Notes From Underground

Is there anyone involved in financial markets who doesn’t  believe that GLOBAL BOND MARKETS ARE BROKEN AS INDICATORS OF PREDICTED ECONOMIC PERFORMANCE? The FED has pursued a policy of TWISTS AND QEs as it pursued a policy of forcing real long-term yields to ultra-low levels in an effort to stimulate the housing market, capital investment and the portfolio balance channel in forcing investors to opt for riskier assets to enhance yield (Greenspan’s beloved wealth effect). The problem is that as the FED and other CENTRAL BANKS have bought TRILLIONS of sovereign debt in an effort to stimulate the global economy much COLLATERAL has gone onto the books of the monetary authorities and left the REPO markets lacking the necessary collateral.

Prior to the banking crisis of the last five years, the SHADOW BANKING SECTOR provided the brunt of credit creation by leveraging up the credit markets. The SHADOW BANKING SYSTEM ran on REPO and now that the market has been encumbered the velocity of money has slowed dramatically. Mervyn King has basically acknowledged this by announcing the BOE‘s plan to allow for a diminished collateral to be acceptable in order to unclog the credit markets in the U.K. (During Bernanke’s press conference, the FED Chairman stated that he found the BOE’s effort interesting.)

The BANK FOR INTERNATIONAL SETTLEMENT (BIS), issued a release over the weekend, “BIS Warns Central Banks Credibility Under Threat.” The release notes that …”Central Banks vast holdings of government bonds–total assets held by central banks have more than doubled over the past years to around $18 TRILLION at the end of 2011–presents a threat to the independence as it starts to blur the lines between monetary and fiscal policy. In the U.S., for example, the Federal Reserve purchased 60%of all newly issued Treasury Bonds last year, in effect subsidizing Washington’s spending.”

The BIS, the central bankers’ bank, is sounding the warning alarm as the policy of massive QE is losing its zest and the MODELS OF PREDICTABILITY OF POLICY ARE PROVING TO BE FLAWED IN A WORLD OF MASSIVE DELEVERAGING OR THE BALANCE SHEET RECESSION. Bernanke has blamed the lackluster U.S. economy on Europe, geopolitics and tsunamis–it is all BAD LUCK and not FLAWED MODELS. Now it is time for the FISCAL CLIFF–exit the FED PURSUED BY A BEAR.

If the impact of FED QE is played out and little to be gained by continued new programs, what will the impact be for the markets going forward? The investor world should be very concerned about an impotent FED and an intransigent CONGRESS, especially with a very anemic global economy. At what point will the FED be forced to seek new tools to ease the BALANCE SHEET RECESSION? Do investors really want to own U.S. Treasuries and BUNDS and rid themselves of all hard assets? We have gone to being worried about the shadow banking system to be more concerned about the SHADOWY MANUEVERS OF A FED USING FLAWED MODELS.

***Two important Financial Times articles last week. Joseph Joffe wrote, “I COME TO PRAISE MS. MERKEL NOT TO BURY HER.” The editor of Die Zeit makes the political case for Chancellor Merkel’s firm stand of fiscal union. It is important to read about the German political view in a time when Merkel is the object of international scorn and ridicule for the German view on austerity. Germany may be the convenient whipping post for all the world’s angst, but French President Hollande must be cognizant that this is 2012 and not 1982, and even 30 years ago Francois Mitterand had to capitulate to Bundesbank desires. The growth at all costs view is not an easy road for a German Europe rather than a Europeanized Germany.

Second: The June 21 FT had an article on Mexico that followed up on a major theme of NOTES FROM UNDERGROUND. It is about Mexico and its growing manufacturing base in spite of the terrible drug wars. One of the main thrusts of the article is that Mexico has become very competitive vis-a-vis China as Chinese wage inflation and MEXICAN PESO DEPRECIATION has made Mexico a compelling story for foreign investment. The China/Mexico story has changed dramatically from January 1, 1994–the day NAFTA STARTED AND THE DAY CHINA DEVALUED THE YUAN BY 50%, from 5.8 to 8.7 YUAN PER DOLLAR.

The PESO was at 3.10 to the DOLLAR versus almost 14 PER DOLLAR TODAY. The presidential election of July 1 looms large for the Mexican economy. If the PRI candidate was to win it will be bullish the PESO as he has pledged to open up the Mexican energy sector to foreign investment. PEMEX needs capital investment to help search for new reserves to replace the depleting CANTRELL OIL FIELD–45% of the Mexican budget comes from OIL REVENUES so capital is needed to insure fiscal rectitude. The article is “BLOODY BUT BOOMING” by Adam Thomson.

Tags: Bank For International Settlements, BIS, BOE, central banks, China, collateral, Fed, Mexican peso, QE, repo, shadow banking, Twist, Yuan

This entry was posted on June 24, 2012 at 9:09 pm and is filed under Central Banks, Mexico. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.