The Last Ammunitions of the FED

[Adam Smith]

Dear Members,


FED's Last Ammunitions:

Last time I told you that we believed that on the 30 years Treasury Bonds we went below the yield of the Liquidity Trap and believed it was due to undue speculation.

Having examined what happened last week we came to a whole different conclusion;

First on Thursday the FED started to buy Mortgage Backed Securities which lowered risk spreads. On that days the yields on long dated securities should have gone up a a result and we saw that they went down and in a big way.

Second it was the rates on the 30 years Treasury Bond that went down leaving the yield on the 10 years note behind, another strange behaviour.

Third te yield on long dated securities went down in a big way in the afte maket hours. Who would be insane enough to wait after market, when liquidity is smaller, to make big transactions?

Aftere having shot up above 3.600% on Friday the yield of the 30 years Treasury Bond returned to below 3.6%.

Then we unnderstood what was going on: there is a strategy against the Liquidity Trap that has been studied by thhe FED which consists in buying long dated securities: the idea is that by briging down the yields investors would shun treasuries (as their yields are below their lower limit) and would invest in te private sector. (It takes care of the supply but what about the demand?)

The supply of the 10 year note is huge but the supply of the 30 years bond is very small.


So the FED started to buy 30 years bonds and drew their yield below the yield of the Liquidity Trap.


We dont believe it is efficient because people will buy 10 years note and not invest in the corporate sector.

Moreover the fact of providing more money does not make corporate borrower able to borrow at a higher yield: still lenders won't lend at these yields.

It shows oly one thing; te FED is desesperate.



Obama Macro Economics:

President Barak Obama has named Volcker as the head of the tem in charge of fighting the recession (they don't call it a depression yiet) For those who might wonder who he is, he was the FED chairman before Alan Greenspan: he was old when Greenspan was young!

What we know about him is that he is not affraied to take bold steps: he did increase sharply interest rates in order to kill thhe inflatio of the 30's.

He is a monetarist and follow the school of Milton Friedman. The only interesting thing thhat Friedma ever come up with was his helicopter drop of money in order to starve off the Liquidity Trap. Which means bringing money in the hand of the consumers bypassing the financial institutions: if it is well engineered and it reaches to thhe poorest it could work on the short run.

We believe that its effective implementation would go against too many vested interest.


Moreover Barak Obama seems to have skipped Macroeconomy 101 at Harvard: he said that he would go through the whole budget to trim down fat: just the opposite of what you want to do in a deep recession.

Moreover he has shown already how much he is sold to vested interest in his strong defense of the Auto Makers: He prefers, too, to prop up supply rather than take care of the demand.

Obama is just the same medecine with a different name.



Supply and Demand:


The reason we are in this crisis is the collapse of the demand due to an excess income/wealth disparities. By rescuing the banks, the auto makers,... you just take care of the suplly what are the use of auto makers or banks if they don't ave customers?

Even Fiscal stimulus they use is by giving tax credit which does not reduce the income disparities it increases them.

Keynes must be having nightmares in is tomb.

As long as a solutio does not take in account demand, which means lower income disparities in a signnificant way, what Mc Cain called spreading the wealth. Nothing can be done against the depression.



What is the Situation?

Politicl figures grossly underestimate the size of thhe downturn they are talking about things like less than 3% point of yearly contraction of the GDP on the fourth quarter.

We know that on a monthly basis the expenses on durable goods, the engine of credit based economy, have fallen more than 6%.

We believe that the contraction of GDP on the fourth quarted can't be less than 10%.



Althoug there is still a light change that Volcker could implement "Milton Friedman's Helicopter Drop of Money" we Believe that our System is the only sound one.



Yours, Sincerely,

Adam Smith