Interesting Videoclips of the Week (November 28 – December 2, 2011)

This is essentially an action by the US Fed to add dollar liquidity to European Banks through European Central Banks. The notion of coordinated global action is merely optical. The Fed does not need Swiss Franc liquidity or Euro liquidity in the American system. The Fed is delivering dollar liquidity to Europe.

So this action again demonstrates the primacy of the US Fed and the US Dollar.  This also shows the smarts of the Chinese and Japanese. Their huge investments in US Treasuries are again proving to be their best investments period.

In a sense, one could view this action by the Bernanke Fed as diabolically clever. Remember the summons by the Fed to all major financial institutions to explain their exposures to Europe a couple of months ago. Since the, the US money market funds essentially vacated the short term dollar lending market for European Banks. This was good risk management for the Fed and US financial institutions. This is the Fed’s primary job and they did it in time & well. Kudos to Chairman Bernanke. We feel fortunate to live in his financial system.

But this necessary and prudent step precipitated the crisis in European financial system by creating a Dollar shortage. So the Bernanke Fed stepped in and provided Dollar liquidity without taking any European corporate credit risk or any FX risk (see clip 1 below for Richard Fisher’s comments). So Bernanke first protected US financial system and then stepped in to offer liquidity to Europe. Smart!

Many ‘connected’ people say that a major European Bank was about to fail this week and that is why the Fed acted so swiftly and so effectively. Just look at the action in US financials to judge the effectiveness of the Fed’s action. Perhaps a better judgement was rendered by the Sovereign bond markets in Europe which rallied big.

2. “Big from ECB or else“

This was a part of a tweet from Bill Gross on Tuesday, November 29 which warned of danger for financial markets if the ECB does not come in with a big solution next week. On Friday, Bloomberg reported on a European proposal to channel European Central Bank loans through the IMF for about 200 Billion Euros to underwrite lending programs for Italy or Spain, the two absolutely too big to fail troubled countries in the EU.

This sounded fine and the markets took it as fine until a rumotory (rumored story?) broke late Friday morning about congressional opposition to any IMF involvement. This was enough to send the market sliding slowly into the close. GS which was trading 102+ at 11am closed at 97+. 

3. “Situation like Summer before Lehman”

In case the previous section did not depress you, the title of this paragraph should. Professor Robert Engle (of NYU Stern & 2003 Nobel prize fame) describes the situation today as “pretty much like the summer before Lehman“. And in case, you don’t remember, the horrific fall in stock prices began after the Lehman bankruptcy. Professor Engle made this comment during a conversation on CNBC about NYU’s ranking of the 10 Riskiest banks in the world (see clip 5 below).

Risk in this context is systemic risk and the “winner” is the bank that poses the greatest danger to the global economy in case of a financial crisis. And that “winner” is Deutsche Bank, according to Professor Engle. The silver and bronze medals go to BNP and RBS, resp.

6. The U.S. Stock Market

Bernanke might have been correct after all. The way we see it, the most reliable economic indicator of all is the U.S. Stock market. Despite all the usual put downs about credit traders being smarter than stock traders, it seems clear that the fate of risk assets, the confidence in the global economy rests on optimism expressed by the U.S. Stock market.

The precarious perch of the U.S. economy is evidenced by the U.S. stock market gyrating like a yo-yo. After the worst thanksgiving week ever for the Dow Jones Industrial Average, this week turned out to be the second best in Dow points. This week’s rally was mainly due to global liquidity move announced by the world’s major central banks. As long as there is hope of a European solution, the stock market maintains a bid in its hope of a year-end rally.  This is why the markets have welcomed each postponement of a European decision.

But we may be coming to the end game of this trading range. The European decision is expected next week and the markets are positioned for a positive message. This makes next week rather important.

7. India to the rescue?

The title is to poke fun at Tim Seymour of CNBC Fast Money who went around this week proclaiming “Emerging Markets to the Rescue“. China’s cut in its RRR ratio was the first sign of rescue. The second sign of EM rescue, per Mr. Seymour, was the decision by Indian Government to open its doors to foreign retailers.  The Indian Government allowed large multi-brand retailers like Walmart, Tesco and Carrefour 100% ownership in their retail ventures. Previously they were required to get a local Indian partner.

CNBC, like Tim Seymour, jumped on this bandwagon and wrote India is poised to be Fashion’s New Muse. Neither understands that the Indian Government makes the U.S. Government look smart and decisive while the Indian political system makes the American system seem like a paragon of compromise and common sense.

The Indian Government should take taken this decision two years ago when it was riding a great election victory and when the Rupee was strong. Instead they waited until the Rupee had collapsed by 20% in a month due to capital flight. Then in the midst of their panic about attracting foreign capital, the Indian Government announced this decision to open the retail sector. In their panic, the Indian Government forgot about discussing it with either the opposition or with groups that would be affected.

So all hell broke loose. Indian towns are full of small traders & businessmen who run local stores. They rose in furious protest. This past week, 50 million traders went on a nationwide strike, yes 50 million. And that is the official count. Every opposition party rejected this move. The allies of the Indian Government also opposed this move. The Parliament has been essentially shut down. India has 26 states and these states are run by different parties, local and national. Retail in India is the responsibility of states and no retail company can do business if the state opposes it. 

This is a jobs issue, first and foremost. The agricultural and retail sector is the one sector that touches all segments of Indian society. It provides hundreds of millions of jobs. This community fears loss of jobs, loss of business from the entry of mammoth organizations like WalMart & Tesco. 

So it will be a long time before “this rescue by India” of EM investors becomes reality.

8. Jobs & Skills Mismatch

We speak about the crippling regulations in the US that are preventing job growth. Those who feel so should read the NYT article Outsourcing Giant Finds It Must be Client Too. This is the story of how truly crippling regulations prevent job creation in India.

To us these stories suggest out-performance by America over EM. In our opinion, the EM countries face very difficult macro issues that have been hidden for many years because the availability of cheap credit. Now that credit & capital flows, especially from European Banks, will be much lower, the problems will surface and create unrest. This suggests an out-performance by America for the next couple of years at least, unless of course, the money printing by DM central banks lead to greater capital flows to EM.

But looking out a few years, the outlook for EM remains very bright if they can build sound institutions and attract long term capital. After all, the NYT points out that India is trying to produce 500 million skilled workers over the next two decades. Now a workforce that big can lead to high GDP and strong growth, two factors that attract big capital inflows. This is why Larry Fink advises long term investors to overweight markets with sustained high GDP growth. 

1. One-on-One with Richard Fisher – Richard Fisher with CNBC’s Larry Kudlow – Thursday, December 1

Richard Fisher is the President of the Dallas Federal Reserve. Larry Kudlow asked him whether the Fed’s action on November 30 pushes the Fed further into the thicket of European problems. 

• Fisher – No. what we are doing is we are providing the European Central Bank, the Bank of Canada, Bank of Japan, British Central Bank and the Swiss with the capacity to borrow dollars if their banks in their jurisdictions need dollars in order to buy dollar-based products or provide dollar-based credits. So it doesn’t solve the problems of Europe. I think Angela Merkel made that clear the last few days, likely to make it even clearer. It’s not a substitute to somehow bail out socialism in Europe or whatever the critics are saying. It’s simply a transaction in case there is a need to meet dollar credit shortages provided through those central banks. I believe it’s a pretty straight forward transaction. I support it fully.
• Kudlow – A lot of people are asking now, does the Fed itself believe it has a mandate to bail out European Socialism? Does the Fed believe in the name of global stability or any other names that it has a mandate to really bail out the European Banks if the Fed becomes the lender of last resort?
• Fisher – I don’t believe we have that mandate. These are European issues. These are European banks. There is the European Central Bank and there are other regulatory authorities in Europe outside the ECB purview. That’s not what this is about. This is about providing access for dollar-based credits if they are needed, then they can draw on this facility. It’s very miniscule risk, as you know. We know what the rate being charged which is 50 basis points and we get paid back in Dollars. We are not lending to those banks. We are lending to the Central Banks, if they need it.
• Kudlow – In the same vein, we learned through the Freedom of Information act that back in 2008, the Fed put out, according to these estimates, 7.7 trillion dollars. It was done in secret. We’ve only now several years later learned about it. Trillions of those $7.7 trillion went to foreign banks, especially foreign banks that operated in the United States. I ask you in the same vein as the earlier question, does the Fed believe it has a mandate to bail out foreign banks operating inside the U.S.?
• Fisher – We want those that under the law operate in the United States to be able to operate and provide for the needs of American companies and American workers, and those that desire credit in the United States. Whatever is happening in the past, obviously things are much more transparent and changed under the legislation known as Dodd-Frank legislation. We were very open and transparent about what was announced yesterday. Everybody knows what we are doing. That’s the way the game is now played, it will be played that way straight up the field going forward.
• Kudlow –  Is it safe to say, therefore, since there wasn’t a shortage of dollar demand, the number $2.4 billion is nothing. in ’08 that was close to $600 billion. (Fisher – it was more than $500 billion). People are asking, and you can put this to rest, is this a back door way, if you have European banks and all the big Euro banks operate in the U.S., especially in New York, is it possible that the Fed is setting up a back door way of bailing out those European Banks?
• Fisher – I would say no. Again, there is a simple purpose. it’s a great toward deal. That is, should there be a shortage of dollars needed for dollar-based credits, that is what this facility is for.
• Kudlow – I guess the last one is, you’ve got a lot of people thinking or asking, after lowering the dollar swap borrowing costs, this is a precursor that the Federal Reserve presumably in connection with the European Central Bank is going to embark on a massive Quantitative Easing – throw money out there, this is just the beginning. What do you think of that speculation?
• Fisher – You know where I stand on that issue. I personal am not in favor of quantitative easing. Here in the united states, FOMC has made abundant liquidity available, the cost of money is cheap. People are not putting it to work to the degree we would like to see all of us, you and I would like to see in terms of job creation. The reason they are not doing it is because fiscal authorities cannot get their act together. we cannot do the job of fiscal authorities. Question – what would additional liquidity do to incent people to create jobs? In my view, that is not something that should be considered at this juncture. No Central Bank can substitute for bad fiscal policy and I don’t think any amount of liquidity makes up for bad fiscal policy. That’s my view, Larry.
• Kudlow – . Thank you, Richard Fisher, president of the Dallas Fed.