Tuesday, October 02, 2007

End Game

It's not often these days that mistakes in Washington leave me speechless, but the Fed's decision to cut interest rates did it. It was a watershed moment with implications far beyond the economy or stock market. I couldn't believe the Fed would be so breathtakingly reckless as to deliver a big rate cut with the dollar at an all-time low, gold at a quarter-century high, oil at an all-time high, and the stock indices near multi-year and all-time highs. As long-time readers know, I've been mostly correct about monetary policy and its effects for the past few years. In this post from December 2005, I wrote:
The Fed can continue to monetize each and every bump in the economy and the stock market, in which case gold will likely head towards $750 and oil for $80 with a concurrent and possibly precipitous rise in geopolitical tensions.
When I wrote that almost two years ago, gold was trading at $521. It closed Monday at $747. Oil was at $60. It's now $80. And "geopolitical tensions"? You be the judge.

What was so stunning about the Fed's decision was how, in one brazen moment, it exposed so many months and indeed years of tough talk as a farce. The gig really is up, and there's no going back. I've never been a big Ben Bernanke fan. But before two weeks ago, I gave him a solid B for his performance. Because of the rate cut, he gets an F. If the Fed continues to cut, he should lose his ticket to the senior prom. Trading data shows that during the summer market decline, the largest players, essentially bulge-bracket Wall Street trading desks, were massively long. The Fed has now done a wonderful job of bailing them out. And since the foreign exchange markets are a brutal taskmaster -- everything comes out in the Forex washing machine, which isn't known for having a gentle "permanent (printing) press" cycle -- everyone else will pay for this at the gas pump and corner market. None of this is a surprise to any appropriately skeptical observer of the Federal Reserve. But it's clearer than ever that policymakers think the viability of our financial system depends on the government's ability to stem soft spots at will, both overtly and covertly. I wrote a long post about the geopolitical implications of this a couple of years ago, and it's as relevant as ever.

During the past few years, it's been hard to miss a subgenre of economic commentary that's best described as apocalyptic. The same thing happened during the 1970's, and a lot of it is overblown. We have a great financial system, in theory and usually in practice, and things generally work out okay. The key words are usually and generally. Since the mid-90's and especially since 2003, the Fed has made it clear it will monetize any air pockets in the economy or financial markets. Of course there are lots of problems with this. A basic one is that it strengthens our adversaries -- one reason why they're "adversaries" in the first place and eventually "enemies." The nanny state's liquidity flows into the financial markets, into bonds, into stocks, into oil, and ultimately into state coffers in Moscow, Caracas, and of course Tehran. That wouldn't be a problem if those countries were willing to play ball with us, as the Saudis were during the 1980's and 1990's. But they're not. They're each shunning the dollar and buying gold. Here's one article about this big no-no. Saddam got the same bright idea before 2003. Remember: statists hate consequences. And the constant media speculation about military action against Iran provides a wonderful cover for the effect of all that liquidity on the price of oil and gold.

A phrase that's become popular is "a clash of cultures" and variations of it. The description's appropriate. The first culture is one in which policymakers believe they've repealed the natural business cycle. This culture of moral hazard and push-button Fed liquidity makes it possible for 30-somethings to sit in front of computer screens in Manhattan and Connecticut and make millions from the flickering green dots, while that same liquidity debases the dollars held by wage earners, retirees, and prudent savers; it allows mediocre corporate executives to exercise stock options and become fabulously wealthy; it tells stock and real estate speculators that if things go south, someone sitting in an office in Washington will press the "print" button and make everything okay; it makes "bridges to nowhere" possible; and it allows a nation to launch a preventive war and decades-long occupation without a thought about how to pay for it. This culture depends on dollar hegemony.

The other culture is composed of a few countries, non-allies, that happen to occupy the ground above the natural resource most sensitive to Washington's print button. Since they have the gall to object to our insistence on exchanging ever-depreciating pieces of paper for their main (and finite) natural resource, they both complicate our attempt at reinflation and profit from it.

If a U.S. attack on Iran happens during this administration, it won't be an act of the White House, neocons, or Republican party. And if it doesn't happen before January '09 and something magically comes along after that to make it "necessary" it won't be an act of the Democrats. It'll be the culture, the establishment. I don't mean "establishment" in the pejorative sense. You don't get to the Oval Office, or even come close, without understanding what that word means. Democratic leaders, including of course Hillary Clinton, understand the underlying exigencies and global market dynamics just as well as the White House. Of course we'll get the obligatory gnashing of teeth about the use of force. But let's see how much real resistance there is. Do you think the Dems want operational responsibility for what they realize must come next? This is deeper than either partisan politics or a weapons program that might produce a nuke three or five or ten years from now. And the geopolitical end game, nudged along by the Fed's action two weeks ago, is unlikely to be pleasant.


Blogger Fred Sanford said...

don't forget the incredibly weak dollar, which has almost nudged the Euro to a valid popint of competetion...or our lack of savings....massive debt, etc etc etc.

you're right, the end won't be pretty. but, as you rightly point out, the politicians will do all they can to forstall that moment.

10/02/2007 7:28 AM  
Anonymous Anonymous said...

Thanks for your post.

Yesterday I noted the headlines on Yahoo business news: banks take huge losses, manufacturing lower than expected, more mortgage problems - and Wall street hits record levels in hope of more interest rate cuts?

Something weird is going on indeed, and I don't believe it is sustainable.

The elites may well determine, that war is the only way out.

10/02/2007 10:54 AM  
Anonymous Anonymous said...

Does this mean we're officially not a free-market economy any more?

10/02/2007 11:26 AM  
Anonymous Anonymous said...

Sadly, you're right. Bread and circuses may have been replaced by gasoline and TV, but the game is the same. Hell, the destruction of the satellite network used to distribute TV feeds across the nation would probably get more American's attention than the nuking of DC.

10/02/2007 3:39 PM  
Anonymous Anonymous said...

Not a bad comment mate, although deflating the dollar is not necessarily a bad thing in the abstract.

10/02/2007 8:53 PM  
Anonymous Anonymous said...

I say that the best way to flank the insanity coming from the White House is to bring articles of impeachment against Cheney as soon as possible. Even if it doesn't suceed, you are putting the chief architect and point man for widening the clusterf!ck that is Iraq into Iran on the defensive. This malevalent toad must simply be neutralized, forced to resign, impeached - whatever, but cowardly Dems avoid this issue to the existential peril of our country.

I've come to believe the overall thrust of the admin's policy in SW Asia is not simply about oil, or enriching cronies, but fundamentally about stoking chaos and an arc of crisis thruout Eurasia. It is the Great Game again, aimed at the muslim countries in that crescent, yes, but really aimed at the emerging Eurasia powers of India, China and Russia. The potential for these countries to ally together for development and against the US/British axis is what most worries the long-term "thinkers" in the Anglo-American camp. The Islamofascist meme is just a cover and smokescreen to avert attention away from the big game.

Wars are fought primarily for economic reasons. I submit that the current floating exchange rate financial system (the post FDR Bretton Woods System - which was destroyed by Nixon and Schultz) is kaput and the people who run it - the City of London and Wall Street - know it only too well. They are going for hyper-inflationary policies (Fed rate cuts, bailing out the Hedge Funds, borrowing and spending like there is no tomorrow to pay for the wars) in order to roll over the mountains of debt and to enrich themselves for as long as possible. When it ceases to be possible any longer, that is when you will see the unconstitutional powers that have accrued to the unity executive really come into play - in the form of direct fascism to put down any dissent.

Whatever small open window of opportunity we have to stop this and save our democratic republic will close soon, because the economic collapse is coming soon. The neocons love to say it is Munich, 1939 again. I say it is 1933 again. Do we go the way of Hitler or FDR? Is there in any of the Dem candidates even a ghostly echo of the political acumen and wiley intelligence of FDR, or with any of his understanding of real economics and his recognition of the true enemies (the Economic Royalists) of the general welfare of the nation?

10/02/2007 9:58 PM  
Anonymous Anonymous said...

Fascism is going to be tough here. We are a very well armed society. When people are broke and hungry they will be less docile. Armed and less docile. Ugly combination for our rulers.

10/02/2007 10:49 PM  
Anonymous Anonymous said...

On a marginally related note, some Dems actually grew something like a notochord, and suggested — get this — a surtax to actually cover the costs of the war!! And who shoots it down after a whopping FOUR HOURS? Why, none other than Nan “I’m a historic figure! Really!” Pelosi.

Fiction writers wouldn’t dream of writing characters as slimy and vile and above all stupid as our “leadership”.
-- sglover

10/03/2007 12:19 AM  
Anonymous Anonymous said...

I, and others, have repeatedly begged TCR for another geopolitical/economic post, and he does not disappoint. Keep it up. On second thought, I guess I see why TCR doesn't write much of this stuff anymore. It's because we are well and truly locked into this dismal course, and the only questions are how fast we sink down, and how horrendous and dishonorable will be the conduct of our so-called "leaders" as they try to avoid the predictable consequences of their exceptionalism and hubris.

10/03/2007 2:10 AM  
Anonymous Anonymous said...

When asked how she felt about future generations having to pay for the war, Speaker Pelosi shrugged and said "Sucks to be them"

10/03/2007 7:03 AM  
Anonymous Anonymous said...

This is such an important topic. Kevin Price also wrote about the Fed's decision on interest rates. Check out his blog at www.bizplusblog.com

10/03/2007 12:10 PM  
Anonymous Anonymous said...


Huge fan!

I'd love to see your take on Jeremy Siegel's latest article praising(!) the CB's.


10/03/2007 1:58 PM  
Anonymous Anonymous said...

Agree with what Goldhorder said. In fact, I'm pretty sure that's what the second amendment was originally about.

10/03/2007 4:28 PM  
Anonymous Anonymous said...

people don't even realize how widespread gun ownership is in the US


Granted much of that is multiple gun ownership...but still. Nobody is even close to second place. No other country in history has had a population so thoroughly armed. Yes...The second ammendment was to protect the people from their government. Our rulers have been trying to teach us otherwise in recent years...and that would be the only way fascism comes to the US. They got their work cut out for them though...as that reuters article shows.

10/03/2007 5:56 PM  
Blogger Grace Nearing said...

If a U.S. attack on Iran happens during this administration, it won't be an act of the White House, neocons, or Republican party. And if it doesn't happen before January '09 and something magically comes along after that to make it "necessary" it won't be an act of the Democrats. It'll be the culture, the establishment.

Funny, I always assumed that it would be the corporatists who would be against this. It is always much, much safer to negotiate or simply steal to get what you want rather than to start a war. Wars are always so uncertain.

What am I missing here?

10/03/2007 9:46 PM  
Blogger Fel said...

Problem is, those guns we have are mostly in the hands of fascist sympathizers. They'll be the enforcers.

10/03/2007 10:13 PM  
Blogger Vercules said...

Excellent post.

10/04/2007 12:35 PM  
Blogger mikej said...

I admit that I usually take an apocalyptic view. I can't imagine why our foreign suppliers are still giving us petroleum and manufactured goods in exchange for our Monopoly money. I'm not worried about fascism, though. When the dollar collapses, our violent underclass will burn all of our cities simultaneously, the government will be unable to restore order, and we'll find ourselves in a Mad Max society. If you don't own a gun, get one while your dollars will still buy one.

All of the preceding aside, I would like to ask TCR whether he thinks that the Bush administration's saber rattling against Iran has anything to do with the Iranian oil bourse.

10/04/2007 4:43 PM  
Anonymous Anonymous said...

Generally a fan, but I think this post is off-base, particularly at the end. You write:

"Democratic leaders, including of course Hillary Clinton, understand the underlying exigencies and global market dynamics just as well as the White House."

I think you're mixing understanding the markets with understanding the markets the same way that you do. That people draw different conclusions from the same events shouldn't surprise you, and that people angling for the White House put greater weight on political developments than on financial markets shouldn't surprise you either. The world looks different away from a Bloomberg box, and the Street is not always right.

10/05/2007 4:07 AM  
Blogger Marcus said...

Thoroughly depressing.

10/05/2007 12:09 PM  
Anonymous Anonymous said...

"The Fed can continue to monetize each and every bump in the economy and the stock market, in which case gold will likely head towards $750 and oil for $80 with a concurrent and possibly precipitous rise in geopolitical tensions."

The cutting of the Fed Funds Target rate was not monetization. In fact for a year the Fed has monetized approximately zero. It is the conventional wisdom, bordering on absolute belief, that the Fed has been agressively monetizing with its open market operations. Nothing could be furter from the truth.

From the time of 911 the Fed was expanding its SOMA, System Open Market Account, ie. monetizing at a 5% growth rate. However from last fall the SOMA's growth has been zero.

There is tons to say about this and this isn't the place. Just keep in mind that all this talk of the Fed papering over the problems is an absolute lie. The purpose of which I can guess at but won't.

10/05/2007 2:52 PM  
Blogger Vercules said...

Interesting observation anonymous.
I've read something very similar, that the Fed has in fact been shrinking growth of money supply to zero.

Check out Mike Shedlock's analysis here; http://globaleconomicanalysis.blogspot.com/

He has charts showing it. You'll have to go back through his posts of the last month or so to find them.

10/05/2007 6:09 PM  
Anonymous Anonymous said...

The Fed does not control the money supply. They do have some influence on M1, little on M2 and none on M3 which is why they stopped reporting M3.

It's pretty astounding all the powers attributed to the Fed routinely are total bunk. In addition the banking system itself long ago became a junior partner in credit creation as Wall Street structured finance and the mortgage market, both GSE and not became the primary sources of credit.

By far the biggest influence of Greenspan's Fed was allowing the giant Wall Street banks to play middle man to the structured financial explosion as well as allowing them to participate directly, yet indirectly, with off balance sheet entities requiring little or no reserves. It's not small thing either that he relentlessly reduced reserve requirements.

Make no mistake that the goal of all this was the redistribution of wealth upwards. Just think about it. He was always almost orgasmic when reporting stagnent wage growth and yet totally sanguine about asset inflation to him. Stocks doubling and redoubling wasn't inflation. Housing rising 10% a year wasn't inflation to him. But he sternly warned again and again if wages rose anywhere near the reported, (and depressed) official inflation rate that the Fed would act.

Speculation and the inflation of assets wasn't just a goal, it is THE goal of the Fed. Wages for work are the enemy of that goal.

10/06/2007 4:18 PM  
Blogger Unknown said...

It seems to me that continuing to weaken the dollar is an excellent move on the Fed's part. We've been funneling American dollars to every part of the world for what, fifty almost 40 years now? Our trade deficit is insanely high. By reducing the value of our currency we are making American goods and services more appealing on the international market. This is an excellent opportunity for us to get some of the wealth we've been distributing around the world to come back to us, and ultimately it will help the little man. Large companies will find it more cost effective to keep jobs in the country than to export them overseas, and the rise of oil costs will jump start drilling operations on American reserves, leading to more jobs.

Sure sure, our dollars can't buy as much now outside of America than it did before, but so what? It's high time we invested in ourselves and attract foreign investors to us, instead of the other way around.

10/10/2007 9:23 AM  
Blogger mikej said...

Weakening the dollar would make American exports more attractive, if America still made anything to export.

The weak dollar will buy less inside or outside of America, most of America's manufactured goods and energy supplies being imports.

10/10/2007 5:28 PM  
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