Paulson Speaks With Forked Tongue

Good day… Another day, another $85 billion of U.S. taxpayer money used to bail out an ailing financial firm. Yes, our Treasury Secretary went on another shopping spree, and this time he was accompanied by Fed Reserve Chairman Ben Bernanke. Just two days ago, Paulson drew a line in the sand when he let Lehman Brothers collapse into bankruptcy. The non-action from Paulson was seen as a good move by most, as he was sending a signal to the markets that the U.S. taxpayer couldn’t be seen as “the buyer of last resort” for failed financial firms.

And Paulson talked tough with regard to AIG. Paulson was asked about reports that AIG wanted an emergency loan to help it through its troubles. “What is going on right now in New York has got nothing to do with any bridge loan from the government,” he replied. “What’s going on in New York is a private sector effort, again, focused on dealing with an important issue that’s, I think, important that the financial system work on right now, and there’s not more I can say than that.”

But as we have seen in the past, Paulson speaks with a forked tongue. Just a day after making statements that he would not put any more taxpayer money at risk to bail out his Wall Street buddies, Paulson and Bernanke did just that, purchasing 79.9% of troubled insurer AIG for about $85 billion of taxpayer money. The purchase was made after the two remaining ‘healthy’ investment banks passed on the deal. I read where investor Warren Buffet says his phone has been ringing off the hook, but the man who is arguably the world’s smartest investor has decided to pass on all of these ‘opportunities’. So U.S. taxpayer money is being used to buy a company that couldn’t get anyone else to lend them money. True, the press reported that the billions were just a ‘bridge loan’, but it really is nothing more than a bailout using taxpayer dollars. And how do you think these latest moves make the folks over at Lehman feel? I guess they just weren’t nice enough to Paulson and Bernanke during their days on Wall Street.

This latest move by Paulson/Bernanke reinforces a very bad precedent, which they set with the bailout of Bear Stearns and Fannie/Freddie. The Fed has moved from its primary goal of price stability to “purchaser of last resort” for ailing financial firms. Our fearless leaders are now making ad-hoc decisions on whom to help, setting new precedents for investors as regulators crowd out the market’s own risk and reward incentives to manage exposures to ailing companies. As expected, the government bailout was top on Chuck’s mind last night as he sent me the following in an email:

“So now the U.S. Treasury is bailing out AIG with conservatorship and an $80 billion allowance for the newest member of their dysfunctional family. What’s next? Oh, I already know, the Big 3 have asked for a government check, and before you know it, Disneyland will be asking for an allowance from the government! (OK, I used Disneyland to show how ridiculous this has gotten)

“And the Fed decided to leave rates unchanged… I’m shocked! All throughout this past year, I called for rate cuts by the Fed, because I thought that’s what they would do, not what I thought they SHOULD do! And now that I think they SHOULD have cut rates…. They leave them unchanged! Clueless, toothless, delusional, there’s lots of descriptions for the Fed Heads, and I can’t pick one, because they all fit!

“And still… People buy dollars. If there isn’t a thing called the PPT (Plunge Protection Team), then I’m a monkey’s uncle! (When was the last time you heard that expression?) But just think about this long and hard folks… All this debt, and all the debt that has yet to be booked (baby boomers all retiring and wanting their payments is a start) has to be paid back… And how does the government plan to do this? With cheaper dollars… With cheaper dollars… Say that to yourself a few times and you’ll begin to wonder what’s going on with people propping up the dollar! With cheaper dollars, folks… With cheaper dollars…”

The currency markets seem to be partially agreeing with Chuck, as the dollar is being sold across the board. But the moves aren’t as dramatic as one would expect (PPT is working overtime). The Fed is monetizing debt at an unprecedented scale. The amount of debt we have put on the books just in the past 60 days is absolutely mind blowing. And the collateral we received for all of these loans? Mortgage backed securities backed by homes that are falling in value. The Fed even started to accept equities as collateral for loans. The fed knows that the toxic debt and equities that firms are posting with them are probably worthless, but they just keep taking them in and handing out more dollars. Yes, Bernanke has the printing presses working overtime. This is inflationary, folks, and inflation will eventually destroy the value of our currency. No Plunge Protection Team will be able to combat the eventual fall of the dollar.

As Chuck mentioned above, the Fed kept interest rates unchanged yesterday, deciding to be more selective in their stimulus. This did help keep the dollar better bid, as they risked an all out freefall if they would have made a dramatic cut. But the market is still betting the FOMC will need to cut rates before they raise them again. I read where the odds makers have put the chances of a U.S. rate cut by year-end at 85%. Readers will remember that a change in rate expectations here in the United States was one of the contributing factors for the dollar’s sudden rise two months ago. Now that rate expectations have again shifted, the dollar is in a pretty precarious position.

And the data released here in the United States hasn’t been dollar positive as of late. On Monday, the news of Lehman overshadowed the Empire Manufacturing data, which showed a drop of 7.4%, and industrial production fell 1.1%. Economists had predicted that both of these numbers would be positive. Capacity utilization was also released on Monday, and showed a drop to 78.7%, from an expected 79.6%. This number is important, as it shows that factories are slowing production, which doesn’t bode well for employment in an already hard-hit manufacturing sector.

Yesterday we saw Consumer Price data that reflected the easing of commodity prices over the past month. This data provided the FOMC with a little breathing room, and should allow them to seriously consider cutting rates at the next meeting.

We also saw the very important TIC flows, which showed that foreign investors have started to back away from additional investments in the United States. The Total Net TIC flows fell $74.8 billion in July, after increasing an adjusted $59.9 billion in June. This is a big number folks, and is dramatically different from the $40 billion expected by economists. As we have pointed out numerous times in the past, the United States is dependent on foreign inflows of capital. After all, someone has to buy all of the debt that Paulson is using for his Wall Street spending sprees!! And it now looks like foreigners are finally pushing back from the table. This is scary folks, and does not bode well for the U.S. dollar! In order to persuade foreign investors to come back to buying our debt, we will have to offer them higher rates, or cheaper dollars. I think a combination of the two is what will be demanded, and even then we may have trouble finding enough buyers for all of the new debt we are taking on.

Today we will get the Current Account Balance numbers, which are expected to show a 180 billion deficit. We will also get the latest information on housing starts and building permits, both of which are expected to show a slight decrease from last month’s numbers. Tomorrow we will close out the week’s data with the jobs reports along with leading indicators, which are expected to show another drop. Nothing in this data should be dollar positive.

The Japanese yen (JPY) and Swiss franc (CHF) continue to benefit from the market volatility. Overnight the euro (EUR) and pound sterling (GBP) also ran up versus the U.S. dollar, which means that now all four of these currencies have rallied over 1.5% versus the dollar over the past five days. Yes, the dollar correction could finally be over. Central banks around the world have been pumping funds into the credit markets to try and ease the pain being exported from Wall Street. Bank of Japan Governor Shirakawa downplayed concern that the U.S. banking crisis will hurt the world’s second largest economy and said Japan’s financial system remains stable.

The BOJ left interest rates unchanged after their policy meeting today. The yen will likely continue to benefit from the deleveraging of financial markets, and the reversal of carry trades.

I just don’t think the U.S. dollar can continue to hold up under the pressures being put on it. I think this may be a good time for those investors who have been sitting on the sidelines waiting for the dollar rally to finally end. Gold and silver look cheap to me also, with all of the market turmoil. Now on to the big finish:

Currencies today 9/17/08: A$ .7942, kiwi .6587, C$ .9398, euro 1.4222, sterling 1.7865, Swiss .8917, ISK 92.62, rand 8.1363, krone 5.827, SEK 6.765, forint 170.45, zloty 2.3531, koruna 16.911, yen 105.83, baht 34.29, sing 1.4357, HKD 7.7816, INR 46.42, China 6.839, pesos 10.7029, BRL 1.808, dollar index 78.71, Oil $93.79, Silver $10.765, and Gold… $780.78

That’s it for today… Great day here yesterday, as we started it off with some good news from Chuck. Weather here is about as good as it gets, probably similar to what Chuck is enjoying down in San Diego. It is great news for me, as I am Chairman of my daughter’s school picnic, scheduled for this weekend. The weatherman says we will have beautiful weather for it! Hope everyone has a Wonderful Wednesday!!

Chris Gaffney
September 17, 2008