To Have and To Hold: Why a Bailout Would Weaken the Dollar

From the I'm not sayin' I'm just sayin'  file: a quick word in case we all get a reminder over the next few days about how trading curbs and circuitbreakers work....

The news about Fannie (FNM) and Freddie (FRE) has kicked up a notch obviously and we have a potentially long two days of just waiting.

The market action of the last many months has been a normal bear market process--scary news, various moves downward, a feel-good rally and so on. If there is a violent move down, i.e. a crash, well, first, it can't be 20% in a day because the market will close before that happens. The modern day equivalent of 20% in a day might be 20% over two or three days.

Panics snap back. This is a just how the market works type of thing. A panic and snap-back can occur in a bull market (like 1997 Asian contagion or the 1998 LTCM/Russian debt default) or in a bear market like last January in le affair du Kerviel (hey, I took Spanish in school).

If we were to see a big panic I would close out my double short position as I did in January. At this point I do not know if after closing ProShares UltraShort S&P500 (SDS) out I would get more long right away, which I did not do in January, or when I would buy SDS back (on the Kerviel trade I bought it back later that week) but the point is I have the first step of a plan in place before anything happens. The rest depends on what the market were to give in that scenario.

A plan could include doing nothing, depending on the appropriate thing for an individual. But deciding ahead of time that "since selling is not right for me, I will not panic along with the market" is a valid course of action.

A reader asked a followup question about why I think a bailout of Fannie and Freddie would weaken the dollar. Not to get too jargonny or sophisticated, LOL, but one problem with the dollar is no one wants to hold it.

Plenty of places have to hold the dollar but they don't want to. I saw one thing early today, maybe from Yves, that opined that bailing out the GSEs would double the US debt. I don't know if that is accurate but obviously the US debt load would skyrocket. Further indebtedness (we are talking a lot more than Dr. Evil kind of money), everything else being equal, is bad for a currency.

This leads to another comment I made yesterday (far from an original thought I might add): At what point does the dollar get defended by anyone? I don't know as I'd have liked to have thought it might have started by now. At some point interest rates should go up, this is how markets work--of course this sentiment has been wrong for a while.

All of this creates the environment I have been writing about for ages, which is weaker growth and higher rates. This is not apocalyptic but it makes the case for the US being a less attractive investment destination than other countries, as has been the case for most of the ' Naughties, or if you prefer, the 'Oughts.

Comments

[User 118015]

At this junction the only way to defend the dollar is to increase interest rates to the point where they are (real inflation % rate) plus 3%. All attempts to bail out institutions just result in more money growth beyond the uninhibited spending spree the government is on. As I think about this bail out its just one more reason we are now in the Age of Financial Discontinuity. What the Fed is doing and going to do is just going to come back and bite us.
I try to look at the big picture and this is just part of a ongoing saga of self destruction. After we go thru the coming DEPRESSION perhaps some linear analysis can take place. Meanwhile keep you cash close to home out of the stock and bond market. You haven't seen anything yet IMHO.

[User 118015]

Incidently the money growth I'm talking about is M3 not M1. M1 money would do some good but in order to get that we need more jobs and less taxes and lower oil and and and and and and...you get the idea.

[blacksilver]

inflation plus 3% would put cds at about 10% not bad

[iThinkBig]

It's interesting. I hear now of all the budget battles being fought at the state and local level. In New England for example, there are being wars waged between political lines to choose between funding health care for impovershed families and subsidizing heating oil. Many people I know whom do not understand economics or refused to listen last June when I told them what was coming do not know how they are going to heat there homes. Even a New Hampshire legislator I know got a $700 home heating oil bill this month, never mind the double usage effect, cost which will occur in November-March. This bill will be larger then many people's mortgages up here.

The bill is now due as you mention user118 about Financial Discontinuity. Nationalizing real estate market means continued mismanagement including theft, scandal and failures, all paid by the taxpayer. The true tax bill would be seen in increases in 2011. Not coincidentally, back in June 2007 this was the year I pegged for Depression. My work was spurned on when I noticed the big money guys liquidating there real-estate holdings while telling the nation that there was only a 25% chance of recession due to housing. I am a student of the Great Depression and here we are again. My numbers in 2007 did not factor in $145 spot price on oil either, it was based on $120. But does Washington respond? No, they need the taxes from gasoline to offset there insane fiscal/energy and foreign policies these last 15 years (although after 911 some of this rampant spending could not be prevented).

What is so much more frustrating about understanding history is that the irresponsible at large are being temporarily bailed out at my expense from the banks to the speculative consumer in real-estate but ultimately responsibility in policy-making resides in Washington.

First -Banks used the liquidity short-term borrowing window to blow up the commodities market to offset there failures in subprime and then add indirect taxation without representation by the Fed through inflation (devalued currency, low rates and further lending to banking parasites). We are beyond moral hazard and into Revolution territory but such will not be seriously considered by the masses for a couple of years as cumulative downward deflation occurs, wages also DECLINE and the common man has all day to sit at his computer and figure it all out. Washington has much to answer for and in particular, the Socialist party of America. As a data guy, I am keeping names this time, as the stupid masses should pinpoint there assult on particular criminals, not overun Washington in there anger when the house of cards falls. That I feel that I must do this at all is beyond disturbing to me as is feeling the need to prepare physically. We'll rebuild and move on but I was beyond pissed off for almost a year but glad I delved deep into the truth.

[Reinko]

To user 118015:

Did you know that the US Federal Reserve stopped publishing the M3 money growth? Here is the link in the H6 release:

www.federalreserve.gov.../

It is always funny to observe that when the ECB publishes her M3 money growth, there are always some Americans shouting that the dollar should go up because the Europeans have such tremendous large M3 money growth.

To understand how terribly far the Federal Reserve has gone from just normal economical reasoning let me quote the reason for stopping M3 money growth publications, quote from the link above:

M3 does not appear to convey any additional information about economic activity that is not already embodied in M2 and has not played a role in the monetary policy process for many years. Consequently, the Board judged that the costs of collecting the underlying data and publishing M3 outweigh the benefits.

Needless to say: This was under the Alan Greenspan watch of the FED... Ever in your life seen such a bunch of fools?

[phinsuntanning]

if you still own some american green pesos get some DUG and enjoy the rik of be alive, my friend, your spanish is not working, your SDS do
but slowly thanks to Zimbabwe Ben.

[bbzz24]

another bailout just will reinforce the notion that all GSEs are in fact scams: sooner or later they enter insolvency and have to be bailed out. given that dangerous path what returns have to be expected? indeed there is no default premium for government debt, but i dont see any adequate dillution premium in the debt markets either. M3 is at about 19% yoy according to shadowstats. i doubt the new stimuli of late have been fully accounted yet. but dont forget that much of that money is withdrawn and 'invested' in governemnt debt by china/japan at -15% real return.

[BS Detector]

"Further indebtedness, everything else being equal, is bad for a currency."

But it's not equal. The debt run up over the last eight years, for example, has bought us very little in terms of real assets. The $5T of debt that FNM and FRE insure (note, they insure it, they don't hold $3.5T of it) comes with something close to $5T of real property. So while nationalizing FNM and FRE would add a huge amount of gross debt, it would add a very small percentage of net debt to the "balance sheet" of the U.S.

By the way, 99% of the mortgages backed by FNM and FRE are current. So while there is $5.2T of liabilities, actual bad mortgages are exceedingly unlikely to exceed 5% of that, or $250B. And in the worst-case scenario, the underlying property will likely be worth (out of my orifice number) 60% of the mortgage value, so the MAXIMUM loss from FNM and FRE won't exceed $100B.

The national debt, including that held by trust funds, stands at $9.5T. So the worst case scenario would add just 1% to the national debt.

The sky is not falling.

[BS Detector]

"one problem with the dollar is no one wants to hold it."

Um... huh?

Last time I looked, the currency markets seemed to be pretty liquid. There were trades going on, and surprise surprise, for every seller THERE WAS A BUYER.

[AmesTiedeman]

Of course these bailouts would weaken the dollar. We may end up with no choice, however.