Rhody Trader

Vincent Fernando at The Business Insider did a post comparing the current economic situation to that of the early 1980s. The upshot of the post is that when one looks at inflation, unemployment, and interest rates as they are now and as they were then things don’t look quite so bad right now.

Actually, from my perspective things now remind me more of the early 90s. That was the time of the RTC after all those thrifts were shut down across the country. In Rhode Island the governor shut down all the credit unions on New Years day 1990, which really did a number on the state economy for a couple of years. I was only a kid in the early 1980s, but I do remember it wasn’t a great time. The cities were in rough shape. I think anyone who was in NYC at the time would agree.

Seperate, former colleague Jamie Coleman at ForexLive posted  a fun look at the yen situation. The Japanese have always stood ready and willing to intervene in the currency markets, either directly or verbally. That, at times, creates some very interesting press and market action – as it did last night.

There’s been talk in the markets about the increasing use of the dollar in carry trade strategies (even the pound is being thrown into that discussion as well). It’s interesting that we’re not just talking about banks and money managers and that sort involved here. Germany and Austria have taken advantage of the lower US rates by issuing dollar-denominated debt. As this Bloomberg article indicates, the swap rates are such that issuing in dollars is about 25bps cheaper than doing so in euros.

If you’re wondering what the big carry trade is right now, look no further than AUD/USD.

I wrote a while back in Surfing the Cash for Clunkers Market Distortion Wave about how I thought the Cash for Clunkers program could potentially mess things up in the auto demand situation by creating an artificial surge that sucked in future demand. It sounds like that indeed may have happened. Reports are indicating that the post-clunkers sales run rates are actually well below where they were before the program started.

Now, as much as I compared the Clunkers program with the Y2K tech cycle, I don’t think the scope is anywhere near the same. Two things were part of the technology upgrading that went into Y2K preparation. One was necessity. The other was ample money from a strong economy. We have neither of those in this case. The figures suggest the annualized sales rate during the Clunkers run reached about 13.7 million. That’s a big bump, but short-lived and from a low base.

So the bottom line is that while I do think the automakers will see a sales lag for some time to come, it’s probably not going to drag on and on, especially if the economy picks up. They will feel the pain into next year, most likely, but my guess is not beyond mid-year if things continue improving as they have done.

There are posts on the Big Picture and Zero Hedge blogs today on the subject of Bloomberg winning a court case against the Fed on Freedom of Information Act grounds in regards to the central bank release the terms of it lending to banks and other institutions. The the Fed has been fighting this sort of disclosure on the basis that it could create competitive disadvantage issues with the borrowers. This, of course, was always the reason why those banks tapping the Discount Window were never revealed.

Here’s my question, though. The Fed isn’t actually a government institution the way I understand it. How does FOIA apply?

I have been lax in my posting of late, but I have good reason. It’s been a bit of a revolving door in the office of late. We’ve got one member of the team out long-term with a broken leg and a few other injuries from a tree falling on him. Last week a second member of the team was out on holiday. This week and next we’ve got another medical absentee. I’m the only not taking any time out – at least so far – and the ins and outs has kept my duties bouncing hither and thither.

I have been trying to keep up with things in the blogosphere, and came across a couple of interesting things. One is a post by Ulli at Wall Street Bully which I found rather funny, in a kind of ironic way. And if you want a free MIT education, you can go here.

Speaking to the Rhody part of my monicker, word has it Sarah Palin is making a move from the biggest state in the union to the littlest. If that were to come to pass, Palin would surely not be a viable candidate for anything anymore. Rhode Island is a classic New England Democrat dominated state.

In terms of being productive outside work, I’ve gotten myself back into gear with my trading faq project. I have a list of about 40 of the new trader questions I see asked most often with answers to them all. That list will probably expand now that I’m recruiting additional answer contributors. The goal is to end up with a really useful reference for those coming into the markets.

The Treasury just came out with the sizes for the quarterly refunding auctions that will be happening next week. A record total of $75bn in Notes and Bonds will be on offer ($37bn 3yrs, $23bn 10yrs, $15bn 30yrs), of which only $14.1bn will be new cash raised. That means the other $60.9bn will go to refinance existing debt. This doesn’t sound like a great ratio, but without knowing how things are on the overall debt calendar it’s hard for me to make any kind of judgement.

What I think would be interesting to see is the comparisson of federal deficit spending to the amount of new debt being issued by the Treasury. The reason I say that is because it has a direct implication on money supply.

When the government spends it increases reserves – the monetary base, also known as M1. That is the base from which so-called “bank money” is created by the lending/borrowing process. When the government taxes (and other income) or borrows it is draining reserves from the system, reducing the monetary base. Thus, the Treasury can have a serious impact on money supply simply through its spending and taxing/borrowing policies – a much bigger one than the Fed could ever have – if it does not match its inflows against its outflows.

Basically, if the federal government wants to adjust money supply in the economy, it doesn’t need to rely on the Fed to do it. All it has to do is adjust its debt issuance relative to the deficit and/or refinancing needs.

Oh, and the Treasury can also influence the slope of the yield curve by altering the amount of issuance it does at the different maturities. Think about that when you ponder how negatively sloped yield curves tend to be recession precursors and steeply positive curves are indications of growth.

Here’s what worries me.

No one seems to be talking about what kind of impact things like Cash for Clunkers programs can have. They create market distortions. Any time the government comes through and incentivizes something it does that. In this particular case I worry about what can be thought of like an ocean wave.

What I mean is that before a wave comes in the water ahead of it actually drains back into the ocean. Think about the tsunami witnesses who talked about how far back the ocean had receeded prior to the surge coming in. When people can anticipate something like this Cash for Clunkers program they will naturally hold off on their purchases until the incentive is available, if they have a choice to do so. That dries up demand prior to the program just like the ocean receeding.

Then the wave comes through when the incentive kicks in. By all accounts it’s a big wave going on right now given how the government is running out of money already. With a tsunami one can see the ocean receeding to get an idea of how big the incoming wave is going to be (or at least that it’s going to be a doozie). It’s a bit harder to do that with car sales in the full economy, but the size of the wave we’re seeing now does tip us off that there was a lot of car buying that was held in check prior to the program kicking in. Some of that is new demand incentivized by the pay-out, and some is demand that was just holding off on a purchase they were poised to make anyway.

And that brings us to the back-end of the wave. Where are we going to settle out after it passes? If the demand caused by the Cash for Clunkers program was mainly folks who just put off a purchase until they could take advantage of the pay-out, then we could expect the demand level to settle back in to whatever the normal replacement cycle level is in relatively short order.

If, however, a large part of the demand created by Cash for Clunkers is from people who would not otherwise have been in the market for a new car at this point – as I think is probably going to end up being the case – then we could see the repurcussions for a while. It will throw off the replacement cycle in much the same way all the technology upgrading in the run up to Y2K did during the early part of this decade (which I have always said was the biggest reason tech stocks got crushed).

Oh, and where do all these clunkers go? If they aren’t getting scrapped then we’ve actually got a net auto supply increase.

John Stuart Mills introduced me to the term “tyranny of the majority” in his essay On Liberty. Basically, that means a group using its majority position to oppress a minority group in some fashion. A classic example in the US is the case of blacks being oppressed by the white majority.

Of course Mills wasn’t the first to introduce the concept. I just happened to read it first in his work. Plato, Aristotle, Madison, and Tocqueville (I’m sure among others), all addressed the issue as well in their discussions of democratic government.

I bring this up because we’re seeing the tyranny of the majority in glaring fashion in Congress right now with the healthcare legislation. Among the plans to pay for the proposed bill is to add a surtax to those who’s earnings exceed certain threshold levels. Why? It pretty much comes down to “because we can”.

This statement was made by answers.com in the definition of tryanny of the majority:

The main danger that worried Aristotle, Madison, and Mill alike was that the majority poor citizenry would vote for confiscatory legislation at the expense of the rich minority. For whatever reason, this has never happened.

Hmmmm….They might need to change that comment before too long.