Money-Grubbing At The Central Bank / The Daily Reckoning

verfasst von - Elli -, 04.08.2003, 19:48

-->Money-Grubbing At The Central Bank / The Daily Reckoning

Ouzilly, France

Monday, 4 August 2003

-------------------

*** Japan? Argentina? Yes, pack your bags, dear reader!
Kabuki with a tango beat...

*** A 100-year storm... it's raining now, worst downpour in
20 years... Watch out for financial stocks...

*** Does it really matter if we make anything? Alan
Greenspan doesn't think so...

-------------------

Oh là là... it is getting more and more interesting.

The economy, we mean.

The stock market is a distraction; pay no attention to it.
What is interesting is the bond market... the
dollar... gold... Japan... and Argentina.

The bond market continued its collapse last week. Yields on
10-year treasures were 3.07% on June 13th. Now, they're
4.40%. This is the worst bond massacre in 20 years. It's"a
100-year storm," said Franklin Raines, CEO of Fannie Mae,
whose bonds have fallen even more than U.S. Treasuries.

But what does it mean?

Which way are we headed, we wanted to know... towards Japan
or Argentina? One country took its bust in the form of the
long, slow, soft depression... with deflation. Since 1990,
the Tokyo stock market fell 80%, wiping out 20 years of
gain. Now, it may have finally bottomed out.

Argentina suffered a different kind of torture - blowout,
with hyperinflation, and nearly a third of the population
unemployed. But Argentina, too, may now be on the road to
recovery. For the last 12 months, the Argentine peso has
gained ground against the dollar and unemployment is down
to 15%!

As for the U.S., we thought it would drift towards Japan
for a few years... and then head towards the pampas. It
seemed inevitable. The U.S. has tracked Japan for many
years; why would it stop now?

Last week's news brought more evidence of movement towards
Nippon. Payrolls dropped for the 6th month in a row. More
than half a million workers are so discouraged they've
given up looking for work altogether.

Auto sales fell last month. The money supply tumbled $21
billion the week of July 21st. And the price of gold
dropped $8, to fall back into our buying range - that is,
below $350. All these things have a whiff of sushi about
them.

Ah, but there is one major difference between the U.S. and
Japan. The Japanese economy was financed internally - by a
population of savers. The U.S., on the other hand, depends
on the kindness of strangers. While the Japanese were able
to sink into their long slump on a cushion of savings,
Americans have nowhere to fall but upon but the hard cement
of debt. And day by day, Alan Greenspan's Fed and G.W.
Bush's federal government pour more concrete. Greenspan cut
rates a 13th time in an attempt to lure consumers deeper
into debt. And the federal government is pushing its own
borrowing up to half a trillion per year.

Sooner or later, we figured, progress towards Japan would
have to cease. America had to take a left turn, towards
Argentina. Because, like Argentina - and Germany in the
'20s - (and unlike Japan) America is deeply in debt to the
rest of the world. It cannot stomach a long, deflationary
decline.

We even wondered if the great ship had begun its turn to
port back on June 14th, when the bond market headed down.
Was this not a signal that the end of the beginning had
come... that the bond boom was over... and that now
inflation, not deflation, was the enemy of bond buyers?

It seemed plausible enough. But we have come to doubt it.
And this where it gets so lovely... so beguilingly
infuriating... so perverse and maddening: because now it
appears that, somehow, we have managed to capture the worst
features of both - the deflation of Japan, with rising
long-term interest rates!

We thought it was impossible... for how could an economy go
in two contradictory directions at once? And yet, that
seems to be what is happening. In a deflationary slump,
yield spreads widen while the best credits rise in value as
interest rates fall. In other words, investors are happy to
accept lower yields in a world of falling prices, but worry
about poor credit risks going broke. But in an inflationary
slump, interest rates rise along with yields, across the
length and breadth of the yield curve. Investors don't
worry about companies going bust as much as they worry
about the value of the dollars they get back.

Currently, to the great puzzlement of investors,
commentators and economists, we have rising yields,
generally, and widening spreads at the same time!

It is"the ultimate vicious cycle," says Stephen Roach.
Rising rates not only destroy the economy... they also
destroy people who owe money, while falling prices destroy
business profits (what's left of them) and jobs. Could it
be, dear reader? Could the U.S. be facing neither Japan nor
Argentina, squarely, but the worst of both possible
worlds... sushi with salsa... kabuki to a tango beat?

We will see.

But first, over to Eric for the latest news:

--------------

Eric Fry on the ground in Manhattan...

- Bonds and stocks both limped through another difficult
week. Bond prices stumbled again, as the yield on the 10-
year note soared to 4.50% mid-week, before settling Friday
at 4.39%. Overall, the value of 10-year Treasury notes has
dropped nearly 10% since mid-June - the largest six-week
drop since 1980.

- The carnage in the bond market seemed to dampen
enthusiasm for stocks as well. The Dow retreated 130 points
to 9,153, while the Nasdaq dipped 1% to 1,715.
Interestingly, the shares of banks and other finance
companies were among the most conspicuous losers last week,
falling more than double the percentage of the overall
market.

- Therein lies one of the market's dirty little secrets:
Financial stocks have provided much of the stock market's
juice over the past several months. So if the financials
now begin to fade, might the entire market be in trouble?

- At its peak in mid-July, the BKX Index of financial
stocks had soared more than 45% from its October lows -
nearly double the gains of the S&P 500 over the same time
frame. But now, the very same sector that has been powering
the stock market's advance is facing the gale-force
headwinds of soaring long-term interest rates.

- While rates were falling over the last several quarters,
banks, mortgage lenders and other finance companies of all
stripes were minting money. Bank of America reported record
net income last quarter up 23% year over year, thanks to
record mortgage originations. Mortgage lender Washington
Mutual's loan volumes doubled last quarter to a record $120
billion, while Countrywide Financial's total loan volumes
more than tripled to $130 billion for the second quarter!

- Topping them all, Fannie Mae's book of business has
swelled by $230 billion year-to-date."The company's book
of business has now ballooned $613 billion, or 43%, over
the past 24 months," notes the Prudent Bear Fund's Doug
Noland,"and has doubled since surpassing $1 Trillion for
the first time during September 1998. Outstanding Mortgage-
backed Securities have expanded at a 40% growth rate to
$1.24 Trillion. There are few places where one can find a
40% growth rate on a base of a trillion dollars."

- What will happen to this spectacular, record-breaking
loan growth, now that 10-year Treasury rates have spiked
from 3.07% to 4.39% in six weeks? We think we know the
answer, and it isn't pretty - not for the financial sector,
nor for the stock market as a whole.

-"So things are becoming more interesting," Noland wryly
observes."The bond bubble has been pricked, which draws
our keen attention as to the ramifications for the historic
mortgage finance bubble."

- Things are becoming particularly interesting at the
government-sponsored entities (GSEs) Fannie Mae and Freddie
Mac. Two weeks ago, the European Central Bank recommended
that the national central banks throughout Europe cut their
holdings of bonds issued by Fannie and Freddie - aka
"agency debt." This recommendation coincided with a
noticeable widening of agency credit spreads.

- In layman's terms, investors have been dumping Fannie's
and Freddie's bonds even faster than they have been dumping
Treasury bonds, thereby causing the yields on agency debt
to soar even higher than the yield on Treasury debt. The
difference between the two is called the"spread." A
widening spread, all else being equal, is often a sign of
corporate distress. And certainly, no company likes to see
its yield spreads widen, especially not the country's
largest mortgage lenders. (Last week, the spread on 10-year
Fannie Mae and Freddie Mac debt increased about 22.5 basis
points to trade at about 72.5 basis points over Treasuries
Friday).

-"Noting that agency spreads have widened notably of
late," Noland continues,"we recall how telecom debt
spreads began to widen back in mid-1999... Credit
availability became more restrictive and speculative losses
began to mount. Eventually, a full-scale retreat of
speculative finance from the sector ushered in spectacular
collapse."

- Your New York editor believes that the widening credit
spreads on Fannie and Freddie debt is the single-most
important trend in the financial markets today. These
widening credit spreads are not necessarily indicative of
any serious trauma at the massive mortgage lenders. On the
other hand, the widening spreads are not necessarily NOT
indicative of serious trauma either.

- If Fannie and Freddie are having a problem, we've all got
a problem.

--------------

Bill Bonner, back in Ouzilly...

***"Is it important for an economy to have manufacturing?"
asked Alan Greenspan, aloud, last week."There is a big
dispute on this issue. What is important is that economies
create value, and whether value is created by taking raw
materials and fabricating them into something consumers
want, or value is created by various different services
which consumers want, it presumably should not make any
significant difference, so far as standards of living are
concerned, because the income, the capability to purchase
goods is there. If there is no concern about access to
foreign producers of manufactured goods, then I think you
can argue it does not really matter whether or not you
produce them or not."

And here, dear reader, we reproduce a little dialog to help
you understand the Fed chairman's new economy:

What will people do if they do not produce things?

Well, we can write mortgage contracts on each other's
houses!

But where will they get the money to buy houses?

Hmmm... we can mow each other's lawns!

Yes, but if they cannot afford houses, how will they have
lawns and lawnmowers?

Okay... well... we'll wash each other's clothes.

I don't think so, because you won't have any
clothes... they're all made in China.

You mean, we'll be stark naked?

That's right, and homeless, because you won't have anything
to trade with for clothes... or houses... or anything else.

Well, at least we won't have to mow the lawn...

--------------------

The Daily Reckoning PRESENTS: Mogambo on Monday! And the
price of gold... The Nobel Prize... and the"Best Investment
Advice Anybody Will Ever Get For The Next Thousand Years Or
So"...


MONEY-GRUBBING AT THE CENTRAL BANK
by the Mogambo Guru

I have something of vital importance to tell you.

Recently, I received intelligence that central banks plan
to continue manipulating everything concerning gold, or
money, or anything remotely connected with gold or money,
until - and you may want to make a note of this in your
planning calendar - long after we are all dead.

A very interesting article in the Financial Times entitled
"Central banks to extend gold sales pact," written by Kevin
Morrison on July 23, says that the"current agreement,
which expires in September 2004, allows for 400 tonnes of
gold to be sold each year. One central banker told the
Financial Times recently that he thought"there was room
for an increase in gold sales." The article speculates as
much as 100 tonnes more room per year - upping the contract
to 500 tonnes per year for five years, or another 2,500
tonnes of room to sell, sell, sell.

"Room," in this case, I guess, is a euphemism for"central
banks would love to sell more" and that there is also a
rising demand, too.

Well, duh.

Since the central banks have no interest in gold or real
values for the money they are pledged to protect, then
obviously there is LOTS of room on the supply side for an
increase in gold sales. Like, sell all of it, dudes! And as
for rising demand, well, all one has to do is look at the
current selling price of gold, which is rising.

Too bad that all that gold, selling at around a measly $350
an ounce, is only worth about a lousy hundred billion or so
dollars, eh? Imagine the money the government could have if
gold was selling at $3,500 an ounce! Think of the social
programs they could start with that trillion dollars! And
if gold was $350,000 an ounce, and I gotta tell you that
I'm getting pretty excited right here, then the governments
could sell the gold for, let me get my calculator here,
wait a minute, where is the damn thing, okay, here we go,
let's see, $350,000 an ounce would be, ummm, $100 trillion
dollars!

Mr. Morrison continues:"The original arrangement was
signed in September 1999 in response to increasing concerns
that uncoordinated central bank sales of gold were adding
volatility to the market and pushing prices lower." This is
what I call Exhibit A - that something is very weird,
because when the supposedly biggest brains in all of
Economics-dom had"increasing concerns" about whether or
not adding huge dollops of supply in sudden chunks
involving hundred of tonnes at a crack, and promises of
more on the way, would meet with the demand curve at a
lower price, you gotta go"Huh? This is news to you?" My
God! If this is the depth of understanding of basic
Economics 101 that is truly indicative of Fed and central
banking thinking, then both common sense and history say
that you would have to be a complete moron to have anything
to do with them or their money, because something is
worrisomely wrong with these guys (and here you gotta
imagine that I am crossing my eyes and waving my index
finger in little circles at my temple, to indicate what is
referred to in polite company as"loony tunes").

The author of the article thoughtfully added a little
educational content when he later writes,"The gold price
fell to a 20-year low of $252 a troy ounce when the Bank of
England announced its gold sales in the summer of 1999."

I remember the time well, as I have scrapbooks filled with
newspaper clippings of me running around the city yelling,
"Gold is at the biggest bargain basement prices of your
lifetime, or any lifetime of your children, or your
grandchildren! Buy gold! Buy gold, you fools! Buy buy buy!"

Well, to be truthful, most of the clippings are photos of
grim policemen trying to wrestle me to the ground and
snapping handcuffs on my wrists because I am creating
another hysterical disturbance somewhere, or determined
mental health workers wielding hypodermic needles full of
powerful tranquilizers are trying to drag me into an
ambulance, and all the accompanying narratives are along
the lines of"Brave government professionals were again
involved in subduing local lunatic."

But the important thing, and you know that this is an
important thing because I just said so, so it must be
important, is that I was right about gold being the biggest
freaking bargain of the whole freaking millennium, and
anyone who had followed my advice would be fabulously
wealthy by now, and would be sending me expensive presents
out of sheer dumb-ass gratitude, like one of those spiffy
new motor scooters would be nice, or maybe a batch of yummy
toll-house cookies or something, but noooOOOooo!

So I say that you are welcome, you ungrateful little
rascals, for giving you the greatest investment tip in all
of recorded history, or what historians will naturally call
the"Best Investment Advice Anybody Will Ever Get For The
Next Thousand Years Or So." Which is, now that I think
about it, worthy of a damn Nobel Prize, wouldn't you think?

And, since we brought up this whole Nobel Prize thing
again, let me say that if I don't get this deserved Nobel
Prize, then I promise you - and look me directly in the
eyes so that you know that I am serious - that I am going
to spend the rest of my life repeatedly repeating the
phrase,"I called the exact bottom of the gold market," and
you know that I am dead serious when I wrote"repeatedly
repeating," which implies that there will be a time when
you are going to get so sick of hearing me say, over and
over and over, how I called the exact bottom in the gold
market I called the exact bottom in the gold market I
called the exact bottom in the gold market I called the
exact bottom in the gold market that you will make it your
holy crusade duty to get me that damn Nobel Prize even if
it's the last thing you ever do on this earth, just to shut
me up because you're so damn sick of hearing it! So if you
know anybody on the Nobel Prize committee, then you let
them know the evil that lurks in the mind of Mogambo, and
perhaps that little bit of knowledge will prompt them into
doing the only decent thing. And, if they ask, I'd like the
million-dollar prize money in gold, as my clever way of
being, well, you know, clever.

Anyway, right after he mentions that the gold price fell to
a 20-year low when the Bank of England announced gold sales
back in '99, this Mr. Morrison fella follows up by
concluding that"the current pact has proved successful in
adding order to the market." Man! This is too, too much! I
mean, here I was paying attention, all serious and all, and
out of left field he lets me have it between the eyes with
this zinger! Pounding down the price of gold is, and
believe me that I am as shocked as you are, known as
"adding order to the market!" Well, I gotta say that I know
a lot of economic buzzwords, and some slang words too, but
I never heard that falling prices was"adding order to the
market!"

But he is right, when you stop to think about it! Back
then, back in the olden days of 1999, gently falling prices
was a GOOD thing, and but we were so backwards that we
merely called it"adding order to the market." And,
actually, when the market is functioning perfectly, prices
SHOULD be gently falling, as productivity works its magic!
That's the whole freaking point of productivity! Ask Alan
Greenspan, for crying out loud! He is positively obsessed
with the idea of productivity, so he should know!

Okay, class, now put your books away, because we have a
treat today. We are going to have a filmstrip supplied to
us by SixSixSix Productions, an agency of the federal
government, entitled"The Truth About Deflation." The
lights go off in the room and the screen fills with images
of price tags being replaced with lower and lower prices,
one after another, as pages of old calendars are being
flipped through in the background. Happy, bouncy music is
played. Off in the distance, smiling little adorable
children are happily playing with adorable puppies, that
are, I might add, also being sold for lower and lower
prices.

Now, the scene dissolves in a blur to signify the shifting
of the scene, and the background music becomes discordant
and dark, with low and gloomy tones. As the screen clears,
we see, gradually coming into focus, that we are back to
the present time. Price tags are being replaced with other
tags for higher prices. The pages of après-2003 calendars
are being flipped through in the background.

In the distance we see nasty, dirty little children tearing
the body of a dead dog apart with their bare teeth. The
scene is soon replaced with the image of an evil creature,
who looks a lot like Greenspan, but with devil's horns
because he is a lying, deceitful, amoral Demon From Hell
Itself, and is thundering from the pulpit of some satanic
dungeon! And whose voice sounds like the hiss of a snake as
he calls prices that are gently falling a"deflation."

And who is chanting, in a rising, thunderous ovation,
"Deflation is evil! Prices are not rising as fast as
necessary! We must raise prices! This is because inflation
is good! Inflation is your friend! I am your friend! Higher
prices are good! Higher prices are your friend, too! We're
all your friends! Ahhhh-hahahaha!" The filmstrip ends by
fading to black, and there is the slight odor of sulfur in
the room.

But, continuing with the metaphor of Greenspan appearing as
the Devil and Jerry Mathers as the Beaver, the forces of
Good and Light were not to be denied. They bought gold. Mr.
Morrison adds credulity to that off-hand remark of mine
when he writes,"Gold rose to about $320 shortly after the
agreement was reached. After a brief subsequent fall it has
risen steadily for the past two years."

"So why would governments, our own governments, do this to
us - why would they sell gold and try to manipulate the
price?" you ask in that charming little way you have that
just melts my heart.

Grabbing our magnifying glasses on a frantic search for
answers, we sleuth around for the vital clues."The low
returns to be made from lending gold to market participants
hedging forward sales," says Mr. Morrison,"and the
budgetary pressures on Germany and other leading economies
will encourage the banks to continue sales of the precious
metal."

"Although the gold price has firmed," our friend Mr.
Morrison goes on,"the rate central banks can charge
borrowers such as gold miners - which use it to hedge
forward sales of the metal - has fallen. The miners have
needed less gold as they have unwound their long-term hedge
positions... Germany would be motivated to sell gold because
it could probably earn a better return from a switch to
other investments."

Of course, Mr. Morrison is befuddled along with the rest of
us when he notes that in the EU,"central banks are not
allowed to sell assets or reserves to help finance
government budgets..." for fear of violating the Maastricht
treaty.

Alas, there are other clues beneath the glass."... there
will be a day," says Robert Pringle of the World Gold
Council,"when [central banks] will be able to conduct
buying and selling activity without disrupting the market
too much." But until such a day,"there are also ways that
funds can transfer from the central banks to the Treasury,
such as dividend payments," chimes in Matthew Turner, an
analyst at Virtual Metals, a consultancy.

The reason, my nimble-minded reader, that European central
banks would like to see their contract for gold selling
renewed... even boosted up from 400 tonnes to 500 tonnes a
year... is as old as the midas metal itself: good old-
fashioned money-grubbing. Even they know a bull market when
they see one coming.

Always with the money grubbing. Even at central banks, it
seems, money-grubbing makes the world go round. I've
already told you what I think you should to get in on it.


Regards,


The Mogambo Guru
for the Daily Reckoning

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• Money-Grubbing At The Central Bank / The Daily Reckoning - - Elli -, 04.08.2003, 19:48