Bailing Out Wall Street

Good day… And a Terrific Tuesday to you! I hope your Labor Day weekend was grand… Mine was wonderful! I got to see my beloved Missouri Tigers play, and then two days of great outdoor fun with friends and family. I have to tell you a secret… Do you want to know a secret? Do you promise not to tell? No… What I’m trying to say is that I’ve become such a softie… My eyes all welled up, when I heard Marching Mizzou playing the Missouri Waltz on Saturday… Maybe it’s the medicine, eh?

Ok… Lots of things to talk about this morning. First things first… There was a bias to buy dollars yesterday in Asia and Europe, but not much movement given the holiday in the United States. This is a big week for the euro (EUR) in that the European Central Bank (ECB) meets on Thursday, and I’m sure the “boys” at the Bank of Japan (BOJ) are laughing and saying I told you so. Here’s the skinny… Some time ago I wrote about how the BOJ was pointing fingers at the ECB and telling them they should not be so transparent with their policy decisions, and I commented at that time that I liked transparency. Uh-Oh…

You see, the ECB had used the “vigilant” word to indicate to the markets that there would be a rate hike at the next meeting. That was their way of being transparent to the markets. So when the ECB met last month and used the “V” word, everyone was prepared for a rate hike at the September 6 meeting. But a funny thing happened on the way to the forum for the ECB, and that was the liquidity/credit crunch, in which they had to inject billions of euros into the banking system. Now, what do they do? Well… I think they do not raise rates this week. I think that ECB President Trichet will do his best to keep the credibility of the ECB intact. Will it be enough for the euro? I’m thinking “not” in the short term… But again, that just gives us more buying opportunities!

Alright now, baby it’s alright now… On Friday, I told you about a rumor going around about this huge amount of $4.5 billion options bet on catastrophe within four weeks… There was some clarity put to this rumor. Dan Perper, a Partner at Peak 6, one of the largest option market makers and proprietary trading firms, has confirmed that the trades are part of a “box-spread trade.” OK… Now that we’ve put that one to bed… Just what is a “box-spread trade”? To put it simply, and there’s nothing simple about these trades, it’s a way to lock in a means of financing.

Well… On Friday, President Bush announced his plans to help out homeowners that face foreclosure on their homes. While I’m sure that this is just peachy dandy with the homeowners… I wonder what size of hickey the balance sheet takes for being such “good folks”?

I was asked the other day why I keep pointing my finger at the Big Al Greenspan Fed as to whom should bear the blame for this mortgage mess… And while I’ve explained myself on this before, I’ll go there again, because I even have more to add this time!

OK… Back at the turn of the millennium, the U.S. economy had just entered a recession, and the Fed (instead of letting the excesses of the previous boom get removed) stepped in, and cut interest rates to the bone. OK… Before you say, “But Chuck, they averted a deep recession for us…” I will say, that what they did was fuel the next bubble. You see if you don’t experience the recession now, when you do, it’s going to be even worse!

Then the Fed left rates at record lows for waaaaaaaaaay tooooooo longggggg… And here goes the mortgage bubble… And that leads to the subprime meltdown…

The subprime crisis supports the argument, first developed by Austrian-school economists Ludwig von Mises and Friedrich Hayek, that the techniques central banks employ to increase spending power are bound to distort spending patterns by driving lending rates below their sustainable, “natural” levels.

You know that I’ve been doing my research when I’m pulling von Mises and Hayek out of the hat on a Tuesday morning!

The other big news from Friday was the Big Ben Bernanke speech. Big Ben… Hmmm… Well, before passing any judgment, let’s go to the tape to see what Big Ben had on his mind from Jackson Hole, Wyoming on Friday, eh? Although he didn’t really even hint about cutting rates, which is what the markets wanted from him, he did throw them a bone by saying, “the Central Bank will act as needed to prevent the credit crisis from hurting the national economy.”

So, we had the “Killer B’s” of Bush and Bernanke, riding in on their white horses to save the damsel in distress. It must really be nice for Wall Street to know that no matter how deep they find themselves in the dookie, they will get bailed out. I find that to be a very scary thought, given the investment schemes these brainiacs have invented before. Now, they will have NO FEAR of failure.

OK… I’ve got to go on to something else or I’m going to be yelling at the walls, and I don’t think my beautiful bride would appreciate that, since it is still quite early!

We’ll see the color of the latest construction spending data this morning, along with the ISM Manufacturing Index. Don’t look for either one to give the dollar any fuel today. The ISM Manufacturing Index will most likely follow up last month’s fall to 53.8 with another move closer to the line in the sand number of 50. Recall, that above 50 indicates expansion, while anything below it indicates contraction. Of course the dollar has really done its part in helping manufacturing by being so weak!

The Swedish Central Bank, Riksbank, should be looking to hike rates this week. I just don’t think they have the ECB’s problem with the billions injected. So, higher rates should be in the cards to help support the Swedish krona (SEK). As you know, Sweden has been one of my faves for over two years now… It’s one of the “Positive Balance of Payments” countries that I highlighted in the fall of 2005.

This back and forth, up and down, by the Japanese yen (JPY) on a daily basis gets old, eh? One day they say the carry trade is over, and yen gains, and the next day they say the carry trade is back on, and yen weakens. I would like to think that this pattern will settle down, and we would have a direction to follow… But when? Yes, that’s the $64 thousand question!

I haven’t talked a lot about pound sterling (GBP) lately, so let me take this opportunity to do so. I still believe sterling has IT all going on, except for the questions surrounding the borrowings by Barclays in the past few days. No one knows if this is a real problem or not at this time. But, if there’s anything holding sterling back right now, it’s the Barclays thing that I told you about last week. But… Let’s take a look at some other sterling analysts to see what they have to say!

“The pound is gaining ground as the market appears to have stabilized a bit,” said Ian Stannard, a London-based senior currency strategist at BNP Paribas SA. And here’s another…  U.K. manufacturing is clearly thriving despite the twin evils of sterling strength and rising borrowing costs,” said Richard McGuire, a fixed-income strategist at Royal Bank of Canada in London. He went on to say… “This ensures the risks to the BOE’s policy will remain slanted to the upside for a while yet.”

The Bank of Canada (BOC) and the Reserve Bank of Australia (RBA) both meet earlier than the ECB meeting this week, but again I don’t expect either one to move rates at this time. There’s just been too much turmoil in recent weeks to allow Central Banks to push rates higher at this time. The RBA doesn’t have to go to a press conference after their decision, while the BOC does. The key here is what the BOC has to say about things. I don’t see where they could drop their hawkish stance in the middle of hurricane season, but they are a Central Bank.

Speaking of hurricanes… It looks like the next one to come along is Felix, and could be a CAT 5 hurricane. This news had oil jumping higher yesterday even in the thin trading of the Holiday in the United States. With oil prices moving higher, the BOC had better be careful with that statement!

And gold finally moved past the $670-680 range overnight. That took some time to move higher… But that’s good as long as it did move higher, and investors didn’t grow tired of waiting for it to move higher and bail out. Now it has formed a nice strong base from which it could trade even higher.

Well… I was ready to go to the Big Finish, and then I glance at the screen and see that the euro has lost about 25 pips from when I first looked at it this morning. UGH! Like I said above… I think a lot of traders are beginning to see the light regarding Thursday’s ECB meeting and realizing that there will be no rate hike at this time, and thus pulling out of euros and taking profits. I suspect we could really see this become the trade of the week, or even month, before the euro turns around and heads to 1.45. It’s all under the forming new bases, before moving higher, etc. trading pattern.

Currencies today: A$ .8245, kiwi .70, C$ .9495, euro 1.3585, sterling 2.013, Swiss .8245, ISK 64.70, rand 7.26, krone 5.84, SEK 6.9130, forint 188.28, zloty 2.8150, koruna 20.36, yen 115.50, baht 32.50, sing 1.5270, HKD 7.7950, INR 40.96, China 7.5495, pesos 11.03, dollar index 80.97, Silver $12.28, and Gold… $683.00

That’s it for today… Congratulations to my friend, Chris Gaffney, who knocked 19 minutes off his triathlon time this past weekend! WOW! I was going to attempt to come into the office today, but unfortunately I don’t think I’ll make it. I really overdid it on Saturday going to see my beloved Missouri Tigers game. Too much walking… Too many stairs… And now too much swelling and pain in my leg! It’s OK, the Physical Therapist told me this would happen from time to time whenever I pushed it to the next level… So… I’ll ice it down and try again tomorrow! Have a Terrific Tuesday!

Chuck Butler
September 4, 2007

The Daily Reckoning