Yesterday, a day when the Dow reached an all time record 1,006 points of intrasession volatility, we discovered an Australian blogger named One Salient Oversight (OSO) who pulled some of the disparate threads lying around (including one from Doom) into an intriguing tapestry.
Now that Doom Castle’s Saturday has caught up with Australia’s, this new Doom friend has kindly let us repost his thoughts from the other side of the world.
Capital Flight is now being discussed
by OSO
Krugman quotes from another blogger:
"Is this the beginning of the end for the dollar and the Treasury market? Is this the first sign of the bursting of the bubble in Treasury securities? That market, in a sense, represents the ultimate bubble as it exists at the whim and caprice of foreign investors, who have as participants in a Faustian bargain, financed our war(s) and our lifestyle so generously over the last decade. Maybe even that bizarre construct is crashing about us as we speak."
And responds:
Maybe I should be drinking something a bit more … calming .. than coffee right now.
This afternoon I co-led a forum on the financial crisis with my Evergreen colleague Peter Bohmer. I had a flash as I was preparing: at some future point we could be in for a reverse tsunami.Here’s the idea: A real tsunami begins with an outward flow of water. If you’re standing on the beach and suddenly the water line retreats 10 or 20 meters, it’s time to race for higher ground. Now consider the opposite phenomenon. The massive Fed/Treasury spending spree to hold the crisis at bay, thus far unsuccessful, is being financed by a massive capital inflow. Some of this comes from foreign CB’s eager to do their part, but a big part is the result of global capital flight to the supposedly least risky currency. Suppose we get out of this alive and calm returns to the markets. Most of those people are going to want to bring their money back—that’s the reverse tsunami. How do we finance that? The Fed’s balance sheet will be wall-to-wall junk.
Housing Doom also points out that foreign central have swapped agencies into treasuries. Apart from abandoning things like Freddie and Fannie bonds (which deserved to be abandoned), the stage is now set for any foreign central bank to pull out of America. All they need to do is sell the bonds and buy Yen or Euro or whatever.
If Krugman’s worried - so should we be. Maybe now is a good time to panic.
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Notes and References
[1]: "Economic Crises still need price stability", One Salient Oversight, October 11, 2008.
Brad Setser has also begun to get worried:
http://blogs.cfr.org/setser/2008/10/10/scared-sovereign-capital/
I have to wonder exactly how the US will manage to pay off it debts, especially in the face of the baby boomers retiring.
How on earth could it be politically (or morally) feasible to have grandma and grandpa dieing on the streets because we can’t fund medicare due to our monthly interest payments to China (or Japan or Dubai or where ever)?
By the time W leaves office, it’s very likely that he will have DOUBLED the national debt ($5.7+ trillion entering, $10.2+ trillion today, plus $850 billion bailout plus Iraq @ $10 billion/month for 4 more months plus $37.5 billion for AIG bailout #2 plus $680 billion liquidity injection from the Fed last week plus…) IN EIGHT YEARS! And right as the boomers are retiring!?
Our debts are denominated in our dollars, if we don’t print grandma likely doesn’t get her SS, Medicare, drugs…
I truly understand the deflation argument, and I feel ya on it (and Mish and others), but I keep coming back to the boomers, the doubling of the debt and the politics of it all. Someone, tell me where I’m wrong!
Cn
The only thing worse than being wrong, is being right too early. Yes, we will experience an inflationary inferno because of expansionary Fed policies. No, it will not be soon.
The domestic money supply is contracting because banks clamped a hemostat to their balance sheets when they started hemhorraging from losses on subprime loans.
Banks are flush with newly printed dollars, gained by selling bad assets to the Fed, but they are either using them to buy Treasury debt or holding them on reserve with the Fed (with interest) so as to bolster their balance sheets against any additional subprime related losses. Deflation (a decrease in credit or money in circulation)is the result.
Political pressure from heavily indebted and unemployed constituents will force Congress to initiate public works projects (read: rebuilding infrastructure). They will spend lavishly, funding it with additional debt. The subsequent demand for labor and materials will begin to lift commodity prices.
This will affect the price of “second order” goods, i.e., the capital industries: petrochemical, steel, heavy construction, etc. Banks will finace this activity as a guaranteed, govenment-financed revenue source.
Then we see if sovereign wealth funds hold dollars or begin to spend them back into circulation because they fear rising commodity prices will depreciate their dollar holdings.
I think we will see a bidding war between Washington and foreigners as to who spends money faster. It will trigger a crack-up boom.
Hyperinflation is on the way, but it will come by way of deflation.
Check similar concerns at
http://www.financialsense.com/Market/pretti/2008/1010.html
Malthus: Hyperinflation is on the way, but it will come by way of deflation.
Would gold be hedge in both scenarios ?
There’s demand for treasuries, but apparently only short term debt? Because everything 2 years and up was either flat this week, or in the case of the 10-year note, down.
Mortgage rates are approaching 7 percent as long-term treasury yields and risk spreads are apparently on the rise as well. So much for this being a good time to buy because of the still historically low interest rates. Eight percent mortgages are going to push home prices in the U.S. down another 20 percent, regardless of any other economic factors.
OSO (#1) -
It was when I read this bit that I felt the goose walking over my grave.
“Scared (sovereign) capital”, by Brad Setser, Council on Foreign Relations, October 10, 2008.
@ daud:
“Would gold be hedge in both scenarios ?”
Bernanke expended a lot of capital (literally) to keep inflation expectations in check. This is why he swapped Treasury debt for non-performing assets instad of monetizing debt. I fully expect gold to retreat from its current high, but then again, I thought gold would NEVER fall below $300/oz.
Gold is money, but silver is a money substitute and can be had at reasonable rates. Stock up when it hits $8.50. You can use silver to buy toothpaste when the dollar dies. Gold may be problematic for such exchanges.