Bailing Out the Thimble With the Titanic

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ashvinp's picture
ashvinp
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Bailing Out the Thimble With the Titanic

Dr. Steve Keen, the ever-insightful Australian economist who runs the Debt Deflation website, wrote an excellent piece in March of 2009 entitled Bailing out the Titanic with a Thimble. It essentially argued that the U.S. government's fiscal stimulus and the Fed's liquidity injections would be wholly insufficient to restart growth in the private credit markets, and so far this analysis has been spot on. 
 
Ilargi and Stoneleigh, who run The Automatic Earth, have also been preaching this same message for several years now, and have repeatedly stated that the U.S. dollar and Treasury market would be the beneficiaries of the debt deflationary trend. It was most recently repeated in Ilargi's latest post, Our Prosperity is Owed Back Plus Interest.
 
Yet, since late 2010, it would appear on the surface that long-term Treasury rates have been inching upwards and that commodity prices have been going through the roof. This superficial trend has led many commentators to "double down" on their predictions of a Treasury market collapse and imminent hyperinflation of the dollar. [/qoute]

Full piece - http://theautomaticearth.blogspot.com/2011/04/april-17-2011-bailing-out-...

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timeandtide
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Deflation is happening

The graphs shown in "Our prosperity is owed back plus interest" say it all, really. That plus Mike Maloney's comment that

"We're in this long term cycle, and there has to be what's called a credit revulsion, where people just WILL not take on any more credit."

and 

"The total currency supply is total outstanding credit, which is up in the $50 trillions. So $825 billion is nothing. You're only talking about a few percent of the currency supply that Ben Bernanke has direct control over. The rest of it, all the Federal Reserve can do is try and influence it; but to influence it, he's got to make us feel good."

Robert Prechter was the first person to point out the importance of the deflationary fall in credit outstanding and he is the pre-eminent theorist on social mood driving the markets. The latter, he maintains cannot be driven or changed by endogenous means. There are no feedback loops. The mood is the mood - it is cyclic and its manifestation is best seen in financial markets, particularly the largest markets like the Dow30 and the S&P 500.

Yes, it is astonishing that Bernanke and Geithner and their supporters can still have the arrogance to believe that they can really affect the eventual outcome. But this has been seen throughout history by the "potent directors" as Prechter ironically calls them. Examined through the lens of Elliott Wave Theory and Prechter's other area of brilliant research, socionomics, the extraordinary behaviour of markets in recent years is pointing to a top of very major degree - grand super cycle in Elliott wave theory.

The behaviour of Fed and Treasury officials is evidence of an extraordinary complacency (we kow what we are doing/we are right) as are the extreme low cash levels held by mutual funds (they are fully invested in the markets). But Bernanke and co represent the elites - the tiny proportion of people who have done so magnificently well out of the Fed inspired Ponzi scheme - they are somewhat insulated from the the mass mood of people across the world who are steadily tightening their belts, paying off borrowings, reducing outstanding credit and saving again. The equity and commodity markets will reflect that in time. They are certainly lagging - most technical measures point to tired markets with volumes falling on upturns and increasing on downturns. 

Their shenanigans with put selling is just another version of what AIG was doing selling more or less naked credit default swops. When the tide goes out and it will, they will be found wanting. In any case, the Fed is no longer unanimous in its outlook - the first stirring of disent have been appearing since January. The mood is descending on that institution too. As for their actions being illegal, they are hardly setting a precedent. At least as far as the US government is concerned, which is quite unconcerned about the legalities of invading other countries.

Some commentary likes to see evidence of conspiracy in the PIMCO pull out of Treasuries. I take it at face value - it is a large bet and the risk is that the Treasury market could be driven up again in the flight to safety. I suspect, though, that the market will gap down and large amounts of wealth will simply disappear, particularly because the markets have been driven by leverage. The large banks and hedge funds are up to their necks in leverage. There will not be the same value amount going into treasuries as disappears in value from equities and commodities as they are sold. The value never really existed in the first place - leverage is, by definition, money from thin air.

Gold and silver will be sold to pay off margin calls. I am sure Bill Goss will not be jumping out of the fat into the frying pan. The US credit market will not disappear but it will fall in value but not evenly. The corporate and municipal markets will be trashed but US governement debt will survive - although I would not want any but the shortest time frame to maturity. The dollar will survive. What would replace it?  Beads or shells? Gold? There is not enough to go round.Buying gold is a symptom of the complacent mindset that so permeates the world. Nobody really believes that the world financial system can break down, that values of most things could be reduced by 90%. In such a situation, what the hell is the use of gold?  You would be better off putting a solar hot water system on your roof, doing anything to cut your costs, stock-piling fuel, stock-piling dried foodstuffs, imagining how bad things could get and taking measures to protect yourself. Imagining how bad things can get is so totally against the gung ho American mindset. Think positive! Find the solution!  I think those exclamations are still valid but within the constraint of recognising that there is no real solution that is not painful. There is almost certain to be civil unrest. Thank goodness I live in Australia. At least we are not armed to the teeth. Aussies have a way of behaving under duress and extreme adversity which gives me lots of hope.

The dollar's real value will return as the deflation lowers values to sensible and most likely less than sensible levels. The deflation is real - outstanding credit is falling for the first time in 80 years. I cannot see  a useful alternative to paper money although, at some point, it needs to be backed by something to prevent the madness breaking out again. We may well be reduced to barter for a while. Whether gold will be much use in barter compared to a sack of potatoes or a tin of petrol. Well, we will find out.

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goes211
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I finally got around to reading this....

Ashvinp,

I am on vacation in AZ this week but I finally got around to reading this.  I really enjoyed your contrarian point of view and think you are on to something.  I find this scenario far more likely than many in the mainstream believe.

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ashvinp
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timeandtide, Quote: Their

timeandtide,

Quote:

Their shenanigans with put selling is just another version of what AIG was doing selling more or less naked credit default swops. When the tide goes out and it will, they will be found wanting. In any case, the Fed is no longer unanimous in its outlook - the first stirring of disent have been appearing since January. The mood is descending on that institution too.

It is the same thing AIG was doing, except they would have to be doing it secretly via primary dealer banks (since noone would buy protection on treasuries directly from the Fed) and, also, they are doing it at a time when there is certain to be more interest in treasuries than there was in mortgage-backed securities a few years ago. It will eventually blow up on the Fed, but that is unlikely to happen any time soon.

Quote:

Some commentary likes to see evidence of conspiracy in the PIMCO pull out of Treasuries. I take it at face value - it is a large bet and the risk is that the Treasury market could be driven up again in the flight to safety. I suspect, though, that the market will gap down and large amounts of wealth will simply disappear, particularly because the markets have been driven by leverage. The large banks and hedge funds are up to their necks in leverage. There will not be the same value amount going into treasuries as disappears in value from equities and commodities as they are sold. The value never really existed in the first place - leverage is, by definition, money from thin air.

For me, the evidence of "conspiracy" between Pimco and the Fed is simply the fact that there is a pretty well established inside line between the two, and the Pimco net short position does not seem to correspond to the Fed's objectives of keeping rates low and the market stable. It doesn't really add up,  unless Pimco has decided to go "rogue", sacrifice the inside line and do it's own thing. Possible, but not very likely, IMO.

The Fed is artificially creating that leverage you reference in the treasury market by selling puts, since it can print up as many contracts as it wants. Even if that leverage does not match what was present in equities and commodities, it will certainly be enough to maintain low rates, when combined with a natural "flight to safety" from risk assets and former safe havens such as European and Japanese bonds/currencies. It is yet another example of using derivative instruments to influence the price of the underlying asset, which so many mainstream financial analysts do not think is possible...

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timeandtide
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Ashvinp, I have no doubt

Ashvinp,

I have no doubt that you are correct in believing that treasury market rates will be maintained at a low level for some time to come. I do not have any really good explanation for the course that PIMCO has taken but they may well be simply wrong. I am not a conspiracy theorist - it just does not make sense to me that a small group of people can in any meaningful or long term way manipulate markets worth trillions of dollars without a word of such conspiracy being leaked. It requires traders and traders talk.

However, I do not think that will be the case for corporate and municipal paper. The spread between treasury paper and the rest will widen which effectively means that there will be one market for the government and another for the majority of commercial borrowers. Under these circumstances, any expansion of businesses will be limited which must impact equity market valuations and commodity valuations. Being a close follower of Elliott Wave Theory, though, these rationalisations are merely an attempt at explaining a sub rational phenomenon that is taking place and precedes these events - namely, that the overall mood has been degenerating since at least 2000. In the shorter term from March 2009, there has been an upward move which is now reaching a full scale herding event - opinion is unanimous that gold will continue upwards as will equity and commodity markets, while the sole exception is the US dollar which opinion almost universally forecasts will continue to fall. To believe this is to believe that the Euro is an inherently stronger and safer currency than the US dollar. This is why I am not really a believer in rational explanations for the markets, although it is relatively easy to construct "rational" explanations. Markets are driven by irrational impulses, that is - emotional reactions from the lower brain stem. This is the main reason why most people buy near the top and sell near the bottom of markets. People do not, in aggregate make rational decisions about financial markets, they simply herd. Nobody wants to accept this, of course. There are simply far too many economists, financial advisors and assorted experts being paid very handsomely for their advice. Unfortunately, there is a huge body of evidence to show that, even though the value of a financial fund may go up over time, the individuals who invest in that fund generally lose money because they trade in and out of funds and tend to buy near highs and sell ot near lows.

ashvinp's picture
ashvinp
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Posts: 412
timeandtide
timeandtide wrote:

Ashvinp,

I have no doubt that you are correct in believing that treasury market rates will be maintained at a low level for some time to come. I do not have any really good explanation for the course that PIMCO has taken but they may well be simply wrong. I am not a conspiracy theorist - it just does not make sense to me that a small group of people can in any meaningful or long term way manipulate markets worth trillions of dollars without a word of such conspiracy being leaked. It requires traders and traders talk.

You very well could be right about Pimco... Gross hasn't shown any signs of backing off his position yet, and sometimes big players just decide to buck the "smart money" trends and the system. An alternative is that Gross is not the same thing as Pimco, and he expects to be compensated very well no matter what happens to the value of his fund... maybe it was "designated" as a sacrificial lamb. Not a lot of time has passed since Pimco took on a net short position, however, and so there is still a chance for an outright reversal before the end of the year. It's all about flexibility these days and having a quick trigger finger, even for the traditionally large and "stable" funds.

Quote:

Being a close follower of Elliott Wave Theory, though, these rationalisations are merely an attempt at explaining a sub rational phenomenon that is taking place and precedes these events - namely, that the overall mood has been degenerating since at least 2000...  This is why I am not really a believer in rational explanations for the markets, although it is relatively easy to construct "rational" explanations. Markets are driven by irrational impulses, that is - emotional reactions from the lower brain stem. This is the main reason why most people buy near the top and sell near the bottom of markets. People do not, in aggregate make rational decisions about financial markets, they simply herd.

The irrationality of collective financial investment is very real, indeed. At the same time, however, we must distinguish between "rational explanations" after the fact and logical influences before the fact. The latter can be predicted to some inexact probability and analyzed, and therefore are very useful to consider. In that sense, an individual can make "rational" financial decisions based on his/her logic and information, even though the collective is destined to forever act on irrational impulses.

An analogy could be smoking tobacco - we know that smoking for many years makes you significantly more likely to develop lung cancer, but it is practically impossible to determine whether a person technically contracted lung cancer from smoking after the fact.

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