Derivatives, Banks, and Bailouts
Don Tiberone
DERIVATIVES, BANKS, AND BAILOUTS
Posted On: Thursday, July 17, 2008
Author: Monty Guild & Tony Danaher
We at Guild Investment Management have mentioned the problems with
derivatives 31 times in the five years between 2003 and the present in
our market commentaries, yet people did not listen.
If the U.S. Fed, U.K. central bank, and other central banks continue
to protect all of the institutions, all of the shareholders, and all
the depositors, the crisis will actually be more prolonged and more
difficult to come out of than if they let a lot of the smaller
institutions go broke.
Thus far, it is obvious that the Fed and the U.S. and U.K.
administrations want to make the government the lender of last resort
and make it a world where mistakes are not punished. We go on record
saying that this is a mistake…the example of Japan comes to mind.
The Japanese market peaked in 1990 at about 40,000 on the Nikkei 225
just as their banking crisis began. Japan did not confront their
banking crisis. They kept a lot of ‘zombie’ banks alive and did not
write off the bad loans. The banking system languished and the
Japanese stock market bottomed down over 75% from its highs when it
got to about 9,000 in 2003. Today it is still only at 13,000.
Is that what you would like to see in the U.S. and Europe? If so,
then go ahead and continue with what looks to be the current Federal
Reserve and U.S. Treasury strategy of keeping weak institutions
operating ‘as if’ they were healthy and able to lend.
FANNIE MAE AND FREDDIE MAC…A BIG BAILOUT HAPPENED THIS WEEK AND IT
WILL CREATE GLOBAL INFLATION
As we all know, these two institutions were in effect taken over by
the U.S. Federal Government, which will supply their equity and
guarantee their debt for the time being. The government intervened
because much of the two agencies’ $5 trillion of endangered debt is
held by foreign central banks. This is a bailout and it will create a
lot of liquidity which will be thrown into the system. An end result
of the bailout is that it pumps massive liquidity into the system.
This new liquidity is on top of all the other liquidity, foreign and
domestic, that is piling into the system…thereby further fueling
inflation in commodities, raw materials, foods, energy, transportation
and services, and of course precious metals.
In our opinion, inflation will be the game, not deflation…unless they
are unable to flood the economy and banking system with enough money
to rebuild liquidity. They will continue to try, but if they cannot
do this within three or four years, then we expect deflation can take
hold. In the meantime, we are planning on inflation for the next few
years and higher gold and food prices…and a lower dollar.
For our clients, we have been shifting out of some gold ETF’s and into
some big cap gold stocks, which can perform better if there is a quick
run in the gold price.
WHAT WE KNOW
1) In the United States (as is already the case in most developed
nations), the federal government will control the residential mortgage
business. The U.S. Government will be more conservative than the old
Fannie Mae, Freddie Mac, and the savings banks…and much more
conservative than the investment bank and commercial bank loan re-
packagers. Thus, the residential mortgage business will be the
bailiwick of the national government, and loans will be harder to
get. The result is bad for real estate values in the U.S. The
residential real estate recession will be longer and stronger than
most had thought.
The reduced availability of capital for real estate will cause prices
to continue to fall in the U.S. and in most other countries in the
developed world. Thus, I look for lower real estate prices in two
years. Real estate will not be a big driver of the developed
economies for years to come…(As an aside, real estate values will
continue to rise in the oil exporting states of the Middle East,
China, and probably Brazil, where big investment flows into the
economies will keep prices high and rising.)
2) Fed Chairman Bernanke has agreed to let the dollar fall. Investors
will move to foreign currencies, especially those with strong current
account surpluses or strong export profiles.
3) Global money supply is strong and growing, so inflation
expectations will push non U.S. currencies up and the U.S. dollar
down. Inflation will follow and investors will focus on gold, food
related and energy investments.
4) Financial stocks in the developed world continue to need to correct
bad loans and need to replenish capital. They will be underperformers
while commodity related sectors and commodities will outperform.
SUMMARY-INFLATION IS IN THE FUTURE
Don’t listen to the PR programs on financial TV about the rally in
financial stocks and how great they are going to be. The plain fact
is that if you look at the quality of the assets and debt on their
balance sheets of most financial companies in all countries of the
developed world, they are in trouble. They need equity, and they need
to get the toxic debt off of their balance sheets.
In our opinion, it will be unwise to buy them. They are doing a big
sales pitch on financial TV and in the press because they want to sell
more equity to investors…and they can’t do that until people believe
that things are getting better.
The U.S. dollar is in danger and will fall a lot in coming years. In
our opinion, gold is the safest bet along with food stuffs and foreign
currencies of well managed countries. This is not a recommendation,
but you may want to take a look at the currencies of Australia,
Canada, China and Norway. However, be careful to monitor their
current account surplus or deficit and their short term interest rates
relative to the U.S. In our opinion, changes in short term interest
rates versus the U.S. and changes in current account versus the U.S.
will determine currency fluctuations.
BIOFUELS OUT…NUCLEAR IN
Today, many media reports are circulating that the European Union is
reconsidering its biofuels policy. I am amazed it has taken so long.
Europe is coming to the realization that we have been mentioning for
years. Biofuels are expensive, they force the price of grains up and
they consume a lot of fuel to create. They are a vote-buying exercise
with a few benefits, but many other alternative fuel options contain
more benefits for the average citizen.
How much longer will it take the U.S. to realize the same thing? To
put it another way, how strong is the U.S. farm lobby in congress? An
alternative energy source that both U.S. presidential candidates
endorse is nuclear. We look for biofuel programs like ethanol (which
are popular with farm voters but expensive for all other voters) to be
reduced, and nuclear (which does have some dangers, but also has many
benefits) to be advanced. Many environmentalists who formerly opposed
nuclear energy now realize that their approach may have been unwise
and that nuclear may be more attractive than bio fuels and fossil
fuels.
com...@webtv.net
"Arrest the oil commodity speculators for conspiracy to commit "price
fixing" !