German Minister Calls Tim Geithner’s Bailout Plan ‘Stupid’

From Telegraph’s Ambrose Evans Pritchard, (bold highlights mine)

German finance minister Wolfgang Schauble said it would be a folly to boost the EU's bail-out machinery (EFSF) beyond its €440bn lending limit by deploying leverage to up to €2 trillion, perhaps by raising funds from the European Central Bank.

"I don't understand how anyone in the European Commission can have such a stupid idea. The result would be to endanger the AAA sovereign debt ratings of other member states. It makes no sense," he said.

Mr Schauble told Washington to mind its own businesss after President Barack Obama rebuked EU leaders for failing to recapitalise banks and allowing the debt crisis to escalate to the point where it is "scaring the world".

"It's always much easier to give advice to others than to decide for yourself. I am well prepared to give advice to the US government," he said.

The comments risk irritating the White House. US Treasury Secretary Tim Geithner has been a key driver of plans to give the EFSF enough firepower to shore up Italy and Spain, fearing a drift into "cascading default, bank runs and catastrophic risk" without dramatic action.

The danger for Germany is that America will lose patience, with unpredictable consequences. The US Federal Reserve is currently propping up the European banking system in a variety of ways, including dollar swaps.

Continuing political schisms will add to concerns over liquidity conditions and will likely continue to pressure financial markets whom have been mainly dependent on steroids. It will take bailout policies with a scale of "shock and awe" to reflate financial markets which implies coordinated actions.

Our Mises Moment Answers Mainstream’s Conundrum of Market-Fundamental Disconnect

``But on the other hand inflation cannot continue indefinitely. As soon as the public realizes that the government does not intend to stop inflation, that the quantity of money will continue to increase with no end in sight, and that consequently the money prices of all goods and services will continue to soar with no possibility of stopping them, everybody will tend to buy as much as possible and to keep his ready cash at a minimum. The keeping of cash under such conditions involves not only the costs usually called interest, but also considerable losses due to the decrease in the money’s purchasing power. The advantages of holding cash must be bought at sacrifices which appear so high that everybody restricts more and more his ready cash. During the great inflations of World War I, this development was termed “a flight to commodities” and the “crack-up boom.” The monetary system is then bound to collapse; a panic ensues; it ends in a complete devaluation of money Barter is substituted or a new kind of money is resorted to. Examples are the Continental Currency in 1781, the French Assignats in 1796, and the German Mark in 1923.”-Ludwig von Mises, Interventionism: An Economic Analysis, Inflation and Credit Expansion

The mainstream is obviously very perplexed.

They can’t seem to figure what’s going on with market prices that can’t seem to match “fundamentals”.

Take this as an example. ``With oil inventories high and demand down year on year, yet prices surging, "fundamentalists" are puzzled” observes Liam Denning of the Wall street Journal.

Skeptical of the fundamental –market disconnect, the unconvinced Mr. Denning concludes his article with, `` Ultimately, however, the danger for China, and commodities bulls, is that Beijing's efforts fail to fully offset the harsh realities afflicting the world economy as a whole.” (bold highlight mine)

Figure 6: Wall Street Journal: China Watch The Body Language

Many have attributed the rise in oil or iron ore prices primarily to China see figure 6. But the unpleasant fact is that this isn’t just about oil or iron ore or China.

It’s about policy induced inflation whose growing influences are being ventilated on markets and which has been percolating and distorting the real economy.

And the primary mechanism for such release valve has been the US dollar.

As we wrote in last week’s Mainstream Denials And The Greenshoots of Inflation, a broadening category of the commodities have been experiencing price gains. So it’s not only oil or iron ore or gold but a whole range of commodities which includes food prices.

In addition, it isn’t just China or Sovereign Wealth Funds, but a broader spectrum of participants have joined the bandwagon as buyers of commodities. As we noted in Hedge Funds Pile Into Commodities, hedge funds have been growing exposure to commodities.

Even life insurance outfit as Northwestern Mutual Life Insurance Co. ``has bought gold for the first time the company’s 152-year history to hedge against further asset declines” (Bloomberg) could be signs of possible major reconfigurations of investments flows towards commodities.

My recent post which surprisingly turned out with a high number of hits, deals with Hedge Fund Ace John Paulson who made an amazing allotment of 46% of his portfolio into gold and gold related investments [see Hedge Fund Wizard John Paulson Loads Up On Gold]! He didn’t say why, but the message was loud and clear! What a statement.

Aside, Bond King and regulatory arbitrageur Bill Gross recently wrote to warn the public to diversify away from US dollar before ``central banks and sovereign wealth funds ultimately do the same amid concern about surging deficits” (Bloomberg)

He thinks that the US has reached a “point of no return”, again from the same Bloomberg article, ``“I think he’ll fail at pulling a balanced rabbit out of a hat,” Gross said from Pimco’s headquarters in Newport Beach, California. “They are talking about -- once the economy in the U.S. renormalizes -- the move back toward balance or much less of a deficit. I suspect that will be hard to do.”

Moreover, a public gold fever (not swine flu) appears to have infected ordinary Chinese sparked by the revelation of massive gold accumulations by the China’s government. According to the China Daily, ``Inspired by the increase in the government gold reserves, the more savvy investors are also buying shares of Chinese gold producers on the Shanghai Stock Exchange and the smaller Shenzhen Stock Exchange.”

Furthermore, drug trades have reportedly been reducing transactions based in the US dollar and could have possibly been replaced by trades in gold bullion (telegraph).

This Dollar based concerns won’t be complete without Russia’s continued outspoken campaign to replace the US dollar as the world’s international reserve currency, which apparently not only got support from major Emerging Markets as China and Brazil, but even the IMF has reportedly jumped on the bandwagon saying that replacing the US dollar is possible.

This from Bloomberg, ``The IMF’s so-called special drawing rights could be used as the basis for a new currency, First Deputy Managing Director John Lipsky told a panel discussing reserve currencies at the St. Petersburg International Economic Forum today.

``“There are many, many attractions in the long run to such an outcome,” Lipsky told a panel discussing reserve currencies at the St. Petersburg International Economic Forum today. “But this is not a quick, short or easy decision,” he said, adding that it would be “quite revolutionary.” (bold highlight mine)

And worst of all, US dollar as a safehaven status has been scoffed at by Chinese students! Incredible.

This from Reuters, ``"Chinese assets are very safe," Geithner said in response to a question after a speech at Peking University, where he studied Chinese as a student in the 1980s.

``His answer drew loud laughter from his student audience, reflecting skepticism in China about the wisdom of a developing country accumulating a vast stockpile of foreign reserves instead of spending the money to raise living standards at home.” (bold highlight mine)

It’s obviously a question of what degree of the Chinese population has been represented by the adverse reactions of Chinese students on Mr. Geithner’s statement. If these students account for a majority of China’s sentiment, then it is quite obvious that the public will likely be shunning the US dollar as mode of payment or as transactional currency or as medium of exchange (sooner than later) despite the Chinese policymakers’ avowed insistence to buy US dollar assets (but on a short term basis) which is no less than politically premised, as previously discussed here and here.

All these account for votes of displeasure over policies governing the US as reflected on its currency the US dollar, which mainstream can’t seem to comprehend.

As I wrote in my March outlook Expect A Different Inflationary Environment (emphasis added), ``This leads us to surmise that most of global stock markets (especially EM economies which we expect to rise faster in relative terms) could rise to absorb the collective inflationary actions led by the US Federal Reserve but on a much divergent scale. Currency destruction measures will also possibly support OECD prices but could underperform, as the onus from the tug-of-war will probably remain as a hefty drag in their financial markets.

``And this also suggests that commodity prices will also likely rise faster (although not equally in relative terms) than the previous experience which would eventually filter into consumer prices.

``In other words, the evolution of the opening up of about 3 billion people into the global markets, a more integrated global economy and the increased sophistication of the financial markets have successfully imbued the inflationary actions by central banks over the past few years. But this isn’t going to be the case this time around-unless economies which have low leverage level (mostly in the EM economies) will manage to sop up much of the slack.”

So far everything that we have said has turned out to be quite accurate.

But we seem to be transitioning to the next level.

This brings us to the question why the public seems to be gravitating towards commodities?

Ludwig von Mises has an explicit answer which I unearthed in Stabilization of the Monetary Unit? From the Viewpoint of Theory,

``If people are buying unnecessary commodities, or at least commodities not needed at the moment, because they do not want to hold on to their paper notes, then the process which forces the notes out of use as a generally acceptable medium of exchange has already begun. This is the beginning of the “demonetization” of the notes. The panicky quality inherent in the operation must speed up the process. It may be possible to calm the excited masses once, twice, perhaps even three or four times. However, matters must finally come to an end. Then there is no going back. Once the depreciation makes such rapid strides that sellers are fearful of suffering heavy losses, even if they buy again with the greatest possible speed, there is no longer any chance of rescuing the currency. In every country in which inflation has proceeded at a rapid pace, it has been discovered that the depreciation of the money has eventually proceeded faster than the increase in its quantity.”

So let us break these down into stages:

First, the loss of the currency’s purchasing power.

Second, is the loss of a currency’s function as medium of exchange or the “demonetization process”.

Third, is the accelerating feedback loop between the first two stages which brings upon the irreversibility of the process and

Finally, the total collapse of the currency.

So there you have it. The public’s increasing exposure to commodities is fundamentally a question of the viability of the present monetary standards.

So far the political path and market responses have been behaving exactly as described by Prof. von Mises.

Hence, I call this the Mises Moment.

Cartoon of the Day: Sons of Frankenstein

A recent headline from the Wall Street Journal says "China Takes Aim at Dollar".

Maybe this is the reason why....

Good humorous stuff from about.com

Why Geither's Toxic Asset Program Won't Float

There are many reasons for us to share the distrust with the apparent misplaced optimism credited to Tim Geither's Public-Private Investment Program or PPIP. Chief among them are issues on market price discovery and distorted incentives from government subsidies.

Nonetheless, I'll leave it to the experts debate on it.

But aside from technicality issues the following charts should explain why this program isn't likely to attain its goals...

One, leveraged loans defaults are likely surge.

The Researchrecap.com quotes a Moody's study (chart above from researchrecap)

``“Given tight credit markets, a worldwide economic slump, and a deteriorating issuer ratings mix, we expect default rates on leveraged loans will continue to climb in 2009, while recovery rates are expected to fall further,” said Sharon Ou, Assistant Vice President in Moody’s Credit Policy Default Research Group.

``Moody’s U.S. leveraged loan default rate ended 2008 at 3.5%, up from the 0.3% recorded in 2007.

``The ratings agency forecasts that 11.1% of U.S. leveraged loan issuers will default by the end of 2009.

``First-lien loan recovery rates fell to 63.4% at the end of 2008, down from 68.6% at the beginning of the year. By comparison, senior unsecured bond recovery rates dropped from 61.8% to 33.0% during the same period." (bold highlight mine)

Next, Fitch Ratings says losses in Residential Backed Mortgage Securities will rise further, see above chart.

The Researchrecap.com wrote, ``A dramatic rise in delinquencies has led Fitch Ratings to raise its average loss estimates for recent vintage jumbo prime mortgage pools to between 3 and 5 times higher than its previous estimate...

``In analyzing recent prime mortgage performance Fitch found that:

``Loans with multiple risk attributes such as limited income documentation and second-liens, are defaulting at rates approximately three times that of loans without those characteristics;

``A growing percentage of prime borrowers have lost all home equity due to declining home prices. Borrowers with negative equity in some recent vintage mortgage pools are approaching 50%;

``After adjusting for home price declines to date, loans estimated to have no equity in the property are defaulting at rates approximately three times that of loans estimated to have equity remaining.

``In addition to high default rates, recovery rates on defaulted loans are also trending downward."(bold highlight mine)

Lastly, Commercial Mortgage delinquencies are likely to worsen, see above chart.

The Researchrecap wrote, ``Commercial mortgage delinquencies rose sharply in February, driven by retail properties and lodging, according to Standard & Poor’s Credit Research, which lowered ratings on more than 200 commercial-backed mortgage securities during the month.

``The delinquency rate in February for U.S. CMBS rose to 1.57 percent from 1.39 percent in January.

``The amount delinquent is rapidly approaching the $10 billion level, closing February at $9.68 billion. The amount delinquent has increased by over 40 percent since the start of 2009, but the rate of growth slowed in February."(bold highlight mine)

The Commercial Mortgage Backed Securities could be the next tsunami of the serial deflating debt bubble.

According to the Wall Street Journal, ``Commercial real-estate debt is potentially more dangerous to the financial system than debt classes such as credit cards and student loans because of its size. The Real Estate Roundtable, a trade group, estimates that commercial real estate in the U.S. is worth $6.5 trillion and financed by about $3.1 trillion in debt. Partly because the commercial real-estate debt market is nearly three times as big now as in the early 1990s, potential losses in dollar terms loom larger.

``According to an analysis of bank financial reports by The Wall Street Journal, the broad shift to real-estate lending can be seen by comparing commercial real-estate loans -- including both mortgages and construction loans -- with banks' so-called Tier 1 capital, a key indicator of a bank's ability to absorb losses. In 1993, less than 2% of the nation's banks and savings institutions had commercial real-estate exposure exceeding five times their Tier 1 capital. By the end of 2008, that had risen to about 12%, or about 800 financial institutions. A higher ratio means a thinner cushion for loans that go sour.

And in contrast to residential mortgages which had been held by a few but largest banks, the general "community based" banking system seems highly exposed to the probable deterioration of commercial loans-as banking capital hasn't kept pace with the identified risks.

Again the Wall Street Journal, ``Of $154.5 billion of securitized commercial mortgages coming due between now and 2012, about two-thirds likely won't qualify for refinancing, Deutsche Bank predicts. Its estimate assumes declines in commercial-property values of 35% to 45% from the peak in 2007. That would exceed the price drops in the downturn of the early 1990s.

``The bank estimates the default rates on the $700 billion of commercial-mortgage-backed securities could hit at least 30%, and loss rates, which figure in the amounts recovered by lenders, could reach more than 10%, the peak seen in the early 1990s.

``Besides securities backed by commercial real-estate loans, about $524.5 billion of whole commercial mortgages held by U.S. banks and thrifts are expected to come due between this year and 2012. Nearly 50% wouldn't qualify for refinancing in a tight credit environment, as they exceed 90% of the property's value, estimates Matthew Anderson, partner at Foresight Analytics. Today, lenders generally won't loan over 65% of a commercial property's value.

``In contrast to home mortgages -- the majority of which were made by only 10 or so giant institutions -- hundreds of small and regional banks loaded up on commercial real estate. As of Dec. 31, more than 2,900 banks and savings institutions had more than 300% of their risk-based capital in commercial real-estate loans, including both commercial mortgages and construction loans."(bold highlight mine)

So if "toxic" asset prices will remain under pressure, the PPIP won't be enough to provide support as a wider range of loans are likely to crumble from the pressures of the combined weight of economic weakness and persistent financial sector eleveraging.

Private investors who are aware of the situation might see this as tantamount to "catching a falling knife"- and may refrain from participating- even if the private sector's risk participation is said to be only 7% while the rest is guaranteed by the goverment. Otherwise this should translate to huge taxpayer losses.

Hence, we can expect Geither's plan to probably expand coverage or introduce more innovative forms of bailout packages-all at the expense of US taxpayers-or for the US government to print more money to make up for the financial blackhole.

Does $7.76 trillion of US Government Guarantees Make The US Dollar A Safehaven Status?

US dollar bulls always insist that the US dollar dispenses its role as safehaven currency when global economies are under strain.

This view has been bolstered by the recent surge of the US dollar fuelling rambunctiousness in their convictions.

While we don’t dispute the US dollar’s role in the past, our belief is that the recent activities of the US dollar has been nothing more than the exercise of deleveraging or debt deflation, the unwinding carry trade and from its status as an international reserve currency standard (where most loans have been US dollar denominated) as discussed in Demystifying the US Dollar’s Vitality.

To consider, we recently cited that US taxpayers were faced with some $4.28 trillion (see The US Mortgage Crisis Taxpayer Tab: $4.28 TRILLION and counting…), a Bloomberg report now tabulates US government guarantees to hit $7.76 trillion or about 50% of the US GDP!

Excerpts from Bloomberg (HT: C. McCarty), ``The U.S. government is prepared to provide more than $7.76 trillion on behalf of American taxpayers after guaranteeing $306 billion of Citigroup Inc. debt yesterday. The pledges, amounting to half the value of everything produced in the nation last year, are intended to rescue the financial system after the credit markets seized up 15 months ago.

``The unprecedented pledge of funds includes $3.18 trillion already tapped by financial institutions in the biggest response to an economic emergency since the New Deal of the 1930s, according to data compiled by Bloomberg. The commitment dwarfs the plan approved by lawmakers, the Treasury Department’s $700 billion Troubled Asset Relief Program. Federal Reserve lending last week was 1,900 times the weekly average for the three years before the crisis…

``Bernanke’s Fed is responsible for $4.74 trillion of pledges, or 61 percent of the total commitment of $7.76 trillion, based on data compiled by Bloomberg concerning U.S. bailout steps started a year ago…

``The Fed’s rescue attempts began last December with the creation of the Term Auction Facility to allow lending to dealers for collateral. After Bear Stearns’s collapse in March, the central bank started making direct loans to securities firms at the same discount rate it charges commercial banks, which take customer deposits.

``In the three years before the crisis, such average weekly borrowing by banks was $48 million, according to the central bank. Last week it was $91.5 billion.

``The failure of a second securities firm, Lehman Brothers Holdings Inc., in September, led to the creation of the Commercial Paper Funding Facility and the Money Market Investor Funding Facility, or MMIFF. The two programs, which have pledged $2.3 trillion, are designed to restore calm in the money markets, which deal in certificates of deposit, commercial paper and Treasury bills.

``The FDIC, chaired by Sheila Bair, is contributing 20 percent of total rescue commitments. The FDIC’s $1.4 trillion in guarantees will amount to a bank subsidy of as much as $54 billion over three years, or $18 billion a year, because borrowers will pay a lower interest rate than they would on the open market, according to Raghu Sundurum and Viral Acharya of New York University and the London Business School.

``Congress and the Treasury have ponied up $892 billion in TARP and other funding, or 11.5 percent.

``The Federal Housing Administration, overseen by Department of Housing and Urban Development Secretary Steven Preston, was given the authority to guarantee $300 billion of mortgages, or about 4 percent of the total commitment, with its Hope for Homeowners program, designed to keep distressed borrowers from foreclosure.

``Most of the federal guarantees reduce interest rates on loans to banks and securities firms, which would create a subsidy of at least $6.6 billion annually for the financial industry, according to data compiled by Bloomberg comparing rates charged by the Fed against market interest currently paid by banks.

``Not included in the calculation of pledged funds is an FDIC proposal to prevent foreclosures by guaranteeing modifications on $444 billion in mortgages at an expected cost of $24.4 billion to be paid from the TARP, according to FDIC spokesman David Barr. The Treasury Department hasn’t approved the program.

``Bernanke and Paulson, former chief executive officer of Goldman Sachs, have also promised as much as $200 billion to shore up nationalized mortgage finance companies Fannie Mae and Freddie Mac, a pledge that hasn’t been allocated to any agency. The FDIC arranged for $139 billion in loan guarantees for General Electric Co.’s finance unit.

``The tally doesn’t include money to General Motors Corp., Ford Motor Co. and Chrysler LLC. Obama has said he favors financial assistance to keep them from collapse.

Amazing stuff. From $4.28 to $7.76 trillion in guarantees, subsidies, bailouts, stimulus packages with more to come.

Our idea is once the deleveraging dynamics ebb, all the recent strength seen in the US dollar will immediately be sapped.

The epicenter or “cause” of the world’s miseries can’t simply account as our safehaven. Such is a delusion.

And all the Keynesian malarkey of falling demand =falling prices loop will likewise evaporate.

The US dollar index had a remarkable one day fall.

Courtesy of Bespoke Invest

According to Bespoke, ``As equity markets stage their second straight day of gains, the US Dollar index is having its worst day since 1985, and its 5th worst day ever (since 1970). And today's fall for the Dollar broke the uptrend the currency had been in over the last couple of months, although it is still in a longer-term uptrend off of its Spring lows. Falls in the Dollar are coinciding with gains in equity markets and economic stability worldwide, since the US currency is now being treated as a safe haven. Go figure.”

Courtesy of Bespoke

As you can see, the US dollar index has broken down from its interim trend, suggesting further liquidations ahead. Pls be reminded the US dollar index is principally weighted against the Euro with 5 other currencies making up the rest of the basket.

Our thought is that commodity and Asian currencies (possibly some EM currencies with current surpluses) could lead the rally.

How has the fall in the US dollar fared to other markets?

Courtesy of stockcharts.com

Well, it’s a contagion in reverse. Former “safehavens” now victims of liquiditations; it’s not just the US dollar but obviously across the Treasury yield curve 10 year note, 3 month bill, 1 and 5 year notes.

And most importantly, some quarters have attributed the recent vigorous stock market rally to the appointment of President elect Barack Obama of Tim Geithner to the post of Hank Paulson or the incoming Secretary of the US Treasury.

While we believe that this causal chain is tenuous at best, a Geithner as 'the messiah rally' will likely to be a sucker’s rally. Yet if the market continues to rally from the recent lows (and establish a bottom!) even with Mr. Geithner doing nothing, as he is yet to assume office in 2009, then he might just be anointed a ‘saint’!

But this doesn’t seem inspired from a Geithner rally…

But probably one from Gold. Gold appears to have provided the recent market leadership.

The recent equity rally during late October hasn’t been confirmed by a rally in the commodities markets or in gold.

This isn’t the case today and looks like a broad market rally. Essentially, it’s a rally among all those asset classes that have been massively sold.

Three thoughts:

1. US dollar’s fall reflects cyclical forces of overbought conditions and may be temporary as the deleveraging dynamics continue. Conversely, equities and commodity markets have been in patently oversold conditions that the present gains reflect simply an oversold bounce.

2. A rotation in deleveraging. Because the US dollar and US sovereigns have immensely gained during the recent market volatility, the deleveraging process could have transferred been into a profit taking carnage in the US Treasuries market and the US dollar and inversely a reverse flow into oversold assets.

3. Markets could incipiently be smelling inflation. With $7.76 trillion of taxpayer exposure in the US and $trillions more from governments elsewhere, perhaps markets are starting to realize that the sheer magnitude of concerted inflationary policies are beginning to have some impact.

To quote CLSA’s Christopher Wood in today’s WSJ Op Ed, ``In this respect the present crisis in the West will ultimately end up discrediting mechanical monetarism -- and with it the fiat paper-money system in general -- as the U.S. paper-dollar standard, in place since Richard Nixon broke the link with gold in 1971, finally disintegrates.

``The catalyst will be foreign creditors fleeing the dollar for gold. That will in turn lead to global recognition of the need for a vastly more disciplined global financial system and one where gold, the "barbarous relic" scorned by most modern central bankers, may well play a part.