|
|
Even to the most complacent
investor, the quiescence of the financial markets given the backdrop of
economic and political turbulence and deep, unaddressed, systemic financial
and economic problems is eerie. Several writers, such as Adam Hamilton and
John Maudlin, have drawn attention to the unusual set of circumstances
current in the markets. Nonetheless, these fundamental major financial and
economic problems, highlighted and described in
detail by the some of the best analysts on the web, such as Jim Puplava and Richard Russell, have far from disappeared. Instead, they continue to worsen.
 
Figure 1: Dow
Jones Industrials, 1-year chart
Whilst the DJIA and S&P500 appear to display
remarkably little volatility, often presaging a major change, the 200 day MA
climbs to meet the 50 day MA, which should be "the moment of
change"; shown on Figure 1. Given the Feds' "high gear" money
printing operation, some writers believe that the stock markets will move
upwards to new highs at this juncture. However, the US dollar, as shown on
Figure 2, has failed to significantly breach the 200 day MA, and last week
ended with it turning south again to conform with
its long term, 30-month bear market, underscoring the runaway US multiple
deficits and hitherto historically unprecedented fiat creation. New US debt is
now running at more than 5% of GDP and is still accelerating under a
President who appears to exert no financial control whatsoever. A collapsing
US dollar is highly unlikely to result in improved US competitiveness, and, hence,
an improved trade balance, as the issues are very much more deep-seated than
mere competition based on price. Indeed, the falling US dollar is
depreciating the value of all US based assets and securities, with
potentially calamitous consequences. As a substantial proportion of US
treasuries and equities are held by foreigners, one may expect them to demand
compensation, including a higher yield on bonds, to offset growing exchange
losses, and, furthermore, to exit US equities in favor
of those listed on foreign bourses in Euro's,
Sterling or Swiss Francs, in order to avoid currency losses.
Figure 2: US
Dollar, 3-year chart
Mr. Greenspan appears to believe he has the
situation well under control. His "gradualist" approach to raising
interest rates is a measure of his greatest nightmare, the terrible twins
"FANNIE MAE and FREDDIE MAC". He now is in the unhappy position of
facing the eventual collapse of these institutions, which, because of the
immense scale of their liabilities, will bring down the entire US financial
system with them. The Fed is already "way behind the curve" with
raising interest rates, as the markets are already some 200 basis points
ahead of him. However, this situation is likely to worsen dramatically over
the coming weeks and months. With inflation already running way ahead of the
manipulated CPI, and accelerating, prospects of the Fed continuing its
"gradualist" approach look grim. Further collapse of the dollar can
only accelerate inflationary pressures and push bond yields up. These factors
will eventually force the Fed's hand over interest rates. Merely threatening
action and following up with "watered down compromises" will not
keep the markets tame for much longer.
The Fed's propaganda machine, and credibility, is increasingly resembling "a busted flush". To
what extent the markets continue to swallow Fed executives' "market
soothing statements" will be determined by events over which their
control is seen to be increasingly wanting. Mr Greenspan's Fed cannot be
compared with J Pierpont Morgan in the 1907 Panic. Unlike Pierpont, Mr.
Greenspan's problems are several orders of magnitude greater and his options
extremely limited, if not to say non-existent.
Any significant rise in interest rates will have a
severe impact on Real Estate Mortgage markets, and, more importantly, for the
US, upon its incredibly highly leveraged Government Sponsored Enterprises (GSE's), " The Purveyors of Dreams", FANNIE MAE
and FREDDIE MAC. These two institutions have more liabilities than CITIBANK.
Both GSE's are in effect quasi-private firms
chartered by Congress to create and provide liquidity in secondary mortgage
markets. Together, these GSE's purchase,
retain, or guarantee more than 70 percent of the conforming US mortgage
market. Mortgages are originated by retail institutions, mostly banks. Fannie
purchases standardized ("conforming") mortgages from the
originators. Fannie then either holds the mortgages or packages them together
as securities, called mortgage-backed securities (MBSs
or "agency debt") and sells those securities on credit markets. Many
of them are purchased by money market funds. In the (mistaken) belief that the
Treasury will back Fannie Mae and Freddie Mac debts, many lending
institutions have granted these institutions loans on much more favorable conditions; i.e., a full 50 to 75 basis points
below normal interest rates on loans. This has had the adverse effect of
encouraging both GSE's to adopt a far riskier
investment profile than had they been companies competing under normal
commercial financial constraints. Given both GSE's
enormous debt risks, heavily based in the derivatives market, any significant
rise in interest rates would quite literally wipe both of them out. Such an
event, in which Fannie Mae's and Freddie Mac's liabilities comprise a
substantial proportion of the US
economy, would result in an all-out systemic financial default sufficient to
bring down the entire US
economy. Stock in these companies can be likened to Michael Milken's "Junk Bonds", with a similar mix of
speculative gain versus high risks.
As the US dollar resumes its voyage to the bottom of
the Mariana's Trench, Mr Greenspan will have much to think about. Like a
chess grandmaster in "Zugzwang" (every
move he now makes loses) his worse nightmares are upon him. Monetizing
Fannie's and Freddie's debts must be at the forefront of his last remaining
strategies. However, this will only buy time. The end game is moving towards
his ultimate "checkmate", and the eventual destruction of the US
dollar as the world's reserve currency. Should such an event occur, it will
have enormous implications for global stability, resulting in a fundamental
power shift of epochal proportions. Indeed, it will be "one of history's
turning points".
July 21, 2004
Nigel H. Maund
|
|
