Friday, January 15, 2010

Effects of Credit Creation Increasingly Clear

Bloomberg is running two stories next to each other that relate to the massive creation of "money" (really credit) that followed the immediate crisis.

In Strengthening U.S. Recovery May Intensify Fed Debate on Exit, we see the following intro:

Federal Reserve officials are more confident the U.S. economy is moving toward self-sustaining growth, giving urgency to discussions about the tactics and timing of an exit from record-low interest rates.

Kansas City Fed Bank President Thomas Hoenig said Jan. 11 the central bank should end purchases of mortgage-backed securities because the market is “healing.” Philadelphia Fed Bank President Charles Plosser said the next day that the recovery is “sustainable even as the fiscal and monetary stimulus programs eventually wind down.”

Policy makers are still studying ways to drain $1 trillion in excess cash from the financial system . . .

In other words, the Fed created credit and purchased Treasuries and mortgage-backed securities (MBS) which have an implicit (Fannie/Freddie) or explicit (Ginnie Mae) Federal guarantee.

I question the self-sustaining nature of the recovery, if there is a recovery.

I also do more than question the wisdom of society rather than companies and investors absorbing hundreds of billions or even more than a trillion dollars eventually of losses on mortgages. It would appear that taxpayers have better things to do for the American people than keep Citigroup alive and its bondholders pain interest and principal timely.

In any case, the Fed will have trouble selling the MBS and so is kicking the can down the road in that the credit it created to pay for the MBS and Treasuries is "out there" somewhere.

The proof that the credit is out there is that well before the real economy has come close to its peak levels is shown by the next article, Ratings Rise Fastest Since ‘07, Boost Ford Bonds, which says:

The spread between yields on corporate bonds and benchmark government securities narrowed to 160 basis points yesterday, the smallest gap since Dec. 31, 2007, according to the Bank of America Merrill Lynch Global Broad Market Corporate Index. As borrowers focused on refinancing debt in the past two years, cash at non-financial companies rose to $708 billion by the end of the third quarter from about $500 billion between 2004 and 2008, according to JPMorgan Chase & Co.

“Companies are coming out of this recession with balance sheets that are as good or better than they were going into the last recession in 2001,” said John Tierney, a U.S. credit market strategist at Deutsche Bank AG in New York. “Leverage is lower, margins are better, however you slice and dice it.”

Globally, the G7 nations "printed" vast quantities of "money". That money has gone into short-term securities and has bid up asset prices. Unfortunately, what the U. S., the epicenter of the Crash of 2008, is left with is struggling small business, levels of new home and auto sales first seen decades ago, record leverage when governmental debt is included, and official December statistics based on surveys of households showing that "Not in labor force" increased in one month at an annualized rate of about 10 million people and the "establishment" survey of companies measured over 100,000 jobs lost in December after stripping out the imaginary "birth-death" adjustment (85,000 jobs officially lost was the headline number).

On the other hand, parts of the globe that did not partake of our bad securities such as most of Latin America, China and India (and even Russia), are moving along much as if nothing had happened. (Of course, China is dependent on exports to the West, so it has been secondarily affected.)

It is unclear to me whether the recent surge in prices of platinum and palladium are fundamentally justified, but while it would be better if Goldline were not advertising on CNBC, gold has not even come close to a true manic stage; let us hope it never gets there. In my opinion, until the powers that be deal honestly with our debt situation and move to an overall much less leveraged situation, excessive downside risk will remain in the markets and the economy, and gold will likely "have a bid".

Copyright (C) Long Lake LLC 2010

So even as labor

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