Short Term Eyes on SPX 960

Minyanville Professor Kevin Depew posts bullish percent indicators every day. Today's numbers were the worst I have ever seen. From Kevin:

Here is where we stand with the point and figure bullish percent indicators for equities, based on Investors Intelligence data.

• NYSE Bullish Percent: Os (Negative) 9% - lowest since 1987
• S&P 500 Bullish Percent: Os (Negative) 7.9% - exceeds 2002 and 1998 lows
• Nasdaq Composite Bullish Percent: Os (Negative) 13.4% - lowest since 1987
• Nasdaq-100 Bullish Percent: Os (Negative) 4% - in 2001, this indicator actually reached 0
• Russell 2000 Bullish Percent: Os (Negative) 14.1% - equals January low
• NYSE High-Low Index: Os (Negative) 2.5%
• Nasdaq High-Low: Os (Negative) 2.8%

It is easy to be bearish given the circumstances, but the fact of the matter is these indicators are so washed out and so low that the probabilities increasingly favor a sustainable rally. Given the macro headwinds combined with approaching earnings season, it is doubtful this is THE bottom, but we are nearing, or at, a low. Keep in mind, these are probabilities. The market may simply continue lower. Yesterday's action was not capitulation in the traditional sense.

Based on some additional technical work I have been looking at SP 960 as a downside target with the intention of buying on moves below 1000.

Here is a chart I am looking at from an Elliott Wave Perspective.

$SPX Monthly Chart



click on chart for sharper image

If this is a wave 5 decline, the target for wave 3 would be near 966 (1.618 * Wave 1).

In Elliott Wave terms, crash wave 3 may be nearly finished. Of course that means wave 4 (a correction up) and wave 5 (yet another move lower) are coming up.

Risk reward is no longer on the short side even if longer term fundamental issues to the downside are not finished. This is a good place to be lightening up on shorts, taking profits on PUTs, and heading for the sidelines for further directional clues.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
Click Here To Scroll Thru My Recent Post List

Global Coordinated Rate Cuts Won't Solve Economic Crisis

This morning the Fed, ECB, Bank of England, Bank of Canada, and Sweden's Riksbank all cut rates by 50 basis points. Japan is on the sidelines cheering.

US Futures that were down as much 4% are now in the green. Short term perhaps the market was due for a bounce, perhaps not as the day is young, but longer term one cannot cure a solvency issue with rate cuts.

Let's take a look at some of the Central Bank statements. I have additional thoughts following the Central Bank statements.

Joint Statement

Throughout the current financial crisis, central banks have engaged in continuous close consultation and have cooperated in unprecedented joint actions such as the provision of liquidity to reduce strains in financial markets.

Inflationary pressures have started to moderate in a number of countries, partly reflecting a marked decline in energy and other commodity prices. Inflation expectations are diminishing and remain anchored to price stability. The recent intensification of the financial crisis has augmented the downside risks to growth and thus has diminished further the upside risks to price stability.

Some easing of global monetary conditions is therefore warranted. Accordingly, the Bank of Canada, the Bank of England, the European Central Bank, the Federal Reserve, Sveriges Riksbank, and the Swiss National Bank are today announcing reductions in policy interest rates. The Bank of Japan expresses its strong support of these policy actions.

Fed Statement

The Federal Open Market Committee has decided to lower its target for the federal funds rate 50 basis points to 1-1/2 percent. The Committee took this action in light of evidence pointing to a weakening of economic activity and a reduction in inflationary pressures.

Incoming economic data suggest that the pace of economic activity has slowed markedly in recent months. Moreover, the intensification of financial market turmoil is likely to exert additional restraint on spending, partly by further reducing the ability of households and businesses to obtain credit. Inflation has been high, but the Committee believes that the decline in energy and other commodity prices and the weaker prospects for economic activity have reduced the upside risks to inflation.

The Committee will monitor economic and financial developments carefully and will act as needed to promote sustainable economic growth and price stability.

Bank of Canada Statement

The intensification of the global financial crisis is having a marked impact on all countries. In recent weeks conditions in global financial markets have deteriorated sharply, the U.S. economy has weakened further, and commodity prices have fallen abruptly.

As a result of these developments, credit conditions in Canada have tightened significantly, despite the relative health of our financial institutions. Weaker growth in the United States and other important trading partners will increase the drag on the Canadian economy coming from net exports. The deterioration of our terms of trade will act to moderate the growth of domestic demand. While the recent depreciation of the Canadian dollar will help cushion the effects of the weaker global outlook on the domestic economy, it will not completely offset them.

Below-potential growth in aggregate demand through 2009, combined with a lower profile for commodity prices, will significantly ease inflation pressures in Canada. Inflation expectations remain well anchored.

In view of these developments, the Bank of Canada decided to join other major central banks and lower its target for the overnight rate by 50 basis points today. This action will provide timely and significant support to the Canadian economy. The Bank will continue to monitor carefully economic and financial developments, along with the evolution of risks, in judging whether any further action might be required to achieve its 2 per cent inflation target over the medium term.

Bank of England Statement

In the United Kingdom, CPI inflation rose to 4.7% in August, reflecting increases in food and energy prices. Inflation is likely to rise further to above 5% in the next month or two, in large part as the full effects of already announced increases in the price of domestic energy are felt. But inflation should then drop back, as the contribution from retail energy prices wanes and the margin of spare capacity in the economy increases. Pay growth has so far remained subdued and commodity price pressures have eased, with oil prices down substantially from their mid-summer peak.

Conditions in international credit and money markets have deteriorated very markedly. Many markets are closed. In the United Kingdom, the supply of credit to households and businesses is clearly tightening further as banks seek to adjust their balance sheets. The Committee noted that cuts in official interest rates could not be expected to resolve the current problems in financial markets and that a significant increase in the capital of the banking sector would be required. The Committee therefore welcomed this morning’s announcement of a Government programme to recapitalise the major UK banks.

Data released over the past month indicate that the outlook for economic activity in the United Kingdom has deteriorated substantially, reflecting a sharp monetary contraction. Output growth slowed to a halt in the second quarter, business surveys point to further weakening during the second half of this year, and the labour market has softened. Consumer spending growth has slowed, in part as a result of the squeeze on real incomes, while business and dwellings investment have declined. Equity prices have fallen, and the further tightening in credit conditions will also weigh on domestic demand growth. The depreciation in sterling over the past year should support net exports, but the prospects for demand growth in the UK’s main export markets have worsened. The weakness in output growth at home will open up a growing margin of spare capacity that will over time bear down on inflation.

The Committee remains focussed on setting Bank Rate in order to meet the 2% inflation target. In doing so it continues to balance two risks. On the downside, there is a risk that a sharp slowdown in the economy, associated with weak real income growth and the tightening in the supply of credit, pulls inflation materially below the target. On the upside, there is a risk that above-target inflation this year and next raises inflation expectations so that inflation persists above the target for a sustained period. During the past month, the balance of those risks to inflation in the medium term has shifted decisively to the downside. In the light of that outlook, the Committee judged at its October meeting that an immediate reduction in Bank Rate of 0.5 percentage points to 4.5% was necessary to meet the 2% target for CPI inflation in the medium term.

Swiss National Bank Statement

The Swiss National Bank (SNB) has decided to ease conditions in the money market by 50 basis points in a bid to bring down the Swiss franc three-month Libor from its most recent level of 3% to 2.5%. To this end, the SNB is lowering the target range to 2–3%.

The global financial crisis has intensified and is having a considerable impact on the international economy. The slowdown in economic activity in the US and Europe is more severe than what the SNB had forecast at its last monetary policy assessment of 18 September 2008.

The Swiss economy is also affected by these developments. Economic growth for 2009 will be weaker than expected at the last assessment. In view of the improved inflation outlook, as a result of the economic downturn and the low oil prices, the SNB is now able to loosen its monetary policy reins.

The Swiss National Bank will continue to provide the Swiss franc money market with liquidity in a generous and flexible manner. It will keep a close watch on developments in the financial markets, so as to assess their impact on economic activity and the inflation outlook and be able to react swiftly, if necessary.

Sweeden's Riksbank Statement

The Executive Board of the Riksbank has today decided to cut the repo rate by 0.50 percentage points to 4.25 per cent. The global financial crisis threatens to reinforce the current slowdown in economic growth with diminished inflationary pressures as a result. Several central banks are today announcing reductions in policy rates in a coordinated action to dampen the consequences of the ongoing financial crisis.

Weaker economic growth in Sweden

The Executive Board of the Riksbank makes the assessment that economic growth in Sweden is slowing down and that inflationary pressures are diminishing as an effect of the financial crisis. This has led to higher interest rates for companies and households, lower capital wealth and increased uncertainty. The Riksbank’s forecast for both inflation and GDP will therefore be revised down.

The labour market is also showing clearer signs of weakening. The downturn in economic activity and lower oil and other commodity prices indicate that inflationary pressures will be lower in the future.

Although developments in Sweden to some extent differ from those in other countries, a cut in the repo rate is warranted here. The fact that the cut is a joint action together with other central banks increases confidence and the likelihood that it will have positive effects. Closer analyses and forecasts of developments in Sweden will be presented after the Executive Board’s next monetary policy meeting, which will take place on 22 October.

ECB Statement

The Governing Council of the ECB, by means of teleconferencing, has taken the following monetary policy decisions:

The minimum bid rate on the main refinancing operations of the Eurosystem will be reduced by 50 basis points to 3.75 %, with effect from the main refinancing operation to be settled on 15 October 2008.

The interest rate on the marginal lending facility will be reduced by 50 basis points to 4.75 %, with immediate effect.

The interest rate on the deposit facility will be reduced by 50 basis points to 2.75 %, with immediate effect.

In the euro area, upside inflationary risks have recently decreased further. It remains imperative to avoid broad-based second-round effects in price and wage-setting. Keeping inflation expectations firmly anchored in line with our objective and securing price stability in the medium term will support sustainable growth and employment and contribute to financial stability.

Bank of Japan Statement

The Bank of Japan welcomes the policy decisions made by six central banks and
hopes that these actions will contribute to securing the stability of both the
financial systems and economies of these countries.

In Japan, policy interest rates are very low and the monetary conditions remain
accommodative. On top of that, the Bank has engaged itself in decisive actions
of liquidity supply, ranging from the uninterrupted provision of ample yen liquidity
in the market to the introduction of US dollar liquidity operations. Against this
background, Japan’s financial market has been stable in comparison with those in
other industrialized countries.

It is of utmost importance for every central bank to maintain stability of financial
markets amidst the ongoing financial turmoil. The Bank of Japan will continue to
do its best to secure the stability of financial markets through money market
operations while staying in close cooperation with other central banks. From this
perspective, Governor of the Bank of Japan has instructed its staff to swiftly
examine possible ways to further enhance the effectiveness of monetary
operations, including those pertaining to BOJ reserve system.

Global Recession Headed Our Way

The world is heading for a global recession and a sure bet is that it will be blamed on a subprime crisis in the US. The reality is the greatest liquidity experiment in history is now crashing to earth.

The root cause of this crisis is fractional reserve lending, and micromanagement of interest rates by the Fed in particular and Central Banks in general. The Fed started the party by slashing interest rates to 1%, but Central Banks everywhere drank the same punch to varying degrees.

The Greenspan Fed lowering interest rates to 1% fueled the initial boom, but like an addict on heroin, the same dose a second time will not have the same effect. The Fed, the ECB, etc. could have slashed rates to 0% today and it would not have mattered one bit.

The reason is simple: There is no reason for banks to go on a lending spree with consumers tossing in the towel, unemployment rising, and rampant overcapacity everywhere one looks with the exception of the energy sector.

Consumers are tapped out, not just in the US, but in nearly every country on the planet. We had our party, and a fine party it was. However, the party is over and the bill is now past due. The price is a global recession. That price must be paid no matter what Central Banks do.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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UK Acts To Prevent Collapse Of Banking System

Bloomberg is reporting U.K. to Inject About $87 Billion in Country's Banks.

Prime Minister Gordon Brown's government will invest about 50 billion pounds ($87 billion) in an unprecedented step to prevent a collapse of the U.K. banking system.

As part of the plan, the government will buy preference shares, and the Bank of England will make at least 200 billion pounds available for banks to borrow under the so-called special liquidity plan, the Treasury said in a statement today. The government will also provide a guarantee of about 250 billion pounds to help refinance debt.

The steps to partially nationalize the banking industry provide "the necessary building blocks to allow banks to return to their basic function of providing cash and investment for families and businesses," Chancellor of the Exchequer Alistair Darling said in a statement.

The worsening credit crisis has forced the U.K to join the U.S., Ireland, Iceland, Belgium and Spain in rushing out untested bailout measures to save their largest banks.

The government said it will make 25 billion pounds immediately available in the form of preference shares and stands ready to provide an additional 25 billion pounds. The amount available to each bank will vary and will depend on their dividend payouts, executive pay policies and will require the banks to lend to small businesses and home owners, the government said.

Besides RBS and HBOS, Abbey, Barclays Plc, HSBC Holdings Plc, Lloyds TSB Group Plc, Nationwide Building Society and Standard Chartered Plc are eligible under the U.K. plan.

Text of British Bailout Plan

Here is the complete Text of British support plan for banks. Following are some highlights:

In these extraordinary market conditions, the Bank of England will take all actions necessary to ensure that the banking system has access to sufficient liquidity.

At least GBP200 billion will be made available to banks under the Special Liquidity Scheme. Until markets stabilise, the Bank will continue to conduct auctions to lend sterling for three months, and also US dollars for one week, against extended collateral.

The following major UK banks and the largest building society have confirmed their participation in a Government-supported recapitalisation scheme:

Abbey (STD), Barclays (BCS)(UK:BARC), HBOS (UK:HBOS), HSBC Bank plc (HBC) (UK:HSBA), Lloyds TSB (LYG) (UK:LLOY), Nationwide Building Society, Royal Bank of Scotland (RBS) (UK:RBS), Standard Chartered (UK:STAN).

These institutions have committed to the Government that they will increase their total Tier 1 capital by GBP25bn. This is an aggregate increase and individual increases will vary from institution to institution.

If the Government is to provide the capital, the issue will carry terms and conditions that appropriately reflect the financial commitment being made by the taxpayer.

In reaching agreement on capital investment the Government will need to take into account dividend policies and executive compensation practices and will require a full commitment to support lending to small businesses and home buyers.

UK Taxpayer Stake

It is difficult to project how UK taxpayers will fare under the above scheme. However, the plan itself seems to do a better job of protecting UK taxpayers than the Paulson ripoff plan does for US taxpayers.

Europe Indices Plunge

Europe is following Asia sharply lower as the following table shows.



click on chart for sharper image

Chart courtesy of Yahoo Finance.

See Global Equities Rout Continues As Toyota Drags Nikkei Lower for additional details on the bloodbath in Asia.

US Futures Plunge

Prior to the announcement, S&P futures were down about 22 points. On news of the UK bailout plan, the S&P futures rallied to -6. The market has since had second thoughts. At 3:24 AM central, futures were -40 points (about 4%). Gold is +23 and crude is down $3 near $87.

Look for the Fed, the Bank of England, and the ECB to announce rate cuts. Options expiration is next Friday. Action between now and October 17th is quite likely.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
Click Here To Scroll Thru My Recent Post List

Yen Rallies as Carry Trade Continues to Unwind

Bloomberg is reporting Yen Rises Toward Six-Month High on Global Recession Concerns.

The yen rose toward a six-month high against the dollar after the International Monetary Fund said the world economy is headed for a recession next year, with expansion in the U.S. forecast to grind to a halt.

The yen also traded near its strongest in three years versus the euro on speculation a global stocks sell-off will prompt investors to reduce holdings of higher-yielding assets financed in Japan, known as carry trades.

"Lingering fears about the health of financial sectors in the U.S. and Europe and concerns over a global recession should continue to underpin the yen," said Danica Hampton, currency strategist at Bank of New Zealand Ltd. in Wellington.

The stocks rout helped deter carry trades, in which investors get funds in nations such as Japan that have low borrowing costs and buy assets where returns are higher. Benchmark rates are 0.5 percent in Japan, 4.25 percent in Europe, 5 percent in the U.K., 6 percent in Australia and 7.5 percent in New Zealand. The risk of a carry trade is that currency moves wipe out profits.

The yen also was supported as implied volatility on one- month dollar-yen options rose to 23.13 percent from 21.79 percent yesterday, when it reached 23.92 percent, the highest since January 1999. Higher volatility may discourage carry trades as it indicates a larger risk of price fluctuations.

Japan Corporate Bankruptcies At 8 Year High

In the wake of slowing export demand, Japan Bankruptcies Climb at Fastest Pace in 8 Years.

Japan's corporate bankruptcies jumped 34 percent last month, the fastest pace in eight years, as demand for exports slumped and credit-market turmoil engulfed the world's second-largest economy.

Japan's Nikkei 225 Stock Average tumbled 8.7 percent, its biggest rout since October 1987, on concern the global credit crisis will prolong the economy's stagnation.

The yen surged beyond 100 per dollar for the first time in six months after a plunge in Asian stocks prompted investors to reduce holdings of higher-yielding assets funded in Japan.

Yen vs. Dollar Monthly Chart



click on chart for sharper image

The Yen hit 103.33 in March in a breakout attempt that failed. Another rally attempt is underway now. I think it succeeds this time. If so there is blue sky ahead with no overhead technical resistance. The first hurdle is to clear is the March high.

Dollar Shortage In Korea

In other currency news Korea Won Drops to Lowest Since 1998 as Dollar Shortage Deepens

South Korea's won slumped to a decade-low as a seizure in global credit markets forced banks and companies to tap currency exchanges to meet their dollar financing requirements.

The won fell as much as 3.3 percent today to a level last seen during the Asian financial crisis, when the nation had to take out a $57 billion emergency loan from the International Monetary Fund to meet overseas debt payments. Deputy Finance Minister Shin Je Yoon said yesterday the government will check for "speculative forces" in the market and use its foreign-exchange reserves to defend the currency.

"The overall tone in the market is bleak with traders extremely cautious about taking won positions in spite of repeated assurances from the government," said Kim Sung Soon, a currency dealer with Industrial Bank of Korea in Seoul. "There's persistent real demand for dollars from companies."

Persistent Real Demand For Dollars

It seems like just a few short weeks ago everyone was complaining we were flooding Asia with dollars. Now, South Korea has to tap currency reserves to meet the demand.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
Click Here To Scroll Thru My Recent Post List

Global Equities Rout Continues As Toyota Drags Nikkei Lower

Reuters is reporting Nikkei falls 7.3 pct on economy fears, Toyota report.

The Nikkei average fell 7.3 percent to a 5-year low on Wednesday as fears about a global recession intensified with Toyota Motor Corp diving on reports it may miss its profit estimates, while a firmer yen added to the pain.

The Indonesia Stock Exchange halted trading on Wednesday after the benchmark composite index .JKSE dropped by more than 10 percent, while Hong Kong's main stock market index .HSI dropped more than 5 percent.

Toyota tumbled 10.5 percent to 3,320 yen after the Nikkei business daily said it is likely to post a 40 percent slide in annual profit, missing its current estimate on weak sales in North America and slower growth in China.

Analysts said that even at lower valuations, investors would still shun the market as more companies are expected to cut their earnings forecasts.

The projected price-earnings ratio of the Nikkei stock average tumbled to a 37-year low at 12.5 times on Tuesday, according to the Nikkei business daily.

Among exporters, Advantest Corp, the world's No.1 maker of chip testers, tumbled 11.3 percent to 1,603 yen, while Honda Motor Corp sank 8.6 percent to 2,350 yen.

Shares of Nippon Steel lost 11.3 percent to 283 yen, while shipping firm Mitsui OSK Lines shed 13.7 percent to 615 yen.

Another Asia Bloodbath



click on chart for sharper image

Chart courtesy of Yahoo Finance.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
Click Here To Scroll Thru My Recent Post List

Nightmare Day For Banks

The Times Online is reporting 300,000 frozen accounts at Icesave bank.

The Financial Services Authority this afternoon drafted in Ernst & Young (E&Y) as emergency administrators of Landsbanki’s UK operations in a bid to protect retail depositors and British financial stability.

However, a spokeswoman for E&Y said the move will not protect the deposits of the 300,000 customers of Icesave, the internet savings bank that is owned by Landsbanki, who found their accounts frozen this morning after Iceland’s financial regulator took control of the country's second largest bank.

A notice on Icesave's website said: “We are not currently processing any deposits or any withdrawal requests through our Icesave internet accounts. We apologise for any inconvenience this may cause our customers. We hope to provide you with more information shortly.”

The Icelandic central bank said that Russia had agreed to provide Iceland with a €4 billion (£3.1 billion) loan to strengthen foreign reserves and support the Icelandic crown, which fell by 35 per cent on Monday.

The Icelandic crown continued to be volatile in today's trading, forcing the central bank to introduce a currency peg at a value of 131 per euro. It was last trading at 144 per euro.

Bank Shares Collapse



Click Here To Play Video

First Quote Of The Day:
Banking Finance Editor Patrick Hosking "No one trusts the banks anymore, it has to come from politicians."

That's one hell of a choice.

Brown Holds Emergency Meetings With Finance Chiefs

Prime Minister Gordon Brown and Chancellor Alistair Darling call an emergency meeting with finance chiefs after nightmare day for banks.

Gordon Brown and Alistair Darling were tonight meeting with finance chiefs to discuss the recapitalisation of the UK banking system after a turbulent day on the markets which also saw British savers hit by the collapse of the Icelandic bank Icesave.

The Prime Minister and Chancellor will meet the Mervyn King, Governor of the Bank of England and Lord Turner of Ecchinswell, Chairman of the Financial Services Authority at 5pm.

No 10 denied that it was “an emergency meeting” and had been in the diary for sometime. But officials had to admit they had not given notice of the meeting at an earlier briefing today.

This suggests that Mr Brown and Mr Darling have been convinced that they must show the market that they are at least close to an announcement in order to restore some calm.

On another rollercoaster day for the markets, banking shares were badly hit as a report leaked out from top-secret talks between the banks and the Treasury in Downing Street last night.

HBOS shares were down 41.5 per cent at 94p, Royal Bank of Scotland was below £1 at 90p, 39 per cent, down, while Lloyds TSB fell 12.9 per cent, or 33.5p, to 225p. Barclays was 9 per cent down at 285p. HSBC was the only big bank to rise by 19p, or 2 per cent, to 901.25p.

The Government is furious with the banks for apparently divulging details of their meeting with the Chancellor at which they asked him to speed up the injection of taxpayers money into their coffers.

In Europe, the 27 member states today agreed to more than double the minimum level of bank deposit protection in Europe to €50,000, and the US Federal Reserve announced that it would start making loans directly to businesses to help them with short-term funding difficulties.

Meanwhile, Icesave's 300,000 British now face a struggle to extract their cash, after withdrawals were blocked this morning when, Landsbanki, the Icelandic parent bank, went bust and was nationalised.

Iceland has been battling to stave off national bankruptcy after its banks took on massive debts in expanding overseas, far exceeding the country's gross domestic product.

British Taxpayer On Hook For £50bn Bailout

In the US the word "recovery" replaced the word bailout. The UK is calling their bailout an "investment". Whatever you want to call it, British taxpayers are on the hook for a £50 billion.

Taxpayers will be committed today to providing more than £50 billion to bail out high street banks in an attempt to avert a cataclysmic failure of confidence.

Alistair Darling was due to tell the City in an early morning announcement today that the sum will be available for “investment” in banks that have demanded help from the Government. The drastic rescue move is designed to help to reassure savers and to kickstart the paralysed credit markets by encouraging banks to lend to each other again.

After meeting Mervyn King, the Governor of the Bank of England, Downing Street was forced to make the announcement earlier than it had intended because of fears that a second day of hammering for bank shares had made leading institutions vulnerable. HBOS shares slumped by 42 per cent yesterday, Royal Bank of Scotland was down 39 per cent and Lloyds TSB dived 13 per cent in another torrid day for the banks.

The taxpayer will take a stake in banks that seek assistance through the purchase of preference shares, which the Chancellor will say could mean ordinary people making a profit once the crisis is over.

Holders of preference shares are the first in line for the payout of dividends but they do not carry voting rights. The bailout is expected to be structured so that the Government also receives rights to ordinary bank shares at low prices, holding out the prospect of profits if and when banks recover. Mr Darling will also announce extra help from the Bank of England to ensure that the banks have enough cash to run their day-to-day activities.

The collapse of the online bank Icesave, leaving 300,000 British depositors with no certainty that they will get their £4.5 billion of savings back, added to the urgency for a scheme to restore confidence. The part-nationalisation of the banks — “recapitalisation” will be the term used by Mr Darling, while Gordon Brown will refer to a “stability and restructuring plan” — comes amid fresh evidence that the economy is deteriorating quickly because of the drying-up of credit.

The British Chambers of Commerce said that Britain was now in recession and faced 350,000 job losses in the next year. Confidence had collapsed in the manufacturing and services sectors, it said, and it joined the CBI and other employer groups in calling for an immediate interest rate cut.

George Osborne, the Shadow Chancellor, reiterated that the Tories would work with the Government, although he added: “We must make sure that any support from the taxpayer is used to help save small businesses from closure and enable families to stay afloat, not to pay the bonuses of bankers. We should be rescuing the banks to rescue the economy, not to rescue the bankers.”

Terms Used So Far

• Bailout
• Part-Nationalisation
• Investment
• Recapitalisation
• Recue Plan

We’re All Brazilians Now

Krugman has an interesting chart on GDP in It’s a small world after all. Let's take a look.


One point I think is really important in understanding the crisis is that there has been a huge increase in financial globalization just in the last few years — basically since 1995. The chart above shows rest-of-world assets in the United States (red) and US assets abroad (blue) as a percentage of non-US GDP; while we talk a lot about the US as a debtor nation, what’s really striking is the surge on both sides of the balance sheet. This has made the global financial system a lot more tightly linked, so that big economies are now experiencing the kind of contagion previously associated with emerging markets caught up in the 1997-1998 crisis. We’re all Brazilians now.

Second Quote Of The Day:
"We’re All Brazilians Now "

In the UK, taxpayers are likely to get some consideration. In the US, Paulson will give every penny to Wall Street. In Both the US and UK these actions are just the initial salvo. More bailout schemes are sure to come.

In the meantime, look for the Bank of England and the Fed to cut interest rates by at least 50 basis points each. The ECB will follow, probably sooner than anyone thinks.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
Click Here To Scroll Thru My Recent Post List

US consumer borrowing falls for the first time since January 1998

The US consumer has tossed in the towel on spending as borrowing falls for the first time since January 1998.

Consumer borrowing fell in August for the first time in more than a decade as U.S. households, battered by rising job layoffs and the decaying economy, cut back sharply on their use of credit.

The Federal Reserve said Tuesday that consumer borrowing fell at an annual rate of 3.7 percent in August, before the financial crisis became acute in September, forcing the government to approve a $700 billion rescue of the financial industry.

August's decline in consumer credit marked the first time that total borrowing had fallen since a 4.3 percent rate of decline in January 1998.

The weakness reflected a big decline of 5.4 percent at an annual rate in the category that includes auto loans and a 0.8 percent rate of decline in the category that includes credit cards.

Economists are worried that consumer spending, which accounts for two-thirds of total economic activity, will decline in the July-September quarter. That has not happened since 1991 and could set the stage for the economy to slip into a recession.

Worrying about this economy slipping into recession is like worrying that your pet goldfish is going to die when it is floating dead on top of the tank.

Economists should to be thankful that consumer spending is dropping. Unemployment is soaring, people have been living beyond their means, and if consumers keep spending recklessly, eventual defaults and bankruptcies will be that much higher.

From the point of view of retailers, this Christmas season may well be one of the worst for decades. From the point of view of an economic recovery, reduced spending is actually a good thing, not a bad one. It's long overdue for the "gotta have it now" generation to show a little fiscal restraint given the pool of savings sorely needs to be replenished.

The US needs to become a nation of savers once again, and that is just what is going to happen, whether Bernanke or anyone else likes it or not.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
Click Here To Scroll Thru My Recent Post List

Real Price Of Gold Soars

Gold in "Real" terms is soaring. "Real" in this case means how much an ounce of gold will buy. Let's compare gold to a commodities, to silver and to the stock market, starting with a basket of commodities as measured by $CRB commodities index. Charts are as of 2008-10-06.

Click on any chart in this set to see a sharper image.

$CRB Monthly



The world economy is rapidly slowing. There is a recession in the US, UK, Australia, Japan, Spain, Ireland, New Zealand, France, and there is manufacturing contraction in China. With that backdrop, one should expect the price of commodities to drop. And drop they have as shown by the above chart.

For the time being, forget about China. There is simply no way growth in China can make up for falling demand virtually everywhere else in the world. U.S. and the Western World is the dog, China remains the tail. That may change in the future, but it is important to concentrate on the present.

I expect the global slowdown to be far bigger than most expect, potentially wiping out all commodity price gains back to the beginning of 2004 if not further. A drop in the $CRB to the 200 EMA would do just that.

Now let's see how gold is holding up vs. commodities.

Gold vs. $CRB Monthly



Gold buys a bigger basket of commodities now than any other point on the chart.

Silver Monthly Chart



Fundamentally, silver is more of an industrial commodity than it is a currency. It is not holding up as well as gold in recent selloffs. There is a very real possibility that silver falls back to the 2004 high around $8. Those who pay attention to moving averages will note that $8 happens to be the 200 EMA as well.

In contrast, gold has almost no industrial use worth mentioning. The demand for gold is the same as it has been throughout history, as money. With that in mind, let's compare gold to silver.

Gold vs. Silver Monthly



One of the ongoing debates was how well silver would hold up in deflation relative to gold. I think we now have our answer, and it does not look pretty.

S&P 500 Index Monthly



In the wake of the dot-com bubble, banks were in bad shape because they made poor lending decisions to busted companies and also to countries like Argentina. To reflate banks, Greenspan slashed rates to 1% fueling a global liquidity boom that lasted 5 years.

The housing boom ended in 2005, but the party in commercial real estate, commodities, and various carry trades continued on for two full years when the pool of greater fools finally ran out. Since August of 2007 the world has been in a massive deleveraging mode.

The S&P 500 made a marginal new top in 2007, but the reality is the secular bear market that started in 2000 is still ongoing. In real terms, (either compared to gold or the CPI) the S&P 500 came nowhere close to making a new high.

Gold vs. S&P 500 Index



Congress passed a $700 billion bailout package but it was a total and complete waste of $700 billion. Actually, it is worse than that as it further depletes the pool of real funding, slowing a possible recovery some point in the future. Yes, the Fed has started a monetary printing campaign. And yes, the SEC will suspend mark to market accounting allowing banks to pretend their book are in order.

But pretending is not reality. I can pretend all I want that Madame Merriweather's Mud Hut is worth $1 billion and I can pretend my pet rock is worth the same. The reality (sorry Madame), is that neither is worth the book value I place on them.

Suspension of the mark to market rules will accomplish nothing but further mistrust of banks and bank stocks. Everyone will know they are lying. No one will know by how much. What we do know is that Citigroup alone holds $1 trillion in off balance sheet SIVs.

Pretending those SIVs are worth $1 trillion will not make it so. Yes, $700 billion is a lot of money. But let's see just how fast it comes and let's see if all of it comes.

But unless it can offset the countless $trillions in total bank assets that are not marked to market, we are realistically still going to see credit contraction (on a marked to market basis, and that is what counts).

Attempts To Spur Lending Are Failing

Bernanke and Paulson think that the Fed buying toxic garbage will spur institutions to start lending. It won't. Banks will know they are holding garbage, and the market can smell that garbage even if the rules allow banks to pretend that garbage is a rose.

For more on the Fed's efforts to spur lending please see Pushing on a String In Academic Wonderland and Thoughts On The Commercial Paper Funding Facility.

Greenspan did not defeat deflation in 2003 as is widely believed. Instead, he fueled the biggest credit boom in history, sowing seeds of the biggest deflationary bust since the great depression.

Deflation Back In The News

It took a while but the "D-Word" is back in the news after a long hiatus. Bloomberg is reporting Deflation Threat Returns as Asset Markets Decline

As Federal Reserve Chairman Ben S. Bernanke and his global colleagues fight the worst financial crisis since the 1930s, one danger is looming larger by the day: deflation.

The deflation scenario might go like this: Banks worldwide, stung by $588 billion in writedowns related to toxic assets -- especially mortgage-related securities -- will further reduce the flow of credit, strangling growth. That will push house prices lower, forcing additional losses and making banks even more reluctant to lend. As the credit crisis worsens, businesses will find it almost impossible to raise prices.

Prices are already falling in parts of the world economy. Home values dropped more than 10 percent in the U.K. and in the U.S. in the past year. Oil, copper and corn drove commodities toward their biggest weekly decline since at least 1956 on Oct. 3, with the Reuters/Jefferies CRB Index of 19 raw materials tumbling 10.4 percent. The Baltic Dry Index, a measure of commodity shipping costs, has dropped 75 percent since May.

Prices manufacturers paid for materials last month plunged the most since at least 1948, with the Institute for Supply Management's index dropping 23.5 points to 53.5 points.

Deflation may be back in the news, but the context is still incorrect. Falling prices are only a symptom of deflation, and not even a mandatory one. Deflation properly defined is a net reduction in money supply and credit, so let's take a look at at base money supply, courtesy of the St. Louis Fed.

Adjusted Monetary Base



The above charts shows the Fed went on a recent printing spree. However, that printing spree is dwarfed by the decline in the value of credit marked to market on the books of banks and brokerages. Unfortunately I cannot prove a decline in marked to market credit because the SEC has suspended mark to market rules.

However, one can judge by actions, and the Fed in particular, and global central banks in general are in easily verifiable panic mode over the ongoing credit crunch.

Nearly Everything Consistent With Deflation

Commodities are sinking, the dollar is strengthening, the stock market is getting crucified, treasuries are rallying, jobs have contracted for 9 straight months with no end in sight, banks do not trust each other, consumer spending is declining, foreclosures are soaring, the TED Spread (3 month Treasury vs. 3 month LIBOR) is at an all time high, and the Fed Funds Rate fell at the fastest rate in history.

That list does not prove deflation, but it is consistent with what one would expect in deflation.

Given that gold is money, and money should do well in deflation, one would expect the purchasing power of gold to rise. The above charts show exactly that. Gold, especially in real terms is soaring.

So why have the miners gotten pounded? Hindsight may be 20-20 (or not) but here are a few possible explanations.

Mining stocks are leveraged compared to gold and a massive unwinding of that leverage is taking place, especially by hedge funds. There are now ongoing funding questions for some of the miners and explorers. There has been indiscriminate selling of virtually everything.

For more on how treasuries and gold should act in deflation, please see Treasuries and Gold Rise as Global Credit Freeze Prompts More Bailouts.

Those believing in stagflation, hyperinflation, or some sort of 70's rerun can now kiss those theories goodbye. Deflation is here and now, the only question now is how long it lasts.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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Thoughts On The Commercial Paper Funding Facility

Boldly going where no Fed has gone before, the Fed has announced the creation of the Commercial Paper Funding Facility (CPFF).

The CPFF will provide a liquidity backstop to U.S. issuers of commercial paper through a special purpose vehicle (SPV) that will purchase three-month unsecured and asset-backed commercial paper directly from eligible issuers. The Federal Reserve will provide financing to the SPV under the CPFF and will be secured by all of the assets of the SPV and, in the case of commercial paper that is not asset-backed commercial paper, by the retention of up-front fees paid by the issuers or by other forms of security acceptable to the Federal Reserve in consultation with market participants. The Treasury believes this facility is necessary to prevent substantial disruptions to the financial markets and the economy and will make a special deposit at the Federal Reserve Bank of New York in support of this facility.

The commercial paper market has been under considerable strain in recent weeks as money market mutual funds and other investors, themselves often facing liquidity pressures, have become increasingly reluctant to purchase commercial paper, especially at longer-dated maturities. As a result, the volume of outstanding commercial paper has shrunk, interest rates on longer-term commercial paper have increased significantly, and an increasingly high percentage of outstanding paper must now be refinanced each day. A large share of outstanding commercial paper is issued or sponsored by financial intermediaries, and their difficulties placing commercial paper have made it more difficult for those intermediaries to play their vital role in meeting the credit needs of businesses and households.

By eliminating much of the risk that eligible issuers will not be able to repay investors by rolling over their maturing commercial paper obligations, this facility should encourage investors to once again engage in term lending in the commercial paper market. Added investor demand should lower commercial paper rates from their current elevated levels and foster issuance of longer-term commercial paper. An improved commercial paper market will enhance the ability of financial intermediaries to accommodate the credit needs of businesses and households.

Commercial Paper Funding Facility (CPFF) Terms and Conditions

Academic Wonderland Expands Again

Already, there is a need to expand the final paragraph in my article earlier this morning called Pushing on a String In Academic Wonderland. Here is the revised text.

The credit markets are choking on credit, yet Bernanke is attempting to force more credit down everyone's throats. Logic dictates the solution cannot be the same as the problem.

Trapped in academic wonderland, such simple logic is far too complex for Bernanke to understand. Sadly, we are all forced to watch Bernanke flop about like a fish out of water attempting to solve a solvency problem with liquidity schemes like the TAF, PDCF, TSLF, TARP, ABCPMMMFLF, and now the CPFF.

Bernanke is pushing on a string. None of these measures can accomplish much other than to delay the inevitable and slow the recovery. I suppose it is possible Bernanke understands this (although I doubt it) and is simply scrambling for time, hoping to prevent a global crash now.

If Bernanke's mission is to buy time, the very best he can hope for is a long prolonged "L" shaped recession similar to what Japan went through in the so called "lost decade". Regardless of what the mission is, the Fed is not in control of the global meltdown, and the continued launching of new facilities, none of which has worked, proves it.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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Pushing on a String In Academic Wonderland

Bloomberg is reporting Fed Boosts Cash Auctions to $900 Billion, May Do More.

The Federal Reserve will double its auctions of cash to banks to as much as $900 billion and is considering further steps to unfreeze short-term lending markets as the credit crunch deepens.

``The Federal Reserve stands ready to take additional measures as necessary to foster liquid money-market conditions,'' the central bank said in a statement released in Washington today. Fed and Treasury officials are ``consulting with market participants on ways to provide additional support for term unsecured funding markets,'' the statement said.

As part of today's steps, the Fed will increase its auctions under the 28-day and 84-day Term Auction Facility operations to $150 billion each. The two forward TAF auctions in November will be increased to $150 billion each, the Fed said.

Assets on the Fed's balance sheet expanded $285 billion last week to $1.498 trillion, the biggest one-week increase ever, according to JPMorgan Chase & Co.

In addition to the cash banks must hold at the Fed, lenders also sometimes place excess reserves. The central bank said today it will pay interest on those funds at the lowest targeted federal funds rate for each period less 75 basis points. That will put a floor under the actual fed funds rate each day and let the Fed `expand its balance sheet as necessary to provide the liquidity necessary to support financial stability.''

Banks Hoard Cash

Bernanke must be at wits end because in spite of his efforts Money-Market Rates Climb as Banks Hoard Cash.

The London interbank offered rate, or Libor, that banks charge each other for overnight dollar loans rose 37 basis points to 2.37 percent today, the British Bankers' Association said. The three-month rate stayed near the highest level since January. Asian rates increased and the Libor-OIS spread, a gauge of cash scarcity among banks, held near a record.

Interbank rates have jumped as banks store cash to meet anticipated funding needs after governments in Europe and the U.S. acted to prevent the collapse of six financial institutions in the past two weeks. The Libor-OIS spread, the difference between the three-month dollar rate and the overnight indexed swap rate, rose to 298 basis points today, before retreating to 291 basis points. It was at 129 basis points two weeks ago and 81 basis points a month ago.

The difference between what banks and the Treasury pay to borrow money for three months, the so-called TED spread, widened today to 393 basis points, the most since Bloomberg began compiling the data in 1984.

Failures of the TAF

The TAF did not spur bank to bank lending yet Bernanke keeps throwing more money at it as if it would do some good. It won't. I talked about Failures of the Term Auction Facility on April 10, 2008.

There is "no empirical evidence" the Term Auction Facility has reduced the premium that banks charge each other to lend cash for three months, Taylor, author of a monetary-policy formula cited as a benchmark by analysts, wrote in a research paper. San Francisco Fed economist John Williams co-wrote the study, which was posted on the San Francisco Fed's Web site yesterday.

The Fed's own website has a study showing why the TAF will not work but Bernanke keeps banging his head against a brick wall anyway. Bernanke might be advised to read the Fed's own report. Here is the conclusion.

In this paper we documented the unusually large spread between term Libor and overnight interest rates in the United States and other money markets beginning on August 9, 2007. We also introduced a financial model to adjust for expectations effects and to test for various explanations that have been offered to explain this unusual development.

The model has two implications. Fist is that counterparty risk is a key factor in explaining the spread between the Libor rate and the OIS rate, and second is that the TAF should not have an effect on the spread. Since the TAF does not affect total liquidity, expectations of future overnight rates, or counterparty risk, the model implies that it will not affect the spread. Our simple econometric tests support both of those implications of our model.

So What Does Bernanke Do?

Answer: Double the TAF to spur lending.

Gross Says Fed Should Buy Commercial Paper

Bill Gross is back at it with socialistic recommendations such as Fed Should Buy Commercial Paper.

Bill Gross, who manages the world's biggest bond fund, said the Federal Reserve should act as a clearinghouse to guarantee that transactions are completed and buy commercial paper to renew confidence in financial markets.

Credit markets are currently "frozen," Gross wrote in a note to clients published today on Newport Beach, California- based Pacific Investment Management Co.'s Web site. Without confidence in the markets, ``our economic center cannot hold.''

Rates on commercial paper, or short-term IOUs sold by companies, soared today and the interest banks charge each other for overnight dollar-denominated loans in London increased as banks remained reluctant to lend. Buying commercial paper would allow the Fed to make unsecured loans and encourage borrowing at rates beyond overnight levels.

Yields on overnight U.S. commercial paper jumped 94 basis points to 3.68 percent, according to data compiled by Bloomberg. Companies sell debt maturing in nine months or less to help pay for day-to-day expenses such as payroll and rent.

Fed To Pay Interest On Deposits; Considers Unsecured Funding

The $700+ Billion Bailout Bill contained a provision that allows the Fed to start paying member banks on required reserves and excess balances. Let's take a look at the Fed press release on deposits.

The Federal Reserve Board on Monday announced that it will begin to pay interest on depository institutions' required and excess reserve balances. The payment of interest on excess reserve balances will give the Federal Reserve greater scope to use its lending programs to address conditions in credit markets while also maintaining the federal funds rate close to the target established by the Federal Open Market Committee.

Consistent with this increased scope, the Federal Reserve also announced today additional actions to strengthen its support of term lending markets. Specifically, the Federal Reserve is substantially increasing the size of the Term Auction Facility (TAF) auctions, beginning with today’s auction of 84-day funds. These auctions allow depository institutions to borrow from the Federal Reserve for a fixed term against the same collateral that is accepted at the discount window; the rate is established in the auction, subject to a minimum set by the Federal Reserve.

In addition, the Federal Reserve and the Treasury Department are consulting with market participants on ways to provide additional support for term unsecured funding markets.

The interest rate paid on required reserve balances will be the average targeted federal funds rate established by the Federal Open Market Committee over each reserve maintenance period less 10 basis points. Paying interest on required reserve balances should essentially eliminate the opportunity cost of holding required reserves, promoting efficiency in the banking sector.

The rate paid on excess balances will be set initially as the lowest targeted federal funds rate for each reserve maintenance period less 75 basis points. Paying interest on excess balances should help to establish a lower bound on the federal funds rate. The formula for the interest rate on excess balances may be adjusted subsequently in light of experience and evolving market conditions. The payment of interest on excess reserves will permit the Federal Reserve to expand its balance sheet as necessary to provide the liquidity necessary to support financial stability while implementing the monetary policy that is appropriate in light of the System’s macroeconomic objectives of maximum employment and price stability.

Bernanke wanted the provision to pay interest on reserves because it allows him to print at will without affecting the Fed Funds Rate, at least in theory.

Fed, Treasury mulling commercial paper support

Reuters is reporting Fed, Treasury mulling commercial paper support.

The U.S. Treasury Department and the Federal Reserve are considering additional steps to support strained commercial paper markets, a source familiar with the discussions said on Monday.

Among steps under consideration would be funding a special purpose vehicle as opposed to outright purchase of commercial paper, the source said. Strained commercial paper markets are seen as a major destabilizing force in financial markets.

"The Federal Reserve and the Treasury Department are consulting with market participants on ways to provide additional support for term unsecured funding markets," the statements said.

Aiding the commercial paper market may test the limits of the Fed's authority because of the possibility of losses. One way the government could get around that constraint would be for the Treasury to provide some buffer against losses, the source said.

Fed Wants To Sponsor Its Own SIV

In spite of the fact that Citigroup is sitting on $1 trillion in SIVs it does not know what to do with, the Fed wants to start its own SIV. Bear in mind the Fed has never in history made unsecured loans, the Fed has no authority to do so, and Congress just authorized $700 billion to buy mortgages purportedly to bail out housing. Yet remarkably, the Fed is considering making unsecured lending.

Bernanke Theories All Failing

• The Term Auction Facility (TAF) is not working to increase bank to bank lending.
• The Primary Dealer Credit Facility (PDCF) was supposed to prevent more dealers from blowing up. Yet, Lehman went bankrupt anyway and Merrill Lynch had to merge with Bank of America to avoid collapse.
• Slashing interest rates to 2% did not prevent a recession.
• The ABCP MMMF Liquidity Facility may have stopped a run on money markets but it has not done anything to restore confidence in in the ABCP market itself.

Keynesian theory suggests the Fed is in a dreaded "liquidity trap". The reality is there is no such thing as a "liquidity trap", at least in Austrian economic terms. There is no trap, because it is impossible to prevent the liquidation of credit boom malinvestments.

Purging of bad debts must take place before a lasting recovery can begin. The mistake the Fed is making is attempting to force liquidity down the throat of a market that does not need it and cannot use it.

Why Aren't Banks Lending?

• Banks do not have money to lend
• Consumers who want to borrow are not credit worthy
• Consumer spending is 75% of the economy and consumers are tapped out.
• Unemployment is rising
• There is rampant over capacity in every sector but energy
• Banks do not trust each other
  
• Cancellation of mark to market accounting heightens that sense of mistrust
  

The problem is not a failure to lend, the main problem is there simply is no pool of real savings to lend. Furthermore, given rampant overcapacity and rising unemployment, there is no reason to lend even if the funding was available.

Robbing taxpayers to the tune of $700 billion does not change the equation.

With that backdrop it's no wonder Bernanke's attempts to free up the credit markets are having the effect of pushing on a string. Should the Fed actually stimulate lending, more money will end up in money heaven as a consequence.

Academic Wonderland

The credit markets are choking on credit, yet Bernanke is attempting to force more credit down everyone's throats. Logic dictates the solution cannot be the same as the problem.

Trapped in academic wonderland, such simple logic is far too complex for Bernanke to understand. Sadly, we are all forced to watch Bernanke flop about like a fish out of water attempting to solve a solvency problem with ridiculous liquidity schemes like the TAF, PDCF, TSLF, TARP, and the ABCPMMMFLF.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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Global Carnage In Pictures

I talked about the Sea of Red except for gold an government bonds earlier today in Treasuries and Gold Rise as Global Credit Freeze Prompts More Bailouts.

Here is a look at today's carnage in chart form.

Index Futures



Energy Futures



Grain Futures



Softs Futures



Metals Futures



Meat And Dairy Futures



Currency Futures



Financial Futures



Government bonds, interest rate futures, and gold are in rally mode. Everything else is getting hammered. Let's look a bit closer at Government Bonds.

US Treasuries



click on chart for sharper image

UK Government Bonds



click on chart for sharper image

German Government Bonds



click on chart for sharper image

Future Tables are Courtesy of Barchart Commodities.
Government Bonds are Courtesy of Bloomberg.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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Treasuries and Gold Rise as Global Credit Freeze Prompts More Bailouts

In a sea of red, government bonds and are gold both rising as the world's banking system cracks under the weight of the biggest debt expansion in history.

Credit Freeze Prompts New Bailouts

Bloomberg is reporting Government Bonds Rise as Credit Freeze Prompts New Bailouts.

Government bonds around the world rose as stocks tumbled and the freeze in credit markets prompted new bailouts of Hypo Real Estate Holding AG and Fortis, stoking demand for the safest assets.

U.S. Treasuries climbed for a fourth day, sending two-year notes to their longest winning streak in six weeks, and gains for German two-year notes drove yields to their lowest levels since March. Japanese 10-year bonds advanced for a second day, pushing yields down to the lowest level since April.

Investors are piling into government bonds on concern the bailouts will fail to stem further bank failures, driving the world's biggest economies into a recession. At the same time, the short-term debt markets that provide financing to the global economy have frozen. The Libor-OIS spread, a gauge of the scarcity of cash among banks, widened to a record today.

The prospect of a global economic slump has caused investors to raise bets the biggest central banks will cut interest rates. Futures on the Chicago Board of Trade show a 60 percent probability the Fed will slash its benchmark interest rate by a half-percentage point at its Oct. 29 meeting. The odds were zero a month ago. The chances of the European Central Bank reducing its main refinancing rate next month are 100 percent, up from 21.5 percent a week ago, according to a Credit Suisse Group index of derivatives.

Inflation expectations as measured by the difference in yield between regular bonds and index-linked bonds fell around the world, giving added cause for policy makers to cut borrowing costs.

Banking Crisis In Europe Widens

For more on the European banking crisis and how it is affecting the US dollar, please see Pound and Euro Sink in European Bank Crisis.

Deflation Models

In Treasury Bull Alive And Kicking I presented my model of how I see things. Here is a small snip:

Deflation Models

I had several models for how deflation might play out. Here they are.

1. Everything but treasuries sink
2. Everything but treasuries and gold sink
3. Gold sells off initially then rallies with treasuries

Yes, this treasury bull is extremely long in the tooth. And yes there will be a time to short treasuries. But there has not been a bull market in history, in anything, that ended with that asset class being nearly universally despised.

And make no mistake about it, treasuries are despised. Foreign central banks do not count because they are not buying treasuries to make a profit, and they are relatively unconcerned about losses.

All things considered there is genuine pent up demand for treasuries right here in the US should foreign buying subside. The reason is simple. It is far better to make 3% in treasuries than to lose 30% in equities, commodities, or corporate bonds.

Potential For Deflationary Crash

At this juncture the markets are definitely in a potential deflationary crash mode. And as stated above, I believe the Fed is essentially powerless to do anything about it. The Fed cannot possibly bail out every bank, brokerage, airline, and automotive company that is in dire straits. They cannot force sovereign wealth funds to do so either.

Sun Sets On Bretton Woods II

The sun is finally setting on Bretton Woods II dollar hegemony as noted in French President Nicolas Sarkozy Calls For "New World".

Trillions of dollars have been borrowed that cannot be paid back, and what cannot be paid back will be defaulted on. Government bonds will not default, and of course gold being no one's liability, will not default either.

Global Credit Boom Goes Bust

Gold is in the green, and the U.S. dollar is soaring along with treasuries. Those are about the only things on my screen that are in the green. Global equities, corporate bonds, and commodities in general are getting hammered. This is entirely consistent with the deflation thesis I have been talking about for a long time.

The global credit boom has gone bust as all credit booms do, and there is nothing the Bernanke Fed or any other Central Bank can do about it (except of course, make matters worse). The Fed itself is the problem and should be abolished. Instead, Congress is giving the Fed more powers exactly as predicted by the Fed Uncertainty Principle on April 3, 2008.

Uncertainty Principle Corollary Number Two: The government/quasi-government body most responsible for creating this mess (the Fed), will attempt a big power grab, purportedly to fix whatever problems it creates. The bigger the mess it creates, the more power it will attempt to grab. Over time this leads to dangerously concentrated power into the hands of those who have already proven they do not know what they are doing.

If you have not yet read the Fed Uncertainty Principle, please do so.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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French President Nicolas Sarkozy Calls For "New World"

Bloomberg is reporting European Crisis Deepens; Officials Vow to Save Banks.

The global credit crunch deepened in Europe as government leaders pledged to bail out troubled banks and protect depositors.

BNP Paribas SA will take control of Fortis's units in Belgium and Luxembourg after government efforts to ensure the company's stability failed, while Germany's government and financial institutions agreed on a 50 billion euro ($68 billion) rescue package for Hypo Real Estate Holding AG. U.K. Chancellor of the Exchequer Alistair Darling said Britain is "ready to do whatever it takes" to help its banks.

The developments yesterday came a day after a summit in Paris where leaders of Europe's four biggest economies stopped short of a plan mirroring the $700 billion rescue in the U.S. to counter the worst financial crisis since World War II. Instead, they agreed to work together to limit the economic fallout, ease accounting rules, and seek tougher financial regulations.

"Until now the solutions have appeared to be uncoordinated, so perhaps it's time for a more coordinated approach globally," said Torsten Slok, an economist at Deutsche Bank AG in New York. "It's not just the U.S. and Europe, it's banks in every part of the world."

French President Nicolas Sarkozy, who convened the Oct. 4 meeting, called for a global summit "as soon as possible" to implement "a real and complete reform of the international financial system." He said "all actors" must be supervised, including credit-rating firms and hedge funds. Executive-pay systems must also be reviewed, he said.

"We want a new world to come out of this," Sarkozy said. "We want to set up the basis for a capitalism of entrepreneurs, not speculators."

States, Corporate Borrowing Are The Next Crisis

Bernanke is in for pure hell. Banks and brokers are blowing up, unemployment is soaring, and states like California and Massachusetts are so cash strapped they may need to borrow from the Fed just to make day to day bills.

Bloomberg is reporting Fed May See Lending to Companies, States as Next Crisis Fronts

Federal Reserve Chairman Ben S. Bernanke may find the next fronts of the financial crisis to be just as chilling as last month's downfall of Wall Street titans: its spread to corporate America and state and local governments.

Duke Energy, the owner of utilities in five U.S. states, last week tapped about $1 billion from a $3.2 billion credit agreement after concluding it may not be able to meet its plan for new financing. Caterpillar, the biggest maker of earthmoving equipment, had to pay the biggest premiums over Treasuries in at least three decades at a sale of five-year and 10-year notes.

Lending between banks is also seizing up. The gap between the three-month London interbank offered rate and the overnight indexed swap rate, a gauge of cash scarcity among banks, climbed to a record 2.80 percentage points three days ago.

State and local governments having trouble meeting cash needs may push for help. Schwarzenegger told Paulson in an Oct. 2 letter that California and other states "may be forced to turn to the federal Treasury for short-term financing" if the crisis doesn't ease.

Cash & Carry Economy

The WSJ is reporting Paulson to Tap Adviser to Run Rescue Program

Treasury Secretary Henry Paulson is expected to tap Neel Kashkari, a key adviser on whom he has come to rely heavily during the financial crisis, to oversee Treasury's $700 billion program to buy distressed assets from financial institutions, according to people familiar with the matter.

Mr. Kashkari, 35 years old, a Treasury assistant secretary for international affairs and a former Goldman Sachs Group Inc. banker, is expected to be named interim head of Treasury's new Office of Financial Stability as early as Monday.

It's quite fitting that Kashkari sounds like Cash & Carry.

Sun Is Setting On US Dollar Supremacy

The end of US dollar's supremacy as the world's reserve currency is finally approaching. How long it takes to play out is anyone's guess.

What central bankers need to do is abolish fractional reserve lending and ideally return to currencies backed by hard assets. Unfortunately, the most likely short term action by central bankers is to try and force liquidity into the system to spur more lending.

Such actions cannot and will not work because the problem is too much lending already, evidenced by rampant overcapacity in housing, in commercial real estate, in restaurants, and nearly everywhere one looks except in the energy arena.

The biggest global credit boom in history is now over. We must now pay the consequences whether Bernanke or anyone else likes it or not. Attempts to force more liquidity into the system will only make matters worse.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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