due to Refco, from clients adversely affected by the Asian financial crisis of the late 1990's, according to a person briefed on the investigation."

"A person briefed on the investigation said. 'This isn't a needle in a haystack,' this person said. 'It's a needle in a pile of needles.'"

"Now, questions are mounting over why others, among them, the company's auditor and the underwriters that took Refco public in August, never discovered what Mr. James did."

"The collapse of Refco has been a black eye particularly for Thomas H. Lee Partners, the private equity firm that bought a majority stake in Refco in August 2004. 'Either Tom Lee and partners are victims of fraud or they dropped the ball in terms of due diligence,' said William Atwood, executive director of the Illinois State Board of Investment, which has put $35 million into the latest Lee fund. 'Today, we don't know which it is.'"

"The Lee partners are likely to face tough questions at their annual meeting with investors in Boston next month. One question the investors may have is Lee's ability to invest in complex financial companies, given its losses in Refco and the $440 million it lost on Conseco, an insurance holding company that filed for bankruptcy protection."

"Mario Giannini said he thought there was no pattern in the Conseco and Refco blowups, but that the coincidence did raise 'an interesting question' about what sort of risks are involved in the buyouts of financial services companies."

Friday, October 21, 2005


Can Japan Fill Economic Boots Of The US?

This Business Week article examines deflation in Japan. " A decade of deflation has helped reduce Japan's notoriously high prices, everything from clothing and telephone bills to beer and real estate has gotten at least somewhat cheaper. But those falling prices have also contributed to the economy's lengthy slump, locking it into a downward spiral that is difficult to stop."

"Higher prices will force Japan's central bank to walk a fine line. Moving too soon to tighten money supply or raise interest rates may not only hobble the world's second-largest economy but contribute to a global slump amid high oil prices and worries about 'stagflation' in the United States."

"'The U.S. appears to be slowing, and Europe remains the laggard. If Japan's economic recovery retrenches because of a policy mistake by the Bank of Japan, we really are left with no major driver of global growth,' said Glenn B. Maguire."

"Bank Governor Toshihiko Fukui kicked off Thursday's meeting saying that the BOJ would stick to its ultra-loose monetary policy, with interest rates virtually at zero, until deflation is dead. But he also predicted prices would level out and possibly begin rising within the next couple months."

"The International Monetary Fund is among voices urging the BOJ to go slow. The risk of slipping back into deflation may still outweigh the perils of rising prices, David Burton, director for the IMF's Asia and Pacific Department. 'The BOJ is right to be cautious,' he said."


US Dollar Hurt By Inflation Talk, Narrower Spreads

The worlds central bankers are talking about inflation. "The dollar stayed on the back foot as players took advantage of narrowing bond yield differentials between the US and elsewhere to move out of the US currency. 'The dollar had strengthened because of yield differentials. Now central bankers around the world, not just in the US, are cranking up the threat of inflation. The differential is now narrower,' said Marios Maratheftis."

"Central bankers as far flung as South Africa and Canada have been talking about rising price pressures. In Europe too, the rhetoric has been decidedly hawkish. Today, European Central Bank chief economist Otmar Issing warned that the latest euro zone inflation numbers are far above the levels compatible with the goal of price stability."

"Some analysts also believe that all the focus on inflation has raised concerns about the potential impact on growth. 'We are becoming concerned that more hawkish Fed comments on the need to curb inflationary pressures is now damaging rather than supporting investor sentiment,' said Mansoor Mohi-uddin at UBS."

"'As investors worry about tighter Fed policy, stronger economic data is not helping the dollar,' said Mohi-uddin. In data out yesterday US jobless claims fell to 355,000 against market consensus of 365,000 while the Philly Fed survey rose sharply to 17.3 in October from 2.2 in September. Both failed to spark a dollar rally."

Thursday, October 20, 2005


Hedge Funds Load Up On Junk Loans

As Business Week reports, hedge funds are playing with dynamite. " As commercial banks back away from making corporate loans, a new breed of lender is stepping in: Hedge funds are providing hundreds of millions of dollars to companies whose shaky credit disqualifies them for prime bank loans or whose needs are too puny to attract big commercial bankers."

"Bank of America Corp. slashed its corporate loan portfolio from $110 billion in 2000 to $34 billion in 2004. For certain borrowers, hedge funds and other investment outfits not normally thought of as lenders are filling the gap."

"Hedge funds and other institutional investors now provide almost 50% of the $509 billion market for riskier, high-interest rate loans to corporations. That's up from less than 20% in 2000."

"One potential peril is that hedge funds will try to lure borrowers with relatively low rates, easy terms, and lax attention to creditworthiness. With barely any government oversight, fund managers inexperienced in lending may misjudge their borrowers. As a result, hedge fund investors ranging from public pension funds to wealthy individuals could face large losses."

"'You cannot have ever-riskier transactions and not ultimately have repercussions,' says Neal Schweitzer, of Moody's Investors Service Corporate Finance Group. Overall conditions in the high-yield debt world are already growing more worrisome. In the third quarter, only 41% of the ratings changes Moody's issued for high-yield paper were upgrades—down from 57% in the second quarter. Default rates are ticking up."

"Hedge funds are notorious for sometimes betting against the very companies whose securities they hold. Funds that buy the bonds of a struggling company, a bet that the issuer will recover, commonly hedge by simultaneously shorting the company's stock, an investment that pays off if the share price falls."

"Many loans made by new-breed lenders are quickly sold off, and hedge-fund money is fueling more intense trading in this secondary market. Trading of high-yield loans has increased from roughly $112 billion in 2002 to about $163 billion in the last 12 months. Loan prices have skyrocketed as new money has poured into the market. Nearly 50% of high-yield loans are priced above their face value, up from less than 2% in 2003."

"In addition to the fear that hedge funds will be tempted to make reckless loans that could go sour when the economy slows, some observers worry that eventually the funds will simply lose interest in lending and buying loans. 'Let's face it: The economy will change someday, and all these hedge funds will decide that there is someplace else they would rather be,' says Darvin Pierce, of Van Kampen Senior Loan Group, which manages about $6 billion in prime bank loan funds for individual investors."


Gold, Dollar Pull Back, Inflation Roars

Things are moving quickly in the metals markets. "Gold futures closed Thursday at their lowest level in five weeks, tallying a three-session loss of over $13 an ounce. 'Gold has more downside work to do and has the potential, short-target, to dip to $445,' James Moore said. 'Physical buying from India is likely to be very strong below $450 and should prevent gold from falling much lower.'"

"Gold for December delivery rose as high as $467.30 an ounce on the New York Mercantile Exchange, before reversing course to close down $2.60 at $463.20. Prices lost $8.80 on Wednesday and fell $2 on Tuesday. 'Certainly the gold market was overbought and vulnerable,' said Nell Sloane."

"She's not convinced that 'the market is poised to resume the rally right away, especially if the oil market continues to weaken and the outlook for the world economy remains mostly mixed.'"

"The US Dollar fell against other major currencies in European trading Thursday. The euro was quoted at $1.1981, up from $1.1976 on Wednesday. Later, in midday New York trading, the euro obtained $1.1982. Other dollar rates included 115.42 Japanese yen, down from 115.47; 1.2926 Swiss francs, down from 1.2962; and 1.1725 Canadian dollars, down from 1.1743."

"Prices continued to surge in October, with the key prices paid index jumping to 67.6 from 52.7, reaching its highest level since November 1980, according to the Philadelphia Fed. The sharp rise in both prices paid and prices received..suggested inflationary pressures are indeed mounting and the Federal Reserve will have to make good on its vow to curb rising prices."

Wednesday, October 19, 2005


Financial 'Meltdowns' Happen All Too Often

This Bloomberg article reviews past Refco like 'meltdowns.' "Refco Inc.'s two-week slide into insolvency stirred memories of the last time a big Wall Street firm teetered, then collapsed, except it was quicker. Fifteen years ago, rumors swirled for weeks that Drexel Burnham Lambert Inc. was being targeted by regulators before the 1980s junk-bond financier filed for bankruptcy, author Martin Mayer said. The demise of Refco took just seven days."

"Between Drexel and Refco, at least half a dozen major financial companies have melted down. Long-Term Capital Management LP, a hedge fund run by John Meriwether, lost $4 billion in 1998 after a debt default by Russia."

"Barings Plc, a 233-year-old British merchant bank, collapsed three years earlier after Singapore-based trader Nick Leeson racked up $1.4 billion in losses. That same year, Tokyo-based Daiwa Bank Ltd. was forced to shut U.S. branches after revealing a $1.1 billion loss from 11 years of unauthorized trading by its chief New York government bond trader."

"Apart from Daiwa, so-called rogue traders have made an appearance most often when financial companies imploded during the past decade. That was the case in 2002, when Allied Irish Banks Plc discovered that John Rusnak, a trader at its Allfirst Financial Inc., had amassed and hidden $691 million in losses in more than five years before the bank noticed any discrepancies."

"It was much the same situation in 1996, when Sumitomo Corp. disclosed a $2.6 billion loss on copper trades. The Japanese firm blamed unauthorized trades by its chief copper trader, Yasuo Hamanaka, who was known as 'Mr. Copper' in the markets because of his aggressive trading."

"A wrong-way market bet spelled doom in 1998 for Peregrine Investments Holdings Ltd., a Hong Kong investment bank run by Philip Tose. The bank fell under the weight of at least $300 million of bad debt that it bought from insolvent Asian companies, including a $265 million loan to Indonesian taxi company PT Steady Safe."

"Four years earlier, Orange County, California Treasurer Robert Citron used borrowed money and derivatives to try to expand the municipality's investment fund. When interest rates rose in 1994, the fund tried to hide the trades before reporting it lost $1.7 billion. The county later filed for bankruptcy."

"Refco's stock plunge wiped out about $924 million in market value, after the company asked a bankruptcy court in Manhattan for permission to reorganize its $48.6 billion in liabilities. The company's bonds due 2012 yesterday traded at 55 cents on the dollar, down from 108 cents on Oct. 7, according to Trace, the bond price reporting system of the NASD."


The Feds 'One Way' Inflationary Error

Caroline Baum at Bloomberg is surprised at how the US dollar has lost value. "Given all the talk about price stability these last few years, I bet you'd be surprised to learn that the price level in the U.S. has doubled in a little more than 20 years. I sure was. Perusing last week's report on the Consumer Price Index for September, I was struck by an entry at the very bottom of Table 1 that, I'm embarrassed to say, I'd never noticed before: 'Purchasing power of the consumer dollar (1982- 84=$1.00).'"

"I followed the dotted line across the page to the figure in the column for the September 2005 unadjusted index, which read $.503. In other words, the dollar today buys half of what it bought in the early 1980s."

"Annual inflation was running at 8.4 percent at the start of 1982, falling to 3.9 percent by the end of 1984, the base period the Bureau of Labor Statistics uses for comparison. Still, the realization that the dollar buys only half as much today as it did in 1982-1984 made me think about how 2 percent inflation, which is well within the Fed's comfort zone using the CPI, would play out over time."

"If the CPI averaged 2 percent a year for the next 20 years, the price level would rise 48.6 percent. In 35 years, it would double. Even if we use the average annual CPI increase over the last 20 years (3 percent) to project forward to the next 20, the price level would be 80.6 percent higher in 2025."

"So what looks like price stability in the short run is hardly price stability in the long run."

"'When you have an inflation target and overshoot and don't insist on a period of deflation to resolve the purchasing power of money to the path you initially specified, it doesn't result in price stability,' says Neal Soss, chief economist at Credit Suisse First Boston. 'That's the flaw in an inflation target.'"

"Because the Fed has decided that a period of deflation, or a decline in the price level, is verboten, it implies a 'tolerance of a persistent, inconsistent depreciation in the value of money,' says Michael Darda, chief economist at MKM Partners in Greenwich, Connecticut. In contrast to today's stated target of price stability, 'under the gold standard, over time there was price stability in the unit of account,' Darda says."

"Former Fed governor Larry Meyer says there are 'consequences of targeting zero inflation.'" Because nominal interest rates can't go below zero, deflation would hamper the ability of the central bank to push the real overnight rate into negative territory, Meyer says. (If short-rates don't matter, which is what Fed policy makers always claim, why do they care about the inability to push the real overnight rate into negative territory?)"

"The Fed's response to the 2003 deflation scare supports the premise that policy makers won't tolerate any offset to inflation surprises. 'When the central bank overshoots its target, because of an oil shock, for instance, it forgives that error,' Soss says. 'Most of the errors, regrettably, are in a single direction.'"

"The result over time is that 'half of the dollar's purchasing power is gone in a period shorter than the time you'd expect to spend in retirement,' he says. 'The phrase `sound as a dollar' ought to mean that.'"


Markets Focus On Yield, Await Fed Data

The US dollar has support this morning. "The dollar was off a two-year high against the yen and a three-month peak versus the euro reached earlier on Wednesday, but still was mostly higher on the day as investors continued to focus on yield."

"Comments from U.S. Federal Reserve officials signaling more interest rate hikes and a break of an option-related key technical level around $1.19 against the euro triggered a bout of dollar buying in early European trading."

"On Tuesday, San Francisco Fed President Janet Yellen said the Fed was well aware rising oil prices could affect the broader price level and would not let prices spiral out of control. Markets widely see the Fed pushing rates higher at its final two meetings this year, taking the fed funds rate to 4.25 percent from the current 3.75 percent."

"Wednesday's calendar includes speeches by Fed Governor Donald Kohn, New York Fed President Timothy Geithner, Dallas Fed President Richard Fisher and Cleveland Fed President Sandra Pianalto, all around midday. The central bank releases the Beige Book of regional economic conditions at 2:00 pm EDT."

Tuesday, October 18, 2005


A 5.5% Fed Funds Rate?

The Daily FX has some observations on a Fed officials speech today. "As we warned yesterday, surging inflation especially on the producer price level will give the Fed a good reason to pump up the need for higher interest rates, which is the primary driver of dollar strength these days. Producer prices surged 1.9% on a monthly basis and a whopping 6.9% on an annualized basis."

"This has given the Fed even more ammo to talk up interest rates; Fed President Yellen, who is a non-voter threw out some numbers today. She said that the 'neutral rate' that everyone seems to believe that the Fed is aiming for is anywhere between 3.5%-5.5%. This is the first time that the market has even considered the possibility of 5.5% rates."

"The 5% level that the experts have been parading around already seemed a bit far-fetched, let alone 5.5%. If 5.5% rates is a really a possibility, then it’s the market that is behind the curve and not the Fed. Either way, the trajectory for rates is higher and for as long as the market thinks that rates are going up, so will the dollar."

"The Japanese Yen has fallen 6% against the dollar over the past two months, with prices pushing easily above the 115 barrier. The central bank seems to be taking this in stride, noting that they have no plans to intervene in their currency to halt its decline and in fact do not view it as a 'problem.' Why should they? As an export dependent economy, a weak currency helps to boost business for their domestic corporations."


Economy Gripped By Forces Of Inflation/Deflation

The New York Times looks at price inflation. "Wholesale prices surged at a faster pace than consumer prices last month, the government reported today, indicating that businesses are not passing on the full brunt of the energy price spike to customers."

"Prices rose even faster for raw materials (up 10.2 percent) and goods that are in intermediate stages of production (up 2.5 percent) than they did for finished goods. 'That suggests that we are getting some inflationary pressures building in the pipeline,' said Nariman Behravesh, chief economist at Global Insight. 'Those are the numbers that are likely to show up in' consumer prices."

"So far, businesses have not passed along the entire increase in their costs to each other and consumers. Economists have struggled to fully explain why that may be happening and whether it can continue for much longer."

"'What is giving us protection is all the global competition that we have,' said Anthony Chan, an economist at J.P. Morgan. 'That is preventing companies from passing on most of the costs. Even through productivity has been slowing down, it's still fairly significant.'"


Refco A Modern Day Bank Run

Slate has a report on the Refco scandal. "If you want to know what a modern bank run looks like, consider the case of the giant commodity trading firm Refco. It went public in mid-August, but in the course of the past week it has gone from $4 billion stock-market darling to carcass."

"Refco was a model 21st-century business—a highly digitized, high-tech services company that traded complicated financial instruments on behalf of customers all over the globe. But its meltdown shows that its real assets were not its New Economy algorithms and brainpower. Rather, this extremely modern company depended ultimately on the kind of assets that built American capitalism in the 19th century: trust, integrity, and the personal reputation of executives."

"But it was already too late. Refco was in the business of facilitating trades that are conducted essentially through a digital handshake. The actual exchange of cash—the settlement—takes place within a few hours or a few days. Any company operating in this environment relies on liquidity; the ability to access vast stores of credit instantaneously and cheaply; and on the willingness of other institutions to act as counterparties, to wait a day or two before receiving payment."

"Once the trouble was announced, Refco's customers wondered whether it was wise to do business with a company whose internal controls were so weak that it didn't know its own CEO was hiding a nine-figure debt. So, the demise was swift."

"In abandoning Refco so rapidly, the market proved that creditworthiness is not an absolute attribute that can be proved by showing you have a certain amount of cash on hand, or that your equity-to-debt ratio is above a certain level. Ultimately, creditworthiness is in the eye of the beholder."

"Refco's downfall isn't simply an occasion for a history lesson, or an object lesson for people who make their living in the commodity pits. The entire global economy runs on the lubricant of easy credit extended among companies. And much of that credit depends on trust and reputation. These days, you don't have to be a bank—or even a liquidity-dependent finance firm—to suffer a run on the bank."


US Inflation Jumps

Among the bevy of financial reports out this morning is this. "Data released in the U.S. today saw headline U.S. wholesale prices escalate 1.9% last month, their largest jump in 31 years."

"The increase in producer price inflation was caused by a 7.1% increase in wholesale energy prices, the largest climb in fifteen years. Notably, the producer price index for finished goods has increased 6.9% over the past twelve months, the sharpest rise in fifteen years. The ex-food and energy PPI was up +0.3%, also hotter-than-expected."

"Remarks from Fed Chairman Greenspan in Tokyo overnight reflected the current environment of accruing price pressures. Greenspan said oil costs will inhibit economic growth for 'some time to come.'"

"Other data released in the U.S. today saw August Treasury International Capital (TIC) portfolio flows print at US$ 91.3 billion, much higher than expected and above the U.S. trade gap around $59.0 billion two months ago."

Looking at the TIC report shows that 'official' or state purchases have slowed to a trickle, meaning the funds are coming from private sources; probably hedge funds.

Monday, October 17, 2005


Dollar Stronger In Busy Week For News

The latest currency news. "The dollar rose against the yen and most other actively traded currencies after China remained vague with the world's top finance ministers about how it would allow freer trading of its yuan. Investors also expect Federal Reserve officials speaking this week will reinforce the need to lift interest rates to stop U.S. inflation from accelerating."

"China's authorities 'affirmed their intention to enhance the flexibility and strengthen the role of market forces in their managed floating exchange-rate regime,' according to a joint U.S.-Chinese statement released today in Beijing, where the Group of 20 meeting was held."

"Higher inflation seems to be the market’s only focus these days as the futures market has now fully priced in at least 2 more rate hikes to 4.25% with a more than 50% likelihood of another rate hike on January 31st to 4.50%. After last Friday’s sharp surge in consumer prices, we saw analysts from the leading investment banks step out to tout the possibility of 5% rates."

"With no less than ten Fed speeches this week..we doubt that the Fed will let the market forget about how concerned they are for inflation. Therefore the risk for the dollar this week appears to be on the upside, but we will first have to see how the results of tomorrow’s TIC report of foreign purchases of US securities fares in the month of August. So far, foreign inflows are expected to reach $60B, which is less than the previous month, but just about meets the funding needs for the same month’s trade deficit."


Futures Industry 'Anxious' Over Refco

The Independent has an update on the Refco situation. "Goldman Sachs and other advisers to the embattled US brokerage Refco continued frantic emergency meetings yesterday to discuss how to save the firm, with bidders including the UK's Man Group circling."

"It seems likely that the brokerage group will be broken up, with the weekend's talks focusing on saving the main futures and commodities trading operations. Goldman has compiled a document detailing Refco's assets and liabilities in the hope of attracting buyers for the regulated futures business, while other parts of the group may have to file for bankruptcy."

"The closure of Refco's other businesses has undermined confidence in the futures division with signs of increasing client defections. Futures industry officials are anxious for Goldman, and other financial firms, to shore up the futures arm to ensure its survival, either through a quick sale or by assuming financial responsibility."

"Refco's rapid decline - until last week it was one of the world's largest commodities and futures brokers, reflects how crucial reputation is for a securities firm, which relies on client trust."

Saturday, October 15, 2005


Goldman Saks On Refco: No Thanks

The New York Post has this update on the Refco bailout. "Goldman Sachs last night apparently rejected pleas from government regulators to take over the tottering commodities trading powerhouse Refco."

"Goldman said a purchase would conflict with its role as Refco's underwriter and financial adviser, for which it was hired yesterday."

"The regulators, from the Commodities and Futures Trading Commission and the Chicago Mercantile Exchange, hoped to calm fears that Refco's collapse could disrupt capital markets across the globe. Goldman and Refco spokesmen did not return calls seeking comment."


Refco To Be Bailed Out?

A reader sent in this link. "Regulators ask Goldman Sachs, others to bail out Refco. Senior regulators at the Chicago Mercantile Exchange and Commodity Futures Trading Commission have asked Goldman Sachs Group Inc. and other firms to buy or assume financial responsibility for Refco Inc.'s massive futures-trading operation, the Wall Street Journal reported after Friday's closing bell, citing unnamed people familiar with the matter."

"Any buyer would likely be expected to guarantee deposits of the unit and allow traders to unwind their positions, the Journal noted. An unnamed person familiar with Goldman Sachs' thinking said the firm isn't interested, according to the Journal. Earlier in the session, Refco said it was unwinding trades at its broker-dealer unit, a day after the commodities and financial-markets broker shut its capital-markets unit in the midst of a scandal."

Friday, October 14, 2005


Gold In 'Tailspin' As Hedge Funds Shake

Here is the weeks precious metals news in light of the Refco fiasco. "Gold in New York tumbled for a third straight session on Friday as some speculators ditched holdings amid a lack of investor interest this week and as uncertainty grew over problems at commodities brokerage Refco."

"But a burst of dealer and local broker buying hoisted silver prices at the close, as some players played the gray metal against much more expensive gold. Benchmark gold futures had hit their highest level since January 1988 on Wednesday, at $483.10 an ounce, before prices then slipped into a tailspin. By Friday's close, December delivery gold lost $2 to stand at $471.80 an ounce on the New York Mercantile Exchange's COMEX division, trading from $474.80 to an eight-day low of $468.30."

"George Nickas said the recent speculative interest seen in gold became more subdued this week. 'Also, the large spec position in COMEX gold has not been addressed yet and it is underlying the market,' he said."

"U.S. economic data was a mixed bag on Friday. Consumer prices shot up an unexpectedly large 1.2 percent last month, the biggest gain in more than 25 years. NYMEX January platinum fell $7.10 to $927.30 an ounce. Spot changed hands at $923/926. December palladium was off $1.75 at $210.20 an ounce. Spot fetched $206/209."

"Refco Inc. sped toward collapse as regulators barred its owners from taking out money and Standard & Poor's said a debt default may be imminent. S&P cut Refco's credit rating for the third time in four days and said 'a payment default is highly likely.'"

"A crisis in the world's hedge fund industry was in prospect last night after one of the world's largest derivatives brokers was forced to freeze trades potentially worth billions of pounds. The implications..may be felt across the world financial system, depending upon the size of the funds caught up inside Refco and the types of institutions which are unable to remove their money from the operation."


Refco 'Winding Down', Bankruptcy Eyed

Bloomberg has this update on the Refco mess. "Refco shutting down even more of its business as regulators take steps to prevent the owners from taking out money. Refco Securities LLC, the broker's biggest unit, 'will begin the process of winding down its business' with clearing houses for its equity and fixed-income trades, the Depository Trust & Clearing Corp. said in a statement today."

"The Securities and Exchange Commission barred withdrawals of equity capital from Refco Securities and Refco Clearing LLC for 20 days. Such withdrawals 'may be detrimental to their financial integrity or unduly jeopardize their ability to repay customer claims or other liabilities which may cause a significant impact on the markets or expose customers or creditors to loss,' the SEC said."

"'If Refco doesn't convince customers over the next several days that it's a financially sound institution, there is a very serious chance they could have to file for bankruptcy protection,' said Robert Heim, a former U.S. Securities and Exchange Commission enforcement attorney."

"Depository Trust said Refco Securities, 'which is currently in full compliance with the membership requirements of all subsidiaries, remains in business for the purpose of winding down its outstanding positions.' Depository Trust is the biggest clearing house for Treasury, corporate and municipal bonds, mortgage-backed securities, credit derivatives and emerging market debt."

"Refco Securities pledged to Depositary Trust..that it won't seek any new business save for that needed to close out positions. It remains unclear whether Refco is taking similar steps with its futures business."

"'A lot of people are fearful there may be more fire behind the smoke,' said Pat Arbor, former chairman of the Chicago Board of Trade. 'It's very important to come forward in a public fashion with as much transparency as they can. That's not occurring.'"

Thursday, October 13, 2005


Does The US Want A 'Plaza Accord' Redux?

This Business Week article looks at what the central banks did in the 1980's and what that means today. "Back on Sept. 22, 1985, the Group of Five nations (the U.S., Japan, Britain, West Germany, and France) agreed to devalue the U.S. dollar vs. the Japanese yen and German deutschemark though a series of currency interventions. A year later, the dollar had depreciated by about 50% in one of the biggest and fastest currency realignments in post-war history. This move would not only revive U.S. competitiveness in exports but also contribute to a massive speculative bubble in Japan."

"In 1985, much like today, there were huge worries about massive budget and current-account deficits in the U.S. In 1985, the U.S. current-account deficit was about 3.5% of gross domestic product. Today, it's about 6%."

"Indeed, the U.S. is sending Federal Reserve Chairman Alan Greenspan and Treasury Secretary John Snow to Beijing this week to urge Chinese monetary authorities to let the yuan appreciate against the dollar."

"As for China, my hunch is that Chinese President Hu Jintao's government has absolutely no intention of repeating the Japanese experience. So where does that leave us? Right now, the U.S. debt machine continues to grow more powerful with little consequence to either the U.S. economy or long-term interest rates. That's because both China and Japan continue to use their surplus savings and current-account surpluses to buy U.S. Treasury bonds."

"But what if the U.S. gets into trouble? What if interest rates soar to keep attracting foreign money? What if the U.S. turns to other economies and their Finance Ministers for some sort of coordinated currency regime to bail it out?"

"Let's hope it doesn't come to that because a U.S. economy in crisis would be bad for everyone. But this much is clear: The U.S. would likely face far more skeptical trading partners than it did back in the mid-1980s. The Plaza Accord may seem like ancient history to most folks, but not to those who count most. The Finance Ministries and central banks of Japan and China have very long memories."


Liquidity Dries Up For Refco, Stock Trade Halted

The situation at Refco is getting more dire by the day. "Refco Inc. said on Thursday that its Refco Capital Markets Ltd. unit doesn't have enough liquidity to keep operating as the futures broker reels in the midst of a scandal. Refco announced a 15-day halt on customer withdrawals from the division to protect the value of the enterprise."

"Refco stock slumped 27% to $7.90 on Thursday morning before trading was halted. The shares have lost more than two-thirds of their value this week."

"Refco also said on Thursday that regulatory capital and excess regulatory capital at Refco LLC, its regulated Futures Commission Merchant, and Refco Securities LLC, its regulated broker dealer, have been substantially unaffected by the scandal. 'The business at these subsidiaries is being conducted in the ordinary course including customer deposit and withdrawal of segregated funds,' the company said."

"Refco, Inc. provides execution and clearing services for exchange-traded derivatives; and brokerage services in the fixed income and foreign exchange markets in the United States, Bermuda, and the United Kingdom. It executes and clears customers'' orders for exchange-traded derivatives."

"It provides these prime brokerage services primarily in the U.S. Treasury securities, foreign exchange, and non-dollar fixed income markets. As of April 8, 2005, the company served approximately 200,000 customer accounts from its 23 locations in 14 countries. Its customers include corporations, government agencies, hedge funds, managed futures funds, pension funds, financial institutions, retail clients, and professional traders."

Wednesday, October 12, 2005


'Abnormal' Negative Interest Rates To End: BOJ

The central bank in Japan is planning some changes. "The Bank of Japan governor Toshihiko Fukui reiterated the central bank could end its super-loose monetary policy before the start of FY 2006 (year to March 2007). 'As to when we can discuss the possibility of changing the current policy, I think that the chances will grow stronger towards fiscal 2006,' he told a press briefing."

"Fukui, just last week, said the central bank could not continue 'the abnormal policy forever,' and that quantitative monetary easing could end before the next fiscal year starts in April 2006."

"'What kind of monetary policy we adopt after interest rates return to zero both in nominal and real terms, depends purely on economic and market conditions,' he said."

"The Bank of Japan's decision to keep monetary policy unchanged this month did not hamper speculation that the current 'super loose' policy will change in the coming year. It did however weigh on the yen which slipped to a 17 month low against the dollar."


Refco CEO And Hedge Fund Hid Losses

More detail is emerging about the derivative and commodity trading firm Refco. "Refco Inc. shares fell sharply Wednesday, after The Wall Street Journal reported that an investment firm controlled by Chief Executive Phillip Bennett paid a New Jersey hedge fund to help him hide a debt to Refco of hundreds of millions of dollars."

"Liberty Corner Capital was paid for telling Refco's auditors that it owed the debts even though Bennett's companies owed the money, a source familiar with the company told MarketWatch. "

"Shares of Refco dropped $3.15, or 23 percent, to $10.70 in late-morning trading on the New York Stock Exchange. Volume was heavy, and Wednesday's weakest level of $9.82, at that time, was a 52-week low surpassing the prior low of $12.79 set Tuesday. There was a 52-week high of $30.55 on Sept. 7."

"The investigation of derivatives brokerage Refco has turned criminal, a person familiar with the matter said. The U.S. attorney for the southern district of New York has scheduled a press conference in a 'major securities fraud scheme,' a spokeswoman for the office said. Sources say Phillip Bennett, Refco's CEO who was ousted on Monday amid an apparent scheme to hide bad debts at the company, has retained criminal counsel."

"A person familiar with the situation at Refco says the obligations transferred by Bennett most likely were unpaid margin loans made by Refco to its customers, including hedge funds."

"Refco's shares are down about 63 percent since closing at $28.56 Friday. The company went public in early August at $22 a share."

Tuesday, October 11, 2005


Derivative Giant Refco On The Ropes

The shares of derivatives trader Refco, Inc. had the halt lifted this afternoon and over 10 million shares quickly traded. "Commodities broker Refco Inc., on Tuesday said its recently removed chief executive took steps to inflate the company's balance sheet, in a scandal than has more than halved Refco shares in two days."

"Following a more than five-hour trading halt, Refco shares fell $2.60, or 16.7 percent, to $13.00 in afternoon trading on the New York Stock Exchange, after declining 45 percent on Monday. The shares had closed Monday at 29 percent below their $22 IPO price."

"One of the most prominent U.S. securities class-action law firms..sued Refco in a New York federal court. Jeff Harte wrote that Banc of America Securities, Credit Suisse First Boston and Goldman Sachs & Co., the lead underwriters on Refco's IPO, would face lawsuits 'sooner rather than later.'"

"Late Monday, Moody's Investors Service downgraded Refco affiliates to medium and low 'junk' grades, two weeks after saying it might raise those ratings. Moody's said it has 'serious concerns' about Refco's internal controls and questioned its corporate governance, and said more downgrades are possible. Rating agency Standard & Poor's downgraded Refco on Monday, and also said another downgrade is possible."


Rate Hikes To Continue: Fed Minutes

The minutes from the latest Fed meeting have been released. "The dollar remained higher against the euro and yen after the Federal Reserve released minutes of last month's meeting indicating policy makers are likely to keep raising interest rates to stem inflation. Higher rates boost the dollar by making U.S. debt securities more attractive to foreign investors."

"'The reason the dollar is staying strong is because markets have continued to price in more Fed tightening,' said Daniel Katzive, a currency strategist at UBS AG. Fed policy makers already have raised the benchmark from 1 percent to 3.75 percent since June 2004."

"Gains for the Japanese currency were limited because investors believe the Bank of Japan will refrain from ending its policy of pumping money into the economy until next year, said Steven Saywell, chief currency strategist at Citigroup Inc.."

"The central bank has added money to the economy and kept interest rates near zero for 4 1/2 years to fight deflation. Minoru Masubuchi, a former executive director of the bank said in an interview on Oct. 7 that it's 'still a bit too early' to predict when policy makers will alter their stance. 'We fully take on the recovery that's been happening in Japan but we've still got very easy monetary policy,' said Saywell. 'When we see the end of that easy money policy, the yen will begin to appreciate.'"

"The euro was quoted at $1.199, down from $1.2052 late Monday. Later, in midday trading in New York, the euro fetched $1.2010. Other dollar rates included 114.34 Japanese yen, up from 114.20; 1.2911 Swiss francs, up from 1.2845; and 1.1778 Canadian dollars, up from 1.1766. The British pound was quoted at $1.7455, down from $1.7537."

"In midday New York trading, the dollar bought 114.22 yen and 1.2881 Swiss francs, while the pound was worth $1.7485. Gold closed in London at $476.05 bid per troy ounce, up from $473.60 on Monday. In Zurich the bid price was $475.75, up from $472.20. Silver closed in London at $7.85 bid per troy ounce, up from $7.76."

Monday, October 10, 2005


Tangled Scandal For Derivatives Firm

The clouded world of derivatives is seeing some light this morning. "Refco, Inc. provides execution and clearing services for exchange-traded derivatives; and brokerage services in the fixed income and foreign exchange markets in the United States, Bermuda, and the United Kingdom. It provides these prime brokerage services primarily in the U.S. Treasury securities, foreign exchange, and non-dollar fixed income markets."

"Refco Inc. shares fell as much as 39% on Monday after the derivatives trading firm said it'll delay an upcoming financial report amid an audit committee investigation that resulted in the company's chief executive taking a leave of absence and a repayment of $430 million to the company."

"Refco said it believes that the $430 million receivable was the result of the assumption by an entity controlled by Bennett of 'certain historical obligations owed by unrelated third parties to the company, which may have been uncollectible.'"

"The company, which went public in August and is one of the world’s largest and most powerful commodities dealers, also said it would probably delay filing its 10-Q quarterly financial statement with securities regulators for the quarter ended Aug. 31."

Friday, October 07, 2005


Foreign Banks, Speculators Bet On Chinese Yuan

The BBC reports on who is holding the Chinese currency. "The amount of yuan held by foreign banks has risen significantly, in anticipation of another rise in the value of China's currency. In the past three months, yuan-denominated debt held overseas rose 3.8% to $266bn, according to figures released by the government."

"Levels of short term deb, regarded by economists as a barometer of the likely speculation in a currency, rose 7.9% to $141.3bn. 'The rise in China's short-term foreign debt reflected continued hot money inflows, showing speculation on a further rise in the yuan remains strong, despite the revaluation,' Xiao Minjie, an economist at the Daiwa Institute of Research."

"US Treasury Secretary John Snow is expected to make the case for a further relaxation in the yuan's exchange rate when he visits China later this month. China's trade surplus rose threefold in the first eight months of 2005 to $60bn, more than for the whole of 2004."


The British Pound Leading The US Dollar?

Asia Times Online had this quote this morning. "'What deflation is, is falling prices precipitated by a credit contraction, by the inability or unwillingness of lenders to lend and borrowers to borrow ... But, for now, a superabundance of money and credit is financing a leap in asset prices across markets and time zones." Jim Grant, Grant's Interest Rate Observer."

"We noticed this comment about the British economy by Anatole Kaletsky, 'The British economy today is struggling against four powerful headwinds: an oil shock, a downturn in the global business cycle, a decline of consumer confidence linked to high interest rates and weak housing, and a loss of control by the Treasury over Britain's public finance. And these headwind forces are likely to intensify, rather than weaken, in the year ahead."

"A great summary of where the US economy is likely to be very soon, if not already there. But because the UK is ahead of the curve, does it make the pound more vulnerable going forward? If Kaletsky's suggestion that the Bank of England may need to prune interest rates back to 3.5% next year proves prescient, one would expect the pound to react badly relative to the rest of the package."

Thursday, October 06, 2005


US Dollar Down On Venezuela Move

The Forbes site is reporting on a development for the US dollar. "The dollar was lower against major currencies, particularly against the euro, on reports that Venezuela may be diversifying its reserves away from the dollar."

"The reports follow news yesterday that Venezuela has transferred 20 bln usd worth of its reserves to the Bank for International Settlements in Switzerland. Domingo Maza Zavala, the head of Venezuela's central bank told El Nacional newspaper that it seems appropriate to increase the country's euro holdings and cut the dollar holdings given that the dollar has weakened against the euro."

"The euro has risen sharply against the dollar overnight and this morning, rising well above the 1.20 usd level and pushing towards 1.21 usd. 'Justification for the fall in the dollar centres around reports that the Central Bank of Venezuela has shifted up to 50 pct of its operational foreign exchange reserves beyond US jurisdiction and placed them in the custody of BIS, Basel,' said HBOS currency analyst Steve Pearson."

"He noted that previously Venezuela has suggested it held only a small amount of non-dollar reserves, and if it were to move in line with the largest emerging market nations, which currently hold 40-45 pct of reserves in non-dollar currencies, it would imply a one-off sale of around 10 bln usd."

Wednesday, October 05, 2005


Park More Cash: BOA Strategist

The Dallas News reports on some surprising investment advice. "It's common knowledge that cash is hot. It's highly uncommon for a Wall Street equity guru to come out and say so. But that's what the chief investment strategist at Banc of America Securities in New York did."

"To be precise, Tom McManus is recommending a 55 percent allocation to equities and 15 percent to bonds, both lower than his 'normal' weightings. And the remaining 30 percent? Park it in greenbacks. (That stands in stark contrast to the normal weighting of 0 percent for cash.)"

"What is his reasoning? The usual suspects everyone is discounting are, shall we say, more meaningful to Mr. McManus: energy prices, stock valuations, the earnings outlook, housing and, of course, rising interest rates. 'We think people should realize that one year ago, when the Federal Reserve was just starting to tighten, that at first these moves didn't amount to anything.'"

"'Can you imagine what it is like to be earning in the bottom quartile, stuck paying rent in an apartment?' Mr. McManus asked. I'm sure such damage caused by speculation in the housing market has not been lost on Fed officials."

"Regardless of the catalyst, Mr. Greenspan will go out with his guns ablazin'. And that can only mean one thing for investors who have yet to face the reality that meaningfully higher interest rates and a weak consumer sector are not the ideal formula to fatten bottom lines. With some online banks paying upwards of 4 percent on cash deposits, Mr. McManus' logic is all too easy to grasp."


Foreign US Debt Purchases Plummet

Economist Mark Skousen has a press release out on foreign inflows of capital. "Foreign governments have been bailing out the U.S. for several years now, buying up 70% or more of our federal debt. At one point, they were financing our ballooning deficit to the tune of $4 billion a day. Selling our debt to overseas banks, however, is getting harder, all too quickly, says Dr. Mark Skousen."

"Debt purchases have started to decline precipitously, from a peak quarterly rate of more than $400 billion in early 2004, to just $100 billion in the most recent quarter. At the same time, the federal deficit is expected to reach more than $500 billion in fiscal 2005. More debt, fewer buyers, a double whammy."

"The sharp slowdown in foreign purchases of U.S. debt will force the Treasury to raise interest rates to keep governments from unloading their T- bonds. Already, central banks from China to Argentina are quietly shifting to non-paper assets, specifically gold and precious metals, to diversify their portfolio."

The release has this chart to demonstrate the situation.

Tuesday, October 04, 2005


US Dollar At 'Critical Resistance'

The Forex news for the morning. "LONDON - The dollar stayed well supported midday as all eyes remained fixed on increasing inflationary pressures and the likelihood that US interest rates will continue rising. 'The dollar remains supported by strong cyclical factors, the Fed looks set to continue raising interest rates with Fed Atlanta President Guynn yesterday joining other officials in warning about inflation risks,' said Mansoor Mohiuddin at UBS."

"The series of manufacturing surveys across the industrial world yesterday all revealed a jump in the prices paid component. In the ISM manufacturing survey which measures the performance of the sector in the US, the prices paid component surged to its highest level since October 2004. 'Clearly energy prices are leaving their mark, but how long will it be before this feeds into the wider economy,'said Mitul Kotecha."

" The question now is how much further the dollar can rise as the yen is already at its lowest since May 2004 and the euro at levels not seen since July. 'The dollar is reaching critical resistance levels against the yen and European currencies,' BNP Paribas analysts said in a research note."

"'With markets developing increasingly conflicting signals, the risk of the dollar rally petering out despite rising US interest rate expectations has increased,' they said."

"The ECB decides on interest rates this Thursday. The pound meanwhile, came back from day lows having been sold down on speculation that the Bank of England will be forced to deliver a rate reduction in December due to faltering consumer demand. News today that mortgage equity withdrawal in the second quarter rose from the previous three month period went some way to ally fears that consumer spending will fall away quickly."

Monday, October 03, 2005


Japans Central Banker Expects No Rate Hikes

The head of Japans central bank had this to say today. "It is suggestive that comments from central bank Governor Toshihiko Fukui had ultimately led the charge for yen bears. Contradicting comments made last week by subsequent officials that forecasted an end to deflationary conditions in the upcoming six months, Fukui confirmed no rush to shift to a tightening policy."

"These recent comments are inline with previous requirements that a minimum of two consecutive monthly pickups in consumer prices would be needed. However, further indications of expansion would also be required in conjunction to viably shift central bank ideology."

The dollar was up against the Japanese currency, rising to 114.20 yen from 113.60 yen.

Saturday, October 01, 2005


Credit Derivatives Up $4 Trillion In 2005

The people at Elliott Wave International have some incredible news on derivatives. "A 'storm' could well come from 'events' that are actually related to the markets, even if they don't show up in the headlines. Such as, the explosion in credit derivatives, which grew 50% in the first half of 2005, to $12.43 trillion. (For comparison's sake, the U.S. gross domestic product is some $11 trillion.)"

"There's no simple way to explain what credit derivatives are; in oversimplified terms, they shift the risk of default away from debt holders to third parties. The immense volume of this activity means that no one really knows who's on the hook for what; reports say that the credit derivatives market now has an eight-month backlog of unconfirmed trades."

This from the subscription service. "In recent months, derivatives transactions have strained Wall Street's ability to process the trading. According to the latest reports, for instance, it will take eight months to clear a backlog of unconfirmed trades in the credit derivatives market. The head of the New York Federal Reserve says the problem 'poses risks not only to the financial institutions which use(derivatives) but to the financial system as a whole.'"

"A general rule of thumb is that the farther a loan gets from the originating lender, the more complex the counterparty claims become and the higher the risk of default. With the weight of deflation and widespread default bearing down on the economy, those risks are rising fast. The explosion in credit derivatives is an effort to 'manage' the escalating risk."

"It cannot end happily, however, because no one now trading credit derivatives(except possibly some of the traditional lenders that are selling susceptible credits into the market) envisions the unprecedented default rates to come. When they can't even figure out who owns what, figuring out who owes what will be nearly impossible."

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