One easy thing China could do to help stabilize global markets: buy Agencies!
There is constant talk – too much, in my view – about whether sovereign funds will come to the rescue of western financial institutions.
Qatar did put a large sum of money into Credit Suisse recently, but in general the Gulf funds are reeling from large losses on their existing portfolio even as they are facing increased domestic demands (see Mufson and Pan of the Washington Post and Steven Johnson of Reuters) . “Rescuing*” US banks but not your own countries’ markets – and our own countries financial institutions — is hard. And some Gulf countries’ ability to carry out their ambitious local development plans will hinge on the availability of financing from their sovereign funds is oil stays at its current levels.
China is still cash rich. But the CIC has yet to prove that it can manage a $100 billion balance sheet (its “frozen” investment in the Reserve Primary Fund is the latest case in point) let alone manage a US or European financial institution with a far larger balance sheet. Moreover, it would seem a bit bizarre – at least to me – for the US taxpayer to guarantee the liabilities (and thus be on the hook for most future losses) of an institution that is effectively owned by China’s government. As Uwe Reinhardt notes, US taxpayers are already on the hook for most of the downside – and handing over both the upside and control to another country’s government (typically a non-democratic government) hardly achieves the goal of keeping major financial institutions in private hands.
But there is something that China could do that would be both stabilizing and pose few difficult policy issues: it could resume its purchases of US agency bonds.
The US hasn’t technically guaranteed the Agencies liabilities because it doesn’t want their (large) book to be consolidated on the US government’s balance sheet. But it has signaled that it stands behind the Agencies – and so long as the Agencies are the only source of mortgage credit for American households, that guarantee is quite credible. This guarantee led PIMCO to add to its already large bed on Agency bonds – but it hasn’t reassured the central banks that until recently were large purchases of Agency bonds.
Agency spreads remain wide. Accrued Interest has reported that they will remain wide until “real” money — and apparently more real money than even PIMCO can mobilize — returns to the Agency market, given the difficulties leveraged investors now face.
In the past, Asian central banks — and especially the PBoC — were a key source of demand for Agency paper. But the Fed’s custodial data – which seems to capture about 90% of all central bank holdings of Agency paper – leaves little doubt that the world’s central banks are now fleeing the Agency market. In the first three weeks of October, the latest New York Fed custodial data indicates central banks have added $53.9b to their Treasury holdings while reducing their Agency holdings by $51.4b. Since September 3 – roughly the time when the Treasury announced it would recapitalize the Agencies as needed – central banks have added $130.2b to their Treasury holdings while reducing their Agency holdings by $40.7 billion.
China accounts – by my estimate – for about 50% of all central bank holdings of Agencies, so it likely has contributed to the broad reorientation of central bank portfolios toward Treasuries. And China – unlike most emerging economies – still has a growing stockpile of reserves. It consequently is in a strong position to add to its Agency portfolio rather than continuing to pile into Treasuries.**
That would facilitate the flow of credit to American households willing to buy homes at current prices – and thus help to support home prices, and indirectly, the US financial system. It doesn’t offer the prospect for turbo-charged returns, but Agencies do offer higher yields than Treasuries. And the downside risk is very small – unlike the downside risk associated investing in a major Western bank.
And while we are on the topic of “stabilizing speculation,” China could also shift some of its portfolios from dollars to euros and pounds and Brazilian real and Australian dollars and Russian rubles. This is the time to diversify – not when the dollar is under pressure! Dollar strength amid US weakness strikes me as a growing problem.
*Rescue is the wrong word. Countries typically invests abroad to achieve their own policy goals — whether financial returns or strengthening their own ambitions to be a global financial center — not to “rescue” another country’s banks and help another country stabilize its markets. True rescues – investments with a high probability of a loss done to assure domestic financial stability – are generally done the government of the country that regulates the troubled financial institution. No country wants to “rescue” another countries’ banking system if that means losing money.
**The argument that China needs liquidity and only Treasuries are liquid doesn’t really work – China’s Treasury holdings are already so large that they are effectively illiquid, especially in the current market environment.
Yes, I think PBoC buying Agencies is a great idea.
In any case with the Agencies being in conservatorship, credit risk on agencies should be seen as credit risk on the US Treasury which should be zero.
And what does China get in return? A nod of approval from the high and holy?
Who cares about interest rates if you’ll never get repaid. This is the prime opportunity to reduce one’s dollar holdings. China will do a lot better by lending to Argentina or South Korea. It helps calming nerves and buys lots of goodwill. And the USD is going to be worthless anywaz.
Brad:
Since at least 2004 you’ve been pointing out to all comers in various forums that the US deficit is gargantuous and getting bigger by the second.
Your ideal world would be one where the US uses their technology superiority to export stuff all around the world, import less and save more in the economy.
Secondly you don’t want PBoC et al to be allowed to be ‘merchantilist’ and you believe the exchange rate should reflect the underlying trade in goods and services.
What I observed is that you revert to this point while discussing carry trade and other topics as well. For instance early this year you had an online discussion with Andrew and others around using USD as a funding currency where once again you relate that to the theme of the US deficit.
Is this understanding of your point correct?
In your debate with the DB economist around BW II you said your audience is policy makers … so essentially you’re advising policy action to make sure that the US economy functions like a normal economy in which a balanced trade in good and services with other countries is promoted.
Cindy one sec … I’ll explain why I’m agreeing with Brad that PBoC should go buy Agencies …
Meanwhile I need to write something that I think will be very interesting and useful to Brad and others
I do not understand why China would want to spend a *single cent* on GSE agency bonds. Debt issued by Freddie and Fannie are *much* more riskier than Treasuries, because Freddie and Fannie debt *do not* have the full faith and credit of the US government. Freddie and Fannie each have a $100 billion line of credit with the US government, but their debt is *NOT*, I repeat *NOT* guaranteed by the US government. To do that would require an act of Congress, and this is going to be part of the general debate on what to do with Freddie and Fannie that can’t happen until we have a new President and Congress in place.
The US Treasury department was willing to bail out Freddie and Fannie once before, but I’d argue that this makes is much less likely that they will do it again.
If the US government wants China to fund credit to US households, then it needs to take responsibility for the credit risk associated with it. This would mean having China buy US Treasuries and then having the US Treasury use it to buy mortgage backed securities so that if anything bad happens then the US Treasury is liable for the credit risk. This is part of the thinking behind Paulson’s mortgage bailout proposal.
I really also don’t see why China should invest much money in the US at all. It’s not as if there is a lack of things in China that it could spend its money on.
Brad:
See what you’re really missing out on understanding is that the policy makers’ objective to make sure that Joe the Plumber is happy with them.
If Joe the Plumber has a nice home to live in, a big SUV to drive around in and a steady job to do, he will be happy.
Joe the Plumber typically doesn’t read the Fed’s balance sheet.
So how the Washington policy makers ensure that every Joe, Tom, Dick and Harry holding a US passport is relatively happy with them?
how do
The policy ensures that tons and tons of cheap goods are available for import from China and other such places.
One of the reasons Chinese goods are cheap is the exchange rate and the other is that the Chinese manufacturing worker doesn’t neccessarily have to own a nice SUV.
Chidambaram says: In any case with the Agencies being in conservatorship, credit risk on agencies should be seen as credit risk on the US Treasury which should be zero.
No. No. No. This is the type of thinking that got us into trouble in the first place, and it’s got to stop. If it says “full faith and credit of the United States” then it has the same risk as US Treasury. The debt from the GSE’s doesn’t say this. They are *not* guaranteed by the Treasury and the fact that they are trading at higher than Treasuries should tell you that people don’t believe that they have the same risk as Treasuries.
So all these Wangs and Wongs work hard to make toys for Christmas and other such things that get exported to the US.
The exporters in return get a larger number of RMB than if they were to sell the same goods inside China.
Some of the exporters there are actually owned by smart American investors.
The folks who work in the export oriented business get higher salaries than the folks who don’t.
Meanwhile PBoC accumulates a tremendous USD reserve and makes the Chinese folks pay a good amount of money out for their imported oil.
This reserve is actually doing nothing. It’s not being used to buy dollars all the time or anything. It just sits on the PBoC balance sheet.
Again Wang the toy maker typically doesn’t read the PBoC balance sheet
As you can see Joe the Plumber is happy to buy cheap stuff and consume it. Similarly Wang is happy to work in an export oriented company and get lots and lots more of RMB.
The only ones who ideally shouldn’t be happy with the whole US deficit trillions are poor half literate folks who live in villages in places like China and India.
These are some uncounted millions of folks who earn less than $1 a day and eke out a meagre existence.
But policy makers in swank buildings in Washington, Beijing and New Delhi are not worried about THOSE folks.
See in China being a premier doesn’t require you to go and ask for votes in villages.
In India the crooked policy makers can bribe the half literate villagers with a gift of a saree or a small payment of $2 and convince them to vote.
bsetser says: But it has signaled that it stands behind the Agencies – and so long as the Agencies are the only source of mortgage credit for American households, that guarantee is quite credible.
We need to indicate who exactly “it signaled” is. In order to guarantee Agency debt, you need an act of Congress since only Congress can authorize the United States to borrow money. Once thing that we learned with the TARP situation, is that it doesn’t matter if the Treasury Secretary or even the President says that something is guaranteed. They don’t have the power to do this, and one thing that people need to understand (and China has gotten burned by this numerous timesbefore) is that just because the President promises something doesn’t mean that Congress will agree to it.
We are putting the cart before the horse. First we have an election. Once we have a new Congress and President, one of the first orders of business is to figure out what to do with Freddie and Fannie and it will take about a year to figure this one. It’s only when you have a restructuring plan in place that we can even begin to talk about whether people should or shouldn’t invest in agencies. It’s very possible that Congress will decide to get out of the mortgage business in which case Freddie and Fannie could be closed down with zero government guarantees behind pre-existing debt.
PBoC will continue to accumulate more and more USD dollars. Occasionally they will announce things like spending on the rural infrastructure. This will ensure some inflation happens and a little bit of money gets re distributed from the richer Wangs in the Daimler factory to the poorer Wongs who’re cultivating rice.
The neo colonial system will continue to flourish, practically for ever and for ever.
Chidambaram: See in China being a premier doesn’t require you to go and ask for votes in villages.
But it does require you to say nice things to peasants so that don’t riot. Ultimately, the Chinese government believes (I think correctly) that if the economy goes bad, they will all be out of jobs, and not in a pleasant way. My own personal opinion is that despite the lack of elections, that the Chinese government is as responsive to public opinion is say the government of the United States.
Also to advancement in the Chinese bureaucracy involves doing economically and politically reasonable things. The people in charge of the China Investment Corporation are not going to get promotions this year because of the losses that they have seen.
Chidambaram: In India the crooked policy makers can bribe the half literate villagers with a gift of a saree or a small payment of $2 and convince them to vote.
Which is why I think that having a good system of government is more than just having elections.
The question then becomes “where does this money come from”. If you aren’t generating wealth and just moving it around, then eventually the system will fall apart. The Chinese Communist Party puts a lot of effort into trying to figure out how to generate wealth since it is the only way that they can stay in power.
There’s really nothing to worry because Wang the factory and Singh the software programmer can read the newspaper and they’re happy; they’re very unlikely to read the Fed or the PBoC balance sheets.
But Wong and Patel the rice farmers can’t even read the newspaper in many cases!
Once they learn some skills they will first think of becoming like Wang the factory worker and Singh the programmer, don’t you think?
Chidambaram Says: PBoC will continue to accumulate more and more USD dollars. Occasionally they will announce things like spending on the rural infrastructure.
One thing about the Chinese government is that when they announce things like rural infrastructure spending, it usually happens. Lots of powerful people make money off infrastructure spending, and so there is a strong political incentive to have it happen.
Chidambaram Says: This will ensure some inflation happens and a little bit of money gets re distributed from the richer Wangs in the Daimler factory to the poorer Wongs who’re cultivating rice.
China has too many rice farmers, and it could produce the same amount of rice with a lot fewer people than it does. If you can move some of the rice farmers to become factory workers or hairdressers or movie actors, then you generate much more wealth. You then collect some of this wealth and make the payoffs you need to keep the system running.
Chidambaram Says: The neo colonial system will continue to flourish, practically for ever and for ever.
The lesson of history is that if you get rid of one wealthy elite, you just end up with another. I think it is useless to try make social better by attacking the rich and powerful. What you want is to change the rules so that the rich and powerful end up doing socially productive things to keep their wealth and power. If the economy is growing it becomes easier to do this.
Chidambaram: But Wong and Patel the rice farmers can’t even read the newspaper in many cases!
China has a 75+% literacy rate, and an under 25+ literacy rate of 90+%. Most rice farmers in China can read newspapers. Mass literacy and land reform was one of the good things that Mao did, since it is very difficult to have effective propaganda if most people can’t read.
This is one reason that China is such a world manufacturing powerhouse. Basically you can take any rice farmer from the countryside, and give him an instruction manual to operate a machine.
But if I’m understanding you aright, Brad, isn’t the larger issue here that we urgently need Bretton Woods III? That is, instead of piecemeal patches, we need an agreement between the major creditors (China, Japan, Russia, petro-states) and the major debtors (US, Eastern Europe, Baltics, Turkey) to work out the existing imbalances in an orderly fashion, i.e. boost non-US consumption, get the US to save again, etc. Given the scale of the problem, I assume the only way forward is coordinated regional action on a global scale – the EU bailing out Eastern Europe, Russia helping Ukraine and Belarus, China and Japan helping SE Asia and Korea), etc.
yes, we need bw 3 — but part of BW 3 is willingness on the part of China to appreciate v the $ and I don’t see that now. as a result, China will still be buying us financial claims — whether treasuries, agencies or something else. I would rather china spend and invest more at home, but that isn’t yet fully in the cards.
incidentally, ukraine isn’t keen on being bailed out by russia and korea isn’t keen on relying on japan — so the regional solution may not fully work.
i wish i saw the contours of a global deal — but right now i don’t. not really. the basic incentive is to try to avoid adjusting rather than to agree on an orderly way to adjust — tho in the current context avoiding adjustment is hard as everything is more less declining.
Twofish:
The lesson of history is that if you get rid of one wealthy elite, you just end up with another.
I agree with you completely and you would have noticed that we’re both saying the same thing.
Chinese Govt can spend a lot of money denominated in RMB to build some infrastructure. (they’ve already been nuilding their infrastructure for some time now)
This will give a fiscal boost to their local economy but naturally it will result in inflation.
More and more rice farmers can move into jobs like the Daimler factory.
Meanwhile PBoC will continue to accumulate USD reserves and everyone will be happy.
Twofish:
The lesson of history is that if you get rid of one wealthy elite, you just end up with another.
True, Twofish.
For instance in the US the relationship between the citizens and the ruling elite is not structurally different from that in any other clearly ‘banana’ republic.
Taking off from a George Soros interview, historically we’ve had social systems like the Kingdom, the Fascist State, The Communist State, and democracy with capitalism. In each of these systems there’s an ‘agency’ problem where the ‘agent’ acts in her own interest rather than in the common interest.
Among these systems what we’ve experientially seen is that the democratic system is the one in which there’s least harm done to the common interest.
In the US, the ruling elite consists of the political leadership, wealthy individual investors and the heads of large corporations.
To understand the nature of the relationship between this elite and Joe the Plumber, try to see how the elite recently hoodwinked the common man out of a huge sum of money, amounting to more than a trillion dollars, and also see how this is likely to evolve now.
You also have to remember that the American ruling elite collaborates with the ruling elite in other nations, with their first priority being to loot the common folks in those nations and their second priority being to loot the common folks in the US.
Since more than a year back, the game was to fix the oil price. Here the collaboration involved
1) SWFs that are under the control of oil sheikhs + the sheikhs themselves
2) US funds that trade in commodity futures (including some institutions like Calpers, who were traditionally not in this game)
3) Some of the relevant regulators, such as the CFTC.
The price of crude rose from $68 to around $146 in the space of a year.
In public statements, this was explained as being the result of ‘increasing demand in emerging countries like India and China’.
On June 28, 2008 Congress wrote a letter to the Commodity and Futures Trading Commission which is quite illustrative.
In their letter the lawmakers commented that the price of oil seemed to have become ‘disconnected from economic fundamentals’. They sought details of the commodities futures positions held by 18 of the traders who were given exemption from position limits by CFTC, and details about another 40+ traders who had similar exemptions in some other category, etc. They wanted this data by August.
CFTC came back and said that they need time till Sept 15 to give this data.
In October 2008 Washington Post reported that the CFTC response showed that 81% of the futures trades were speculative.
So this shows you that for more than one full year, the oil price was artificially hiked by the ruling elite of the US together with the oil sheikhs.
(J Aaron & Co, a Goldman subsidiary, was the first to receive exemptions from CFTC position limits. Also the letter notes that all IBs, including Goldman, Lehman,, etc have SWFs as their clients)
Following the letter from Congress to CFTC the speculators got the message to get out and the oil price has since been collapsing.
What motivated the Congressmen to finally act on this issue in June 2008?
At that time the price of oil was becoming too hot a political issue. Surveys showed that American voters were actually discussing the price of gas at the dinner table.
As the oil price and associated prices of food, etc rose, Joe the plumber was becoming increasingly uncomfortable. Many people like Judy the waitress, who had indulged in what the dinosaur economists call ‘living above her means’ by taking a home loan, were compelled to default.
Similarly, during this period (of sheikhdom dominating the NYMEX) , in almost all other oil-importing countries, the price of homes either remained the same, or increased less, with some cases where they went down .
Now we have covered the part which explains the origin and causes of the global housing price decline.
You will note that things like ‘lax lending norms’, ‘risky borrowers’, ‘The costly War in Iraq’, etc didn’t really cause the global downturn in housing.
In my next blog I will explain the subsequent ‘credit crisis’ that ensued.
Ok, so the defaults caused a loss of around $100b (could be slighter higher) to the banks that lent the money.
Meanwhile the FIs had made unrealistic bets worth at least $ 40 trillion just to book a relatively small premium as a profit; they did this in the CDS market.
Since the data on the CDS bet losses weren’t transparent even amongst themselves, the FIs stopped lending to one another.
Apart from this they also stopped to foreign banks, foreign CBs, basically stopped lending to all comers.
When they stopped lending to one another, the Fed stepped to lend money out to them.
the total of this lending from the Fed to the FIs so far is estimated at something like $1.8 Trillion (Cedric’s post)
The FIs have also tightened their lending norms for customers and so right now what you have is a situation where the banks and FIs that borrowed $ 1.8 Trillion from the Fed have used the money to settle the CDS bets amongst themselves.
The CDS game, like the oil futures game is now over and the CDS that are still trading will either be normal ones or close to normal.
As to the unwinding of the global currency carry trades, it’s quite simple to understand. An FI suddenly owes a huge amount to another FI because of being short CDS. They are also long in a carry trade. They unwind the trade, book profits and settle the CDS bet.
This sequence has had a major impact on those who didn’t default their loans or enter the CDS market.
Because some really big players are selling equities, not only in the US, but also in most other markets, it creates a strong momentum for everyone else to sell off as well.
The favorite way that US policymakers and other elites use to loot the public is to go on live national TV and tell some really big lies.
This strategy fools not only Joe the Plumber but also Brad the Economist.
Brad has been advocating some pious stuff like lower deficits for a long time.
When the cads went on live national TV and said these tremendous lies about this Armageddon-like financial crisis which is comparable to the historical ‘Great Depression’… he got so strongly influenced by it that he started linking the ‘credit crisis’ to the ‘US Deficit’.
Twofish:
China has a 75+% literacy rate, and an under 25+ literacy rate of 90+%. Most rice farmers in China can read newspapers. Mass literacy and land reform was one of the good things that Mao did, since it is very difficult to have effective propaganda if most people can’t read.
Twofish, with all due respect … hats off to you!
This is perhaps the funniest-ever comment on Brad’s blog site
Twofish:
China has a 75+% literacy rate, and an under 25+ literacy rate of 90+%.
“since it is very difficult to have effective propaganda if most people can’t read.”
LOL .. ROFL …:-)
And what, may we all know, … is the source of your comment that 75% of the Chinese are literate????
Chidambaram:
1) you are spot-on man. Btw, your blog link doesn’t work.
2) I think I’ve identified the source of ALL deflation: the drop in GSE paper. I would wager that there’s almost perfect correlation between the spread between GSE and treasuries and gold prices.
3) China buying GSE paper will induce MOTHER OF ALL RALLIES!
Brad,
I’ll believe the Agencies’ debt is actually guaranteed by the Treasury when I see their budgets integrated with the U.S. Federal Budget. Period.
As you know, the Social Security debt of the U.S. government (which is bonds issued to the S.S. Trust Fund directly by the Treasury) is also not guaranteed – a fact that is emphasized by all Administration and Congressional Republican politicians to get taxpayer money to stop investing in Social Security. And, like Agency debt, it is not integrated into the U.S. Federal Budget, either.
This use of Federal SIV-type off-budget financial shenanigans to accomplish political goals while limiting the transparency of the deficits and liabilities of the government is long-standing, and is NOT a confidence-builder for investors.
Hey, just about everyone lost their common sense regarding honest accounting and risk evaluation during the last couple of decades. So, sure, the Chinese overloaded on Agencies because they had a lot of dollars to invest and that’s what everyone who was underestimating risk did.
Now, like everyone elses, they’ve wizened up and (in addition to threatening the U.S. Government in order to get temporary bailout of Agency debt) they’re moving out of Agencies (and following the herd again into more and more Treasuries). Given that the latest political turbulence includes “directing” Fannie and Freddie to spend $40 billion per month to buy bad mortgages, it’s far from clear that these organizations have any coherent financial process at all any more.
In a previous post, you brilliantly summarized the relationship between the Chinese “sponge” of dollars from the currency markets into their reserves (invested in Agencies and Treasuries) and the madness of credit explosion and mis-allocation creating the U.S. housing bubble. I hope (and assume) you are not now advocating a “hair of the dog” practice in which the Chinese sunsidize the U.S. in trying to avoid deleveraging its bloated housing credit bubble by ignoring Agency risk and chaos and re-directing its dollars back to this mis-allocation.
Another thing I read is that the People’s Rebublic is about to ensure 95% health care coverage for the largest population in the world!
As soon as this happens China will then be more prosperous than the US, which will be still left behind.
LOL
Credulous …
While I’ve made the CDS game clear I don’t intend it to mean that the CDS folks are like Greenspan or anything.
The CDS folks are mostly kids playing with their newly invented toys.
See in 2007 Mortgage Bankers Association Estimated that while 35% of Americans own their home outright, around 5% of the homes are in both sub prime and Ajustable Rate category (ARM).
Nobody could have imagined that the bearded Arabian sheikhs would have such a runaway success in looting Judy the waitress at the gas pump and making her give up her starry eyed American dream.
The reason I reference Greenspan is that he is in my opinion the greatest living propagandist and the United States owes much of her wealth and power to his policies.
Witness this report from Ron Paul on a conversation he had with Greenspan:
“Fed Chair Alan Greenspan, on several occasions before the House Banking Committee, answered my challenges to him about his previously held favorable views on gold by claiming that he and other central bankers had gotten paper money– i.e. the dollar system– to respond as if it were gold. Each time I strongly disagreed, and pointed out that if they had achieved such a feat they would have defied centuries of economic history regarding the need for money to be something of real value. He smugly and confidently concurred with this.”
You can read the full Ron Paul speech around this quote at this link:
http://www.house.gov/paul/congrec/congrec2006/cr021506.htm
Notice how Ron Paul, along with Brad, belongs in the ‘American competitiveness with reduced deficits’ brigade. I wonder if these folks are folks that have never ever HEARD of the erstwhile East India Company, or perhaps even taxes on tea at Boston Harbor.
Chid:
Fallout from the oil speculation game isn’t over yet. Oil companies and refineries all hedge prices in the oil futures market. So many hedged oil at high prices and prices dropped in half so whomever is on the other side of the hedge is looking at potentially a few $100B in losses.
The CDS game isn’t over either. The DTCC report you posted yesterday implies remaining CDS are insuring corporate bankruptcies. As a spokesman for Joe Backstop, I don’t like the thought of backstopping phony insurance policies on corporate bankruptcies when the economy is going into a recession.
They may have fooled me into insuring mortgages during a housing bust, paying $4 for gas, but enough is enough.
Michael:
It’s only a matter of time before China comes to bid again for GSE paper: the alternative is martial law in China.
The Chinese will do it… eventually: they’re trying to paying as little as possible, since they want to preserve as much of their wealth as possible.
Of course, the Treasury is going to make that REALLY difficult.
That’s why we indulge Paulson!
Cedric:
Fallout from the oil speculation game isn’t over yet. Oil companies and refineries all hedge prices in the oil futures market. So many hedged oil at high prices and prices dropped in half so whomever is on the other side of the hedge is looking at potentially a few $100B in losses.
Act II was that after the oil prices fell around 50% from $146, OPEC issued a statement calling for ‘an end to speculative activities in oil prices’ LOL
Then they issued a statement that they’re going to ‘cut oil production’.
What a barrel of crude is worth in USD is actually anybody guess, I bet what it costs a sheikh to produce a barrel is far far below the $70 that he charges for it right now!
The folks that hedge oil at a high price while all the speculators in the know are either exiting the long futures and staying in cash or exiting the long futures and going cash are folks that we don’t need to worry about too much … precisely because those are folks that aren’t ‘in the know’ …
The CDS game isn’t over either. The DTCC report you posted yesterday implies remaining CDS are insuring corporate bankruptcies. As a spokesman for Joe Backstop, I don’t like the thought of backstopping phony insurance policies on corporate bankruptcies when the economy is going into a recession.
They may have fooled me into insuring mortgages during a housing bust, paying $4 for gas, but enough is enough.
The CDS that are outstanding right now will probably be a combination of those that have physical settlement, with their principal being the same as the loan principal and the old ‘bets’.
Of course, once the election is through there isn’t anything that should stop the sheikhs from making a good 30% more on oil than they are right now …
Brad,
Sometimes you are exactly on target with your advice for China, as when you wrote yesterday:
“China is the major oil-importing economy with the fastest growth, the biggest current account surplus and the lowest fiscal deficit (a surplus actually) going into the current crisis. It has the most capacity to use counter-cyclical fiscal policy to support its growth. Its currency should be appreciating in real terms right now.”
Today, you are off-target again. The world recession is not being caused by the slightly high U.S. interest rate on mortgages, it is being caused by too much lending by China to the rest of the world.
By the way, I’d like to call to your attention a monumental event in the history of your blog. RebelEconomist and I agree about something!
Yesterday I wrote, “There is a simple solution to the dollar’s rise versus the currencies of the world’s weak export-oriented economies: THE FED SHOULD BUY FOREIGN CURRENCIES!”
RebelEconomist responded, “Howard Richman, You have seen the light! The US should indeed buy foreign currencies, as I have been saying for years.”
This one is a no-brainer. Buying foreign currency right now would help to stabilize world currency markets while helping U.S. production and while giving the Fed currency reserves that could help in case of a run on the dollar.
Not only that, but those currency purchases would likely be profitable. These currencies are irrationally low compared to the dollar at present. The Fed would buy the currencies and then use the proceeds to buy the foreign government bonds, just as the Asian countries have been buying dollars and then using the proceeds to buy U.S. Treasuries.
Howard Richman
http://www.tradeandtaxes.blogspot.com
The reference for China’s literacy rate is the CIA factbook
https://www.cia.gov/library/publications/the-world-factbook/geos/ch.html
It lists the literacy at 90%.
Chid:
It’s production cost plus domestic social spending/infrastructure spending, etc… that sets what they would like to get for oil.
This has gone up to around $60 or so for the middle east, based on some swags I’ve seen.
Simmons The Oil Expert puts production cost at old Saudi fields around $5/bbl.
The new fields which need more costly methods to exploit, he puts in the $15 – $20 range.
These are his guesses since the Saudis don’t release info like this.
If OPEC wants to make more money, then I think we need to have them do it the old fashioned way, which is cut production. That way it’s a painful decision for them too. We now know speculators can double the price, and that is ridiculous.
We also need to make CDS go away permanently, along with a number of other financial reforms.
Judging from the public uproar over TARP, I think even Joe The Plumber thinks his butt looks like a great big baseball catcher’s mitt to Washington DC and Wall Street, and is suffering from extreme identity crisis over whether he is really Joe The Plumber, or Joe Backstop.
Michael: As you know, the Social Security debt of the U.S. government (which is bonds issued to the S.S. Trust Fund directly by the Treasury) is also not guaranteed.
Yes they are. Social Security invests payroll taxes in standard garden variety Treasury bonds. Social Security payouts aren’t guaranteed, but that’s a different issue.
Howard:
Intervention? That’s useless: the problem is solvency!
Until the agency mbs market is bolstered using foreign USD reserves, the deflation WILL NOT STOP.
Paulson will get those dollar reserves… actually, no: eventually, BRICOPEC will GIVE us the dollar reserves to finance agency MBS to avert their own demise.
Chidambaram: Another thing I read is that the People’s Rebublic is about to ensure 95% health care coverage for the largest population in the world!
They’ve been working on a new health care system since 2000. China had a decent health care system until about 1990 when it completely fell apart and since about 2000 they’ve been working on a new one. It’s already gone through several phases of trial and error, but it’s about to go national.
A lot has to do with the timing of the Chinese political cycle. Hu and Wen are scheduled to leave official in 2012, and a funded health care and educational system have been part of their political program.
The interesting thing about Chinese politics is that we are starting to get signs of what the Xi-Li team is going to look like, and it looks like that they are going to focus on rural areas.
Chidambaram: As soon as this happens China will then be more prosperous than the US, which will be still left behind.
No. China is not going to reach US standards of living until about 2080 at the earliest. The problem with US health care isn’t prosperity, the US could have had universal health care at any time since the 1930’s if people really wanted it, but people haven’t wanted it enough to make it happen.
Howard, and all
——————
Yesterday I wrote, “There is a simple solution to the dollar’s rise versus the currencies of the world’s weak export-oriented economies: THE FED SHOULD BUY FOREIGN CURRENCIES!”
RebelEconomist responded, “Howard Richman, You have seen the light! The US should indeed buy foreign currencies, as I have been saying for years.”
=============
I’ve been thinking the world should go back to the original concept of floating currencies. The natural consequence of this is the CB needs to have a currency/short term investment mix that matches up with it’s trading partners. That was the mechanism how fiat currency would get valued by the market and automatically work towards balancing trade. That way if you try to be an exporter only, your currency rises and you have to buy stuff from the other trading partner to make your currency go back down again.
We could call it BW Version 1.5, or BW3 as Brad suggested would be ok too.
In fact, Snow spent most of his Treasury career trying to convince China to do this.
The other problem is our Fed doesn’t have any dollars to buy foreign currency with.
However, I did see some gold in Ft. Knox.
Twofish:
The reference for China’s literacy rate is the CIA factbook
https://www.cia.gov/library/publications/the-world-factbook/geos/ch.html
It lists the literacy at 90%.
And here’s what CIA says about the ‘literacy’ statistic that they have on their web site:
There are no universal definitions and standards of literacy. Unless otherwise specified, all rates are based on the most common definition – the ability to read and write at a specified age. Detailing the standards that individual countries use to assess the ability to read and write is beyond the scope of the Factbook. Information on literacy, while not a perfect measure of educational results, is probably the most easily available and valid for international comparisons. Low levels of literacy, and education in general, can impede the economic development of a country in the current rapidly changing, technology-driven world.
Twofish:
I’m going to have to say that you need to get a low C- in hedgonomics for comparing all the CDS contracts with a gap insurance on an auto loan.
Secondly I have a geopolitics 101 question for you:
What is the CIA’s business?
Micheal,
Please don’t abbreviate Soc Sec as the S.S. Trust fund if possible. It reminds some folks of something called the Schutz Staffel.
Chidambaram Says: In the US, the ruling elite consists of the political leadership, wealthy individual investors and the heads of large corporations.
I’d add thinktanks like the Council on Foreign Relations and the major universities. Also there are the journalists in major newspapers and also lobbyists and special interest groups. The important thing about the ruling elite in the United States (and also in China) is that they are a very diverse bunch of people.
Chidambaram Says: You also have to remember that the American ruling elite collaborates with the ruling elite in other nations, with their first priority being to loot the common folks in those nations and their second priority being to loot the common folks in the US
That’s total nonsense.
The first priority for any ruling elite is to stay in power. “Looting common people” is rarely the most effective way of doing that because if you do that people get upset, and this means that you are much less likely to keep your power. In order to keep power in any developed nation, you have to maintain a healthy economy so that you generate enough wealth to keep the masses content with bread and circuses so that they don’t object to your control.
Chidambaram Says: Since more than a year back, the game was to fix the oil price. Here the collaboration involved.
No. First of all high oil prices are killing General Motors and the airlines so you can’t get anything like a consensus within the ruling elite that high oil prices are a good thing. Second, you can’t change the price of oil by trading futures. You can only change the price of oil by increasing demand or reducing supply, and that is outside the control of the United States.
There are some grand conspiracies, but most conspiracy theorists miss the real conspiracies.
Chidambaram Says: What a barrel of crude is worth in USD is actually anybody guess, I bet what it costs a sheikh to produce a barrel is far far below the $70 that he charges for it right now!
These numbers are quite well known. Production prices for Saudi are $5/barrel.
Seriously, China doesn’t need to do squat to bailout anyone. Countries around the world need to learn to open up its market and market down asset value to attract capital investment. it is capitalism and free market 101.
Cedric:
Please let’s go back to our discussion yesterday.
1) Mortgage loan recovery loss: $ 100b (could be abit higher but not too much higher)The loss in the latest quarter is around $35 b I think.
2) Fed’s credit to banking system:
$1.8 trillion.
3) Swap lines: not counted yet.
From one of Brad’s previous blog posts:
Foreign CBs increased their Treasury holdings by $ 1 Trillion, and corresponding reduced their Agency holdings by $1 Trillion, I think this was over a period of time.
Secondly the global equity market caps have fallen quite a lot.
There’s been a flight to Treasuries.
So the $ 1.8 Trillion that the Fed has lent to the FIs … where is it sitting right now?
Being held in Treasuries?
If foreign CBs sold off their Agency holdings then does that mean that private sector players bought the Agencies?
e.g. Pimco.
Twofish:
Chidambaram Says: Since more than a year back, the game was to fix the oil price. Here the collaboration involved.
No. First of all high oil prices are killing General Motors and the airlines so you can’t get anything like a consensus within the ruling elite that high oil prices are a good thing. Second, you can’t change the price of oil by trading futures. You can only change the price of oil by increasing demand or reducing supply, and that is outside the control of the United States.
There are some grand conspiracies, but most conspiracy theorists miss the real conspiracies.
Twofish, who’s the conspiracy theorist according to you, me or the United States Senate?
http://levin.senate.gov/newsroom/supporting/2006/PSI.gasandoilspec.062606.pdf
If you go to an average village in rural China and fund your average peasant, and ask them to read a newspaper, they can do so. Yes sometimes you end up with bogus statistics, but the fact that China has very high literacy rates is not one one them.
Also the oil and currency markets are too large and liquid for anyone in the finance industry to “fix.” The amount of capital that would be needed to set oil prices is far too high to allow for the type of market manipulation that people are talking about here.
Also getting from “high oil prices” to “I make money” is also not a simple thing to do. Let’s suppose you drive up the price of oil to $200 by buying up lots of oil. Fine, the spot price is now $200, how are you going to make money off of this? If you sell your oil to make a cash profit, that’s going to cause the price to go down again.
Oil traders get paid bonus and not commission. Hypothetically, if you make the price of oil go up to $150 in the summer, it’s not going to do you any good until bonuses get paid in January.
The other thing about “Joe the plumber” is that you have this guy which the McCain campaign is trying to portray as this “average everyman” but as a plumber he makes more money than the typical employee of Goldman-Sachs.
Twofish:
Also getting from “high oil prices” to “I make money” is also not a simple thing to do. Let’s suppose you drive up the price of oil to $200 by buying up lots of oil. Fine, the spot price is now $200, how are you going to make money off of this? If you sell your oil to make a cash profit, that’s going to cause the price to go down again.
You could tell that to the Senate Permanent Sub Committee on Investigations and see if they sort of agree with you
Twofish:
You’ll get the picture when you read the report at this link, seriously
I’m the last guy on earth who would want to invest a conspiracy theory all by himself …
http://levin.senate.gov/newsroom/supporting/2006/PSI.gasandoilspec.062606.pdf
Chidambaram Says: Twofish, who’s the conspiracy theorist according to you, me or the United States Senate?
Here is a perfect example of missing the real conspiracy. You have a Senator that wants to bash Wall Street bankers so that he looks good to the folks back home. He really doesn’t understand how commodity markets work, and he really doesn’t care, as long as he can find some nice person to blame so that he can get votes back home.
You can put all sorts of rules and regulations, but it’s not going to make any difference, but the Senators don’t really care if it makes a difference or not. Ask yourself this obvious question if CFTC adds reporting requirements on NY exchanges then how does it affect oil futures that are traded in London?
This is how people get fooled. Whenever someone talks about standing up for the common man against the ruling elites, in almost all cases its one part of the elite wanting your support against the other part.
If you really want to get something done about high oil prices, it’s actually something rather complex and difficult. But if you want to just get elected, you just have an investigative committee that issues a report. The fact that the report is clueless and useless is irrelevant.
And you fell for it…..
Chidambaram Says: You could tell that to the Senate Permanent Sub Committee on Investigations and see if they sort of agree with you
They won’t care. All they care about is getting elected, and issuing the report is enough to get voters to elect them for “doing something.”
Also oil traders don’t care either. The interesting thing about the report is that there is absolutely *nothing* in that report that would change the way that oil is traded. All that report recommends is more reporting.
Finally, the statistics that the report issues seem somewhat bogus. Suppose a small company wants to buy an energy future. He is going to do so through an investment bank, and it’s not clear to me how that gets counted in the statistics.
Chid:
Why do I get all the hard questions that have to do with numbers and evidence and stuff like that??? That’s Brad’s job.
But he’s probably sleeping now and it’s not quite nightclub time here yet, so I’ll divulge what I think I know.
“So the $ 1.8 Trillion that the Fed has lent to the FIs … where is it sitting right now?”
Some the banks are sitting on, since Libor hasn’t moved down much yet. $70B is slated for banking bonuses. The Fed balance sheet shows lots of excess reserves.
But TARP pays out over time. I think the first $125B may be on the way to the big 9 banks. Another $125B is by the end of the year to the rest of the banks that want to participate. $100B goes for buying MBS directly. $350B is held back for next year.
$300B was for the original FHA plan where banks are supposed to re-negotiate terms with the borrower and in return the USG guarantees the loan. This would only pay out as defaults occur of course. Then the open question is what does the USG do with the Deed.
Then there was the AIG loan, BS and other bailouts. Some of these deals sounded complicated, where the USG assumed future losses above a certain amount.
Then a lot of it is those new credit facilities at Fed.
And I still wonder what happened to all the mortgage CDS that DTCC claims isn’t there anymore. That’s the case of the missing Trillion, and I want the IRS, FBI, NSA and economics dept. of the CIA figuring out how that works.
So I guess to summarize, some of it is in a bank somewhere, and some of it is future liability.
“Being held in Treasuries?”
Short term Treasuries at 0% interest are looking very popular lately.
“If foreign CBs sold off their Agency holdings then does that mean that private sector players bought the Agencies?”
That plus part of the $1.8T tally was for treasury purchases of MBS.
Why buy agencies. Let them put yuan directly into joe’s account and the filter through will
prop up all markets. retail sales will explode.
No foreclosures as all of them will pay their mortgage. No corporate defaults. No bankrupties. No writedowns. No loss. Dow jones at 20000 immediately and then 100000 etc. CDS, CDO, Swaps explode higher.
Anyway China’s reserve profits are paper profits. To keep existing price, they keep pumping more. They cannot realize the profit
at all in bank account.Basically they are going to collect worthless dollars if they are paid back. They are going to collect worthless dollars if they invest in agencies
or not get paid by average american if they invest money into their account.
They both are same. Investing in agencies tends to zero while Putting money in account is zero. Why not do the latter?
Brad, there are people in China who are thinking about buying into non-dollar assets, including buying assets in emerging economies. But how would that help US? Although the American consumer demand has sagged in recent months, the need for capital inflow into US has increased, due to all these rescue efforts. When foreign capital is diverted from treasury purchasing to other things, wouldn’t you see an immediate hike in the treasury rate, with all the other rates, such as mortgate, commercial loans, credit card, etc, going up as well?
As far as currency reserve is concerned, China may well benifit from such a diversion. The currency loss induced by the depreciation of US dollar shall be compensated by the rising interest rate, and by the much bigger potential rise in the non-dollar asset values. But economically, it would deepen the US recession and the global recession as well, which is not in China’s interests. (Unless, the non-dollar part of the world could make up the lag in American demand.) In that sense, by buying treasuries, China is already playing the role of subsidizing and supporting US economy, while incurring the inevitable currency loss.
There are also broad geopolitical issues as well, and the best illustration is not the case of China, but the case of Japan. Despite the lost decade, Japan has a huge amount of savings and capitals. But for all these years, Japan has kept low interest rate, bought huge amount of US treasuries, and “manipulated” exchange rate to maintain its export. Japan would rather let others play the “carry trade”, while forcing Japanese savers sitting on low interest deposits. It is interesting to notice that the two “arch-enemies” in East Asia find themselves in such similar situation when it comes to international trade and finances.
Nowadays, there are also Japanese politicians talking about a great opportunities to divert Japanese savings and capitals in other directions. Not only these assets have fallen so much in price, but also Japanese yen has appreciated significantly.
But investing in the emerging world means political risks. Instability in these third world countries is one such risk, and Japan simply does not have the clout to deal with such risks on its own. The same is true for China. The American displeasure is another risk, to which the Japanese are probably more sensitive than the Chinese.
Energy Markets Emergency Act of 2008
http://www.opencongress.org/bill/110-h6377/show
SEN. JOSEPH I. LIEBERMAN HOLDS A HEARING ON COMMODITY MARKET SPECULATION.(Broadcast transcript)
Publication: Political/Congressional Transcript Wire
Publication Date: 25-JUN-08
http://www.accessmylibrary.com/coms2/summary_0286-34696428_ITM
Brad: It is interesting to read your following quote: “As Uwe Reinhardt notes, US taxpayers are already on the hook for most of the downside – and handing over both the upside and control to another country’s government (typically a non-democratic government) hardly achieves the goal of keeping major financial institutions in private hands.”
One small step forward, it would lead to the thinking: if worst comes worst, why don’t we let the agencies default? The loss will be incurred mainly by the government of another non-democratic country, while the enclosure laws can be revised so that American homeowners can be protected by rewriting the mortgage contracts, as forced by the US government.
Americans should be grateful that China and other foreign governments are still willing to buy treasuries and thus supporting US government in its efforts to sort out this mess originated from Wall Street. This is not the time to ask foreigners for more sacrifices, by taking up the risky agency debts, and popping up an impossible housing bubble. What made the mercantilist behavior of China and other Asian countries possible has been American profligacy.
Unfortunately, it is easier to blame others for causing the problem. None of the presidential candidates even mention the possibility that Americans will have to tighten their belts. They are still talking about tax cuts and fiscal stimulus. Monetarists got us into this hole with their advocacy of deregulation, and Keynesianists will turn it into an unmitigated disaster by throwing good money after bad during a time of deteriorating public finances. You, the economist readers out there, now have a great opportunity to make your fame, on par with Thomas Friedman and John Maynard Keynes, if you could come up with a nice solution.
Brad, reading your recent posts about BW2 and the follow of money reminds me a disturbing possibility: the credit turmoil gets worse with the deep recession, and the American public finance may soon be stretched to limit. The amount of issued treasuries is so big that either the liability on public finance would be unbearable in the foreseeable future or no one wants to buy it anymore.
In that situation, merely asking the Chinese and other central banks to buy agencies won’t do. The responsible thing to do is for the world leaders to sit down, and come up with an explicit plan with two important components: America makes an effort to sort out its financial mess, by cutting expenditure and raising taxes, while the Chinese, Japanese, and other reserve rich countries cough up the money, not to shore up the agencies, but to salvage the financial system. That’s what IMF typically does to a country that gets into financial trouble.
Cedric: And I still wonder what happened to all the mortgage CDS that DTCC claims isn’t there anymore.
I think that most of them got cashed in when Freddie and Fannie had a credit event. Also when Lehman sank there was a round of CDS musical chairs in which trades were done to move Lehman out of the picture and that got rid of a lot of CDS’s.
Cedric: That’s the case of the missing Trillion, and I want the IRS, FBI, NSA and economics dept. of the CIA figuring out how that works.
One problem is that government agencies don’t pay well enough to attract people that actually do understand how all of this works.
Limit Speculation in Oil Futures, Drop the Price of Oil by Half Analysts SayPublished on June 26th, 2008 Posted by McCullough in General
WASHINGTON (MarketWatch) — The price of retail gasoline could fall by half, to around $2 a gallon, within 30 days of passage of a law to limit speculation in energy-futures markets, four energy analysts told Congress on Monday.
Testifying to the House Energy and Commerce Committee, Michael Masters of Masters Capital Management said that the price of oil would quickly drop closer to its marginal cost of around $65 to $75 a barrel, about half the current $135. Fadel Gheit of Oppenheimer & Co., Edward Krapels of Energy Security Analysis and Roger Diwan of PFC Energy Consultants agreed with Masters’ assessment at a hearing on proposed legislation to limit speculation in futures markets. Krapels said that it wouldn’t even take 30 days to drive prices lower, as fund managers quickly liquidated their positions in futures markets.
“Record oil prices are inflated by speculation and not justified by market fundamentals,” according to Gheit. “Based on supply and demand fundamentals, crude-oil prices should not be above $60 per barrel.” Futures trading in London has not been a major factor in rising oil prices, testified Sir Bob Reid, chairman of the Chairman of London-based ICE Futures Europe. Rising prices are largely a function of fundamental supply and demand, not manipulation or speculation, he said.
“Energy speculation has become a growth industry and it is time for the government to intervene,” said Rep. John Dingell, D-Mich., chairman of the full committee. “We need to consider a full range of options to counter this rapacious speculation.” It was Dingell’s strongest statement yet on the role of speculators.
DavidHK: One small step forward, it would lead to the thinking: if worst comes worst, why don’t we let the agencies default?
The trouble is that when you default, people stop loaning you money, and without Freddie or Fannie in place or something like it, it becomes impossible to buy or sell a house without a 100% cash payment which most people can’t afford.
DavidHK: The loss will be incurred mainly by the government of another non-democratic country, while the enclosure laws can be revised so that American homeowners can be protected by rewriting the mortgage contracts, as forced by the US government.
If Freddie and Fannie go, then it just completely destroys the US banking system. The big problem isn’t foreclosure. The big problem is someone that just wants to sell their house. Without Freddie or Fannie, there is just no mechanism for funding US mortgages. This isn’t to say that there can’t be an alternative. It’s just to say that any alternative to the current system will take about two to three years to work out.
DavidHK: The amount of issued treasuries is so big that either the liability on public finance would be unbearable in the foreseeable future or no one wants to buy it anymore.
If you look at the debt/GDP ratio of the United States, it’s not particularly high by either international or historical standards, so we are very far from a situation in which no one is willing to buy US Treasury debt.
The big problem with the US isn’t the amount of debt, it is that if you have low savings rates then all of the funding is external and that can lead to problems.
DavidHK: America makes an effort to sort out its financial mess, by cutting expenditure and raising taxes, while the Chinese, Japanese, and other reserve rich countries cough up the money, not to shore up the agencies, but to salvage the financial system.
This is the standard IMF approach to dealing with a financial crisis. Unfortunately, I don’t think that the IMF approach to dealing with a financial crisis is a good one, and one thing that may save us is that the IMF doesn’t have nearly the power that it once did.
Fortunately for the US, it still has enough power to basically ignore what the rest of the world thinks, which is better than the situation for most developing nations that have to deal with the IMF loan sharks.
DavidHK: That’s what IMF typically does to a country that gets into financial trouble.
Which in my mind is a very good reason not to do it. If you look at the history of the IMF, it’s suggestions have made the situation for people living in those countries much worse than they have to be, and it has held to the a pro-market governments-are-evil ideology that has gotten us into this mess.
From the American point of view, one good thing about the US is that it tells the IMF what to do rather than listen to what the IMF says to it. Japan may be interested in telling the US what to do, but China certainly isn’t. China really doesn’t care what the US does as long as it doesn’t impact China.
Sovereign Wealth Funds – Energy Futures Speculators?
by: Donald Johnson June 24, 2008 | about stocks: DBC / GSG / RJA
Donald Johnson
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Become a Contributor Submit an Article Font Size: PrintEmail In a little noted or reported letter requesting information about commodities speculators, Congress has asked the Commodities Futures Trade Commission for information about how other countries are speculating in U.S. oil, grain and other commodities futures markets. The letter is here.
The question is, are net oil exporters like Venezuela, Nigeria, Iran, Mexico and Saudi Arabia inflating oil prices by buying futures contracts on the New York Mercantile Exchange? Are the Sovereign Wealth funds, as they are known, trading heavily enough to inflate prices. If they are inflating prices, by how much? While Saudi Arabia and other OPEC countries are making nice noises about the need to take speculators out of the oil markets, they may at the same time be lining their pockets with inflated oil revenues caused by their own speculative activities. John D. Dingell (D-MI), chairman of the House Committee on Energy and Commerce, and Bart Stupak (D-MI), chairman of the Subcommittee on Oversight and Investigation, asked the CFTC to:
Please provide a list of Sovereign Wealth Funds that have commodity investments including: a. An estimate of the open intererst in futures and options held by Sovereign Wealth Funds. b. How many Sovereign Wealth Funds from countries that are net exporters of oil are taking positions in oil or other energy futures? c. In the event that CFTC does not have sufficient information to assess the size and extent of these investments, please issue a Special Call for information to obtain a list of the Sovereign Wealth Funds, identify their aggregate positions in commodities, and make this aggregated information public.
Congress asked for a report by June 20, but the CFTC told a Congressional hearing Monday that the agency would have the information by Sept. 15. Read the whole letter. It’s a very interesting discussion of speculation in the futures markets.
The letter’s in this link:
http://energycommerce.house.gov/Press_110/110-ltr.061708.CFTC.OilFutures.pdf
To Chidambaram:
You can cut and paste as much as you want, but that doesn’t change the fact that the people in those hearings are pretty clueless about how the energy markets work, and they are more interested in looking for scapegoats than anything else.
Every summer energy prices go up. Every summer you have these hearings that blame speculators, and then nothing gets done. Nothing gets done because the main purpose of the hearing is to look good on television.
Also anytime a hedge fund manager says anything in public the first thing that I look at is what his positions are since most of the time they are “talking their book.” It’s also not a coincidence that these hearings take place in an election year, and are led by a congressman from Michigan.
If you want to see a real conspiracy, you need to ask yourself why congressmen from Michigan want low oil prices. You also need to ask the *big question* which is whether or not low oil prices are actually in the US national interest.
What I think is funny is that no one ever blames speculators from driving down the price of oil even though you can make as much money trading oil going down as you can going up.
Also, it’s not clear to me exactly how trading oil futures is going to affect the price of spot oil which is what determines what gets paid at the pump.
bset: “But there is something that China could do that would be both stabilizing and pose few difficult policy issues: it could resume its purchases of US agency bonds.”
honestly, if you were a central banker in a foreign country knowing what you really know about this mess in the ‘Agencies’, would you seriously consider buying US agency bonds as an investment?
even if you or other western minds would, with all due respect, i think we in the west would all do ourselves a service to understand a little better chinese cultural attitudes towards savings, investment & debt.
heck, even Taiwan doesn’t want them anymore:
http://tinyurl.com/5twgde
and they’re the u.s.’s ALLY.
but this begs the further question:
why so hard on china?
why not Saudi Arabia or Kuwait or Iraq (who has a $80B surplus) to buy some?
why not japan who’s another ally with the strongest currency in the world right now?
(not that they would anyway, because what the rest of the world is smelling is a rotting corpse, but that just might my sensitive nose of course)
so why china?
ok, so maybe you disagree with china’s mercantilist policies and their currency peg and how that affected the american trade imbalances,
but isn’t what china did/is doing comparable to what the u.s. did to great britain in the 20’s (different particulars, same effect)?
isn’t what’s good for the goose good for the gander?
did china force the u.s. to spend $1T or more on military campaigns all over the world?
did it force the u.s. gov’t to continue to run obscene budget deficits?
did it force the u.s. consumer to buy ‘made in china’ (including these computers that all of us are typing on right now)?
so again why china?
please please please tell me that it isn’t perhaps to help set the stage for your audience to justify a ‘failure to deliver’.
because that is a very dangerous game.
Very.
Dangerous.
to all of us.
as anyone who has ever been in one knows, dysfunctional relationships never end well until each party is willing to look in the mirror and see their own culpability, rather continuing to blame the other for the problem.
until that happens, situations have a tendency to become somewhat explosive.
nations are not much different than people in this regard.
let us please try to understand this and work to at least do our part to resolve the situation before it ever gets to that.
(sorry for the long post and any inaccurate assumptions contained therein)
slightly OT, but did anyone notice that BoC just bought 20% of the French unit of Rothschilds?
straight from the horse’s mouth:
http://www.reuters.com/article/bankingFinancial/idUSLI54405720080918
davidHK — didn’t see your post b4 i posted. your case is much more eloquent & diplomatic than mine…cheers.
2fish: You also need to ask the *big question* which is whether or not low oil prices are actually in the US national interest.
agreed, it just drives the US deeper into debt spending on unproductive behavior…as does artificially propping up home prices.
Oil prices fell becausse of demand destruction in US particular where demadn fell by 10% from summer to now. Production did not increase during the same period. Now we have surplus of 3 to 4% in the market. YoY US drove 5.6% less.
US economy is likely to contract by atleast 3% next year. With demand falling in rest of world, we could in a surplus of 5% to 10% in a year. That could bring the prices to low single digit. Since oil is such a essential commodity small changes in demand supply gap could mean violentg swings in both upside and downside. D-S gap and price are not linear but highly exponential.
Brad,
sometimes you can have your cake and eat it too but, most of the time you can’t.
I would agree that in principle agency debt ought to be ok, but I am not certain that I am right. In principle doesn’t cut it.
There is a difference between a legal guarantee and a statement of support by the Washington branch of Goldman Sachs. Especially if the next guy is not Rubin.
I think that the Chinese would have to be very gullible to confuse both. While the managers of the investment funds have certainly not displayed great investment capacities, I would expect that the leadership is much smarter.
If the recent events have taught us anything, it is that events do not always unfold as we expect. Imagination about possible future outcomes cannot come in too big a supply.
cedric- you are right FED must buy foreign currencies if it wants make china depeg its currency. But Brad argues china does not have
capital account convertability. Then buy japanese yen, swiss franc and euro. The excess dollar has to be mopped by china to defend its peg. If everybody blocks current account convertabilty, buy all the cash circulating in the market. It will squeeze liquidity completely out in the chinese banking system
and that will force them to depeg and then US can sell foreign currencies after defaulting on all their debt commitments to foreigners. US dollar will not fall in this case simply because defaulting and at the same time holding enough foreign currencies to make the transition to balanced economy will enable them to survive in the transition period. IT means all foreigners have given the goods to US essentially for free.
Rescue is indeed the wrong word, the USA is hardly iceland or even Hungary (which is apparently the next in line) – if it doesn’t need rescuing it probably doesn’t need stabilizing, after all, it’s all part of consumption and the economic cycle right? Look, financing part of the consumption cycle is bad enough, imagine should China have the temerity to buy substantial amounts of agency bonds it might just be seen as part of the problem, not the solution , might just breed more xenophobia
:p
much better to finance the treasury’s bailout efforts perhaps?
liquidity of treasury bonds is probably relative to the illiquidity of other assets perhaps?
The liquid test of whether anyone should try some brave acts vis~a~vis agencies; ask allies to buy them , if the british and french show interest, perhaps others may follow, after all there is a concerted effort to stabilize things right? Where angels fear to tread…
apologies, acid test, not liquid test,
btw, roubini has come up with advice ; avoid distressed assets and stay in cash
hmm…
U.S. has plundered world wealth with dollar hegemony: China government
Fri Oct 24, 2008 6:14am EDT
http://www.reuters.com/article/email/idUSTRE49N1XX20081024
BEIJING (Reuters) – The United States has plundered global wealth by exploiting the dollar’s dominance, and the world urgently needs other currencies to take its place, a leading Chinese state newspaper said on Friday.
“The grim reality has led people, amidst the panic, to realize that the United States has used the U.S. dollar’s hegemony to plunder the world’s wealth,” said the commentator, Shi Jianxun, a professor at Shanghai’s Tongji University.
Shi, who has before been strident in his criticism of the U.S., said other countries had lost vast amounts of wealth because of the financial crisis, while Washington’s sole concern had been protecting its own interests.
“The U.S. dollar is losing people’s confidence. The world, acting democratically and lawfully through a global financial organization, urgently needs to change the international monetary system based on U.S. global economic leadership and U.S. dollar dominance,” he wrote.
Better than wasting money on toxic US mortgage junk bonds.
China to invest in rail network as stimulus measure: report
BEIJING, Oct 25 (AFP) Oct 25, 2008
http://www.sinodaily.com/2006/081025065214.ehtopo5z.html
China will invest nearly 300 billion dollars in its overburdened rail system as a stimulus measure aimed at blunting the impact of the global financial crisis, state press said on Saturday.
The investment is part of plans to extend the country’s railway network from the current roughly 78,000 miles to nearly 100,000 miles by 2010, Shanghai’s Oriental Morning Post reported.
The Beijing News quoted a rail official as saying that, while the network needed extending, the massive investment of 292 billion dollars was also intended to help lift the nation’s economy as it suffers amid the global woes.
“New rail investment will become a shining light in efforts to push forward economic growth,” railway ministry spokesman Wang Yongping was quoted saying.
China’s economy recorded its slowest growth in five years at 9.0 percent in the third quarter of 2008.
Credulous Prole,
In response to my posting that the FED SHOULD BUY FOREIGN CURRENCIES, you wrote: “Howard: Intervention? That’s useless: the problem is solvency! Until the agency mbs market is bolstered using foreign USD reserves, the deflation WILL NOT STOP.”
You fail to understand that the way to fight deflation is for the Federal Reserve to increase the money supply.
I am advocating that the Fed expand the US money supply (by buying long-term US Treasuries) and use the proceeds to buy foreign currencies.
Then the Fed would invest the proceeds in foreign government bonds. This would lower the dollar compared to these currencies and would increase our exports and reduce our imports, thus increasing Aggregate Demand for American products.
This would not work as well as my complete solution which would immediately restore American prosperity and keep the United States out of the worldwide depression ( http://www.enterstageright.com/archive/articles/1008/1008buffet.htm ), but it would be a small step in the right direction.
Howard Richman
http://www.tradeandtaxes.blogspot.com
Cedric Regula,
In response to my posting that the FED SHOULD BUY FOREIGN CURRENCIES, you made an excellent suggestion when you wrote:
“I’ve been thinking the world should go back to the original concept of floating currencies. The natural consequence of this is the CB needs to have a currency/short term investment mix that matches up with it’s trading partners. That was the mechanism how fiat currency would get valued by the market and automatically work towards balancing trade. That way if you try to be an exporter only, your currency rises and you have to buy stuff from the other trading partner to make your currency go back down again.”
You are correct. If every Central Bank had the exact reciprocal currency-intervention action to every foreign Central Bank, then the two actions would neutralize each other. For example, if the Federal Reserve and the People’s Bank of China both expanded their money supplies by issuing their respective Treasury Bonds and buying the other country’s Treasury Bonds, then the actions would exactly counter each other, except that both countries would end up with currency reserves.
The only problem here is that China prevents foreigners from buying their treasury bonds. The Fed would have to create a Sovereign Wealth Fund and use its purchased yuan to buy Chinese stocks.
Howard Richman
http://www.tradeandtaxes.blogspot.com
Correction: In my post to Credulous Prole, change “buying long-term US Treasuries” to “issuing long-term US Treasuries”.
DJC:
BEIJING (Reuters) – The United States has plundered global wealth by exploiting the dollar’s dominance, and the world urgently needs other currencies to take its place, a leading Chinese state newspaper said on Friday.
DJC, this is truly the only news that should be taken as disturbing.
Brad, please note that this piece of news is the only one that can actually make the US dollar collapse and make all of your related dire predictions come true.
In the global round table on November 15, the Europeans are going to try to insist on a system where Petro trade will be in Euro, instead of dollars.
If China has been influenced to support that somehow, then the move will almost certainly go through.
Western press agencies usually very much misunderstand how Chinese newspapers work. Just because an opinion is published in the People’s Daily doesn’t mean that much really.
If the Chinese government were officially expressing an opinion on something, you’d have an instruction from the Central Publicity Bureau of the Party go out to all of the newspapers to publish something.
If you have an article that is published in one newspaper, then it’s usually something that isn’t an official opinion. There is censorship, but on economic issues it tends to be very light. So there is nothing to suggest that People’s Daily was just reprinting something that was a professor’s personal opinion.
It’s also times like this that reading Chinese comes in very useful since you can actually read the original newspaper, and see what they are saying. Over the past few days, most of the coverage in the Chinese press has been 1) to promote rural infrastructure development and 2) to reassure people that the impact of the crisis on China is limited.
Also, as I’ve mentioned time and time again, oil is priced in dollars. It’s not paid in dollars, and none of this discussion is likely to make the dollar move very much.
Why should China fix the mess, let the ones fix the mess that caused it. Get back the money who stole it. Mr. Fuld and his gangsters there are tons of people who did profit from this scheme so now start the machinery to collect it back.
China meanwhile would be stupid to delay the fall of the empire. From now on the world is more balanced and thats good so.
Twofish/Brad:
Here’s the only way Brad’s ‘hard landing’ hypothesis can actually pan out, as far as I can analyze.
63% of the world’s CB forex reserves are currently held in USD.
There’s a lot of USD denominated debt, mainly US Treasuries, which is being held as part of these reserves.
Similarly, there’s a lot of USD denominated debt that’s actually been made out in the EUR economies, which they have to repay in USD.
Most of the Pacific Rim countries have been accumulating USD reserves.
I’m not sure about this data but the holdings of the SWFs are also likely to be denominated in USD.
Come November 15, Brown, Sarkosy and Merkel will benefit if they can get agreement to import crude in EUR, without having to buy USD.
The reason this will benefit them is that their economies have to pay a lot of money out in USD to finance their USD denominated debts.
If the USD weakens, they will have less to pay in EUR.
The other folks who’re going to be invited are the BRIC countries, Japan, etc.
In case of China, ideally they should resist a change in the petro-dollar arrangement because they’re holding the largest quantum of USD denominated reserves.
If USD weakens rapidly, PBoC’s forex reserves will become worthless overnight.
Of course, as the Central Publicity Bureau has reportedly been assuring Chinese people, this will have limited impact on the ordinary Chinese.
As the Euro rallies after the new agreement, Chinese people will simply continue their export activities to EUR economies at a higher margin and to the US at a lower margin.
Worst case, the USD export business needs to realign on to EUR exports in a massive way.
As EUR strengthens, EUR economies can take the lead in cheap imports on a neo-colonial basis.
The oil sheikhs need not necessarily care what currency their crude is going to be paid in, as long as it’s something good and strong.
They will also lose heavily out of USD denominated holdings in their SWFs.
For the US, there are several benefits in allowing the USD to weaken against the EUR.
Imports will become more expensive, which is likely to provide a boost to local employment.
Exports will become much more profitable, which will also boost the local economy.
As of now there’s a lot of USD owing from the US to China, etc. And there’s a lot of USD owing from EUR economies to the US. If the USD becomes weaker against most world currencies, then the US can repay and reduce its debt to the world much more easily.
However, US government will either agree to or resist this depending on the ‘other elite’ … the investors.
It’s important to know where the money is sitting right now, so that it’s easy to see whether they will benefit from this or not.
Knowing where the money is right now will also tell you when the markets are likely to go up again.
Q1) To what extent has the increased credit from the Fed been used to settle outstanding CDS payables?
Q2) As the Fed’s balance sheet increased tremendously, where’s that money sitting right now?
wow — you all are prolific.
Why China?
With oil at $70, the oil exporters surplus has disappeared — and inflation has corrected their real undervaluation (not how I would do it, but it has happened). They aren’t central to global adjustment right now.
the yen is moving in the right way as well — it is a surplus country, and its currency has appreciated. it also hasn’t intervened in a big way in the currency market.
China’s rmb is moving the right way — b/c the dollar is going up. but relying on $ appreciation for RMB appreciation never made sense to me — and i don’t want to continue to rely on it. plus china will be the main current account surplus country next year/ the main source of reserve growth.
As for why Agencies rather than Treasuries — tis true that if China wants treasuries rather than agencies, the us gov can issue treasuries and buy agencies, and play the role of the intermediary. if that is necessary the us will do so — it might be easier tho if the us gov found a structure for the agencies that china liked. call it my concession to the reality that china has a large stake in the us debt market/ that stake will grow over time in a gradual adjustment scenario.
that said, i would prefer to see china spend more at home and less on treasuries and agencies — and have no problems with China diversifying into other currencies and financing other countries deficits. Both mean more demand for us exports — and I would trade reduced demand for us debt for more global demand and demand for us exports.
one misconception is that the big us fiscal deficit implies more reliance on foreign funds — that almost certainly won’t be the case. the trade deficit will fall (b/c of oil if nothing else), which means smaller net inflows from abroad even as the us fiscal deficit grows. americans will be saving more and investing less — which frees up new US funds to buy treasuries.
plus there are ways of doing asset swaps that take bad assets off the banks books in exchange for treasuries that don’t actually involve any market issuance. that isn’t the route the us has gone, but it standard in a banking crisis (see argentina in 02, most emerging economies).
Twofish : If you look at the debt/GDP ratio of the United States, it’s not particularly high by either international or historical standards, so we are very far from a situation in which no one is willing to buy US Treasury debt.
I’ve heard that argument many times. But it is invalid, because debt/GDP ratio is not even relevant.
For example, Japan has a much larger debt/GDP ratio than US. However, it has no external funding problem, because Japan has a high domestic saving rate, and Japan has run a trade surplus most of the times. So Japanese government could and did tap into these savings. Even though their debt/GDP ratio is high, they can still maintain low interest rate and from time to time have to intervene in the currency market to LOWER yen. They export capital.
US is the opposite. American consumers are heavily indebted, with little savings. In fact, they have used their home equity as an ATM machine during the housing boom. As a nation, America has run a huge trade deficit most of the times. So, when US government needs money, it has to sell treasuries. Well, that’s better than Brazil or Thailand, which had to ask IMF for credit lines. But, still, every penny of the US rescue package and fiscal stimulus must come from money borrowed abroad.
Brad’s analysis on BW2, agency debts, imbalances, etc, can be viwed from another interesting angle: now with the financial turmoil and deflation of the housing market, could US government maintain its access to external funding?
The need for such funding is increasing, with rescue efforts, guarantee of agency debts, and fisical stimulus. But the source of such funding is dcreasing: with China’s falling export, increasing domestic expenditure in every country, and possible diversion of reserves into other currencies and assets.
Maybe the Japanese would come to the rescue. Yen is rising, which the Japanese don’t like, and they should spend the windfall buying treasuries, or even agency debts.
Brad:
I discussed this with Cedric as well and it would be really helpful to get your inputs on this:
Q1) To what extent has the increased credit from the Fed been used to settle outstanding CDS payables?
Q2) As the Fed’s balance sheet increased tremendously, where’s that money sitting right now?
The simple confusion is that Cedric and others estimated increased credit from the Fed during this crisis to be around $1.8 Trillion, whereas the loss from reduced recovery on home loans is in the $100b range.
Nobody knows for sure how much people who were short CDS have actually paid out so far.
If FIs have borrowed upwards of $1.8 Trillion from the fed, haven’t increased lending to one another significantly, and haven’t increased thier lending to customers, … where’s that money right now?
Cedric’s analysis is pasted again below:
Chid:
Why do I get all the hard questions that have to do with numbers and evidence and stuff like that??? That’s Brad’s job.
But he’s probably sleeping now and it’s not quite nightclub time here yet, so I’ll divulge what I think I know.
“So the $ 1.8 Trillion that the Fed has lent to the FIs … where is it sitting right now?”
Some the banks are sitting on, since Libor hasn’t moved down much yet. $70B is slated for banking bonuses. The Fed balance sheet shows lots of excess reserves.
But TARP pays out over time. I think the first $125B may be on the way to the big 9 banks. Another $125B is by the end of the year to the rest of the banks that want to participate. $100B goes for buying MBS directly. $350B is held back for next year.
$300B was for the original FHA plan where banks are supposed to re-negotiate terms with the borrower and in return the USG guarantees the loan. This would only pay out as defaults occur of course. Then the open question is what does the USG do with the Deed.
Then there was the AIG loan, BS and other bailouts. Some of these deals sounded complicated, where the USG assumed future losses above a certain amount.
Then a lot of it is those new credit facilities at Fed.
And I still wonder what happened to all the mortgage CDS that DTCC claims isn’t there anymore. That’s the case of the missing Trillion, and I want the IRS, FBI, NSA and economics dept. of the CIA figuring out how that works.
So I guess to summarize, some of it is in a bank somewhere, and some of it is future liability.
“Being held in Treasuries?”
Short term Treasuries at 0% interest are looking very popular lately.
“If foreign CBs sold off their Agency holdings then does that mean that private sector players bought the Agencies?”
That plus part of the $1.8T tally was for treasury purchases of MBS.
The reason this is crucial to know is that the natural conclusion from the analysis indicates that the increased credit from the Fed was used to pay out against CDS payables.
Which means that the people who were long CDS now have a big bank balance. So the money is either sitting in simple cash or it’s being held in US Treasuries and Agency bonds.
Pimco is an interesting case. Pimco was heavily into CDS. Recently they bought a lot of Agencies, as you posted earlier.
If private players are long in Agencies, the the need/reason for the PBoC to get into Agencies doesn’t make too much sense to me.
At the same time PBoC buying agencies from the private sector shouldn’t harm them in any either … am I thinking in the right direction?
DavidHK: So, when US government needs money, it has to sell treasuries.
It can also raise taxes or print money. Also, the fact that the US consumer hasn’t saved in the past doesn’t mean that policies can’t be changed to encourage savings in the future.
DavidHK: But, still, every penny of the US rescue package and fiscal stimulus must come from money borrowed abroad.
No it doesn’t. The US can (and I think should) increase taxes on people with high incomes. The thing about the US economy is that the boom of the last few years has generated a huge amount of wealth, but it has been very badly distributed. Increasing taxes on the higher tax brackets and then using it to clean up the financial mess seems like a good thing to do.
Also the US *could* print money. I think it is a bad idea, but if given a choice between using the printing press or putting the US under the control of IMF, I’m sure the printing press will be chosen.
This is why other countries really can’t pressure the US to do much of anything, because the US has the ability to inflate away other nation’s holdings of treasuries.
DavidHK: Brad’s analysis on BW2, agency debts, imbalances, etc, can be viwed from another interesting angle: now with the financial turmoil and deflation of the housing market, could US government maintain its access to external funding?
I don’t see any reason why not. It’s important to note that the United States just isn’t “country A.” It has two major characteristics. First, most debt is denominated in dollars which the US Federal Reserve can print. Second, if “too big to fail” describes anyone, it describes the US. No matter how awful US economic policy is, it will be bailed out, and has been bailed out, because cutting out the US is simply not a realistic option.
As far as BW2 is concerned there are only two valid choices:
1) Status quo – leads to a soft landing.
Foreign CBs accumulate USD, Treasuries and Agencies.
Foreign countries increase fiscal stimuli and gradually allow their currency to appreciate.
2) Shift to EUR:
Suddenly Foreign CB’s USD reserves lose value. … rest of the hard landing scenario is described above.
In either case equities will go up.
Chidam: Some the banks are sitting on, since Libor hasn’t moved down much yet. $70B is slated for banking bonuses. The Fed balance sheet shows lots of excess reserves.
LIBOR has moved down quite a bit. Also people misunderstand the point of the capitalization. The point is not to directly loan out the money from the Fed, the point is to increase reserves. If you take $10 billion from the Fed and put it into your capital reserves and don’t touch it, this means that you can loan out an extra $100 billion, whereas if you take that $10 billion and loan it out directly, you don’t get that much extra stimulus.
Also loaning out an extra $100 billion takes some time. There has been a massive effort to figure who to lend to and who not to lend to.
The bonus numbers that people have been quoting are bogus since bonuses don’t get calculated until December. Most people are guessing that they will be down 30-50% off last year, and last year was not a good year. 2005-2006 was a great year.
Also people are operating under a lot of stereotypes about how much investment bankers actually make. Even with bonus, most people working in an IB just do not make as much money as “Joe the Plumber” supposedly does. There are people at the top that make obscene amounts of money, but like most corporations, compensation is extremely skewed toward the top.
Chidambaram Says: … where’s that money right now?
Sitting in cash reserves, waiting for the world to fall apart. People are only going so gradually ramp up lending as it becomes clear that the world isn’t going to fall apart.
Chidambaram Says: Which means that the people who were long CDS now have a big bank balance.
Not necessarily. First there haven’t been that many CDS’s that have been tripped. Freddie, Fannie, Lehman, WaMu, and maybe a few others that I’ve forgotten.
Most people that hold CDS’s do so for hedging purposes, and if you were long WaMu CDS, it was probably because you held a WaMu bond that is now worthless and you are waiting for the auction at which you can trade in your WaMu bond for cash.
Chidambaram Says: Pimco is an interesting case. Pimco was heavily into CDS. Recently they bought a lot of Agencies, as you posted earlier.
Most hedge funds don’t trade entirely their own money. Typically what happens is that they borrow money from an investment bank. If they were long CDS’s, then may just use the money to pay back the bank, and if they’ve gotten themselves into a situation where they can’t pay the bank, then the bank has to eat the loss out of reserve.
Also, if a hedge fund panics and wants to withdraw the $150 million or so money (which did happen right after the Lehmann default), the bank better have lots of cash available.
This is why banks want lots of cash and why they are slow to lend it out right now.
Chidambaram Says: The simple confusion is that Cedric and others estimated increased credit from the Fed during this crisis to be around $1.8 Trillion, whereas the loss from reduced recovery on home loans is in the $100b range.
Right, and these numbers make sense. Commericial banks are leveraged 10:1 and investment banks were leveraged 30:1. This means that for every dollar in bad loans that you have to cover by reducing reserves, this decreases the amount of credit that you can extend by $10. Which means that if you have $100 billion in bad loans in the system, this reduces the amount of credit that exists in the system by about $1 trillion.
One other way of thinking about it is suppose you have a $100 billion bank with $10 billion in bad loans. Once people start lining up wanting their money, it’s not enough get enough cash to cover the $10 billion in bad loans, you need enough cash to cover the $100 billion that everyone could potentially cash out, and that’s just to stop a run and survive. Just because you’ve survived doesn’t mean that anyone is going to lend money to you.
FDIC covers small investors, but it doesn’t cover big investors with money on deposit in investment banks. What finally killed the investment bank model was the day after Lehman defaulted, you had lot of hedge funds with Lehman Europe with their accounts frozen, so all of the hedge funds went to the investment banks demanding that they withdraw all of their money.
One final thing is how much money you get back in 15 years is irrelevant if you need the money now. For much of the last month, people really didn’t care how much they stood to lose or gain in 10 years since they were desperate to just survive the next day. This kills you if you have a mortgage security since you aren’t going to get your money for another 10 years.
This points out why people are buying US treasuries. In the last money, one care if the US defaults or has hyperinflation in ten years. What they do care about is whether they can convert the security to cash *RIGHT NOW*.
One good thing about all of this is that it looks like the US and China are going to have something akin to a normal diplomatic relationship. The notion of China is the “ultimate foe of the United States” has completely evaporated, as is the notion that US foreign policy must change the Chinese political system to resemble the American one. Or that the primary question in US-China relations is how US actions affect domestic affairs in China.
It’s going to be a lot like the US relationship with Saudi Arabia, Pakistan, or even Russia in which the US complains about human rights, but it’s not the sole focus or even the major focus of the relationship.
Personally, I think that is a good thing.
bsetser: As for why Agencies rather than Treasuries — tis true that if China wants treasuries rather than agencies, the us gov can issue treasuries and buy agencies, and play the role of the intermediary. if that is necessary the us will do so — it might be easier tho if the us gov found a structure for the agencies that china liked.
The only structure that would be acceptable is a “full faith and credit” pledge, at which point agencies become treasuries. This I think may be a bad idea, but it is something that is going to be debated next year.
One thing that is interesting is how China’s actions are going to influence the legislative debate next year. If the US wants Chinese money (or Saudi money), then this requires that the US either put a “full faith and credit” guarantee on Fannie/Freddie or that the US Treasury becomes the major purchaser of these bonds. Either choice is going to completely reshape the financial structure of the US. If the US doesn’t want Chinese money buying agencies, this leads to a whole different set of choices that are also going to massively reshape the US financial structure.
I think we should hold an Emergency Olympics.
Open the Shea Coliseum to China, Japan, Saudi Arabia, Pakistan, Russia, Uganda if they’re still around, the President of France and anyone else European, and let the games begin as we feed our investment bankers to our preditory Brooklyn Zoo animals.
This would put some teeth into the hollowed out words “full faith and credit of the
United States” and prove to our economic allies that we are not that concerned with “human rights” here either.
Joe The Plumber will sing the National Anthem, with background vocals harmonized by the Dixie Chicks.
Admission is free, but Bernanke and Paulson will have concession stands where long term Treasuries bonds and GSEs will be offered for sale. No limit per customer.
There will be currency exchange machines in all the bathrooms taking anything in exchange for brand new dollars.
Bush will provide the half time entertainment, performing a juggling act he’s been working on, and then announce a “surprise” 1.5% interest rate cut to stimulate the economy.
As usual, the US will ask the British if they wish to participate.
[...] most interesting proposal from Brad Setser at the CFR is for China (and other large $ holders) to diversify their $ holdings and buy assets [...]
Brad,
Having China buy GSE debts does not make sense (unless it chooses to). If the GSE credit is equivalent to Treasury except in name, Treasury department itself could easily arbitrage the spread and taxpayers would benefit. If they are not equivalent why would PBoC want to hold GSE debt in a time of uncertainty? The fact that China is still willing to accumulate Treasury is enough support for the US market — buying which one is unimportant.
I agree with you that there is more bang for the buck for China to buy EM and South Korean debts instead — both in stabilizing the global financial market and stabilizing global demand. My observation is that China would rather do this through a multi-lateral mechanism than a bilateral one. Unlike the US, it does not have (near) imperial power to enforce its claims if things go sour (say due to political changes instead of economic ones) — a multi-lateral mechanism would afford it protection. It has directed Pakistan to the IMF instead of directly helping out one of its staunchest allies. Today’s WSJ also has an opinion piece about a grand bargain re IMF with China.
Twofish:
Right, and these numbers make sense. Commericial banks are leveraged 10:1 and investment banks were leveraged 30:1. This means that for every dollar in bad loans that you have to cover by reducing reserves, this decreases the amount of credit that you can extend by $10. Which means that if you have $100 billion in bad loans in the system, this reduces the amount of credit that exists in the system by about $1 trillion.
Twofish,
Firstly let me elaborate on what I think you mean by commercial banks are leveraged 10:1:
A commercial bank gets a deposit of $100,000. they can keep $10,000 as capital and lend out $90,000 as a mortgage loan. Then the mortgage can be collaterilized and the collateralized mortgage obligation will fetch the $90,000 back to be lent again.
Through securitization the bank can repeat the process to lend out anywhere between $10 and $12 for every $1 of capital reserve.
Now what happens when the bank loses around $10,000 cash from a recovery?
They already have oustanding securitized debt in the market out there for 10*$10,000.
Even if as you say $100,000 of oustanding securitized debt is ‘reduced credit in the system’ the commercial bank can always borrow the same $10,000 from the Fed that it lost and leverage it up to $100,000 in the market.
It’s simple enough to see that the money the Fed lent out is sitting on the books of the FIs. Most of the global equity markets and real estate markets have collapsed.
As soon as the election is over they will either declare an equally miraculous victory in solving the mythical crisis; or else they will al; switch to the EUR. Then the ‘new world order’ can cause a really miraculous solution and equities can boom.
Chid:
“Even if as you say $100,000 of oustanding securitized debt is ‘reduced credit in the system’ the commercial bank can always borrow the same $10,000 from the Fed that it lost and leverage it up to $100,000 in the market.”
Except that this is how the system broke. They really did lose the money. They now need a $90K deposit from somewhere to add to the $10k from the Fed. That’s why SWFs and Buffet have been injecting cash for equity. It’s also why our last two IBs applied and were quickly approved to change their status to commercial banks. They can now accept deposits from Joe The Plumber and all his cousins.
I know what you will ask next…where did all the money go?
It disappeared in shrinking asset values.
Would you like an invitation to the Emergency Olympics?
Cedric:
It disappeared in shrinking asset values.
This is exactly the kind of stuff that they want you to think !
Homeowners, stockholders, bondholders, CDO and CDS holders not only think so, they know so !
LOL … how many of those folks can correctly spell the word ‘propaganda’.???
Cedric, have you been listening to the’Presidential Debates’???
Sen. Obama believes that if everybody keeps talking about the economy, he will win.
At the same time the Reps also want to project a major crisis so that they can justify some huge amounts in bailouts.
The Congress wanted to know what Greenspan thought… if he’d said that this whole ‘crisis’ is like a phony stomachache excuse folks would n’t have been happy with him.
So instead he said that it’s a crisis that he could ‘never even have imagined’.
LOL
Cedric:
Except that this is how the system broke. They really did lose the money. They now need a $90K deposit from somewhere to add to the $10k from the Fed. That’s why SWFs and Buffet have been injecting cash for equity.
Cedric, you need a primer on CDOs, seriously…
They don’t need a ‘deposit’ of $90K from somewhere. In this example they started with a $100K deposit, kept $10K as a capital reserve and lent out $90 K as a home loan; then created a CMO (collateralized mortgage obligation) 9 times to lend out $810K in home loans to Joes against the $10 K that’s set aside in capital.
On $810K oustanding home loans they had a reduced recovery loss of $10K. If the fed gives them the $10K they’re fine again.
If the fed instead gives them $100K because they have a leveraged stomach ache, then they can actually use that $100K to lend out more than $1 million in new home loans to new Judys….
Cedric:
That’s why SWFs and Buffet have been injecting cash for equity.
SWFs and Buffet haven’t been ‘injecting’ cash for equity in the benevolent spirit of a Jesuit nurse.
They know the markets are going to rally sometime soon.
Buffett
hmm Cedric I need to get the example more realistic:
What Twofish is explaining is that they’re leveraged 10:1. I.e. if they have $1 in a cash reserve account they have somewhere between $10 and $12 in outstanding loans.
If they lose $1 out of the outstanding loans in reduced recovery, nothing happens as a result to the overall credit outstanding.
My point is that if the Fed gives them the $1 that they lost, they’re fine again.
If the Fed instead gives them $10 then instead of having a cash reserve of $1 that they started with they now have a cash reserve reserve of $11 so they can lend out ANOTHER new $110 against it if they want to, without any new deposits from anyone.
I don’t see any point in looking to China for help here. We’ll be lucky if they’re not looking for bids on like half a Trillion Dollars worth of Treasuries soon.
They could offer a few hundred billion Dollars of FX swaps around the region to aid trading partners, and establish some political goodwill.
Also, they’re going to be needing some cash soon to keep that house of cards economy of theirs afloat.
Cedric:
It disappeared in shrinking asset values.
This can’t happen, Cedric, think about it. Dollars in cash don’t disappear. Bonds disappear when they mature. CDS contracts can disappear only if the parties come together and cancel them, or if they’re tripped. Bank balances can only move from one account to another.
Chid,
I’m sorry, but you are dangerously wrong regarding the debt which the Treasury owes to the Social Security Trust Fund. They are not regular, garden-variety Treasury bonds, they are special bonds that our President, Treasury Secretary, and many other government officials have referred to as “worthless I.O.U.s” That’s a quote. Don’t take my word for it, here’s Wikipedia:
“The federal government of the United States transfers and spends all Social Security tax surpluses on unrelated programs. The Trust Fund is simply an accounting of this transferred and spent money. As such, the Fund contains no true assets and has no net worth. Fund transferrence happens through a special form of bond. These bonds are only sold by the Social Security Administration and only purchased by other arms of the federal government. Even though these securities bear certain similarities to traditional bonds, they are strictly an internal commitment between branches of the federal government.”
If these Social Security bonds were put up for sale to private and foreign CB investors, do you think that they would be treated as equally safe with Treasury bonds, and that they would be snapped up at this time by China (or anyone else?). I don’t think so, and I don’t think Agencies will be any more either, until and unless they are accounted for within the fiscal obligations of the U.S. government like Treasuries are.
Michael,
I don’t know much about these bonds and didn’t say anything about the bonds.
I just didn’t think the abbreviation S.S. is a good one, because it’s used in dinosaurish to describe something called the Schutz Staffel that you apparently aren’t familiar with, which is good…
By the way Michael,
Why are you debating something about the Social Security Fund?
What’s actually going on is that the banks and FIs lost around $100b in reduced recovery from home loans. That $100b is sitting mostly in the SWF accounts.
The Fed lent out around $1.8 T in new credit to banks and FIs.
That $ 1.8 T is sitting in the books of the FIs.
The global equity markets have sold off and the sales proceeds are sitting in Treasuries, Agencies, regular bank accounts, etc.
Once the election is over people will discover some miraculous cure or solution for this phony crisis and that’s when all the markets will rally.
What does this whole thing have to with Social Security?
The markets started reacting to the home loan issue when Greenspan said something or other in Hong Kong in an interview about the housing downturn.
All it takes for all these markets to rally is if Greenspan goes somewhere else after the election & the global talks etc and he will say something like ‘the excess supply of housing units is now exhausted’. Or he will invent some term or other which is the opposite of the term ‘irrational exuberance’ to describe this phony crisis.
Chid & Micheal:
Just got back from the gym and now I’m all pumped up to ponder this blog.
I’ll clear up the easy one first. It was a Twofish fact that stated social security is fine and it has garden variety bonds in it. Micheal and Wiki have a handle on the truer facts.
I’m still reading all chid’s stuff and will get back on that, but if you start at the top, your first example I replied to was for the 10:1 case which would be a commercial fractional reserve bank(its 12:1 really, or 8% reserve requirement) and not a investment bank which would be the 30:1 case. They also are regulated diferently and do not have consumer savings, checking accounts or bank CDs.
30:1 and CDOs are brand new ground for me and I’ll have to think about that tangent a bit I’m sure.
Waw! It is incredible the level of shortsightedness and pure evil coming out of the written blogger and the commentators. Evil, because everything that is been written here comes from a perspective of separateness, of “Who gives a shit about Joe Plumber.” And you are right, no one does. As a Joe Plumber, myself, I am amazed at the crassness of the interlocutors. There is no restrain in their show of contempt for the working person and the common good. It is as if, there is another planet for you all to go and continue in the greedy hedonistic behaviour, that you bought hook and sink. This behaviour is being taught by the elite in academia as a gospel throughout colleges, universities and the rest of the very flawed educational system. Of course there are some exceptions, but they don’t have a platform to be heard (Dr. Michael Hudson, Catherine Austin Fitts, Henry K Liu, Richard C. Cook, F. William Engdahl, Ellen Brown etc…
What are you going to do when there is not enough forests for keeping all the species in the planet breathing, not enough clean water, clean soil, clean relationships (nurturing, respectful, etc)? Have you ever thought about the legacy you and your economic class is leaving to future generations and other species?
Why I am “ranting” as you will characterize it? Because, I Joe Plumber/Ivette the waitress, have being robbed by your economic class, by your elite (politicians, business, banksters, FI, academia, civil servants and professional consultants). There is a revolving door of politicians’ aides to lobbyists and vice versa. There is an army of fascists in a symbiotic relationship with the commoners. We Joe Plumbers of the world know it. We also know that when we become very vocal about the situation the government create a “Waco” situation to make an example of Joe Plumbers’ audacity to denounce the facistoid behaviour of the elite.
We Joe Plumber’s of the world knows that everything the elite PR, mouth gabber’s and other interlocutors are saying are straight lies. All the discussion about the economic crisis and the solutions presented so far are to enhance the pocket books of those on the take. Even the one that have predicted the doom and gloom are on the taking, because they are working towards integrating the market’s further and making countries to be bought by huge investment capitals of other countries. The destruction of the sovereignty of nations are being dismantled, without the participation of the people in the discussion. The hell with democracy. I can see that at the end of the crisis the solution from the so called experts will be one world currency.
I remember when I first got curious about these issues, was after I read in German, a book America Inc. Who owes and operates the United States, 1971 – authors, Jerry S. Cohen and Morton Mintz
After that I have learned a lot due to the fact I can read books in Spanish, Portuguese, French, Italian and English. That is not bad for a black Joe Plumber? I also have told my family and close friends to keep and eye on the elite and see how deluded they are. If they were not deluded they would behave differently. I finally realized why there is such huge demand for drugs among the elite and how the hot money problem is not abated. There is money to be made by rogue traders and vulture capitalists.
As you can see, there are many Joe Plumbers that are vey aware of what is going on. And we can see another war in the making and disasters of unimaginable magnitude, unless the elite see to it that we all have had enough.
The experts have created a financial disaster. If this disaster was not planned, they would have been excoriated and sent packing to trials for fraud and robbery. They are all being given a “get out of jail free card” and more taxpayer money.
Chidabarama,
We need to chat. How should we go about doing so?
That is, of course, you’re not too busy netting a few trillion of CDS’ (and getting a boring sum as a consequence!).
Btw, can anyone spare a brother a lehman bond?
“I think we should hold an Emergency Olympics.”
Pre-emptive pre-game infomercial paid for by Barack Obama for President.
[...] And Brad Setser suggests another possible way out of this mess: [...]
bsetser “The US hasn’t technically guaranteed the Agencies liabilities because it doesn’t want their (large) book to be consolidated on the US government’s balance sheet.”
Yet another local USA problem that has nothing to do with China whatsoever. If USA wants foreign money on agencies, it just has to write a one line law giving the proper treatment to agencies, including faithful and honest accounting.
If economists stopped one second to focus on government debt and started to count all debts including household, business and fincancial that would be great.
You can’t get trust without being honnest!
Chidambaram: Even if as you say $100,000 of oustanding securitized debt is ‘reduced credit in the system’ the commercial bank can always borrow the same $10,000 from the Fed that it lost and leverage it up to $100,000 in the market.
No it can’t. If it borrows $10,000 from the Fed or anyone else, it’s balance sheet hasn’t changed, and it can’t use any of that money to increase it’s leverage. If a bank loses $10,000 and goes below minimum capital, then its creditors will demand that it pay back some of its loans.
Wikipedia is not necessarily a good source for anything. There are a lot of cranks who post about the Federal Reserve and Social Security. The securities that SSA purchases *are* “full faith and credit securities.”
http://www.ssa.gov/OACT/ProgData/fundFAQ.html
I did hear Bush say the “bonds” in the fund pay 2%. There are no such long term real treasury bonds traded at 2%.
Maybe “full faith and credit” for sure. Same as in God We Trust.
But for a ss recipient it becomes a check clearing problem. The bonds in the fund are “non-marketable”, and have never been official debt of the treasury. So to get money to put in a bank to draw the ss check on, the USG has to sell real treasuries to a real market.
So the question is whether we will still be able to do that or not.
But if USG ends up defaulting on real treasuries someday or wiping out the dollar, the result for ss wanabees is the same anyway.
But as far as the banking discussion with Chid goes, I think the final word is assets must equal liabilities. If they don’t, then that means someone is running a private printing press and I think that is still illegal even for IBs and hedgies.
Why doesn’t the US government issue debt to buy agencies? It’s essentially one class of use government debt for another? Does that require congressional approval?
[...] Setser offers one way China could help stabilize the global markets. Permalink | Trackback URL: [...]
[...] Setser offers one way China could help stabilize the global [...]
[...] Setser offers one way China could help stabilize the global [...]
[...] The explosive growth of exports from China and the emergence of the US credit bubble were opposite sides of the same coin. Americans borrowed money to buy homes and saw them appreciate tremendously in value. Wall Street bought the mortgages, sliced and diced them, and sold them to foreign investors with a grade AAA seal of approval, courtesy of oblivious ratings agencies and undercapitalized insurers. Exporters bought the paper. In recent years, the United States sucked in 85% of the world’s savings. It turned out that Chinese peasants were speculating (they bought the paper courtesy of their central bank) in the wild manias of Miami, Phoenix, and Inland Empire real estate. (Until it started fleeing from agency debt, as it did in November 2008, China accounted for “about 50% of all central bank holdings of Agencies.”) [...]