Notes From Underground: Sir Moral Hazard

Well we are happy to report that Sir Moral Hazard, Alan Greenspan, has come clean about the FED’s role as a serial bubble blower.

Appearing on Meet The Press today, he explained the important role the stock rally has played in turning the economy around. He said a major source of the recovery has been the increase in stock market wealth as it encourages people to spend and puts fluidity into the financial system. If this is not bubble blowing 101 then we don’t know what is! This unequivocally provides the impetus for the FED to maintain interest rates at low levels until they can be sure that there is traction in the growth story. Thus,maintain the global carry trade for it is maintaining the system at present.

Jim Cramer was on the panel with Greenspan and we criticize him for not challenging the former Fed chief. Greenspan has previously acknowledged that he missed the collapse on Wall Street because most of what he had thought proved to be wrong–and yet Cramer sat quietly and just nodded in agreement. In fact, Cramer’s comments were so full of adulation that he made Larry King look like he was Bob Gibson. We say loud and clear that it is the bubble mentality that got us into this mess and for it to go unchallenged as a bonafide policy is madness of the first order. Even Greenspan talked about the need for interest rates to head higher. Wouldn’t that in fact end the stock market rally?

Greenspan thought that rates would need to head higher as businesses rebuilt inventories and had to finance that rebuilding. This thinking flies in the face of what has been taking place in the real world. Interest rates are extremely low across the board and yet corporations and households are not borrowing but rather paying down debt which is contrary to all conventional models. The amount of wealth destruction has caused the entire economy to reverse the debt picture which makes Sir Alan’s views all that much more suspect. For further analysis see Richard Koo’s work on a balance sheet recession.

Friday saw a continustion of the DOLLAR rally and the further correction in the GOLD market. What diverged though was that the SPS stayed bid and wound up unchanged on the week even as the DOLLAR closed firmer. This is the divergence that we have been watching and it gained some further credibility as the correlative trades begin to break down. This is a good thing as markets will return to fundamentals and technicals as the algorithms get readjusted. The EURO was under the stress of fundamentals as the DEBT picture of the European Union was called into question. However, some of the weak sisters of European DEBT did stage a rally on Friday–the German/Greek 10-year differential wound up at 210 basis points on the close after being out to more than 250 points. Some market participants believe that the European commission will come to the aid of the Greek government but we are very leery of that. It was intersting that as the DEBT differntials narrowed the EURO still could not find a rally so further weakness is to be expected.

Most of the media passed over an important news story. Daimler came to an agreement with its unions to secure 37,000 jobs in Germany for the next 10 years. After Mercedes announced they were moving some C-Class production to Tuscaloosa, Alabama, the unions wanted to secure jobs in Germany so they agreed to wage moderation. The unions even gave Daimler management an opt-out clause on this deal if the economy were to deteriorate further.

This is Europe’s problem. The Germans have adjusted to globalization in a much more forthright way then the rest of Europe. German industry operates at a much more efficient level because they have gotten wages under control making the other European nations far less competitive. It used to be that the PIIGS could devalue their way out but not anymore. At some point wages in the less competitive economies are going to have to adjust downward causing great economic pain, or Germany will have to basically transfer huge amounts of money to shore up their finances–this is the dilemma they face. When the U.S. truly starts on a growth path this issue will be brought to the forefront.

Also out of Europe this weekend was a story from Germany and the head of the DEUTSCHE BANK, Josef Ackermann. Ackermann said Germany would not go the way of Britain and France on the “banker bonus tax” and would thus have a “comparative advantage” over the other financial hubs. Germany has no plans to tax bonuses and this is after the geniuses in London and Paris announced that for political expediency this was path they were going down. Should they have all agreed to the same plan so as not to beggar thy neighbor before they signed on to this punitive tax? If three leaders in Europe cannot synchronize exactly, what chance does the G20 really have? The imbecility of the governing classes makes our eyes roll in our heads.

We will be watching the DEBT markets this week as the long end of the Treasuries came under pressure and the 2/10 steepened further.The overnight/30-year went out further and this is getting a great deal of attention as it calls the question as to why the banks are in no hurry to lend. As we have talked about ad nauseam–surf’s up and the free money is riding the crest of the wave. We will wait to see if the Fed speaks about this in their FOMC statement. It would surprise us if it did but there is a great deal of heat on the banks for not lending so we await further discussion. As previously stated, we believe that is the balance sheets that have been the greatest impediment and the curve surfing is just the easiest and cheapest way to rebuild balances. It will take the FED doing mass reverse repos and whatever other tools they have to curtail this action.With the DOLLAR finding some traction we don’t think they will be in any hurry.

And remember, Bernanke has not been reconfirmed yet.

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