Subprime read “deadbeat”
Loans
SIV’s
CDO’s
RMBS’s
ABCP

Major Corporate leaders ousted
Major leaders retire
Heightened insider stock sales
Little M&A activity
Little IPO activity, many withdrawn
Free fall in Equities stopped by unknown, unseen forces
High Libor Spreads
Dollar Devaluation
Huge Drop in ABX index
Govt. Intervention in free market contracts
Large swath purchasing by foreigners of hard assets
Tremendous volatility in markets
Fed cuts despite high inflation
Rush to quality and safe havens
Inverted yield curve
Credit Market Lock-up
Desperate asset sales or stock issues to obtain cash or capital
Loss of confidence
Huge rise in price of commodities
Consumer & Governmental Debt in multiples over GDP
Foreclosures
Runs on Banks and Fund managers
Lack of any meaningful coverage of distresses on major networks
Artificial Rallies in seriously diseased business sectors
Speculation
Expensive overseas wars without exit strategy
Massive deficits without accountability
Political Intrigue

It all adds up, don’t let them deceive you that these aren’t real. There can’t be anymore kicking the can down the road. It’s time, there has never been a more perfect storm of correlating evils, take your own precautions.

If the Fed rate cuts are successful in rescuing assets at the expense of higher inflation now or afterwards, they will simply start another cycle, with an even bigger mess when the next downturn comes. The UK tried this in the 1960s and 70s, and ended up going cap in hand to the IMF, before Mrs Thatcher’s austerity and North Sea oil rescued us. Don’t go there!

The Das article is mostly crap. The credit contraction is deflationary. The Fed will cut rates hard to temper the deflationary impact. There will be a ‘cleansing’ of the credit system, which is much needed, but without net inflation impact. The bank ‘carry’ trade on bonds is a factor in the resulting environment, but a much-overestimated factor, and it is only temporary. The Fed’s easing program will be followed by a subsequent tightening cycle.

Gold is a joke. It won’t be a reliable inflation indicator this time around. Look to the bond market for a much more solid indicator of inflation premiums.

The Fed will ease by 50 bp in December. They will cut subsequently as much as required to avoid a deflationary bust. The cycle will restart, US financial assets will become increasingly attractive, and the dollar will find a bottom and actually start to strengthen once this is more evident.

I doubt that this scheme would help in the US, unless it has a Japan style bust that hugely raises the demand for base money. It works as follows:

(1) the central bank buys debt (typically repo issued by a bank) for base money, to the point that the yield on repo falls below that on government bonds.
(2) the bank which has borrowed this base money from the central bank uses it to buy the (now) higher yielding government bonds to capture positive carry
(3) the seller of the government bonds is left holding the base money

Unless the seller of the government bonds really, really wants base money, which is only likely in a slump, they will go out and spend the base money, and generate inflation. Moreover, since bank repo is unlikely to yield less than government debt, step 2 will probably require a maturity mismatch, which will present its own problems.

I would be wary about drawing conclusions from Japan’s experience until its economy finally normalises, other than the fact that the solutions tried there are certainly not quick ones!

My advice to the US would be to accept a slump deep enough to find the floor for asset prices, and then relax policy aggressively. Ultimately there is no free lunch; the mess has to be cleaned up. If the people who made the mess are not obliged to pay as much of the cost as possible, they, and quite possibly the previously prudent too, will simply make another mess, and the US will take another step on the road to Argentina.

Part of the answer to the China question is this growing investment in real assets, though the reserve accumulation in the $20+ billion/month range makes such “asset” buys a drop in the bucket! Or perhaps there is no alternative, which bolsters Goldman’s long dollar call.

As an aside, the SOVs rescue of US banks could continue. it is interesting that in many circles the US mideast summit is being branded a meeting of the moderates: kind of anti-iranian axis building. This is kind of a strech, but the Iraq venture has shifted the balance of power and the Saudi’s etc would appear to need the US more than ever. Lift that umbrella and who knows? Bodes well for further investment should we need it.

Who knows how the system recalibrates itself: as brad says, maybe it will not?

I’ll also be interested in your opinion of how deep that sentiment goes. For example, at what level of local inflation will these benefactors need more enticement than wretched assets, (the real return on USD debt held by foreigners post Bretton Woods has been ~.3%!!), to maintain their dollar peg? Will China view heady fixed capital investment and export growth as a source of stability if it means headline inflation at 20 some odd percent and presiding over a ballooning percentage of national wealth fetching negative real returns?

Obviously you can toss around hypotheticals to beg a question, but 20% inflation in China doesn’t feel far fetched. Inflationary forces are clearly picking up a head of steam there (as it is the gulf and, to a lesser extent, globally), while central banks seem poised to act against the building disinflationary forces of the credit crunch, (the Fed aggressively, the Brits eventually, the Europeans reluctantly, and the Japanese through unsterilized intervention if the ¥ continues to go against them). Which doesn’t sound good. Depending on your answer above, and knowing how much asset markets appreciate a good bout of rapidly rising inflation, (and the only way central banks can deal with them), this could be the brick wall waiting for us around the corner.

Exciting times though- even if, for my wallet’s sake, I’ll have to continue hoping that I’m wrong.

This article is being brought to you by Minyan Satyajit Das, a risk consultant and author of Traders, Guns & Money: Knowns and Unknowns in the Dazzling World of Derivatives (2006, FT-Prentice Hall) as well as the author of The Super Conduit Proposal.

If true then the banks could essentially make up for the demand shortfall while rebuilding thier balance sheets. Makes perfect sense…

Rather than the usual foreign demand having come to a sudden stop, is it not possible that the precipitous decline is simply a reflection of new demand supplanting the usual suspects?

The decline corresponds to the credit crunch, which has lent a certain appeal to debt that stands a good chance of not defaulting in the next few years. Presumably the greatest marginal benefit of owning US debt at this time is not to foreign central banks (they are already well equipped!). Surely the falling yield curve is evidence of increasing demand for US debt, rather than revulsion to it.