"I think we're going to experience a stagflation like we have never seen." ~ the Dude

The Lessons of Lehman...and Leeson
Unfortunately, there are some in the financial industry who are misreading this moment. Instead of learning the lessons of Lehman and the crisis from which we're still recovering, they're choosing to ignore those lessons. President Obama

I burst out laughing when I read the above line in the President's speech yesterday. "The lessons of Lehman!" I thought, "he's got to be joking." I have no doubt Big Finance took that lesson straight to heart.

Let's consider the meaning of the "lessons of Lehman." Given the context, I suspect the President wants Big Finance to see the demise of Lehman as an object lesson- as one might warn a friend trying to ride out a hurricane in New Orleans by reminding him to remember the lessons of Katrina. If this friend had just moved to New Orleans and was unfamiliar with Gulf Coast hurricanes, the "lessons of Katrina" reminder would likely be sufficient.

If, however, this friend owned a house in the French Quarter and had ridden out Katrina the reminder of the lessons thereof might evoke a chuckle and a quick retort, "Katrina taught me that the French Quarter is safe." "The lesson of Lehman," Big Finance CEOs might chuckle to themselves, "is to make sure we're too big to fail." Lehman's balance sheet wasn't big enough, thus failure was an option for them, but not for the biggest banks.

Or so they seem to think.

One of the reasons I didn't write much over the past few months (besides a general laziness and desire to enjoy the summer) was a strong feeling, whenever I looked at the data, of watching a horrible car crash in slow motion. Better, I thought, to avert my eyes.

Yesterday I spent a few hours filling up my spread sheets and catching up on policy speeches and decided the feeling that came over me wasn't as if I was watching a slow motion car crash. I feel now as if I'm a position clerk for Nick Leeson, the bane of Barings Bank, and everyone in the country works for them.

As is my wont, when a feeling like that hits me a quick Google search for "Nick Leeson" is just a few clicks away. Among the more familiar reports I was surprised to find a scholarly examination of the event from NYU's Stern School of Business, about which, more later.

In the movie, Rogue Trader, Nick Leeson explains the secret of his success in a sound bite Big Finance would love, "You keep doubling up, and sooner or later you're bound to win." In the event, Mr. Leeson found this not to be true as the losses on his long position in Nikkei futures (and related derivatives) exploded after the Kobe Earthquake sent the Japanese market plunging early in 1995.

The lesson of Leeson is that doubling up is no guarantee of success. Indeed, according to the NYU paper: Our interest in Mr. Leeson comes from the fact that doubling strategies are potentially dangerous from a systemic point of view. An important attribute of doubling strategies is that the inevitable and devastating loss is preceded by a period of high returns with low volatility. Conditional on the bad event not having happened (yet), the doubler’s investment performance appears to indicate significant investment skill. The doubler may then become too big to fail, both from the perspective of the investment firm and from the market regulators, so that the inevitable failure can have catastrophic effects, both for the firm and for the market. Among other things, this has important consequences for the effectiveness of Value at Risk-controls. Being able to track and take out these traders sooner, would limit possible systemic risks.

Of course, I'm not arguing that Big Finance is doubling up on a hidden (losing) long position in the Nikkei. Their losses are reasonably well known (if not well quantified) and, at least with respect to real estate, not about to turn into profits any time soon. This rogue is out in the open.

Like Leeson, Big Finance doesn't consider liquidation, which would realize the losses, an option. Like Leeson (whose book would make a great study in a Psych course), Big Finance would have us believe their motives are pure. I, however, find this view from the NYU paper interesting: That managers take additional risks to escape from a threatening situation is a well known theme in the field of managerial decision making. For example, Shapira (1997) and Kahneman and Tversky (1986, p. S258) show that people will take greater risks to escape losses than to secure gains. As a consequence, people's behavior tends to change in unexpected and unattractive ways when they are confronted with increasing losses. Thus in finance, where many occupations are high-wire acts, the fear of falling is constantly in the background and sometimes can lure people into disastrous activities. Individuals can become gripped by a frantic panic and may try to conceal these losses, or double up their bets like crazed gamblers trying to punt their way out of their mounting debts. This is the classic gambler’s fallacy.

There are, however, differences between the two.

Unlike Leeson, Big Finance has a supporter who agrees that liquidation isn't an option in the form of the Fed. If Nick had the Fed on his side he could have held on for a few more years (although current levels around 10K for the N225 suggest a loss orders of magnitude larger). The Fed (and Treasury) upon discovering the huge losses, not only provided liquidity to Big Finance, they provided capital support and relaxed accounting rules. As many others have covered (so I'll be brief) this support is unprecedented and ongoing. The "tide" of liquidity is high, as Warren Buffett might put it, and financial markets have responded (albeit with far less bang per buck).

Thus Bernanke, Geithner and even President Obama are engaged in a bit of cautious back-slapping.

This back slapping reminds me of another scene in Rogue Trader: 1994 is coming to a close and Leeson is long Nikkei futures and short Nikkei calls. The price is shown in big numbers, dominating the screen. He cheers and congratulates his team as as the Nikkei keeps rising and closes on its high.

In the NYU paper on the event the authors write: Leeson first sold options on the Nikkei index in October 1992, but his activity in this market really started in the second half of 1993. The value of the option portfolio fluctuated wildly over time, but it had mostly been positive. The highest value was reached by the end of December 1994, when the total value of the options was approximately US$178 million. Mainly due to the Kobe Earthquake, this reversed to a loss of approximately US$108 million by the end of February 1995 (SR App. 3K, p.179)

Given that he wasn't unwinding his risk into the rally, the cheers and back-slapping in December 1994 proved a bit premature. I'm pretty sure if he tried to unwind his position the market would have reversed.

Given that Big Finance isn't unwinding its balance sheet (I know that position can't be unwound without serious market damage) in the current environment, I suspect Bernanke's victory laps and Obama's reassurances may also prove premature, if, as I suspect, the transfer of "toxic" debt to the Fed proves as successful as similar operations in Japan. The reason for this, I surmise, is that such transfers merely buy time, which, when the losses are a large percentage of GDP, is only useful if one can grow out of the problem (which would require rapid growth) or if underlying conditions which created the loss, reverse.

These "underlying conditions" are the crux of the issue. When positions sizes are small enough for a given market, managers can play (and win) under the greater fool theory. The illusion of demand can be created long enough to sell out (or vice versa). However, when positions grow such that they cannot be dumped, the greater fool theory is disproved- you are the greatest fool. This doesn't necessarily guarantee a loss. It does, however, bring finance back to its beginning- the bets must prove out in the real sector.

Thus my concern.

Leeson bet the ranch on Japan returning to its go-go days. But Japan was an aging population with high wealth concentration in the aftermath of a bubble- a perfect recipe for risk aversion. Fortunately, Japan could self-finance and until recently seemed reasonably content to be a mature economy.

Big Finance, in a far more profound sense, has bet the ranch (our ranch) on the US returning to its go-go days. But the US (somewhat obscured by looser immigration standards) is an aging population with high wealth concentration. From whence will come the next productivity enhancing investments that (importantly) can operate within the existing capital structure (since liquidation is off the table). The computer and related communication boom was a perfect way to extend the life of the post WWII infrastructure, but those productivity effects are in the past.

Unfortunately, unlike Japan, we cannot self-finance. We need those capital markets flowing, however inspired.

Thus we took a page from the BoJ playbook and adopted a ZIRP (the world's reserve currency managers opt for a zero interest rate policy....amazing), and the effects are manifesting. Cheap $ finance is already working its magic in the commodity and equity markets. Gold is trading at $1000 as the US$ nears all time lows.

We're inflating all right, but the US real sector will be last in line to catch those flows- the conduits are broken. In the 90s above trend employment growth came, as noted, from the Tech boom, albeit with income gains that were far lower than in previous post WWII expansions. During this century there was no above trend employment growth and income is lower. The real estate wealth effect kept people happy on the margin but that is over too. Once a critical mass of the population is underwater on their mortgages real estate inflation will lag, not lead, more general inflation- an effect we would have experienced in the 90s but for the Tech Boom.

As a comic aside, we are like a team of old baseball players who just got purchased by Steinbrenner and don't want to be replaced by newer younger guys.

I think we're going to experience a stagflation like we have never seen.

But first, we will see a Leeson-esque collapse, first of the US$, and then, when they try to tighten to save it, of large chunks of Big Finance.

Sudden and swift.

I could, of course, be wrong.

Have a nice day.

http://dharmajoint.blogspot.com/2009/09/lessons-of-lehmanand-leeson.html

Iran, China moves in Americas ‘disturbing’

http://www.gulf-times.com/site/topics/article.asp?cu_no=2&item_no=288120&version=1&template_id=43&parent_id=19

AFP/Washington
Hillary: gains made by Iran and China not in US’s interests

Secretary of State Hillary Clinton has defended new moves to engage anti-US leaders in Latin America as a way to check what she calls “quite disturbing” Iranian and Chinese inroads in the region.
Clinton said that President Barack Obama has had to take a new tack after his predecessor George W Bush’s efforts to isolate such leaders only made them “more negative” toward Washington and receptive to other powers.
“I don’t think in today’s world ... that it is in our interest to turn our back on countries in our own hemisphere,” Clinton told diplomats and other State Department staff.
She described the new world as “a multi-polar world where we are competing for attention and relationships with at least the Russians, the Chinese, the Iranians”, adding such countries can soon fill the void.
“If you look at the gains, particularly in Latin America, that Iran is making, that China is making, it’s quite disturbing,” the chief US diplomat said.
“They’re building very strong economic and political connections with (many) of these leaders. I don’t think that it’s in our interests,” Clinton said.
Her answer was prompted by concerns aired by a retired State Department official about the Obama administration’s overtures toward Venezuelan President Hugo Chavez, an elected leftist-populist anti-US firebrand.
Clinton said the new administration was still exploring how to deal with such leaders.
“I’m certainly open to both constructive criticism and ideas,” Clinton said after reviewing the overtures both she and Obama made at the Summit of the Americas in Trinidad and Tobago earlier this month.
“But we talked about exchanging ambassadors again with Chavez which I think we will do at some point,” she said.
“We are looking at how to figure out how to deal with Ortega,” she said referring to Nicaraguan President Daniel Ortega.
“The Iranians are building a huge embassy in Managua. And we can only imagine what it’s for,” she said.
“We want to try building better relationships with Correa,” she said, referring to Ecuadoran President Rafael Correa. “And we want to see if we can figure out how to get an ambassador back and work with (Evo) Morales in Bolivia.”
Obama and Chavez met at the opening of a 34-nation Americas summit and photos of the encounter showed the US leader smiling as he shook the Venezuelan’s hand and patted him on the shoulder.
It was Obama’s first encounter with the Venezuelan leader, which critics back home assailed as naïve and “irresponsible”.
Obama hit back, saying: “It’s unlikely that as a consequence of me shaking hands or having a polite conversation with Mr Chavez that we are endangering the strategic interest of the US.”
But, he stressed he still had concerns about Venezuela and Chavez’s often heated rhetoric.
Obama later downplayed his interaction with Chavez as not particularly unique, noting conversations with other US critics, including Nicaragua’s Ortega and Bolivia’s Morales.

"The world is burning to the ground" ~ Quinn

“The US government is on a ‘burning platform’ of unsustainable policies and practices with fiscal deficits, chronic healthcare underfunding, immigration and overseas military commitments threatening a crisis if action is not taken soon. There are striking similarities between America’s current situation and the factors that brought down Rome, including declining moral values and political civility at home, an over-confident and over-extended military in foreign lands and fiscal irresponsibility by the central government.”

http://www.financialsense.com/editorials/quinn/2009/0428.html

Winners; China, Poland, Chile

"And the losers now will be later to win, cause' the times they are changing.... Bob Dylan

Staying off financial meth will be better for you in the long run. and sticking with the methamphetamine paradigm for a moment; that excessive leverage gives you financial energy and makes you feel great but at the cost of running down your vitamins and immune system and making you prone to psychosis, whats he current course.

I think the European rehab of a week in bed ( severe recession) is better than kicking the corpse with more of the same.

From Times Online
April 28, 2009
Brown left red-faced by debt lecture from Polish Prime Minister


Gordon Brown's attempt to put the economic misery of Britain behind him on a whistle-stop world tour were stymied today when Poland's Prime Minister embarrassed him with a lecture on the perils of excessive public borrowing and culture of debt.

Speaking after a breakfast meeting between the two leaders in Warsaw, Donald Tusk, the Polish premier said that while he did not want to comment on any other economy, the Poles had fared so well because they behaved with "full responsibility in terms of their deficit".

While Britain is struggling to cope with the effect of three quarters of economic contraction, Poland is basking in 12 years of consecutive, uninterrupted growth.

With Mr Brown standing next to him, Mr Tusk said that one of the main reasons Poland has so far managed to avoid the ravages of the credit crisis was because Warsaw had "efficient supervision to banks and sticking to the rules.... not exaggerating with living on credit. These are the most certain ways of avoiding of financial crisis."

Only last week, Alistair Darling, the Chancellor, was forced to admit in his Budget that Britain's public borrowing was on course for a record £700 billion.

Mr Tusk said: "After a few months our Government made the assumption that the method to cope with the financial crisis was not to increase expenditure but the availability of public funds."

While Mr Brown has long backed measures to pump capital back into the banking system, the Prime Minister has been a proponent of trying to spend the way out of a recession, but failed last month to garner a massive co-ordinated fiscal stimulus package across the major economies of the world.

The unintentional slight from the Polish Prime Minister marks the second time in two months when Mr Brown has been reminded that the past course taken by the British economy of light financial regulation and massive over-endebtedness has contributed to the worst slowdown since the Second World War.

Last month, President Michelle Bachelet of Chlie embarrassed Mr Brown ahead of the G20 summit when she said that the Chilean economy had performed so well because the country was able to save during the good times as a cushion for the bad. She said: "I must say that because of the decisions we took in good times, we were able to save money during the bad times."

The IMF's gold gambit ~ Wall Street Journal

The Fund's Misuse of Bullion Reserves is Crucial to its Plan to Use the Financial Crisis to Expand its Power.

By Judy Shelton
The Wall Street Journal
Monday, April 27, 2009

http://online.wsj.com/article/SB124078772568857401.html

The International Monetary Fund deserves credit, figuratively speaking, for cleverly manipulating the financial troubles of emerging and low-income nations to procure a fresh infusion of capital for itself. But its tactics at this month's G-20 summit in London -- where President Barack Obama signed off on tripling the IMF's lending resources -- should not hoodwink anyone, least of all American taxpayers who pay the largest share of IMF expenses.

Lost in the lofty talk about putting the IMF in the center of world economic recovery is the fact that the organization has been quietly attempting to ensure its own survival by seeking permission to engage in gold sales. While IMF officials insinuate that the receipts would be used to help poor countries, the real goal is to set up a permanent endowment fund for the IMF.

The U.S. should not replenish the coffers of a multilateral bureaucracy that quite literally lost its reason for being on Aug. 15, 1971 -- the day President Richard Nixon "closed the gold window" and brought an end to the Bretton Woods agreement, which allowed countries to convert their dollar holdings, via the IMF, into gold at a fixed price. Instead, Congress should call for the IMF's dismantlement and restitution of its assets.

The most solid asset owned by the IMF, purely as a legacy of its original incarnation, is gold. The IMF holds 3,217 metric tons (103.4 million ounces) of gold, which makes it the world's third largest official holder. Actually, it's a misnomer to say the IMF "owns" the gold since the bullion belongs, according to the IMF articles of agreement adopted at Bretton Woods in 1944, to its member nations.

Nevertheless, the IMF is now seeking to sell a considerable chunk of those gold holdings -- some 12.9 million ounces -- which it insists are exempt from restitution to members in the event of IMF liquidation.

Its reason? Between December 1999 and April 2000, to fund its Heavily Indebted Poor Countries (HIPC) initiative, the IMF arranged to sell gold it held on its books at a price of roughly $50 to two member countries, Brazil and Mexico, at the market price of $355. It put the profits of close to $4 billion in a special HIPC account; simultaneously, the IMF accepted back the gold sold to Brazil and Mexico in settlement of their financial obligations of that amount.

Bottom line: The balance of IMF holdings of physical gold was left unchanged, although it raked in the substantial difference between the gold's market price and its book value. The IMF asserts a propriety claim over the 12.9 million ounces it "acquired" through these transactions.

Unfortunately, artful accounting -- from the deceptive practice of carrying gold at its former official price (about $52) rather than its current market value (about $914), to the arcane usage of an intangible monetary unit called a Special Drawing Right (SDR) -- has become the IMF's defining characteristic.

The IMF once served as administrator for the gold-anchored Bretton Woods system of fixed exchange rates among currencies. It now stands for laxity, for endless government fixes, for ineptitude, and political compromise. The IMF preaches budgetary discipline one moment, only to abandon it under pressure from the current crop of presidents, prime ministers, and potentates who authorize its spending.

Now the IMF is attempting an end run around Congress, as it quietly moves toward selling gold, most likely to China. Why does the IMF need the money? Just three years ago the bloated organization (half of its 2,600 staff are economists) was nearly defunct; headquartered in Washington, the IMF was desperate to create an endowment fund to provide for its continued existence.

But in 2007 a specially convened committee of "eminent persons" helpfully suggested that if the IMF could sell those 12.9 million ounces of gold and set up a trust fund with the windfall profits, the investment returns could plug the gap between its administrative expenditures and the amount it earns as an intermediary that channels funds from rich countries to poor countries.

Sound familiar? Only one problem: IMF gold sales must be approved by an 85 percent voting majority of its members. The U.S. has a 17 percent vote; thus the IMF cannot sell gold without the explicit consent of Congress. But Rep. Barney Frank, D-Mass., who chairs the House Financial Services Committee, has indicated his openness to approving IMF gold sales -- conditional that some of the receipts be used to "help finance debt relief for poor countries."

Ah, yes, it is always about helping the poor. Which is why the IMF emphasized its willingness to assist "poor countries" in its carefully calibrated request for additional resources from G-20 nations. Not surprisingly, the London stratagem proved successful. It was readily embraced by G-20 leaders eager to demonstrate how much they care about the human consequences of economic meltdown. Ironically, the IMF has been widely blamed by recipient nations in Africa and Latin America for perpetuating poverty. Excessive transfers to less-developed countries have the perverse effect of suppressing the entrepreneurial reserves of citizens. It is only when nations manage to get off the global dole that they are taken seriously by global capital markets and can start to achieve bankable growth.

The IMF has shown an uncanny ability to transmogrify into whatever politically acceptable form necessary to ensure its survival. Throughout the intervening decades since the end of Bretton Woods, the IMF has scrambled to redefine itself as (in rough chronological order): a global debt-collection agency, an economic-research organization, a referee for financial disputes among the Group of Seven leading industrialized nations, and a front to permit Western nations to avoid being blamed for problems arising in the transition to democratic capitalism for formerly communist nations.

In its latest manifestation as global financial surveillance monitor and G-20 sidekick, the IMF has taken to delivering somber pronouncements about the world economic outlook, concluding in mid-April: "The current recessions are likely to be unusually severe, and the forthcoming recoveries sluggish." And what does the IMF recommend? "Aggressive monetary and, particularly, fiscal policies could strengthen and bring forward recoveries."

This sage advice conveniently dovetails with the agenda of Mr. Obama, who, as mentioned earlier, agreed to tripling the IMF's lending resources at the London summit. And to remain au courant with British Prime Minister Gordon Brown, IMF chief Dominique Strauss-Kahn has also called for expanding "the regulatory perimeter to encompass all activities that pose economy-wide risks."

Zhou Xiaochuan, China's powerful central banker, has authored a proposal for international monetary reform that would replace the dollar with "a super-sovereign reserve currency managed by a global institution." Citing "the inherent deficiencies caused by using credit-based national currencies," he suggests the SDR could assume this role. In the view of Mr. Zhou, the way to enhance international monetary and financial stability is to have member countries gradually entrust their reserves "to the centralized management of the IMF."

Before anyone gives any credence to the notion of having the IMF take on the task of issuing a new global currency, however, we need to remember that the original Bretton Woods system worked precisely because the dollar was convertible into gold at a fixed price. And gold is real money.

Congress should just say no.

-----

Ms. Shelton, an economist, is author of "Money Meltdown: Restoring Order to the Global Currency System" (Free Press, 1994).

IMf Bond sales needed to fund stimulus

The move, announced after the IMF's annual spring meeting, indicates the world's leading economies are having difficulty following through on a pledge made in London on April 2 to boost an IMF emergency-lending facility $500 billion. The bonds will contribute toward that goal, but will provide shorter-term financing than the loans that Japan, the European Union, and the United States have promised.

The Group of 20, which includes wealthy and developing countries, pledged in London to provide a total of $1.1 trillion to the IMF and other international lending institutions.

"The major emerging markets have made it clear that they . . . will no longer be pushed around by the advanced economies," said Eswar Prasad, an economics professor at Cornell University and former IMF official. While "the net effect" on IMF resources of loans or bond sales is the same, Prasad said, "the symbolic difference between these two types of contributions is huge."

Meanwhile, more than 100 demonstrators angered by how world leaders have handled the economic crisis took on police outside the headquarters of the IMF and World Bank. Authorities used batons and pepper spray when activists tried to march onto a prohibited street, and several people were pushed to the ground by police. The protesters swarmed officers, and police had to respond, said D.C. Police Capt. Jeffrey Harold.

Treasury Secretary Timothy Geithner yesterday urged world finance officials to pony up more money to meet the $500 billion goal. Progress toward that target "must be an important outcome of these meetings," he said.

President Obama is seeking congressional approval for up to $100 billion, matching commitments for the same amount made by Japan and the European Union. Canada and Switzerland have pledged $10 billion, and Norway about $4.5 billion. But the full $500 billion has not yet been raised.

A Japanese official said Friday that countries would meet again with the hope of closing the gap before the end of June.

The additional funds reflect the growing importance of the IMF in dealing with the global downturn, the worst the world economy has experienced in six decades. Just a year ago, the 185-member organization was seen as increasingly irrelevant as the economies of many developing countries boomed.

The additional money could aid countries in Latin America, Eastern Europe, and elsewhere that are reeling from sharp drops in exports and foreign investment. Many poor countries and nongovernmental organizations have long criticized the IMF for failing to give sufficient voice to emerging economies.

Geithner urged that developing countries be given a greater voice. He called for reducing the number of seats on the IMF's governing board to 20 from 24 over the next three years, while maintaining the same number of seats for developing countries. The IMF "needs a more representative, responsive, and accountable governance structure," he said.

http://www.philly.com/inquirer/world_us/20090426_IMF_plans_bond_sales_to_raise_money.html

Gold - The Yuan goes Global Consequences! by Julian D. W. Phillips

by Julian D. W. Phillips


For years now we have been warning of the decline of the $ as the globe's reserve currency. The threat is not so much that the monetary policies of the U.S. are cheapening the worth of the $, but that these are pressing so many other nations to search for ways to avoid the US $ in international dealings. China has now taken a momentous, structurally adjusting step to change matters in their favor.

The bulk of international trade transactions have nothing to do with the U.S. except through the use of the $ to denominate their trade. Approximately 75% of global trade is denominated in the U.S. $ in this way. But the volatility of the U.S. $ has distorted and damaged, this aspect of global trade. Thus has been created an ideal environment for gold to rise as its importance in the changing global monetary system grows again.

Having been cornered by the sheer percentage of U.S. $s in their foreign exchange reserves [every nation has this problem] the Chinese are, at last, moving to make their own currency a reserve currency.

The credit crunch and policies taken to rectify it, have triggered these actions by the Chinese. Despite the fact that the € is an up and coming global reserve currency that has not threatened the almost imperial dominance of the $, the arrival of the Yuan as a global currency will reduce the role of the U.S. $ in global trade significantly. We believe that the recent moves to introduce the Yuan across the globe will shrink the use of the $ in global trade. With the U.S. in decline, will come a fragmentation of world monetary power. In such a climate, gold will be attractive again, as a long-term investment, as a protection against the uncertainties and strains this will cause. It will also become a more vital hedge against local currency volatility. As the Yuan appreciates against the U.S.$ and other currencies as a consequence of these changes even the Chinese will find gold more attractive as part of the 'basket' in which they hold foreign currencies in their reserves and personal portfolios. Will this bring about the ban on Chinese exports of gold and sale of any such exports to the central bank? It is more than probable at some point in time!

So where will all these dollars go? They will have to go home to where they will add to the massive recent issues of dollars and will precipitate inflation dramatically, once the process is really underway. Bear in mind that it is not only the Chinese who will lower the use of the $, all nations with an overexposure to the $ in their reserves will leap at the chance to reduce this percentage and introduce the Yuan to these reserves as a replacement to the $. It is a major structural move that is part of the process of $ de-colonization. It is likely that even central banks will appreciate gold in their reserves again. This will result in a cessation of "Official" gold sales and the accumulation of gold in central bank reserves in an increasing number of countries.

Actions taken already to make the Yuan global

China has agreed a 70 billion Renminbi [Yuan] currency swap with Argentina that will allow it to receive Renminbi instead of U.S. dollars for its exports to the Latin American country.

Beijing has signed 650 billion Renminbi ($95 billion, €72 billion) worth of deals since December with Malaysia, South Korea, Hong Kong, Belarus, Indonesia. This, and now Argentina, in an attempt to unblock trade financing that has been severely curtailed by the crisis.

Now, the Chinese government has permitted five major trading cities to use the Yuan in overseas trade settlement. This is a very important step towards the establishment of the Yuan as a global and reserve currency.

Shanghai, Guangzhou [The old Canton], Shenzhen, Dongguan, and Zhuhai, are the cities that have been designated for the purpose. Concentrated in the South the Pearl River Delta cities are the spearhead of Chinese exports and already developed to the extent that even the most high tech of products is rapidly approaching international standards.

Why?

The Chinese government has watched with deep concern the prospect of it export surpluses [held in the U.S. $] move to the point where their buying power will drop heavily. On the horizon sits the prospect of the U.S. $ being used in as one of four or five global reserve currencies and not as the dominant one! Understandably then, the Chinese government is taking steps now to reduce the risk from exchange rate volatility and the prospect of the U.S.$'s buying power falling. With China's growth to a global economic driver, these moves had to come in time and that time is now.

Rising Yuan?

Consistent with these moves will, eventually, come the 'floating' of the Yuan, so that a break in the current managed float of the Yuan tied to the U.S. $ will allow a separation of the Yuan from the $. This will only happen when the Chinese are convinced that the move will not damage the international competitiveness of China. The hoped-for stability that this brings with it will allow Chinese international trade to improve and will cause an appreciation in the international value of the Yuan. The central bank of China is likely to use this appreciation as an opportunity to diversify away from the U.S. $, export the Yuan and bring in currencies that accurately reflect the spread of international trade the Chinese have at present. This would reflect the decades-long Japanese policies of exporting goods when the Yen is cheap and exporting capital when the Yen becomes expensive.

The Impact on Gold

While market attention has been riveted on the price of gold a more important feature of the gold market has caused gold to evolve as money, in increasingly difficult times. The concerns of the Chinese are the concerns of all investors particularly U.S. investors the main buyers of gold shares in the gold Exchange Traded Funds. Consequently, this has broadened the base and improved the quality of gold investors worldwide. While the jewelry trade has retreated from gold and scrap sales have supported the supply of gold, the time is coming when supplies will just not be enough to satisfy investors and scrap sales peter out. The only way such investors will be deterred from buying then is a gold price rising out of their buying zones. This will certainly mean an over four-figure gold price.

The fears of investors are outside the gold market and concern exchange rates, massive tsunamis of dollars and other currencies being printed to shore up the present system in the grips of a credit crunch. Many investors are certain inflation is roaring towards us, to spring up, as deflation is overcome. The future of the monetary system is bleak and extreme.

Locally, gold is priced in home currencies and serves as a hedge against the dramatic moves of those currencies. Rapidly, investors are seeing that their price of gold doesn't reflect only the value of gold, but the value of their local currencies as well. Awareness of gold as a protection against weakening currencies is growing rapidly. This awareness is growing in central banks, sovereign wealth funds, institutions, amongst wealthy individuals and is now spreading to the man in the street. Once sound money backed by assets was forsaken in favor of man managed and created money, the disintegration of the banking system, the credit system and confidence in currencies and economies was inevitable. Only the credibility of and confidence in paper money made it work anyway. That now stands badly mauled with potentially worse to come. But most observers are not buying gold yet! Once they do, sit back and wonder!

As Greenspan wrote decades ago, "Without a gold standard in place, there is little to prevent governments indulging in wild credit creation. Deficit spending is simply a scheme for the confiscation of wealth. Gold stands in the way of this insidious process." We do not believe there will be a Gold Standard because it is anathema to all bankers, central bankers included. What is likely to happen is that a formula will be worked out where gold can be used to increase the credibility of and confidence in paper money again. Before that discussion comes to reality, individuals and institutions are and will turn to gold. When governments contemplate gold's use in money again, you can be sure they will want the metal to themselves and exclude Joe public!

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Wille's Hat trick letter ~ Chinese Diversification Strategy

In a series of maneuvers, Chinese officials have revealed their strategy implementation in a very broad set of steps. Beijing leaders plan to establish the yuan currency as a global reserve currency. The process will be made more complete after issuance of a large volume of Chinese Govt debt securities, soon in coming. The number of policy actions is impressive. While the USGovt is busy stepping backwards with FASB rules enabling false bank accounting, gearing up Treasury programs to direct colossal elite welfare / confiscation to failed banks responsible for the crisis, covering up Wall Street fraud and regulatory lapses and debt rating agency collusion, and ordering pork like the $9 billion high speed train from Disneyland to Las Vegas, the Chinese are making important meaningful critical strides. Within a year, the Chinese will have established the yuan currency as a legitimate alternative to the USDollar for global trade, and later to some extent for global banking. The Chinese Govt has ordered monetary policy changes that have boosted their money supply by 25.5% over the last twelve months, with a giant stimulus program and relaxed bank credit rules. Since new maneuvers are being funded by incremental new surplus funds, they are exhibiting their financial power without upsetting their vast reserves accounts. The lost in the USCongress might talk about ‘Pay-Go’ measures to pay for programs as we go forward, but China does it in actual terms.

The Chinese are finally deploying alternative strategic plans in heavy volume, in open defiance, and even finger wagging at USGovt leaders. From their perspective, Beijing suspects that the US Federal Reserve is engineering a covert default on America’s debt by printing money on a vast scale. The Beijing leaders have reacted in a very noticeable profound comprehensive manner that has taken many analysts and observers off guard.

In my view, the Chinese will successfully serve as the spearhead for dethroning the USDollar from its primary global reserve currency position, called by me the catbird seat. The US has become a horrible steward, in recent years promoting massive syndicates that finally are being recognized. Both Bob Moriarity and Gary Dorsch have put forth articles in the last couple weeks pointing out Financial Coup d’Etat events and forces that reveal Obama in service to his Wall Street masters. The Wall Street Journal and London-based journals also have begun to cite endorsed and covered-up failure. This is unprecedented in journalism. After the Chinese spearhead does its work, the new partially gold-backed currencies can more easily be launched. One might say that Beijing leaders and their cast of economist and banking leaders are tilling the soil for planting the new currencies. At one time, my perception was that the yuan would follow the new hard asset launched currencies, linking to them with basket weightings. Now it is quite clear that China will lead and others will follow, benefiting from the heavy spadework, after dealing with geopolitical headwinds and interference.

SPECIFIC CHINESE STEPS TOWARD GLOBAL POSITION

The April Hat Trick Letter report for Gold & Currencies has been posted. Here are some outlined details on the important maneuvers recently made by China. They appear to be positioning themselves both to establish the yuan across the world and to fortify reserves with hard assets. Their steps are broad and effective upon examination. Their initiatives display coordination, planning, and research. Next they must deal with political backlash, unintended consequences, internal social problems, and hidden retaliation that will not be discussed (much precedent).

Since last December, China has signed deals with six countries, including Indonesia, South Korea, Hong Kong, Malaysia, Belarus, and most recently Argentina, for currency swaps that would inject Chinese money into foreign banking systems. That would allow foreign companies to pay for goods they import from China in yuan, bypassing the USDollar. This is an international settlement function.

Beijing is taking initiatives to use the yuan to settle trade accounts between some Chinese provinces and neighboring states, starting with Hong Kong. Shanghai and the four cities Guangzhou, Shenzhen, Dongguan and Zhuhai have been designated to use the yuan in overseas trade settlements, ordered by a State Council under the auspices of Premier Wen Jiabao. This Pearl River Delta region is the location of the biggest concentration of export oriented factories. The motive is to reduce the risk from exchange rate fluctuations, and to encourage their overseas trade in decline.

Chinese officials have called attention to the risks of an international monetary system that relies on the USDollar, seen as increasingly unstable and subject to further indirect devaluation. A broad campaign has been underway for a couple months that seems coordinated, with participation by many bank and economic leaders.

A plan to set up a $10 billion cooperation fund to support infrastructure projects in countries in the Assn of Southeast Asian Nations (ASEAN) has been hatched. The plan was announced earlier this month by Chinese Foreign Minister Yang Jiechi. The ASEAN member countries are Thailand, Malaysia, the Philippines, Singapore, Brunei, Vietnam, and Indonesia. The fund could morph into a regional development fund.

more

Global toxic assets could reach $5.7 trillion:IMF~AAP

http://business.smh.com.au/business/world-business/global-toxic-assets-could-reach-57-trillionimf-20090422-ae8l.html

Bank writedowns associated with so-called "toxic assets" clogging up the global financial system could eventually reach $US4 trillion ($5.73 trillion), the International Monetary Fund says.

This is nearly double the amount the IMF predicted in January.

With this in mind, the IMF warns in its latest Global Financial Stability Report that costs to taxpayers could be greater if governments do not continue with policies to restore confidence in the financial system.

The IMF estimates writedowns on US-originated assets since the outbreak of the crisis will increase to $US2.7 trillion from its previous forecast of $US2.2 trillion.

This, it says, is largely as a result of the worsening base-case scenario for economic growth.

"In this GSFR, estimates for writedowns have been extended to include other mature market-originated assets and, while the information underpinning these scenarios is more uncertain, such estimates suggest writedowns could reach a total of around $US4 trillion," it said.

It said while there had been some improvements in interbank money markets over the last few months, funding strains were persisting and banks' access to longer-term funding had diminished.

"While in many jurisdictions banks can now issue government-guaranteed, longer-term debt, their funding gap remains large," it said.

"As a result, many corporations are unable to obtain bank-supplied working capital and some are having difficulty raising longer-term debt, except at much more elevated yields."

Australia's major banks failed to pass on in full this month's 25-basis-point cut in the official interest rate, blaming higher wholesale funding costs.

The IMF says that despite unprecedented initiatives to stop the downward spiral in advanced economies, further policy action would be required to relieve the uncertainties in financial markets that were undermining the prospects for an economic recovery.

However, it said political support for such action appeared to be waning as the public was becoming disillusioned by what it perceived as abuse of taxpayers' funds.

"There is a real risk that governments will be reluctant to allocate enough resources to solve the problem," it said.

It said that without a thorough cleansing of impaired assets on bank balance sheets, accompanied by restructuring and, where needed, recapitalisation, risks remained that problems being experienced by banks would continue to exert downward pressure on economic activity.

A recent IMF analysis showed that past episodes of financial crisis have shown that restoring the banking system to normal operation takes several years, and that recessions tend to be deeper and longer lasting when associated with a financial crisis.

"This same experience shows that when policies are unclear and implemented forcefully and promptly, or are not aimed at the underlying problem, the recovery process is even more delayed and the costs, both in terms of taxpayer money amd economic activity, are even greater," it said.

The Real Implications Of China’s Currency Policy

Great item from a blog called Shadow Bankers..... go Roy, well done.


By Ranjan X. Roy

Yesterday, as Americans paid their taxes and partied like it was 1773, China took yet another action little noticed in the American media, but with major long term implications. China finalized a deal with Argentina, arranging a $10.2bn currency swap of their respective currencies (70bn CNY/38bn ARS). While Michele Bachmann and the like were up in arms after Zhou Xiaochuan, Governor of the People’s Bank of China (PBoC), suggested that SDRs could potentially function as a new global reserve currency, this particular story appears to have garnered little attention from those paranoid of a “one world currency“. However, this development is of crucial strategic importance and should be recognized by US policymakers as a development that must be addressed, rather than proposing legislation that doesn’t even begin to make any sense.

The move will allow Argentineans to directly access Chinese Yuan for trade, rather than having to settle in US Dollars. Previously, as the USD has been the primary reserve currency for international trade, an importer would have to cross two “spreads”, first converting ARS to USD, and then the USD to CNY (just imagine having to go to the airport currency exchange twice just to buy a souvenir). The Argentine Central Bank is explaining the move as a “contingency plan to bolster liquidity amid the global financial crisis,” but this vague statement is better explained by Passport at Foreign Policy:

As Xinhua reports, the Argentines can essentially use the RMB as extra cash to pay for imports. But one might note that, since the Yuan is not a convertible currency, the money can only be used to purchase goods from — you guessed it — China, potentially giving a boost the Dragon’s ailing export sector.

China’s economy has suffered along with the rest of the world since they have long been reliant on export-led growth, and in this market, major trading partners just aren’t importing any more. And so this currency swap is shrewd move for China, in that it has the dual effect of both promoting Chinese exports to Argentina, while also allowing this trade to be settled in Yuan rather than Dollars. Michele Bachmann’s paranoia meter should have been turned up a notch, since with this move, China has slowly begun initiating a shift away from the USD while simultaneously increasing its economic presence in an unfamiliar region. It marks yet another step towards full convertibility of the Yuan. While the swap shouldn’t incite outright panic, US policymakers need to recognize these coordinated actions in the broader context. This isn’t just about the US Dollar: it’s about our leadership role in these regions.

This swap is the sixth of its kind since this past December, with South Korea, Malaysia, Indonesia, Hong Kong and Belarus all coming to similar arrangements with the PBoC, totaling 650bn CNY ($95bn USD). Note that last fall, as the Federal Reserve “stepped it up” and arranged currency swaps with many central banks, including swaps worth $30bn USD with both Brazil and Mexico, economies like Argentina were left out. Romero and Barrionuevo at the NYT have documented a number of additional coordinated initiatives China is taking in nations generally ignored by the US, including direct loans to Ecuador and Venezuela.

Both the rise of China’s presence globally, along with the eventual shift away from the USD as the sole reserve currency, are generally accepted as longer-term eventualities. In the meantime, the United States must recognize that it is in our interest to get our own house in order while not ignoring nations that have looked to us for leadership in the past, rather than turning inward and resorting to protectionism.

Read it with the links

US dollar faces death of a thousand "yuan currency swap" deals

A first step in this redirection of policy focus on domestic development is for China to free itself from dollar hegemony. This can be done by legally requiring payment of all Chinese exports to be denominated in yuan to stop the unproductive role of exporting for dollars that cannot be spent domestically without incurring heavy monetary penalty. Such a policy affects only Chinese exporters and can be implemented unilaterally by Chinese law as a sovereign nation, without any need for international coordination or foreign or supranational approval. (See Breaking free from dollar hegemony, Asia Times Online, July 30, 2008.)

Cross-border exchange of regional currencies is an important way to circumvent a shortage of dollars and other currencies, as well as reduce exposure to exchange rate volatility. Developing countries in eastern and central Asia as well as South America are beginning to recognize the Chinese yuan as an appropriate currency for bilateral trade settlements. In some case, the yuan is beginning to serve as a reserve currency for bilateral trade.



Central banks in China and South Korea signed a 180 billion yuan (US$26.4 billion) currency swap framework agreement on December 12, 2008. The People's Bank of China entered into a 200 billion yuan swap with the Hong Kong Monetary Authority on January 20, 2009; an 80 billion yuan agreement with Malaysia's central bank on February 8; a 20 billion yuan deal with the National Bank of Belarus on March 11, a 100 billion yuan swap with the central bank of Indonesia on March 24, and an 80 billion yuan swap with the central bank of Argentina. The swaps will allow the parties to avoid using dollars in trade between them and China. Other central banks have also indicated a willingness to enter currency swap agreements with China.

Currency swaps allows a central bank to inject a counter-party's currency into its own financial system, allowing domestic businesses to borrow the other country's currency and use it to pay for imports of that country's goods, thereby easing the pressure on trade caused by an insufficiency of dollar. Technically, currency swap agreements are simply two-way loans between central banks. Foreign central banks generally use borrowed yuan to settle trades with China or as a reserve currency. China, on the other hand, uses foreign currency holdings as collateral. Consequently, regional circulation of the yuan expands with bilateral currency swaps.

The system hinges on confidence in the yuan among all swap parties. As liquidity of the dollar, the generally accepted reserve currency for international settlement, dries up in the current financial crisis, serious problems in credit and exchange rate risks have emerged. As a result, regional demand for trade settlement in local currency has appeared. As the currency of the largest economy engaged in the production of manufactured goods, the yuan naturally fills in as the preferred currency to respond to this demand. The scale of currency swaps is determined by market demand, not by currency hegemony.

http://www.atimes.com/atimes/Global_Economy/KD15Dj04.html

World leaders miss the target

The logic behind putative US capital controls; split old/new dollars

Only way to inflate without destroying the current monetary order....

Decouple the world from the dollar
By Korkut A Erturk

"While an emphasis on reviving banks and an injection of public spending are both important, the trouble is that neither one directly addresses the main source of global deflation, which is that global imbalances are no longer being recycled effectively. Because US households and banks are now bankrupt, the United States has lost much of its capacity to absorb and recycle foreign trade surpluses. That, in a nutshell, is the driving force behind the global deflationary trend.

Substituting massive public spending for private consumption and putting banks on life support are at best stopgap measures, and it is unlikely that they will bring back the ability to recycle trade surpluses. Even in the best-case scenario, where confidence in the dollar holds up, the broken machinery that produced the world's credit supply cannot not be reassembled because too many borrowers and intermediaries are insolvent. There is no easy way to make the debt overhang go away, and neither tax cuts nor cleansing banks of toxic assets will bring about a lasting increase in private consumption............

The extreme monetary easing and a massive fiscal stimulus being implemented amounts to fighting deflation by trying to destabilize the monetary standard to induce inflation. If it fails, the current slump can turn into a great depression worse than the last, and if it works, the resulting inflation will probably make the 1970s look good................

....
That requires that the global monetary standard, and by extension the integrity of monetary reserves, is safeguarded as more stimulus is implemented.

A credible plan to achieve this would involve figuring out a way to draw a wedge between the global dollars accumulated in foreign reserves and the domestic dollars that the US will be creating at a much faster clip. That way, the world economy can reinflate at the same time, since everyone would be able to devalue in relation to a stable monetary standard.

Technically, this wouldn't be hard to do. An idea such as setting up a substitution account at the International Monetary Fund (IMF) to convert unwanted dollars to special drawing rights (SDRs) can be considered. The idea was considered before in the late 1970s when international confidence in the dollar was ebbing, only to be shelved once the political swing to the right made it redundant. In principle, the IMF could issue as many new SDRs as demanded without being inflationary and could even refashion itself as the asset manager of the world. The IMF could even help generalize new instruments such as the proposed Asia bond by using Chinese reserves.

The real question is whether there will be the political will to carry out these proposals....

http://www.atimes.com/atimes/Global_Economy/KD16Dj03.html

Liquid war: Welcome to Pipelineistan

What happens on the immense battlefield for the control of Eurasia will provide the ultimate plot line in the tumultuous rush towards a new, polycentric world order, also known as the New Great Game.

Our good ol' friend the nonsensical "global war on terror", which the Pentagon has slyly rebranded "the Long War", sports a far more important, if half-hidden, twin - a global energy war. I like to think of it as the Liquid War, because its bloodstream is the pipelines that crisscross the potential imperial battlefields of the planet. Put another way, if its crucial embattled frontier these days is the Caspian Basin, the whole of Eurasia is its chessboard. Think of it, geographically, as Pipelineistan.

All geopolitical junkies need a fix. Since the second half of the1990s, I've been hooked on pipelines. I've crossed the Caspian in an Azeri cargo ship just to follow the $4 billion Baku-Tblisi-Ceyhan pipeline, better known in this chess game by its acronym, BTC, through the Caucasus. (Oh, by the way, the map of Pipelineistan is chicken-scratched with acronyms, so get used to them!)

I've also trekked various of the overlapping modern Silk Roads, or perhaps Silk Pipelines, of possible future energy flows from Shanghai to Istanbul, annotating my own do-it-yourself routes for LNG (liquefied natural gas). I used to avidly follow the adventures of that once-but-not-future Sun-King of Central Asia, the now deceased Turkmenbashi or "leader of the Turkmen", Saparmurat Niyazov, head of the immensely gas-rich Republic of Turkmenistan, as if he were a Conradian hero.

In Almaty, the former capital of Kazakhstan (before it was moved to Astana, in the middle of the middle of nowhere) the locals were puzzled when I expressed an overwhelming urge to drive to that country's oil boomtown Aktau. ("Why? There's nothing there.") Entering the Space Odyssey-style map room at the Russian energy giant Gazprom's headquarters in Moscow - which digitally details every single pipeline in Eurasia - or the National Iranian Oil Company (NIOC)'s corporate HQ in Tehran, with its neat rows of female experts in full chador, was my equivalent of entering Aladdin's cave. And never reading the words "Afghanistan" and "oil" in the same sentence is still a source of endless amusement for me.

Last year, oil cost a king's ransom. This year, it's relatively cheap. But don't be fooled. Price isn't the point here. Like it or not, energy is still what everyone who's anyone wants to get their hands on. So consider this dispatch just the first installment in a long, long tale of some of the moves that have been, or will be, made in the maddeningly complex New Great Game, which goes on unceasingly, no matter what else muscles into the headlines this week.

Forget the mainstream media's obsession with al-Qaeda, Osama "dead or alive" bin Laden, the Taliban - neo, light or classic - or that "war on terror", whatever name it goes by. These are diversions compared to the high-stakes, hardcore geopolitical game that follows what flows along the pipelines of the planet.

Who said Pipelineistan couldn't be fun?

Calling Dr Zbig In his 1997 magnum opus The Grand Chessboard, Zbigniew Brzezinski - realpolitik practitioner extraordinaire and former national security advisor to Jimmy Carter, the president who launched the US on its modern energy wars - laid out in some detail just how to hang on to American "global primacy". Later, his master plan would be duly copied by that lethal bunch of Dr No's congregated at Bill Kristol's Project for a New American Century (PNAC, in case you'd forgotten the acronym since its website and its followers went down).

For Dr Zbig, who, like me, gets his fix from Eurasia - from, that is, thinking big - it all boils down to fostering the emergence of just the right set of "strategically compatible partners" for Washington in places where energy flows are strongest. This, as he so politely put it back then, should be done to shape "a more cooperative trans-Eurasian security system".

By now, Dr Zbig - among whose fans is evidently President Barack Obama - must have noticed that the Eurasian train which was to deliver the energy goods has been slightly derailed. The Asian part of Eurasia, it seems, begs to differ.

Global financial crisis or not, oil and natural gas are the long-term keys to an inexorable transfer of economic power from the West to Asia. Those who control Pipelineistan - and despite all the dreaming and planning that's gone on there, it's unlikely to be Washington - will have the upper hand in whatever is to come, and there's not a terrorist in the world, or even a "long war", that can change that.

Energy expert Michael Klare has been instrumental in identifying the key vectors in the wild, ongoing global scramble for power over Pipelineistan. These range from the increasing scarcity (and difficulty of reaching) primary energy supplies to "the painfully slow development of energy alternatives". Though you may not have noticed, the first skirmishes in Pipelineistan's Liquid War are already on, and even in the worst of economic times, the risk mounts constantly, given the relentless competition between the West and Asia, be it in the Middle East, in the Caspian theater, or in African oil-rich states like Angola, Nigeria and Sudan.

In these early skirmishes of the 21st century, China reacted swiftly indeed. Even before the attacks of September 11, 2001, its leaders were formulating a response to what they saw as the reptilian encroachment of the West on the oil and gas lands of Central Asia, especially in the Caspian Sea region. To be specific, in June 2001, its leaders joined with Russia's to form the Shanghai Cooperation Organization. It's known as the SCO and that's an acronym you should memorize. It's going to be around for a while.

Back then, the SCO's junior members were, tellingly enough, the Stans, the energy-rich former SSRs of the Soviet Union - Kyrgyzstan, Uzbekistan, Kazakhstan and Tajikistan - which the Bill Clinton administration and then the new George W Bush administration, run by those former energy men, had been eyeing covetously. The organization was to be a multi-layered economic and military regional cooperation society that, as both the Chinese and the Russians saw it, would function as a kind of security blanket around the upper rim of Afghanistan.

Iran is, of course, a crucial energy node of West Asia and that country's leaders, too, would prove no slouches when it came to the New Great Game. It needs at least $200 billion in foreign investment to truly modernize its fabulous oil and gas reserves - and thus sell much more to the West than US-imposed sanctions now allow.

No wonder Iran soon became a target in Washington. No wonder an air assault on that country remains the ultimate wet dream of assorted Likudniks as well as former vice president Dick ("Angler") Cheney and his neo-conservative chamberlains and comrades-in-arms. As seen by the elite from Tehran and Delhi to Beijing and Moscow, such a US attack, now likely off the radar screen until at least 2012, would be a war not only against Russia and China, but against the whole project of Asian integration that the SCO is coming to represent.

Global BRIC-a-brac
Meanwhile, as the Obama administration tries to sort out its Iranian, Afghan, and Central Asian policies, Beijing continues to dream of a secure, fast-flowing, energy version of the old Silk Road, extending from the Caspian Basin (the energy-rich Stans plus Iran and Russia) to Xinjiang province, its Far West.

The SCO has expanded its aims and scope since 2001. Today, Iran, India, and Pakistan enjoy "observer status" in an organization that increasingly aims to control and protect not just regional energy supplies, but Pipelineistan in every direction. This is, of course, the role the Washington ruling elite would like the North Atlantic Treaty Organization (NATO) to play across Eurasia. Given that Russia and China expect the SCO to play a similar role across Asia, clashes of various sorts are inevitable.

Ask any relevant expert at the Chinese Academy of Social Sciences in Beijing and he will tell you that the SCO should be understood as a historically unique alliance of five non-Western civilizations - Russian, Chinese, Muslim, Hindu, and Buddhist - and, because of that, capable of evolving into the basis for a collective security system in Eurasia. That's a thought sure to discomfort classic inside-the-Beltway global strategists like Dr Zbig and president George H W Bush's national security advisor Brent Scowcroft.

According to the view from Beijing, the rising world order of the 21st century will be significantly determined by a quadrangle of BRIC countries - for those of you by now collecting New Great Game acronyms, that stands for Brazil, Russia, India and China - plus the future Islamic triangle of Iran, Saudi Arabia and Turkey. Add in a unified South America, no longer in thrall to Washington, and you have a global SCO-plus. On the drawing boards, at least, it's a high-octane dream.

The key to any of this is a continuing Sino-Russian entente cordiale.

Already in 1999, watching NATO and the United States aggressively expand into the distant Balkans, Beijing identified this new game for what it was: a developing energy war. And at stake were the oil and natural gas reserves of what Americans would soon be calling the "arc of instability," a vast span of lands extending from North Africa to the Chinese border.

No less important would be the routes pipelines would take in bringing the energy buried in those lands to the West. Where they would be built, the countries they would cross, would determine much in the world to come. And this was where the empire of US military bases (think, for instance, Camp Bondsteel in Kosovo) met Pipelineistan (represented, way back in 1999, by the AMBO pipeline).

AMBO, short for Albanian Macedonian Bulgarian Oil Corporation, an entity registered in the US, is building a $1.1 billion pipeline, aka "the Trans-Balkan", slated to be finished by 2011. It will bring Caspian oil to the West without taking it through either Russia or Iran. As a pipeline, AMBO fit well into a geopolitical strategy of creating a US-controlled energy-security grid that was first developed by president Bill Clinton's energy secretary Bill



Richardson and later by Cheney.

Behind the idea of that "grid" lay a go-for-broke militarization of an energy corridor that would stretch from the Caspian Sea in Central Asia through a series of now independent former SSRs of the Soviet Union to Turkey, and from there into the Balkans (from thence onto Europe). It was meant to sabotage the larger energy plans of both Russia and Iran. AMBO itself would bring oil from the Caspian basin to a terminal in the former SSR of Georgia in the Caucasus, and then transport it by tanker through the Black Sea to the Bulgarian port of Burgas, where another pipeline would connect to Macedonia and then to the Albanian port of Vlora.

As for Camp Bondsteel, it was the "enduring" military base that Washington gained from the wars for the remains of Yugoslavia. It would be the largest overseas base the US had built since the Vietnam War. Halliburton's subsidiary Kellogg Brown & Root would, with the Army Corps of Engineers, put it up on 400 hectares of farmland near the Macedonian border in southern Kosovo.

Think of it as a user-friendly, five-star version of Guantanamo with perks for those stationed there that included Thai massage and loads of junk food. Bondsteel is the Balkan equivalent of a giant immobile aircraft carrier, capable of exercising surveillance not only over the Balkans but also over Turkey and the Black Sea region (considered in the neo-con-speak of the Bush years "the new interface" between the "Euro-Atlantic community" and the "Greater Middle East").

How could Russia, China, and Iran not interpret the war in Kosovo, then the invasion of Afghanistan (where Washington had previously tried to pair with the Taliban and encourage the building of another of those avoid-Iran, avoid-Russia pipelines), followed by the invasion of Iraq (that country of vast oil reserves), and finally the recent clash in Georgia (that crucial energy transportation junction) as straightforward wars for Pipelineistan?

Though seldom imagined this way in our mainstream media, the Russian and Chinese leaderships saw a stark "continuity" of policy stretching from Bill Clinton's humanitarian imperialism to Bush's "global war on terror". Blowback, as then Russian President Vladimir Putin himself warned publicly, was inevitable - but that's another magic-carpet story, another cave to enter another time.

Rainy night in Georgia
If you want to understand Washington's version of Pipelineistan, you have to start with Mafia-ridden Georgia. Though its army was crushed in its recent war with Russia, Georgia remains crucial to Washington's energy policy in what, by now, has become a genuine arc of instability - in part because of a continuing obsession with cutting Iran out of the energy flow.

It was around the Baku-Tblisi-Ceyhan (BTC) pipeline, as I pointed out in my book Globalistan in 2007, that American policy congealed. Zbig Brzezinski himself flew into Baku in 1995 as an "energy consultant", less than four years after Azerbaijan became independent, and sold the idea to the Azerbaijani elite. The BTC was to run from the Sangachal Terminal, half-an-hour south of Baku, across neighboring Georgia to the Marine Terminal in the Turkish port of Ceyhan on the Mediterranean.

Now operational, that 1,767-kilometer-long, 44-meter-wide steel serpent straddles no less than six war zones, ongoing or potential: Nagorno-Karabakh (an Armenian enclave in Azerbaijan), Chechnya and Dagestan (both embattled regions of Russia), South Ossetia and Abkhazia (on which the 2008 Russia-Georgia war pivoted), and Turkish Kurdistan.

From a purely economic point of view, the BTC made no sense. A "BTK" pipeline, running from Baku through Tehran to Iran's Kharg Island, could have been built for, relatively speaking, next to nothing - and it would have had the added advantage of bypassing both mafia-corroded Georgia and wobbly Kurdish-populated Eastern Anatolia. That would have been the really cheap way to bring Caspian oil and gas to Europe.

The New Great Game ensured that that was not to be, and much followed from that decision. Even though Moscow never planned to occupy Georgia long-term in its 2008 war, or take over the BTC pipeline that now runs through its territory, Alfa Bank oil and gas analyst Konstantin Batunin pointed out the obvious: by briefly cutting off the BTC oil flow, Russian troops made it all too clear to global investors that Georgia wasn't a reliable energy transit country. In other words, the Russians made a mockery of Zbig's world.

For its part, Azerbaijan was, until recently, the real success story in the US version of Pipelineistan. Advised by Zbig, Bill Clinton literally "stole" Baku from Russia's "near abroad" by promoting the BTC and the wealth that would flow from it. Now, however, with the message of the Russia-Georgia War sinking in, Baku is again allowing itself to be seduced by Russia. To top it off, Azerbaijan President Ilham Aliyev can't stand Georgia's brash President Mikhail Saakashvili. That's hardly surprising. After all, Saakashvili's rash military moves caused Azerbaijan to lose at least $500 million when the BTC was shut down during the war.

Russia's energy seduction blitzkrieg is focused like a laser on Central Asia as well. (We'll talk about it more in the next Pipelineistan installment.) It revolves around offering to buy Kazakh, Uzbek, and Turkmen gas at European prices instead of previous, much lower Russian prices. The Russians, in fact, have offered the same deal to the Azeris: so now, Baku is negotiating a deal involving more capacity for the Baku-Novorossiysk pipeline, which makes its way to the Russian borders of the Black Sea, while considering pumping less oil for the BTC.

Obama needs to understand the dire implications of this. Less Azeri oil on the BTC - its full capacity is 1 million barrels a day, mostly shipped to Europe - means the pipeline may go broke, which is exactly what Russia wants.

In Central Asia, some of the biggest stakes revolve around the monster Kashagan oil field in "snow leopard" Kazakhstan, the absolute jewel in the Caspian crown with reserves of as many as 9 billion barrels. As usual in Pipelineistan, it all comes down to which routes will deliver Kashagan's oil to the world after production starts in 2013. This spells, of course, Liquid War. Wily Kazakh President Nursultan Nazarbayev would like to use the Russian-controlled Caspian Pipeline Consortium (CPC) to pump Kashagan crude to the Black Sea.

In this case, the Kazakhs hold all the cards. How oil will flow from Kashagan will decide whether the BTC - once hyped by Washington as the ultimate Western escape route from dependence on Persian Gulf oil - lives or dies.

Welcome, then, to Pipelineistan! Whether we like it or not, in good times and bad, it's a reasonable bet that we're all going to be Pipeline tourists. So, go with the flow. Learn the crucial acronyms, keep an eye out for what happens to all those US bases across the oil heartlands of the planet, watch where the pipelines are being built, and do your best to keep tabs on the next set of monster Chinese energy deals and fabulous coups by Russia's Gazprom.

And, while you're at it, consider this just the first postcard sent off from our tour of Pipelineistan. We'll be back (to slightly adapt a quote from Terminator). Think of this as a door opening onto a future in which what flows where and to whom may turn out to be the most important question on the planet.

Pepe Escobar is the roving correspondent for Asia Times Online and an analyst for the Real News. This article draws from his new book, Obama does Globalistan. He is also the author of Globalistan: How the Globalized World is Dissolving into Liquid War (Nimble Books, 2007) and Red Zone Blues: a snapshot of Baghdad during the surge. Pepe may be reached at pepeasia@yahoo.com.

(Copyright 2009 Pepe Escobar.)

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China’s Surge: There’s Infrastructure and Infrastructure

March 4th, 2009
By David Goldman

My longtime colleague Uwe Parpart, now chief Asia strategist at Cantor Fitzgerald in Hong Kong, has argued all year that the Chinese economy will avoid recession thanks to aggressive intervention by the Chinese government. Today’s 6.2% surge in the Shanghai Composite in response to the likely increase in the existing stimulus package bears out the China bulls. This optimism has spilled over into commodity prices and raw materials stocks worldwide.

What’s the difference between infrastructure spending in China (stocks up 20% year to date) and infrastructure spending in the US (stocks down 20% year to date)? China needs infrastructure; the interior of the country remains horrifically backward and spending on infrastructure feeds rapidly into productivity, just as the huge infrastructure spend in the coast had a massive effect on productivity. The US could use some repairs, but putting a few hundred billion dollars into the hands of construction unions won’t change life in the United States.

The US was invited to take part in the $120 billion Asian currency stabilization fund created last month, and turned the opportunity down — again, epic stupidity on the Cecil B. DeMille scale (Ridley Scott for you youngsters). Stabilizing the dollar against the Chinese yuan (and prospectively against other currencies in the region) could be the first step in a Sino-American economic partnership.

Francesco Sisci, La Stampa’s Asia Editor, and I argued that America’s road to recovery ran through China last November:

Recovery requires a great change in direction of capital flows. For the past decade, poor people in the developing world have financed the consumption of rich people in America. America has borrowed nearly $1 trillion a year, mostly from the developing world, and used these funds to import consumer goods and buy homes at low interest rates. The result is a solvency crisis of the American household, which shows up as a solvency crisis for financial institutions. If we reckon the retirement needs of households as a liability, the household sector is as good as bankrupt.

No recovery is possible unless American households can save, and they cannot save in an economic contraction when incomes spiral downwards. To save, Americans must sell goods and services to someone else, and a glance at the globe makes clear who that must be: nearly half the world’s population, and most of the world’s capacity for economic growth, is concentrated in China and the Pacific Littoral.

China’s economic problem is the inverse of America’s: China has achieved fast rates of growth at the expense of huge disparities between the prosperous coast and the backward interior, as well as excessive dependence on foreign markets. China’s policy response to the economic crisis is far more radical than Washington’s. Rather than attempting to patch up the situation and restore the status quo ante, China plans to spend nearly a fifth of its gross domestic product on an internal stimulus focused on infrastructure in its interior. Severe execution risk attends the Chinese proposal, and markets remain to be convinced.

China can reduce the execution risk of its great economic shift towards home consumption, and America can solve its savings problem, through a grand partnership. This partnership need not be exclusive to America and China, but it must be founded on America and China, two of the world’s largest economies. India and the other Asian economies should be encouraged to join this partnership. A great deal has been written about prospective conflict between China and the United States, but very little explanation is offered as to what issues might arise between China and the United States. China and America have far more to gain from cooperation than from conflict.

link

Just say sorry, The US and Iran

The shah used to be no more than a playboy. John F Kennedy, who met him on the Rivera party circuit before he became US president, thought he was a dangerous megalomaniac. As president, Kennedy anyway supported him, suggesting a little harmless reform here and there. The shah made a few cosmetic overtures towards women, for instance declaring non-obligatory the use of the chador. But this only concerned the wealthy and the Iranian upper-middle class, the small consumer society created by the multinational corporations to whom the shah opened up the country.

What the shah and his secret police did with relish was to persecute all political parties, as well as Kurds, one of the very "minorities" David Rockefeller said was protected.

And just like president George W Bush a few decades later, Mohammad Reza started to believe in his own propaganda and regard himself as king of kings. Especially because he was instrumental behind the spectacular rise in the price of oil in 1973 of the Organization of Petroleum Exporting Countries (OPEC). This - the real story - will never be featured in the mainstream US media.

Now do the Kissinger shuffle
The shah got his green light from national security advisor cum secretary of state Henry Kissinger. In 1972, president Richard Nixon had introduced the Nixon Doctrine (pity no one never asked Alaska governor Sarah Palin about that). Based on the US defeat in Vietnam, and convinced he would never be able to directly combat all the global subversion nodes springing up against US interests, Nixon started to promote global "gatekeepers". No gatekeeper was more essential than the one in charge of the Persian Gulf. The shah gladly accepted the role, but complained he was broke - he could not buy the weapons the US was trying to sell him.

The wily Kissinger found out how: the rise of OPEC oil prices. This is how Kissinger - employed by the Rockefellers - drove to the roof the profits by US Big Oil, which at the time consisted of five of the Seven Sisters, and especially Rockefeller Big Oil (Exxon, Mobil and SoCal, three of the four majors, the other being Texaco). And all this with an added big bonus. Japan, Germany and the rest of Western Europe depended on Persian Gulf oil much more than the US; thus Kissinger also found out how to undermine the devastating industrial and commercial competition to the US by especially Japan and Germany.

A case can be made that the whole shah/Kissinger racket inevitably led to the fall of the shah. The shah - like Somoza, Suharto or an array of Latin American dictators - never understood that he was no more than a puppet.

He spent tens of billions of dollars on American weapons. His multinational model fit the obvious pattern seen all over the developing world: a minority swimming in gold and conspicuous consumption while the absolute majority faced dire poverty. The shah pushed for cash crops instead of conducting a real agrarian reform that would guarantee the subsistence of millions of Iranian peasants - all of them diehard Shi'ites and most of them illiterate.

These peasant masses in the end got the boot from the countryside by American agribusiness; for the Americans, they were nothing but a "superfluous" workforce, non-adaptable to a Western, mechanized, selective model. It was those miserable masses, flooding Tehran and other large Iranian cities in a fight for survival, who composed the mass base of Khomeini's revolution in 1979. The rest is, of course, history.

Save us from these barbarians
The US ruling class simply could not - and still cannot - acknowledge the power of Third World nationalism; there's the risk American public opinion, if well informed, could sympathize with nationalists everywhere.

That's why the Vietnamese were portrayed as puppets of Beijing; after taking out Indochina, they would - according to the domino theory - invade the Philippines and in the end Los Angeles and San Francisco.

US corporate media endlessly denounced the horrendous crimes of the genocidal psychopath Pol Pot in Cambodia; but US public opinion was never told that it was Nixon and Kissinger who destroyed neutral Cambodia in 1970, thus allowing the Khmer Rouge to flower and take over power, destroying it even further.

As for the Iranian revolution against the oppressive, mega-corrupt shah/US multinational corporations regime, it was relentlessly depicted as "subversion" perpetrated by an old religious fanatic and a demented mob (the CIA at least got it right in 1978, depicting Khomeini in a memo as "a sort of moralist, a philosopher-king").

In 1978, the whole US corporate media were hammering that the shah was invincible; that the Khomeinist mobs were a minority; and that the shah was a "great modernizer" opposed by "Muslim fanatics". Then, after the revolution, American guilt for the life and "work" of the shah was psychologically replaced by hatred of Iran because of the American hostage crisis.

It's never enough to remember today: virtually everything happening in the world during the Cold War had to have behind it the hand – and the gold - of Moscow. Why didn't Carter block Iran - whose oil Japan and Europe badly needed? It was fear that Khomeini would fall into Moscow's arms.

The Islamic Revolution was received with supreme perplexity in Washington. The perplexity remains to this day - the 30th anniversary of the revolution. The process inevitably went through the paranoia of a (frustrated) attempt to blame it all on Moscow.

Recent history has shown - from Vietnam to Iraq - that the "policies" concocted by the Washington establishment never matched reality, and that's why they spectacularly failed. Added to the inevitable decadence of empire, it has become increasingly difficult to hide the stark consequences from American public opinion. Nevertheless, it's still taboo in the US to acknowledge September 11, 2001, as blowback for US foreign policy in the Arab and Muslim world. So how far would Obama really go to explain in detail to US public opinion how the CIA coup against Mossadegh in 1953, and the support for the shah dictatorship, led to the 1979 Islamic Revolution and 30 years (or 56 years?) of mistrust?

Hail to the revolution
Thirty years after the fact, the shadow of the Smasher of Idols, the Glorious Upholder of the Faith, the Sole Hope of the Downtrodden, the Vicar of Islam, His Holiness Grand Ayatollah Haj Sayyed Ruhollah Mussavi Khomeini still looms large over Iran.

He was no less than a living essay on hieratic severity. After 16 years in exile, back to Iran to lead his revolution, he said he felt "nothing". A few months later, on April 1, 1979, an astonishing 98.2% of Iranians, in a national referendum, endorsed his dream of an Islamic Republic.

Khomeini had the genius to brand himself as the incarnated utopia of a world where the weak would be strong, where the law of god would erase the injustice of man, where faith would be knowledge, where the certitude of tradition would trump the angst of progress. Even the Arab masses were seduced; they did not understand any talk of class struggle or plus value, but Khomeini talked in terms of god and satan - the global language of the downtrodden.

This dream of a world devoid of contradiction and conflict, united under the watchful eye of Allah, died with the death of Khomeini - by a fabulous twist of history on the day in 1989 Chinese paramount leader Deng Xiaoping's squads were smashing students in Tiananmen Square, thus, in Deng's view, preventing luan ("chaos") from hijacking the Chinese economic miracle.

Khomeini adopted "neither East or West", neither the Great Satan nor communism. He offered redemption through martyrdom - sending hundreds of thousands of young martyrs to certain death into a horrendous war in the 1980s against Saddam that of course he did not want but in the end fully adopted, deploying an incendiary rhetoric of death and proclamations. The victims were in the end the same mostazaffin - the oppressed - whom he claimed to defend.

Khomeini deployed instant tribunals and suicide commandos, the human waves of the Iran-Iraq war and the hostage crisis humiliation. Carter lost his re-election because of the hostage crisis. Iran ridiculed the US with Irangate. Against the terrorism of the Great Satan, Khomeini deployed sacred terrorism. None won. Everyone lost.

For the past two decades, the "dream" has been carried out by the Supreme Leader Ayatollah Ali Khamenei, born in 1940 in Mashhad into a family of preachers, and just a second-tier cleric. When Khomeini died, he was not even an ayatollah, not to mention an imam: just a hojjatoleslam, a student. He had studied the Koran in Najaf under Khomeini. Today his grip on absolute power is tighter than ever. Iran today is not a theocracy or a democracy: it's a clerical autocracy, where Khamenei is indeed supreme. He will decide under which terms Iran will talk to Obama.

Still, those apologies remain in order. Like the Airbus from Iran Air, flight 655, destroyed by two Standard ER2 missiles shot from the USS Vincennes under the orders of Captain Will Rogers, killing almost 300 civilians in 1988 (that was one of the key reasons that led Khomeini to accept an "ignominious" ceasefire ending the Iran-Iraq war).

If Obama really wants to make the effort to understand Iran he could do no worse than read the great Iranian philosopher Daryush Shayegan, a former professor at the University of Tehran. When Khomeini died, Shayegan identified him and the shah as the two juxtaposed Irans: imperial Iran and the painful Iran of the blood of the martyr, "a juxtaposition that symbolizes an unreal dream: as the 12th century mystical poet Ruzbehan from Shiraz would say, this 'dementia of the inaccessible'."

The good news is that from Obama's point of view, the "inaccessible" can become more than accessible with just a simple "we're sorry".

Will Obama say 'we're sorry'?
By Pepe Escobar

Continued Monetary Disorder assured ~ Nolan

The Fed and other G7 monetary authorities have kept the system alive via massive hits to the balance sheets of their central banks as they absorb collateral.

"As I have highlighted in the past, Total Non-Financial Credit (NFC) expanded $578bn in 1994. By 1998, annual NFC growth exceeded $1.0 TN for the first time. After year 2000’s pullback, by 2002 NFC growth was up to a record $1.412 TN, followed by 2003’s $1.677 TN, 2004’s $1.991 TN, 2005’s $2.322 TN, 2006’s $2.422 TN, and 2007’s $2.523 TN. From my analytical perspective, it has always been a case of the inevitable predicament of an impaired (post-Bubble) Credit system not having the capacity to create sufficient new Credit to stem financial and economic implosion.

To this point, a barrage of unprecedented monetary and fiscal policy responses has restrained the forces of systemic collapse. On a quarterly basis the Federal Reserves Z.1 “Flow of Funds” report will help us better appreciate the profound effects the bursting of the Credit Bubble and resulting policymaking are exerting upon the underlying functioning of the Credit system and real economy.

Total Non-Financial Credit expanded at a surprising 7.2% rate during Q3, up sharply from Q2’s 3.1% pace to the most robust Credit growth since Q4 2007. By sector, Household Debt actually contracted at a 0.8% rate, down from Q2’s 0.6% growth and compared to 2007’s annual increase of 6.8%. Household Mortgage Debt contracted at an unprecedented 2.4% rate. Corporate borrowings slowed to a 3.7% pace from Q2’s 5.6%. This was a marked slowdown from the 13.2% surge in Corporate debt growth for all of 2007. State & Local Governments increased borrowings at a 2.9% pace. This was up from Q2’s 0.8%, but was much slower than 2007’s 9.3%. With private sector Credit growth struggling mightily, public finance really took up the slack. Federal Government debt expanded at a 39.2% pace, playing a decisive role in generating sufficient system-wide Credit expansion.

On a Seasonally-Adjusted and Annualized Rate (SAAR), Total Non-Financial Credit expanded $2.348 TN during the quarter – a quantity of new finance that would be in the analytical ballpark (down only marginally from $2007’s $2.5 TN growth) to restrain the forces of systemic collapse. But of this amount, Federal Government borrowings accounted for SAAR $2.079 TN, or almost 90% of Q3’s Credit expansion.

With even an unsustainable $2.0 TN annual pace of federal borrowings failing to reverse the downward economic spiral, the Federal Reserve this week was compelled to signal in no uncertain terms that policymakers “will employ all available tools to promote the resumption of sustainable economic growth and to preserve price stability.”

In tandem with Treasury efforts, the Federal Reserve expanded “Fed Credit” SAAR $2.353 TN during Q3. This unprecedented ballooning accommodated deleveraging and helped offset a sharp decline in lending through the financial sector. “Fed Funds and Repos” contracted SAAR $969bn during the quarter, while “Open Market Paper” declined SAAR $580bn. Savings Institutions reduced assets at SAAR $1.281 TN, bank Credit at “Foreign Banking Offices in U.S.” contracted at SAAR $415bn, and lending at Finance Companies dropped SAAR $113bn. The Asset-Backed Securities (ABS) market shrank at SAAR $419bn during Q3. After Q2’s SAAR $913bn contraction, Security Brokers and Dealers expanded SAAR $12.6bn.

Yet the Fed was not all by its lonesome expanding system Credit. Total Bank Credit actually expanded at a robust SAAR $1.365 TN - at least somewhat receptive to the “buyer of last resort” roll for Open Market Paper (SAAR $413bn) and Mortgages (SAAR $688bn). On the Liability side, “Net Interbank Liabilities” expanded at an unprecedented SAAR $897bn, of which SAAR $515bn was borrowed from the Fed. Elsewhere, the GSEs expanded assets SAAR $85bn (about 2.5% annualized), and Agency MBS surged SAAR $508bn (11.2% annualized). Notably, Total Bank Assets were up $1.385 TN, or 12.7%, over the past four quarters.

The dollar was clobbered after Wednesday’s bold “employ all available tools” pronouncement from the Federal Reserve. The way I see it, the Fed Board sent a direct message to the markets that it is resolved to do whatever is necessary to ensure sufficient system Credit will be forthcoming – a quantity that for our purposes is in the, say, $2.0 TN annual range. The dilemma for the Fed (and markets) is that while such an enormous amount of Credit would do little more than steady our maladjusted “Bubble Economy,” it would perpetuate the massive flow of dollar finance out to the global financial system. In short, the Fed’s determination to reflate ensures continued Monetary Disorder. And I would further argue that Ongoing Monetary Disorder – and associated corruption to various market pricing mechanisms – will impede system adjustment and extend the lengths of U.S. and global downturns and restructuring periods.

During Q3, Rest of World (ROW) accumulated U.S. financial assets at SAAR $816bn. Over the past year, ROW holdings increased a staggering $1.224 TN to $16.772 TN. And it is this nearly $17 Trillion number that I use in my mind as a rough proxy for what I refer to as the “Global Pool of Speculative Finance” – the source of unwieldy financial flows that continue to wreak bloody havoc on global markets and market pricing mechanisms. Over just the past 12 quarters, ROW holdings ballooned more than 50%.

It is also worth nothing that ROW Treasury holdings expanded SAAR $819bn during the quarter and were up $674bn, or 30%, over the past year to $2.913 TN. Ominously, ROW reduced holdings of U.S. Credit Market Instruments SAAR $547bn during Q3, with Commercial Paper down SAAR $273bn and Bonds down SAAR $291bn. Holdings of Agency Securities declined SAAR $241bn, reducing the one-year increase to $246bn. ROW holdings of “Security Repurchase Agreements” contracted SAAR $368bn during Q3, with a one-year drop of $254bn (22%). We continue to witness the astounding market extremes fostered by ROW risk aversion (zero T-bill yields vs. hopeless illiquidity in many risk markets).

The currency markets are shaping up as a major issue for the coming year. The dollar rallied sharply during the fourth quarter, although much of this gain was recently wiped away in six tumultuous trading sessions. I view the dollar’s recovery in the context of a bear market rally. The dollar bear had become a crowded trade, and many were caught on the wrong side of various markets this year – certainly including the leveraged players in the currency markets.

There is a school of thought out there that the dollar bear has seen its lows. A consensus view seems to be taking shape that, at the minimum, the dollar wins (by default) the near-term battle against most currencies. Part of this analysis is the reasonable proposition that our currency benefits from the capacity of our policymakers to move earlier and more aggressively than their global counterparts. The euro-zone, in particular, is seen hamstrung by the constraints of its strange political and monetary structure.

My analytical framework takes a different approach. Especially after examining the most recent “Flow of Funds” report, I contemplate the dollar’s prospects from a global flow of funds perspective. At this point I will assume that fiscal and monetary policies will succeed in generating $2.0 TN or so of new Credit in 2009 (Trillion dollar growth each in federal borrowings, the Fed’s balance sheet, and commercial bank Credit would push the system much of the way there). In this scenario, the economy would likely still be mired in recession, short-term rates would remain near zero, and our Current Account Deficit would remain in the $600bn to $650bn range. Including other financial outflows, the Rest of World would be called upon to purchase another Trillion or so of our financial claims next year - and for years on end.

I will posit that the 2002-2007 dollar bear market did not manifest into a full-fledged currency crisis simply because of the massive purchases of U.S. securities by the Chinese (and to a lesser extent the OPEC, Russia, and India). At this point, I would not want to count on the Chinese (or others) accumulating another Trillion of our IOUs anytime soon. I don’t expect the return of their appetite for U.S. securitizations, corporate bonds, and “repos” anytime soon. Indeed, these IOUs have lost their acceptability as a means of global payment remuneration. It also seems reasonable that this year’s market dislocations have reduced the appeal of the strategy of holding U.S. securities while hedging underlying currency exposure in the derivatives market. And, at today’s pitiful yields, there is little ongoing incentive to continue hording Treasuries.

It is impossible to know how much remains of the Crowded Dollar Bear Unwind. But if this dollar buying hasn’t yet about run its course, when it eventually does global markets will again face the specter of massive and seemingly unending dollar liquidity flows. At the end of the day, I expect the dollar to suffer from its relative dismal position with respect to both financial flows and our economy’s deep structural maladjustment. Years of egregious Credit and spending excesses have left an economic structure uniquely dependent upon, on the one hand, huge ongoing public sector Credit injunctions and, on the other, huge unending imports. This is a terrible predicament for a currency."

nolan