Central banks' magic wands--Alikazim

European and US governments happily guarantee most deposits and the inter-banks loans with no money upfront. As for buying up the banks, again it costs next to nothing as most of these banks' shares worth almost nothing too. The stock markets bounce up as I mentioned in my previous blog. Everything sounds too good to be true, well, you are right!

Now, the hard part, most of the banks' money had been wiped out. Money has to be injected by the central banks, so that the commercial banks can start lending again to individuals and corporations, but the fast falling demands and rising unemployment will be followed by tidal waves of bankruptcies of individuals and corporate loans, which mean more and more money will be needed. Now, Europe governments talk about EUR2tn while US, USD2tn. Money do not falls from the sky.

Europe do not believe in printing money (1930s of European's hyperinflation experience taught them of the dangers). The Europeans will bite the bullets of reducing consumption (to increase savings) and at the later stage, increase taxes. Fortunately, Europeans has savings to tide them over this rough period (though southern Europeans are poor savers, and will be more painful). There is a risk that the Southern Europeans may resolve to money printing as they have the history of doing so. Should they print money in large quantities, the EUR may be threaten.

US never has the need to print money as they were the world economic master for the 20th century and at the start of 2000, they have the benefit of borrowing from the world to finance their spending spree. US now uses its financial wizardry (or in fact, trickery) of promising to inject funds into AIG, Detroits-3, the banks...etc but in stages. At the same time, they just simply exchange USD for those worthless housing assets, giving the impression that no money is printed.

Don't be fooled. When the US FED finally needs money out there, US will have to borrow from the wary world. The interest rate (yield) they have to pay will start to rise, causing all other loans rates (and mortgage rate) to rise. US can choose to print money, and the effect on the yield is the same, up. The rising rate will strangle US economy and push it deeper into its recession of bankruptcies, unemployment and even social upheavals for many years.

I feel sad for US. If US has lost the 2nd World War, I may be kaysoon San and probably writing on behalf of some Ikuyo San. As I am still alive today, I sincerely wish US a miracle, avoiding the painful scenario that I believe is going to happen.

Rescue plan for the US economy? You must be kidding!

'Less than one week after the taxpayers rescued AIG (with USD85bn), company executives could be found wining and dining (costing USD0.4mn) at one of the most exclusive resorts in the nation,' US Congressman Henry Waxman told the House Committee on Oversight and Government Reform.

Beside the USD85bn, USD0.7trn has been designated to buy up houses from the banks at above market prices so as to stabilise the property market. Soros wisely pointed out that the banks will be glad to load off all the worst of the worst housing loans to the FED and keeping the good quality housing loans in their own books. These worst of worst housing loans will not see the light of the day. It is as good as accepting full losses on the FED's books.

Before FED is able to get on with their housing 'rescue' plan, large US companies are in such desperate conditions, that AAA company, GE has to resort to borrow at 10% from Buffet (and additional sweeties thrown in) when normally GE would pay 5% for their working capital from any banks that would usually queuing to lend GE. GM just shut down their whole Europe production because they have run out of cash. FED has to quickly fight the engulfing fire of corporate credit seizure by doing what the banks suppose to do (never before, done by the central bank, FED), provide working capital to normal companies. In short, FED is now behaving like the only bank in USA, as all the US commercial banks try to horde their cash for rainy days (bank run). It is beyond FED to know the quality from the dubious companies in lending money to them, yet FED is now the only standing hero.

As they used to say 'hero dies young' but in the case of FED, he may die cock standing. That is to say, even FED is dead, she still need to give the impression that she is still alive and full of vigor. To do that, she probably already order lots of printing machines for the humongous tasks ahead. Of course, this is a modern world, FED just has to key in additional zeros to the banks' asset values, which is being done now and more zeros as the days go by.

US only real option, and with it, its implications

As CERN has come to a halt, global central bankers have been injecting tons of cash into the seized up credit market, where cash are no longer easily available to the banks and banks, in turn, are tightening loan approvals (or loaning their cash) to businesses. As the global banks' deleverage, more companies will fail. Even AIG, largest US insurance company failed, there is no such thing as large company are safe, GM has just stretched out their hands for billions of 'dole' money from the US government recently.

USD0.7 trillion rescue package is likely to be passed by US Congress this Thursday (or Friday morning Sgp time). As mentioned in my earlier blog, the US government already has USD11 trillions debt and it cannot continue to dole out cash forever. In fact, the Medicare and Social Security alone costs an average of USD4 trillions per year. With the economic downturn, tax revenues will be greatly reduced, causing even higher US government deficit.

US government has 3 options; borrow from the world, raise tax or print money. Recent data has indicated a slowdown of foreigners' willingness to lend to US, which will cause the rise of long term interest rate. Raising tax during recession is politically not possible and in fact, US Senate wants to reduce taxes, which will further widen the deficit.

The rescue package can only spread out the pain of the deep recession. US jobless rate will be climbing rapidly just as retail sales plunges. US houses prices will fall further (despite a 20% drop, it is currently still 70% above its Y2000 house prices). There will be rising mortgage defaults and wide spread bankruptcies.

US government is no different from all other governments that faces economic crisis, they tend to choose money printing. It is politically most expedient in solving economic crisis. It will indirectly reduces their debt, pump more 'steroids' into the economy and create jobs. The price; inflation. The faster the printing machine, the higher the inflation. Foreigners will be reluctant to hold USD, causing the USD to fall, real interest rates to raise. As a result, the import prices will raise, (one good example is the recent oil price hike whenever USD weakens). Long term interest rates will also raises as lenders will expect to be paid above inflation rate.

The US economic fallout will impact on other countries depending on their respective nations' economic structure; domestic vs export oriented growth, domestic demand potential, national savings, resources availability, government economic management skill, t....etc. In short, the higher the exposure to US (direct and indirect export to US, to US' financial instruments, ...etc), the greater the economic weakness going forward.

Similarly, it is also applicable to the companies, keeping in mind that the general respective market demand will weaken considerably and be watchful of the indirect and secondary demand effects. For example, a company may only have 5% direct export to US, but indirectly sold 70% of its products to a third country which ultimately are re-sold to US and, the weakening US economy will weaken Europe economy, causing Europe (secondary) demand to weaken too.