Last Updated: Nov 19th, 2009 - 11:07:39 Newsletters : 2007 Newsletters : 24 August 2007 Thought for the Day I read many interesting and sometimes alarming things on the internet but always The Economist is a sound voice of reason and common sense. It is therefore of some concern when I am confronted with the following headlines from this week's Economist: Banks in trouble - The Game is Up. In a special section, we look at how trouble in the credit markets has led to a crisis of confidence in global finance. A liquidity squeeze - Bankers' Mistrust. Central banks struggle to prevent money markets from drying up. Funding difficulties - A conduit to Nowhere. Even conservative banks are rumbled by risky credit-arbitrage funds. Hedge funds - Behind The Veil. Big market losses provide insights into a volatile financial world. Financial contagion - Mortgage Flu. Turmoil in America's mortgage market has spread far and wide. I guess that you get the picture. Aug 23, 2007, 11:50 Newsletters : 2007 Newsletters : 24 August 2007 Nope, That’s Not Money. Prudent Bear’s Doug Noland has for years been pointing out that one of the drivers of the credit bubble has been the ever-broadening definition of money. As the global economy expanded without a hic-up, more and more instruments came to be used as a store of value or medium of exchange or even a standard against which to value other things - in other words, as money. Thus mortgage-backed bonds and even more exotic things came to be seen as nearly risk-free and infinitely liquid. In Noland’s terms, credit gained “moneyness,” which sent the effective global money supply through the roof. This in turn allowed the U.S. and its trading partners to keep adding jobs and appearing to grow, despite debt levels that were rising into the stratosphere. For a while there, borrowing actually made the world richer, because both the cash received and the debt created functioned as money. With a few months of hindsight, it’s now clear that debt-as-money was not one of humanity’s better ideas. When the U.S. housing market - the source of all that mortgage-backed pseudo money - began to tank, hedge funds found out that an asset-backed bond wasn’t exactly the same thing as a stack of hundred dollar bills. The global economy then started taking inventory of what it was using as money. And it began crossing things off the list. Subprime ABS? Nope, that’s not money. BBB corporate bonds? Nope. High-grade corporates? Alas, no. Credit default swaps? Are you kidding me? No longer able to function as money, these instruments are being “repriced” (a slick little euphemism for “dumped for whatever anyone will pay”), which is causing a cascade failure of the many business models that depend on infinite liquidity. The effective global money supply is contracting at a double-digit rate, reversing out much of the past decade’s growth. But here’s where it gets really interesting. The reaction of the world’s central banks to the freezing-up of the leveraged speculating community has, predictably, been to create massive amounts of new fiat currency and hand it to the banking system. They’re not dropping twenties out of helicopters yet, but functionally it’s the same thing. By swapping dollars, euros and yen for no-longer-money bonds that are plunging in price, creating some paper profits where there once were catastrophic losses, the Bankers hope to revive the animal spirits of the leveraged speculators. Specifically, they hope to stop the financial community from going further down the moneyness checklist and eliminating any more instruments. But you don’t forget a brush with death that easily. The process of debt reclassification has a momentum that a few hundred billion new dollars won’t stop. And once corporate bonds and agency bonds and emerging market bonds have been crossed off the list, the system will start eyeing the dollar. Is it really a store of value after falling by half against oil and gold in the past five years? Didn’t the Fed just create a tidal wave of new dollars and promise to create infinitely more if needed? Isn’t the U.S. economy hobbled by the implosion of housing and mortgage finance and hedge funds and (soon) derivatives? Don’t Americans owe more per capita than any people in human history? And a realization will begin to dawn: Maybe the paper currency of an over-indebted country isn’t money either. Aug 23, 2007, 11:39 Newsletters : 2007 Newsletters : 24 August 2007 Blame Central Banking, Not Capitalism Capitalism is not to blame for the debacle. The witch hunt has begun. Aug 22, 2007, 10:11 Newsletters : 2007 Newsletters : 24 August 2007 How A Panicky Day Led The Fed To Act The money people have been borrowing short and lending long, on mortgages for the large part. Isn't this breaking one of the fundamental rules of banking? Especially when they borrow short in one currency and lend out in another! So the markets have taken fright and become "illiquid". Banks won't lend to each other because they are afraid they won't get their money back. The solution is to print more money. Yeah right! But how did this all unfold around the world. Here is the story. Aug 21, 2007, 09:56 Newsletters : 2007 Newsletters : 24 August 2007 Banks In Trouble: The Game Is Up. Fiat money is backed by nothing but confidence by the people in their governments and the banking system. What happens when this confidence drops? Aug 20, 2007, 14:13 Newsletters : 2007 Newsletters : 24 August 2007 Surviving The Markets Our modern society is playing with fire. Electronic and paper currencies are acts of faith by all. When that faith is questioned then trouble starts. Paper money has always failed in the past and civilisation has been forced to revert to gold and silver. Has human nature changed or will this happen again? Will it happen in this round of destabilisation? Or in the next? Or the next? Zimbabwe is leading the way. Will the rest of the world follow or can the Central Banks hold everything together? We await the outcome with bated breath. Aug 20, 2007, 10:35